UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________to _________

Commission file number 001-13106

ESSEX PROPERTY TRUST, INC.
ESSEX PORTFOLIO, L.P.
(Exact name of Registrant as Specified in its Charter)

Maryland (Essex Property Trust, Inc.)
 
77-0369576 (Essex Property Trust, Inc.)
California (Essex Portfolio, L.P.)
 
77-0369575 (Essex Portfolio, L.P.)
  (State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification Number)

925 East Meadow Drive
Palo Alto, California    94303
(Address of Principal Executive Offices including Zip Code)

(650) 494-3700
(Registrant's Telephone Number, Including Area Code)
 
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 reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Essex Property Trust, Inc.    Yes x   No o
Essex Portfolio, L.P.     Yes x   No o
                                                                                                                     
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Essex Property Trust, Inc.    Yes x   No o
Essex Portfolio, L.P.     Yes x   No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” ”accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Essex Property Trust, Inc.:
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o  
(Do not check if a smaller reporting company)
Smaller reporting company o

Essex Portfolio, L.P.:
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x  
(Do not check if a smaller reporting company)
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Essex Property Trust, Inc.    Yes o   No x
Essex Portfolio, L.P.     Yes o   No x
 
 APPLICABLE ONLY TO CORPORATE ISSUERS:
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:  63,485,469 shares of Common Stock ($0.0001 par value) of Essex Property Trust, Inc. were outstanding as of August 8, 2014.

ii
EXPLANATORY NOTE

This report combines the reports on Form 10-Q for the three month period ended June 30, 2014 of Essex Property Trust, Inc. and Essex Portfolio, L.P. Unless stated otherwise or the context otherwise requires, references to “Essex” mean Essex Property Trust, Inc., a Maryland corporation that operates as a self-administered and self-managed real estate investment trust (“REIT ”), and references to “EPLP” mean Essex Portfolio, L.P. (the “Operating Partnership” ). References to the “Company,” “we,” “us” or “our” mean collectively Essex, EPLP and those entities/subsidiaries owned or controlled by Essex and/or EPLP.  References to the “Operating Partnership” mean collectively EPLP and those entities/subsidiaries owned or controlled by EPLP.

Essex is the general partner of  EPLP and as the sole general partner of EPLP, Essex has exclusive control of EPLP's day-to-day management.

The Company is structured as an umbrella partnership REIT (“UPREIT”) and Essex contributes all net proceeds from its various equity offerings to the Operating Partnership. In return for those contributions, Essex receives a number of OP Units (see definition below) in the Operating Partnership equal to the number of shares of common stock it has issued in the equity offering.  Contributions of properties to the Company can be structured as tax-deferred transactions through the issuance of OP Units in the Operating Partnership, which is one of the reasons why the Company is structured in the manner outlined above. Based on the terms of EPLP's partnership agreement, OP Units can be exchanged with Essex common stock on a one-for-one basis. The Company maintains a one-for-one relationship between the OP Units of the Operating Partnership issued to Essex and shares of common stock.

The Company believes that combining the reports on Form 10-Q of Essex and EPLP into this single report provides the following benefits:

 
·
enhances investors' understanding of the Company and the Operating Partnership by enabling investors to view the business as a whole in the same manner as management views and operates the business;
 
·
eliminates duplicative disclosure and provides a more streamlined and readable presentation since a substantial portion of the disclosure applies to both the Company and the Operating Partnership; and
 
·
creates time and cost efficiencies through the preparation of one combined report instead of two separate reports

Management operates the Company and the Operating Partnership as one business. The management of Essex consists of the same members as the management of EPLP.

All of the Company's property ownership, development and related business operations are conducted through the Operating Partnership and Essex has no material assets, other than its investment in EPLP. Essex's primary function is acting as the general partner of EPLP.  As general partner with control of the Operating Partnership, the Company consolidates the Operating Partnership for financial reporting purposes. Therefore, the assets and liabilities of the Company and the Operating Partnership are the same on their respective financial statements.  Essex also issues equity from time to time and guarantees certain debt of EPLP, as disclosed in this report. The Operating Partnership holds substantially all of the assets of the Company, including the Company's ownership interests in its joint ventures. The Operating Partnership conducts the operations of the business and is structured as a partnership with no publicly traded equity.  Except for the net proceeds from equity offerings by the Company, which are contributed to the capital of the Operating Partnership in exchange for additional limited partnership interests in the Operating Partnership (“OP Units”) (on a one-for-one share of common stock per OP Unit basis), the Operating Partnership generates all remaining capital required by the Company's business. These sources include the Operating Partnership's working capital, net cash provided by operating activities, borrowings under its revolving credit facilities, the issuance of secured and unsecured debt and equity securities and proceeds received from disposition of certain properties and joint ventures.

The Company believes it is important to understand the few differences between Essex and EPLP in the context of how Essex and EPLP operate as a consolidated company.  Stockholders' equity, partners' capital and noncontrolling interest are the main areas of difference between the consolidated financial statements of the Company and those of the Operating Partnership. The limited partners of the Operating Partnership are accounted for as partners' capital in the Operating Partnership's consolidated financial statements and as noncontrolling interest in Essex’s consolidated financial statements. The noncontrolling interest in the Operating Partnership's consolidated financial statements include the interest of unaffiliated partners in various consolidated partnerships and joint venture partners. The noncontrolling interest in the Company's  consolidated financial statements include (i) the same noncontrolling interest as presented in the Operating Partnership’s consolidated financial statements and (ii) limited partner OP Unitholders of the Operating Partnership. The differences between stockholders' equity and partners' capital result from differences in the equity issued at the Company and Operating Partnership levels.
iii
To help investors understand the significant differences between the Company and the Operating Partnership, this report provides separate consolidated financial statements for the Company and the Operating Partnership; a single set of consolidated notes to such financial statements that includes separate discussions of stockholders' equity or partners' capital, and earnings per share/unit, as applicable; and a combined Management's Discussion and Analysis of Financial Condition and Results of Operations.

This report also includes separate Part I, Item 4. Controls and Procedures sections and separate Exhibits 31 and 32 certifications for each of the Company and the Operating Partnership in order to establish that the requisite certifications have been made and that the Company and the Operating Partnership are compliant with Rule 13a-15 or Rule 15d-15 of the Securities Exchange Act of 1934 and 18 U.S.C. §1350.

In order to highlight the differences between the Company and the Operating Partnership, the separate sections in this report for the Company and the Operating Partnership specifically refer to the Company and the Operating Partnership. In the sections that combine disclosure of the Company and the Operating Partnership, this report refers to actions or holdings as being actions or holdings of the Company. Although the Operating Partnership is generally the entity that directly or indirectly enters into contracts and joint ventures and holds assets and debt, reference to the Company is appropriate because the Company is one business and the Company operates that business through the Operating Partnership. The separate discussions of the Company and the Operating Partnership in this report should be read in conjunction with each other to understand the results of the Company on a consolidated basis and how management operates the Company.

The information furnished in the accompanying unaudited condensed consolidated balance sheets, statements of operations and comprehensive income, equity, capital, and cash flows of the Company and the Operating Partnership reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the aforementioned condensed consolidated financial statements for the interim periods and are normal and recurring in nature, except as otherwise noted.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the notes to such unaudited condensed consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations herein.  Additionally, 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, 2013.
iv
ESSEX PROPERTY TRUST, INC.
ESSEX PORTFOLIO, L.P.
FORM 10-Q
INDEX

 
 
Page No.
PART I. FINANCIAL INFORMATION
 
 
Item 1.
Condensed Financial Statements of Essex Property Trust, Inc. (Unaudited)
 
 
 
 
 
2
 
 
 
 
3
 
 
 
 
4
 
 
 
 
5
 
 
Condensed Financial Statements of Essex Portfolio L.P. (Unaudited)
 
 
7
 
 
8
 
 
9
 
 
10
 
 
12
 
Item 2.
27
 
 
 
Item 3.
38
 
 
 
Item 4.
39
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
Item 1.
40
 
 
 
Item 1A.
40
 
 
 
Item 2.
40
 
 
 
Item 6.
41
 
 
 
43

1
Part I – Financial Information

Item 1.
Condensed Financial Statements

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited)
(Dollars in thousands, except share amounts)

Assets
  
June 30,
2014
    
December 31,
2013
  
Real estate:
  
   
 
Rental properties:
  
   
 
Land and land improvements
  
$
2,354,585
    
$
1,083,552
  
Buildings and improvements
    
8,517,728
      
4,360,205
  
 
                
 
    
10,872,313
      
5,443,757
  
Less accumulated depreciation
    
(1,384,726
)
    
(1,254,886
)
 
                
 
    
9,487,587
      
4,188,871
  
Real estate under development
    
422,372
      
50,430
  
Co-investments
    
964,970
      
677,133
  
Real estate held for sale, net
    
107,772
      
-
  
 
    
10,982,701
      
4,916,434
  
Cash and cash equivalents-unrestricted
    
17,946
      
18,491
  
Cash and cash equivalents-restricted
    
29,592
      
35,275
  
Marketable securities
    
106,358
      
90,084
  
Notes and other receivables
    
66,522
      
68,255
  
Acquired in place lease value and other assets
    
113,398
      
33,781
  
Deferred charges, net
    
31,846
      
24,519
  
 
                
Total assets
  
$
11,348,363
    
$
5,186,839
  
 
                
Liabilities and  Equity
                
Mortgage notes payable
  
$
2,250,510
    
$
1,404,080
  
Unsecured debt
    
2,748,494
      
1,410,023
  
Lines of credit
    
66,975
      
219,421
  
Accounts payable and accrued liabilities
    
132,424
      
67,183
  
Construction payable
    
34,701
      
8,047
  
Dividends payable
    
86,615
      
50,627
  
Other liabilities
    
32,896
      
24,871
  
 
    
 
          
Total liabilities
    
5,352,615
      
3,184,252
  
Commitments and contingencies
                
Redeemable noncontrolling interest
    
23,566
      
-
  
Cumulative convertible Series G preferred stock
    
-
      
4,349
  
 
                
Equity:
                
Cumulative redeemable Series H preferred stock at liquidation value
    
73,750
      
73,750
  
Common stock, $.0001 par value, 656,020,000 shares authorized 62,301,305 and 37,421,219 shares issued and outstanding
    
6
      
4
  
Additional paid-in capital
    
6,414,258
      
2,345,763
  
Distributions in excess of accumulated earnings
    
(575,772
)
    
(474,426
)
Accumulated other comprehensive loss, net
    
(53,794
)
    
(60,472
)
 
                
Total stockholders' equity
    
5,858,448
      
1,884,619
  
Noncontrolling interest
    
113,734
      
113,619
  
 
                
Total equity
    
5,972,182
      
1,998,238
  
 
                
Total liabilities and equity
  
$
11,348,363
    
$
5,186,839
  

See accompanying notes to the unaudited condensed consolidated financial statements.
2
ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations and Comprehensive Income
(Unaudited)
(Dollars in thousands, except share and per share amounts)

 
  
Three Months Ended
June 30,
    
Six Months Ended
June 30,
  
 
  
2014
    
2013
    
2014
    
2013
  
Revenues:
  
   
   
   
 
Rental and other property
  
$
256,614
    
$
148,781
    
$
415,631
    
$
293,839
  
Management and other fees
    
2,836
      
2,034
      
4,495
      
4,041
  
 
    
259,450
      
150,815
      
420,126
      
297,880
  
Expenses:
                                
Property operating, excluding real estate taxes
    
52,875
      
34,131
      
89,508
      
66,385
  
Real estate taxes
    
30,345
      
14,165
      
45,684
      
28,238
  
Depreciation
    
97,510
      
47,673
      
147,822
      
94,459
  
General and administrative
    
9,558
      
6,589
      
17,142
      
13,588
  
Merger expenses
    
26,497
      
-
      
42,556
      
-
  
Acquisition and dispositions costs
    
529
      
168
      
1,504
      
555
  
 
    
217,314
      
102,726
      
344,216
      
203,225
  
 
                                
Earnings from operations
    
42,136
      
48,089
      
75,910
      
94,655
  
 
                                
Interest expense
    
(42,151
)
    
(29,327
)
    
(71,192
)
    
(57,468
)
Interest and other income
    
2,814
      
1,917
      
5,693
      
6,939
  
Equity income in co-investments
    
5,629
      
7,282
      
16,155
      
11,493
  
Gain on early retirement of debt
    
-
      
1,024
      
-
      
1,024
  
Gains on sale of real estate and land
    
-
      
-
      
8,268
      
1,503
  
Income from continuing operations
    
8,428
      
28,985
      
34,834
      
58,146
  
Income from discontinued operations
    
-
      
590
      
-
      
1,132
  
Net income
    
8,428
      
29,575
      
34,834
      
59,278
  
Net income attributable to noncontrolling interest
    
(2,125
)
    
(3,261
)
    
(5,251
)
    
(6,393
)
Net income attributable to controlling interest
    
6,303
      
26,314
      
29,583
      
52,885
  
Dividends to preferred stockholders
    
(1,314
)
    
(1,368
)
    
(2,682
)
    
(2,736
)
Net income available to common stockholders
  
$
4,989
    
$
24,946
    
$
26,901
    
$
50,149
  
 
                                
Comprehensive income
  
$
11,088
    
$
35,355
    
$
41,817
    
$
66,094
  
Comprehensive income attributable to noncontrolling interest
    
(2,184
)
    
(3,574
)
    
(4,856
)
    
(6,761
)
Comprehensive income attributable to controlling interest
  
$
8,904
    
$
31,781
    
$
36,961
    
$
59,333
  
 
                                
Per common share data:
                                
Basic:
                                
Income from continuing operations
  
$
0.08
    
$
0.65
    
$
0.54
    
$
1.32
  
Income from discontinued operations
    
-
      
0.02
      
-
      
0.03
  
Net income available to common stockholders.
  
$
0.08
    
$
0.67
    
$
0.54
    
$
1.35
  
Weighted average number of common shares outstanding during the period
    
61,884,963
      
37,292,720
      
49,857,233
      
37,149,120
  
 
                                
Diluted:
                                
Income from continuing operations
  
$
0.08
    
$
0.65
    
$
0.54
    
$
1.32
  
Income from discontinued operations
    
-
      
0.02
      
-
      
0.03
  
Net income available to common stockholders
  
$
0.08
    
$
0.67
    
$
0.54
    
$
1.35
  
Weighted average number of common shares outstanding during the period
    
62,059,762
      
37,390,987
      
50,087,161
      
37,241,968
  
 
                                
Dividend per common share
  
$
1.30
    
$
1.21
    
$
2.51
    
$
2.42
  

See accompanying notes to the unaudited condensed consolidated financial statements.
3
ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Equity for the six months ended June 30, 2014
(Unaudited)
(Dollars and shares in thousands)

 
  
Series H
    
   
   
Additional
    
Distributions
in excess of
    
Accumulated
other
    
   
 
 
  
Preferred stock
    
Common stock
    
paid-in
    
accumulated
    
comprehensive
    
Noncontrolling
    
 
 
  
Shares
    
Amount
    
Shares
    
Amount
    
capital
    
earnings
    
loss, net
    
Interest
    
Total
  
Balances at December 31, 2013
    
2,950
    
$
73,750
      
37,421
    
$
4
    
$
2,345,763
    
$
(474,426
)
  
$
(60,472
)
  
$
113,619
    
$
1,998,238
  
Net income
    
-
      
-
      
-
      
-
      
-
      
29,583
      
-
      
5,251
      
34,834
  
Reversal of unrealized gains upon the sale  of marketable securities
    
-
      
-
      
-
      
-
      
-
      
-
      
(841
)
    
(45
)
    
(886
)
Change in fair value of derivatives and amortization of swap settlements
    
-
      
-
      
-
      
-
      
-
      
-
      
4,105
      
188
      
4,293
  
Change in fair value of marketable securities
    
-
      
-
      
-
      
-
      
-
      
-
      
3,414
      
162
      
3,576
  
Issuance of common stock under:
                                                                        
Stock Consideration in the Merger
    
-
      
-
      
23,093
      
2
      
3,777,644
      
-
      
-
      
-
      
3,777,646
  
Stock option and restricted stock plans
    
-
      
-
      
109
      
-
      
10,350
      
-
      
-
      
-
      
10,350
  
Equity distribution agreements
    
-
      
-
      
1,644
      
-
      
299,397
      
-
      
-
      
-
      
299,397
  
Equity based compensation costs
    
-
      
-
      
-
      
-
      
(1,126
)
    
-
      
-
      
1,266
      
140
  
Reclassification of noncontrolling interest to redeemable noncontrolling interest
    
-
      
-
      
-
      
-
      
(20,134
)
    
-
      
-
      
1,368
      
(18,766
)
Conversion of Series G preferred stock
    
-
      
-
      
34
      
-
      
4,349
      
-
      
-
      
-
      
4,349
  
Contributions from noncontrolling interest
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
1,419,816
      
1,419,816
  
Retirement of noncontrolling interest
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(1,419,816
)
    
(1,419,816
)
Distributions to noncontrolling interest
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(7,510
)
    
(7,510
)
Redemptions of noncontrolling interest
    
-
      
-
      
-
      
-
      
(1,985
)
    
-
      
-
      
(565
)
    
(2,550
)
Common and preferred stock dividends
    
-
      
-
      
-
      
-
      
-
      
(130,929
)
    
-
      
-
      
(130,929
)
Balances at June 30, 2014
    
2,950
    
$
73,750
      
62,301
    
$
6
    
$
6,414,258
    
$
(575,772
)
  
$
(53,794
)
  
$
113,734
    
$
5,972,182
  

See accompanying notes to the unaudited condensed consolidated financial statements.
4
ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)

 
  
Six Months Ended
June 30,
  
 
  
2014
    
2013
  
Cash flows from operating activities:
  
   
 
Net income
  
$
34,834
    
$
59,278
  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Gain on sale of marketable securities
    
(886
)
    
(1,767
)
Company's share of gain on the sales of co-investment
    
(3,213
)
    
(2,366
)
Gain on the sales of real estate and land
    
(8,268
)
    
(1,503
)
Gain on early retirement of debt
    
-
      
(1,024
)
Noncash merger expense
    
7,562
      
-
  
Co-investments, net
    
(10,719
)
    
(280
)
Amortization expense
    
(846
)
    
5,932
  
Amortization of discount on notes receivables
    
-
      
(844
)
Amortization of discount on marketable securities
    
(3,965
)
    
(2,776
)
Depreciation
    
147,822
      
95,175
  
Equity-based compensation
    
3,625
      
2,126
  
Changes in operating assets and liabilities:
                
Prepaid expenses and other assets
    
2,425
      
802
  
Accounts payable and accrued liabilities
    
10,086
      
(2,433
)
Other liabilities
    
665
      
266
  
Net cash provided by operating activities
    
179,122
      
150,586
  
Cash flows from investing activities:
                
Additions to real estate:
                
Acquisitions of real estate
    
(93,772
)
    
(175,950
)
Improvements to recent acquisitions
    
(6,148
)
    
(6,288
)
Redevelopment
    
(19,503
)
    
(17,616
)
Revenue generating capital expenditures
    
(11,967
)
    
(742
)
Lessor required capital expenditures.
    
(7,562
)
    
(3,557
)
Non-revenue generating capital expenditures
    
(15,048
)
    
(12,349
)
Acquisitions of and additions to real estate under development.
    
(58,899
)
    
(9,290
)
Advance from insurance claim
    
10,000
      
-
  
Dispositions of real estate
    
14,123
      
9,051
  
BRE merger cash consideration paid
    
(555,826
)
    
-
  
Changes in restricted cash and deposits.
    
(3,606
)
    
18,290
  
Purchases of marketable securities
    
(14,341
)
    
(14,002
)
Sales and maturities of marketable securities
    
5,192
      
20,335
  
Purchases of and advances under notes and other receivables
    
-
      
(99,164
)
Collections of notes and other receivables
    
56,750
      
53,438
  
Dispositions of co-investments
    
13,900
      
-
  
Contributions to co-investments
    
(58,029
)
    
(101,295
)
Distributions from co-investments
    
18,467
      
57,458
  
Net cash used in investing activities
    
(726,269
)
    
(281,681
)
Cash flows from financing activities:
                
Borrowings under debt agreements
    
1,321,044
      
604,472
  
Repayment of debt
    
(1,077,210
)
    
(495,072
)
Additions to deferred charges instruments
    
(16,401
)
    
(3,838
)
Equity related issuance cost
    
(1,093
)
    
(525
)
Net proceeds from stock options exercised
    
5,503
      
4,190
  
Net proceeds from issuance of common stock
    
279,427
      
122,905
  
Distributions to noncontrolling interest
    
(7,510
)
    
(9,811
)
Redemption of noncontrolling interest
    
(2,550
)
    
(2,017
)
Common and preferred stock dividends paid
    
(94,961
)
    
(87,598
)
Net cash provided by financing activities.
    
406,249
      
132,706
  
Net (decrease) increase in cash and cash equivalents
    
(140,898
)
    
1,611
  
Cash assumed in the BRE merger
    
140,353
      
-
  
Cash and cash equivalents at beginning of year
    
18,491
      
18,606
  
Cash and cash equivalents at end of period
  
$
17,946
    
$
20,217
  
 
(Continued)
5
ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)

  2014 2013
Supplemental disclosure of cash flow information:
  
   
 
Cash paid for interest, net of $11.7 million, and $8.1 million capitalized in 2014 and 2013, respectively
  
$
44,437
    
$
50,053
  
Supplemental disclosure of noncash investing and financing activities:
                
Issuance of Operating Partnership units for contributed properties
  
$
1,419,816
    
$
-
  
Retirement of Operating Partnership units
  
$
(1,419,816
)
    
-
  
Transfer from real estate under development to land and building
  
$
4,580
    
$
67
  
Transfer from real estate under development to co-investments
  
$
49,776
    
$
-
  
Mortgage notes assumed in connection with purchases of real estate including the loan premiums recorded.
  
$
49,009
    
$
-
  
Change in accrual of dividends
  
$
35,896
    
$
5,436
  
Change in fair value of derivative liabilities
  
$
122
    
$
4,820
  
Change in fair value of marketable securities
  
$
3,121
    
$
2,256
  
Change in construction payable
  
$
26,654
    
$
2,339
  
Accrued distribution from co-investment
  
$
19,836
    
$
-
  
Common stock proceeds receivable
  
$
19,970
    
$
-
  
Reclassification to redeemable noncontrolling interest from additional paid in capital and noncontrolling interest
  
$
18,766
    
$
-
  
 
                
Assets and liabilities assumed in BRE merger:
                
Cash assumed in merger
$
 140,353
$
-
Rental properties and real estate under development
  
$
5,613,031
    
$
-
  
Real estate held for sale, net
  
$
107,772
    
$
-
  
Co-investments
  
$
223,438
    
$
-
  
Acquired in-place lease value
  
$
80,358
    
$
-
  
Other assets
  
$
15,676
    
$
-
  
Mortgage notes payable and unsecured debt
  
$
1,747,382
    
$
-
  
Other liabilities
  
$
94,976
    
$
-
  
Redeemable noncontrolling interest
  
$
4,798
    
$
-
  
Equity consideration for BRE merger
  
$
3,777,646
    
$
-
  
 
See accompanying notes to the unaudited condensed consolidated financial statements
6
ESSEX PORTFOLIO, L.P.  AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited)
(Dollars in thousands, except unit amounts)

 
  
June 30,
2014
    
December 31,
2013
  
ASSETS
  
   
 
Real estate:
  
   
 
Rental properties:
  
   
 
Land and land improvements
  
$
2,354,585
    
$
1,083,552
  
Buildings and improvements
    
8,517,728
      
4,360,205
  
 
                
 
    
10,872,313
      
5,443,757
  
Less accumulated depreciation
    
(1,384,726
)
    
(1,254,886
)
 
                
 
    
9,487,587
      
4,188,871
  
Real estate under development
    
422,372
      
50,430
  
Co-investments
    
964,970
      
677,133
  
Real estate held for sale, net
    
107,772
      
-
  
 
    
10,982,701
      
4,916,434
  
Cash and cash equivalents-unrestricted
    
17,946
      
18,491
  
Cash and cash equivalents-restricted
    
29,592
      
35,275
  
Marketable securities
    
106,358
      
90,084
  
Notes and other receivables
    
66,522
      
68,255
  
Acquired in place lease value and other assets
    
113,398
      
33,781
  
Deferred charges, net
    
31,846
      
24,519
  
 
                
Total assets
  
$
11,348,363
    
$
5,186,839
  
 
                
LIABILITIES AND CAPITAL
                
Mortgage notes payable
  
$
2,250,510
    
$
1,404,080
  
Unsecured debt
    
2,748,494
      
1,410,023
  
Lines of credit
    
66,975
      
219,421
  
Accounts payable and accrued liabilities
    
132,424
      
67,183
  
Construction payable
    
34,701
      
8,047
  
Distributions payable
    
86,615
      
50,627
  
Other liabilities
    
32,896
      
24,871
  
 
                
Total liabilities
    
5,352,615
      
3,184,252
  
Commitments and contingencies
                
Redeemable noncontrolling interest
    
23,566
      
-
  
Cumulative convertible Series G preferred interest (liquidation value of $4,456)
    
-
      
4,349
  
Capital:
                
General Partner:
                
Common equity (62,301,305 and 37,421,219  units issued and outstanding at June 30, 2014 and December 31, 2013, respectively)
    
5,841,033
      
1,873,882
  
Series H Preferred interest (liquidation value of $73,750)
    
71,209
      
71,209
  
 
    
5,912,242
      
1,945,091
  
Limited Partners:
                
Common equity (2,171,422 and 2,149,802 units issued and outstanding at June 30, 2014 and December 31, 2013, respectively)
    
49,633
      
45,957
  
Accumulated other comprehensive loss
    
(51,957
)
    
(58,940
)
Total partners' capital
    
5,909,918
      
1,932,108
  
Noncontrolling interest
    
62,264
      
66,130
  
Total capital
    
5,972,182
      
1,998,238
  
 
                
Total liabilities and capital
  
$
11,348,363
    
$
5,186,839
  

See accompanying notes to the unaudited condensed consolidated financial statements
7
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations and Comprehensive Income
(Unaudited)
(Dollars in thousands, except unit and per unit amounts)

 
  
Three Months Ended
June 30,
    
Six Months Ended
June 30,
  
 
  
2014
    
2013
    
2014
    
2013
  
Revenues:
  
   
   
   
 
Rental and other property
  
$
256,614
    
$
148,781
    
$
415,631
    
$
293,839
  
Management and other fees
    
2,836
      
2,034
      
4,495
      
4,041
  
 
    
259,450
      
150,815
      
420,126
      
297,880
  
Expenses:
                                
Property operating, excluding real estate taxes
    
52,875
      
34,131
      
89,508
      
66,385
  
Real estate taxes
    
30,345
      
14,165
      
45,684
      
28,238
  
Depreciation
    
97,510
      
47,673
      
147,822
      
94,459
  
General and administrative
    
9,558
      
6,589
      
17,142
      
13,588
  
Merger expenses
    
26,497
      
-
      
42,556
      
-
  
Acquisition and dispositions costs
    
529
      
168
      
1,504
      
555
  
 
    
217,314
      
102,726
      
344,216
      
203,225
  
 
                                
Earnings from operations
    
42,136
      
48,089
      
75,910
      
94,655
  
 
                                
Interest expense
    
(42,151
)
    
(29,327
)
    
(71,192
)
    
(57,468
)
Interest and other income
    
2,814
      
1,917
      
5,693
      
6,939
  
Equity income in co-investments
    
5,629
      
7,282
      
16,155
      
11,493
  
Gain on early retirement of debt
    
-
      
1,024
      
-
      
1,024
  
Gains on sale of real estate and land
    
-
      
-
      
8,268
      
1,503
  
Income from continuing operations
    
8,428
      
28,985
      
34,834
      
58,146
  
Income from discontinued operations
    
-
      
590
      
-
      
1,132
  
Net income
    
8,428
      
29,575
      
34,834
      
59,278
  
Net income attributable to noncontrolling interest
    
(1,916
)
    
(1,714
)
    
(3,625
)
    
(3,345
)
Net income attributable to controlling interest
    
6,512
      
27,861
      
31,209
      
55,933
  
Preferred interest distributions
    
(1,314
)
    
(1,368
)
    
(2,682
)
    
(2,736
)
Net income available to common unitholders
  
$
5,198
    
$
26,493
    
$
28,527
    
$
53,197
  
 
                                
Comprehensive income
  
$
11,088
    
$
35,355
    
$
41,817
    
$
66,094
  
Comprehensive income attributable to noncontrolling interest
    
(1,916
)
    
(1,714
)
    
(3,625
)
    
(3,345
)
Comprehensive income attributable to controlling interest
  
$
9,172
    
$
33,641
    
$
38,192
    
$
62,749
  
 
                                
Per common unit data:
                                
Basic:
                                
Income from continuing operations
  
$
0.08
    
$
0.65
    
$
0.54
    
$
1.32
  
Income from discontinued operations
    
-
      
0.02
      
-
      
0.03
  
Net income available to common unitholders
  
$
0.08
    
$
0.67
    
$
0.54
    
$
1.35
  
Weighted average number of common units outstanding during the period
    
64,058,505
      
39,444,214
      
52,127,261
      
39,264,790
  
 
                                
Diluted:
                                
Income from continuing operations
  
$
0.08
    
$
0.65
    
$
0.54
    
$
1.32
  
Income from discontinued operations
    
-
      
0.02
      
-
      
0.03
  
Net income available to common unitholders
  
$
0.08
    
$
0.67
    
$
0.54
    
$
1.35
  
Weighted average number of common units outstanding during the period
    
64,233,304
      
39,542,481
      
52,357,189
      
39,357,638
  
 
                                
Distribution per common unit
  
$
1.30
    
$
1.21
    
$
2.51
    
$
2.42
  

See accompanying notes to the unaudited condensed consolidated financial statements
8
­­­ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Statement of Capital for the six months ended June 30, 2014
(Unaudited)
(Dollars and units in thousands)

 
  
General Partner
    
Limited Partners
    
Accumulated
    
   
 
 
  
Common Equity
    
Preferred
Equity
    
Common Equity
    
other
comprehensive
    
Noncontrolling
    
 
 
  
Units
    
Amount
    
Amount
    
Units
    
Amount
    
(loss) income
    
Interest
    
Total
  
Balances at December 31, 2013
    
37,421
    
$
1,873,882
      
71,209
      
2,150
    
$
45,957
    
$
(58,940
)
  
$
66,130
    
$
1,998,238
  
Comprehensive income:
                                                                
Net income
    
-
      
26,901
      
2,682
      
-
      
1,626
      
-
      
3,625
      
34,834
  
Reversal of unrealized gains upon the sale of marketable securities
    
-
      
-
      
-
      
-
      
-
      
(886
)
    
-
      
(886
)
Change in fair value of derivatives and amortization of swap settlements
    
-
      
-
      
-
      
-
      
-
      
4,293
      
-
      
4,293
  
Change in fair value of marketable securities
    
-
      
-
      
-
      
-
      
-
      
3,576
      
-
      
3,576
  
Issuance of common units under:
                                                                
Common stock issued as consideration by general partner in merger
    
23,093
      
3,777,646
      
-
      
-
      
-
      
-
      
-
      
3,777,646
  
General partner's stock  based compensation
    
109
      
10,350
      
-
      
-
      
-
      
-
      
-
      
10,350
  
Sale of common stock by general partner
    
1,644
      
299,397
      
-
      
-
      
-
      
-
      
-
      
299,397
  
Equity based compensation costs
    
-
      
(1,126
)
    
-
      
23
      
1,266
      
-
      
-
      
140
  
Reclassification of noncontrolling interest to redeemable noncontrolling interest
    
-
      
(20,134
)
    
-
      
(2
)
    
6,400
      
-
      
(5,032
)
    
(18,766
)
Conversion of Series G preferred stock
    
34
      
4,349
      
-
      
-
      
-
      
-
      
-
      
4,349
  
Contributions from noncontrolling interest
    
-
      
-
      
-
      
8,561
      
1,419,816
      
-
      
-
      
1,419,816
  
Retirement of noncontrolling interest
    
-
      
-
      
-
      
(8,561
)
    
(1,419,816
)
    
-
      
-
      
(1,419,816
)
Distributions to noncontrolling interes
    
-
      
-
      
-
      
-
      
-
      
-
      
(2,045
)
    
(2,045
)
Redemptions
    
-
      
(1,985
)
    
-
      
-
      
(151
)
    
-
      
(414
)
    
(2,550
)
Distributions declared
    
-
      
(128,247
)
    
(2,682
)
    
-
      
(5,465
)
    
-
      
-
      
(136,394
)
Balances at June 30, 2014
    
62,301
    
$
5,841,033
    
$
71,209
      
2,171
    
$
49,633
    
$
(51,957
)
  
$
62,264
    
$
5,972,182
  

See accompanying notes to the unaudited condensed consolidated financial statements
9
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)

 
  
Six Months Ended June 30,
  
 
  
2014
    
2013
  
Cash flows from operating activities:
  
   
 
Net income
  
$
34,834
    
$
59,278
  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Gain on sale of marketable securities
    
(886
)
    
(1,767
)
Operating Partnership's share of gain on the sales of co-investment
    
(3,213
)
    
(2,366
)
Gain on the sales of real estate and land
    
(8,268
)
    
(1,503
)
Gain on early retirement of debt
    
-
      
(1,024
)
Noncash merger expense
    
7,562
      
-
  
Co-investments, net
    
(10,719
)
    
(280
)
Amortization expense
    
(846
)
    
5,932
  
Amortization of discount on notes receivables
    
-
      
(844
)
Amortization of discount on marketable securities
    
(3,965
)
    
(2,776
)
Depreciation
    
147,822
      
95,175
  
Equity-based compensation
    
3,625
      
2,126
  
Changes in operating assets and liabilities:
                
Prepaid expenses and other assets
    
2,425
      
802
  
Accounts payable and accrued liabilities
    
10,086
      
(2,433
)
Other liabilities
    
665
      
266
  
Net cash provided by operating activities
    
179,122
      
150,586
  
Cash flows from investing activities:
                
Additions to real estate:
                
Acquisitions of real estate
    
(93,772
)
    
(175,950
)
Improvements to recent acquisitions
    
(6,148
)
    
(6,288
)
Redevelopment
    
(19,503
)
    
(17,616
)
Revenue generating capital expenditures
    
(11,967
)
    
(742
)
Lessor required capital expenditures
    
(7,562
)
    
(3,557
)
Non-revenue generating capital expenditures
    
(15,048
)
    
(12,349
)
Acquisitions of and additions to real estate under development
    
(58,899
)
    
(9,290
)
Advance from insurance claim
    
10,000
      
-
  
Dispositions of real estate
    
14,123
      
9,051
  
BRE merger cash consideration paid
    
(555,826
)
    
-
  
Changes in restricted cash and deposits
    
(3,606
)
    
18,290
  
Purchases of marketable securities
    
(14,341
)
    
(14,002
)
Sales and maturities of marketable securities
    
5,192
      
20,335
  
Purchases of and advances under notes and other receivables
    
-
      
(99,164
)
Collections of notes and other receivables
    
56,750
      
53,438
  
Dispositions of co-investments
    
13,900
      
-
  
Contributions to co-investments
    
(58,029
)
    
(101,295
)
Distributions from co-investments
    
18,467
      
57,458
  
Net cash used in investing activities
    
(726,269
)
    
(281,681
)
Cash flows from financing activities:
                
Borrowings under debt agreements
    
1,321,044
      
604,472
  
Repayment of debt
    
(1,077,210
)
    
(495,072
)
Additions to deferred charges
    
(16,401
)
    
(3,838
)
Equity related issuance cost
    
(1,093
)
    
(525
)
Net proceeds from stock options exercised
    
5,503
      
4,190
  
Net proceeds from issuance of common units
    
279,427
      
122,905
  
Distributions to noncontrolling interest
    
(2,045
)
    
(4,536
)
Redemption of noncontrolling interest
    
(414
)
    
(1,471
)
Common units and preferred units and preferred interests distributions paid
    
(102,562
)
    
(93,419
)
Net cash provided by financing activities
    
406,249
      
132,706
  
Net (decrease) increase in cash and cash equivalents
    
(140,898
)
    
1,611
  
Cash assumed in the BRE merger
    
140,353
      
-
  
Cash and cash equivalents at beginning of year
    
18,491
      
18,606
  
Cash and cash equivalents at end of period
  
$
17,946
    
$
20,217
  

(Continued)
10
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)

 
  
2014
    
2013
  
Supplemental disclosure of cash flow information:
  
   
 
Cash paid for interest, net of $11.7 million, and $8.1 million capitalized in 2014 and 2013, respectively
  
$
44,437
    
$
50,053
  
Supplemental disclosure of noncash investing and financing activities:
                
Issuance of limited partner common units for contributed properties
  
$
1,419,816
    
$
-
  
Retirement of limited partner common units
  
$
(1,419,816
)
    
-
  
Transfer from real estate under development to land and building
  
$
4,580
    
$
67
  
Transfer from real estate under development to co-investments
  
$
49,776
    
$
-
  
Mortgage notes assumed in connection with purchases of real estate including the loan premiums recorded
  
$
49,009
    
$
-
  
Change in accrual of distributions
  
$
35,896
    
$
5,436
  
Change in fair value of derivative liabilities.
  
$
122
    
$
4,820
  
Change in fair value of marketable securities
  
$
3,121
    
$
2,256
  
Change in construction payable
  
$
26,654
    
$
2,339
  
Accrued distribution from co-investment
  
$
19,836
    
$
-
  
Common stock proceeds receivable
  
$
19,970
    
$
-
  
Reclassification to redeemable noncontrolling interest from general partner and limited partners common units
  
$
18,766
    
$
-
  
 
                
Assets and liabilities assumed in BRE merger:
                
Cash assumed in merger
$
 140,353
$
-
Rental properties and real estate under development
  
$
5,613,031
    
$
-
  
Real estate held for sale, net
  
$
107,772
    
$
-
  
Co-investments
  
$
223,438
    
$
-
  
Acquired in-place lease value
  
$
80,358
    
$
-
  
Other assets
  
$
15,676
    
$
-
  
Mortgage notes payable and unsecured debt
  
$
1,747,382
    
$
-
  
Other liabilities
  
$
94,976
    
$
-
  
Redeemable noncontrolling interest
  
$
4,798
    
$
-
  
Equity consideration for BRE merger
  
$
3,777,646
    
$
-
  

See accompanying notes to the unaudited condensed consolidated financial statements
11
ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2014 and 2013
(Unaudited)

(1)
Organization and Basis of Presentation

The accompanying unaudited condensed consolidated financial statements present the accounts of Essex Property Trust, Inc. (“Essex” or the “Company”), which include the accounts of the Company and Essex Portfolio, L.P. and subsidiaries (the “Operating Partnership,” which holds the operating assets of the Company), prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) 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, 2013.

All significant intercompany balances and transactions have been eliminated in the condensed consolidated financial statements.  Certain reclassifications have been made to conform to the current year’s presentation. Such reclassification had no effect on previously reported financial results.

On April 1, 2014, Essex completed the merger with BRE Properties, Inc. (“BRE”).  In connection with the closing of the merger, (1) BRE merged into a wholly owned subsidiary of Essex, and (2) each outstanding share of BRE common stock was converted into (i) 0.2971 shares (the “Stock Consideration”) of Essex common stock, and (ii) $7.18 in cash, (the “Cash Consideration”), plus cash in lieu of fractional shares for total consideration of approximately $4.3 billion.  The Cash Consideration was adjusted as a result of the authorization and declaration of a special distribution to the stockholders of BRE of $5.15 per share of BRE common stock payable to BRE stockholders of record as of the close of business on March 31, 2014 (the “Special Dividend”).  The Special Dividend was payable as a result of the closing of the sale of certain interests in assets of BRE to certain parties, which closed on March 31, 2014.  Pursuant to the terms of the merger agreement, the amounts payable as a Special Dividend reduced the Cash Consideration of $12.33 payable by Essex in the merger to $7.18 per share of BRE common stock.

Essex issued approximately 23.1 million shares of Essex common stock as Stock Consideration in the merger.  For purchase accounting, the value of the common stock issued by Essex upon the consummation of the merger was determined based on the closing price of BRE’s common stock on the closing date of the merger. As a result of Essex being admitted to the S&P 500 on the same date as the closing of the merger, Essex’s common stock price experienced significantly higher than usual trading volume and the closing price of $174 per share was significantly higher than its volume-weighted average trading price for the days before and after April 1, 2014.  BRE’s common stock did not experience the same proportionate increase in common stock price leading up to April 1, 2014.  As a result, given that a substantial component of the purchase price is an exchange of equity instruments, Essex used the closing price of BRE’s common stock on April 1, 2014 of $61 per share, less the Cash Consideration, as the fair value of the equity consideration.  After deducting the Special Dividend and the Cash Consideration per share, this resulted in a value of $48.67 per share of BRE common stock which is the equivalent of approximately $164 per share of Essex common stock issued.

The unaudited condensed consolidated financial statements for the three months ended June 30, 2014 and 2013 include the accounts of the Company and the Operating Partnership.  Essex is the sole general partner in the Operating Partnership, with a 96.6% general partnership interest as of June 30, 2014.  Total OP units outstanding were 2,171,422 and 2,149,802 as of June 30, 2014 and December 31, 2013, respectively, and the redemption value of the OP units, based on the closing price of the Company’s common stock totaled $401.5 million and $308.5 million, as of June 30, 2014 and December 31, 2013, respectively.

As of June 30, 2014 the Company owned or had ownership interests in 239 apartment communities, aggregating 55,855 units, excluding the Company’s ownership in preferred interest co-investments,  (collectively, the “Communities”, and individually, a “Community”), five commercial buildings and eleven active developments (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 and Phoenix metropolitan areas.

12
ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2014 and 2013
(Unaudited)

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, 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 June 30, 2014 and December 31, 2013, 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 June 30, 2014 and December 31, 2013, 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.  As of June 30, 2014 and December 31, 2013 marketable securities consist of the following ($ in thousands):

 
  
June 30, 2014
  
 
  
Cost/
Amortized
Cost
    
Gross
Unrealized
Gain
    
Carrying Value
  
Available for sale:
  
   
   
 
Investment-grade unsecured bonds
  
$
11,627
    
$
217
    
$
11,844
  
Investment funds - US treasuries
    
3,842
      
6
      
3,848
  
Common stock
    
25,492
      
2,467
      
27,959
  
Held to maturity:
                        
Mortgage backed securities
    
62,707
      
-
      
62,707
  
Total
  
$
103,668
    
$
2,690
    
$
106,358
  
 
 
  
December 31, 2013
  
 
  
Cost/
Amortized
Cost
    
Gross
Unrealized
Gain (Loss)
    
Carrying Value
  
Available for sale:
                        
Investment-grade unsecured bonds
  
$
15,446
    
$
509
    
$
15,955
  
Investment funds - US treasuries
    
3,675
      
3
      
3,678
  
Common stock
    
13,104
      
(1,304
)
    
11,800
  
Held to maturity:
                        
Mortgage backed securities
    
58,651
      
-
      
58,651
  
Total
  
$
90,876
    
$
(792
)
  
$
90,084
  

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 six months ended June  30, 2014, and 2013,  the proceeds from sales of available for sale securities totaled $5.2 million and $20.3 million, respectively, which resulted in gains of $0.9 million and $1.8 million, respectively.

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 994,258 and 1,007,879 as of June 30, 2014 and December 31, 2013 respectively, and the redemption value of the units, based on the closing price of the Company’s common stock totaled $183.8 million and $144.6 million, as of June 30, 2014 and December 31, 2013, respectively.  The consolidated total assets and liabilities related to these VIEs, net of intercompany eliminations, were approximately $232.6 million and $221.2 million, respectively, as of June 30, 2014 and $194.9 million and $178.3 million, respectively, as of December 31, 2013.  Interest holders in VIEs consolidated by the Company are allocated income equal to the cash distributions made to those interest holders.  The remaining results of operations are allocated to the Company.  As of June 30, 2014 and December 31, 2013, the Company did not have any other VIEs of which it was deemed to be the primary beneficiary.
13
ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2014 and 2013
(Unaudited)

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, 2013) are being amortized over the expected service periods.

Stock-based compensation expense for options and restricted stock totaled $1.6 million and $0.5 million for the three months ended June 30, 2014 and 2013, respectively, and $2.2 million and $1.1 million for the six months ended June 30, 2014 and 2013, respectively.  The intrinsic value of the stock options exercised during the three months ended June 30, 2014 and 2013 totaled $2.5 million and $1.9 million, respectively, and $3.2 million and $2.8 million for the six months ended June 30, 2014 and 2013, respectively. As of June 30, 2014, the intrinsic value of the stock options outstanding and fully vested totaled $17.4 million.  As of June 30, 2014, total unrecognized compensation cost related to unvested share-based compensation granted under the stock option and restricted stock plans totaled $5.5 million.  The cost is expected to be recognized over a weighted-average period of 1 to 5 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.  The Operating Partnership also issued 50,500 units under the 2014 Long-Term Incentive Plan Award agreements in December 2013.  Pursuant to the 2014 Long-Term Incentive Plan Awards, each recipient was initially granted a number of 2014 Long-Term Incentive Plan Units (the “2014 LTIP Units”), 90% of which are subject to performance-based vesting, and 10% of which are subject to service-based vesting based on continued employment.  One-third of the performance-based vesting of the 2014 LTIP Units initially granted will be eligible to be earned by recipients based on Essex’s absolute total stockholder return and two-thirds will be eligible to be earned based on Essex’s relative total stockholder return, in each case, during a one-year performance period beginning on the initial grant date of the awards.  All 2014 LTIP Units that are earned vest over a four year period commencing on the grant date.

Stock-based compensation expense for Z-1 Units and 2014 LTIP Units totaled $0.2 million and $0.5 million for the three months ended June 30, 2014 and 2013, respectively, and $0.8 million and $1.0 million for the six months ended June 30, 2014 and 2013, respectively. As of June 30, 2014, the intrinsic value of the Z-1 Units and 2014 LTIP Units subject to future vesting totaled $24.3 million.  As of June 30, 2014, total unrecognized compensation cost related to Z-1 Units and 2014 LTIP Units subject to future vesting totaled $7.1 million.  The unamortized cost is expected to be recognized over 6 years subject to the achievement of the stated performance criteria.

Fair Value of Financial Instruments

Management believes that the carrying amounts of outstanding lines of credit, notes and other receivables approximate fair value as of June 30, 2014 and December 31, 2013, 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 $4.46 billion of fixed rate debt, including unsecured bonds, at June 30, 2014 is approximately $4.63 billion and the fair value of the Company’s $539.2 million of variable rate debt, excluding borrowings under the lines of credit, at June 30, 2014 is $520.4 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 June 30, 2014 due to the short-term maturity of these instruments.  Marketable securities, except mortgage backed securities that are held to maturity, and derivatives are carried at fair value as of June 30, 2014.
14
ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2014 and 2013
(Unaudited)

At June 30, 2014, the Company’s investments in mortgage backed securities had a carrying value of $62.7 million and the Company estimated the fair value to be approximately $92.0 million.  At December 31, 2013, the Company’s investments in mortgage backed securities had a carrying value of $58.7 million and the Company estimated the fair value to be approximately $86.2 million.  The Company determines the fair value of the mortgage backed securities based on unobservable inputs (level 3 of the fair value hierarchy) considering the assumptions that market participants would make in valuing these securities.  Assumptions such as estimated default rates and discount rates are used to determine expected, discounted cash flows to estimate the fair value.

Capitalization of Costs

The Company’s capitalized internal costs related to development and redevelopment projects totaled $3.0 million and $1.7 million during the three months ended June 30, 2014 and 2013, respectively, and  $4.7 million and $3.3 million during the six months ended June 30, 2014 and 2013, respectively, most of which relates to development projects.  These totals include capitalized salaries of $2.0 million and $0.6 million for the three months ended June, 2014 and 2013, respectively, and $4.2 million and $1.2 million for the six months ended June 30, 2014 and 2013, respectively.  The Company capitalizes leasing commissions associated with the lease-up of a development community and amortizes the costs over the life of the leases.  The amounts capitalized are immaterial for all periods presented.

Co-investments

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-investment entities are consistent with those of the Company in all material respects.  For preferred equity investments, the Company recognizes its preferred interest in equity income in co-investments.

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 income 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. Any promote fees are reflected in equity income (loss) from co-investments.

Changes in Accumulated Other Comprehensive Loss, Net by Component

Essex Property Trust, Inc.

($ in thousands):

 
  
Change in fair
value and amortization
of derivatives
    
Unrealized
gains/(losses) on
available for sale
securities
    
Total
  
Balance at December 31, 2013
  
$
(59,724
)
  
$
(748
)
  
$
(60,472
)
Other comprehensive income (loss) before reclassification
    
123
      
3,414
      
3,537
  
Amounts reclassified from accumulated other comprehensive loss
    
3,982
      
(841
)
    
3,141
  
Net other comprehensive income (loss)
    
4,105
      
2,573
      
6,678
  
Balance at June 30, 2014
  
$
(55,619
)
  
$
1,825
    
$
(53,794
)

15
ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2014 and 2013
(Unaudited)
 
Essex Portfolio, L.P.

($ in thousands):

 
  
Change in fair
value and amortization
of derivatives
    
Unrealized
gains/(losses) on
available for sale
securities
    
Total
  
Balance at December 31, 2013
  
$
(58,148
)
  
$
(792
)
  
$
(58,940
)
Other comprehensive income (loss) before reclassification
    
130
      
3,576
      
3,706
  
Amounts reclassified from accumulated other comprehensive loss
    
4,163
      
(886
)
    
3,277
  
Net other comprehensive income (loss)
    
4,293
      
2,690
      
6,983
  
Balance at June 30, 2014
  
$
(53,855
)
  
$
1,898
    
$
(51,957
)

Amounts reclassified from accumulated other comprehensive loss in connection with derivatives are recorded in interest expense before amortization on the condensed consolidated statement of operations and comprehensive income.  Realized gains and losses on available for sale securities are included in interest and other income on the condensed consolidated statement of operations and comprehensive income.

Accounting Estimates

The preparation of condensed consolidated financial statements, in accordance with GAAP, 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.

Discontinued Operations

In April 2014, the Financial Accounting Standards Board (“FASB”) issued ASU, No. 2014-018, Presentation of Financial Statements, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-018 changes the requirements for reporting discontinued operation under Subtopic 205-20, Presentation of Financial Statements—Discontinued Operations.  The amendment updates the definition of discontinued operations and defines discontinued operations to be those disposals of components of an entity that represent a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.  This ASU is effective for disposals of components of an entity that occur within annual periods beginning on or after December 15, 2014 with early adoption permitted , but only for disposals that have not been reported in financial statements previously issued.

The Company adopted ASU 2014-018 in its first quarter of 2014.  In the first quarter of 2014, Essex sold Vista Capri North, a 106 unit community located in San Diego, CA for $14.4 million. The total gain on sale was $7.9 million. The Company determined that the disposal was not a discontinued operation in accordance with ASU 2014-018. The gain is recorded in gains on sale of real estate and land in the condensed consolidated statements of operations and comprehensive income. The Company did not sell any properties in the second quarter of 2014.
16
ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2014 and 2013
(Unaudited)
 
BRE Merger

As previously discussed in Note 1, the merger with BRE closed on April 1, 2014 and 14 of the BRE properties were acquired on March 31, 2014.  The preliminary fair value of the assets acquired on March 31, 2014 in exchange for $1.4 billion of OP units was substantially all attributable to rental properties which included land, buildings and improvements, and real estate under development and approximately $19 million attributable to acquired in-place lease value.  With regards to the BRE merger that closed on April 1, 2014, a summary of the preliminary fair value of the assets and liabilities acquired on April 1, 2014 in exchange for the total consideration of approximately $4.3 billion were as follows (includes the 14 properties acquired on March 31, 2014 as the OP units issued were retired on April 1, 2014) (in millions):

Cash assumed
  
$
140
  
Rental properties and real estate under development
    
5,613
  
Real estate held for sale, net
    
108
  
Co-investments
    
223
  
Acquired in-place lease value
    
80
  
Other assets
    
16
  
Mortgage notes payable and unsecured debt
    
(1,747
)
Other liabilities
    
(94
)
Redeemable noncontrolling interest
    
(5
)
 
  
$
4,334
  
 
        
Cash consideration for BRE merger
  
$
556