INDEPENDENCE REALTY TRUST, INC. (IRT) FY 2021 MD&A

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management's Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help provide an understanding of our business, financial condition and results of operations. This MD&A should be read in conjunction with our Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included elsewhere in this report. This report, including the following MD&A, contains forward-looking statements regarding future events or trends that are intended to be made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are based upon the current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are difficult to predict and generally beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We assume no obligation to update or supplement forward-looking statements because of subsequent events.  Actual results may differ materially from the anticipated results discussed in these forward-looking statements.  Factors which may cause our actual results or performance to differ materially from those contemplated by forward-looking statements include, but are not limited to, the risk the following:

• Unfavorable changes in economic conditions, either nationally or regionally in one or more of the markets in which we operate, could adversely impact us;

• Short-term leases expose us to the effects of declining rents;

• Competition could limit our ability to lease our units or increase or maintain rental income;

• Redevelopment risks could impact our profitability;

• Labor and materials required for maintenance, repair, renovation or capital expenditure may be more expensive than anticipated or significantly delayed;

• Competition could adversely affect our ability to acquire properties;

• Our acquisition strategy may not produce the cash flows expected;

• Failure to qualify as a REIT could have adverse consequences;

• Litigation risks could affect our business;

• A cybersecurity incident and other technology disruptions could negatively impact our business;

• Damage from catastrophic weather and other natural events could result in losses;

• Volatility in capital markets may result in fluctuations in our share price;

• Debt financing and other required capital may not be available to us or may only be available on adverse terms;

• Substantial inflationary or deflationary pressures could adversely affect our financial condition or results of operations;

• Rising interest rates could both increase our borrowing costs, thereby adversely affecting our cash flows and the amounts available for distribution to our stockholders, and decrease our share price, if investors seek higher yields through other investments;

• Failure to hedge effectively against interest rates may adversely affect results of operations; and

• Additional factors as discussed in Item 1A. “Risk Factors”.

Forward-looking statements and related uncertainties are also included in the Notes to Consolidated Financial Statements in this report.

Overview

See Item 1. Business for an overview of our company.

Business Objective and Investment Strategies

See Item 1. Business for discussion regarding our business objective and investment strategies.

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Through the STAR Merger, we acquired 68 apartment communities that contain 21,394 units and two apartment communities under development and that will contain upon completion an aggregate of 621 units. Through the STAR Merger, we acquired assets of $4.8 billion and assumed liabilities of $1.9 billion for total consideration of $2.9 billion. The net assets and results of operations of STAR are included in our consolidated financial statements from December 16, 2021 (the date we completed the STAR Merger) through December 31, 2021, the end of our fiscal year.

We incurred approximately $47.1 million in transaction costs related to the STAR Merger during the year ended December 31, 2021. These costs primarily consist of advisory fees, employee severance costs, and attorney fees. These costs are presented in a separate line item, “Merger and integration costs,” on the face of the condensed consolidated statements of operations.

An important part of our investment strategy is to strengthen our balance sheet and drive long-term growth and unlock value through portfolio enhancements.  Our value add initiative, which is comprised of renovations and upgrades at selected communities to drive increased rental rates, is a core component of this strategy. As discussed earlier, as of December 31, 2021, we had identified 7,851 units across 26 of our communities for renovations and upgrades as part of value add initiative. Since January 2018 and through December 31, 2021, we renovated and upgraded 4,672 of the 7,851 units while achieving a return on total investment of 18.0% (and approximately 20.2% on the interior portion of such renovation costs). We compute return on cost by measuring our cost against our rent premiums. We expect to complete the remaining value add projects at the selected communities during 2022 and 2023.

In addition to assets acquired in the STAR Merger, in 2021 we acquired two wholly-owned communities, totaling 594 units, and disposed of three communities, totaling 824 units. We also formed two unconsolidated joint ventures (in one of which we own 85% interest, and in the other we hold a 50% interest) that are developing communities that will contain, upon completion, 906 units.  These acquisitions, dispositions and joint venture investments represent the execution of our strategy to gain scale within desired submarkets, while exiting markets we lack scale. In 2022, subject to market conditions, we intend to continue to seek opportunities to gain scale within our existing markets through acquisitions of communities which fit within our investment strategy. We face competition for attractive investment opportunities from other real estate investors and, as a result, we may be unable to acquire additional properties on desirable terms, or at all.

See Item 1. Business for an additional discussion regarding developments in our business during 2021.

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Results of Operations

The following discussion is based on our Consolidated Financial Statements for the years ended December 31, 2021 and 2020. Refer to Item 7, “Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2020 for a comparison of the year ended December 31, 2020 to the year ended December 31, 2019.

Year Ended December 31, 2021 Compared to the Year Ended December 31, 2020

Revenue

Rental and other property revenue. Rental and other property revenue increased $38.3 million to $249.5 million for the year ended December 31, 2021 from $211.2 million for the year ended December 31, 2020. The increase was primarily attributable to a $23.4 million increase in our non same store portfolio driven by $15.6 million of revenue for the period December 16, 2021 through December 31, 2021 from properties acquired in the STAR Merger. Also contributing to the increase in rental and other property revenue was a $14.9 million increase in same store rental income driven by a 5.9% increase in average effective monthly rents and a 230-basis point increase in average occupancy compared to the prior year period.

Other revenue. Other revenue increased $0.1 million to $0.8 million for the year ended December 31, 2021 compared to $0.7 million for the year ended December 31, 2020.

Expenses

Property operating expenses. Property operating expenses increased $10.3 million to $93.3 million for the year ended December 31, 2021 from $83.0 million for the year ended December 31, 2020. The increase was primarily due to a $7.7 million increase in non same store real estate operating expenses driven by $6.0 million of operating expenses for the period December 16, 2021 through December 31, 2021 from properties acquired in the STAR Merger. Also contributing to the increase in property operating expenses was a $2.6 million increase in same store real estate operating expenses primarily due to an increase in repairs and maintenance, personnel, utilities, property insurance, and contract costs.

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Property management expenses. Property management expenses increased $1.0 million to $9.5 million for the year ended December 31, 2021 from $8.5 million for the year ended December 31, 2020. This increase was primarily due to the STAR Merger, which contributed $0.7 million of property management expenses for the period from merger closing on December 16, 2021 through year-end.

General and administrative expenses. General and administrative expenses increased $3.5 million to $18.6 million for the year ended December 31, 2021 from $15.1 million for the year ended December 31, 2020. This increase was primarily due to a $2.7 million increase in incentive compensation expense due to company performance.

Depreciation and amortization expense. Depreciation and amortization expense increased $16.2 million to $76.9 million for the year ended December 31, 2021 from $60.7 million for the year ended December 31, 2020. The increase was attributable to a $3.9 million increase in depreciation expense from capital expenditures related to our value add initiative, a $9.5 million increase in depreciation and amortization expense related to the STAR Merger, and a $2.5 million increase in depreciation and amortization expense due to other property acquisitions in 2021.

Casualty losses. During the year ended December 31, 2021, we incurred $0.4 million in casualty losses due to winter storm damage at various properties where the carrying value of the damage exceeds our expected insurance proceeds due to policy deductibles. During the year ended December 31, 2020, we incurred $0.7 million in casualty losses due to fires at three of our properties where the carrying value of the damage exceeds our expected insurance proceeds due to policy deductibles.

Interest expense. Interest expense decreased $0.1 million to $36.4 million for the year ended December 31, 2021 from $36.5 million for the year ended December 31, 2020. The STAR Merger contributed $2.6 million to interest expense during the period from merger closing on December 16, 2021 through year-end. This increase was more than offset by lower average interest rates during 2021 compared to 2020.

Gain on sale (loss on impairment) of real estate assets, net. During the year ended December 31, 2021, three multi-family properties were sold resulting in gains of $87.7 million. During the year ended December 31, 2020, three multi-family properties were sold resulting in net gains of $7.6 million.

Loss on extinguishment of debt. During the year ended December 31, 2021, we incurred losses on extinguishment of debt totaling $10.3 million as a result of deleveraging efforts undertaken in contemplation of the STAR Merger.

Merger and integration costs. In connection with the STAR Merger, we incurred approximately $47.1 million of merger-related transaction costs during the year ended December 31, 2021. These costs primarily consist of advisory fees, employee severance costs, and attorney fees.

Non-GAAP Financial Measures

Funds from Operations and Core Funds from Operations

We believe that Funds from Operations (“FFO”) and Core FFO (“CFFO”), each of which is a non-GAAP financial measure, are additional appropriate measures of the operating performance of a REIT and us in particular. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts (“NAREIT”), as net income or loss allocated to common shares (computed in accordance with GAAP), excluding real estate-related depreciation and amortization expense, gains or losses on sales of real estate and the cumulative effect of changes in accounting principles. While our calculation of FFO is in accordance with NAREIT’s definition, it may differ from the methodology for calculating FFO utilized by other REITs and, accordingly, may not be comparable to FFO computations of such other REITs.

We updated our definition of CFFO during the three months ended March 31, 2021 to the definition described below. All prior periods have been adjusted to conform to the current CFFO definition.

CFFO is a computation made by analysts and investors to measure a real estate company’s operating performance by removing the effect of items that do not reflect ongoing property operations, including depreciation and amortization of other items not included in FFO, and other non-cash or non-operating gains or losses related to items such as merger and integration costs, casualty losses, abandoned deal costs, loan discount amortization, loan premium accretion, and debt extinguishment costs from the determination of FFO.

Our calculation of CFFO may differ from the methodology used for calculating CFFO by other REITs and, accordingly, our CFFO may not be comparable to CFFO reported by other REITs. Our management utilizes FFO and CFFO as measures of our operating performance, and believe they are also useful to investors, because they facilitate an understanding of our operating performance after

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adjustment for certain non-cash or non-recurring items that are required by GAAP to be expensed but may not necessarily be indicative of current operating performance and our operating performance between periods. Furthermore, although FFO, CFFO and other supplemental performance measures are defined in various ways throughout the REIT industry, we believe that FFO and CFFO may provide us and our investors with an additional useful measure to compare our financial performance to certain other REITs. Neither FFO nor CFFO is equivalent to net income or cash generated from operating activities determined in accordance with GAAP. Furthermore, FFO and CFFO do not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations or other commitments or uncertainties. Accordingly, FFO and CFFO do not measure whether cash flow is sufficient to fund all of our cash needs, including principal amortization and capital improvements. Neither FFO nor CFFO should be considered as an alternative to net income or any other GAAP measurement as an indicator of our operating performance or as an alternative to cash flow from operating, investing, and financing activities as a measure of our liquidity.

Set forth below is a reconciliation of net income to FFO and Core FFO for the years ended December 31, 2021, 2020 and 2019 (in thousands, except share and per share information):

Same Store Portfolio Net Operating Income

We believe that Net Operating Income (“NOI”), a non-GAAP financial measure, is a useful measure of our operating performance. We define NOI as total property revenues less total property operating expenses, excluding depreciation and amortization, casualty related costs, property management expenses, general administrative expenses, interest expense, and net gains on sale of assets.

Other REITs may use different methodologies for calculating NOI, and accordingly, our NOI may not be comparable to other REITs. We believe that this measure provides an operating perspective not immediately apparent from GAAP operating income or net income. We use NOI to evaluate our performance on a same store and non same store basis because NOI measures the core operations of property performance by excluding corporate level expenses and other items not related to property operating performance and captures trends in rental housing and property operating expenses. However, NOI should only be used as an alternative measure of our financial performance.

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We review our same store portfolio at the beginning of each calendar year.  Properties are added into the same store portfolio if they were owned at the beginning of the previous year. Properties that are held-for-sale or have been sold are excluded from the same store portfolio. The table below presents our same store results for the years ended December 31, 2021 and 2020 (in thousands).

Combined Same Store Portfolio and STAR Same Store Portfolio

Through the STAR Merger, we acquired 68 apartment communities and 21,394 units, which more than doubled our property and unit count. In 2022, we will continue to follow the definition of same store described above but we will also begin presenting a Combined Same Store Portfolio. The Combined Same Store Portfolio represents the combination of the IRT same store portfolio, as described above, and the STAR Same Store Portfolio considered as a single portfolio. The STAR Same Store Portfolio represents the STAR portfolio that would be part of the same store portfolio had the STAR portfolio been owned by IRT since January 1, 2020 and assuming the actual purchase date for any properties owned by a STAR-related entity prior to STAR’s mergers with Steadfast Income REIT, Inc. and Steadfast Apartment REIT III, Inc., both of which occurred on March 6, 2020. Because these properties have only been owned by IRT since December 16, 2021, they are not included in the IRT same store portfolio. Results for periods prior to December 16, 2021 have been adjusted for consistency with IRT accounting policies and classifications. The below table provides the 2021 quarterly and annual property operating results for the 2022 Combined Same Store Portfolio (in thousands).

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Liquidity and Capital Resources

Overview

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain investments, pay distributions and other general business needs. We believe our available cash balances, financing arrangements and cash flows from operations will be sufficient to fund our liquidity requirements with respect to our existing portfolio for the next 12 months and the foreseeable future.

Our primary cash requirements are to:

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We intend to meet our liquidity requirements primarily through a combination of one or more of the following:

We continue to seek to reduce our leverage ratio over time through the execution of various strategies. These strategies include using the proceeds from sales of properties which are outside our core geographic footprint in the Southeastern United States or which we believe have limited potential for further improvements to their operating results to repay a portion of our indebtedness or to acquire new properties at a lower leverage and selectively raising capital through the sale of common stock under our at-the-market program and re-investing the proceeds into our value add initiative in order to increase our portfolio’s gross asset value. We have successfully continued to implement these strategies to reduce our leverage and reduce our exposure to short term indebtedness.

Cash Flows

As of December 31, 2021 and 2020, we maintained cash, cash equivalents, and restricted cash of approximately $65.7 million and $13.6 million, respectively. Our cash and cash equivalents were generated from the following activities (dollars in thousands):

Our cash inflow from operating activities during the years ended December 31, 2021 was primarily driven by $99.4 million of cash flow from ongoing operations of our properties partially offset by $47.1 million of merger and integration costs. Our cash inflow from operating activities during the years ended December 31, 2020 and 2019 were primarily driven by ongoing operations of our properties.

Our cash inflow from investing activities during the year ended December 31, 2021 was primarily driven by $186.1 million of outflows related to the STAR Merger, $139.5 million of outflows related to two property acquisitions, $25.0 million of outflows related to our investment in two unconsolidated real estate entities, and capital expenditures of $43.0 million partially offset by $177.5 million of inflows from property dispositions. Our cash outflow from investing activities during the year ended December 31, 2020 was primarily driven by $145.3 million of outflows related to two property acquisitions and capital expenditures of $37.4 million. This was partially offset by cash inflows of $58.1 million related to three property dispositions. Our cash outflow from investing activities during the year ended December 31, 2019 was primarily driven by $128.9 million of outflows related to three property acquisitions and capital expenditures of $45.6 million. This was partially offset by cash inflows of $68.1 million related to four property dispositions.

Our cash inflow from financing activities during the year ended December 31, 2021 was primarily driven by $594.5 million of term loan and credit facility proceeds and $317.0 million of proceeds from sales of common stock partially offset by $312.9 million of mortgage repayments, $302.3 million of credit facility repayments, and $49.8 million of distributions on our common stock. Our cash inflow from financing activities during the year ended December 31, 2020 was primarily driven by $148.2 million of proceeds from

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common stock issuances and was partially offset by $56.1 million of distributions on our common stock and mortgage repayments of $39.8 million.  Our cash inflow from financing activities during the year ended December 31, 2019 was primarily driven by net borrowings under our unsecured credit facility and term loans totaling $80.6 million plus $21.0 million of proceeds from common stock issuances and was partially offset by $64.7 million of distributions on our common stock.

Capitalization

Equity

On July 27, 2021, we entered into an underwriting agreement with Barclays Capital Inc. and BMO Capital Markets Corp., as representatives of the several underwriters named therein (collectively, the “Underwriters”), BMO Capital Markets Corp., in its capacity as agent (in such capacity, the “Forward Seller”) for Bank of Montreal, as forward counterparty (the “Forward Counterparty”) related to the offering of an aggregate of 16.1 million shares of our common stock at a price to the Underwriters of $17.04 per share consisting of 16.1 million shares of common stock offered by the Forward Seller in connection with the forward sale agreements described below (inclusive of 2.1 million shares offered pursuant to the Underwriters’ option to purchase additional shares, which was exercised in full).

In connection with the offering, we also entered into two forward sale agreements. The first forward sale agreement (the “Initial Forward Sale Agreement”), dated July 27, 2021, with the Forward Seller and Forward Counterparty, and the second forward sale agreement (the “Additional Forward Sale Agreement”, together with the Initial Forward Sale Agreement, the “Forward Sale Agreements”), dated July 29, 2021, with the Forward Seller and the Forward Counterparty. In connection with the Forward Sale Agreements, the Forward Seller borrowed from third parties and sold to the Underwriters an aggregate of 16.1 million shares of our common stock that was sold in the offering. On December 14, 2021, in connection with the completion of the STAR Merger, the forward sale transactions were all physically settled and we issued 16.1 million shares of common stock and received $271.8 million in net proceeds. These proceed were used to delever the combined balance sheet.

On November 13, 2020, we entered into an equity distribution agreement pursuant to which we may from time to time offer and sell shares of our common stock having an aggregate offering price of up to $150 million (the “ATM Program”) in negotiated transactions or transactions that are deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act of 1933, as amended. Under the ATM Program, we may also enter into one or more forward sale transactions for the sale of shares of our common stock on a forward basis. During the fourth quarter of 2020 and the first half of 2021, we sold 2.9 million shares on a forward basis under the ATM program. On June 29, 2021, the forward sale transactions were all physically settled and we issued 2.9 million shares of common stock for a total of $41.7 million in net proceeds. On November 1, 2021, we entered into a forward sale transaction under the ATM Program for the forward sale of 1.0 million shares of our common stock that have not yet been settled. Subject to our right to elect net share settlement, we expect to physically settle the forward sale transaction by the maturity date (December 15, 2022) set forth in the forward sale transaction placement notice.  Assuming the forward sales transaction is physically settled in full utilizing the December 31, 2021 forward sale price of $23.78 per share, net of sales commissions, we expect to receive net proceeds of approximately $23.8 million, subject to adjustment in accordance with the forward sale transaction.

We evaluated the accounting for the forward sale transactions under FASB ASC Topic 480 “Distinguishing Liabilities from Equity” and FASB ASC Topic 815 “Derivatives and Hedging”.  As the forward sale transactions are considered indexed to our own equity and since they meet the equity classification conditions in ASC 815-40-25, the forward sale transactions have been classified as equity.

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Debt

The following tables contain summary information concerning our indebtedness as of December 31, 2021:

As of December 31, 2021 we were in compliance with all financial covenants contained in our indebtedness.

PNC Secured Credit Facility

On December 16, 2021, in connection with the STAR Merger, we assumed the PNC MCFA, a fixed rate multifamily note and other loan documents for the benefit of PNC Bank. The PNC MCFA provided for a fixed rate loan in the aggregate principal amount of $79,170 that accrues interest at 2.82% per annum. As of December 31, 2021, the outstanding principal balance was $76,248.

Newmark Secured Credit Facility

On December 16, 2021, in connection with the STAR Merger, we assumed the Newmark MCFA, which includes four tranches: (1) a fixed rate loan in the aggregate principal amount of $331,001 that accrues interest at 4.43% per annum; (2) a fixed rate loan in the aggregate principal amount of $137,917 that accrues interest at 4.57% per annum; (3) a variable rate loan in the aggregate principal amount of $49,493 that accrues interest at the one-month LIBOR plus 1.70% per annum; and (4) a fixed rate loan in the aggregate principal amount of $40,468 that accrues interest at 3.34% per annum. The first three tranches have a maturity date of August 1, 2028, and the fourth tranche has a maturity date of March 1, 2030, unless in each case the maturity date is accelerated in accordance with the terms of the loan documents. Interest only payments are payable monthly through August 1, 2025 and April 1, 2027 on the first three tranches and fourth tranche, respectively, with interest and principal payments due monthly thereafter.

Unsecured Credit Facility and Revolving Line of Credit

On December 14, 2021, we entered into a Third Amended, Restated and Consolidated Credit Agreement (the "Third Restated Credit Agreement") which provides for a $1,000,000 unsecured credit facility (the “Facility”) that consists of a $500,000 revolving line of credit (the “Unsecured Revolver”), a $200,000 senior term loan, a $200,000 term loan and a $100,000 term loan, (together, the “Unsecured Term Loans”), primarily to (1) increase the borrowing capacity under the Unsecured Revolver from $350,000 to $500,000, (2) extend the maturity date of the Unsecured Revolver from May 9, 2023 to Jan 31, 2026 and (3) consolidate the Unsecured Term Loans into one combined agreement. We have the right to increase the aggregate amount of the Third Restated Credit Agreement from $1,000,000 to $1,500,000, subject to certain terms and conditions. We may prepay the Third Restated Credit Agreement, in whole or in part, at any time without prepayment fee or penalty. Borrowings under the Unsecured Revolver bear interest at a rate equal to either (i) the LIBOR rate plus a margin of 125 to 200 basis points, or (ii) a base rate plus a margin of 25 to 100 basis points and borrowings under the Unsecured Term Loans bear interest at a rate equal to either (i) the LIBOR rate plus a margin of 120 to 190 basis points, or (ii) a base rate plus a margin of 20 to 90 basis points.  The applicable margin will be determined based upon IROP’s consolidated leverage ratio. The Unsecured Revolver requires monthly payments of interest only, but requires

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mandatory prepayments under certain circumstances, as set forth in the Third Restated Credit Agreement.  At the time of closing, based on IROP’s consolidated leverage ratio, the applicable margin was 125 basis points for the Unsecured Revolver and was 120 basis points for the Unsecured Term Loans. We recognized the restructuring of the Third Restated Credit Agreement as a modification of debt and incurred deferred financing costs of $1,886 associated with the transaction.

In addition to certain negative covenants, the Third Restated Credit Agreement has financial covenants that require us to (i) maintain a consolidated leverage ratio below specified thresholds, (ii) maintain a minimum consolidated fixed charge coverage ratio, and (iii) maintain a minimum consolidated tangible net worth, (iv) and maintain secured and unsecured leverage ratios below specified thresholds. Additionally, the covenants (i) limit (a) the amount of distributions that IRT can make to a percentage of Funds from Operations (as such term is described in the debt agreement), (b) and the ratio of unencumbered asset adjusted net operating income to unsecured interest expense.

During November 2021 and December 2021, we drew down on our unsecured credit facility to extinguish nine property mortgages totaling $212,600,000. The property mortgage had a weighted-average rate of 3.8%.

On October 1, 2021, we drew down on our unsecured credit facility to extinguish a property mortgage totaling $19,400,000. The property mortgage had a weighted-average rate of 3.4%.

On July 1, 2021, we drew down on our unsecured credit facility to extinguish a property mortgage totaling $18,700,000. The property mortgage had a weighted-average rate of 3.4%.  On July 30, 2021, we drew down on our unsecured credit facility to extinguish a property mortgage totaling $16,000,000. The property mortgage had a weighted-average rate of 3.7%.

On March 1, 2021, we drew down on our unsecured credit facility to extinguish a property mortgage totaling $6,000,000. The property mortgage had a weighted-average rate of 5.7%.

On April 5, 2021, we drew down on our unsecured credit facility to extinguish a property mortgage and made partial

paydowns on another mortgage totaling $13,700,000. The property mortgages had a weighted-average rate of 4.2%.

During the year ended December 31, 2021, in connection with three property dispositions, we extinguished property mortgages totaling $42,100,000.

In connections with mortgage debt prepaid during November and December 2021, we incurred losses on extinguishment of debt totaling $10,300,000.

Contractual Obligations

The table below summarizes our contractual obligations as of December 31, 2021 (dollars in thousands):

Terms of Leases and Resident Characteristics

The leases for our portfolio typically follow standard forms customarily used between landlords and residents in the geographic area in which the relevant property is located. Under such leases, the resident typically agrees to pay an initial deposit (generally one month’s rent) and/or associated application and move in-fees, and then pays rent on a monthly basis during the term of the lease. As landlord, we are directly responsible for all real estate taxes, sales and use taxes, special assessments, property-level utilities, insurance and building repairs, and other building operation and management costs. Individual residents are generally responsible for the utility costs of their unit. Our lease terms are generally for one year or less and average twelve months.

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Our apartment resident composition varies across the regions in which we operate, includes singles, roommates and family renters and is generally reflective of the principal employers in the relevant region. Our apartment properties predominantly consist of one-bedroom and two-bedroom units, although some of our apartment properties also have studio and three-bedroom units.

Insurance

Our multifamily properties are covered by all risk property insurance covering the replacement cost for each building and business interruption and rental loss insurance. On a case-by-case basis, based on an assessment of the likelihood of the risk, availability and cost of insurance, and in accordance with standard market practice, we obtain earthquake, windstorm, flood, terrorism and boiler and machinery insurance. We carry comprehensive liability insurance and umbrella policies for each of our properties at levels which we believe are prudent in light of our business activities and are in accordance with standard market practice. We seek certain extensions of coverage, valuation clauses, and deductibles in accordance with standard market practice and availability. Although we may carry insurance for potential losses associated with our multifamily properties, we may still incur losses due to uninsured risks, deductibles, co-payments or losses in excess of applicable insurance coverage and those losses may be material. In addition, we generally obtain title insurance policies when we acquire a property, with each policy covering an amount equal to the initial purchase price of each property. Accordingly, any of our title insurance policies may be in an amount less than the current value of the related property.

Inflation

Our resident leases at our apartment communities allow, at the time of renewal, for adjustments in the rent payable thereunder, and thus may enable us to seek rent increases. Almost all leases are for one year or less. The short-term nature of these leases has generally served to reduce our risk to adverse effects of inflation. However, substantial inflationary pressures could have a negative effect on rental rates and property operating expenses. The general risk of inflation is that interest on our debt, general and administrative expenses and other expenses, including our costs of capital improvements and expenditures, increase at a rate faster than increases in our residential rental rates, which would adversely affect our financial condition or results of operations.

Critical Accounting Estimates and Policies

We consider the accounting policies discussed below to be critical to an understanding of how we report our financial condition and results of operations because their application places the most significant demands on the judgment and estimates of our management.

Our financial statements are prepared on the accrual basis of accounting in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires management to make use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.

Investments in Real Estate

Allocation of Purchase Price of Acquired Assets

In accordance with FASB ASC Topic 805, the properties we acquire are generally accounted for as asset acquisitions. Under asset acquisition accounting, the costs to acquire real estate, including transaction costs related to the acquisition, are accumulated and then allocated to the individual assets and liabilities acquired based upon their relative fair value. Transaction costs and fees incurred related to the financing of an acquisition are capitalized and amortized over the life of the related financing.

We estimate the fair value of acquired tangible assets (consisting of land, building and improvements), identified intangible assets (consisting of in-place leases), and assumed debt at the date of acquisition, based on the evaluation of information and estimates available at that date.

Business Combinations

For properties we acquire or transactions we entered into that are accounted for as business combinations, we apply the acquisition method of accounting under ASC 805, which requires the identification of the acquiror, the determination of the acquisition date, and the recognition and measurement, at fair value, of the assets acquired and liabilities assumed. To the extent that the fair value of net assets acquired differs from the fair value of consideration paid, ASC 805 requires the recognition of goodwill or a gain from a bargain purchase, if any.

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Impairment of Long-Lived Assets

Management evaluates the recoverability of its investment in real estate assets, including related identifiable intangible assets, in accordance with FASB ASC Topic 360, “Property, Plant and Equipment”. This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that recoverability of the assets is not assured.

Management reviews its long-lived assets on an ongoing basis and evaluates the recoverability of the carrying value when there is an indicator of impairment. An impairment charge is recorded when it is determined that the carrying value of the asset exceeds the fair value. The estimated cash flows used for the impairment analysis and the determination of estimated fair value are based on our plans for the respective assets (e.g., hold period) and our views of market and economic conditions. The estimates consider matters such as current and historical rental rates, occupancies for the respective and/or comparable properties, and recent sales data for comparable properties. Changes in estimated future cash flows due to changes in our plans or views of market and economic conditions could result in recognition of impairment losses, which, under the applicable accounting guidance, could be substantial.