Edgar Filing: PREFERRED APARTMENT COMMUNITIES INC

Three months ended March 31,

PAC-10-Q 1Q2014

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 March 31, 2014


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

For the transition period from to

Commission File No. 001-34995

Preferred Apartment Communities, Inc.

(Exact name of registrant as specified in its charter)



Maryland	27-1712193
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

3625 Cumberland Boulevard, Suite 1150, Atlanta, GA 30339

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (770) 818-4100

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec. 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). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

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

The number of shares outstanding of the registrant’s Common Stock, as of May 7, 2014 was 16,379,794.



	INDEX

			Page No.
PART I - FINANCIAL INFORMATION

Item 1.		Financial Statements

		Consolidated Balance Sheets (unaudited) – as of March 31, 2014 and December 31, 2013	1

		Consolidated Statements of Operations (unaudited) – Three Months Ended March 31, 2014 and 2013	2

		Consolidated Statements of Stockholders' Equity (unaudited) – Three Months Ended March 31, 2014 and 2013	3

		Consolidated Statements of Cash Flows (unaudited) – Three Months Ended March 31, 2014 and 2013	4

		Notes to Consolidated Financial Statements (unaudited)	6

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	31

Item 3.		Quantitative and Qualitative Disclosures About Market Risk	49

Item 4.		Controls and Procedures	49

PART II - OTHER INFORMATION

Item 1.		Legal Proceedings	50

Item 1A		Risk Factors	50

Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	50

Item 3.		Defaults Upon Senior Securities	50

Item 4.		Mine Safety Disclosures	51

Item 5.		Other Information	51

Item 6.		Exhibits	51

SIGNATURES			52

EXHIBIT INDEX			53

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements



Preferred Apartment Communities, Inc.
Consolidated Balance Sheets
(Unaudited)

	March 31, 2014			December 31, 2013
Assets

Real estate
Land	$	32,070,576		$	30,320,000
Building and improvements	120,626,673			116,716,766
Furniture, fixtures, and equipment	18,313,449			18,183,822
Construction in progress	101,263			53,663
Gross real estate	171,111,961			165,274,251
Less: accumulated depreciation	(13,304,013		)	(11,410,035		)
Net real estate	157,807,948			153,864,216
Property held for sale (net of accumulated depreciation of $2,723,386 and $2,723,386)	36,491,529			36,451,523
Real estate loans, net ($14,842,018 and $14,332,658 carried at fair value)	107,181,677			103,433,147
Real estate loans to related parties, net	8,081,532			7,164,768
Total real estate and real estate loans, net	309,562,686			300,913,654

Cash and cash equivalents	9,109,413			9,180,431
Restricted cash	2,442,610			2,064,819
Notes receivable	11,252,035			10,248,178
Note receivable from related party	1,500,000			1,500,000
Revolving line of credit to related party	7,794,718			5,358,227
Accrued interest receivable on real estate loans	4,258,841			3,286,660
Acquired intangible assets, net of amortization of $12,975,953 and $12,569,581	441,932			907,883
Deferred loan costs, net of amortization of $872,261 and $963,043	1,993,777			1,719,194
Deferred offering costs	6,077,441			5,255,636
Tenant receivables and other assets	901,469			1,202,013

Total assets	$	355,334,922		$	341,636,695

Liabilities and equity

Liabilities
Mortgage notes payable	$	140,873,000		$	140,516,000
Revolving credit facility	32,007,780			29,390,000
Accounts payable and accrued expenses	2,126,167			1,638,401
Accrued interest payable	348,016			443,099
Dividends and partnership distributions payable	2,988,176			2,900,478
Security deposits and other liabilities	847,044			695,998
Total liabilities	179,190,183			175,583,976

Commitments and contingencies (Note 11)

Equity

Stockholders' equity
Series A Redeemable Preferred Stock, $0.01 par value per share; 989,408 shares authorized;
101,581 and 89,408 shares issued; 101,486 and 89,313 shares
outstanding at March 31, 2014 and December 31, 2013, respectively	1,015			893
Common Stock, $0.01 par value per share; 400,066,666 shares authorized; 15,390,839 and
15,294,578 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively	153,908			152,945
Additional paid in capital	185,511,627			177,824,720
Accumulated deficit	(10,634,358		)	(13,391,341		)
Total stockholders' equity	175,032,192			164,587,217
Non-controlling interest	1,112,547			1,465,502
Total equity	176,144,739			166,052,719

Total liabilities and equity	$	355,334,922		$	341,636,695

The accompanying notes are an integral part of these consolidated financial statements.



Preferred Apartment Communities, Inc.
Consolidated Statements of Operations
(Unaudited)

	Three months ended March 31,
	2014			2013
Revenues:
Rental revenues	$	4,889,463		$	3,689,832
Other property revenues	567,194			333,820
Interest income on loans and notes receivable	4,293,442			1,295,080
Interest income from related party	432,307			16,850
Total revenues	10,182,406			5,335,582

Operating expenses:
Property operating and maintenance	785,503			528,822
Property salary and benefits reimbursement to related party	532,163			408,529
Property management fees to related party	218,020			160,666
Real estate taxes	541,128			390,255
General and administrative	173,867			108,036
Equity compensation to directors and executives	444,222			308,921
Depreciation and amortization	2,308,526			3,913,508
Acquisition and pursuit costs	188,031			198,611
Acquisition fees to related party	57,268			908,400
Management fees to related party	688,749			383,868
Insurance, professional fees and other expenses	365,321			288,095
Total operating expenses	6,302,798			7,597,711

Operating income (loss)	3,879,608			(2,262,129		)
Interest expense	1,401,188			1,019,867

Net income (loss) from continuing operations	2,478,420			(3,281,996		)
Income from discontinued operations	317,425			96,167
Net income (loss)	2,795,845			(3,185,829		)
Consolidated net (income) loss attributable to non-controlling interests	(38,862		)	61,486

Net income (loss) attributable to the Company	2,756,983			(3,124,343		)

Dividends declared to preferred stockholders	(1,420,536		)	(1,050,515		)
Earnings attributable to unvested restricted stock	(4,678		)	(4,792		)

Net income (loss) attributable to common stockholders	$	1,331,769		$	(4,179,650	)

Net income (loss) per share of Common Stock, basic:
From continuing operations	$	0.07		$	(0.81	)
From discontinued operations	0.02			0.02
Available to Common Stockholders	$	0.09		$	(0.79	)

Net income (loss) per share of Common Stock, diluted:
From continuing operations	$	0.07		$	(0.81	)
From discontinued operations	0.02			0.02
Available to Common Stockholders	$	0.09		$	(0.79	)

Dividends per share declared on Common Stock	$	0.16		$	0.145

Weighted average number of shares of Common Stock outstanding:
Basic	15,316,816			5,289,690
Diluted	15,562,608			5,289,690

The accompanying notes are an integral part of these consolidated financial statements.



Preferred Apartment Communities, Inc.
Consolidated Statements of Stockholders' Equity
For the three months ended March 31, 2014 and 2013
(Unaudited)

	Series A Redeemable Preferred Stock		Common Stock		Additional Paid in Capital			Accumulated (Deficit)			Total Stockholders' Equity			Non-Controlling Interest			Total Equity

Balance at January 1, 2013	$	198	$	52,885	$	59,412,744		$	(9,408,253	)	$	50,057,574		$	1		$	50,057,575
Issuance of Units	217		—		20,840,428			—			20,840,645			—			20,840,645
Syndication and offering costs	—		—		(1,408,665		)	—			(1,408,665		)	—			(1,408,665		)
Equity compensation to executives and directors	—		21		308,900			—			308,921			—			308,921
Vesting of Class B Units and conversion to Class A Units	—		—		(479,841		)	—			(479,841		)	479,841			—
Net loss	—		—		—			(3,124,343		)	(3,124,343		)	(61,486		)	(3,185,829		)
Distributions to non-controlling interests	—		—		—			—			—			(15,513		)	(15,513		)
Dividends to series A preferred stockholders
($5.00 per share per month)	—		—		(360,039		)	—			(360,039		)	—			(360,039		)
Dividends to series B preferred stockholders
($17.26 per share)	—		—		(690,476		)	—			(690,476		)	—			(690,476		)
Dividends to common stockholders ($0.145 per share)	—		—		(771,923		)	—			(771,923		)	—			(771,923		)
Balance at March 31, 2013	$	415	$	52,906	$	76,851,128		$	(12,532,596	)	$	64,371,853		$	402,843		$	64,774,696

Balance at January 1, 2014	$	893	$	152,945	$	177,824,720		$	(13,391,341	)	$	164,587,217		$	1,465,502		$	166,052,719
Issuance of Units	122		—		12,157,658			—			12,157,780			—			12,157,780
Syndication and offering costs	—		—		(1,394,971		)	—			(1,394,971		)	—			(1,394,971		)
Equity compensation to executives and directors	—		22		82,265			—			82,287			—			82,287
Conversion of Class A Units to Common Stock	—		941		504,540			—			505,481			(505,481		)	—
Current period amortization of Class B OP Units	—		—		—			—			—			361,936			361,936
Net income	—		—		—			2,756,983			2,756,983			38,862			2,795,845
Reallocation adjustment to non-controlling interests	—		—		211,720			—			211,720			(211,720		)	—
Distributions to non-controlling interests	—		—		—			—			—			(36,552		)	(36,552		)
Dividends to series A preferred stockholders
($5.00 per share per month)	—		—		(1,420,536		)	—			(1,420,536		)	—			(1,420,536		)
Dividends to common stockholders ($0.16 per share)	—		—		(2,453,769		)	—			(2,453,769		)	—			(2,453,769		)
Balance at March 31, 2014	$	1,015	$	153,908	$	185,511,627		$	(10,634,358	)	$	175,032,192		$	1,112,547		$	176,144,739

The accompanying notes are an integral part of these consolidated financial statements.



Preferred Apartment Communities, Inc.
Consolidated Statements of Cash Flows
(Unaudited)

	Three months ended March 31,
	2014			2013
Operating activities:
Net income (loss)	$	2,795,845		$	(3,185,829	)
Reconciliation of net income (loss) to net cash provided by operating activities:
Depreciation expense	1,894,411			1,728,867
Amortization expense	414,115			2,383,436
Amortization of below market leases	(5,723		)	(115,498		)
Deferred fee income amortization	(308,608		)	(37,031		)
Deferred loan cost amortization	140,658			137,761
Change in accrued interest income on real estate loans	(972,181		)	(443,362		)
Equity compensation to executives and directors	444,222			308,921
Deferred cable income amortization	(2,734		)	(2,733		)
Changes in operating assets and liabilities:
Decrease (increase) in tenant receivables and other assets	307,425			(10,176		)
Increase in accounts payable and accrued expenses	356,039			39,630
(Decrease) in accrued interest payable	(95,083		)	(51,796		)
(Decrease) increase in prepaid rents	(44,790		)	184
Increase in security deposits and other liabilities	185,170			4,016
Net cash provided by operating activities	5,108,766			756,390

Investing activities:
Investments in real estate loans	(4,880,179		)	(4,776,376		)
Repayments of real estate loans	520,009			—
Notes receivable issued	(1,175,905		)	(2,155,529		)
Notes receivable repaid	164,743			456,665
Draws on line of credit by related party	(3,311,611		)	(1,410,778		)
Repayments of line of credit by related party	771,449			1,421,384
Acquisition fees received on real estate loans	21,576			308,348
Acquisition fees paid on real estate loans	(10,788		)	(154,174		)
Acquisition of properties	(5,701,393		)	(21,647,242		)
Additions to real estate assets - improvements	(299,765		)	(103,482		)
(Increase) decrease in restricted cash	(150,961		)	77,006
Net cash used in investing activities	(14,052,825		)	(27,984,178		)

Financing activities:
Proceeds from mortgage notes payable	13,357,000			59,045,000
Payments for mortgage extinguishment	(13,000,000		)	(69,428,389		)
Payments for mortgage loan costs	(415,241		)	(907,477		)
Proceeds from lines of credit	3,700,001			12,943,000
Payments on lines of credit	(1,082,220		)	(27,744,197		)
Proceeds from sales of Series B Preferred Stock, net of offering costs	—			37,238,896
Proceeds from sales of Units, net of offering costs	10,954,492			19,983,826
Common Stock dividends paid	(2,451,697		)	(771,616		)
Series A preferred stock dividends paid	(1,354,344		)	(307,304		)
Distributions to non-controlling interests	(17,118		)	—
Payments for deferred offering costs	(817,832		)	(349,962		)
Net cash provided by financing activities	8,873,041			29,701,777

Net (decrease) increase in cash and cash equivalents	(71,018		)	2,473,989
Cash and cash equivalents, beginning of period	9,180,431			2,973,509
Cash and cash equivalents, end of period	$	9,109,413		$	5,447,498

The accompanying notes are an integral part of these consolidated financial statements.



Preferred Apartment Communities, Inc.
Consolidated Statements of Cash Flows (unaudited) - continued

	Three months ended March 31,
	2014		2013
Supplemental cash flow information:
Cash paid for interest	$	1,165,447	$	1,142,715

Supplemental disclosure of non-cash activities:
Accrued capital expenditures	$	113,377	$	131,463
Dividends payable - common	$	2,453,769	$	771,923
Dividends payable - preferred	$	497,855	$	823,079
Partnership distributions payable to non-controlling interest	$	36,552	$	15,513
Accrued and payable deferred offering costs	$	478,671	$	479,599
Reclass of offering costs from deferred asset to equity	$	154,211	$	85,220
Mortgage loans assumed on acquisitions	$	—	$	69,428,389

The accompanying notes are an integral part of these consolidated financial statements.

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)


1.	Organization

Preferred Apartment Communities, Inc. was formed as a Maryland corporation on September 18, 2009, and elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code, effective with its tax year ended December 31, 2011. Unless the context otherwise requires, references to the "Company", "we", "us", or "our" refer to Preferred Apartment Communities, Inc., together with its consolidated subsidiaries, including Preferred Apartment Communities Operating Partnership, L.P., or the Operating Partnership. The Company was formed primarily to acquire and operate multifamily properties in select targeted markets throughout the United States. As part of its business strategy, the Company may enter into forward purchase contracts or purchase options for to-be-built multifamily communities and may make mezzanine loans, provide deposit arrangements, or provide performance assurances, as may be necessary or appropriate, in connection with the construction of multifamily communities and other properties. As a secondary strategy, the Company also may acquire or originate senior mortgage loans, subordinate loans or mezzanine debt secured by interests in multifamily properties, membership or partnership interests in multifamily properties and other multifamily related assets and invest not more than 10% of its total assets in other real estate related investments, as determined by its Manager (as defined below) as appropriate for the Company. The Company is externally managed and advised by Preferred Apartment Advisors, LLC, or its Manager, a Delaware limited liability company and related party (see Note 6).

The Company completed its initial public offering, or IPO, on April 5, 2011. As of March 31, 2014, the Company had 15,390,839 shares of common stock, par value $0.01 per share, or Common Stock, issued and outstanding and owned units in the Operating Partnership which represented a weighted-average ownership percentage of 98.61% for the three-month period ended March 31, 2014. The number of partnership units not owned by the Company totaled 144,432 at March 31, 2014 and represented Class A OP Units of the Operating Partnership, or Class A OP Units. The Class A OP Units are convertible at any time at the option of the holder into the Company's choice of either cash or Common Stock. In the case of cash, the value is determined based upon the trailing 20-day volume weighted average price of the Company's Common Stock.

The consolidated financial statements include the accounts of the Company and the Operating Partnership. The Company controls the Operating Partnership through its sole general partner interest and plans to conduct substantially all of its business through the Operating Partnership.


2.	Summary of Significant Accounting Policies

Basis of Presentation

The unaudited consolidated financial statements include all of the accounts of the Company and the Operating Partnership presented in accordance with accounting principles generally accepted in the United States of America, or GAAP. All significant intercompany transactions have been eliminated in consolidation. Certain adjustments have been made consisting of normal recurring accruals, which, in the opinion of management, are necessary for a fair presentation of the Company's financial condition and results of operations. These financial statements should be read in conjunction with our audited financial statements and notes thereto included in our 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission, or the SEC, on March 17, 2014.

Use of Estimates

The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Acquisitions and Impairments of Real Estate Assets

The Company generally records its initial investments in income-producing real estate at fair value at the acquisition date in accordance with ASC 805-10, Business Combinations. The aggregate purchase price of acquired properties is apportioned to the tangible and identifiable intangible assets and liabilities acquired at their estimated fair values. The value of acquired land, buildings

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

and improvements is estimated by formal appraisals, observed comparable sales transactions, and information gathered during pre-acquisition due diligence activities and the valuation approach considers the value of the property as if it were vacant. The values of furniture, fixtures, and equipment are estimated by calculating their replacement cost and reducing that value by factors based upon estimates of their remaining useful lives. Intangible assets and liabilities for multifamily communities include the values of in-place leases, customer relationships, and above-market or below-market leases. In-place lease values are estimated by calculating the estimated time to fill a hypothetically empty apartment complex to its stabilization level (estimated to be 92% occupancy) based on historical observed move-in rates for each property. Carrying costs during these hypothetical expected lease-up periods are estimated, considering current market conditions and include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates. The intangible assets are calculated by estimating the net cash flows of the in-place leases to be realized, as compared to the net cash flows that would have occurred had the property been vacant at the time of acquisition and subject to lease-up. The acquired in-place lease values are amortized to operating expense over the average remaining non-cancelable term of the respective in-place leases. The values of customer relationships are estimated by calculating the product of the avoided hypothetical lost revenue and the average renewal probability and are amortized to operating expense over the average remaining historical period of residency, plus an estimate of the average expected renewal period. The amounts of above-market or below-market lease values are developed by comparing the Company's estimate of the average market rent to the average contract rent of the leases in place at the property acquisition date any amount. This ratio is applied on a lease by lease basis to derive a total asset or liability amount for the property. The above-market or below-market lease values are recorded as a reduction or increase, respectively, to rental income over the remaining average non-cancelable term of the respective leases, plus any below market renewal options. Acquired intangible assets have no residual value.

The Company evaluates its tangible and identifiable intangible real estate assets for impairment when events such as declines in a property’s operating performance, deteriorating market conditions, or environmental or legal concerns bring recoverability of the carrying value of one or more assets into question. The total undiscounted cash flows of the asset group, including proceeds from disposition, are compared to the net book value of the asset group. If this test indicates that impairment exists, an impairment loss is recorded in earnings equal to the shortage of the book value to the discounted net cash flows of the asset group.

Loans and Notes Held for Investment

The Company carries its investments in real estate loans at amortized cost with assessments made for impairment in the event recoverability of the principal amount becomes doubtful. If, upon testing for impairment, the fair value result is lower than the carrying amount of the loan, a valuation allowance is recorded to lower the carrying amount to fair value, with a loss recorded in earnings. Recoveries of valuation allowances are only recognized in the event of maturity or a sale or disposition in an amount above carrying value. The balances of real estate loans presented on the consolidated balance sheets consist of drawn amounts on the loans, net of deferred loan fee revenue. See the "Revenue Recognition" section of this Note for other loan-related policy disclosures required by ASC 310-10-50-6. Certain loans contain contingent exit fees, which are deemed to be embedded derivatives. The Company elects the fair value option for these loans and recognizes in earnings any material changes in fair value.

Cash and Cash Equivalents and Restricted Cash

The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Restricted cash includes cash restricted by state law or contractual requirement and relates primarily to tax and insurance escrows and resident security deposits.

Fair Value Measurements

Certain assets and liabilities are required to be carried at fair value, or if they are deemed impaired, to be adjusted to reflect this condition. The Company follows the guidance provided by ASC 820, Fair Value Measurements and Disclosures, in accounting and reporting for real estate assets where appropriate, as well as debt instruments both held for investment and as liabilities. The standard requires disclosure of fair values calculated under each level of inputs within the following hierarchy:

•Level 1 – Quoted prices in active markets for identical assets or liabilities at the measurement date.

•Level 2 – Inputs other than quoted prices that are observable for the asset or liability, either directly or

indirectly.

•Level 3 – Unobservable inputs for the asset or liability.

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

Deferred Loan Costs

Deferred loan costs are amortized using the straight-line method, which approximates the effective interest method, over the terms of the related indebtedness.

Deferred Offering Costs

Deferred offering costs represent direct costs incurred by the Company related to current equity offerings, excluding costs specifically identifiable to a closing, such as commissions, dealer-manager fees, and other registration fees. For issuances of equity that occur on one specific date, associated offering costs are reclassified as a reduction of proceeds raised on the date of issue. Our ongoing offering of up to a maximum of 900,000 units, consisting of one share of Series A Redeemable Preferred Stock, or Series A Preferred Stock, and one warrant, or Warrant, to purchase 20 shares of Common Stock, or Units, generally closes on a bimonthly basis in variable amounts. Such offering is referred to herein as the Follow-on Offering, pursuant to our registration statement on Form S-3 (registration number 333-183355), as may be amended from time to time. Deferred offering costs related to the Follow-on Offering and Shelf Offering (as defined in note 5) are reclassified to the stockholders’ equity section of the consolidated balance sheet as a reduction of proceeds raised on a pro-rata basis equal to the ratio of total Units or value of shares issued to the maximum number of Units, or the value of shares, as applicable, that are expected to be issued.

Non-controlling Interest

Non-controlling interest represents the equity interest of the Operating Partnership that is not owned by the Company. Non-controlling interest is adjusted for contributions, distributions and earnings or loss attributable to the non-controlling interest in the consolidated entity in accordance with the Agreement of Limited Partnership of the Operating Partnership, as amended.

Redeemable Preferred Stock

Shares of the Series A Preferred Stock issued pursuant to the Primary Series A Offering (further described in note 5) are redeemable at the option of the holder, subject to a declining redemption fee schedule. Redemptions are therefore outside the control of the Company. However, the Company retains the right to fund any redemptions of Series A Preferred Stock in either Common Stock or cash at its option. Therefore, the Company records the Series A Preferred Stock as a component of permanent stockholders’ equity.

Revenue Recognition

Rental revenue is recognized when earned from residents of the Company's multifamily communities, which is over the terms of rental agreements, typically of 13 months’ duration. Differences from the straight-line method, which recognize the effect of any up-front concessions and other adjustments ratably over the lease term, are not material. The Company evaluates the collectability of amounts due from residents and maintains an allowance for doubtful accounts for estimated losses resulting from the inability of residents to make required payments then due under lease agreements. The balance of amounts due from residents are generally deemed uncollectible 30 days beyond the due date, at which point they are fully reserved.

Rental revenue from tenants' operating leases in the Company's retail shopping center is recognized on a straight-line basis over the term of the lease regardless of when payments are due. The Company estimates the collectability of the accounts receivable related to base rents, straight-line rents, expense reimbursements, and other revenue taking into consideration the Company's historical write-off experience, tenant credit-worthiness, current economic trends, and remaining lease terms. Substantially all of the lease agreements with anchor tenants contain "percentage rent" provisions that provide for additional rents that become due upon achievement of specified sales revenue targets as defined in their lease agreements. Substantially all lease agreements contain provisions for reimbursement of the tenants' share of real estate taxes, insurance and common area maintenance costs, or CAM, costs. Recovery of real estate taxes, insurance, and CAM costs are recognized as the respective costs are incurred in accordance with the lease agreements.

Interest income on real estate loans and notes receivable is recognized on an accrual basis over the lives of the loans using the effective interest method. In the event that a loan or note is refinanced with the proceeds of another loan issued by the Company,

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

any unamortized loan fee revenue from the first loan will be recognized as interest revenue over the term of the new loan. Direct loan origination fees and origination or acquisition costs applicable to real estate loans are amortized over the lives of the loans as adjustments to interest income. The accrual of interest on all these instruments is stopped when there is concern as to the ultimate collection of principal or interest, which is generally a delinquency of 30 days in required payments of interest or principal. Any payments received on such non-accrual loans are recorded as interest income when the payments are received. Real estate loan assets are reclassified as accrual-basis once interest and principal payments become current. Certain real estate loan assets include limited purchase options and exit fees or additional interest payments that are due the Company at maturity or in the event of a sale of the property or refinancing of the loan by the borrower to a third party. If the Company purchases the subject property, any accrued exit fee will be treated as additional consideration for the acquired project.

Promotional fees received from service providers at the Company’s properties are deferred and recognized on a straight-line basis over the term of the agreement.

The PAC Rewards program, implemented in the first quarter of 2012, allows residents to accumulate reward points on a monthly basis for actions such as resident referrals and making rent payments online. A resident must rent an apartment from the Company for at least 14 months before reward points may be redeemed for services or upgrades to a resident’s unit. The Company accrues a liability for the estimated cost of these future point redemptions, net of a 35% breakage fee, which is the Company’s current estimate of rewards points that will not be redeemed. In accordance with Staff Accounting Bulletin 13.A.3c, the Company deems its obligations under PAC Rewards as inconsequential to the delivery of services according to the lease terms. Therefore, the expense related to the PAC Rewards Program is included in property operating and maintenance expense on the consolidated statements of operations.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with guidance provided by ASC 505, Equity-Based Payments to Non-Employees and ASC 718, Stock Compensation. We calculate the fair value of equity compensation instruments at the date of grant based upon estimates of their expected term, the expected volatility of and dividend yield on our Common Stock over this expected term period and the market risk-free rate of return. We will also estimate forfeitures of these instruments and accrue the compensation expense, net of estimated forfeitures, over the vesting period(s). We record the fair value of restricted stock awards based upon the closing stock price on the trading day immediately preceding the date of grant.

Acquisition Costs

The Company expenses property acquisition costs as incurred, which include costs such as due diligence, legal, certain accounting, environmental and consulting, when the acquisition constitutes a business combination. The Company capitalizes these costs for transactions deemed to be asset acquisitions.

Capitalization and Depreciation

The Company capitalizes replacements of furniture, fixtures and equipment, as well as carpet, appliances, air conditioning units, certain common area items, and other assets. Significant repair and renovation costs that improve the usefulness or extend the useful life of the properties are also capitalized. These assets are then depreciated on a straight-line basis over their estimated useful lives, as follows:

•Buildings 30 - 40 years

•Furniture, fixtures & equipment 5 - 10 years

•Improvements to buildings and land 5 - 10 years

Operating expenses related to unit turnover costs, such as carpet cleaning, mini-blind replacements, and minor repairs are expensed as incurred.

Discontinued Operations

The Company evaluates all disposal groups for held-for-sale classification and for those disposal groups for which it will have no continuing involvement, nor receipt of cash flows post-disposal, for presentation in the consolidated financial statements according

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

to criteria provided by ASC 360-10-45-9. If the disposal group meets the criteria necessary for held for sale classification, the assets and liabilities to be transferred upon sale or disposal are summarized into single line items entitled property held for sale on the consolidated balance sheets, and the results of operations are reclassified into a single line entitled gain/loss from discontinued operations on the consolidated statements of operations. Previous periods are similarly reclassified for comparability.

Income Taxes

The Company has elected to be taxed as a REIT under the Code. To continue to qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of the Company's annual REIT taxable income to its stockholders (which is computed without regard to the dividends paid deduction or net capital gain which does not necessarily equal net income as calculated in accordance with GAAP). As a REIT, the Company generally will not be subject to federal income tax to the extent it distributes qualifying dividends to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially adversely affect the Company's net income and net cash available for distribution to stockholders. The Company intends to operate in such a manner as to maintain its election for treatment as a REIT.

The Company recognizes a liability for uncertain tax positions. An uncertain tax position is defined as a position taken or expected to be taken in a tax return that is not based on clear and unambiguous tax law and which is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The Company measures the tax benefits recognized based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income taxes.

Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net income or loss available to common stockholders by the weighted average number of shares of Common Stock outstanding for the period. Net income or loss attributable to common stockholders is calculated by deducting dividends due to preferred stockholders, as well as non-forfeitable dividends due to holders of unvested restricted stock, which are participating securities under the two-class method of calculating earnings per share. Diluted earnings (loss) per share is computed by dividing earnings or net loss available to common stockholders by the weighted average number of shares of Common Stock outstanding adjusted for the effect of dilutive securities such as share grants or warrants. No adjustment is made for potential Common Stock equivalents that are anti-dilutive during the period.

New Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-08 (“ASU 2014-08”), Reporting Discontinued Operations and Disclosures of Disposals of Components of Entity. Under this new guidance, a disposal of a component of an entity or a group of components of an entity shall only be reported in discontinued operations if the disposal represents a strategic shift that has, or will have, a major effect on an entity’s operations and financial results. ASU 2014-08 is to be applied prospectively for annual and interim periods beginning on or after December 31, 2014, with early adoption permitted. Early adoption is not permitted for assets that have previously been reported as held for sale in the consolidated financial statements. Therefore, application of this new guidance was not permitted for the Company’s Trail Creek multifamily community, which was reported as held for sale in the Company’s Annual Report on Form 10-K for the twelve-month period ended December 31, 2013.

3. Real Estate Assets

The Company's real estate assets consisted of six multifamily communities with 1,929 total units at March 31, 2014 and six multifamily communities with 1,693 total units at March 31, 2013. The acquired second phases of our Trail Creek and Summit Crossing communities (described below) are managed in combination with the initial phases of these communities, both of which were acquired in April 2011 and are therefore considered single properties. At March 31, 2014, the combined phases of our Trail Creek communities, which is comprised of 300 units, was classified as held for sale.

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

On February 12, 2014, the Company completed the acquisition of a 66,122 square foot retail shopping center in Woodstock, Georgia, or Woodstock Crossing, for $5,701,393, which approximated the fair value of the acquired assets.

The Company allocated the purchase price of Woodstock Crossing to the acquired assets and liabilities based upon their fair values, as follows:



Land	$	1,750,576
Buildings and Improvements	3,760,654
Escrow fund for improvements	226,830
Tenant improvements	39,447
In-place leases	245,850
Above market leases	30,051
Leasing costs	123,731
Below market leases	(450,310		)
Other liabilities	(25,436		)

Net assets acquired	$	5,701,393

The in-place leases, above market leases, legal fees and commissions, and below-market leases will be amortized over the remaining lease terms, which range from six months to ten years as of March 31, 2014. Woodstock Crossing contributed approximately $89,000 of revenue and $37,000 of net income to the Company's consolidated results for the three-month period ended March 31, 2014. See note 6 for details regarding the acquisition fee paid related to this transaction.

On January 23, 2013, the Company completed the acquisition of 100% of the membership interests of the following three entities from Williams Multifamily Acquisition Fund, LP, a Delaware limited partnership, or WMAF, an entity whose properties were also managed by Preferred Residential Management LLC.


•	Ashford Park REIT, Inc., the fee-simple owner of a 408-unit multifamily community located in Atlanta, Georgia, or Ashford Park, for a total purchase price of approximately $39.6 million, exclusive of assumed mortgage debt, acquisition-related and financing-related transaction costs.


•	Lake Cameron REIT, Inc., the fee-simple owner of a 328-unit multifamily community located in Raleigh, North Carolina, or Lake Cameron, for a total purchase price of approximately $30.5 million, exclusive of assumed mortgage debt, acquisition-related and financing-related transaction costs.


•	McNeil Ranch REIT, Inc., the fee-simple owner of a 192-unit multifamily community located in Austin, Texas, or McNeil Ranch, for a total purchase price of approximately $21.0 million, exclusive of assumed mortgage debt, acquisition-related and financing-related transaction costs.

Amortization of acquired intangible assets for the three-month period ended March 31, 2013 related to the Ashford Park, McNeil Ranch and Lake Cameron communities commenced on January 23, 2013, the date of acquisition. The intangible assets were amortized over a period ranging from the average remaining lease term, which was approximately six to twelve months, to the average remaining lease term plus the average estimated renewal period.

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

On December 4, 2013, pursuant to the approval of the investment committee of the board of directors, the Company entered into an exclusive marketing agreement with an outside firm to market for sale the combined phases of its Trail Creek multifamily community (Trail I and Trail II). The operating results of the community are classified as held for sale and are included in the line entitled income from discontinued operations on the consolidated statements of operations and are reported within the Company's multifamily communities segment. Effective on December 4, 2013, the Company ceased recording depreciation on the communities. The following is a summary of income from discontinued operations:



	Three months ended March 31,
	2014		2013
Property revenues	$	1,057,677	$	655,377
Property expenses	425,789		238,348
Interest expense	314,463		122,067
Depreciation and amortization	—		198,796
Income from discontinued operations	$	317,425	$	96,166

The Company recorded depreciation and amortization of tangible and intangible assets, excluding such charges for the combined Trail Creek multifamily community, as follows:



	Three months ended March 31,
	2014		2013
Depreciation:
Buildings and improvements	$	942,746	$	736,600
Furniture, fixtures, and equipment	951,665		793,472
	1,894,411		1,530,072
Amortization:
Acquired intangible assets	412,924		2,382,285
Website development costs	1,191		1,151
Total depreciation and amortization	$	2,308,526	$	3,913,508

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

4. Real Estate Loans, Notes Receivable, and Line of Credit

At March 31, 2014, our portfolio of real estate loans consisted of:

Project/Property

Location

Date of loan

Maturity date

Optional extension date

Total loan commitments

Approved senior loan held by unrelated third party

Current / deferred interest % per annum

⁽¹⁾

City Park

Charlotte, NC

9/6/2012

9/5/2017

N/A

10,000,000

18,600,000

8 / 6

City Vista

Pittsburgh, PA

8/31/2012

6/1/2016

7/1/2017

12,153,000

28,400,000

8 / 6

Madison - Rome

Rome, GA⁽²⁾

11/13/2012

10/15/2015

N/A

5,360,042

11,500,000

8 / 6

Lely

Naples, FL

3/28/2013

2/28/2016

2/28/2018

12,713,242

25,000,000

8 / 6

Crosstown Walk

Suburban Tampa, FL⁽³⁾

4/30/2013

11/1/2016

5/1/2018

10,962,000

25,900,000

8 / 6

Overton

Atlanta, GA

5/8/2013

11/1/2016

5/1/2018

16,600,000

31,700,000

8 / 6

Haven West

Carrollton, GA ^{(4) (6)}

7/15/2013

6/2/2016

6/2/2018

6,940,795

16,195,189

8 / 6

Starkville

Starkville, MS ^{(5) (6)}

8/21/2013

5/31/2014

N/A

1,730,000

N/A

8 / 0

Founders' Village

Williamsburg, VA

8/29/2013

8/29/2018

N/A

10,346,000

26,936,000

8 / 6

Encore

Atlanta, GA ⁽⁷⁾

11/18/2013

8/18/2014

N/A

16,026,525

N/A

8 / 2

Manassas

Northern VA ⁽⁸⁾

12/23/2013

5/31/2014

N/A

10,932,000

N/A

8 / 5

Irvine

Irvine, CA ⁽⁹⁾

12/18/2013

5/31/2014

N/A

16,250,000

N/A

8.5 / 4.3

130,013,604

⁽¹⁾

All loans are mezzanine loans pertaining to developments of multifamily communities, except as otherwise indicated. The borrowers for each of these projects are as follows: "City Park" - Oxford City Park Development LLC; "City Vista" - Oxford City Vista Development LLC; "Madison - Rome" - Madison Retail - Rome LLC; "Lely" - Lely Apartments LLC; "Crosstown Walk" - Iris Crosstown Partners LLC; "Overton" - Newport Overton Holdings, LLC; "Haven West" - Haven Campus Communities Member, LLC; "Starkville" - Haven Campus Communities - Starkville, LLC; "Founders' Village" - Oxford NTW Apartments LLC; "Encore" - GP - RV Land I, LLC; "Manassas" - Oxford Palisades Apartments LLC; and "Irvine" - 360 - Irvine, LLC.

⁽²⁾

Madison-Rome is a mezzanine loan for an 88,351 square foot retail development project. On October 16, 2013, the anchor tenant obtained a certificate of occupancy and took possession of approximately 54,340 square feet of space.

⁽³⁾

Crosstown Walk was a land acquisition bridge loan that was converted to a mezzanine loan in April 2013.

⁽⁴⁾

Planned 568 bed student housing community adjacent to the University of West Georgia campus.

⁽⁵⁾

A land acquisition loan which pays 8% current interest only, in support of a planned 168-unit, 536-bed student housing community adjacent to the Mississippi State University campus.

⁽⁶⁾

See note 6 - Related Party Transactions.

⁽⁷⁾

Bridge loan of up to approximately $16.0 million to partially finance the acquisition of land and predevelopment costs for a 340-unit multifamily community in Atlanta, Georgia.

⁽⁸⁾

Bridge loan of up to approximately $10.9 million to partially finance the acquisition of land and predevelopment costs for a 304-unit multifamily community in Northern Virginia.

⁽⁹⁾

Bridge loan of up to approximately $16.3 million to partially finance the acquisition of land and predevelopment costs for a 280-unit multifamily community in Irvine, California.

The Company's real estate loans are collateralized by 100% of the membership interests of the underlying project entity, and, where necessary, by unconditional joint and several repayment guaranties and performance guaranties by the principal(s) of the borrower. These guaranties generally remain in effect until the receipt of a final certificate of occupancy. All of the guaranties are subject to the rights held by the senior lender pursuant to a standard intercreditor agreement. The Starkville, Encore, Manassas and Irvine loans are also collateralized by the acquired land. The Haven West loan is additionally collateralized by an assignment by the developer of security interests in an unrelated project. Prepayment of the mezzanine loans are permitted in whole, but not in part, without the Company's consent.

Management monitors the level of credit quality for each of the Company's mezzanine real estate loans by tracking the timeliness of scheduled interest and principal payments relative to the due dates as specified in the loan documents, as well as draw requests on the

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

loans relative to the project budgets. In addition, management monitors the actual progress of development and construction relative to the construction plan, as well as local, regional and national economic conditions as may bear on our current and target markets. The credit quality of the Company’s borrowers is primarily based on their payment history on an individual loan basis, and as such, the Company does not assign quantitative credit value measures or categories to its real estate loans and notes receivable in credit quality categories.



	As of March 31, 2014									Carrying amount as of
	Amount drawn		Loan Fee received from borrower - 2%		Acquisition fee paid to Manager - 1%		Unamortized deferred loan fee revenue			March 31, 2014		December 31, 2013
Project/Property	Amount drawn		Loan Fee received from borrower - 2%		Acquisition fee paid to Manager - 1%		Unamortized deferred loan fee revenue			March 31, 2014		December 31, 2013

City Park	$	10,000,000	$	200,000	$	100,000	$	(65,810	)	$	9,934,190	$	9,928,017
City Vista	12,153,000		243,040		121,520		(81,941		)	12,071,059		12,063,939
Madison - Rome	5,360,042		107,201		53,600		(31,317		)	5,328,725		5,322,770
Lely	11,721,229		254,265		127,133		(75,839		)	11,645,390		11,402,372
Crosstown Walk	10,247,119		219,240		109,620		(42,398		)	10,204,721		9,997,245
Overton	14,911,166		332,079		166,040		(111,216		)	14,799,950		14,487,178
Haven West	6,543,076		138,816		69,408		(49,009		)	6,494,067		5,582,018
Starkville	1,590,600		34,600		17,300		(3,134		)	1,587,466		1,582,750
Founders' Village	9,033,839		197,320		98,660		(79,317		)	8,954,522		7,572,698
Encore	8,772,524		320,531		160,265		(78,423		)	8,694,101		7,716,421
Manassas	10,707,000		214,140		107,070		—			10,707,000		10,609,849
Irvine	14,897,033		298,634		149,317		(55,015		)	14,842,018		14,332,658

	$	115,936,628	$	2,559,866	$	1,279,933	$	(673,419	)	$	115,263,209	$	110,597,915

The Company holds options, but not obligations, to purchase certain of the properties which are partially financed by its mezzanine loans, as shown in the table below. The option purchase prices are negotiated at the time of the loan closing.



	Purchase option window		Purchase option price		Total units upon completion
Project/Property	Begin	End	Purchase option price		Total units upon completion

City Park	11/1/2015	3/31/2016	$	30,945,845	284
City Vista	2/1/2016	5/31/2016	$	43,560,271	272
Madison - Rome	N/A	N/A	N/A		N/A
Lely	4/1/2016	8/30/2016	$	43,500,000	308
Crosstown Walk	7/1/2016	12/31/2016	$	39,654,273	342
Overton	7/8/2016	12/8/2016	$	51,500,000	294
Haven West	8/1/2016	1/31/2017	$	26,138,466	160
Starkville	N/A	N/A	N/A		168
Founders' Village	2/1/2016	9/15/2016	$	44,266,000	247
Encore	N/A	N/A	N/A		340
Manassas	N/A	N/A	N/A		304
Irvine	N/A	N/A	N/A		280

					2,999

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

At March 31, 2014, our portfolio of notes and line of credit receivable consisted of:

Borrower

Type of instrument

Date of loan

Maturity date

Total loan commitments

Amount drawn

Interest rate

360 Residential, LLC

Bridge loan

3/20/2013

12/31/2014

2,000,000

1,077,035

⁽¹⁾

TPKG 13th Street Development, LLC

Land acquisition loan

5/3/2013

8/1/2014

7,200,000

⁽²⁾

Preferred Capital Marketing Services, LLC

Promissory note

1/24/2013

1/23/2015

1,500,000

Riverview Associates, Ltd.

Promissory note

12/17/2012

12/16/2014

1,300,000

⁽³⁾

Pecunia Management, LLC

Subordinated loan

11/16/2013

11/15/2014

200,000

Oxford Contracting LLC

Promissory note

8/27/2013

4/30/2017

1,500,000

1,475,000

⁽⁴⁾

Preferred Apartment Advisors, LLC

Revolving credit line

8/21/2012

12/31/2015

9,500,000

7,794,718

⁽⁵⁾

23,200,000

20,546,753

⁽¹⁾ Amendment of the bridge loan which was originated on March 20, 2013. The amounts payable under the terms of the loan, which include an additional 6% deferred interest, are collateralized by guaranties of payment and performance by the principals of the borrower.

⁽²⁾Note pays current interest at 8% per annum, plus an additional interest amount necessary to provide the Company with a 14% cumulative simple rate of return through August 31, 2013, scaling upward to 20% per annum on January 1, 2014 and thereafter. The loan was amended on March 17, 2014 to extend the maturity date to August 1, 2014. The borrower paid deferred interest of $351,491 and repaid principal of $164,743 at the date of amendment. The note is collateralized by a pledge of 100% of the membership interests of the project as well as by a first mortgage on the property.

⁽³⁾The amounts payable under the terms of the loan are collateralized by an assignment of project documents and guaranties of payment and performance by the principal of the borrower.

⁽⁴⁾ The amounts payable under the terms of the loan are collateralized by a personal guaranty of repayment by the principals of the borrower.

⁽⁵⁾ The amounts payable under the credit line are collateralized by an assignment of the Manager's rights to fees due under the third amended and restated management agreement, or Management Agreement, between the Company and the Manager. On February 10, 2014, this instrument was amended to increase the commitment amount and extend the maturity date as shown.

The Company recorded interest income and other revenue from these instruments as follows:



	Three months ended March 31,
	2014		2013
Real estate loans:
Current interest payments	$	2,295,963	$	732,180
Additional accrued interest	1,514,161		442,989
Deferred loan fee revenue	308,457		27,311
Total real estate loan revenue	4,118,581		1,202,480
Interest income on notes and line of credit	607,168		109,450
Interest income on loans and notes receivable	$	4,725,749	$	1,311,930

The Company extends loans for purposes such as to partially finance the development of multifamily residential communities, to acquire land in anticipation of developing and constructing multifamily residential communities, and for other real estate or real estate related projects. Certain of these loans include characteristics such as exclusive options to purchase the project at a fixed price within a specific time window following project completion and stabilization, the rights to incremental exit fees over and above the amount of periodic interest paid during the life of the loans, or both. These characteristics can cause the loans to create variable interests to the Company and require further evaluation as to whether the variable interest creates a variable interest entity, or VIE, which would necessitate consolidation of the project. The Company considers the facts and circumstances pertinent to each entity borrowing under the loan, including the relative amount of financing the Company is contributing to the overall project cost, decision making rights or control held by the Company, guarantees provided by third parties, and rights to expected residual gains or obligations to absorb expected residual losses that could be significant from the project. If the Company is deemed to be the primary beneficiary of a VIE, consolidation treatment would be required.

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

The Company has evaluated its real estate loans, where appropriate, for accounting treatment as loans versus real estate development projects, as required by ASC 310. For each loan, the characteristics and the facts and circumstances indicate that loan accounting treatment is appropriate.

The Company's real estate loans partially finance the development activities of the borrowers' associated legal entities. Each of these loans create variable interests in each of these entities, and according to the Company's analysis, are deemed to be VIEs, due to the combined factors of the sufficiency of the borrowers' investment at risk, the existence of payment and performance guaranties provided by the borrowers, as well as the limitations on the fixed-price purchase options on the City Park, City Vista, Overton, Crosstown Walk, Lely, Haven West and Founders' Village loans. The Company has concluded that it is not the primary beneficiary of the borrowing entities. It has no decision making authority or power to direct activity, except normal lender rights, which are subordinate to the senior loans on the projects. Therefore, since the Company has concluded it is not the primary beneficiary, it has not consolidated these entities in its consolidated financial statements. The Company's maximum exposure to loss from these loans is their drawn amount as of March 31, 2014 of approximately $74.6 million. The maximum aggregate amount of loans to be funded as of March 31, 2014 was approximately $79.7 million.

The Company is subject to a concentration of credit risk that could be considered significant with regard to the Crosstown Walk, City Park, City Vista, Founders' Village and Manassas real estate loans and the promissory note to Oxford Contracting, LLC, as identified specifically by the two named principals of the borrowers, W. Daniel Faulk, Jr. and Richard A. Denny, and as evidenced by repayment guaranties offered in support of these loans. The drawn amount of these loans total approximately $53.6 million (with a total commitment amount of $55.9 million) and in the event of a total failure to perform by the borrowers and guarantors, would subject the Company to a total possible loss of that amount. The Company generally requires secured interests in one or a combination of the membership interests of the borrowing entity or the entity holding the project, guaranties of loan repayment, and project completion performance guaranties as credit protection with regard to its real estate loans, as is customary in the mezzanine loan industry. The Company has performed assessments of the guaranties with regard to the obligors' ability to perform according to the terms of the guaranties if needed and has concluded that the guaranties reduce the Company's risk and exposure to the above-described credit risk in place as of March 31, 2014.

The borrowers and guarantors behind the Crosstown Walk, City Park, City Vista, Founders' Village and Manassas real estate loans and the promissory note to Oxford Contracting, LLC collectively qualify as a major customer as defined in ASC 280-10-50, as the revenue recorded from this customer exceeded ten percent of the Company's total revenues. The Company recorded revenue from transactions with this major customer within its financing segment of approximately $1.9 million and $1.0 million for the three-month periods ended March 31, 2014 and 2013, respectively.

5. Redeemable Preferred Stock and Equity Offerings

The Company's Follow-on Offering is being offered by the dealer manager on a "reasonable best efforts" basis. Each share of Preferred Stock ranks senior to Common Stock and carries a cumulative annual 6% dividend of the stated per share value of $1,000, payable monthly as declared by the Company’s board of directors. Dividends begin accruing on the date of issuance. The Preferred Stock is redeemable at the option of the holder beginning two years following the date of issue subject to a 10% redemption fee. After year three the redemption fee decreases to 5%, after year four it decreases to 3%, and after year five there is no redemption fee. Any redeemed shares of Preferred Stock are entitled to any accrued but unpaid dividends at the time of redemption and any redemptions may be in cash or Common Stock, at the Company’s discretion. The Warrant is exercisable by the holder at an exercise price of 120% of the current market price per share of the Common Stock on the date of issuance of such warrant with a minimum exercise price of $9.00 per share. The current market price per share is determined using the volume weighted average closing market price for the 20 trading days prior to the date of issuance of the Warrant. The Warrants are not exercisable until one year following the date of issuance and expire four years following the date of issuance.

As of March 31, 2014, offering costs specifically identifiable to Unit offering closing transactions, such as commissions, dealer manager fees, and other registration fees, totaled approximately $9.1 million. These costs are reflected as a reduction of stockholders' equity at the time of closing. In addition, the costs related to the offering not related to a specific closing transaction totaled approximately $6.5 million. As of March 31, 2014, the Company had issued 101,581 Units and collected net proceeds of approximately $92.0 million from the Primary Series A Offering after commissions. A total of 95 shares of Series A Preferred Stock were subsequently redeemed. The number of Units issued was approximately 10.3% of the maximum number of Units anticipated to be issued under the Primary Series A Offering and the Follow-On Offering. Consequently, the Company cumulatively recognized approximately 10.3% of the approximate $6.5 million deferred to date, or approximately $660,000 as a reduction of stockholders' equity. The remaining balance of offering costs not yet reflected as a reduction of stockholder's equity, approximately

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

$6.1 million, are reflected in the asset section of the consolidated balance sheet as deferred offering costs at March 31, 2014. The remainder of current and future deferred offering costs related to the Follow-on Offering will likewise be recognized as a reduction of stockholders' equity in the proportion of the number of Units issued to the maximum number of Units anticipated to be issued. Offering costs not related to a specific closing transaction are subject to an overall cap of 1.5% of the total gross proceeds raised during the Unit offerings.

On January 17, 2013, the Company issued 40,000 shares of its Series B Preferred Stock at a purchase price of $1,000 per share through a private placement transaction. The net proceeds totaled approximately $37.6 million after commissions. On May 9, 2013, the common stockholders approved the issuance of Common Stock upon the conversion of the Series B Preferred Stock. As a result of such approval, the Series B Preferred Stock was converted into 5,714,274 shares of Common Stock on May 16, 2013.

On May 17, 2013, the Company filed a registration statement on Form S-3 (File No. 333-188677) for an offering up to $200 million of equity or debt securities, or Shelf Registration Statement, which was declared effective by the SEC on July 19, 2013. Deferred offering costs related to this Shelf Registration Statement totaled approximately $112,000 as of March 31, 2014. These costs will likewise be recognized as a reduction of stockholders' equity in the proportion of the proceeds from securities issued to the maximum amount of securities registered. During November 2013, we sold approximately 4.2 million shares of Common Stock and collected net proceeds of approximately $30.7 million, or 16.5% of the total amount of securities available for issuance under the Shelf Registration Statement. These offering costs related to the Shelf Registration Statement will likewise be recognized as a reduction of stockholders' equity in the proportion of the proceeds from securities issued to the maximum amount of securities registered.

On February 28, 2014, the Company filed a prospectus supplement to the Shelf Registration Statement to issue and sell up to $100 million of Common Stock from time to time in an "at the market" offering, or the ATM Offering, through MLV & Co. LLC as sales agent.

6. Related Party Transactions

John A. Williams, the Company's Chief Executive Officer and Chairman of the Board, and Leonard A. Silverstein, the Company's President and Chief Operating Officer and a member of the Board, are also executive officers and directors of NELL Partners, Inc., which controls the Manager. Mr. Williams is the Chief Executive Officer and President and Mr. Silverstein is the President and Chief Operating Officer of the Manager.

Mr. Williams, Mr. Silverstein and Michael J. Cronin, the Company's Executive Vice President, Chief Accounting Officer and Treasurer are executive officers of Williams Realty Advisors, LLC, or WRA, which is the manager of the day-to-day operations of Williams Opportunity Fund, LLC, or WOF, as well as Williams Realty Fund I, LLC, or WRF.

The Management Agreement entitles the Manager to receive compensation for various services it performs related to acquiring assets and managing properties on the Company's behalf:



		Three months ended
Type of Compensation	Basis of Compensation	March 31, 2014		March 31, 2013

Acquisition fees	1% of the gross purchase price of real estate assets acquired or loans advanced	$	68,056	$	1,062,574
Asset management fees	Monthly fee equal to one-twelfth of 0.50% of the total book value of assets, as adjusted	466,868		265,801
Property management fees	Monthly fee equal to 4% of the monthly gross revenues of the properties managed	262,121		187,642
General and administrative expense fees	Monthly fee equal to 2% of the monthly gross revenues of the Company	221,881		118,067

		$	1,018,926	$	1,634,084

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

In addition to property management fees, the Company incurred the following reimbursable on-site personnel salary and related benefits expenses at the properties, which are included in property operating and maintenance expense on the Consolidated Statements of Operations:

The Manager utilizes its own personnel and certain personnel of its affiliates to accomplish certain tasks related to raising capital that would typically be performed by third parties, including, but not limited to, legal and marketing functions. As permitted under the Management Agreement, the Manager requested reimbursement of $109,120 and $70,485 for the three-month periods ended March 31, 2014 and 2013, respectively. These costs are recorded as deferred offering costs until such time as additional closings occur on the Unit offerings or the Shelf Offering, at which time they are reclassified on a pro-rata basis as a reduction of offering proceeds within stockholders’ equity.

The Company's Haven West and Starkville real estate loans are supported in part by guaranties of repayment and performance by John A. Williams, Jr., a principal of the borrowers and a related party of the Company under GAAP, as our Chief Executive Officer's son.

In addition to the fees described above, the Management Agreement also entitles the Manager to other potential fees, as follows:


•	Disposition fees - Based on the lesser of (A) one-half of the commission that would be reasonable and customary; and (B) 1% of the sale price of the asset.


•	Construction, development, and landscaping fees - Customary and competitive market rates in light of the size, type and location of the asset.

Furthermore, the Manager holds the special limited partnership interest in the Operating Partnership, which entitles the Manager to distributions from the Operating Partnership equal to 15% of any net proceeds from the sale of a property that are remaining after the payment of (i) the capital and certain expenses related to all realized investments (including the sold asset), and (ii) a 7% priority annual return on such capital and expense; provided that all accrued and unpaid dividends on the Series A Preferred Stock have been paid in full.

The Company did not incur any of these other potential fees during the three-month periods ended March 31, 2014 or 2013.

7. Dividends and Distributions

The Company declares and pays monthly cash dividend distributions on its Series A Preferred Stock in the amount of $5.00 per share per month, prorated for partial months at issuance as necessary. The Company's cash distributions on its Series A Preferred Stock were:



2014				2013
Record date	Number of shares	Aggregate dividends declared		Record date	Number of shares	Aggregate dividends declared

January 31, 2014	89,313	$	454,344	January 31, 2013	19,732	$	107,551
February 28, 2014	93,005	468,337		February 28, 2013	23,094	119,885
March 31, 2014	98,200	497,855		March 28, 2013	25,755	132,603

	Total	$	1,420,536		Total	$	360,039

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

In addition, the Company declared on February 7, 2013 and paid a cash dividend on its Series B Preferred Stock at the same rate and frequency as those dividends declared on the Common Stock, equal to 5,714,274 as-converted shares of Common Stock, in an aggregate amount of $690,476.

The Company's dividend activity on its Common Stock for the three-month periods ended March 31, 2014 and 2013 was:



2014						2013
Record date	Number of shares	Dividend per share		Aggregate dividends paid		Record date	Number of shares	Dividend per share		Aggregate dividends paid
March 14, 2014	15,336,059	$	0.16	$	2,453,769	March 28, 2013	5,323,605	$	0.145	$	771,923

The holders of Class A OP Units of the Operating Partnership are entitled to equivalent distributions as those declared on the Common Stock. At March 31, 2014, the Company had 144,432 Class A OP Units outstanding, which are exchangeable on a one-for-one basis for shares of Common Stock or the equivalent amount of cash. On February 6, 2014, the Operating Partnership declared cash distributions to holders of Class A OP Units totaling $36,552, which were paid on April 22, 2014. On February 7, 2013, the Operating Partnership declared cash distributions to holders of Class A OP Units totaling $15,513, which were paid on April 25, 2013.

8. Equity Compensation

Stock Incentive Plan

On February 25, 2011, the Company’s board of directors adopted, and the Company’s stockholders approved, the Preferred Apartment Communities, Inc. 2011 Stock Incentive Plan, or, as amended, the 2011 Plan, to incentivize, compensate and retain eligible officers, consultants, and non-employee directors. Awards may be made in the form of issuances of Common Stock, restricted stock, stock appreciation rights (“SARs”), performance shares, incentive stock options, non-qualified stock options, or other forms. Eligibility for receipt of, amounts, and all terms governing awards pursuant to the 2011 Plan, such as vesting periods and voting and dividend rights on unvested awards, are determined by the Compensation Committee of the Company’s Board of Directors.

On May 9, 2013, the Company's stockholders approved the second amendment to the 2011 Plan, to increase the aggregate number of authorized shares of Common Stock authorized for issuance under the 2011 Plan to 1,317,500 and to extend the expiration date of the 2011 Plan to December 31, 2016.

Equity compensation expense by award type for the Company was:



	Three-month period ended March 31,				Unamortized expense as of March 31,
	2014		2013		2014

Quarterly board member committee fee grants	$	17,928	$	18,168	$	—
Class B Unit awards:
Executive officers - 2012	—		2,580		—
Executive officers - 2013	2,318		213,237		—
Executive officers - 2014	359,617		—		1,094,488
Vice chairman of board of directors	—		10,249		—
Restricted stock grants:
2012	—		64,687		—
2013	64,359		—		21,453

Total	$	444,222	$	308,921	$	1,115,941

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

Restricted Stock Grants

On May 9, 2013, the Company granted a total of 29,016 shares of restricted Common Stock to its independent board members, in payment of their annual retainer fees. The per-share fair value was $8.85 and total compensation cost in the amount of $256,792 will be recognized on a straight-line basis over the period ending on the earlier of first anniversary of the grant date or the next annual meeting of the Company's stockholders. On January 1, 2014, 1,957 shares of restricted stock from this grant were forfeited upon the transition of the vice chairman of the Company's board of directors from an independent director status to an employee of the Manager; 27,059 unvested shares from this grant were outstanding at March 31, 2014.

On January 1, 2014, the Company granted 2,178 shares of restricted Common Stock to a new independent board member, in pro-rata payment of his annual retainer fee. The per-share fair value was $8.04 and total compensation cost in the amount of $17,511 will be recognized on a straight-line basis over the period beginning on the date of grant and ending on the date of the next annual meeting of the Company's stockholders.

Directors’ Stock Grants

On February 7, 2013, the Company granted 2,115 shares of Common Stock to its independent board members, in payment of their quarterly meeting fees. The per-share fair value of this immediate-vesting award was $8.59, which was the closing price of the Common Stock on the prior business day. The total compensation cost of $18,168 was recorded in full at the grant date.

On February 6, 2014, the Company granted 2,241 shares of Common Stock to its independent board members, in payment of their quarterly meeting fees. The per-share fair value of this immediate-vesting award was $8.00, which was the closing price of the Common Stock on the prior business day. The total compensation cost of $17,928 was recorded in full at the grant date.

Class B OP Units

On January 2, 2013, pursuant to the limited partnership agreement of the Operating Partnership, the Company granted 142,046 Class B Units of the Operating Partnership, or Class B OP Units, to certain of its executive officers as compensation for service in 2013. On January 2, 2014, the Company granted 239,556 Class B OP Units for service to be rendered during 2014.

The Class B OP Units become Vested Class B OP Units at the Initial Valuation Date, which is one year from the date of grant. For each grant, on the Initial Valuation Date, the market capitalization of the number of shares of Common Stock at the date of grant is compared to the market capitalization of the same number of shares of Common Stock at the Initial Valuation Date. If the market capitalization measure results in an increase which exceeds the target market threshold, the Vested Class B OP Units become earned Class B OP Units and automatically convert into Class A OP Units of the Operating Partnership (as long as the capital accounts have achieved economic equivalence), which are henceforth entitled to distributions from the Operating Partnership and become exchangeable for Common Stock on a one-to-one basis at the option of the holder. Vested Class B OP Units may become Earned Class B OP Units on a pro-rata basis should the result of the market capitalization test be an increase of less than the target market threshold. Any Vested Class B OP Units that do not become Earned Class B OP Units on the Initial Valuation Date are subsequently remeasured on a quarterly basis until such time as all Vested Class B OP Units become Earned Class B OP Units or are forfeited due to termination of continuous service as an officer of the Company due to an event other than as a result of a qualified event, which is generally the death or disability of the holder. Continuous service through the final valuation date is required for the Vested Class B OP Units to qualify to become fully Earned Class B OP Units.

Because of the market condition vesting requirement that determines the transition of the Vested Class B OP Units to Earned Class B OP Units, a Monte Carlo simulation was utilized to calculate the total fair values, which will be amortized as compensation expense over the one-year periods beginning on the grant dates through the Initial Valuation Dates. On January 3, 2013, the 106,988 outstanding Class B OP Units for service provided during 2012 became fully vested and earned and automatically converted to Class A OP Units of the Operating Partnership. On January 2, 2014, 131,464 of the 142,046 outstanding Class B OP Units for 2013 became fully vested and earned and automatically converted to Class A OP Units of the Operating Partnership. The remaining 10,582 unvested 2013 Class B OP Units were outstanding at March 31, 2014.

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

The underlying valuation assumptions and results for the Class B OP Unit awards were:



Grant dates	1/2/2013			1/2/2014
Stock price	$	7.88		$	8.05
Dividend yield	7.36		%	8.12		%
Expected volatility	32.1		%	32.72		%
Risk-free interest rate	2.91		%	3.80		%

Derived service period (years)	1.0			1.0

Number of Units granted	142,046			239,556
Calculated fair value per Unit, assuming:
50% vesting	$	—		$	—
100% vesting	$	6.07		$	5.94

Total fair value of Units	$	862,219		$	1,422,963

Target market threshold increase	$	1,150,000		$	1,959,000

The expected dividend yield assumptions were derived from the Company’s closing prices of the Common Stock on the grant dates and the projected future quarterly dividend payments of $0.145 for the 2013 annual awards and $0.16 for the 2014 awards.

Since the Company has a limited amount of operating history in the public equity market, the expected volatility assumption was derived from the observed historical volatility of the common stock prices of a select group of peer companies within the REIT industry that most closely approximate the Company’s size, capitalization, leverage, line of business and geographic focus markets.

The risk-free rate assumptions were obtained from the Federal Reserve yield table and were calculated as the interpolated rate between the 20 and 30 years year yield percentages on U. S. Treasury securities on the grant dates.

Since the likelihood of attainment of the market condition for each of the Class B OP Units to become earned is believed to be high and the vesting period is one year, the forfeiture rate assumption for these Class B OP Units was set to 0%.

Since the Class B OP Units have no expiration date, a derived service period of one year was utilized, which equals the period of time from the grant date to the initial valuation date.

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

9. Indebtedness

Mortgage Notes Payable

The following table shows certain details regarding our mortgage notes payable:

Acquisition/

Principal balance as of

refinancing date

March 31, 2014

December 31, 2013

Maturity date

Interest rate

Trail Creek

6/25/2013

28,109,000

7/1/2020

Fixed

4.22%

⁽¹⁾

Stone Rise

4/15/2011

19,500,000

5/1/2018

1 month LIBOR+

2.77%

^{(2) (3)}

Summit Crossing

4/21/2011

20,862,000

5/1/2018

Fixed

4.71%

⁽²⁾

Summit II

12/31/2013

13,357,000

13,000,000

4/1/2021

Fixed

4.49%

⁽⁴⁾

Ashford Park

1/24/2013

25,626,000

2/1/2020

Fixed

3.13%

⁽⁵⁾

McNeil Ranch

1/24/2013

13,646,000

2/1/2020

Fixed

3.13%

⁽⁵⁾

Lake Cameron

1/24/2013

19,773,000

2/1/2020

Fixed

3.13%

⁽⁵⁾

Total

140,873,000

140,516,000

⁽¹⁾ Monthly payments of interest only are due through July 1, 2020, followed by monthly payments of accrued interest and principal based on a 30-year amortization period through the maturity date.

⁽²⁾ Monthly payments of interest only are due through May 1, 2014, followed by monthly payments of accrued interest and principal based on a 30-year amortization period through the maturity date.

⁽³⁾The variable monthly interest rate is capped at 7.25%. The embedded interest rate cap was deemed to be clearly and closely related to the debt host instrument.

⁽⁴⁾ On March 20, 2014, the Company refinanced the $13.0 million mortgage assumed in connection with the acquisition of the property, which occurred on December 31, 2013. Monthly interest only payments are due through March 1, 2020, followed by monthly payments of accrued interest and principal based on a 30-year amortization period.

⁽⁵⁾ Monthly payments of interest only are due through February 28, 2018, followed by monthly payments of accrued interest and principal based on a 30-year amortization period through the maturity date.

Credit Facility

The Company has a $40.0 million revolving credit facility with Key Bank National Association, or Key Bank, which is used to fund investments, capital expenditures, dividends (with consent of Key Bank), working capital and other general corporate purposes on an as needed basis.

The Credit Facility contains certain affirmative and negative covenants, including negative covenants that limit or restrict secured and unsecured indebtedness, mergers and fundamental changes, investments and acquisitions, liens and encumbrances, dividends, transactions with affiliates, burdensome agreements, changes in fiscal year and other matters customarily restricted in such agreements. The amount of dividends that may be paid out by the Company is restricted to a maximum of 95% of AFFO for the trailing rolling four quarters without the lender's consent; solely for purposes of this covenant, AFFO is calculated as earnings before interest, taxes, depreciation and amortization expense, plus reserves for capital expenditures, less normally recurring capital expenditures, less consolidated interest expense.

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

As of March 31, 2014, the Company was in compliance with all covenants related to the Credit Facility, as shown in the following table:



Covenant ⁽¹⁾	Requirement		Result
Senior leverage ratio	Maximum 60%		38.6%
Net worth	Minimum $160,000,000	⁽²⁾	$176,144,739
Debt yield	Minimum 8.25%		8.96%
Payout ratio	Maximum 95%	⁽³⁾	87.2%
Total leverage ratio	Maximum 65%		47.2%
Debt service coverage ratio	Minimum 1.50x		3.88x

⁽¹⁾All covenants are as defined in the credit agreement for the Credit Facility.

⁽²⁾Minimum $160 million, plus 75% of the net proceeds of any equity offering, which totaled $11,782,823 as of March 31, 2014.

⁽³⁾Calculated on a trailing four-quarter basis. For the twelve-month period ended March 31, 2014, the maximum dividends and distributions allowed under this covenant was $13,784,351.

Loan fees and closing costs for the establishment and subsequent amendments of the Credit Facility, as well as the mortgage debt on the Company's multifamily communities, are amortized over the lives of the loans. At March 31, 2014, aggregate unamortized loan costs were approximately $2.0 million, which will be amortized over a weighted average remaining loan life of approximately 5.6 years. The weighted average interest rate for the Credit Facility was 4.2% for the three-month period ended March 31, 2014.

Interest Expense

Interest expense, including amortization of deferred loan costs was:



	Three months ended March 31,
	2014		2013

Stone Rise	$	150,543	$	152,696
Summit Crossing	369,787		252,093
Ashford Park	213,501		166,779
McNeil Ranch	117,130		93,562
Lake Cameron	163,600		132,273

	1,014,561		797,403
Revolving credit facility	386,627		222,464
Interest expense	$	1,401,188	$	1,019,867

Preferred Apartment Communities, Inc.

Notes to Consolidated Financial Statements – (continued)

March 31, 2014

(Unaudited)

Future Principal Payments

The Company’s estimated future principal payments due on its debt instruments, including its line of credit as of March 31, 2014 were:



Period	Future principal payments
2014	$	32,416,789
2015	730,516
2016	754,131		</