<PAGE>   1
================================================================================

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549


                                   FORM 10-Q

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


                 For the quarterly period ended March 31, 1997


                         Commission file number 1-12452


                            AVALON PROPERTIES, INC.
             (Exact name of registrant as specified in its charter)

                         --------------------------

<TABLE>
<S>                                                                                                   <C>
Maryland                                                                                              06-1379111
(State or other jurisdiction of                                                                       (I.R.S. Employer
incorporation or organization)                                                                        Identification No.)
</TABLE>


                                 15 River Road
                           Wilton, Connecticut 06897
             (Address of principal executive offices) - (Zip Code)

                                 (203) 761-6500
              (Registrant's telephone number, including area code)

                         --------------------------




Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                              Yes   [X]    No [ ]




                     APPLICABLE ONLY TO CORPORATE ISSUERS:
                     -------------------------------------

Indicate the number of shares outstanding of each issuer's classes of common
stock as of the latest practicable date:


                36,281,838 shares outstanding as of May 5, 1997.

================================================================================
<PAGE>   2
                            AVALON PROPERTIES, INC.



                                     INDEX

<TABLE>
<CAPTION>
PART I         FINANCIAL INFORMATION

Item 1         Financial Statements                                                             Page
                                                                                                ----
<S>            <C>                                                                              <C>
               Condensed Consolidated Balance Sheets as of March 31, 1997
               and December 31, 1996  . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  1

               Condensed Consolidated Statements of Operations for the three months
               ended March 31, 1997 and 1996  . . . . . . . . . . . . . . . . . . . . . . . . .  2

               Condensed Consolidated Statements of Cash Flows for the three months
               ended March 31, 1997 and 1996  . . . . . . . . . . . . . . . . . . . . . . . . .  3

               Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . .  4

Item 2         Management's Discussion and Analysis of Financial Condition
               and Results of Operations  . . . . . . . . . . . . . . . . . . . . . . . . . . .  9

PART II        OTHER INFORMATION

Item 1         Legal Proceedings  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   23

Item 2         Changes in Securities  . . . . . . . . . . . . . . . . . . . . . . . . . . . .   23

Item 3         Defaults upon Senior Securities  . . . . . . . . . . . . . . . . . . . . . . .   23

Item 4         Submission of Matters to a Vote of Stockholders  . . . . . . . . . . . . . . .   23

Item 5         Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   23

Item 6         Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . .   23

               Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   24
</TABLE>
<PAGE>   3

PART I  FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

                            AVALON PROPERTIES, INC.
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                  (Unaudited)
                 (Dollars in thousands, except per share data)


<TABLE>
<CAPTION>
ASSETS                                                                                       3-31-97       12-31-96
                                                                                          ------------   ------------
<S>                                                                                       <C>           <C>
Real estate
   Land                                                                                   $   $188,982   $   169,079
   Buildings and improvements                                                                  841,749       754,545
   Furniture, fixtures and equipment                                                            29,635        27,455
                                                                                          ------------   ------------
                                                                                             1,060,366       951,079
      Less:  accumulated depreciation                                                          (50,784)      (44,547)
                                                                                          ------------   ------------
                                                                                             1,009,582       906,532
   Construction in progress (including land)                                                   113,069       130,827
                                                                                          ------------   ------------
            TOTAL REAL ESTATE, NET                                                           1,122,651     1,037,359

Cash and cash equivalents                                                                        3,036        14,241
Cash in escrow                                                                                   4,156         3,945
Resident security deposits                                                                       6,129         5,995
Investments in joint ventures                                                                    2,757         2,573
Deferred financing and other costs, net                                                          6,821         7,702
Deferred development costs, prepaid expenses and other assets                                   12,719        10,956
                                                                                          ------------   ------------
            TOTAL ASSETS                                                                  $  1,158,269   $ 1,082,771
                                                                                          ============   ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current maturities of long-term notes payable                                             $     24,241   $    24,335
Unsecured Facilities                                                                            76,500            --
Unsecured senior notes, 7-3/8% due 2002, net of unamortized discount                            99,875        99,869
Notes payable                                                                                  186,218       186,402
Payables for construction                                                                       11,122        12,613
Accrued expenses and other liabilities                                                          14,474        10,580
Accrued interest payable                                                                         3,000         4,342
Resident security deposits                                                                       7,373         6,642
                                                                                          ------------   ------------
            TOTAL LIABILITIES                                                                  422,803       344,783
                                                                                          ------------   ------------

Minority interest of unitholders in subsidiary operating partnership                               700            --
Stockholders' equity

   Preferred Stock, $.01 par value; 20,000,000 shares authorized;
      4,455,000 shares of 9% Series A Cumulative Redeemable Preferred Stock
        issued and outstanding (Aggregate liquidation preference of $111,375)                       45            45
      4,300,000 shares of 8.96% Series B Cumulative Redeemable Preferred Stock
        issued and outstanding (Aggregate liquidation preference of $107,500)                       43            43

   Common Stock, $.01 par value; 80,000,000 shares authorized;
      33,531,172 and 33,391,992 shares issued and outstanding at March  31, 1997
        and December 31, 1996, respectively                                                        335           334
   Additional paid-in capital                                                                  755,812       752,159
   Deferred compensation                                                                        (4,036)       (1,699)
   Distributions in excess of accumulated earnings                                             (17,433)      (12,894)
                                                                                          ------------   ------------
            STOCKHOLDERS' EQUITY                                                               734,766       737,988
                                                                                          ------------   ------------
            TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                    $  1,158,269   $ 1,082,771
                                                                                          ============   ============
</TABLE>

     See accompanying notes to condensed consolidated financial statements.

                                       1
<PAGE>   4
                            AVALON PROPERTIES, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (Unaudited)
                 (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                           Three months ended
                                                                       ---------------------------
                                                                         3-31-97        3-31-96
                                                                       ------------   ------------
<S>                                                                    <C>            <C>
Revenue:
   Rental income                                                       $    37,152    $    27,593
   Management fees                                                             255            402
   Other income                                                                120            113
                                                                       ------------   ------------
            Total revenue                                                   37,527         28,108
                                                                       ------------   ------------

Expenses:
   Operating expenses                                                       13,256         10,934
   Interest expense                                                          3,717          2,583
   Depreciation and amortization                                             6,560          4,654
   General and administrative expenses                                       1,109            963
                                                                       ------------   ------------
            Total expenses                                                  24,642         19,134
                                                                       ------------   ------------

Equity in income of joint ventures                                           1,042            166
Interest income                                                                275            238
Minority interest income                                                        94            164
                                                                       ------------   ------------
Net income before extraordinary item                                        14,296          9,542
Extraordinary item                                                          (1,183)            --
                                                                       ------------   ------------
Net income                                                                  13,113          9,542
Dividends attributable to preferred stock                                   (4,914)        (1,086)
                                                                       ------------   ------------
Net income available to common stockholders                            $     8,199    $     8,456
                                                                       ============   ============


Net income per weighted average
   common share outstanding (Note 2)                                   $      0.24    $      0.28
                                                                       ============   ============
</TABLE>


     See accompanying notes to condensed consolidated financial statements.


                                       2
<PAGE>   5
                            AVALON PROPERTIES, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (Unaudited)
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                                     Three months ended
                                                                               ---------------------------------
                                                                                  3-31-97            3-31-96
                                                                               --------------     --------------
<S>                                                                            <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
    Net income                                                                 $     13,113       $      9,542
    Adjustments to reconcile net income to
        cash provided by operating activities:
                Depreciation and amortization                                         6,560              4,654
                Equity in income of joint ventures                                      (17)               321
                Amortization of deferred compensation                                   248                 94
                Extraordinary item                                                    1,183                 --
               (Increase) decrease in resident security deposits,
                     net of related liability                                           597                (45)
                Increase in cash in escrow                                             (211)                (2)
                Increase in prepaid expenses
                      and other assets                                               (1,763)            (1,332)
                Increase (decrease) in accrued expenses, other liabilities
                     and accrued interest payable                                     2,803             (1,441)
                                                                               --------------     --------------
                     Total adjustments                                                9,400              2,249
                                                                               --------------     --------------
                     Net cash provided by operating activities                       22,513             11,791
                                                                               --------------     --------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
    Investment in joint venture                                                        (167)              (476)
    (Decrease) increase in construction payables                                     (1,491)             1,427
    Purchase and development of real estate                                         (90,775)           (76,806)
                                                                               --------------     --------------
                     Net cash used in investing activities                          (92,433)           (75,855)
                                                                               --------------     --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
    Issuance of common stock, net                                                       269             46,481
    Issuance of preferred stock, net                                                     --            107,581
    Dividends paid                                                                  (17,652)           (11,362)
    Repayments of notes payable                                                        (321)            (6,269)
    Borrowings under Unsecured Facilities                                            83,000             61,500
    Repayments of Unsecured Facilities                                               (6,500)          (119,500)
    Borrowings under construction loans                                                  --                 31
    Repayments of construction loans                                                     --            (10,507)
    Payments of deferred financing costs                                                (81)              (114)
                                                                               --------------     --------------
                     Net cash provided by financing activities                       58,715             67,841
                                                                               --------------     --------------
                     Net (decrease) increase in cash                                (11,205)             3,777
Cash and cash equivalents, beginning of period                                       14,241              1,801
                                                                               --------------     --------------

Cash and cash equivalents, end of period                                       $      3,036       $      5,578
                                                                               ==============     ==============

Cash paid during period for interest, net of amount capitalized                $      4,858       $      3,677
                                                                               ==============     ==============
</TABLE>



     See accompanying notes to condensed consolidated financial statements.

                                       3
<PAGE>   6
                            AVALON PROPERTIES, INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)
                 (Dollars in thousands, except per share data)


1.       Organization of the Company and Recent Developments

                 Avalon Properties, Inc. (the "Company") is a self-administered
         and self-managed Real Estate Investment Trust ("REIT"), as defined
         under the Internal Revenue Code of 1986 (as amended) and was
         incorporated under the General Corporation Law of Maryland on August
         24, 1993.  The Company is engaged principally in the development,
         construction, acquisition and operation of residential apartment
         communities in the Northeast and Mid-Atlantic regions of the United
         States.  Additionally, the Company provides management services for
         communities owned by unrelated parties.

                 On January 11, 1997, the Company acquired two apartment
         communities, Avalon at Ballston-Quincy and Vermont Towers, in
         Arlington, Virginia for a total purchase price of approximately
         $45,698 of which approximately $700 was paid in the form of
         partnership units exchangeable for shares of the Company's Common
         Stock (based on the market value of the Common Stock on the closing
         date of the acquisition).  One of these luxury, high-rise apartment
         communities contains 222 apartment homes; the other contains 232
         apartment homes.             

                 The Company contracted to purchase 16 acres of land in
         Alexandria, Virginia for an aggregate purchase price of $10,014. On
         January 15, 1997, the Company purchased the first seven acres of land
         in Alexandria, Virginia for $4,300 and acquired the remaining tracts
         in April 1997 (see Note 8). Construction of a new 460 apartment home
         community, Avalon at Cameron Court, commenced in the second quarter of
         1997.               

                 On February 24, 1997, the Company filed a shelf registration
         statement with the Securities and Exchange Commission covering up to
         $350,000 of securities.  The registration statement provides for the
         issuance of common stock, preferred stock, debt securities and
         warrants to purchase common stock.
                                 
                 On March 12, 1997, the Company purchased 8.29 acres of land in
         Quincy, Massachusetts for $950.  Construction of a new 171 apartment
         home community, Avalon at Faxon Park, commenced in the second quarter
         of 1997.         

                 On March 31, 1997, the Company obtained a new unsecured credit
         facility (the "Unsecured Facility") for $175,000. This new facility
         replaced the previous $165,000 unsecured credit facility.  The new
         three-year Unsecured Facility is provided by a consortium of six banks
         and is subject to an annual facility fee of $263.  Borrowings under
         the Unsecured Facility bear an interest rate of .8% over LIBOR, except
         that up to $75,000 can be competitively bid at lower pricing if market
         conditions allow.
                              



2.       Summary of Significant Accounting Policies

         Principles of Consolidation of the Company

                 The accompanying condensed consolidated financial statements
         include the accounts of the Company and its wholly-owned partnerships
         and subsidiaries.  All significant intercompany balances and
         transactions have been eliminated in consolidation.

         Real Estate

                 Buildings and improvements are recorded at cost and are
         depreciated on a straight-line basis over their estimated useful lives
         of 40 years.  The Company's policy is to annually assess any
         impairment





                                       4
<PAGE>   7
         in value by making a comparison of the current and projected operating
         cash flows of each of its communities over its remaining useful life,
         on an undiscounted basis, to the carrying amount of each community.
         Such carrying amounts would be adjusted, if necessary, to reflect an
         impairment in the value of the assets.  The cost of buildings and
         improvements include capitalized interest, property taxes and
         insurance incurred during the construction period.  Furniture and
         fixtures are stated at cost and depreciated over their estimated
         useful lives of seven years.  Expenditures for maintenance and repairs
         are charged to operations as incurred.  Significant renovations or
         betterments that exceed $15 and extend the economic useful life of an
         asset are capitalized and depreciated over seven years.

         Deferred Financing and Development Costs

                 Deferred financing costs include fees and costs incurred to
         obtain financings and are amortized on a straight-line basis over the
         shorter of the term of the loan or the related credit enhancement
         facility, if applicable.  Fees and other incremental costs incurred in
         developing new communities are capitalized as deferred development
         costs and are included in the cost of the community when construction
         commences. The accompanying condensed consolidated financial
         statements include a charge to expense for unrecoverable deferred
         development costs related to pre-development communities that may not
         proceed to development.

         Net Income per Common Share

                 Net income per common share for the three months ended March
         31, 1997 and 1996 is based upon 33,478,709 and 30,247,503 weighted
         average number of shares of common stock outstanding, respectively.

         Interim Financial Statements

                 These condensed consolidated financial statements are
         unaudited and were prepared pursuant to the rules and regulations of
         the Securities and Exchange Commission. However, in the opinion of
         management, all adjustments (consisting solely of normal recurring
         adjustments) necessary for a fair presentation of the financial
         statements have been included.  The operating results for these
         periods are not necessarily indicative of the operating results that
         may be attained for a full fiscal year.  The accompanying condensed
         consolidated financial statements should be read in conjunction with
         the consolidated financial statements included in the Company's Annual
         Report on Form 10-K for the fiscal year ended December 31, 1996.

         Recently Issued Accounting Pronouncement

                 In February 1997, the Financial Accounting Standard Board 
         issued SFAS No. 128, "Earnings per share" ("SFAS 128"), which
         simplified existing computational guidelines, revised disclosure
         requirements and icreases the comparability of earnings per share
         data. The impact of adoption of SFAS 128 on the Company's financial
         results is not expected to be significant. This statement is effective
         for financial statements for periods ending after December 31, 1997
         and requires restatement of all prior-period earnings per share data
         presented.

3.       Senior Participating Mortgage Note

                 The Company's ownership of the senior participating mortgage
         note related to the Town Arbor Partnership ("Avalon Arbor") has been
         accounted for as an investment in real estate.  Minority interest
         represents the excess of the interest income at the pay rate on the
         mortgage loan over the cash flow from operations generated by the
         community.  This excess is funded from payments drawn from an escrow
         account established from contributions by the minority partners.  At
         March 31, 1997, the partnership had $2,991 of cash from these
         contributions available to fund interest payments.  The note bears
         interest at 10.2%.  Upon acquisition, the note was restructured to
         provide for a 9% pay rate.  The difference between the stated interest
         and the pay rate is deferred interest and is added to the principal.
         The loan also provides for contingent interest of 50% of gross
         revenues, as defined, and is payable prior to any payments to the
         partners.  No contingent interest has been paid through March 31,
         1997.  The note entitles the holder to a 50% net residual value of the
         property at maturity or upon prior disposition of the property.  The
         note may be prepaid subject to stipulated penalties.

4.       Unsecured Facilities

                 The Company's Unsecured Facility is provided by a consortium
         of six banks that provides for $175,000 in short-term credit.  The
         Unsecured Facility expires on March 31, 2000.  As of March 31,





                                       5
<PAGE>   8
         1997, approximately $11,296 of available capacity was used to provide
         letters of credit and $48,500 was borrowed under the facility.
         Accordingly, the balance that remains available at March 31, 1997 to
         be drawn under the Unsecured Facility is $115,204.  The Unsecured
         Facility bears interest based upon a LIBOR, Prime or CD rate election
         at the Company's option.  The current pricing is LIBOR plus 80 basis
         points and may be adjusted higher or lower depending on the Company's
         senior unsecured debt ratings.

                 The Company's supplemental unsecured credit facility (the
         "Supplemental Unsecured Facility" and together with the Unsecured
         Facility, the "Unsecured Facilities") is provided by First Union
         National Bank in the amount of $35,000.  The Supplemental Unsecured
         Facility expires in January 1998 and bears a current interest rate of
         LIBOR plus .95%.  At March 31, 1997, $3,985 of available capacity was
         used to provide letters of credit and $28,000 was borrowed under the
         Supplemental Unsecured Facility.  Accordingly, the balance that
         remains available at March 31, 1997 to be drawn under the Supplemental
         Unsecured Facility is $3,015.  See Note 8 for subsequent event
         information pertaining to lower pricing and an agreement to increase
         the capacity, extend the expiration date and add a competitive bid
         option with respect to the Supplemental Unsecured Facility.

                 The weighted average effective interest rates (excluding the
         cost of unused line of credit fees) on borrowings under the Unsecured
         Facilities for the three months ended March 31, 1997 and 1996 were
         6.5% and 7.1%, respectively.  Including the cost of unused fees, the
         weighted average effective interest rates on borrowings under the
         Unsecured Facilities for the three months ended March 31, 1997 and
         1996 were 7.0% and 8.1%, respectively.


5.       Stockholders' Equity

                 The following summarizes the changes in stockholders' equity
         for the three months ended March 31, 1997:

<TABLE>
<CAPTION>
                                                                                      Distributions
                                                            Additional                in excess of
                                        Preferred  Common    paid-in      Deferred     accumulated
                                          Stock     Stock    capital    compensation    earnings      Total
                                        ---------  -------- ---------- --------------  ------------ ----------
<S>                                     <C>        <C>       <C>       <C>             <C>           <C>
Stockholders' equity, 12-31-96          $     88   $   334   $752,159  $      (1,699)  $   (12,894)  $737,988
Net income                                    --        --         --             --        13,113     13,113
Dividends declared                            --        --         --             --       (17,652)   (17,652)
Issuance of Restricted Common
   Stock                                      --         1      3,384             --            --      3,385
Deferred compensation,
   net of amortization                        --        --         --         (2,337)           --     (2,337)
Issuance of Common Stock                      --        --        269             --            --        269
                                        ---------  -------- ---------- --------------  ------------ ----------
Stockholders' equity, 3-31-97           $     88   $   335   $755,812  $      (4,036)  $   (17,433)  $734,766
                                        =========  ======== ========== ==============  ============ ==========
</TABLE>

6.       Investments in Joint Ventures

                 At March 31, 1997, investments in joint ventures consist of a
         50% general partnership interest in Falkland Partners, a 49% equity
         interest in Avalon Run, an 86.5% effective equity interest in Town
         Close Associates (the New Canaan Development Right) and 100% of the
         operating income from the anticipated Avalon Grove joint venture (a
         Development Community).  The following is a combined summary of the
         financial position of these joint ventures for the periods presented:





                                       6
<PAGE>   9

<TABLE>
<CAPTION>
                                            3-31-97       12-31-96
                                           ---------     ---------
<S>                                        <C>           <C>
Assets:
    Real estate, net                       $  96,541     $  92,835
    Other assets                               5,690         5,029
                                           ---------     ---------
Total assets                               $ 102,231     $  97,864
                                           =========     =========

Liabilities and partners' equity:
    Mortgage notes payable                 $  26,000     $  26,000
    Other liabilities                          3,565         3,786
    Partners' equity                          72,666        68,078
                                           ---------     ---------
Total liabilities and partners' equity     $ 102,231     $  97,864
                                           =========     =========
</TABLE>


                 At March 31, 1996, the investments in joint ventures include a
         50% general partnership interest in Falkland Partners, a 49% equity
         interest in Avalon Run and an 86.5% effective equity interest in Town
         Close Associates. The following is a combined summary of the operating
         results of these joint ventures for the periods presented:

<TABLE>
<CAPTION>
                                   Three months ended
                                 -----------------------
                                  3-31-97       3-31-96
                                 ---------     ---------
<S>                              <C>           <C>
Rental income                    $  3,373      $  2,342
Other income                           12            14
Operating expenses                 (1,128)         (987)
Mortgage interest expense            (196)         (199)
Depreciation and amortization        (571)         (408)
                                 ---------     ---------

     Net income                  $  1,490      $    762
                                 =========     =========
</TABLE>





7.       Extraordinary Item

                 In March 1997, the unamortized deferred financing costs
         associated with the early retirement of the Company's $165,000
         unsecured credit facility were written off.

8.       Subsequent Events

                 On April 7, 1997, pricing on the Company's Supplemental
         Unsecured Facility was reduced to .8% over LIBOR and, through an
         agreement that is subject to completion of documentation, a
         competitive bid option is to be added, the capacity is to be increased
         to $50,000 and the expiration date is to be extended to March 31,
         2000.

                 On April 15, 1997, the Company purchased the remaining nine
         acres of land relating to the development of Avalon at Cameron Court
         in Alexandria, Virginia for $5,714.

                 On April 17, 1997, the Company completed a direct placement of
         2,740,000 shares of its Common Stock to an institutional investor
         under its existing shelf registration statement at a purchase price of
         $27.375 per share.  Net cash proceeds of approximately $73,500 were
         used to retire indebtedness under the Company's Unsecured Facilities.

                 On April 18, 1997, the Company purchased the remaining 1.7
         acres of land relating to the Avalon Willow development in Mamaroneck,
         New York for $2,300.  This land is adjacent to a 2.3 acre parcel
         purchased in December 1996 and construction of a 227 apartment home
         community (Avalon Willow) on the entire four acre site commenced in
         the first quarter of 1997.





                                       7
<PAGE>   10
                 On April 28, 1997, the Company completed the loan closing
         related to the tax-exempt financing for the Avalon Fields apartment
         community.  The Community Development Administration of Maryland
         issued $12,088 of thirty-year fixed-rate bonds at an all-in rate of
         7.55%.  The net cash proceeds from the loan closing (approximately
         $11,565) were used to repay amounts outstanding under the Company's
         Unsecured Facilities.





                                       8
<PAGE>   11
PART I   FINANCIAL INFORMATION (CONTINUED)
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

       Certain statements in this Form 10-Q constitute "forward-looking
statements" as that term is defined under the Private Securities Litigation
Reform Act of 1995 (the "Reform Act").  The words "believe," "expect,"
"anticipate," "intend," "estimate," "assume" and other similar expressions
which are predictions of or indicate future events and trends and which do not
relate to historical matters identify forward-looking statements.  In addition,
information concerning construction, occupancy and completion of Development
Communities and Development Rights (as hereinafter defined) and related cost
and EBITDA estimates, are forward-looking statements.  Reliance should not be
placed on forward-looking statements because they involve known and unknown
risks, uncertainties and other factors, which are in some cases beyond the
control of the Company and may cause the actual results, performance or
achievements of the Company to differ materially from anticipated future
results, performance or achievements expressed or implied by such
forward-looking statements.

         Certain factors that might cause such differences include, but are not
limited to, the following:  The Company may abandon development opportunities;
construction costs of a community may exceed original estimates; construction
and lease-up may not be completed on schedule, resulting in increased debt
service expense and construction costs and reduced rental revenues; occupancy
rates and market rents may be adversely affected by local economic and market
conditions which are beyond management's control; financing may not be
available on favorable terms; the Company's cash flow may be insufficient to
meet required payments of principal and interest; and existing indebtedness may
not be able to be refinanced or the terms of such refinancing may not be as
favorable as the terms of existing indebtedness.

         The following discussion should be read in conjunction with the
condensed consolidated financial statements and notes thereto included
elsewhere herein.

RECENT DEVELOPMENTS

         Acquisitions of Existing Communities.  On January 11, 1997, the
Company acquired two apartment communities, Avalon at Ballston-Quincy and
Vermont Towers, in Arlington, Virginia for a total purchase price of
approximately $45,698,000 of which approximately $700,000 was paid in the form
of partnership units exchangeable for shares of the Company's Common Stock
(based on the market value of the Common Stock on the closing date of the
acquisition).  One of these luxury, high-rise apartment communities contains
222 apartment homes; the other contains 232 apartment homes.

         Land Acquisitions for New Development.  On January 15, 1997, the
Company purchased the first seven acres of land related to the Avalon at
Cameron Court community in Alexandria, Virginia for $4,300,000.  The remaining
nine acres were acquired on April 15, 1997 for $5,714,000.  Construction of
this new 460 apartment home community commenced in the second quarter of 1997.

         On March 12, 1997, the Company purchased 8.29 acres of land in Quincy,
Massachusetts for $950,000.  Construction of a new 171 apartment home
community, Avalon at Faxon Park, commenced in the second quarter of 1997.

         On April 18, 1997, the Company purchased the remaining 1.7 acres of
land relating to the Avalon Willow community in Mamaroneck, New York for
$2,300,000.  This land is adjacent to a 2.3 acre parcel purchased in December
1996 and construction of a 227 apartment home community (Avalon Willow) on the
entire four acre site commenced in the first quarter of 1997.

         Financing Activities.  On February 24, 1997, the Company filed a shelf
registration statement with the Securities and Exchange Commission covering up
to $350,000,000 of securities.  The registration statement provides for the
issuance of common stock, preferred stock, debt securities and warrants to
purchase common stock.





                                       9
<PAGE>   12
         On March 31, 1997, the Company obtained a new unsecured credit
facility (the "Unsecured Facility") for $175,000,000.  This new facility
replaced the previous $165,000,000 unsecured credit facility.  The new
three-year Unsecured Facility is provided by a consortium of six banks and is
subject to an annual facility fee of $262,500.  Borrowings under the Unsecured
Facility bear an interest rate of .8% over LIBOR.  A competitive bid option is
available for up to $75,000,000 which may result in lower pricing if market
conditions allow.

         On April 7, 1997, pricing on the Company's supplemental unsecured
credit facility (the "Supplemental Unsecured Facility" and together with the
Unsecured Facility, the "Unsecured Facilities") was reduced to .8% over LIBOR
and, through an agreement that is subject to completion of documentation, a
competitive bid option is to be added, the capacity is to be increased to
$50,000,000 and the expiration date is to be extended to March 31, 2000.

         On April 17, 1997, the Company completed a direct placement of
2,740,000 shares of its Common Stock to an institutional investor under its
existing shelf registration statement at a purchase price of $27.375 per share.
Net cash proceeds of approximately $73,500,000 were used to retire indebtedness
under the Company's Unsecured Facilities.

         On April 28, 1997, the Company completed the loan closing related to
the tax-exempt financing for the Avalon Fields apartment community.  The
Community Development Administration of Maryland issued $12,088,000 of
thirty-year fixed-rate bonds at an all-in rate of 7.55%.  The net cash proceeds
from the loan closing (approximately $11,565,000) were used to repay amounts
outstanding under the Company's Unsecured Facilities.

GENERAL

         The Company's operations consist of the development, construction,
acquisition and operation of apartment communities in the Mid-Atlantic and
Northeast regions of the United States.  At May 5, 1997, the Company owned 45
completed and operating communities, a general partnership interest in two
other communities (a 50% interest in Falkland Chase and a 49% interest in
Avalon Run) and a 100% interest in a senior participating mortgage note secured
by another community (Avalon Arbor) which is accounted for as an investment in
real estate.  The Company also has a fee simple ownership interest in 10
Development Communities.  One of the 10 Development Communities is subject to
an agreement to form a joint venture.

         The Company's real estate holdings consist exclusively of apartment
communities in various stages of the development cycle and can be divided into
three categories:

         "Current Communities" are apartment communities where construction is
         complete and the community has either reached stabilized occupancy or
         is in the initial lease-up process.  A "Stabilized Community" is a
         Current Community that has completed its initial lease-up and has
         attained a physical occupancy level of 94% or has been completed for
         one year, whichever occurs earlier.  An "Established Community" is a
         Current Community that has been a Stabilized Community with stabilized
         operating costs during the current and the beginning of the previous
         calendar year such that its year-to-date operating results are
         comparable between periods.

         "Development Communities" are communities that are under construction
         and may be partially complete and operating and for which a final
         certificate of occupancy has not been received.

         "Development Rights" are development opportunities in the very
         earliest phase of the development process for which the Company has an
         option to acquire land or owns land to develop a new community and
         where related pre-development costs have been incurred and capitalized
         in pursuit of these new developments.





                                       10
<PAGE>   13
RESULTS OF OPERATIONS

         The changes in operating results from period-to-period are primarily
the result of increases in the number of apartment homes owned due to the
development and acquisition of additional communities.  Where appropriate,
comparisons are made on a weighted average basis for the number of occupied
apartment homes in order to adjust for such changes in the number of apartment
homes.  For Stabilized Communities (excluding communities owned by joint
ventures), all occupied apartment homes are included in the calculation of
weighted average occupied apartment homes for each reporting period.  For
communities in the initial lease-up phase, only apartment homes of communities
that are completed and occupied are included in the weighted average number of
occupied apartment homes calculation for each reporting period.

         The analysis that follows compares the operating results of the
Company for the three months ended March 31, 1997 and 1996.

         Net income increased $3,571,000 (37.4%) to $13,113,000 for the three
months ended March 31, 1997 compared to $9,542,000 for the comparable period of
the preceding year.  The primary reasons for this increase are additional
operating income from communities developed or acquired during 1997 and 1996,
as well as growth in operating income from existing communities.

         Rental income increased $9,559,000 (34.6%) to $37,152,000 for the
three months ended March 31, 1997 compared to $27,593,000 for the comparable
period of the preceding year.  Of the increase for the three month period,
$8,779,000 was due to newly completed or acquired communities and $780,000 was
due to rental rate growth from Established Communities that were owned or
completed throughout the period.

         Overall Portfolio - The $9,559,000 increase in rental income for the
         three month period is primarily due to increases in the weighted
         average number of occupied apartment homes as well as an increase in
         the weighted average monthly rental income per occupied apartment
         home.  The weighted average number of occupied apartment homes
         increased from 10,231 apartment homes for the three months ended March
         31, 1996 to 12,045 apartment homes for the three months ended March
         31, 1997 as a result of the development and acquisition of new
         communities.  For the three months ended March 31, 1997, the weighted
         average monthly revenue per occupied apartment home increased $35
         (4.0%) to $911 compared to $876 for the comparable period of the
         preceding year.

         Established Communities - For the three months ended March 31, 1997,
         the weighted average monthly revenue per occupied apartment home
         increased $29 (3.3%) to $901 compared to $872 for the comparable
         period of the preceding year. The average economic occupancy decreased
         to 95.5% compared to 95.6% for the comparable period of the preceding
         year.  Accordingly, rental revenue from Established Communities
         increased $780,000 (3.2%) for the three month period ended March 31,
         1997, compared to the comparable period of the preceding year.

         Management fees decreased $147,000 (36.6%) to $255,000 for the three
months ended March 31, 1997 compared to $402,000 for the comparable period of
the preceding year.  The decrease for the three month period is due to a
decline in the number of apartment homes managed for third-party owners in the
first quarter of 1997. This decline is due to the sale and the cancellation of
management contracts of some third-party communities in 1996 as well as the
acquisition of one Current Community in the second quarter of 1996 that was
managed by the Company for third-party owners prior to its acquisition.
Management has decided not to aggressively pursue new fee management business
at this time.  New fee management business will be accepted in cases where it
is profitable and where it presents a possible acquisition opportunity.  This
creates a very selective environment under which new fee management business
will be added, and which the Company anticipates will likely result in an
overall decline in this revenue source in the future.

         Operating expenses increased $2,322,000 (21.2%) to $13,256,000 for the
three months ended March 31, 1997 compared to $10,934,000 for the comparable
period of the preceding year.





                                       11
<PAGE>   14
         Overall Portfolio - The $2,322,000 increase for the three month period
         is primarily due to the acquisition of new communities, as well as the
         completion of Development Communities whereby maintenance, property
         taxes, insurance and other costs are expensed as communities move from
         the initial construction and lease-up phase to the operating phase.

         Established Communities - Operating expenses decreased $40,000 (.5%)
         to $8,220,000 for the three months ended March 31, 1997 compared to
         $8,260,000 for the comparable period of the preceding year.  The
         decrease was concentrated in the maintenance and utilities categories
         as a result of the mild weather conditions throughout the Northeast
         and Mid-Atlantic regions during the first quarter of 1997, as compared
         to the severe winter weather experienced during the first quarter of
         1996.  This decrease was offset by increases in marketing and property
         taxes.

         Interest expense increased $1,134,000 (43.9%) to $3,717,000 for the
three months ended March 31, 1997 compared to $2,583,000 for the comparable
period of the preceding year.  This increase is primarily attributable to
higher outstanding balances under the Company's Unsecured Facilities in the
first quarter of 1997 compared to the first quarter of 1996.  In addition, the
Company assumed approximately $29,900,000 of conventional debt resulting from
the acquisitions of two communities in 1996.  This increase was offset by lower
interest and credit enhancement costs in connection with the completion of the
tax-exempt, credit enhancement facility with the Federal National Mortgage
Association ("Fannie Mae") in the third quarter of 1996 and lower pricing under
the Unsecured Facilities.

         Depreciation and amortization increased $1,906,000 (41.0%) to
$6,560,000 for the three months ended March 31, 1997 compared to $4,654,000 for
the comparable period of the preceding year.  This increase reflects additional
depreciation expense for recently acquired and developed communities, offset by
lower amortization expense due to the completion of the new credit enhancement
facility with Fannie Mae.

         General and administrative expenses increased $146,000 (15.2%) to
$1,109,000 for the three months ended March 31, 1997 compared to $963,000 for
the comparable period of the preceding year.  This increase is primarily due to
higher telecommunication costs and staff additions related to the
implementation of the company-wide systems enhancement program, as well as
higher compensation expense under the restricted stock grant program.  General
and administrative expenses as a percentage of total revenue, however,
decreased .4% to 3.0% for the three months ended March 31, 1997 compared the
same period a year ago.

         Equity in income of joint ventures increased $876,000 to $1,042,000
for the three months ended March 31, 1997 compared to $166,000 for the
comparable period of the preceding year.  This increase is principally the
result of the non-recurring income from the anticipated Avalon Grove joint
venture in which the Company is allocated 100% of the lease-up period income.

         Interest income increased $37,000 (15.5%) to $275,000 for the three
months ended March 31, 1997 compared to $238,000 for the comparable period of
the preceding year.  The increase is primarily due to higher average escrowed
cash balances in the first quarter of 1997 compared to the first quarter of
1996.

         Extraordinary item totaled $1,183,000 for the three months ended March
31, 1997 and reflects the write-off of unamortized deferred financing costs
associated with the early retirement of the $165 million unsecured credit
facility.

FUNDS FROM OPERATIONS

         Management generally considers Funds from Operations ("FFO") to be an
appropriate measure of the operating performance of the Company.  The Company
believes that in order to facilitate a clear understanding of the operating
results of the Company, Funds from Operations should be examined in conjunction
with net income as presented in the condensed consolidated financial statements
included elsewhere in this report.  Funds from Operations is determined in
accordance with a resolution adopted by the Board of Governors of the National
Association of Real Estate Investment Trusts, Inc. ("NAREIT"), and is defined
as net income (loss) (computed in accordance with generally accepted accounting
principles), excluding gains (or losses) from debt restructuring and





                                       12
<PAGE>   15
sale of property, plus depreciation of real estate assets and after adjustments
for unconsolidated partnerships and joint ventures.

  ANALYSIS OF FUNDS FROM OPERATIONS ($ in 000's)

<TABLE>
<CAPTION>
                                                              Three months ended
                                                           ---------------------------
                                                              3-31-97         3-31-96 
                                                           ------------    -----------
  <S>                                                      <C>            <C>        
  NET INCOME                                               $    13,113     $     9,542
                                                                                      
     Depreciation (real estate related)                          6,138           4,038
     Joint venture adjustment                                       81              79
     Extraordinary item                                          1,183              --
     Preferred stock dividends                                  (4,914)         (1,086)
                                                           ------------    -----------
  FUNDS FROM OPERATIONS                                    $    15,601     $    12,573
                                                           ============    ===========
                                                                                      
  WEIGHTED AVERAGE SHARES OUTSTANDING                       33,478,709      30,247,503
                                                           ============    ===========
                                                                                      
  OTHER CAPITALIZED EXPENDITURES AND OTHER INFORMATION                                
     Capital expenditures:                                                            
         Community level (1)                               $       439     $       353
         Corporate level (2)                               $       263     $       510
     Loan principal amortization payments                  $       321     $       124
     Capitalized deferred financing costs (3)              $        81     $       114
</TABLE>




---------------------
  Footnotes to Analysis of Funds from Operations

(1) The Company expenses all recurring non-revenue generating community
    expenditures, including carpet and appliance replacements.  See 
    "Capitalization of Fixed Assets and Community Improvements."

(2) Represents the cost of new office equipment and computer costs related to
    the implementation of a company-wide systems enhancement plan.

(3) Substantially all of the deferred financing costs incurred for the three
    months ended March 31, 1997 relate to the costs incurred on the closing 
    of the Avalon Fields tax-exempt bonds.





                                       13
<PAGE>   16
CAPITALIZATION OF FIXED ASSETS AND COMMUNITY IMPROVEMENTS

         The Company maintains a policy with respect to capital expenditures
that generally provides that only non-recurring expenditures are capitalized.
Improvements and upgrades are capitalized only if the item exceeds $15,000,
extends the useful life of the asset and is not related to making an apartment
home ready for the next resident. Under this policy, virtually all capitalized
costs are non-recurring, as recurring make ready costs are expensed as
incurred, including costs of carpet and appliance replacements, floor
coverings, interior painting and other redecorating costs.  Purchases of
personal property (such as computers and furniture) are capitalized only if the
item is a new addition (i.e., not a replacement) and only if the item exceeds
$2,500.  The application of these policies for the three months ended March 31,
1997 resulted in capitalized expenditures for Stabilized Communities of
approximately $39 per apartment home.  For the three months ended March 31,
1997, the Company charged to maintenance expense, including carpet and
appliance replacements, a total of approximately $2,405,000 for Stabilized
Communities or $212 per apartment home.  Management anticipates that
capitalized costs per apartment home will gradually rise as the Company's
portfolio of communities matures.  The table on the following page is a summary
of expenditures for both recurring maintenance costs (expensed) and community
upgrades (capitalized) for the three months ended March 31, 1997.





                                       14
<PAGE>   17
 EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES (CAPITALIZED) AND COMMUNITY
                            MAINTENANCE (EXPENSED)
                  (Dollars in thousands, except per home data)

<TABLE>
<CAPTION>
                                                                                         Q1 1997                     Q1 1997  
                                                                                  Capitalized Upgrades        Maintenance Expensed
                                         Number     Balance at    Balance at    ------------------------    -----------------------
              Community                 of Homes   12/31/96 (1)  03/31/97 (1)      Total      Per Home        Total       Per Home
--------------------------------       ----------  -------------  -------------  ----------  -----------    ----------   ----------
<S>                                       <C>      <C>            <C>            <C>          <C>           <C>           <C>
STABILIZED                                                                                                                  
----------
Avalon Watch                                 512   $    28,340    $   28,351     $       11   $       21    $       91   $   178
Avalon Pavilions                             932        56,523        56,533             10           11           133       143
Avalon Glen                                  238        30,077        30,077             --           --            62       261
Avalon Walk I                                430        34,505        34,505             --           --            67       156
Avalon Walk II                               334        23,597        23,597             --           --            62       186
Avalon View                                  288        17,773        17,773             --           --            95       330
Avalon Park                                  372        19,717        19,722              5           13            96       258
Avalon at Ballston - Washington Towers       344        36,797        36,884             87          253            65       189
Avalon Farm                                  306        17,332        17,345             13           42            71       232
Avalon at Gayton                             328         9,830         9,842             12           37            60       183
Avalon at Hampton I                          186         3,702         3,706              4           22            46       247
Avalon at Hampton II                         231         8,144         8,180             36          156            52       225
Avalon at Dulles                             236        11,599        11,607              8           34            57       242
Avalon Knoll                                 300         7,905         7,911              6           20            80       267
Avalon Lea                                   296        16,101        16,101             --           --            62       209
Avalon at Fairway Hills I                    192         9,368         9,369              1            5            39       203
Avalon Ridge                                 432        25,030        25,048             18           42            87       201
Avalon at Symphony Glen                      174         8,079         8,079             --           --            43       247
Avalon at Park Center                        492        37,337        37,339              2            4            96       195
4100 Mass. Avenue                            308        34,879        34,879             --           --            85       276
Avalon Woods                                 268         8,235         8,265             30          112            34       127
Avalon at Carter Lake                        259        11,502        11,502             --           --            73       282
Avalon Pointe                                140         7,748         7,757              9           64            34       243
Avalon Landing                               158         9,261         9,278             17          108            46       291
Avalon Birches                               312        13,419        13,419             --           --            54       173
Avalon at Lake Arbor                         209        11,900        11,902              2           10            47       225
Avalon at Decoverly                          368        30,978        30,979              1            3            66       179
Avalon Summit                                245        16,152        16,246             94          384            54       220
Avalon Towers                                109        15,826        15,826             --           --            44       404
Longwood Towers                              250        16,620        16,623              3           12           100       400
Avalon Fields                                192        14,262        14,262             --           --            33       172
Avalon West                                  120        10,624        10,655             31          258            27       225
Avalon Chase                                 360        23,615        23,618              3            8            93       258
Avalon Pines                                 174         8,578         8,578             --           --            24       138
Avalon at Fairway Hills II                   527        33,807        33,823             16           30           102       194
Avalon at Boulders                           284        16,038        16,039              1            4            58       204
AutumnWoods                                  420        30,474        30,493             19           45            67       160
                                       ----------  -------------  -------------  ----------  -----------   -----------    ---------
                                          11,326       715,674       716,113            439           39         2,405       212
                                       ----------  -------------  -------------  ----------  -----------   -----------    ---------
                                                                                                                            
NEWLY ACQUIRED/DEVELOPED                                                                                                    
------------------------
Avalon Run East                              206        16,002        16,041             39          189            21       102
Avalon Station                               223        11,838        11,936             98          439            40       179
Avalon Cove                                  504        85,831        88,598          2,767        5,490            19        38
Avalon Crossing                              132        13,387        13,638            251        1,902            27       205
Avalon at Ballston - Vermont/Quincy (2)      454            --        46,700         46,700      102,863            81       178
                                       ----------  -------------  -------------  ----------  -----------   -----------   ----------
                                           1,519       127,058       176,913         49,855       N/A              188       124
                                       ----------  -------------  -------------  ----------  -----------   -----------   ----------
                                                                                                                            
NEW DEVELOPMENTS                           3,464       174,188       212,699         38,510       11,117            29       N/A
----------------     
OTHER                                                                                                                       
Avalon at Lexington                          198        14,117        14,325            208 (3)    1,051            45       227
Longwood Towers - Renovation                  --         6,829         8,860          2,031 (4)       --            --        --
Avalon Green                                 105        12,294        12,368             74          705            44       419
Avalon Arbor (5)                             302        27,822        27,970            148          490            87       288
Corporate Level Expenditures                  --         3,924         4,187            263           --            --        --
                                                                                                                            
                                       ----------  -------------  -------------  ----------  -----------    ----------   ----------
Grand Total                               16,914(6) $1,081,906    $1,173,434     $   91,528          N/A    $    2,798       N/A
                                       ==========  =============  =============  ==========  ===========    ==========   ==========
</TABLE>

------------------
(1) Costs are presented in accordance with generally accepted accounting
    principles ("GAAP") and exclude the step-up in basis attributed to 
    continuing investors.

(2) Acquired in 1997.

(3) Payment of contingent land cost to land seller based on operating results.
    This is the complete and final contingent payment due under the land 
    purchase agreement.

(4) Represents renovation costs incurred.

(5) Ownership through ownership of the Avalon Arbor mortgage note.  See Note 3
    to the unaudited condensed consolidated financial statements.  Increases in
    capitalized value relate primarily to accrued interest and do not reflect
    capitalized community upgrades.

(6) Excludes Falkland Chase and Avalon Run, 876 apartment homes owned by joint
    ventures in which the Company holds a 50% interest and 49% interest,
    respectively.





                                       15
<PAGE>   18
LIQUIDITY AND CAPITAL RESOURCES

         Liquidity.  A primary source of liquidity to the Company is cash flows
from operations.  Operating cash flows have historically been determined by the
number of apartment homes, rental rates and the Company's expenses with respect
to such apartment homes.  Cash flows used in investing activities and provided
by financing activities have historically been dependent on the number of
apartment homes under active development and construction or that were acquired
during any given period.

         Cash and cash equivalents decreased from $5,578,000 at March 31, 1996
to $3,036,000 at March 31, 1997 due to an increase in the cash used by
investing activities (mainly attributable to an increase in the number of newly
developed and acquired communities).  Such increase funded by cash on hand and
increased operating cash flow and not by a corresponding increase in financing
activities.

                 Net cash provided by operating activities increased by
         $10,722,000 from $11,791,000 to $22,513,000 primarily due to an
         increase in operating income from newly developed and acquired
         communities and Established Communities.

                 Cash used in investing activities increased by $16,578,000
         from $75,855,000 to $92,433,000 primarily due to an increase in the
         number of apartment homes under development from an average of 2,900
         in the first quarter of 1996 to 3,400 in 1997.

                 Net cash provided by financing activities decreased by
         $9,126,000 from $67,841,000 to $58,715,000 primarily due to the net
         proceeds received from the sale of 2,227,000 shares of the Company's
         Common Stock and the sale of 4,455,000 shares of the Company's Series
         A cumulative redeemable Preferred Stock in the first quarter of 1996
         and an increase in dividends paid in the first quarter of 1997, offset
         by increased borrowings under Unsecured Facilities.

         The Company regularly reviews short-term liquidity needs and the
adequacy of Funds from Operations and other expected liquidity sources to meet
these needs.  The Company's primary short-term liquidity needs are to fund
normal recurring operating expenses, debt service payments and the minimum
dividend payment required to maintain the Company's REIT qualification under
the Internal Revenue Code.  Management anticipates that these needs will be
fully funded from cash flows provided by operating activities.  Normal
recurring expenditures for maintenance and repairs (including carpet and
appliance replacements) are funded from the operating cash flows of Stabilized
Communities and are expensed as incurred.  Major upgrades or community
improvements are capitalized and depreciated over the expected economic useful
life of the item only if the expenditure exceeds $15,000 per occurrence and
only if the expenditure extends the economic useful life of the community.
Purchases of personal property (such as computers and furniture) are
capitalized only if the item is a new addition (i.e., not a replacement) and
only if the item exceeds $2,500.  The application of these policies for the
three month period ended March 31, 1997 resulted in capitalized expenditures
for Stabilized Communities of $39 per apartment home.

         Permanent mortgage indebtedness will require balloon payments coming
due over the years 1997 to 2002, including $24,241,000 in 1997 and $100,000,000
in 2002.  Additionally, an aggregate of $44,655,000 principal amount of bonds
will require remarketing or have credit enhancements that will mature in the
fourth quarter of 1997.  Certain of these payments may be accelerated upon the
termination of credit enhancements if such credit enhancements are not renewed
or replaced. The Company believes that it will be able to successfully remarket
these bonds and obtain renewal or replacement credit enhancements.  Since
Management anticipates that only a small portion of the principal of such
indebtedness will be repaid prior to maturity and the Company may not have
funds on hand sufficient to repay such indebtedness, it may be necessary for
the Company to refinance this debt.  Such refinancing could be accomplished
through additional debt financing, which may be collateralized by mortgages on
individual communities or groups of communities, by uncollateralized private or
public debt offerings or by additional equity offerings.  There can be no
assurance that such additional debt financing or debt offerings will be
available on terms satisfactory to the Company.





                                       16
<PAGE>   19
         Capital Resources.  To sustain the Company's active development and
acquisitions program, continuous access to the capital markets is required.
Management intends to match the long-term nature of its real estate assets with
long-term cost effective capital.  The Company has demonstrated regular and
continuous access to the capital markets since its initial public offering,
raising approximately $717.8 million and over $431 million in the last 15 
months.  Management follows a focused strategy to help ensure uninterrupted 
access to capital.  This strategy includes:

1.  Hire, train and retain associates with a strong resident service focus,
    which should lead to higher rents, lower turnover and reduced operating
    costs;

2.  Manage, acquire and develop institutional quality communities with in-fill
    locations that should provide consistent, sustained earnings growth;

3.  Operate in markets with growing demand (as measured by household formation
    and job growth) and high barriers to entry.  These characteristics combine
    to provide a favorable demand-supply balance, creating a favorable
    environment for future rental rate growth while protecting existing and new
    communities from new supply.  This strategy is expected to result in a high
    level of quality to the revenue stream;

4.  Maintain a conservative capital structure largely comprised of equity and
    with modest, cost-effective leverage.  Secured debt will generally be
    avoided and used primarily to secure low cost, tax-exempt debt.  Such a
    structure should promote an environment for ratings upgrades that can lead
    to a lower cost of capital;

5.  Timely, accurate and detailed disclosures to the investment community;

6.  Conservative accounting practices that provide a high level of quality to
    reported earnings.

         Management believes that these strategies provide a disciplined
approach to capital access that is expected to ensure that capital resources
are available to fund portfolio growth.

         The following is a discussion of specific capital transactions,
arrangements and agreements that are important to the capital resources of the
Company.

Unsecured Facilities

         The Company's new three-year term Unsecured Facility (see "Financing
Commitments/Transactions Completed") is provided by a consortium of six banks
that provides for $175,000,000 in short-term credit.  At March 31, 1997,
$48,500,000 was borrowed, $11,296,000 was used to provide letters of credit and
$115,204,000 was available for borrowing under the Unsecured Facility.  The
Company will use borrowings under the Unsecured Facility for capital
expenditures, acquisitions of developed or undeveloped communities,
construction, development and renovation costs, credit enhancement for
tax-exempt bonds and for working capital purposes.

         The Company's Supplemental Unsecured Facility is provided by First
Union National Bank in the amount of $35,000,000.  The Supplemental Unsecured
Facility expires in January 1998 and bears an interest rate of LIBOR plus .95%.
At March 31, 1997, $3,985,000 of available capacity was used to provide letters
of credit, and $28,000,000 was borrowed under the Supplemental Unsecured
Facility.  Accordingly, the balance that remains available at March 31, 1997 to
be drawn under the Supplemental Unsecured Facility is $3,015,000.  See
Financing Commitments below for modifications to the Supplemental Credit
Facility.

Interest Rate Protection Agreements

         The Company is not a party to any long-term interest rate agreements.
The Company intends, however, to evaluate the need for long-term interest rate
protection agreements as interest rate market conditions dictate and has
engaged a consultant to assist in managing the Company's interest rate risks
and exposure.

Financing Commitments/Transactions Completed

         On March 31, 1997, the Company obtained a new unsecured credit
facility for $175,000,000.  This new facility replaced the previous
$165,000,000 unsecured credit facility.  The new three-year Unsecured Facility
is





                                       17
<PAGE>   20
provided by a consortium of six banks and is subject to an annual facility fee
of $262,500.  Borrowings under the new facility bear an interest rate of .8%
over LIBOR.  A competitive bid option is available for up to $75 million which
may result in lower pricing if market conditions allow.

         On April 7, 1997, pricing on the Company's Supplemental Unsecured
Facility was reduced to .8% over LIBOR and, through an agreement that is
subject to completion of documentation, a competitive bid option is to be
added, the capacity is to be increased to $50 million and the expiration date
is to be extended to March 31, 2000.

         On April 17, 1997, the Company completed a direct placement of
2,740,000 shares of its Common Stock to an institutional investor under its
existing shelf registration statement at a purchase price of $27.375 per share.
Net cash proceeds of approximately $73,500,000 were used to retire indebtedness
under the Company's Unsecured Facilities.

         On April 28, 1997, the Company completed the loan closing related to
the tax-exempt financing on the Avalon Fields community.  The Community
Development Administration of Maryland has issued approximately $12.1 million
of thirty-year fixed-rate bonds at an all-in rate of 7.55%.  The net cash
proceeds from the loan closing (approximately $11.6 million) were used to repay
amounts outstanding under the Company's Unsecured Facilities.

Registration Statements Filed in Connection with Financings

         On February 24, 1997, the Company filed a shelf registration statement
with the Securities and Exchange Commission covering up to $350,000,000 of
securities.  The registration statement provides for the issuance of common
stock, preferred stock, debt securities and warrants to purchase common stock.

Future Financing Needs

         Substantially all of the capital expenditures to complete the
communities currently under construction will be funded from the Unsecured
Facilities and/or issuance of debt or equity securities.  Except for Longwood
Towers, the Company has no present plans for any major capital improvements to
any of the Current Communities.  The renovation of Longwood Towers is being
funded by advances under the Unsecured Facilities, operating cash flow or other
financing sources over the next two to three years.  Management expects to
continue to fund deferred development costs related to future developments from
Funds from Operations and advances under the Unsecured Facilities.  The Company
believes that these sources of capital are adequate to take each of the
proposed communities to the point in the development cycle where construction
can commence.

         Management anticipates that available borrowing capacity under the
Unsecured Facilities and Funds from Operations will be adequate to meet future
expenditures required to commence construction of each of the Development
Rights.  In addition, the Company currently anticipates funding construction of
some (but not all) of the Development Rights under the expected remaining
capacity of the Unsecured Facilities. However, before the construction of a
Development Right commences, the Company intends, if necessary, to issue
additional equity or debt securities, arrange additional capacity under the
Unsecured Facilities or future credit facilities or obtain additional
construction loan commitments not currently in place to ensure that adequate
liquidity sources are in place to fund the construction of a Development Right,
although no assurance can be given in this regard.

         The table on the following page summarizes debt maturities for the
next five years (excluding the Unsecured Facilities):





                                       18
<PAGE>   21

                            AVALON PROPERTIES, INC.
                             DEBT MATURITY SCHEDULE
                             (Dollars in thousands)


<TABLE>
<CAPTION>
                                                       Balance Outstanding at                  Total Maturities
                                                       ----------------------  ---------------------------------------------------
                                  All-in     Maturity                          Balance    
      Community                Interest Rate   date      12/31/96  03/31/97    of 1987   1998    1999    2000    2001  Thereafter
---------------------------    ------------- ---------  ---------  --------   --------- ------- -------  -----  ----- ------------
<S>                                <C>         <C>      <C>        <C>        <C>       <C>     <C>     <C>     <C>      <C>
Tax-Exempt Bonds:                                                                                                        

    Fixed Rate                                                                                                           

  * Avalon Lea                 
      (Custodial Receipts)(1)       5.71%      Nov-07   $ 16,782   $ 16,798   $     --  $    -- $    --  $   --  $   --  $  16,798
  * Avalon Ridge               
      (Custodial Receipts)(1)       5.69%      Nov-07     26,724     26,751         --       --      --      --      --     26,751
  * Avalon at Dulles                7.04%      Jul-24     12,360     12,360         --       --      --      --      --     12,360
  * Avalon at Hampton II            7.04%      Jul-24     11,550     11,550         --       --      --      --      --     11,550
  * Avalon at Symphony Glen         7.06%      Jul-24      9,780      9,780         --       --      --      --      --      9,780
  * Avalon View                     7.55%      Aug-24     19,487     19,451        137      230     290     330     350     18,114
  * Avalon at Lexington             6.56%      Feb-25     15,284     15,232        161      226     240     255     271     14,079
  * Avalon Knoll                    6.95%      Jun-26     14,070     14,033        115      163     175     187     200     13,193
  * Avalon Landing                  6.85%      Jun-26      6,969      6,950         58       83      89      95     101      6,524
  * Avalon West                     7.73%      Dec-36      8,771      8,760         32       46      50      53      57      8,522
                                                        --------   --------   --------  ------- -------  ------  ------  ---------
                                                         141,777    141,665        503      748     844     920     979    137,671
    Variable Rate                                                                                                        

  * Avalon at Fairway Hills I                  Jun-26     11,500     11,500         --       --      --      --      --     11,500
  * Avalon at Hampton I                        Jun-26      8,060      8,060         --       --      --      --      --      8,060
  * Avalon Pointe                              Jun-26      6,387      6,387         --       --      --      --      --      6,387
                                                        --------   --------   --------  ------- -------  ------  ------  ---------
                                                          25,947     25,947         --       --      --      --      --     25,947
Conventional Loans:                                                                                                      

    Fixed Rate                                                                                                           

  * AutumnWoods                     9.25%      Nov-97     24,335     24,241     24,241       --      --      --      --         --
    Unsecured Senior Notes         7.375%      Sep-02     99,869     99,875         --       --      --      --      --     99,875
  * Avalon Pines                    8.00%      Dec-03      5,529      5,506         72      103     112     121     131      4,967
  * Avalon Walk II                  8.93%      Nov-04     13,149     13,100        136      202     221     241     264     12,036
                                                        --------   --------   --------  ------- -------  ------  ------  ---------
                                                         142,882    142,722     24,449      305     333     362     395    116,878
    Variable Rate-None                                        --         --         --       --      --      --      --         --
                                                        --------   --------   --------  ------- -------  ------  ------  ---------
Total notes payable -                                                                                                             
   excluding Unsecured Facilities                       $310,606   $310,334   $ 24,952  $ 1,053 $ 1,177  $1,282  $1,374  $ 280,496
                                                        ========   ========   ========  ======= =======  ======  ======  =========
</TABLE>


(1) Subject to remarketing November 1, 1997.

  * Indicates loan is collateralized.

                                       19
<PAGE>   22
BUSINESS CONDITIONS; INFLATION

         The Company's principal markets are characterized by high barriers to
entry and restrictive zoning and it often takes years to obtain entitlements to
build an apartment community.  For this reason, little new rental product has
been added in recent years.  For the markets north of Maryland, Management is
not aware of any significant level of planned apartment construction starts.
For the Washington, D.C. metropolitan area, permitting activity has increased,
with 8,000 apartment homes in planning for delivery over the next 36-month
period.  Estimated absorption during this period totals 9,000 apartment homes,
which would create a supply-demand balance that would be favorable for owners
of multifamily apartment communities.

         At March 31, 1997, Management had positioned the Company's portfolio
of Established Communities, excluding communities owned by joint ventures, to a
physical occupancy level of 96.9% and achieved an average economic occupancy of
95.5% for the three months ended March 31, 1997.  Average economic occupancy
for the portfolio for the three months ended March 31, 1996 was 95.6%.  This
continued high occupancy was achieved through aggressive marketing efforts
combined with limited and targeted pricing adjustments.  This positioning has
resulted in overall growth in rental revenue from Established Communities
between periods.  It is Management's strategy to maximize total rental revenue
through management of rental rates and occupancy levels.  If market and
economic conditions change, Management may adopt a strategy of maximizing
rental rates, which could lead to lower occupancy levels, if Management
believes that this strategy will maximize rental revenue.  Given the currently
high occupancy level of the portfolio, Management anticipates that, for the
foreseeable future, any rental revenue and net income gains from currently
owned and Established Communities would be achieved primarily through higher
rental rates and enhanced operating cost leverage provided by high occupancy,
rather than through continued occupancy gains.

         Substantially all of the leases at the Current Communities are for a
term of one year or less, which may enable the Company to realize increased
rents upon renewal of existing leases or commencement of new leases. Such
short-term leases generally minimize the risk to the Company of the adverse
effects of inflation, although as a general rule these leases permit residents
to leave at the end of the lease term without penalty.  The Company's current
policy is to permit residents to terminate leases upon 60-days written notice
and payment of one month's rental as compensation for early termination.
Short-term leases combined with relatively consistent demand allow rents, and
therefore cash flow from the Company's portfolio of apartments, to provide an
attractive inflation hedge.

DEVELOPMENT COMMUNITIES

         At May 5, 1997, 10 Development Communities were under construction.
The total capitalized cost of these Development Communities, when completed, is
currently expected to be approximately $368.9 million.  The Company intends to
periodically update the projections in the table on the following page to the
extent Management believes there may be or has been a material change in these
projections on an aggregate basis. There can be no assurance that the Company
will complete the Development Communities, that the Company's budgeted costs,
leasing, start dates, completion dates, occupancy or estimates of "EBITDA as %
of Total Budgeted Cost" will be realized or that future developments will
realize comparable returns.

         In accordance with GAAP, the Company capitalizes interest expense
during construction until each building obtains a certificate of occupancy,
thereafter, interest for each completed building is expensed. Capitalized
interest for the three months ended March 31, 1997 and 1996 totaled $2,511,000
and $2,971,000, respectively.

         The following page presents a summary of Development Communities:





                                       20
<PAGE>   23
                        DEVELOPMENT COMMUNITIES SUMMARY

<TABLE>
<CAPTION>
                             NUMBER OF   BUDGETED                              ESTIMATED     ESTIMATED      EBITDA AS %        
                             APARTMENT     COST       CONSTRUCTION  INITIAL   COMPLETION   STABILIZATION      OF TOTAL         
                               HOMES    ($ MILLIONS)     START     OCCUPANCY     DATE        DATE (1)     BUDGETED COST (2)    
                             --------  -------------  -----------  ---------   ---------   ------------   -----------------    
<S>                              <C>    <C>            <C>          <C>         <C>           <C>                    <C>     
Conventionally Financed                                                                                                      
------------------------
                                                                                                                             
Avalon Gates                                                                                                                 
Trumbull, CT                       340  $     35.0      Q3 1994     Q2 1996     Q3 1997       Q4 1997                 9.6%   
                                                                                                                             
Avalon Grove (3)                                                                                                             
Stamford, CT                       402        52.0      Q1 1995     Q3 1996     Q2 1997       Q3 1997                12.0%   
                                                                                                                             
Avalon Commons                                                                                                               
Smithtown, NY                      312        30.6      Q1 1996     Q1 1997     Q3 1997       Q4 1997                11.1%   
                                                                                                                             
Avalon Crescent                                                                                                              
Tysons Corner, VA                  558        57.2      Q1 1996     Q4 1996     Q4 1997       Q1 1998                10.7%   
                                                                                                                             
Avalon Gardens                                                                                                               
Nanuet, NY                         504        53.1      Q3 1996     Q3 1997     Q4 1998       Q1 1999                10.1%   
                                                                                                                             
Avalon Court                                                                                                                 
Melville, NY                       154        17.8      Q4 1996     Q2 1997     Q1 1998       Q2 1998                10.5%   
                                                                                                                             
Avalon at Fair Lakes                                                                                                         
Fairfax, VA                        234        23.2      Q1 1997     Q1 1998     Q3 1998       Q4 1998                10.0%   
                                                                                                                             
Avalon at Faxon Park                                                                                                         
Quincy, MA                         171        15.8      Q2 1997     Q1 1998     Q3 1998       Q1 1999                11.0%   
                                                                                                                             
Avalon Willow                                                                                                                
Mamaroneck, NY                     227        39.5      Q1 1997     Q3 1998     Q4 1998       Q2 1999                 9.7%   
                                                                                                                             
Avalon at Cameron Court                                                                                                      
Alexandria, VA                     460        44.7      Q2 1997     Q1 1998     Q4 1998       Q1 1999                10.2%   
                             ---------  -----------                                                        ----------------    
                                 3,362  $    368.9                                                                   10.5%   
                             =========  ===========                                                        ================    
</TABLE>

-------------
(1) Stabilized occupancy is defined as the first full quarter of 94% or greater
    occupancy.

(2) Projected EBITDA represents gross potential earnings projected to be
    achieved based on current rents prevailing in the respective community's
    local market (without adjustment for potential growth factors) and before
    interest, income taxes, depreciation, amortization and extraordinary items,
    minus (a) economic vacancy and (b) projected stabilized operating expenses.
    Total budgeted cost includes all capitalized costs projected to be incurred
    to develop the respective Development Community, including land acquisition
    costs, construction costs, real estate taxes, capitalized interest and loan
    fees, permits, professional fees, allocated development overhead and other
    regulatory fees.

(3) Currently anticipated to be held by a joint venture.





                                       21
<PAGE>   24
DEVELOPMENT RIGHTS

         The Company is considering the development of 17 new apartment
communities.  The status of these Development Rights range from land owned or
under contract for which design and architectural planning has just commenced
to land under contract or owned by the Company with completed site plans and
drawings where construction can commence almost immediately. There can be no
assurance that the Company will succeed in obtaining zoning and other necessary
governmental approvals or the financing required to develop these communities,
or that the Company will decide to develop any particular community.  Further,
there can be no assurance that construction of any particular community will be
undertaken or, if undertaken, will begin at the expected times assumed in the
financial projections or be completed at the total budgeted cost.  Although
there is no assurance that all or any of these communities will proceed to
development, the successful completion of all of these communities would
ultimately add approximately 4,865 institutional-quality apartment homes to the
Company's portfolio.  At March 31, 1997, the cumulative capitalized costs
incurred in pursuit of the 17 Development Rights were approximately $12.2
million, including the capitalized cost of $6.6 million related to the purchase
of land in New Canaan, Connecticut.  Many of these apartment homes will offer
features like those offered by the communities currently owned by the Company.
The 17 Development Rights that the Company is currently pursuing are summarized
below.


                          DEVELOPMENT RIGHTS SUMMARY

<TABLE>
<CAPTION>
                                                          TOTAL
                                    ESTIMATED            BUDGETED
                                    NUMBER OF              COST
          LOCATION                    HOMES            ($ MILLIONS)
      ---------------------     -------------------   ---------------
<S>  <C>                              <C>                 <C>
 1.  Freehold, NJ                       452                $37.3
 2.  New Canaan, CT (1)                 104                 24.4
 3.  Greenburgh - II, NY                500                 71.5
 4.  Greenburgh - III, NY               294                 38.1
 5.  Darien, CT                         172                 21.0
 6.  Fort Lee, NJ                       351                 53.3
 7.  Peabody, MA                        434                 35.9
 8.  Hull, MA                           206                 18.0
 9.  Jersey City - II, NJ               245                 40.7
10.  New Rochelle, NY                   363                 55.2
11.  Melville - II, NY                  350                 37.0
12.  Wilmington, MA                     204                 19.9
13.  Gaithersburg - II, MD               96                  9.0
14.  Bronxville, NY (1)                 110                 19.3
15.  Parsippany, NJ                     460                 60.8
16.  Danbury, CT                        268                 24.4
17.  Yonkers, NY                        256                 31.2
                                -------------------   ---------------
     Total                            4,865               $597.0
                                ===================   ===============
</TABLE>

(1)    Currently anticipated that the land seller will retain a minority
       limited partnership interest.





                                       22
<PAGE>   25
PART II          OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         In March 1996, Procida Construction Corporation, the original
contractor selected to build Avalon Cove, notified the Company that it was not
able to complete the contract within the guaranteed maximum price and
subsequently defaulted on its contractual obligations.  In April 1996, the
Company filed a demand for arbitration with the American Arbitration
Association in New York against Procida Construction Corporation to recover any
excess over the original guaranteed maximum price contract and instituted suit
in the U.S. District Court to compel arbitration. Procida Construction has
since filed Chapter 11 Bankruptcy, and consequently no assurance can be
provided that collection efforts will be successful.  Procida Construction has
an unspecified claim against Avalon Properties, Inc. arising out of its
termination. Management believes this claim is without merit.  However, should
Procida Construction prevail, Management believes that the cost of this claim
would not have a material adverse impact on the financial condition or results
of operations of the Company.

ITEM 2.  CHANGES IN SECURITIES

         None.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

         None.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS

         None.

ITEM 5.  OTHER INFORMATION

         On April 17, 1997, the Company completed a direct placement of
2,740,000 shares of its Common Stock to an institutional investor under its
existing shelf registration statement at a purchase price of $27.375 per share.
Net cash proceeds of approximately $73,500,000 were used to retire indebtedness
under the Company's revolving unsecured credit facilities.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

         a)  Exhibit No.          Description

             10.13                Amended and Restated Revolving Credit
                                  Agreement dated as of March 31, 1997 

             27.1                 Financial Data Schedule

         b)  No reports of Form 8-K have been filed by the Company for the
             period covered by this report.





                                       23
<PAGE>   26
                                   SIGNATURES





         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.



                              AVALON PROPERTIES, INC.
                              
                              
 Date:  May 14, 1997          By       /s/  RICHARD L. MICHAUX                 
                                  ---------------------------------------------
                              Richard L. Michaux, Chairman of the Board,
                              Chief Executive Officer and
                              Director (Principal Executive Officer)
                              
                              
                              
                              
 Date:  May 14, 1997          By       /s/  THOMAS J. SARGEANT                 
                                  ---------------------------------------------
                              Thomas J. Sargeant, Chief Financial Officer,
                              Treasurer and Secretary
                              (Principal Financial and Accounting Officer)





                                       24