<PAGE>   1
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                                UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                                      
                            Washington, D.C. 20549
                                      
                                      
                                 FORM 10-Q/A
   
                              (Amendment No. 1)
    

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


               For the quarterly period ended September 30, 1997


                         Commission file number 1-12452


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

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

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


                                 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:


             38,471,981 shares outstanding as of November 7, 1997.


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<PAGE>   2
                            AVALON PROPERTIES, INC.



                                     INDEX


<TABLE>
<CAPTION>
PART I         FINANCIAL INFORMATION

   
               This amendment is filed to correct the typographical error in
               the earnings per share reported on the Condensed Consolidated
               Statement of Operations on the Company's Form 10-Q for the
               quarterly period September 30, 1997 filed on November 14, 1997.
    

Item 1         Financial Statements                                                           Page
                                                                                              ----
<S>            <C>                                                                              <C>
               Condensed Consolidated Balance Sheets as of September 30, 1997
               and December 31, 1996  . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  1

               Condensed Consolidated Statements of Operations for the three and nine months
               ended September 30, 1997 and 1996  . . . . . . . . . . . . . . . . . . . . . . .  2

               Condensed Consolidated Statements of Cash Flows for the nine months
               ended September 30, 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                                                                                   9-30-97         12-31-96
                                                                                      -------------   -------------
<S>                                                                                   <C>             <C>
Real estate
   Land                                                                                $   206,279     $   169,079
   Buildings and improvements                                                              954,261         754,545
   Furniture, fixtures and equipment                                                        32,918          27,455
                                                                                      -------------   -------------
                                                                                         1,193,458         951,079
      Less:  accumulated depreciation                                                      (63,325)        (44,547)
                                                                                      -------------   -------------
                                                                                         1,130,133         906,532
   Construction in progress (including land)                                                89,347         130,827
                                                                                      -------------   -------------
            TOTAL REAL ESTATE, NET                                                       1,219,480       1,037,359

Cash and cash equivalents                                                                    3,373          14,241
Cash in escrow                                                                              20,509           3,945
Resident security deposits                                                                   8,063           5,995
Investments in joint ventures                                                                3,327           2,573
Deferred financing, net                                                                      7,421           7,702
Deferred development costs                                                                   9,611           5,179
Prepaid expenses and other assets                                                           11,253           5,777
                                                                                      -------------   -------------
            TOTAL ASSETS                                                               $ 1,283,037     $ 1,082,771
                                                                                      =============   =============
LIABILITIES AND STOCKHOLDERS' EQUITY

Unsecured Facilities                                                                      $ 82,000     $        --
Unsecured senior notes, 7-3/8% due 2002, net of unamortized discount                        99,886          99,869
Notes payable                                                                              197,897         210,737
Payables for construction                                                                   14,771          12,613
Accrued expenses and other liabilities                                                      13,184          10,580
Accrued interest payable                                                                     3,201           4,342
Resident security deposits                                                                   9,303           6,642
                                                                                      -------------   -------------
            TOTAL LIABILITIES                                                              420,242         344,783
                                                                                      -------------   -------------

Minority interest of unitholders in consolidated 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;
      38,453,315 and 33,391,992 shares issued and outstanding at September 30, 1997
        and December 31, 1996, respectively                                                    384             334
   Additional paid-in capital                                                              887,181         752,159
   Deferred compensation                                                                    (3,583)         (1,699)
   Distributions in excess of accumulated earnings                                         (21,975)        (12,894)
                                                                                      -------------   -------------
            STOCKHOLDERS' EQUITY                                                           862,095         737,988
                                                                                      -------------   -------------
            TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                 $ 1,283,037     $ 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                    Nine months ended
                                               -----------------------------       ------------------------------
                                                 9-30-97           9-30-96           9-30-97             9-30-96
                                               -----------        ----------       -----------         ----------
<S>                                             <C>               <C>              <C>                 <C>
Revenue:
   Rental income                                $ 44,120           $ 32,364         $ 121,646           $ 89,286
   Management fees                                   280                355               779              1,151
   Other income                                      184                 92               457                313
                                               -----------        ----------       -----------         ----------
            Total revenue                         44,584             32,811           122,882             90,750
                                               -----------        ----------       -----------         ----------

Expenses:
   Operating expenses                             16,550             12,702            44,551             35,025
   Interest expense                                4,211              2,847            11,850              7,093
   Depreciation and amortization                   7,558              5,326            21,086             15,025
   General and administrative expenses             1,416                902             3,375              2,597
                                               -----------        ----------       -----------         ----------
            Total expenses                        29,735             21,777            80,862             59,740
                                               -----------        ----------       -----------         ----------

Equity in income of joint ventures                 1,799                282             4,145                598
Interest income                                      430                195               926                641
Minority interest                                     69                111               210                410
                                               -----------        ----------       -----------         ----------
Income before gain on sale of community
   and extraordinary items                        17,147             11,622            47,301             32,659
Gain on sale of community                            677                 --               677                 --
                                               -----------        ----------       -----------         ----------
Income before extraordinary items                 17,824             11,622            47,978             32,659
Extraordinary items                                   --             (2,356)           (1,183)            (2,356)
                                               -----------        ----------       -----------         ----------
Net income                                        17,824              9,266            46,795             30,303
Dividends attributable to preferred stock         (4,914)            (2,468)          (14,742)            (6,070)
                                               -----------        ----------       -----------         ----------
Net income available to common stockholders     $ 12,910           $  6,798         $  32,053           $ 24,233
                                               ===========        ==========       ===========         ==========


Per common share (Note 2):
   Income before extraordinary items            $   0.34           $   0.30         $    0.93           $   0.87
                                               ===========        ==========       ===========         ==========

   Net income per common share                  $   0.34           $   0.22         $    0.89           $   0.79
                                               ===========        ==========       ===========         ==========
</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>

                                                                              Nine months ended
                                                                        -----------------------------
                                                                         9-30-97             9-30-96
                                                                        ----------         ----------
<S>                                                                      <C>                <C>

CASH FLOWS FROM OPERATING ACTIVITIES:
    Net income                                                           $ 46,795           $ 30,303
    Adjustments to reconcile net income to
      cash provided by operating activities:
          Depreciation and amortization                                    21,086             15,025
          Equity in income of joint ventures                                 (300)               370
          Amortization of deferred compensation                               722                280
          Gain on the sale of community                                      (677)                --
          Extraordinary items                                               1,183              2,356
          Decrease in resident security deposits,
                net of related liability                                      593                 60
          Decrease in cash in escrow                                          191                246
          Increase in prepaid expenses and other assets                    (9,908)            (4,384)
          Increase in accrued expenses, other liabilities
                and accrued interest payable                                1,678              3,182
                                                                        ----------         ----------
                Total adjustments                                          14,568             17,135
                                                                        ----------         ----------
                Net cash provided by operating activities                  61,363             47,438
                                                                        ----------         ----------
CASH FLOWS USED IN INVESTING ACTIVITIES:
    Investment in joint venture                                              (454)              (875)
    Increase in construction payables                                       2,158              4,321
    Purchase and development of real estate                              (217,583)          (230,762)
                                                                        ----------         ----------
                Net cash used in investing activities                    (215,879)          (227,316)
                                                                        ----------         ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
    Issuance of common stock, net                                         131,505             47,027
    Issuance of preferred stock, net                                           --            107,581
    Dividends paid                                                        (55,876)           (38,912)
    Borrowings on notes payable                                            12,088              7,000
    Repayments of notes payable                                           (25,058)            (7,127)
    Borrowings under Unsecured Facilities                                 340,000            216,500
    Repayments of Unsecured Facilities                                   (258,000)          (138,500)
    Borrowings under construction loans                                        --                 31
    Repayments of construction loans                                           --            (10,508)
    Payments of deferred financing costs                                   (1,011)            (2,053)
                                                                        ----------         ----------
                Net cash provided by financing activities                 143,648            181,039
                                                                        ----------         ----------
                Net (decrease) increase in cash                           (10,868)             1,161
Cash and cash equivalents, beginning of period                             14,241              1,801
                                                                        ----------         ----------

Cash and cash equivalents, end of period                                 $  3,373           $  2,962
                                                                        ==========         ==========

Cash paid during period for interest, net of amount capitalized          $ 12,339           $  7,541
                                                                        ==========         ==========
</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 July 1, 1997, the Company completed a public offering of
         2,163,000 shares of common stock at a gross sales price of $28.0625
         per share. The net cash proceeds from the offering of approximately
         $57,671 were used primarily to repay amounts outstanding under the
         Company's unsecured credit facilities.

                 On July 18, 1997, the Company sold a garden-style apartment
         community, Avalon Farm, located in Frederick, Maryland, to a single
         buyer for a total sales price of $17,047.  The net proceeds from the
         sale of approximately $16,500 will be used for reinvestment in a new
         acquisition community. The Company recorded a gain of approximately
         $677 from the sale and structured the sale as a Section 1031 like-kind
         exchange under the Internal Revenue Code to defer the recognition of
         the taxable gain.

                 On August 18, 1997, the Company purchased a 3.54 acre tract of
         land adjacent to an existing community, Avalon Fields, in
         Gaithersburg, Maryland for $1,400 for the purpose of expanding the
         existing community.  Construction of a new 96 apartment home
         community, Avalon Fields II, has started and is expected to be
         completed in the fourth quarter of 1998.

2.       Summary of Significant Accounting Policies

         Principles of Consolidation of the Company

                 The accompanying condensed consolidated financial statements
         include the accounts of the Company, its wholly owned partnerships and
         subsidiaries and the operating partnership structured as a DownREIT.
         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  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.  If such carrying amount is in excess of the
         estimated projected operating cash flow of the community, the Company
         would recognize an impairment loss, equivalent to an amount required
         to adjust the carrying amount to its estimated fair market value.

                 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





                                       4
<PAGE>   7
         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.

                 The Company's policy is not to actively market any of its
         communities for sale.  In the event the Company decides to sell a
         community, it will be reclassified as "held for sale" when the Board
         of Directors approves the decision to sell.

         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
         September 30, 1997 and 1996 is based upon 38,453,694 and 30,726,468
         weighted average shares of common stock outstanding, respectively. Net
         income per common share for the nine months ended September 30, 1997
         and 1996 is based upon 35,889,375 and 30,563,292 weighted average
         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
         the Company's 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 Pronouncements

                 During 1997, the Financial Accounting Standard Board issued
         Statements of Financial Accounting Standards No. 128 "Earnings Per
         Share" ("SFAS 128"), No. 129 "Disclosure of Information About Capital
         Structure" ("SFAS 129") and No. 130 "Reporting Comprehensive Income"
         ("SFAS 130").

                 SFAS 128 simplifies existing computational guidelines, revises
         disclosure requirements and increases the comparability of earnings
         per share data.  This statement is effective for financial statements
         for periods ending after December 15, 1997 and requires restatement of
         all prior period earnings per share data presented.  SFAS 129
         establishes standards for disclosing information about an entity's
         capital structure such as information about securities, liquidation
         preference of preferred stock and redeemable stock.  SFAS 130
         specifies the presentation and disclosure requirement for reporting
         comprehensive income which includes those items which have been
         formerly reported as a component of shareholders' equity.

                 The adoption of SFAS 128, SFAS 129 and SFAS 130 is not
         expected to have a material impact on the Company's financial
         condition or results of operations.





                                       5
<PAGE>   8


         Stockholder's Equity

                 Dividends on the Series A and Series B Cumulative Redeemable
         Preferred Stock are cumulative from the date of original issue and are
         payable quarterly on or about the fifteenth day of February, May,
         August and November of each year, at the annual rate of 9% and 8.96%,
         respectively, on the liquidation preference of $25 per share.  The
         Series A Preferred Stock is not redeemable prior to February 15, 2001.
         On or after February 15, 2001, the Series A Preferred Stock may be
         redeemed for cash at the option of the Company in whole or in part, at
         a redemption price of $25 per share, plus all accrued and unpaid
         dividends, if any.  The Series B Preferred Stock is not redeemable
         prior to October 15, 2001.  On or after October 15, 2001, the Series B
         Preferred Stock may be redeemed for cash at the option of the Company
         in whole or in part, at a redemption price of $25 per share, plus all
         accrued and unpaid dividends, if any.

         Reclassifications

                 Certain reclassifications have been made to amounts in prior
         year financial statements to conform with current year presentations.
         Specifically, overhead expense related to acquisitions previously
         classified as general and administrative is now included in operating
         expenses.

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
         September 30, 1997, the partnership had $2,903 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 September 30,
         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 credit facility (the "Unsecured
         Facility") is provided by a consortium of six banks that provides for
         $175,000 in short-term credit and is subject to an annual facility fee
         of $263.  The Unsecured Facility expires on March 31, 2000.  As of
         September 30, 1997, approximately $13,025 of available capacity was
         used to provide letters of credit and $42,000 was borrowed under the
         facility.  Accordingly, the balance that remains available at
         September 30, 1997 to be drawn under the Unsecured Facility is
         $119,975.  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%, provided, however, that up to $75,000 can
         be competitively bid at lower pricing if market conditions allow.
         Pricing 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 $50,000 and is subject to an annual
         facility fee of $75.  The Supplemental Unsecured Facility expires on
         March 31, 2000 and bears a current interest rate of LIBOR plus .80%.
         At September 30, 1997, $2,542 of available capacity was used to
         provide letters of credit and $40,000 was





                                       6
<PAGE>   9
         borrowed under the Supplemental Unsecured Facility.  Accordingly, the
         balance that remains available at September 30, 1997 to be drawn under
         the Supplemental Unsecured Facility is $7,458.

                 The weighted average effective interest rates (excluding the
         cost of facility fees and unused line of credit fees) on borrowings
         under the Unsecured Facilities for the nine months ended September 30,
         1997 and 1996 were 6.4% and 7.0%, respectively.  Including the cost of
         facility  fees and unused fees, the weighted average effective
         interest rates on borrowings under the Unsecured Facilities for the
         nine months ended September 30, 1997 and 1996 were 7.0% and 7.6%,
         respectively.

5.       Stockholders' Equity

                 The following summarizes the changes in stockholders' equity
         for the nine months ended September 30, 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                              --        --          --            --         46,795      46,795
         Dividends declared                      --        --          --            --        (55,876)    (55,876)
         Issuance of Restricted Common
            Stock                                --         1       3,566            --             --       3,567
         Deferred compensation,
            net of amortization                  --        --          --        (1,884)            --      (1,884)
         Issuance of Common Stock                --        49     131,456            --             --     131,505
                                           ---------  --------  ----------  ------------  -------------  ----------
         Stockholders' equity, 9-30-97      $    88    $  384    $887,181    $   (3,583)   $   (21,975)   $862,095
                                           =========  ========  ==========  ============  =============  ==========
</TABLE>


6.       Investments in Joint Ventures

                 At September 30, 1997 and December 31, 1996, 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.  The following is a combined
         summary of the financial position of these joint ventures for the
         periods presented:

<TABLE>
<CAPTION>

                                                               9-30-97        12-31-96
                                                             ----------      ---------
                   <S>                                        <C>             <C>
                   Assets:
                       Real estate, net                       $ 99,226        $92,835
                       Other assets                              3,883          5,029
                                                             ----------      ---------
                   Total assets                               $103,109        $97,864
                                                             ==========      =========

                   Liabilities and partners' equity:
                       Mortgage notes payable                 $ 26,000        $26,000
                       Other liabilities                         2,879          3,786
                       Partners' equity                         74,230         68,078
                                                             ----------      ---------
                   Total liabilities and partners' equity     $103,109        $97,864
                                                             ==========      =========
</TABLE>

                 At September 30, 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:






                                       7
<PAGE>   10

<TABLE>
<CAPTION>
                                            Three months ended         Nine months ended
                                          ----------------------    ----------------------
                                           09-30-97     9-30-96      9-30-97      9-30-96
                                          ---------    ---------    ---------    ---------

          <S>                              <C>          <C>          <C>          <C>
          Rental income                    $ 4,505      $ 2,586      $11,794      $ 7,257
          Other income                          11           17           36           45
          Operating expenses                (1,384)      (1,133)      (3,793)      (3,028)
          Mortgage interest expense           (222)        (215)        (661)        (639)
          Depreciation and amortization       (735)        (446)      (1,991)      (1,266)
                                          ---------    ---------    ---------    ---------

               Net income                  $ 2,175      $   809      $ 5,385      $ 2,369
                                          =========    =========    =========    =========
</TABLE>

7.       Extraordinary Items

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


                 In August 1996, the Company recorded a non-recurring charge to
         earnings for the recorded value of the unamortized deferred financing
         costs associated with the refinancing of tax-exempt bonds in
         conjunction with the completion of the new credit enhancement facility
         with the Federal National Mortgage Association.


8.       Subsequent Events


                 On October 1, 1997, the Company purchased Avalon Colchester
         (formerly 1470 Beacon Street), a 57 apartment home community in
         Brookline, Massachusetts for $4,500.  This community is near an
         existing community, Longwood Towers, and the Company will combine the
         operations of these two communities.

                 On October 8, 1997, the Company purchased interest rate
         protection in the form of a treasury lock from PaineWebber.  The
         forward commitment of the lock agreement terminates on December 11,
         1997.

                 On October 30, 1997, the Company completed a refinancing of
         approximately $44,000 of tax-exempt bonds related to the Avalon Ridge
         and Avalon Lea communities.  These bonds bear a variable interest
         rate, will mature on June 15, 2026 and are credit enhanced by the
         Company's credit enhancement facility with the Federal National
         Mortgage Association.  In connection with this refinancing, the
         Company purchased an interest rate cap for $101.  This cap terminates
         October 31, 2002 and serves to fix the interest rate on the bonds at
         6.9%.





                                       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 solely 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

         Acquisition of Existing Community.  On October 1, 1997, the Company
purchased Avalon Colchester (formerly 1470 Beacon Street), a 57 apartment home
community, in Brookline, Massachusetts for $4,500,000. This community is near
an existing community, Longwood Towers, and the Company will combine the
operations of these two communities.

         Sale of Existing Community.  On July, 18 1997, the Company sold a
garden-style apartment community, Avalon Farm, located in Frederick, Maryland,
to a single buyer for a total sales price of $17,047,000. The net proceeds of
approximately $16,500,000 from the sale will be used for reinvestment in a new
acquisition community. The Company recorded a gain of approximately $677,000
from the sale and structured the sale as a Section 1031 like-kind exchange
under the Internal Revenue Code to defer the recognition of the taxable gain.

         Land Acquisitions for New Development.  On August 18, 1997, the
Company purchased a 3.54 acre tract of land adjacent to an existing community,
Avalon Fields, in Gaithersburg, Maryland for $1,400,000 for the purpose of
expanding the existing community.  Construction of a new 96 apartment home
community, Avalon Fields II, has started and is expected to be completed in the
fourth quarter of 1998.

         Financing Activities.  On July 1, 1997, the Company completed a public
offering of 2,163,000 shares of common stock at a gross sales price of $28.0625
per share.  The net cash proceeds from the offering of approximately
$57,671,000 were used primarily to repay amounts outstanding under the
Unsecured Facilities.

         On October 8, 1997, the Company purchased interest rate protection in
the form of a treasury lock from PaineWebber.  The forward commitment of the
lock agreement terminates on December 11, 1997.

         On October 30, 1997, the Company completed a refinancing of
approximately $44,000,000 of tax-exempt bonds related to the Avalon Ridge and
Avalon Lea communities.  These bonds bear a variable interest





                                       9
<PAGE>   12
rate, will mature on June 15, 2026 and are credit enhanced by the Company's
credit enhancement facility with the Federal National Mortgage Association.  In
connection with this refinancing, the Company purchased an interest rate cap
for $101,000.  This cap terminates on October 31, 2002 and serves to fix the
interest rate on the bonds at 6.9%.

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 September 30, 1997, the Company
held a fee simple ownership in 47 completed and operating communities (one of
which, Avalon at Center Place, is subject to a 149 year land lease), a general
partnership interest in two other communities (a 50% interest in Falkland Chase
and a 49% interest in Avalon Run), a 99% general partner interest in a
partnership structured as a "DownREIT" (Avalon at Ballston - Vermont/Quincy)
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 nine
Development Communities.

         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.

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 and nine months ended September 30, 1997 and 1996.

         Net income increased $8,557,000 (92.3%) to $17,823,000 for the three
months ended September 30, 1997 compared to $9,266,000 for the comparable
period of the preceding year.  Net income increased $16,492,000 (54.4%) to
$46,795,000 for the nine months ended September 30, 1997 compared to
$30,303,000 for the comparable period of the preceding year.  The primary
reason for these increases is additional operating income from communities
developed or acquired during 1997 and 1996.  Growth in operating income from





                                       10
<PAGE>   13
existing communities as well as the gain recognized from the sale of a
community also contributed to these increases.

         Rental income increased $11,756,000 (36.3%) to $44,120,000 for the
three months ended September 30, 1997 compared to $32,364,000 the comparable
period of the preceding year.  Rental income increased $32,360,000 (36.2%) to
$121,646,000 for the nine months ended September 30, 1997 compared to
$89,286,000 for the comparable period of the preceding year.  Of the increase
for the nine month period, $29,824,000 was due to newly completed or acquired
communities and $2,536,000 was due to rental rate growth from Established
Communities that were owned or completed during the period.

         Overall Portfolio - The increase in rental income for the three month
         and nine 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. For the three months ended September 30, 1997, the weighted
         average monthly revenue per occupied apartment home increased $63
         (7.0%) to $963 compared to $900 for the  comparable period of the
         preceding year.  For the nine months ended September 30, 1997, the
         weighted average monthly revenue per occupied apartment home increased
         $66 (7.4%) to $956 compared to $890 for the comparable period of the
         preceding year.  The weighted average number of occupied apartment
         homes increased from 10,930 apartment homes for the nine months ended
         September 30, 1996 to 12,265 apartment homes for the nine months ended
         September 30, 1997 as a result of the development and acquisition of
         new communities.

         Established Communities - For the three months ended September 30,
         1997, the weighted average monthly revenue per occupied apartment home
         increased $33 (3.6%) to $943 compared to $910 for the comparable
         period of the preceding year.  The average economic occupancy
         increased .4% to 96.5% in 1997 from 96.1% in 1996.  For the nine
         months ended September 30, 1997, the weighted average monthly revenue
         per occupied apartment home increased $30 (3.4%) to $925 compared to
         $895 for the comparable period of the preceding year.  The average
         economic occupancy increased by .1% to 96.2% in 1997 from 96.1% in
         1996.  Accordingly, rental revenue from Established Communities
         increased $989,000 (4.0%) and $2,536,000 (3.5%) for the three and nine
         month period ended September 30, 1997, respectively, compared to the
         comparable periods of the preceding year.

         Management fees decreased $75,000 (21.1%) to $280,000 for the three
months ended September 30, 1997 compared to $355,000 for the comparable period
of the preceding year.  These fees decreased $372,000 (32.3%) to $779,000 for
the nine months ended September 30, 1997 compared to $1,151,000 for the
comparable period of the preceding year.  These decreases are primarily due to
a decline in the number of apartment homes managed for third-party owners
during 1997.  These declines are 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 and another
Current Community in the second quarter of 1997 that were managed by the
Company for third-party owners prior to their acquisitions.

         Operating expenses increased $3,848,000 (30.3%) to $16,550,000 for the
three months ended September 30, 1997 compared to $12,702,000 for the
comparable period of the preceding year.  These expenses increased $9,526,000
(27.2%) to $44,551,000 for the nine months ended September 30, 1997 compared to
$35,025,000 for the comparable period of the preceding year.

         Overall Portfolio - The $9,526,000 increase for the nine 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 stabilized
         operating phase.

         Established Communities - Operating expenses increased $311,000 (3.7%)
         to $8,756,000 for the three months ended September 30, 1997 compared
         to $8,445,000 for the comparable period of the preceding year.
         Operating expenses increased $384,000 (1.6%) to $24,877,000 for the
         nine





                                       11
<PAGE>   14
         months ended September 30, 1997 compared to $24,493,000 for the
         comparable period of the preceding year. These increases were
         concentrated in the marketing, maintenance and insurance categories,
         offset by lower snow removal costs 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.

         Interest expense increased $1,364,000 (47.9%) to $4,211,000 for the
three months ended September 30, 1997 compared to $2,847,000 for the comparable
period of the preceding year.  Interest expense increased $4,757,000 (67.1%) to
$11,850,000 for the nine months ended September 30, 1997 compared to $7,093,000
for the comparable period of the preceding year.  These increases are primarily
attributable to higher average outstanding balances under the Company's
Unsecured Facilities (as hereinafter defined) in 1997 compared to 1996.  In
addition, the Company assumed approximately $29,900,000 of conventional debt
resulting from the acquisitions of two communities in 1996 and completed the
loan closings related to the tax-exempt financing for the Avalon West and
Avalon Fields communities in December 1996 and April 1997, respectively.  These
increases were 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 $2,232,000 (41.9%) to
$7,558,000 for the three months ended September 30, 1997 compared to $5,326,000
for the comparable period of the preceding year. Depreciation and amortization
increased $6,061,000 (40.3%) to $21,086,000 for the nine months ended September
30, 1997 compared to $15,025,000 for the comparable period of the preceding
year.  These increases reflect additional depreciation expense for recently
acquired and developed communities, offset by lower amortization expense of
deferred financing costs due to the completion of the new credit enhancement
facility with Fannie Mae.

         General and administrative expenses increased $514,000 (57.0%) to
$1,416,000 for the three months ended September 30, 1997 compared to $902,000
for the comparable period of the preceding year.  These expenses increased
$778,000 (30.0%) to $3,375,000 for the nine months ended September 30, 1997
compared to $2,597,000 for the comparable period of the preceding year.  These
increases are 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 .2% to 2.7% for the nine months ended September 30,
1997 compared to 2.9% for the comparable period of the preceding year.

         Equity in income of joint ventures increased $1,517,000 to $1,799,000
for the three months ended September 30, 1997 compared to $282,000 for the
comparable period of the preceding year.  This income increased $3,547,000 to
$4,145,000 for the nine months ended September 30, 1997 compared to $598,000
for the comparable period of the preceding year.  These increases are
principally the result of the non-recurring income from the anticipated Avalon
Grove joint venture in which the Company is allocated 100% of the income prior
to the formation of the joint venture.

         Interest income increased $235,000 to $430,000 for the three months
ended September 30, 1997 compared to $195,000 for the comparable period of the
preceding year.  Interest income increased $285,000 to $926,000 for the nine
months ended September 30, 1997 compared to $641,000 for the comparable period
of the preceding year.  These increases are primarily due to higher average
escrowed cash balances in 1997 compared to 1996 from the sale of Avalon Farm
that was structured as a Section 1031 like-kind exchange under the Internal
Revenue Code whereby the escrowed proceeds from the sale will be used for
reinvestment in a new acquisition community.

         Extraordinary items totaled $1,183,000 for the nine months ended
September 30, 1997 and reflects the write-off of unamortized deferred financing
costs associated with the early retirement of the Company's previous
$165,000,000 unsecured credit facility.





                                       12
<PAGE>   15

FUNDS FROM OPERATIONS

         Management generally considers Funds from Operations ("FFO") to be an
appropriate measure of the operating performance of the Company because it
provides investors an understanding of the ability of the Company to incur and
service debt and to make capital expenditures.  The Company believes that in
order to facilitate a clear understanding of the operating results of the
Company, FFO should be examined in conjunction with net income as presented in
the condensed consolidated financial statements included elsewhere in this
report. FFO 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 ("GAAP")), excluding gains (or losses)
from debt restructuring and sale of property, plus depreciation of real estate
assets and after adjustments for unconsolidated partnerships and joint
ventures.  FFO does not represent cash generated from operating activities in
accordance with GAAP and therefore should not be considered an alternative to
net income as an indication of the Company's performance or to net cash flows
from operating activities as determined by GAAP as a measure of liquidity and
is not necessarily indicative of cash available to fund cash needs.  Further,
FFO as disclosed by other REITs may not be comparable to the Company's
calculation of FFO.

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

<TABLE>
<CAPTION>

                                                                Three months ended            Nine months ended
                                                          -----------------------------  ----------------------------
                                                             9-30-97         9-30-96        9-30-97        9-30-96
                                                          -------------   -------------  -------------  -------------
<S>                                                       <C>              <C>            <C>            <C>
   NET INCOME                                              $    17,823     $     9,266    $    46,795    $    30,303

      Depreciation (real estate related)                         7,130           4,783         19,818         13,247
      Joint venture adjustment                                     108              81            278            240
      Gain on sale of community                                   (677)             --           (677)            --
      Extraordinary items                                           --           2,356          1,183          2,356
      Preferred stock dividends                                 (4,914)         (2,468)       (14,742)        (6,070)
                                                          -------------   -------------  -------------  -------------
   FUNDS FROM OPERATIONS                                   $    19,470     $    14,018    $    52,655    $    40,076
                                                          =============   =============  =============  =============

   CASH FLOW PROVIDED BY (USED IN):
      Operating activities                                 $    18,648     $    16,133    $    61,363    $    47,438
      Investing activities                                 $   (42,123)    $  (104,157)   $  (215,879)   $  (227,316)
      Financing activities                                 $    24,096     $    88,873    $   143,648    $   181,039

   WEIGHTED AVERAGE SHARES OUTSTANDING                      38,453,694      30,726,468     35,889,375     30,563,292
                                                          =============   =============  =============  =============

   OTHER CAPITALIZED EXPENDITURES AND OTHER INFORMATION
      Non-recurring capital expenditures:
          Community level- non-revenue generating (1)      $       441     $       453    $     1,721    $     1,287
          Corporate level (2)                              $       185     $       219    $       658    $     1,810
      Loan principal amortization payments                 $       304     $       187    $       946    $       423
      Capitalized deferred financing costs (3)             $       142     $     1,594    $     1,011    $     2,053
</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 nine
    months ended September 30, 1997 relate to the costs incurred on the
    closing of the Avalon Fields tax-exempt bonds, the closing of the new
    $175 million unsecured credit facility and the refinancing of
    tax-exempt bonds related to the Avalon Lea and Avalon Ridge
    Communities.




                                       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 nine months ended September
30, 1997 resulted in non-revenue, generating capitalized expenditures for
Stabilized Communities of approximately $1,721,000 or $128 per apartment home.
For the nine months ended September 30, 1997, the Company charged to
maintenance expense, including carpet and appliance replacements, a total of
approximately $9,142,000 for Stabilized Communities or $682 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 nine months ended
September 30, 1997.





                                       14
<PAGE>   17

  EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES (CAPITALIZED) AND COMMUNITY
                             MAINTENANCE (EXPENSED)
                  (Dollars in thousands, except per home data)

<TABLE>
<CAPTION>

                                                                                                        
                                                                                                        
                                                    Number          Balance at         Balance at       
                   Community                       of Homes          12-31-96 (1)       9-30-97  (1)    
------------------------------------------------  -----------     ---------------    ----------------   
<S>                                                   <C>            <C>                 <C>            
STABILIZED                                                                                              
----------                                                                                              
Avalon Watch                                             512            $ 28,340            $ 28,423    
Avalon Pavilions                                         932              56,523              56,619    
Avalon Glen                                              238              30,077              30,177    
Avalon Walk I                                            430              34,505              34,560    
Avalon Walk II                                           334              23,597              23,719    
Avalon View                                              288              17,773              17,812    
Avalon Park                                              372              19,717              19,945    
Avalon at Ballston - Washington Towers                   344              36,797              36,887    
Avalon at Gayton                                         328               9,830               9,931    
Avalon at Hampton I                                      186               3,702               3,739    
Avalon at Hampton II                                     231               8,144               8,196    
Avalon at Dulles                                         236              11,599              11,678    
Avalon Knoll                                             300               7,905               7,980    
Avalon Lea                                               296              16,101              16,130    
Avalon at Fairway Hills I                                192               9,368               9,401    
Avalon Ridge                                             432              25,030              25,184    
Avalon at Symphony Glen                                  174               8,079               8,116    
Avalon at Park Center                                    492              37,337              37,612    
4100 Mass. Avenue                                        308              34,879              34,919    
Avalon Woods                                             268               8,235               8,318    
Avalon at Carter Lake                                    259              11,502              11,560    
Avalon Pointe                                            140               7,748               7,832    
Avalon Landing                                           158               9,261               9,302    
Avalon Birches                                           312              13,419              13,458    
Avalon at Lake Arbor                                     209              11,900              11,914    
Avalon at Decoverly                                      368              30,978              31,108    
Avalon Summit                                            245              16,152              16,287    
Avalon Towers                                            109              15,826              15,895    
Longwood Towers                                          307              16,620              16,623    
Avalon Fields                                            192              14,262              14,298    
Avalon West                                              120              10,624              10,810    
Avalon Chase                                             360              23,615              23,636    
Avalon Pines                                             174               8,578               8,592    
Avalon at Fairway Hills II                               527              33,807              33,840    
Avalon at Boulders                                       284              16,038              16,064    
AutumnWoods                                              420              30,474              30,593    
Avalon Run East                                          206              16,002              16,000    
Avalon Station                                           223              11,838              11,932    
Avalon Cove                                              504              85,831              89,875    
Avalon Crossing                                          132              13,387              13,771    
Avalon Springs                                           102              13,628              15,799    
Avalon at Ballston - Vermont/Quincy (2)                  454                  --              46,707    
Avalon at Center Place (2)                               225                  --              26,411    
Avalon at Providence Park (2)                            140                  --              11,051    
Avalon Gates                                             340              30,348              34,885    
                                                  -----------     ---------------    ----------------   
                                                      13,403             869,376             967,589    
                                                  -----------     ---------------    ----------------   
                                                                                                        
NEW DEVELOPMENTS                                       3,118             130,212             241,567    
----------------                                                                                        
                                                                                                        
OTHER                                                                                                   
-----                                                                                                   
Avalon at Lexington                                      198              14,117              14,325    
Longwood Towers - Renovation                              --               6,829              14,022    
Avalon Green                                             105              12,294              12,424    
Avalon Arbor (5)                                         302              27,822              28,296    
Avalon Farm (6)                                           --              17,332                  --    
Corporate Level Expenditures                              --               3,924               4,582    
                                                  -----------     ---------------    ----------------   
Grand Total                                           17,126 (7)     $ 1,081,906         $ 1,282,805    
                                                  ===========     ===============    ================   
</TABLE>

<TABLE>
<CAPTION>


                                                          YTD 1997 Capitalized Costs
                                            -------------------------------------------------------
                                                Acquisitions,                 Non-Revenue                       YTD 1997
                                                Construction                Generating Capx               Maintenance Expensed
                                                 and Revenue         ------------------------------   ------------------------------
                   Community                  Generating Costs           Total          Per Home          Total          Per Home
------------------------------------------  ----------------------   --------------    ------------   --------------   -------------
<S>                                                       <C>              <C>            <C>              <C>             <C>
STABILIZED                                  
----------                                  
Avalon Watch                                                 $ --             $ 83           $ 162            $ 339           $ 662
Avalon Pavilions                                               --               96             103              421             452
Avalon Glen                                                     7               93             391              204             857
Avalon Walk I                                                   2               53             123              216             502
Avalon Walk II                                                 --              122             365              176             527
Avalon View                                                    --               39             135              300           1,042
Avalon Park                                                   118              110             296              325             874
Avalon at Ballston - Washington Towers                         --               90             262              263             765
Avalon at Gayton                                               32               69             210              245             747
Avalon at Hampton I                                            12               25             134              155             833
Avalon at Hampton II                                           --               52             225              168             727
Avalon at Dulles                                               46               33             140              220             932
Avalon Knoll                                                   55               20              67              248             827
Avalon Lea                                                     --               29              98              233             787
Avalon at Fairway Hills I                                      --               33             172              151             786
Avalon Ridge                                                   89               65             150              340             787
Avalon at Symphony Glen                                         3               34             195              164             943
Avalon at Park Center                                         140              135             274              304             618
4100 Mass. Avenue                                              15               25              81              290             942
Avalon Woods                                                   --               83             310              149             556
Avalon at Carter Lake                                          --               58             224              228             880
Avalon Pointe                                                  35               49             350              119             850
Avalon Landing                                                 --               41             259              170           1,076
Avalon Birches                                                 --               39             125              165             529
Avalon at Lake Arbor                                           --               14              67              256           1,225
Avalon at Decoverly                                           109               21              57              202             549
Avalon Summit                                                 128                7              29              167             682
Avalon Towers                                                  --               69             633              173           1,587
Longwood Towers                                                --                3              10              290             945
Avalon Fields                                                  --               36             188              116             604
Avalon West                                                   173               13             108               78             650
Avalon Chase                                                   --               21              58              294             817
Avalon Pines                                                   --               14              80               80             460
Avalon at Fairway Hills II                                     17               16              30              345             655
Avalon at Boulders                                             --               26              92              197             694
AutumnWoods                                                   114                5              12              241             574
Avalon Run East                                                (2)              --              --               91             442
Avalon Station                                                 94               --              --              129             578
Avalon Cove                                                 4,044               --              --              191             379
Avalon Crossing                                               384               --              --               87             659
Avalon Springs                                              2,171               --              --               46             451
Avalon at Ballston - Vermont/Quincy (2)                    46,707               --              --              336             740
Avalon at Center Place (2)                                 26,411               --              --               86             382
Avalon at Providence Park (2)                              11,051               --              --               63             450
Avalon Gates                                                4,537               --              --               81             238
                                            ----------------------   --------------    ------------   --------------   -------------
                                                           96,492            1,721             128            9,142             682
                                            ----------------------   --------------    ------------   --------------   -------------
                                            
NEW DEVELOPMENTS                                          111,355               --              --              173             N/A
----------------                            
                                            
OTHER                                       
-----                                       
Avalon at Lexington                                           208 (3)           --              --              165             833
Longwood Towers - Renovation                                7,193 (4)           --              --               --              --
Avalon Green                                                  130               --              --              146           1,390
Avalon Arbor (5)                                              474               --             N/A              273             904
Avalon Farm (6)                                           (17,332)              36             118              140             458
Corporate Level Expenditures                                  658               --             N/A               --              --
                                            ----------------------   --------------    ------------   --------------   -------------
Grand Total                                             $ 199,178          $ 1,757             N/A         $ 10,039             N/A
                                            ======================   ==============    ============   ==============   =============
</TABLE>                                


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

(1) Costs are presented in accordance with 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) Community sold in July 1997.

(7) 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 development and construction or that were acquired during
any given period.

         Cash and cash equivalents increased $411,000 from $2,962,000 at
September 30, 1996 to $3,373,000 at September 30, 1997 due to an increase in
operating cash flow and a decrease in investing activities, offset by a
decrease in cash provided by investing activities.

                 Net cash provided by operating activities increased by
         $13,925,000 from $47,438,000 at September 30, 1996 to $61,363,000 at
         September 30, 1997 primarily due to an increase in operating income
         from newly developed and acquired communities and Established
         Communities.

                 Cash used in investing activities decreased by $11,437,000
         from $227,316,000 at September 30, 1996 to $215,879,000 at September
         30, 1997 primarily due to decreased costs related to the development
         and construction of apartment communities.

                 Net cash provided by financing activities decreased by
         $37,391,000 from $181,039,000 at September 30, 1996 to $143,648,000 at
         September 30, 1997 primarily due to the repayment of the loan on the
         AutumnWoods community and an increase in dividends paid.

         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
nine month period ended September 30, 1997 resulted in non-revenue, generating
capitalized expenditures for Stabilized Communities of $128 per apartment home.

         The Company's $100,000,000 unsecured senior notes will mature in 2002.
Since Management anticipates that no 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 will 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.  Currently, no other permanent
indebtedness will require balloon payments prior to the year 2002.

         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 $778.5 million and over $492 million in the last 22
months.  Management follows a focused strategy to help facilitate uninterrupted
access to capital.  This strategy includes:





                                       16
<PAGE>   19
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 supply-demand balance,
         which the Company believes will create 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.       Conservative accounting practices that provide a high level of quality
         to reported earnings; and

6.       Timely, accurate and detailed disclosures to the investment community.

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

         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
Unsecured Facility is provided by a consortium of six banks and is subject to
an annual facility fee of $262,500. The Unsecured Facility expires in March
2000.  Borrowings under the new facility bear an interest rate of .80% over
LIBOR.  A competitive bid option is available for up to $75,000,000 which may
result in lower pricing if market conditions allow.  At September 30, 1997,
$42,000,000  was borrowed, $13,025,000 was used to provide letters of credit
and $119,975,000 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 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 $50,000,000 and is subject to an annual facility fee of $75,000.  The
Supplemental Unsecured Facility expires in March 2000 and bears an interest
rate of LIBOR plus .80%.  At September 30, 1997, $2,542,000 of available
capacity was used to provide letters of credit and $40,000,000 was borrowed
under the Supplemental Unsecured Facility.  Accordingly, the balance that
remains available at September 30, 1997 to be drawn under the Supplemental
Unsecured Facility is $7,458,000.

Interest Rate Protection Agreements

         On October 8, 1997, the Company purchased interest rate protection in
the form of a treasury lock from PaineWebber.  This agreement serves to hedge
interest rate risk of the Company's planned corporate 10-year debt offering at
an interest rate of 6.125% on a notional amount of $75,000,000.  The forward
commitment of the lock agreement terminates on December 11, 1997.

         In connection with the refinancing of the tax-exempt bonds related to
the Avalon Lea and Avalon Ridge communities, the Company purchased an interest
rate cap for $101.  This cap terminates October 31, 2002 and serves to fix the
interest rate on the bonds at 6.9% (see "Financing Transactions Completed" on
the next page).





                                       17
<PAGE>   20
         The Company is not a party to any long-term interest rate agreements,
other than the interest rate protection agreements described above.  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 Transactions Completed

         On July 1, 1997, the Company completed a public offering of 2,163,000
shares of common stock at a gross sales price of $28.0625 per share.  The net
cash proceeds from the offering of approximately $57,671,000 were used
primarily to repay amounts outstanding under the Unsecured Facilities.

         On October 30, 1997, the Company completed a refinancing of
approximately $44,000,000 of tax-exempt bonds related to the Avalon Ridge and
Avalon Lea communities.  These bonds bear a variable interest rate, will mature
on June 15, 2026 and are credit enhanced by the Company's credit enhancement
facility with the Federal National Mortgage Association.

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 year.  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, as appropriate, 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
                                                                             ------------------------
                                                      All-in       Maturity
                   Community                       Interest Rate     Date     12-31-96       9-30-97
------------------------------------------------   -------------   --------  ----------    ----------
<S>                                                    <C>         <C>       <C>           <C>
Tax-Exempt Bonds:

    Fixed Rate

  * Avalon Lea (Custodial Receipts)                      5.71%       Nov-07   $  16,782     $  16,830
  * Avalon Ridge  (Custodial Receipts)                   5.69%       Nov-07      26,724        26,806
  * Avalon at Dulles                                     7.04%       Jul-24      12,360        12,360
  * Avalon at Hampton II                                 7.04%       Jul-24      11,550        11,550
  * Avalon at Symphony Glen                              7.06%       Jul-24       9,780         9,780
  * Avalon View                                          7.55%       Aug-24      19,487        19,365
  * Avalon at Lexington                                  6.56%       Feb-25      15,284        15,125
  * Avalon Knoll                                         6.95%       Jun-26      14,070        13,956
  * Avalon Landing                                       6.85%       Jun-26       6,969         6,912
  * Avalon West                                          7.73%       Dec-36       8,771         8,739
  * Avalon Fields                                        7.57%       May-27          --        12,049
                                                                              ---------     ---------

                                                                                141,777       153,472
    Variable Rate

  * Avalon at Fairway Hills I                                        Jun-26      11,500        11,500
  * Avalon at Hampton I                                              Jun-26       8,060         8,060
  * Avalon Pointe                                                    Jun-26       6,387         6,387
                                                                              ---------     ---------

                                                                                 25,947        25,947
Conventional Loans:

    Fixed Rate

  * AutumnWoods (1)                                      9.25%       Nov-97      24,335            --
    Unsecured Senior Notes                              7.375%       Sep-02      99,869        99,886
  * Avalon Pines                                         8.00%       Dec-03       5,529         5,466
  * Avalon Walk II                                       8.93%       Nov-04      13,149        13,012
                                                                              ---------     ---------

                                                                                142,882       118,364
     Variable Rate-None                                                              --            --
                                                                              ---------     ---------

Total notes payable - excluding Unsecured Facilities                          $ 310,606     $ 297,783
                                                                              =========     =========
<CAPTION>

                                                                              Total Maturities
                                                       ----------------------------------------------------------
                                                       Balance
                   Community                           of 1997   1998     1999     2000       2001     Thereafter
---------------------------------------------------    -------  ------   ------   ------    -------    ----------
<S>                                                    <C>      <C>      <C>      <C>        <C>       <C>
Tax-Exempt Bonds:

    Fixed Rate

  * Avalon Lea  (Custodial Receipts)                   $   --   $   --   $   --   $   --    $    --    $  16,830
  * Avalon Ridge  (Custodial Receipts)                     --       --       --       --         --       26,806
  * Avalon at Dulles                                       --       --       --       --         --       12,360
  * Avalon at Hampton II                                   --       --       --       --         --       11,550
  * Avalon at Symphony Glen                                --       --       --       --         --        9,780
  * Avalon View                                            51      230      290      330        350       18,114
  * Avalon at Lexington                                    54      226      240      255        271       14,079
  * Avalon Knoll                                           38      163      175      187        200       13,193
  * Avalon Landing                                         20       83       89       95        101        6,524
  * Avalon West                                            11       46       50       53         57        8,522
  * Avalon Fields                                          40      127      137      147        157       11,441
                                                       ------   ------   ------   ------    -------    ---------

                                                          214      875      981    1,067      1,136      149,199
    Variable Rate

  * Avalon at Fairway Hills I                              --       --       --       --         --       11,500
  * Avalon at Hampton I                                    --       --       --       --         --        8,060
  * Avalon Pointe                                          --       --       --       --         --        6,387
                                                       ------   ------   ------   ------    -------    ---------

                                                           --       --       --       --         --       25,947
Conventional Loans:

    Fixed Rate

  * AutumnWoods (1)                                        --       --       --       --         --           --
    Unsecured Senior Notes                                 --       --       --       --         --       99,886
  * Avalon Pines                                           32      103      112      121        131        4,967
  * Avalon Walk II                                         48      202      221      241        264       12,036
                                                       ------   ------   ------   ------    -------    ---------

                                                           80      305      333      362        395      116,889
     Variable Rate-None                                    --       --       --       --         --           --
                                                       ------   ------   ------   ------    -------    ---------

Total notes payable - excluding Unsecured Facilities   $  294   $1,180   $1,314   $1,429    $ 1,531    $ 292,035
                                                       ======   ======   ======   ======    =======    =========
</TABLE>


 (1) Note repaid in August 1997.

  *  Indicates loan is collateralized by the community.


                                       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 slightly favorable for
owners of multifamily apartment communities.

         At September 30, 1997, Management had positioned the Company's
portfolio of Established Communities, excluding communities owned by joint
ventures, to a physical occupancy level of 97.3% and achieved an average
economic occupancy of 96.2% for the nine months ended September 30, 1997.
Average economic occupancy for the Established Communities for the nine months
ended September 30, 1996 was 96.1%.  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 rent 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 September 30, 1997, nine Development Communities were under
construction.  The total capitalized cost of these Development Communities,
when completed, is currently expected to be approximately $295.6 million.
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 September 30, 1997 and 1996 totaled
$2,076,000 and $3,280,000, respectively.  Capitalized interest for the nine
months ended September 30, 1997 and 1996 totaled $7,092,000 and $9,690,000,
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)
                           ----------  ------------- -------------- ------------ ------------ --------------- -------------------
Conventionally Financed
-----------------------
<S>                         <C>         <C>             <C>          <C>           <C>           <C>              <C>
Avalon Commons
Smithtown, NY                    312    $       32.5     Q1 1996      Q1 1997       Q3 1997       Q4 1997           10.2%

Avalon Crescent
Tysons Corner, VA                558            57.3     Q1 1996      Q4 1996       Q4 1997       Q1 1998           10.9%

Avalon Gardens
Nanuet, NY                       504            53.3     Q3 1996      Q2 1997       Q4 1998       Q1 1999           10.8%

Avalon Court
Melville, NY                     154            17.8     Q4 1996      Q2 1997       Q4 1997       Q1 1998           10.9%

Avalon at Fair Lakes
Fairfax, VA                      234            23.2     Q1 1997      Q4 1997       Q2 1998       Q4 1998           10.0%

Avalon at Faxon Park
Quincy, MA                       171            15.8     Q1 1997      Q1 1998       Q3 1998       Q4 1998           11.0%

Avalon Fields II
Gaithersburg, MD                  96             9.2     Q3 1997      Q3 1998       Q4 1998       Q1 1999           10.2%

Avalon Willow
Mamaroneck, NY                   227            41.8     Q2 1997      Q3 1998       Q1 1999       Q2 1999            9.2%

Avalon at Cameron Court
Alexandria, VA                   460            44.7     Q2 1997      Q1 1998       Q4 1998       Q1 1999           10.3%
                           ----------  -------------                                                          -------------------

                               2,716    $      295.6                                                                10.4%
                           ==========  =============                                                          ===================

</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.





                                       21
<PAGE>   24
DEVELOPMENT RIGHTS

         The Company is currently considering the development of 20 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 5,628
institutional-quality apartment homes to the Company's portfolio.  At September
30, 1997, the cumulative capitalized costs incurred in pursuit of the 20
Development Rights were approximately $16.1 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 20 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>
                    1.  Freehold, NJ                               452                   $     38.7
                    2.  New Canaan, CT (1)                         104                         24.9
                    3.  Greenburgh - II, NY                        500                         74.0
                    4.  Greenburgh - III, NY                       266                         39.3
                    5.  Darien, CT                                 172                         22.3
                    6.  Fort Lee, NJ                               351                         56.4
                    7.  Peabody, MA                                434                         35.9
                    8.  Hull, MA                                   162                         15.0
                    9.  Jersey City - II, NJ                       269                         50.8
                   10.  New Rochelle, NY                           408                         62.7
                   11.  Melville - II, NY                          340                         39.8
                   12.  Wilmington, MA                             204                         19.5
                   13.  Stamford, CT                               190                         29.6
                   14.  Orange, CT                                 172                         15.7
                   15.  Ridgefield, CT                             240                         30.2
                   16.  Bronxville, NY (1)                         110                         24.7
                   17.  Parsippany, NJ                             460                         64.0
                   18.  Danbury, CT                                268                         24.4
                   19.  Yonkers, NY                                256                         33.7
                   20.  Florham Park, NJ                           270                         37.5
                                                          -------------                 ------------
                        Total                                    5,628                   $    739.1
                                                          =============                 ============
</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.  On October 21, 1997, the United States
Bankruptcy court entered an order authorizing a settlement reached between Town
Cove Jersey City Urban Renewal Inc. and the debtor, Procida Construction.
Pursuant to the settlement Town Cove Jersey City Urban Renewal Inc. agreed to
pay the Debtor $387,500.00 and the parties agreed to release one another from
any and all claims arising from performance of the work on the project.  The
settlement was finalized on November 12, 1997.

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 July 1, 1997, the Company completed a public offering of 2,163,000
shares of common stock at a gross sales price of $28.0625 per share.  The net
cash proceeds from the offering of approximately $57,671,000 were used
primarily to repay amounts outstanding under the Company's Unsecured
Facilities.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

<TABLE>
<S>                             <C>
         a)      Exhibit No.     Description
                                
   
               (1)   10.15       New Employment Agreement between the Company and Richard L.
                                 Michaux dated July 15, 1997
    
                                
   
               (1)   10.16       New Employment Agreement between the Company and Charles H.
                                 Berman dated July 16, 1997
    
                                
   
               (1)   27.1        Financial Data Schedule
    

   
               (1) Previously filed as an exhibit to the Company's Form 10-Q
                   for the quarterly period ended September 30, 1997 filed on 
                   November 14, 1997.
    

         b)    Reports on Form 8-K
</TABLE>

On July 1, 1997, the Company filed a Current Report on Form 8-K relating to the
public offering of 2,163,000 shares of common stock.





                                       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:  November 12, 1997        By       /s/  RICHARD L. MICHAUX
                                     ------------------------------------------
                                 Richard L. Michaux, Chairman of the Board,
                                 Chief Executive Officer and
                                 Director (Principal Executive Officer)




 Date:  November 12, 1997        By       /s/  THOMAS J. SARGEANT
                                     ------------------------------------------
                                 Thomas J. Sargeant, Chief Financial Officer,
                                 Treasurer and Secretary
                                 (Principal Financial and Accounting Officer)





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