<PAGE>   1



===============================================================================


                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549


                                   FORM 10-Q

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


                  For the quarterly period ended June 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:


              38,453,318 shares outstanding as of August 8, 1997.


===============================================================================


<PAGE>   2


                            AVALON PROPERTIES, INC.



                                     INDEX
<TABLE>
<CAPTION>

PART I   FINANCIAL INFORMATION

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

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

         Condensed Consolidated Statements of Cash Flows for the six months
         ended June 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...................................................24

         Signatures.........................................................................25

</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                                                                                      6-30-97                 12-31-96   
                                                                                        --------------          -------------- 
<S>                                                                                       <C>                     <C>          
Real estate                                                                                                                    
   Land                                                                                   $   200,956             $   169,079  
   Buildings and improvements                                                                 923,310                 754,545  
   Furniture, fixtures and equipment                                                           31,891                  27,455  
                                                                                        --------------          -------------- 
                                                                                            1,156,157                 951,079  
      Less:  accumulated depreciation                                                         (57,543)                (44,547) 
                                                                                        --------------          -------------- 
                                                                                            1,098,614                 906,532  
   Construction in progress (including land)                                                  102,427                 130,827  
                                                                                        --------------          -------------- 
            TOTAL REAL ESTATE, NET                                                          1,201,041               1,037,359  

Cash and cash equivalents                                                                       2,752                  14,241  
Cash in escrow                                                                                  3,916                   3,945  
Resident security deposits                                                                      7,425                   5,995  
Investments in joint ventures                                                                   2,988                   2,573  
Deferred financing and other costs, net                                                         7,455                   7,702  
Deferred development costs, prepaid expenses and other assets                                  14,246                  10,956  
                                                                                        --------------          -------------- 
            TOTAL ASSETS                                                                  $ 1,239,823             $ 1,082,771  
                                                                                        ==============          ============== 
LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                           
Current maturities of long-term notes payable                                             $    24,145             $    24,335  
Unsecured Facilities                                                                           71,500                      --  
Unsecured senior notes, 7-3/8% due 2002, net of unamortized discount                           99,880                  99,869  
Notes payable                                                                                 198,125                 186,402  
Payables for construction                                                                      14,967                  12,613  
Accrued expenses and other liabilities                                                         11,125                  10,580  
Accrued interest payable                                                                        4,890                   4,342  
Resident security deposits                                                                      8,684                   6,642  
                                                                                        --------------          -------------- 
            TOTAL LIABILITIES                                                                 433,316                 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;                                                                 
      36,285,568 and 33,391,992 shares issued and outstanding at June 30, 1997                                                 
        and December 31, 1996, respectively                                                       363                     334  

   Additional paid-in capital                                                                 829,604                 752,159  
   Deferred compensation                                                                       (3,976)                 (1,699) 
   Distributions in excess of accumulated earnings                                            (20,272)                (12,894) 
                                                                                        --------------          -------------- 
            STOCKHOLDERS' EQUITY                                                              805,807                 737,988  
                                                                                        --------------          -------------- 
            TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                    $ 1,239,823             $ 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           Six months ended
                                                   ----------------------      -----------------------
                                                     6-30-97     6-30-96         6-30-97      6-30-96
                                                   ---------   ----------      ----------   ----------
<S>                                                 <C>          <C>             <C>          <C>
Revenue:

   Rental income                                    $40,375      $29,329         $77,526      $56,922
   Management fees                                      244          394             499          796
   Other income                                         153          108             273          221
                                                   ---------   ----------      ----------   ----------
            Total revenue                            40,772       29,831          78,298       57,939
                                                   ---------   ----------      ----------   ----------

Expenses:

   Operating expenses                                14,505       11,234          27,761       22,168
   Interest expense                                   3,922        1,663           7,639        4,246
   Depreciation and amortization                      6,968        5,045          13,527        9,699
   General and administrative expenses                1,090          887           2,199        1,850
                                                   ---------   ----------      ----------   ----------
            Total expenses                           26,485       18,829          51,126       37,963
                                                   ---------   ----------      ----------   ----------

Equity in income of joint ventures                    1,304          150           2,346          316
Interest income                                         220          208             495          446
Minority interest                                        48          135             142          299
                                                   ---------   ----------      ----------   ----------
Net income before extraordinary item                 15,859       11,495          30,155       21,037
Extraordinary item                                       --           --          (1,183)          --
                                                   ---------   ----------      ----------   ----------
Net income                                           15,859       11,495          28,972       21,037
Dividends attributable to preferred stock            (4,914)      (2,516)         (9,828)      (3,602)
                                                   ---------   ----------      ----------   ----------
Net income available to common stockholders         $10,945      $ 8,979         $19,144      $17,435
                                                   =========   ==========      ==========   ==========

Net income per weighted average
   common share outstanding (Note 2)                $  0.31      $  0.29         $  0.55      $  0.57
                                                   =========   ==========      ==========   ==========
</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>
                                                                              Six months ended        
                                                                      ------------------------------- 
                                                                          6-30-97           6-30-96   
                                                                      -------------     ------------- 
<S>                                                                      <C>               <C>        
CASH FLOWS FROM OPERATING ACTIVITIES:                                                                 
    Net income                                                           $  28,972         $  21,037  
    Adjustments to reconcile net income to                                                            
        cash provided by operating activities:                                                        
                Depreciation and amortization                               13,527             9,699  
                Equity in income of joint ventures                            (128)               79  
                Amortization of deferred compensation                          485               187  
                Extraordinary item                                           1,183                --  
                Decrease (increase) in resident security deposits,                                    
                     net of related liability                                  612               (72) 
                Decrease (increase) in cash in escrow                           29              (105) 
                Increase in prepaid expenses and other assets               (3,290)           (1,485) 
                Increase in accrued expenses, other liabilities                                       
                     and accrued interest payable                            1,325             1,965  
                                                                      -------------     ------------- 
                     Total adjustments                                      13,743            10,268  
                                                                      -------------     ------------- 
                     Net cash provided by operating activities              42,715            31,305  
                                                                      -------------     ------------- 
CASH FLOWS USED IN INVESTING ACTIVITIES:                                                              
    Investment in joint venture                                               (287)             (455) 
    Increase in construction payables                                        2,354             2,007  
    Purchase and development of real estate                               (175,823)         (124,711) 
                                                                      -------------     ------------- 
                     Net cash used in investing activities                (173,756)         (123,159) 
                                                                      -------------     ------------- 
CASH FLOWS FROM FINANCING ACTIVITIES:                                                                 
    Issuance of common stock, net                                           73,825            46,399  
    Issuance of preferred stock, net                                            --           107,581  
    Dividends paid                                                         (36,350)          (25,038) 
    Borrowings on notes payable                                             12,088                --  
    Repayments of notes payable                                               (642)           (6,340) 
    Borrowings under Unsecured Facilities                                  161,000           101,000  
    Repayments of Unsecured Facilities                                     (89,500)         (120,500) 
    Borrowings under construction loans                                         --                31  
    Repayments of construction loans                                            --           (10,508) 
    Payments of deferred financing costs                                      (869)             (459) 
                                                                      -------------     ------------- 
                     Net cash provided by financing activities             119,552            92,166  
                                                                      -------------     ------------- 
                     Net (decrease) increase in cash                       (11,489)              312  
Cash and cash equivalents, beginning of period                              14,241             1,801  
                                                                      -------------     ------------- 
                                                                                                      
Cash and cash equivalents, end of period                                 $   2,752         $   2,113  
                                                                      =============     ============= 
                                                                                                      
Cash paid during period for interest, net of amount capitalized          $   6,692         $   3,415  
                                                                      =============     ============= 
</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 April 7, 1997, pricing on the Company's supplemental
         unsecured credit facility (the "Supplemental Unsecured Facility") was
         reduced to .80% over LIBOR. Also, on May 30, 1997, the Supplemental
         Unsecured Facility was amended and restated to provide for an increase
         in capacity to $50,000, an extension of the expiration date to March
         31, 2000 and the introduction of a competitive bid option.

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

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

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

                  On April 28, 1997, the Company completed the loan closing
         related to the tax-exempt financing for the Avalon Fields apartment
         community. The Community Development Administration of Maryland issued
         $12,088 of thirty-year fixed-rate bonds at an all-in rate of 7.57%.
         The net cash proceeds from the loan closing (approximately $11,565)
         were used to repay amounts outstanding under the Company's unsecured
         credit facilities.

                  On May 16, 1997, the Company acquired Avalon at Center Place,
         a 225 apartment home, high- rise apartment community located in
         Providence, Rhode Island for $26,000. This nine-story apartment
         community contains approximately 21,000 square feet of commercial
         space on the first floor with residential apartment homes on the upper
         eight floors. This community was managed by the Company prior to its
         acquisition and is subject to a 149 year land lease.

                  On June 27, 1997, the Company acquired Avalon at Providence
         Park, a 140 apartment home, garden-style community located in Fairfax
         City, Virginia for $10,750.


                                       4


<PAGE>   7
2.       Summary of Significant Accounting Policies

         Principles of Consolidation of the Company

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

         Real Estate

                  Buildings and improvements are recorded at cost and are
         depreciated on a straight-line basis over their estimated useful lives
         of 40 years. The Company's policy is to annually assess any impairment
         in value by making a comparison of the current and projected operating
         cash flows of each of its communities over its remaining useful life,
         on an undiscounted basis, to the carrying amount of each community.
         Such carrying amounts would be adjusted, if necessary, to reflect an
         impairment in the value of the assets. The cost of buildings and
         improvements include capitalized interest, property taxes and
         insurance incurred during the construction period. Furniture and
         fixtures are stated at cost and depreciated over their estimated
         useful lives of seven years. Expenditures for maintenance and repairs
         are charged to operations as incurred. Significant renovations or
         betterments that exceed $15 and extend the economic useful life of an
         asset are capitalized and depreciated over seven years.

         Deferred Financing and Development Costs

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

         Net Income per Common Share

                  Net income per common share for the three months ended June
         30, 1997 and 1996 is based upon 35,791,985 and 30,715,884 weighted
         average shares of common stock outstanding, respectively. Net income
         per common share for the six months ended June 30, 1997 and 1996 is
         based upon 34,635,347 and 30,481,694 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
         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").


                                       5


<PAGE>   8
                  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 impact of adoption of SFAS 128, SFAS 129 and SFAS 130 on
         the Company's financial results is not expected to be significant.

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
         June 30, 1997, the partnership had $3,026 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 June 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 June
         30, 1997, approximately $15,536 of available capacity was used to
         provide letters of credit and $64,500 was borrowed under the facility.
         Accordingly, the balance that remains available at June 30, 1997 to be
         drawn under the Unsecured Facility is $94,964. 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%, except 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 Facility (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 June 30, 1997, $2,167 of available capacity was used to
         provide letters of credit and $7,000 was borrowed under the
         Supplemental Unsecured Facility. Accordingly, the balance that remains
         available at June 30, 1997 to be drawn under the Supplemental
         Unsecured Facility is $40,833.

                  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 six months ended June 30, 1997
         and 1996 were 6.5% and 8.5%, respectively. Including the cost of
         facility fees and unused fees, the weighted average effective interest
         rates on borrowings under the Unsecured Facilities for the six months
         ended June 30, 1997 and 1996 were 7.0% and 8.6%, respectively.


 
                                      6


<PAGE>   9


5.       Stockholders' Equity

                  The following summarizes the changes in stockholders' equity
         for the six months ended June 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                             --          --           --              --        28,972       28,972
Dividends declared                     --          --           --              --       (36,350)     (36,350)
Issuance of Restricted Common
   Stock                               --           1        3,648              --            --        3,649
Deferred compensation,
   net of amortization                 --          --           --          (2,277)           --       (2,277)
Issuance of Common Stock               --          28       73,797              --            --       73,825
                                  ---------- --------- ------------  --------------- -------------- ----------
Stockholders' equity, 6-30-97       $  88      $  363    $ 829,604        $ (3,976)    $ (20,272)   $ 805,807
                                  ========== ========= ============  =============== ============== ==========
</TABLE>

6.       Investments in Joint Ventures

                  At June 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 (a Development Community). The following is a
         combined summary of the financial position of these joint ventures for
         the periods presented:

<TABLE>
<CAPTION>
                                            6-30-97      12-31-96
                                         -----------   -----------
<S>                                        <C>           <C>
Assets:
    Real estate, net                       $ 98,220      $92,835
    Other assets                              6,838        5,029
                                         -----------   -----------
Total assets                               $105,058      $97,864
                                         ===========   ===========

Liabilities and partners' equity:
    Mortgage notes payable                 $ 26,000      $26,000
    Other liabilities                         3,716        3,786
    Partners' equity                         75,342       68,078
                                         -----------   -----------
Total liabilities and partners' equity     $105,058      $97,864
                                         ===========   ===========
</TABLE>


                  At June 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               Six months ended
                                   ------------------------------   ----------------------------
                                      6-30-97          6-30-96         6-30-97        6-30-96
                                   -------------    -------------   ------------   -------------
<S>                                  <C>              <C>             <C>            <C>
Rental income                        $  3,916         $  2,329        $  7,289       $  4,671
Other income                               12               14              24             28
Operating expenses                     (1,280)            (908)         (2,408)        (1,895)
Mortgage interest expense                (243)            (225)           (439)          (424)
Depreciation and amortization            (685)            (413)         (1,256)          (820)
                                   -------------    -------------   ------------   -------------

     Net income                      $  1,720         $    797        $  3,210       $  1,560
                                   =============    =============   ============   =============
</TABLE>

7.       Extraordinary Item

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

8.       Subsequent Events

                  On July 1, 1997, the Company completed a public offering of
         2,163,000 shares of common stock at a purchase 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
         Unsecured 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 expects to record an accounting
         gain of $570 from the sale and will structure the sale as a section
         1031 like-kind exchange under the Internal Revenue Code to defer the
         recognition of the taxable gain.


                                       8

<PAGE>   11


PART I     FINANCIAL INFORMATION (CONTINUED)

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

FORWARD-LOOKING STATEMENTS

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

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

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

RECENT DEVELOPMENTS

         Acquisitions of Existing Communities. On May 16, 1997, the Company
acquired Avalon at Center Place, a 225 apartment home, high-rise apartment
community located in Providence, Rhode Island for $26,000,000. This nine-story
apartment community contains approximately 21,000 square feet of commercial
space on the first floor with residential apartment homes on the upper eight
floors. This community was managed by the Company prior to its acquisition and
is subject to a 149 year land lease.

         On June 27, 1997, the Company acquired Avalon at Providence Park, a
140 apartment home, garden-style community located in Fairfax City, Virginia
for $10,750,000.

         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 expects to record an accounting gain of
$570,000 from the sale and will structure the sale as a ss.1031 like-kind
exchange under the Internal Revenue Code to defer the recognition of the
taxable gain.

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

         Financing Activities. On April 7, 1997, pricing on the Company's
supplemental unsecured credit facility (the "Supplemental Unsecured Facility"
and together with the unsecured credit facility, the "Unsecured Facilities")
was reduced to .80% over LIBOR. Also, on May 30, 1997, the Supplemental
Unsecured Facility was amended and restated to provide for an increase in
capacity to $50,000,000, an extension of the expiration date to March 31, 2000
and the introduction of a competitive bid option.



                                       9

<PAGE>   12


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

         On April 28, 1997, the Company completed the loan closing related to
the tax-exempt financing for the Avalon Fields apartment community. The
Community Development Administration of Maryland issued $12,088,000 of
thirty-year fixed-rate bonds at an all-in rate of 7.57%. The net cash proceeds
from the loan closing (approximately $11,565,000) were used to repay amounts
outstanding under the Company's Unsecured Facilities.

         On July 1, 1997, the Company completed a public offering of 2,163,000
shares of common stock at a purchase 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.

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 June 30, 1997, the Company held a
fee simple ownership in 46 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 10 Development
Communities. One of the 10 Development Communities is subject to an agreement
to form a joint venture.

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

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

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

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


                                      10

<PAGE>   13


RESULTS OF OPERATIONS

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

         The analysis that follows compares the operating results of the 
Company for the six months ended June 30, 1997 and 1996.

         Net income increased $4,364,000 (38.0%) to $15,859,000 for the three
months ended June 30, 1997 compared to $11,495,000 for the comparable period of
the preceding year. Net income increased $7,935,000 (37.7%) to $28,972,000 for
the six months ended June 30, 1997 compared to $21,037,000 for the comparable
period of the preceding year. The primary reasons for these increases are
additional operating income from communities developed or acquired during 1997
and 1996, as well as growth in operating income from existing communities.

         Rental income increased $11,046,000 (37.7%) to $40,375,000 for the
three months ended June 30, 1997 compared to $29,329,000 for the comparable
period of the preceding year. Rental income increased $20,604,000 (36.2%) to
$77,526,000 for the six months ended June 30, 1997 compared to $56,922,000 for
the comparable period of the preceding year. Of the increase for the six month
period, $19,037,000 was due to newly completed or acquired communities and
$1,567,000 was due to rental rate growth from Established Communities that were
owned or completed throughout the period.

         Overall Portfolio - The $20,604,000 increase in rental income for the
         six month period is primarily due to increases in the weighted average
         number of occupied apartment homes as well as an increase in the
         weighted average monthly rental income per occupied apartment home.
         The weighted average number of occupied apartment homes increased from
         10,312 apartment homes for the six months ended June 30, 1996 to
         12,331 apartment homes for the six months ended June 30, 1997 as a
         result of the development and acquisition of new communities. For the
         three months ended June 30, 1997, the weighted average monthly revenue
         per occupied apartment home increased $40 (4.5%) to $931 compared to
         $891 for the comparable period of the preceding year. For the six
         months ended June 30, 1997, the weighted average monthly revenue per
         occupied apartment home increased $40 (4.5%) to $924 compared to $884
         for the comparable period of the preceding year.

         Established Communities - For the three months ended June 30, 1997,
         the weighted average monthly revenue per occupied apartment home
         increased $28 (3.2%) to $916 compared to $888 for the comparable
         period of the preceding year. The average economic occupancy remained
         unchanged at 96.5%. For the six months ended June 30, 1997, the
         weighted average monthly revenue per occupied apartment home increased
         $28 (3.2%) to $909 compared to $881 for the comparable period of the
         preceding year. The average economic occupancy remained unchanged at
         96.0%. Accordingly, rental revenue from Established Communities
         increased $788,000 (3.2%) and $1,567,000 (3.2%) for the three and six
         month period ended June 30, 1997, respectively, compared to the
         comparable periods of the preceding year.

         Management fees decreased $150,000 (38.1%) to $244,000 for the three
months ended June 30, 1997 compared to $394,000 for the comparable period of
the preceding year. These fees decreased $297,000 (37.3%) to $499,000 for the
six months ended June 30, 1997 compared to $796,000 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


                                      11


<PAGE>   14


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 $3,271,000 (29.1%) to $14,505,000 for the
three months ended June 30, 1997 compared to $11,234,000 for the comparable
period of the preceding year. These expenses increased $5,593,000 (25.2%) to
$27,761,000 for the six months ended June 30, 1997 compared to $22,168,000 for
the comparable period of the preceding year.

         Overall Portfolio - The $5,593,000 increase for the six 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 $93,000 (1.1%)
         to $8,318,000 for the three months ended June 30, 1997 compared to
         $8,225,000 for the comparable period of the preceding year. Operating
         expenses increased $53,000 (.3%) to $16,538,000 for the six months
         ended June 30, 1997 compared to $16,485,000 for the comparable period
         of the preceding year. These increases were concentrated in the
         marketing 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 $2,259,000 (135.8%) to $3,922,000 for the
three months ended June 30, 1997 compared to $1,663,000 for the comparable
period of the preceding year. Interest expense increased $3,393,000 (79.9%) to
$7,639,000 for the six months ended June 30, 1997 compared to $4,246,000 for
the comparable period of the preceding year. These increases are primarily
attributable to higher outstanding balances under the Company's Unsecured
Facilities 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 $1,923,000 (38.1%) to
$6,968,000 for the three months ended June 30, 1997 compared to $5,045,000 for
the comparable period of the preceding year. Depreciation and amortization
increased $3,828,000 (39.5%) to $13,527,000 for the six months ended June 30,
1997 compared to $9,699,000 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 $203,000 (22.9%) to
$1,090,000 for the three months ended June 30, 1997 compared to $887,000 for
the comparable period of the preceding year. These expenses increased $349,000
(18.9%) to $2,199,000 for the six months ended June 30, 1997 compared to
$1,850,000 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 .4% to 2.8% for the six months ended June 30, 1997 compared to 3.2%
for the comparable period of the preceding year.

         Equity in income of joint ventures increased $1,154,000 to $1,304,000
for the three months ended June 30, 1997 compared to $150,000 for the
comparable period of the preceding year. This income increased $2,030,000 to
$2,346,000 for the six months ended June 30, 1997 compared to $316,000 for the
comparable period of the preceding year. These increases are principally the
result of the non-recurring income from the 


                                      12

<PAGE>   15


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 $12,000 (5.8%) to $220,000 for the three
months ended June 30, 1997 compared to $208,000 for the comparable period of
the preceding year. Interest income increased $49,000 (11.0%) to $495,000 for
the six months ended June 30, 1997 compared to $446,000 for the comparable
period of the preceding year. These increases are primarily due to higher
average escrowed cash balances in 1997 compared to 1996.

         Extraordinary item totaled $1,183,000 for the six months ended June
30, 1997 and reflects the write-off of unamortized deferred financing costs
associated with the early retirement of the $165 million unsecured credit
facility.

FUNDS FROM OPERATIONS

         Management generally considers Funds from Operations ("FFO") to be an
appropriate measure of the operating performance of the Company. The Company
believes that in order to facilitate a clear understanding of the operating
results of the Company, 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),
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.

<TABLE>
<CAPTION>
  ANALYSIS OF FUNDS FROM OPERATIONS ($ in 000's)
  ----------------------------------------------

                                                              Three months ended               Six months ended
                                                        -----------------------------   --------------------------------
                                                            6-30-97         6-30-96         6-30-97          6-30-96
                                                        -------------  --------------   --------------     -------------
  <S>                                                    <C>            <C>              <C>                <C>
  NET INCOME                                             $    15,859    $     11,495     $     28,972       $    21,037

     Depreciation (real estate related)                        6,550           4,426           12,688             8,464
     Joint venture adjustment                                     89              80              170               159
     Extraordinary item                                           --              --            1,183                --
     Preferred stock dividends                                (4,914)         (2,516)          (9,828)           (3,602)
                                                        -------------  --------------   --------------     -------------
  FUNDS FROM OPERATIONS                                  $    17,584    $     13,485     $     33,185       $    26,058
                                                        =============  ==============   ==============     =============

  WEIGHTED AVERAGE SHARES OUTSTANDING                     35,791,985      30,715,884       34,635,347        30,481,694
                                                        =============  ==============   ==============     =============

  OTHER CAPITALIZED EXPENDITURES AND OTHER INFORMATION
     Capital expenditures:
         Community level (1)                             $       841    $        481     $      1,280       $       834
         Corporate level (2)                             $       210    $      1,081     $        473       $     1,591
     Loan principal amortization payments                $       321    $        112     $        642       $       236
     Capitalized deferred financing costs (3)            $       788    $        345     $        869       $       459
</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 six
    months ended June 30, 1997 relate to the costs incurred on the closing of
    the Avalon Fields tax-exempt bonds and the closing of new the $175 million
    unsecured credit facility.


                                      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 six months ended June 30,
1997 resulted in non-revenue, generating capitalized expenditures for
Stabilized Communities of approximately $96 per apartment home. For the six
months ended June 30, 1997, the Company charged to maintenance expense,
including carpet and appliance replacements, a total of approximately
$5,811,000 for Stabilized Communities or $437 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 six months ended June 30, 1997.



                                      14



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

<TABLE>
<CAPTION>
                                                                          YTD 1997 Capitalized Costs
                                                                     ---------------------------------------
                                                                       Acquisitions,         Non-Revenue             YTD 1997
                                                                       Construction        Generating Caps    Maintenance Expensed
                                Number    Balance at    Balance at      and Revenue    --------------------   ---------------------
              Community        of Homes    12-31-96 (1)  6-30-97 (1) Generating Costs   Total      Per Home    Total      Per Home
---------------------------    --------   ------------ ------------  ----------------  ---------  ----------  --------   ----------
<S>                            <C>        <C>           <C>              <C>             <C>        <C>         <C>         <C>
STABILIZED                                                                                                   
Avalon Watch                      512     $   28,340    $   28,406       $         --    $   66     $   129     $  203      $  396
Avalon Pavilions                  932         56,523        56,545                 --        22          24        276         296
Avalon Glen                       238         30,077        30,100                 --        23          97        121         508
Avalon Walk I                     430         34,505        34,524                  2        17          40        138         321
Avalon Walk II                    334         23,597        23,666                 --        69         207        114         341
Avalon View                       288         17,773        17,773                 --        --          --        198         688
Avalon Park                       372         19,717        19,815                 --        98         263        207         556
Avalon at Ballston -                                                                                         
   Washington Towers              344         36,797        36,887                 --        90         262        155         451
Avalon Farm                       306         17,332        17,368                 --        36         118        140         458
Avalon at Gayton                  328          9,830         9,887                 --        57         174        155         473
Avalon at Hampton I               186          3,702         3,725                  3        20         108         92         495
Avalon at Hampton II              231          8,144         8,185                 --        41         177        103         446
Avalon at Dulles                  236         11,599        11,626                 --        27         114        140         593
Avalon Knoll                      300          7,905         7,939                 14        20          67        159         530
Avalon Lea                        296         16,101        16,130                 --        29          98        153         517
Avalon at Fairway Hills I         192          9,368         9,396                 --        28         146         94         490
Avalon Ridge                      432         25,030        25,148                 12       106         245        210         486
Avalon at Symphony Glen           174          8,079         8,115                  2        34         195        100         575
Avalon at Park Center             492         37,337        37,368                 --        31          63        201         409
4100 Mass. Avenue                 308         34,879        34,897                 15         3          10        177         575
Avalon Woods                      268          8,235         8,319                 --        84         313         92         343
Avalon at Carter Lake             259         11,502        11,560                 --        58         224        157         606
Avalon Pointe                     140          7,748         7,780                 --        32         229         87         621
Avalon Landing                    158          9,261         9,282                 --        21         133        106         671
Avalon Birches                    312         13,419        13,458                 --        39         125        107         343
Avalon at Lake Arbor              209         11,900        11,902                 --         2          10        141         675
Avalon at Decoverly               368         30,978        31,047                  1        68         185        139         378
Avalon Summit                     245         16,152        16,286                128         6          24        112         457
Avalon Towers                     109         15,826        15,877                 --        51         468        103         945
Longwood Towers                   250         16,620        16,623                 --         3          12        191         764
Avalon Fields                     192         14,262        14,298                 --        36         188         73         380
Avalon West                       120         10,624        10,649                 12        13         108         56         467
Avalon Chase                      360         23,615        23,626                 --        11          31        189         525
Avalon Pines                      174          8,578         8,582                 --         4          23         52         299
Avalon at Fairway Hills II        527         33,807        33,831                 17         7          13        223         423
Avalon at Boulders                284         16,038        16,057                 --        19          67        130         458
AutumnWoods                       420         30,474        30,498                 19         5          12        149         355
Avalon Run East                   206         16,002        16,021                 19        --          --         47         228
Avalon Station                    223         11,838        11,940                 98         4          18         81         363
Avalon Cove                       504         85,831        89,539              3,708        --          --        104         206
Avalon Crossing                   132         13,387        13,710                323        --          --         59         447
Avalon Springs                    102             --        15,493             15,493        --          --         27         265
Avalon at Ballston -                                                                                         
   Vermont/Quincy (2)             454             --        46,702             46,702        --          --        223         491
Avalon at Center Place (2)        225             --        26,426             26,426        --          --         26         116
Avalon at Providence Park (2)     140             --        11,139             11,139        --          --          1           7
                               --------   ------------ ------------  ----------------  ---------  ----------  --------   ----------
                               13,312        842,732       948,145            104,133     1,280          96      5,811         437
                               --------   ------------ ------------  ----------------  ---------  ----------  --------   ----------
                                                                                                             
NEW DEVELOPMENTS                3,362        174,188       239,394             65,206        --          --         80         N/A
                                                                                                             
OTHER                                                                                                        
Avalon at Lexington               198         14,117        14,325                208(3)     --          --         98         495
Longwood Towers - Renovation       --          6,829        11,796              4,967(4)     --          --         --          --
Avalon Green                      105         12,294        12,397                103        --          --         93         886
Avalon Arbor (5)                  302         27,822        28,130                 --       308         N/A        167         553
Corporate Level Expenditures       --          3,924         4,397                 --       473         N/A         --          --
                               --------   ------------ ------------  ----------------  ---------  ----------  --------   ----------
Grand Total                    17,279(6)  $1,081,906    $1,258,584                N/A    $2,061         N/A     $6,249         N/A
                               ========   ============ ============  ================  =========  ==========  ========   ==========
</TABLE>
------------------------

(1) Costs are presented in accordance with generally accepted accounting
    principles ("GAAP") and exclude the step-up in basis attributed to 
    continuing investors.
(2) Acquired in 1997.
(3) Payment of contingent land cost to land seller based on operating results.
    This is the complete and final contingent payment due under the land 
    purchase agreement.
(4) Represents renovation costs incurred.
(5) Ownership through ownership of the Avalon Arbor mortgage note. See Note 3
    to the unaudited condensed consolidated financial statements. Increases in
    capitalized value relate primarily to accrued interest and do not reflect
    capitalized community upgrades.
(6) Excludes Falkland Chase and Avalon Run, 876 apartment homes owned by joint
    ventures in which the Company holds a 50% interest and 49% interest,
    respectively.


                                      15

<PAGE>   18


LIQUIDITY AND CAPITAL RESOURCES

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

         Cash and cash equivalents increased $639,000 from $2,113,000 at June
30, 1996 to $2,752,000 at June 30, 1997 due to an increase in operating cash
flow and an increase in financing activities, offset by an increase in cash
used by investing activities (mainly attributable to an increase in the number
of newly developed and acquired communities).

                  Net cash provided by operating activities increased by
         $11,410,000 from $31,305,000 at June 30, 1996 to $42,715,000 at June
         30, 1997 primarily due to an increase in operating income from newly
         developed and acquired communities and Established Communities.

                  Cash used in investing activities increased by $50,597,000
         from $123,159,000 at June 30, 1996 to $173,756,000 at June 30, 1997
         primarily due to an increase in the number of apartment homes under
         development from an average of 2,664 in the first six months of 1996
         to 3,362 in the first six months of 1997.

                  Net cash provided by financing activities increased by
         $27,386,000 from $92,166,000 at June 30, 1996 to $119,552,000 at June
         30, 1997 primarily due to the increased borrowings under the Unsecured
         Facilities, offset by 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 six
month period ended June 30, 1997 resulted in non-revenue, generating
capitalized expenditures for Stabilized Communities of $96 per apartment home.

         Permanent mortgage indebtedness will require balloon payments coming
due over the years 1997 to 2002, including $24,145,000 in November 1997 and
$100,000,000 in 2002. Additionally, an aggregate of $44,655,000 principal
amount of bonds will require remarketing or have credit enhancements that will
mature in the fourth quarter of 1997. Certain of these payments may be
accelerated upon the termination of credit enhancements if such credit
enhancements are not renewed or replaced. The Company believes that it will be
able to successfully remarket these bonds and obtain renewal or replacement
credit enhancements. Since Management anticipates that only a small portion of
the principal of such indebtedness will be repaid prior to maturity and the
Company may not have funds on hand sufficient to repay such indebtedness, it
may be necessary for the Company to refinance this debt. Such refinancing could
be accomplished through additional debt financing, which may be collateralized
by mortgages on individual communities or groups of communities, by
uncollateralized private or public debt offerings or by additional equity
offerings. There can be no assurance that such additional debt financing or
debt offerings will be available on terms satisfactory to the Company.

         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 


                                      16

<PAGE>   19

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 $774.2 million and over $487.9 million in the
last 18 months. Management follows a focused strategy to help ensure
uninterrupted access to capital. This strategy includes:

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

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

3.   Operate in markets with growing demand (as measured by household formation
     and job growth) and high barriers to entry. These characteristics combine
     to provide a favorable 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.   Timely, accurate and detailed disclosures to the investment community; and

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

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

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

Unsecured Facilities

         On March 31, 1997, the Company obtained a new 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 million which may result in lower pricing if market conditions allow. At
June 30, 1997, $64,500,000 was borrowed, $15,536,000 was used to provide
letters of credit and $94,964,000 was available for borrowing under the
Unsecured Facility. The Company will use borrowings under the Unsecured
Facility for capital expenditures, acquisitions of developed or undeveloped
communities, construction, development and renovation costs, credit enhancement
for tax-exempt bonds and for working capital purposes.

         The Company's Supplemental Unsecured Facility is provided by First
Union National Bank in the amount of $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 June 30, 1997,
$2,167,000 of available capacity was used to provide letters of credit and
$7,000,000 was borrowed under the Supplemental Unsecured Facility. Accordingly,
the balance that remains available at June 30, 1997 to be drawn under the
Supplemental Unsecured Facility is $40,833,000. See Financing Commitments on
the following page for modifications to the Supplemental Credit Facility.

Interest Rate Protection Agreements

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


                                      17


<PAGE>   20

Financing Commitments/Transactions Completed

         On April 7, 1997, pricing on the Company's Supplemental Unsecured
Facility was reduced to .80% over LIBOR. Also, on May 30, 1997, the
Supplemental Unsecured Facility was amended and restated to provide for an
increase in capacity to $50,000,000, an extension of the expiration date to
March 31, 2000 and the introduction of a competitive bid option.

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

         On April 28, 1997, the Company completed the loan closing related to
the tax-exempt financing on the Avalon Fields community. The Community
Development Administration of Maryland issued approximately $12,100,000 of
thirty-year fixed-rate bonds at an all-in rate of 7.57%. The net cash proceeds
from the loan closing (approximately $11,600,000 million) were used to repay
amounts outstanding under the Company's Unsecured Facilities.

         On July 1, 1997, the Company completed a public offering of 2,163,000
shares of common stock at a purchase 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.

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, if necessary, to issue
additional equity or debt securities, arrange additional capacity under the
Unsecured Facilities or future credit facilities or obtain additional
construction loan commitments not currently in place to ensure that adequate
liquidity sources are in place to fund the construction of a Development Right,
although no assurance can be given in this regard.

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


                                      18


<PAGE>   21


                            AVALON PROPERTIES, INC.

                             DEBT MATURITY SCHEDULE

                             (Dollars in thousands)


<TABLE>
<CAPTION>
                                                                                          Balance Outstanding at
                                                                                       ---------------------------
                                                         All-in            Maturity                                    
               Community                             Interest Rate          Date          12-31-96       06-30-97 
---------------------------------------------       --------------      ------------   ------------   -------------
<S>                                                     <C>                 <C>          <C>            <C>            
Tax-Exempt Bonds:                                                                                                      

    Fixed Rate                                                                                                         

  * Avalon Lea  (Custodial Receipts) (1)                 5.71%              Nov-07       $ 16,782       $ 16,814
  * Avalon Ridge  (Custodial Receipts) (1)               5.69%              Nov-07         26,724         26,779
  * 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         19,415
  * Avalon at Lexington                                  6.56%              Feb-25         15,284         15,179
  * Avalon Knoll                                         6.95%              Jun-26         14,070         13,995
  * Avalon Landing                                       6.85%              Jun-26          6,969          6,931
  * Avalon West                                          7.73%              Dec-36          8,771          8,749
  * Avalon Fields                                        7.57%              May-27             --         12,079
                                                                                        ---------      ---------
                                                                                          141,777        153,631
    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                                          9.25%              Nov-97         24,335         24,145
    Unsecured Senior Notes                              7.375%              Sep-02         99,869         99,880
  * Avalon Pines                                         8.00%              Dec-03          5,529          5,490
  * Avalon Walk II                                       8.93%              Nov-04         13,149         13,057
                                                                                        ---------      ---------
                                                                                          142,882        142,572
    Variable Rate-None                                                                         --             --
                                                                                        ---------      ---------
Total notes payable - excluding Unsecured Facilities                                     $310,606       $322,150
                                                                                        =========      =========


<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) (1)                  $    --    $   --   $   --    $   --     $   --     $ 16,814 
  * Avalon Ridge  (Custodial Receipts) (1)                     --        --       --        --         --       26,779 
  * Avalon at Dulles                                           --        --       --        --         --       12,360 
  * Avalon at Hampton II                                       --        --       --        --         --       11,550 
  * Avalon at Symphony Glen                                    --        --       --        --         --        9,780 
  * Avalon View                                               101       230      290       330        350       18,114 
  * Avalon at Lexington                                       108       226      240       255        271       14,079 
  * Avalon Knoll                                               77       163      175       187        200       13,193 
  * Avalon Landing                                             39        83       89        95        101        6,524 
  * Avalon West                                                22        46       50        53         57        8,521 
  * Avalon Fields                                              70       127      137       147        157       11,441 
                                                         --------    ------  -------   -------    -------    ---------  
                                                              417       875      981     1,067      1,136      149,155 
    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                                            24,145        --       --        --         --           -- 
    Unsecured Senior Notes                                     --        --       --        --         --       99,880 
  * Avalon Pines                                               56       103      112       121        131        4,967 
  * Avalon Walk II                                             93       202      221       241        264       12,036 
                                                         --------    ------  -------   -------    -------    ---------  
                                                           24,294       305      333       362        395      116,883 
    Variable Rate-None                                         --        --       --        --         --           -- 
                                                         --------    ------  -------   -------    -------    ---------  
Total notes payable - excluding Unsecured Facilities      $24,711    $1,180   $1,314    $1,429     $1,531     $291,985 
                                                         ========    ======  =======   =======    =======    =========  
</TABLE>


(1) Subject to remarketing November 1, 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 favorable for owners
of multifamily apartment communities.

         At June 30, 1997, Management had positioned the Company's portfolio of
Established Communities, excluding communities owned by joint ventures, to a
physical occupancy level of 97.2% and achieved an average economic occupancy of
96.0% for the six months ended June 30, 1997. Average economic occupancy for
the portfolio for the six months ended June 30, 1996 was 96.0%. 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 June 30, 1997, 10 Development Communities were under construction.
The total capitalized cost of these Development Communities, when completed, is
currently expected to be approximately $373.0 million. The Company intends to
periodically update the projections in the table on the following page to the
extent Management believes there may be or has been a material change in these
projections on an aggregate basis. There can be no assurance that the Company
will complete the Development Communities, that the Company's budgeted costs,
leasing, start dates, completion dates, occupancy or estimates of "EBITDA as %
of Total Budgeted Cost" will be realized or that future developments will
realize comparable returns.

         In accordance with GAAP, the Company capitalizes interest expense
during construction until each building obtains a certificate of occupancy,
thereafter, interest for each completed building is expensed. Capitalized
interest for the three months ended June 30, 1997 and 1996 totaled $2,505,000
and $3,482,000, respectively. Capitalized interest for the six months ended
June 30, 1997 and 1996 totaled $5,016,000 and $6,314,000, respectively.

         The following page presents a summary of Development Communities:



                                      20


<PAGE>   23


                        DEVELOPMENT COMMUNITIES SUMMARY




<TABLE>
<CAPTION>
                              NUMBER OF     BUDGETED                                   ESTIMATED      ESTIMATED       EBITDA AS %
                              APARTMENT       COST        CONSTRUCTION    INITIAL     COMPLETION    STABILIZATION       OF TOTAL
                                HOMES      ($ MILLIONS)      START       OCCUPANCY       DATE          DATE(1)     BUDGETED COST(2)
                             -----------  -------------- -------------  -----------  ------------   -------------  ----------------
<S>                               <C>         <C>           <C>           <C>           <C>            <C>                 <C>
Conventionally Financed                                                                                                    
-----------------------
                                                                                                    
Avalon Gates                                                                                                               
Trumbull, CT                        340       $  35.0       Q3 1994       Q2 1996       Q3 1997        Q4 1997              9.8%
                                                                                                                           
Avalon Grove (3)                                                                                                           
Stamford, CT                        402          52.5       Q1 1995       Q3 1996       Q3 1997        Q4 1997             12.2%
                                                                                                                           
Avalon Commons                                                                                                             
Smithtown, NY                       312          31.8       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             10.8%
                                                                                                                           
Avalon Gardens                                                                                                             
Nanuet, NY                          504          53.1       Q3 1996       Q3 1997       Q4 1998        Q1 1999             10.8%
                                                                                                                           
Avalon Court                                                                                                               
Melville, NY                        154          17.8       Q4 1996       Q2 1997       Q1 1998        Q2 1998             10.7%
                                                                                                                           
Avalon at Fair Lakes                                                                                                       
Fairfax, VA                         234          23.2       Q1 1997       Q1 1998       Q3 1998        Q4 1998             10.0%
                                                                                                                           
Avalon at Faxon Park                                                                                                       
Quincy, MA                          171          15.8       Q1 1997       Q1 1998       Q3 1998        Q1 1999             11.0%
                                                                                                                           
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%
                             ------------ -------------                                                            ----------------
                                  3,362       $ 373.0                                                                      10.6%
                             ============ =============                                                            ================
</TABLE>

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

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

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

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

                                      21




<PAGE>   24



DEVELOPMENT RIGHTS

         The Company is considering the development of 18 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 5,114 institutional-quality apartment homes to the
Company's portfolio. At June 30, 1997, the cumulative capitalized costs
incurred in pursuit of the 18 Development Rights were approximately $13.6
million, including the capitalized cost of $6.4 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 18 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            $    38.0
 2. New Canaan, CT(1)                 104                 24.4
 3. Greenburgh - II, NY               500                 71.2
 4. Greenburgh - III, NY              266                 41.8
 5. Darien, CT                        172                 21.0
 6. Fort Lee, NJ                      351                 53.7
 7. Peabody, MA                       434                 35.9
 8. Hull, MA                          162                 14.8
 9. Jersey City - II, NJ              268                 48.3
10. New Rochelle, NY                  375                 57.3
11. Melville - II, NY                 356                 36.3
12. Wilmington, MA                    204                 19.3
13. Gaithersburg - II, MD              96                  8.9
14. Bronxville, NY (1)                110                 20.1
15. Parsippany, NJ                    460                 63.2
16. Danbury, CT                       268                 24.4
17. Yonkers, NY                       256                 33.7
18. Florham Park, NJ                  280                 37.9
                                 -----------       --------------
    Total                           5,114            $   650.2
                                 ===========       ==============
</TABLE>


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



                                      22
<PAGE>   25


PART II           OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

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

ITEM 2.  CHANGES IN SECURITIES

         None.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

         None.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS

         The Annual Meeting of Stockholders of Avalon Properties, Inc. was held
on May 6, 1997, at which meeting each of the five Directors then serving and
previously nominated for election as a Director and a new nominee for election
as a Director were elected to serve until the 1998 Annual Meeting of
Stockholders and until their respective successors shall be duly elected and
qualified. Of 33,534,789 shares outstanding and eligible to vote at the Annual
Meeting of Stockholders, 28,468,202 shares were present in person or by proxy.
Of the votes cast, 28,446,055 were cast in favor of the reelection of Richard
L. Michaux and authority was withheld as to 22,147 shares; 28,446,546 votes
were cast in favor of the reelection of Charles H. Berman and authority was
withheld as to 21,656 shares; 28,451,755 votes were cast in favor of the
reelection of Michael A. Futterman and authority was withheld as to 16,447
shares; 28,451,755 votes were cast in favor of the reelection of Christopher B.
Leinberger and authority was withheld as to 16,447 shares; 28,451,755 votes
were cast in favor of the election of Richard W. Miller and authority was
withheld as to 16,447 shares; and 28,452,246 votes were cast in favor of the
reelection of Allen D. Schuster and authority was withheld as to 15,956 shares.

         Certain amendments to the Avalon Properties, Inc. 1995 Amended and
Restated Equity Incentive Plan were approved by the Company's stockholders at
the Annual Meeting of Stockholders by the affirmative vote of 21,196,063
shares; 4,994,238 shares were voted against, 2,254,488 shares were broker no
votes and 23,413 shares abstained from voting.

ITEM 5.  OTHER INFORMATION

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

         On July 1, 1997, the Company completed a public offering of 2,163,000
shares of common stock at a purchase 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.



                                      23

<PAGE>   26
ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

         a)    Exhibit No.          Description

               10.14                Amended and Restated Revolving Credit 
                                    Agreement dated as of May 30, 1997

               27.1                 Financial Data Schedule


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


                                      24


<PAGE>   27


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




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



                                      25