<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 September 30, 1996

                         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:

               30,735,694 shares outstanding as of November 1, 1996.

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


<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 September 30, 1996
                and December 31, 1995................................................................1

                Condensed Consolidated Statements of Operations for the three and 
                nine months ended September 30, 1996 and 1995........................................2

                Condensed Consolidated Statements of Cash Flows for the nine months
                ended September 30, 1996 and 1995....................................................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...................................................................24

Item 2          Changes in Securities...............................................................24

Item 3          Defaults upon Senior Securities.....................................................24

Item 4          Submission of Matters to a Vote of Stockholders.....................................24

Item 5          Other Information...................................................................24

Item 6          Exhibits and Reports on Form 8-K....................................................24

                Signature...........................................................................25

</TABLE>

<PAGE>   3




PART I  FINANCIAL INFORMATION

ITEM 1  FINANCIAL STATEMENTS

                             AVALON PROPERTIES, INC.

                      CONDENSED CONSOLIDATED BALANCE SHEETS

                                   (Unaudited)

                    (Dollars in thousands, except share data)



<TABLE>
<CAPTION>




ASSETS                                                                                   9-30-96            12-31-95       
                                                                                     ---------------     -------------
<S>                                                                                   <C>                 <C>       
Real estate (Notes 1, 2, 3 and 8)                                                                        
   Land                                                                                $    158,756       $   128,754
   Buildings and improvements                                                               691,771           521,082
   Furniture, fixtures and equipment                                                         26,140            19,369    
                                                                                     ---------------     -------------
                                                                                            876,667           669,205
      Less:  accumulated depreciation                                                       (40,685)          (27,059)
                                                                                     ---------------     -------------
                                                                                            835,982           642,146
   Construction in progress (including land)                                                141,908           113,228    
                                                                                     ---------------     -------------
            TOTAL REAL ESTATE, NET                                                          977,890           755,374

Cash and cash equivalents                                                                     2,962             1,801    
Cash in escrow                                                                                3,694             3,940    
Resident security deposits                                                                    5,743             4,193    
Investments in joint ventures (Note 6)                                                        2,240             1,735    
Deferred financing and other costs, net (Notes 2 & 7)                                         9,109             9,959    
Deferred development costs, prepaid expenses and other assets (Note 2)                       13,368             9,709    
                                                                                     ---------------     -------------
            TOTAL ASSETS                                                               $  1,015,006       $   786,711
                                                                                     ===============     =============
LIABILITIES AND STOCKHOLDERS' EQUITY                                                   
Unsecured Facilities (Notes 1, 4 and 8)                                                $    136,000       $    58,000
Construction loans                                                                               --            10,477             
Tax-exempt custodial receipts, net of unamortized discount                                   43,463            43,333             
Unsecured senior notes, 7-3/8% due 2002, net of unamortized discount                         99,864            99,846             
Mortgage notes payable (Note 1)                                                             134,336           114,900             
Unsecured tax-exempt bonds (Note 1)                                                              --            14,130             
Payables for construction                                                                    14,031             9,710             
Accrued expenses and other liabilities                                                       16,402            11,522             
Accrued interest payable                                                                      2,985             4,477             
Resident security deposits                                                                    6,529             4,919             
                                                                                     ---------------     -------------            
            TOTAL LIABILITIES                                                               453,610           371,314             
                                                                                     ---------------     -------------            
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 at September 30, 1996 (Note 8)                                                 45               --    

   Common stock, $.01 par value; 80,000,000 shares authorized; 30,732,361 and                            
      28,373,065 shares issued and outstanding at September 30, 1996 and                                 
      December 31, 1995, respectively                                                           307               284    
   Additional paid-in capital                                                               580,486           425,946
   Distributions in excess of accumulated earnings                                          (19,442)          (10,833)    
                                                                                     ---------------     -------------
            STOCKHOLDERS' EQUITY                                                            561,396           415,397
                                                                                     ---------------     -------------
            TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                 $  1,015,006       $   786,711
                                                                                     ===============     =============

</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 share data)
<TABLE>
<CAPTION>



                                                          Three months ended                    Nine months ended
                                                    --------------------------------     --------------------------------
                                                       9-30-96           9-30-95            9-30-96           9-30-95
                                                    --------------    --------------     --------------    --------------
<S>                                                     <C>               <C>                 <C>               <C>     
Revenue:
   Rental income                                        $  32,364         $  24,591           $ 89,286          $ 68,545
   Management fees                                            355               490              1,151             1,485
   Other income                                                92               106                313               332
                                                    --------------    --------------     --------------    --------------
            Total revenue                                  32,811            25,187             90,750            70,362
                                                    --------------    --------------     --------------    --------------

Expenses:
   Operating expenses                                      12,608             9,312             34,776            25,891
   Interest expense                                         2,847             3,065              7,093             7,398
   Depreciation and amortization                            5,326             4,176             15,025            11,969
   General and administrative expenses                        996               923              2,846             2,507
                                                    --------------    --------------     --------------    --------------
            Total expenses                                 21,777            17,476             59,740            47,765
                                                    --------------    --------------     --------------    --------------

Equity in income of joint ventures (Note 6)                   282               125                598               309
Interest income                                               195               247                641               736
Minority interest income (Note 3)                             111               143                410               481
                                                    --------------    --------------     --------------    --------------
Net income before extraordinary item                       11,622             8,226             32,659            24,123
Extraordinary item  (Note 7)                               (2,356)               --             (2,356)               --
                                                    --------------    --------------     --------------    --------------
Net income                                                  9,266             8,226             30,303            24,123
Dividends attributable to preferred stock                  (2,468)               --             (6,070)               --
                                                    --------------    --------------     --------------    --------------
Net income available to common stockholders             $   6,798         $   8,226           $ 24,233          $ 24,123
                                                    ==============    ==============     ==============    ==============

Net income per weighted average
  common share outstanding (Note 2)                     $    0.22         $    0.29           $   0.79          $   0.85
                                                    ==============    ==============     ==============    ==============
</TABLE>

     See accompanying notes to condensed consolidated financial statements.


                                       2
<PAGE>   5


                             AVALON PROPERTIES, INC.

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                                   (Unaudited)

                             (Dollars in thousands)
<TABLE>
<CAPTION>


                                                                                         Nine months ended
                                                                               --------------------------------------
                                                                                  9-30-96                 9-30-95
                                                                               ---------------         --------------
<S>                                                                              <C>                      <C>        
CASH FLOWS FROM OPERATING ACTIVITIES:
    Net income                                                                     $   30,303              $  24,123
    Adjustments to reconcile net income to cash provided by operating               
        activities:
                Depreciation and amortization
                Extraordinary item                                                     15,025                 11,969
                Decrease in resident security deposits,                                                             
                     net of related liability                                           2,356                     --
                Decrease in cash in escrow                                                 60                    818
                Increase in prepaid expenses                                                                        
                      and other assets                                                    246                    204
                Increase in accrued expenses, other liabilities                                                                    
                     and accrued interest payable                                      (4,609)                (2,392)     
                     Total adjustments                                                  3,182                  4,292               
                                                                               ---------------         --------------              
                     Net cash provided by operating activities                         16,260                 14,891               
                                                                               ---------------         --------------              
                                                                                       46,563                 39,014               
                                                                               ---------------         --------------              
CASH FLOWS USED IN INVESTING ACTIVITIES:                                       
    Increase in construction payables                                                   4,321                  7,148  
    Purchase and development of real estate                                          (230,762)              (158,809)               
                                                                               ---------------         --------------              
                     Net cash used in investing activities                           (226,441)              (151,661)               
                                                                               ---------------         --------------              
CASH FLOWS FROM FINANCING ACTIVITIES:                                                                                              
    Issuance of common stock, net                                                      47,027                    329               
    Issuance of preferred stock, net                                                  107,581                     --               
    Dividends paid                                                                    (38,912)               (30,915)               
    Borrowings under notes                                                              7,000                150,125               
    Repayments of notes                                                                (7,127)                (1,673)               
    Borrowings under Unsecured Facilities                                             216,500                193,625               
    Repayments of Unsecured Facilities                                               (138,500)              (192,395)               
    Borrowings under construction loans                                                    31                  3,615               
    Repayments of construction loans                                                  (10,508)                (5,172)               
    Payments of deferred financing costs                                               (2,053)                (5,579)               
                                                                               ---------------         --------------              
                     Net cash provided by financing activities                        181,039                111,960               
                                                                               ---------------         --------------              
                     Net increase (decrease) in cash                                    1,161                   (687)               
Cash and cash equivalents, beginning of period                                          1,801                  2,862               
                                                                               ---------------         --------------              

Cash and cash equivalents, end of period                                           $    2,962              $   2,175              
                                                                               ===============         ==============              

Cash paid during period for interest, net of amount capitalized                    $    7,541              $   5,331              
                                                                               ===============         ==============              
                                                                                                                                   
</TABLE>

Non-cash investing and financing activities: $5,581 of debt was assumed in
connection with the Avalon Pines acquisition in May 1996.

     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 share data)

1.       Organization of the Company and Recent Developments

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

                  On July 3, 1996, the Company purchased a 47.4 acre tract of
         land in Nanuet, New York for $7,000. A new 504 apartment home community
         commenced construction in the third quarter of 1996.

                  On July 23, 1996, the Company purchased Avalon at Fairway
         Hills II, two luxury garden-style communities (formerly Greenbriar and
         Fairway Pointe) located in Columbia, Maryland for $32,430. These
         communities contain a total of 527 apartment homes and, along with
         another Company-owned community, Avalon Meadows (renamed Avalon at
         Fairway Hills I), will be operated as two phases of one community.

                   On August 1, 1996, the Company completed a new
         tax-exempt credit enhancement facility with the Federal National
         Mortgage Association ("Fannie Mae") that will provide a long-term,
         cost-effective credit enhancement source for the Company's current and
         future tax-exempt bond communities. In connection with this facility,
         the Company completed a refinancing of approximately $91,000.  The
         facility involves eleven communities, seven that are financed with
         tax-exempt bonds and four previously unencumbered communities that
         are pledged as additional collateral.

                  On September 25, 1996, the Company purchased Avalon at The
         Boulders (formerly Boulder Springs) in Richmond, Virginia for $14,831.
         This luxury garden-style community contains a total of 284 apartment
         homes.

                  In September 1996, pricing on the Company's unsecured credit  
         facilities ("Unsecured Facilities") was reduced. The consortium of
         banks providing the Company's $165,000 unsecured credit facility
         lowered the interest rate charged under the facility to LIBOR plus
         1.19% from LIBOR plus 1.44%. After a ratings upgrade from Moody's
         Investors Service in October 1996, the interest rate was further
         reduced to LIBOR plus 1.125%. Pricing under the $35,000 unsecured
         credit facility provided by First Union National Bank was reduced to
         LIBOR plus .95% from LIBOR plus 1.25%.

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.

                                       4
<PAGE>   7

         Real Estate

                  Buildings and improvements are recorded at cost and are
         depreciated on a straight-line basis over their estimated useful lives
         of 40 and 7 years, respectively. 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 nine months ended
         September 30, 1996 and 1995 is based upon 30,563,292 and 28,362,921
         weighted average number of shares of common stock outstanding,
         respectively. Net income per common share for the three months ended
         September 30, 1996 and 1995 is based upon 30,726,488 and 28,372,588
         weighted average number of shares of common stock outstanding,
         respectively.

         Interim Financial Statements

                  These condensed consolidated financial statements are
         unaudited and were prepared pursuant to the rules and regulations of
         the Securities and Exchange Commission. However, in the opinion of the
         Company's management, all adjustments (consisting solely of normal
         recurring adjustments) necessary for a fair presentation of the
         financial statements have been included. The operating results for
         these periods are not necessarily indicative of the operating results
         that may be attained for a full fiscal year. The accompanying condensed
         consolidated financial statements should be read in conjunction with
         the consolidated financial statements included in the Company's Annual
         Report on Form 10-K for the year ended December 31, 1995.

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 note over the cash flow from operations generated by
         the community. This excess is funded from payments drawn from an
         escrow account established from contributions by the minority
         partners. At September 30, 1996, the partnership had $3,229 of cash
         from these contributions available to fund interest payments. The note
         bears interest at 10.2%. Upon acquisition, the note was restructured
         to provide for a 9% pay rate. The difference between the stated
         interest and the pay rate is deferred interest and is added to the
         principal. The loan also provides for contingent interest of 50% of
         gross revenues, as defined, and is payable prior to any payments to
         the partners. No contingent interest has been paid through September
         30, 1996. The note entitles the holder


                                       5
<PAGE>   8

         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 three-year revolving credit facility (the
         "Unsecured Facility") is provided by a consortium of nine banks ("Bank
         Group"), led by JP Morgan and Fleet Bank that provides for $165,000 in
         short-term credit. The Unsecured Facility expires in April 1998. As of
         September 30, 1996, approximately $8,427 of available capacity was used
         to provide letters of credit and $105,500 was borrowed under the
         facility. Accordingly, the balance that remains available at September
         30, 1996 to be drawn under the Unsecured Facility is $51,073. The
         Unsecured Facility bears interest based upon a LIBOR, Prime or CD rate
         election at the Company's option. Current pricing level is LIBOR plus
         1.125%.

                  In January 1996, the Company arranged the two-year
         supplemental unsecured facility provided by First Union National Bank
         (the "Supplemental Unsecured Facility") in the amount of $35,000. The
         Supplemental Unsecured Facility expires in January 1998 and bears a
         current interest rate of LIBOR plus .95%. At September 30, 1996, $4,030
         of available capacity was used to provide letters of credit and $30,500
         was borrowed under the Supplemental Unsecured Facility. Accordingly,
         the balance that remains available at September 30, 1996 to be drawn
         under the Supplemental Unsecured Facility is $470. The weighted average
         effective interest rates (excluding the cost of unused fees) on
         borrowings under the Unsecured Facilities and prior year's Unsecured
         Facility for the three and nine months ended September 30, 1996 and
         1995 were 6.8%, 7.6%, 7.0% and 8.1%, respectively. Including the cost
         of unused fees, the weighted average effective interest rates on
         borrowings under the Unsecured Facilities and prior year's Unsecured
         Facility for the three and nine months ended September 30, 1996 and
         1995 were 7.1%, 7.8%, 7.6% and 8.2%, respectively.

                  On May 30, 1995, the Company entered into an interest rate
         protection agreement in the form of an accreting swap agreement (the
         "Swap") with a triple A rated counterparty (the "Counterparty"). The
         Swap specifies that, commencing October 15, 1995, the Company shall pay
         the Counterparty a fixed rate of 5.89% on an initial principal amount
         that began at $8,000 and increases in varying amounts to a maximum of
         $45,000 in February 1997, at which time the agreement terminates. The
         principal amount in effect at September 30, 1996 is $40,000. In return,
         the Counterparty will pay to the Company a variable rate payment equal
         to 30-day LIBOR on the respective principal amounts. This Swap serves
         to fix the variable component of the Company's total interest rate at
         5.89% on the principal amounts during the term of the agreement.
         Payments made by the Company under this agreement totaled $37 and $83
         during the three and nine month period ended September 30, 1996,
         respectively.

5.       Stockholders' Equity

                  The following summarizes the changes in stockholders' equity
         for the nine months ended September 30, 1996:


<TABLE>
<CAPTION>

                                                                             Distributions
                                                             Additional      in excess of
                                  Preferred      Common        paid-in        accumulated
                                    stock        stock         capital         earnings          Total
                                 ------------  -----------  --------------  ----------------  -------------
<S>                                 <C>          <C>            <C>            <C>               <C>      
Stockholders' equity,12-31-95       $     --     $    284       $ 425,946        $  (10,833)     $ 415,397
Net income                                --           --              --            30,303         30,303
Dividends declared                        --           --              --           (38,912)       (38,912)
Issuance of common stock                  --           23          47,004                --         47,027
Issuance of preferred stock               45           --         107,536                --        107,581
                                  ------------  -----------  --------------    -------------- -------------
Stockholders' equity, 9-30-96       $     45     $    307       $ 580,486        $  (19,442)     $ 561,396
                                 ============  ===========  ==============     =============  =============

</TABLE>


                                       6
<PAGE>   9


6.       Investments in Joint Ventures

                  At September 30, 1996, investments in joint ventures consisted
         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
         (Development Community). At December 31, 1995, investments in joint
         ventures also consisted of a 50% general partnership interest in
         Evergreen Hamden Joint Venture. On February 15, 1996, the Company
         assigned its 50% partnership interest in Evergreen Hamden Joint Venture
         to the institutional partner in the joint venture. The following is a
         combined summary of the financial position of these joint ventures for
         the periods presented:

<TABLE>
<CAPTION>

                                               9-30-96          12-31-95
                                              ----------       -----------
<S>                                           <C>              <C>    
Assets:
    Real estate, net                            $89,009           $60,821
    Other assets                                  4,217             3,964
                                              ----------       -----------
Total assets                                    $93,226           $64,785
                                              ==========       ===========

Liabilities and partners' equity:
    Mortgage notes payable                      $26,000           $34,786
    Other liabilities                             3,786             3,686
    Partners' equity                             63,440            26,313
                                              ----------       -----------
Total liabilities and partners' equity          $93,226           $64,785
                                              ==========       ===========

</TABLE>

                  The following is a combined summary of the operating results
         of these joint ventures for the periods presented. At September 30,
         1995, the investments in joint ventures also included a 50% general
         partnership interest in Evergreen Hamden Joint Venture:

<TABLE>
<CAPTION>

                                               Three months ended                 Nine months ended
                                          -----------------------------      -----------------------------
                                           9-30-96           9-30-95          9-30-96           9-30-95
                                          -----------      ------------      -----------       -----------
<S>                                        <C>               <C>              <C>               <C>     
Rental income                              $   2,586         $   2,299        $   7,257          $  6,685
Other income                                      17                18               45                52
Operating expenses                            (1,133)             (897)          (3,028)           (2,538)
Mortgage interest expense                       (215)             (239)            (639)             (762)
Depreciation and amortization                   (446)             (427)          (1,266)           (1,278)
                                          -----------      ------------      -----------       -----------

     Net income                            $     809         $     754        $   2,369          $  2,159
                                          ===========      ============      ===========       ===========
</TABLE>

7.       Extraordinary Item

                In August 1996, the Company recorded a non-recurring charge to
         earnings for the recorded value of the unamortized deferred financing
         costs associated with the refinancing of $91,000 of tax-exempt bonds
         in conjunction with the completion of the new credit enhancement
         facility with Fannie Mae.

8.       Subsequent Events

                  On October 2, 1996, the Company purchased a 10.8 acre tract of
         land in Melville, New York for $3,000. A new 154 apartment home
         community, Avalon Court, will start construction in the fourth quarter
         of 1996.

                  On October 22, 1996, the Company completed an offering of
         4,300,000 shares of 8.96% Series B cumulative redeemable preferred
         stock. The gross proceeds of the offering totaled $107,500. The net

                                       7
<PAGE>   10

         cash proceeds from the sale (approximately $104,114) were used to
         retire indebtedness under the Company's Unsecured Facility.

                  On November 1, 1996, the Company sold two existing
         communities, Avalon Brooke and Avalon Heights, located in Middletown
         (Hartford), Connecticut for $32,650. These communities contained a
         total of 518 apartment homes. In connection with this sale, the Company
         will recognize a non-recurring gain totaling approximately $8,000. Net
         proceeds from the sale (approximately $32,000) was used to reduce
         outstanding balances under the Unsecured Facilities.



                                       8
<PAGE>   11



PART I     FINANCIAL INFORMATION (CONTINUED)

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

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

         This Form 10-Q contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Although the Company believes that the expectations
reflected in such forward-looking statements are based on reasonable
assumptions, the Company's actual results could differ materially from those set
forth in the forward-looking statements.  Certain factors that might cause
such a difference include, but are not limited to, the following:  development
opportunities may be abandoned; construction costs of a community may exceed
original estimates; construction and lease-up of new communities may not be
completed on schedule, resulting in increased interest expense and construction
costs and reduced rental revenues; occupancy rates and rents may be adversely
affected by local economic and market conditions; 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 the Company may not be
able to refinance existing indebtedness or the terms of such refinancing may
not be as favorable as the terms of existing indebtedness as well as other 
factors discussed periodically in the Company's reports filed with the
Securities and Exchange Commission, including the reports on Form 10-Q for the
quarters ended March 31, 1996 and June 30, 1996 and the Form 10-K for the year
ended December 31, 1995. Those factors that might cause such a difference
include those set forth under the "Recent Developments," "Liquidity and Capital
Resources," "Business Conditions; Inflation" and "Development Communities"
sections of this Item 2.

RECENT DEVELOPMENTS

         Acquisitions or Dispositions of Existing Communities. On July 23, 1996,
the Company purchased Avalon at Fairway Hills II, two luxury garden-style
communities (formerly Greenbriar and Fairway Pointe) located in Columbia,
Maryland for $32,430,000. These communities contain a total of 527 apartment
homes and, along with Avalon at Fairway Hills I (a community currently owned by
the Company), will be operated as two phases of one community.

         On September 25, 1996, the Company purchased Avalon at The Boulders
(formerly Boulder Springs) in Richmond, Virginia for $14,831,000. This luxury
garden-style community contains a total of 284 apartment homes.

         On November 1, 1996, the Company sold two existing communities, Avalon
Brooke and Avalon Heights, located in Middletown (Hartford), Connecticut for
$32,650,000. These communities contained a total of 518 apartment homes. In
connection with this sale, the Company will recognize a non-recurring gain
totaling approximately $8,000,000. Net proceeds from the sale (approximately
$32,000,000) was used to reduce outstanding balances under the Company's
revolving credit facilities ("Unsecured Facilities".)

         Land Acquisitions for New Development. On July 3, 1996, the Company
purchased a 47.4 acre tract of land in Nanuet, New York for $7,000,000. A new
504 apartment home community commenced construction in the third quarter of
1996.

         On October 2, 1996, the Company purchased a 10.8 acre tract of land in
Melville, New York for $3,000,000. Construction of a new 154 apartment home
community, Avalon Court, will start in the fourth quarter of 1996.

         Financing Activities. On August 1, 1996, the Company completed a new
tax-exempt credit enhancement facility with the Federal National Mortgage
Association ("Fannie Mae") that will provide a long-term cost-effective credit
enhancement source for the Company's current and future tax-exempt bond
portfolio. In connection with this facility, the Company completed a refinancing
of approximately $91,000,000 of its tax-exempt bond portfolio. The facility
involves eleven communities, seven that are financed with tax-exempt bonds and
four previously unencumbered communities that are pledged as additional
collateral.

         In September 1996, pricing on the Company's Unsecured Facilities was
reduced. The consortium of banks providing the Company's $165,000,000 unsecured
credit facility ("Unsecured Facility") lowered the interest rate charged under
the facility to LIBOR plus 1.19% from LIBOR plus 1.44%. After a ratings upgrade
from Moody's Investor Service in October 1996 (see "Liquidity and Capital
Resources"), the interest rate was reduced to LIBOR plus 1.125%. Pricing under
the $35,000,000 supplemental unsecured credit facility

                                       9
<PAGE>   12

("Supplemental Unsecured Facility") provided by First Union National Bank was
reduced to LIBOR plus .95% from LIBOR plus 1.25%.

         On October 22, 1996, the Company completed an offering of 4,300,000
shares of 8.96% Series B cumulative redeemable preferred stock. The gross
proceeds of the offering totaled $107,500,000. The net cash proceeds from the
sale (approximately $104,114,000) were used to retire indebtedness under the
Company's Unsecured Facility.

GENERAL

         The Company's operations consist of the development, construction,
acquisition and operation of apartment communities in the Mid-Atlantic and
Northeast regions of the United States. At September 30, 1996, the Company owned
42 completed and operating communities, a general partnership interest in two
other communities (a 50% interest in Falkland Chase and a 49% interest in Avalon
Run) and a 100% interest in a senior participating mortgage note secured by
another community (Avalon Arbor) which is accounted for as an investment in real
estate. The Company also has a fee simple ownership interest in eight
Development Communities (as hereinafter defined). One of the eight 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 95% 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 both the current year and the beginning of the
         previous calendar year such that its year-to-date operating results are
         comparable between periods.

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

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

RESULTS OF OPERATIONS

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

         The analysis that follows compares the operating results of the Company
for the three and nine months ended September 30, 1996 and 1995.

         Net income before extraordinary item increased $8,536,000 (35.4%) to
$32,659,000 from $24,123,000 for the nine months ended September 30, 1996
compared to the comparable period of the preceding year. Net 

                                       10
<PAGE>   13

income increased $3,396,000 (41.3%) to $11,622,000 from $8,226,000 for the three
months ended September 30, 1996 compared to the comparable period of the
preceding year. The notable reasons for these increases are additional operating
income from communities developed or acquired during 1995 and 1996 as well as
growth in operating income from existing communities.

         Rental income increased $20,741,000 (30.3%) to $89,286,000 from
$68,545,000 for the nine months ended September 30, 1996 compared to the
comparable period of the preceding year. Rental income increased $7,773,000
(31.6%) to $32,364,000 from $24,591,000 for the three months ended September 30,
1996 compared to the comparable period of the preceding year. Of the increase
for the nine month period, $17,902,000 was due to newly completed or acquired
communities and $2,839,000 was due to rental rate growth from Established
Communities that were owned or completed throughout both periods.

         Overall Portfolio - The $20,741,000 increase in rental income for the
         nine month period is primarily due to increases in the weighted average
         number of occupied apartment homes as well as an increase in the
         weighted average monthly rental income per occupied apartment home. The
         weighted average number of occupied apartment homes increased from
         9,100 apartment homes for the nine months ended September 30, 1995 to
         10,930 apartment homes for the nine months ended September 30, 1996 as
         a result of the development and acquisition of new communities. For the
         nine months ended September 30, 1996, the weighted average monthly
         revenue per occupied apartment home increased $54 (6.5%) to $890 from
         $836 compared to the comparable period of the preceding year. For the
         three months ended September 30, 1996, the weighted average monthly
         revenue per occupied apartment home increased $48 (5.6%) to $900 from
         $852 compared to the comparable period of the preceding year.

         Established Communities - For the nine months ended September 30, 1996,
         the weighted average monthly revenue per occupied apartment home
         increased $41 (4.9%) to $880 from $839 compared to the comparable
         period of the preceding year, and the average economic occupancy
         declined to 96.1% from 96.5%. For the three months ended September 30,
         1996, the weighted average monthly revenue per occupied apartment home
         increased $42 (4.9%) to $895 from $853, and the average economic
         occupancy declined to 95.9% from 96.7%. Accordingly, rental revenue
         from Established Communities increased $2,839,000 (4.5%) and $892,000
         (4.1%) for the nine month and three month periods ended September 30,
         1996, respectively, compared to the comparable periods of the preceding
         year. When combined with other income from Established Communities,
         total revenue from Established Communities increased 4.5% and 4.1% for
         the nine month and three month periods ended September 30, 1996,
         respectively, compared to the comparable periods of the preceding year.

         Management fees decreased $334,000 (22.5%) to $1,151,000 from
$1,485,000 for the nine months ended September 30, 1996 compared to the
comparable period of the preceding year. These fees decreased $135,000 (27.6%)
to $355,000 from $490,000 for the three months ended September 30, 1996 compared
to 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
in 1996. This decline is due to the sale and cancellation of management
contracts of some third-party communities in 1995 and 1996 as well as the
acquisition of two Current Communities in the third quarter of 1995 and one
Current Community in the second quarter of 1996 that were previously managed by
the Company for third-party owners prior to their acquisition. The Company has
decided not to aggressively pursue new fee management business at this time. New
fee management business will be accepted in cases where it is profitable and
where it presents a possible acquisition opportunity. This creates a very
selective environment under which new fee management business will be added and
will likely result in an overall decline in this revenue source in the future.

         Operating expenses, including write-off of deferred development costs,
increased $8,885,000 (34.3%) to $34,776,000 from $25,891,000 for the nine months
ended September 30, 1996 compared to the comparable period of the preceding
year. These expenses increased $3,296,000 (35.4%) to $12,608,000 from $9,312,000
for the three months ended September 30, 1996 compared to the comparable period
of the preceding year.

                                       11
<PAGE>   14

         Overall Portfolio - The $8,885,000 increase for the nine month period
         is primarily due to the acquisition of new communities, as well as the
         completion of Development Communities whereby maintenance, property
         taxes, insurance and other costs are expensed as communities move from
         the initial construction and lease-up phase to the operating phase. The
         increased costs of snow removal and other weather related expenses as a
         result of the severe winter weather during the first quarter of 1996
         also contributed to the increase.

         Established Communities - Operating expenses increased $1,278,000
         (6.0%) to $22,528,000 from $21,250,000 for the nine months ended
         September 30, 1996 compared to the comparable period of the preceding
         year. Operating expenses increased $303,000 (4.1%) to $7,678,000 from
         $7,375,000 for the three months ended September 30, 1996 compared to
         the comparable period of the preceding year. These increases were
         concentrated in the maintenance category partially due to the severe
         winter weather throughout the Northeast and Mid-Atlantic regions during
         the first quarter of 1996 as well as increases in the property taxes
         for newly stabilized development communities and marketing expenses.

         Interest expense decreased $305,000 (4.1%) to $7,093,000 from
$7,398,000 for the nine months ended September 30, 1996 compared to the
comparable period of the preceding year. Interest expense decreased $218,000
(7.1%) to $2,847,000 from $3,065,000 for the three months ended September 30,
1996 compared to the comparable period of the preceding year. These decreases
are primarily attributable to the sale of 2,227,000 shares of the Company's
common stock and the sale of 4,455,000 shares of the Company's preferred stock
in the first quarter of 1996, as the net cash proceeds from the sales were used
to retire indebtedness under the Company's Unsecured Facility, variable
rate construction loans and to repay the mortgage note encumbering the Avalon
at Carter Lake community. Lower short-term interest rates under the Unsecured 
Facilities due to structural rate reductions achieved as well as lower LIBOR 
rates also contributed to the declines. Finally, an increase in capitalized 
interest due to an increase in the number of apartment homes under construc-
tion and lower interest and credit enhancement costs in connection with the 
completion of the tax-exempt, credit enhancement facility with Fannie Mae are 
other reasons for the overall declines.

         Depreciation and amortization increased $3,056,000 (25.5%) to
$15,025,000 from $11,969,000 for the nine months ended September 30, 1996
compared to the comparable period of the preceding year. Depreciation and
amortization increased $1,150,000 (27.5%) to $5,326,000 from $4,176,000 for the
three months ended September 30, 1996 compared to the comparable period of the
preceding year. These increases reflect additional depreciation expense for
recently acquired and developed communities and the amortization of the costs
related to the issuance of tax-exempt custodial receipts in May 1995 as well as
the costs related to the closing of the Unsecured Facility and the issuance of
$100,000,000 of unsecured senior notes in September 1995, offset by lower
amortization expense due to the new Fannie Mae credit enhancement facility.

         General and administrative expenses increased $339,000 (13.5%) to
$2,846,000 from $2,507,000 for the nine months ended September 30, 1996 compared
to the comparable period of the preceding year. These expenses increased $73,000
(7.9%) to $996,000 from $923,000 for the three months ended September 30, 1996
compared to the comparable period of the preceding year. These increases are
primarily due to the introduction of the amended and restated 1996 and 1995
Equity Incentive Plan (and related legal and proxy costs) as well as staff
additions related to growth in the Company's portfolio and the implementation of
the company-wide systems enhancement program.

         Equity in income of joint ventures increased $289,000 (93.5%) to
$598,000 from $309,000 for the nine months ended September 30, 1996 compared to
the comparable period of the preceding year. This income increased $157,000 to
$282,000 from $125,000 for the three months ended September 30, 1996 compared to
the comparable period of the preceding year. These increases are principally the
result of increased net income from the Falkland Partners joint venture due to
an increase in rental revenue as well as the income from the Town Close
Associates joint venture that was formed in June 1995. Non-recurring income from
the anticipated Avalon Grove joint venture in which the Company is allocated
100% of the lease-up period income also contributed to the increases.

                                       12
<PAGE>   15

         Extraordinary item of $2,356,000 for the three and nine months ended
September 30, 1996 reflects the write-off of the unamortized deferred financing
costs associated with the refinancing of the $91,000,000 of tax-exempt bonds in
conjunction with the completion of the new credit enhancement facility with
Fannie Mae.

FUNDS FROM OPERATIONS

         The Company's management ("Management") generally considers Funds from
Operations ("FFO") to be an appropriate measure of the operating performance of
the Company. Management believes that in order to facilitate a clear
understanding of the operating results of the Company, Funds from Operations
should be examined in conjunction with the net income as presented in the
condensed consolidated financial statements included elsewhere in this report.
Funds from Operations is determined in accordance with a resolution adopted by
the Board of Governors of the National Association of Real Estate Investment
Trusts, Inc. ("NAREIT"). NAREIT adopted a revised definition of FFO commencing
with reporting periods ending after January 1, 1996 and is defined as net income
(loss) (computed in accordance with generally accepted accounting principles),
excluding gains (or losses) from debt restructuring and sales of property, plus
depreciation of real estate and after adjustments for unconsolidated
partnerships and joint ventures. The Company adopted the revised definition
commencing January 1, 1996.

         The table on the following page presents an analysis of Funds from
Operations under the revised and former definition for the periods presented:

                                       13
<PAGE>   16

ANALYSIS OF FUNDS FROM OPERATIONS ($ IN 000'S)      

<TABLE>
<CAPTION>
                                                                         REVISED DEFINITION                     
                                                          Three months ended             Nine months ended      
                                                       --------------------------    -------------------------- 
                                                         9-30-96       9-30-95         9-30-96       9-30-95    
                                                       ------------  ------------    ------------  ------------ 
<S>                                                    <C>           <C>              <C>          <C>          
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS             $     6,798   $     8,226     $    24,233   $    24,123 
  Depreciation:                                                                                                   
     Community level                                          4,783         3,538          13,247        10,455 
     Corporate level (FF&E)                                      --            --              --            -- 
  Extraordinary item                                          2,356            --           2,356            -- 
  Amortization of deferred financing and other  
     deferred costs                                              --            --              --            -- 
  Allocated share of joint venture depreciation                  81            79             240           237 
  Allocated share of joint venture amortization                  --            --              --            -- 
                                                       ------------  ------------    ------------  ------------ 
FUNDS FROM OPERATIONS                                   $    14,018   $    11,843     $    40,076   $    34,815 
                                                       ============  ============    ============  ============ 
WEIGHTED AVERAGE SHARES OUTSTANDING                      30,726,488    28,372,588      30,563,292    28,362,921 
                                                       ============  ============    ============  ============ 
                                                                                                                
OTHER CAPITALIZED EXPENDITURES AND OTHER        
  INFORMATION                                                            
  Capital expenditures:                                                                                           
    Community level (1)                                 $       453   $       360     $     1,287   $       834 
    Corporate level (2)                                 $       219   $       153     $     1,810   $       470 
  Loan principal amortization payments                  $       187   $       128     $       423   $       383 
  Capitalized deferred financing costs (3)              $     1,594   $     3,024     $     2,053   $     5,579 
                                                                                                                
</TABLE>

                                                      

<TABLE>
<CAPTION>                                                                                                                     
                                                                                                                              
                                                                                    FORMER DEFINITION                         
                                                                  Three months ended               Nine months ended          
                                                                                                                              
                                                              --------------------------     ------------------------------   
                                                                9-30-96       9-30-95           9-30-96         9-30-95       
                                                              ------------  ------------     --------------  --------------   
<S>                                                            <C>           <C>             <C>             <C>              
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS                    $     6,798   $     8,226      $      24,233   $      24,123   
  Depreciation:                                                                                                               
     Community level                                                 4,783         3,538             13,247          10,455   
     Corporate level (FF&E)                                            132            61                362             166   
  Extraordinary item                                                 2,356            --              2,356              --   
  Amortization of deferred financing and other  
     deferred costs                                                    411           577              1,416           1,348   
  Allocated share of joint venture depreciation                         81            79                240             237   
  Allocated share of joint venture amortization                          2             2                  6               6   
                                                              ------------  ------------     --------------  --------------   
FUNDS FROM OPERATIONS                                          $    14,563   $   $12,483      $      41,860   $      36,335   
                                                              ============  ============     ==============  ==============   
WEIGHTED AVERAGE SHARES OUTSTANDING                             30,726,488    28,372,588         30,563,292      28,362,921   
                                                              ============  ============     ==============  ==============   
                                                                                                                              
OTHER CAPITALIZED EXPENDITURES AND OTHER                                                                                      
  INFORMATION                                                                                                                 
  Capital expenditures:                                                                                                       
    Community level (1)                                        $       453   $       360      $       1,287   $         834   
    Corporate level (2)                                        $       219   $       153      $       1,810   $         470   
  Loan principal amortization payments                         $       187   $       128      $         423   $         383   
  Capitalized deferred financing costs (3)                     $     1,594   $     3,024      $       2,053   $       5,579   

</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 leasehold improvements, office equipment
   and computer costs related to the implementation of a company-wide systems
   enhancement plan.

(3)Substantially all of the deferred financing costs incurred for the nine
   months ended September 30, 1996 relate to the closing of the Supplemental
   Unsecured Facility and costs incurred related to the credit enhancement
   facility with Fannie Mae.


                                       14
<PAGE>   17
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.
Community level 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 (computers, furniture) are capitalized only if the item is a
new addition (i.e., not a replacement) and only if the item exceeds $2,500. The
application of these policies for the nine months ended September 30, 1996
resulted in capitalized expenditures for Stabilized Communities of approximately
$128 per apartment home. For the nine months ended September 30, 1996, the
Company charged to maintenance expense, including carpet and appliance
replacements, a total of approximately $7,579,000 for Stabilized Communities or
$752 per apartment home. Management anticipates that capitalized costs per
apartment home will gradually rise as the Company's portfolio of communities
matures. The table on the following page is a summary of expenditures for both
recurring maintenance costs (expensed) and community upgrades (capitalized) for
the nine months ended September 30, 1996.

                                       15
<PAGE>   18


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

<TABLE>
<CAPTION>

                                                                                             YTD 1996 Capitalized Upgrades     
                                           Number         Balance at        Balance at       -------------------------------   
            Community                     of Homes         12-31-95   (1)     9-30-96    (1)     Total           Per Home      
----------------------------------       -----------     -------------     --------------    ---------------    ------------   
<S>                                          <C>            <C>               <C>                   <C>            <C>    
STABILIZED                                                                                                                     
----------                                                                                                                     
Avalon Park                                     372         $  19,635         $   19,716             $   81        $    218    
Avalon at Ballston                              344            36,617             36,682                 65             189    
Avalon at Gayton                                328             9,715              9,814                 99             302    
Avalon at Symphony Glen                         174             8,034              8,066                 32             184    
Avalon at Hampton I                             186             3,661              3,712                 51             274    
Avalon at Hampton II                            231             8,093              8,125                 32             139    
Avalon at Dulles                                236            11,540             11,599                 59             250    
Avalon Knoll                                    300             7,851              7,886                 35             117    
Avalon Lea                                      296            16,057             16,100                 43             145    
Avalon at Fairway Hills I                       192             9,281              9,344                 63             328    
Avalon Ridge                                    432            24,874             25,023                149             345    
Longwood Towers                                 250            16,600             16,617                 17              68    
Avalon Farm                                     306            17,270             17,306                 36             118    
Avalon Brooke                                   280            13,258             13,305                 47             168    
Avalon Glen                                     238            30,066             30,075                  9              38    
Avalon Pavilions                                932            56,418             56,491                 73              78    
Avalon Heights                                  238            12,217             12,244                 27             113    
Avalon View                                     288            17,725             17,778                 53             184    
4100 Massachusetts Ave.                         308            34,859             34,865                  6              19    
Avalon at Carter Lake                           259            11,413             11,484                 71             274    
Avalon Pointe                                   140             7,731              7,748                 17             121    
Avalon Station                                  127             5,920              5,925                  5              39    
Avalon Woods                                    268             8,237              8,235                (2)             (7)    
Avalon at Park Center                           492            37,244             37,297                 53             108    
Avalon at Lexington                             198            14,102             14,102                 --              --    
Avalon Watch                                    512            28,215             28,308                 93             182    
Avalon Walk I                                   430            34,417             34,445                 28              65    
Avalon Walk II                                  334            23,537             23,541                  4              12    
Avalon Landing                                  158             9,256              9,257                  1               6    
Avalon Birches                                  312            13,413             13,416                  3              10    
Avalon at Lake Arbor                            209            11,895             11,899                  4              19    
Avalon at Decoverly                             368            30,947             30,974                 27              73    
Avalon Summit West                              125             6,764              6,764                 --              --    
Avalon Towers                                   109            15,820             15,823                  3              28    
Avalon Green                                    105            12,017             12,020                  3              29    
                                         -----------     -------------     --------------    ---------------    ------------   
                                             10,077           624,699            625,986              1,287             128    
                                         -----------     -------------     --------------    ---------------    ------------   
NEWLY ACQUIRED/DEVELOPED                                                                                                       
------------------------                                                                                                       
Avalon Fields                                   192            14,103             14,262                159             828    
Avalon West                                     120             6,938             10,550              3,612          30,100    
Avalon Station II                                96             3,771              5,848              2,077          21,635    
Avalon Summit East                              120             6,351              9,274              2,923          24,358    
Avalon Run East                                 206             4,421             15,238             10,817          52,510    
Avalon Chase (2)                                360                --             23,611             23,611          65,586    
Avalon Pines (2)                                174                --              8,577              8,577          49,293    
Avalon at Fairway Hills II (2)                  527                --             33,735             33,735          64,013    
Avalon at the Boulders (2)                      284                --             16,027             16,027          56,433    
                                         -----------     -------------     --------------    ---------------    ------------   
                                              2,079            35,584            137,122            101,538          48,840    
                                         -----------     -------------     --------------    ---------------    ------------   
                                                                                                                               
NEW DEVELOPMENTS                              2,854            91,990            220,711            128,721          45,102    
----------------                                                                                                               
                                                                                                                               
OTHER                                                                                                                          
-----                                                                                                                          
Longwood Towers - Renovation                     --             1,089              3,439              2,350 (5)       9,400    
Avalon Arbor (3)                                302            27,234             27,670                436           1,444    
Corporate Level Expenditures                     --             1,837              3,647              1,810              --    
                                         ===========     =============     ==============    ===============    ============   
Grand Total                                  15,312 (4)     $ 782,433         $1,018,575                N/A             N/A   
                                         ===========     =============     ==============    ===============    ============   
</TABLE>

<TABLE>
<CAPTION>
                                                    YTD 1996
                                             Maintenance Expensed
                                         ------------------------------
            Community                        Total          Per Home
----------------------------------       --------------    ------------
<S>                                             <C>          <C>
STABILIZED                               
----------                               
Avalon Park                                     $  296       $     796
Avalon at Ballston                                 243             706
Avalon at Gayton                                   273             832
Avalon at Symphony Glen                            151             868
Avalon at Hampton I                                165             887
Avalon at Hampton II                               166             719
Avalon at Dulles                                   223             945
Avalon Knoll                                       299             997
Avalon Lea                                         215             726
Avalon at Fairway Hills I                          188             979
Avalon Ridge                                       277             641
Longwood Towers                                    343           1,372
Avalon Farm                                        237             775
Avalon Brooke                                      136             486
Avalon Glen                                        203             853
Avalon Pavilions                                   486             521
Avalon Heights                                     164             689
Avalon View                                        273             948
4100 Massachusetts Ave.                            297             964
Avalon at Carter Lake                              211             815
Avalon Pointe                                      135             964
Avalon Station                                      99             780
Avalon Woods                                       159             593
Avalon at Park Center                              277             563
Avalon at Lexington                                165             833
Avalon Watch                                       396             773
Avalon Walk I                                      180             419
Avalon Walk II                                     159             476
Avalon Landing                                     155             981
Avalon Birches                                     182             583
Avalon at Lake Arbor                               215           1,029
Avalon at Decoverly                                233             633
Avalon Summit West                                  90             720
Avalon Towers                                      154           1,413
Avalon Green                                       134           1,276
                                         --------------    ------------
                                                 7,579             752
                                         --------------    ------------
NEWLY ACQUIRED/DEVELOPED                 
------------------------                 
Avalon Fields                                       44             229
Avalon West                                         38             317
Avalon Station II                                   24             250
Avalon Summit East                                  62             517
Avalon Run East                                     24             117
Avalon Chase (2)                                   347             964
Avalon Pines (2)                                    48             276
Avalon at Fairway Hills II (2)                      83             157
Avalon at the Boulders (2)                          --              --
                                         --------------    ------------
                                                   670             322
                                         --------------    ------------
                                         
NEW DEVELOPMENTS                                    61             N/A
----------------                         
                                         
OTHER                                    
-----                                    
Longwood Towers - Renovation                        --              --
Avalon Arbor (3)                                   225             745
Corporate Level Expenditures                        --              --
                                         ==============    ============
Grand Total                                     $8,535             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 1996.

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

(4)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.

(5)Represents renovation costs incurred.


                                       16
<PAGE>   19



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 from $2,175,000 at September 30,
1995 to $2,962,000 at September 30, 1996 due to the excess of cash provided by
operating and financing activities over cash used by investing activities,
primarily due to the completion of the common stock offering in January 1996 and
the preferred stock offering in February 1996 as more fully described below:

                  Net cash provided by operating activities increased by
         $7,549,000 from $39,014,000 to $46,563,000, primarily due to an
         increase in operating income from newly developed and acquired
         communities and Established Communities.

                  Net cash used in investing activities increased by $74,780,000
         from $151,661,000 to $226,441,000, primarily due to an increase in the
         number of apartment homes under development from an average of 1,969 in
         the first nine month period of 1995 to 2,767 in 1996.

                  Net cash provided by financing activities increased by
         $69,079,000 from $111,960,000 to $181,039,000, primarily due to the
         excess net proceeds received from the completion of the sale of
         2,227,000 shares of the Company's common stock and the sale of
         4,455,000 shares of the Company's Series A cumulative redeemable
         preferred stock in 1996 and 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
(computers, furniture) are capitalized only if the item is a new addition (i.e.,
not a replacement) and only if the item exceeds $2,500. The application of these
policies for the nine month period ended September 30, 1996 resulted in
capitalized expenditures for Established Communities of $128 per apartment home.

         Capital Resources. To sustain the Company's active development and
acquisitions program, continuous access to the capital markets is required.
Management understands the need to match the long-term nature of its real estate
assets with long-term cost effective capital. The Company has demonstrated
regular and continuous access to the capital markets since its initial public
offering, raising approximately $553 million in seven offerings over a two-year
period and over $400 million in the last year and a half. 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 leads to higher rents, lower turnover and reduced operation costs;

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

3.   Operate in markets with growing demand (as measured by household formation
     and job growth) and high barriers to entry. These characteristics combine
     to provide a favorable demand-supply balance, creating a 

                                       17
<PAGE>   20

     favorable environment for future rental rate growth while protecting 
     existing and new communities from new supply. This strategy results 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. Collateralized debt will generally be
     avoided and used primarily to obtain low cost, tax-exempt debt. Such a
     structure will 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 following these strategies provides a
disciplined approach to capital access and will help 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 and Investment Grade Ratings Upgrade

         The Company's Unsecured Facility is provided by a consortium of nine
banks ("Bank Group") led by JP Morgan and Fleet Bank that provides for
$165,000,000 in short-term credit. At September 30, 1996, $105,500,000 was
borrowed, $8,427,000 was used to provide letters of credit and $51,073,000 was
available for borrowing under the Unsecured Facility.

         In January 1996, the Company arranged the two-year Supplemental
Unsecured Facility provided by First Union National Bank in the amount of
$35,000,000. The Supplemental Unsecured Facility expires in January 1998 and
bears a current interest rate of LIBOR plus .95%. At September 30, 1996,
$4,030,000 of available capacity was used to provide letters of credit, and
$30,500,000 was borrowed under the Supplemental Unsecured Facility. Accordingly,
the balance that remains available at September 30, 1996 to be drawn under the
Supplemental Unsecured Facility is $470,000. 

         In September 1996, pricing on the Company's Unsecured Facilities was
reduced. The consortium of banks providing the Company's $165,000,000 Unsecured
Facility lowered the interest rate charged under the facility to LIBOR plus
1.19% from LIBOR plus 1.44%. Following a ratings upgrade from Moody's Investors
Service (see below), the interest rate was further reduced to LIBOR plus
1.125%. Pricing under the Supplemental Unsecured Facility provided by First
Union National Bank was reduced to LIBOR plus .95% from LIBOR plus 1.25%.

         The Company will use borrowings under the Unsecured Facilities 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.
                                             
         In October 1996, Moody's Investor Service ("Moody's") raised the
Company's ratings on the 7 3/8% senior notes to Baa2 from Baa3. At the
same time, Moody's raised its rating on the Company's cumulative redeemable
preferred stock to baa3 from ba1 and the ratings on three tax-exempt bond
issues that are guaranteed by the Company to Baa2 from Baa3.

Interest Rate Protection Agreements

         The Company entered into another interest rate protection agreement in
the form of an accreting swap transaction ("the Swap") with a triple A rated
counterparty (the "Counterparty") on May 30, 1995. The Swap serves to fix the
floating component of the Company's total interest rate at 5.89% on notional
amounts which increase over time. On the 15th day of each month during the term
of the agreement, the Company will pay to the Counterparty interest equal to
5.89% on the then principal amount in effect, divided by twelve months. The
Counterparty will pay to the Company interest equal to the actual 30 day LIBOR
rate on the principal amount then in effect, divided by twelve months. Payments
will be based on the following schedule:

                                       18
<PAGE>   21

<TABLE>
<CAPTION>
            Periods Covered              Principal (Notional) Amount in Effect
            ---------------              -------------------------------------
<S>                                                    <C>
       6/15/96  through   7/15/96                      $32,000,000
       7/15/96  through   8/15/96                      $35,000,000
       8/15/96  through   9/15/96                      $37,000,000
       9/15/96  through  10/15/96                      $40,000,000
      10/15/96  through  11/15/96                      $41,000,000
      11/15/96  through  12/15/96                      $43,000,000
      12/15/96  through   1/15/97                      $44,000,000
       1/15/97  through   2/15/97                      $45,000,000
</TABLE>

         Payments made by the Company under the Swap totaled $37,000 and 
$83,000 during the three and nine month periods ended September 30, 1996, 
respectively.

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

Financing Transactions Completed

         On August 1, 1996, the Company completed a new tax-exempt credit
enhancement facility with Fannie Mae that will provide a long-term
cost-effective credit enhancement source for the Company's current and future
tax-exempt bond portfolio. In connection with this facility, the Company
completed a refinancing of approximately $91,000,000 of its tax-exempt bond
portfolio. The facility involves eleven communities, seven that are financed
with tax-exempt bonds and four previously unencumbered communities that are
pledged as additional collateral.

         In October 1996, the Company completed an offering of 4,300,000 shares
of 8.96% Series B cumulative redeemable preferred stock. The gross proceeds of
the offering totaled $107,500,000. The net cash proceeds from the sale
(approximately $104,114,000) were used to retire indebtedness under the
Company's Unsecured Facility.

Financing Commitments

         The Company has received commitments for tax-exempt financing on the
Avalon Fields and Avalon West communities. The Community Development
Administration of Maryland has issued $12.1 million of thirty-year fixed-rate
bonds, at an all-in rate of 7.55% related to Avalon Fields. The proceeds will be
made available to the Company upon completion of documentation. The
Massachusetts Housing Finance Agency has issued $8.8 million of tax-exempt bonds
to finance the Avalon West community upon completion at an all-in cost of 7.72%
for 42 years. Management expects to receive funding under both commitments
during the fourth quarter of 1996.

Future Financing Needs

         Substantially all of the capital expenditures to complete the
communities currently under construction will be funded from proceeds of
permanent financing commitments already in place or from proceeds drawn under
Unsecured Facilities, and little, if any, additional capital sources are
expected to be needed to complete the communities. 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 a three-year period. 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.

                                       19
<PAGE>   22

         To continue to implement its growth strategy, the Company will pursue
additional capital as needed from sources that may include additional public or
private offerings of debt or equity securities, as well as bank or institutional
credit facilities. If all of the Development Rights proceed to development,
Management believes that additional debt or equity financing will be needed.
There can be no assurance that such additional debt financing or debt offerings
will be available on terms satisfactory to the Company. Additionally, the
Company's Funds from Operations and the availability of additional debt or
equity financing can be adversely impacted by negative changes in the economy,
particularly as those changes may relate to real estate assets or interest
rates.

BUSINESS CONDITIONS; INFLATION

         The Company's principal markets are characterized by high barriers to
entry and restrictive zoning which 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
8,800 apartment homes in planning for delivery over the next 36-month period.
Estimated absorption during this period totals 12,000 apartment homes, which
would create a supply-demand balance that would be favorable for owners of
multifamily apartment communities.

         At September 30, 1996, Management had positioned the Company's
portfolio of Stabilized Communities, excluding communities owned by joint
ventures, to a physical occupancy level of 96.9%, and achieved an average
economic occupancy of 95.3% for the nine months ended September 30, 1996.
Average economic occupancy for the portfolio for the nine months ended September
30, 1995 was 95.8%. 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 Stabilized 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 Stabilized Communities would be achieved primarily through
higher rental rates and enhanced operating cost leverage provided by high
occupancy, rather than through continued occupancy gains.

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

DEVELOPMENT COMMUNITIES

         At September 30, 1996, eight Development Communities were under
construction. The total capitalized cost of these Development Communities, when
completed, is currently expected to be approximately $323.8 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.

         The Company maintains an active development capacity that Management
anticipates will provide a continuing source of portfolio growth. During the
lease-up period of the development process, the Company anticipates that
Development Communities will experience operating deficits for a three-to-six
month period until such time as the new community approaches stabilized
occupancy. The amount and duration of operating deficits 

                                       20
<PAGE>   23

to be incurred are dependent upon a number of factors, including the size of the
community, the season in which leasing activity occurs and the extent to which
delivery of new apartment homes coincides with leasing and occupancy of these
new apartment homes (which is dependent on local market conditions). Any
operating deficits that occur during the initial lease-up phase of a new
development are expensed in accordance with GAAP. For the nine months ended
September 30, 1996, initial lease-up deficits were not material to the financial
position and operating results of the Company.

         The following page presents a summary of Development Communities:

                                       21
<PAGE>   24

                       DEVELOPMENT COMMUNITIES SUMMARY

<TABLE>
<CAPTION>

                               NUMBER OF        BUDGETED                                       ESTIMATED        ESTIMATED      
                               APARTMENT          COST         CONSTRUCTION        INITIAL     COMPLETION     STABILIZATION    
                                 HOMES        ($ MILLIONS)         START          OCCUPANCY       DATE           DATE (1)       
                              ------------    -------------   ----------------   -----------  ------------   ---------------
<S>                                 <C>       <C>               <C>             <C>           <C>              <C>           
Conventionally Financed                                                                                                        
-----------------------                                                                                                        
                                                                                                                               
Avalon Gates                                                                                                                   
Trumbull, CT                          340      $  32.7            Q3 1994         Q2 1996       Q3 1997          Q4 1997        
                                                                                                                               
Avalon Crossing                                                                                                                
Rockville, MD                         132         13.5            Q3 1995         Q2 1996       Q4 1996          Q1 1997       
                                                                                                                               
Avalon Cove                                                                                                                    
Jersey City, NJ                       504         70.5(3)         Q4 1994         Q2 1996       Q1 1997          Q2 1997       
                                                                                                                               
Avalon Grove(4)                                                                                                                
Stamford, CT                          402         51.3            Q1 1995         Q3 1996       Q2 1997          Q3 1997       
                                                                                                                               
Avalon Springs                                                                                                                 
Wilton, CT                            102         15.2            Q3 1995         Q3 1996       Q1 1997          Q2 1997       
                                                                                                                               
Avalon Crescent                                                                                                                
Tysons Corner, VA                     558         56.7            Q1 1996         Q1 1997       Q4 1997          Q1 1998       
                                                                                                                               
Avalon Commons                                                                                                                 
Smithtown, NY                         312         30.6            Q1 1996         Q1 1997       Q3 1997          Q4 1997       
                                                                                                                               
Avalon Gardens                                                                                                                 
Nanuet, NY                            504         53.3            Q3 1996         Q3 1997       Q4 1998          Q1 1999       
                              ------------    ----------                                                                       
                                    2,854      $ 323.8                                                                         
                              ============    ==========                                                                       

</TABLE>

<TABLE>
<CAPTION>
                              
                                 EBITDA AS %
                                   OF TOTAL
                              BUDGETED COST (2)
                              -------------------
<S>                                <C>  
Conventionally Financed       
-----------------------       
                              
Avalon Gates                  
Trumbull, CT                        10.0%
                              
Avalon Crossing               
Rockville, MD                       11.0%
                              
Avalon Cove                   
Jersey City, NJ                     11.0%
                              
Avalon Grove(4)               
Stamford, CT                        12.2%
                              
Avalon Springs                
Wilton, CT                          11.6%
                              
Avalon Crescent               
Tysons Corner, VA                   10.2%
                              
Avalon Commons                
Smithtown, NY                       11.1%
                              
Avalon Gardens                
Nanuet, NY                          10.1%
                              -------------
                                    10.8%
                              =============
</TABLE>

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

The table above includes forward looking information within the meaning of the
Private Securities Litigation Reform Act of 1995 regarding the delivery,
occupancy and total budgeted cost of newly developed apartment homes. This
information is based on a series of projections, estimates and local experience
with construction practices that affect construction costs and completion as
well as market conditions that affect how quickly a community leases and at what
rental rates. The Company's ability to achieve these projections is affected by
continued market demand for the Company's new apartment homes as well as other
factors discussed periodically in the Company's reports filed with the
Securities and Exchange Commission including the reports on Form 10-Q for the
quarters ended March 31, 1996 and June 30, 1996 and the Form 10-K for the year
ended December 31, 1995. If the Company's performance differs materially from
these projections, actual results could vary significantly from the performance
projected in the forward looking information.

(1)  Stabilized occupancy is defined as the first full quarter of 95% 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)  In March 1996, 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. The Company selected Tishman 
     Construction Company of New Jersey to be the replacement contractor, 
     and the replacement contractor is currently managing the construction 
     operations. Management expects that total actual costs to exceed the
     current $70.5 million budget presented herein. The Company is pursuing 
     collection of any excess over the original guaranteed maximum price 
     contract, but no assurance can be provided that collection efforts will
     be successful.  Management believes that the excess cost, even if no
     recovery from original contractor is made, will not have a material 
     adverse impact on the financial condition or results of operations of the
     Company.

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

                                       22
<PAGE>   25



DEVELOPMENT RIGHTS


         The Company is considering the development of 20 new apartment
communities. The status of these Development Rights range from land 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 5,767 institutional-quality apartment homes to the
Company's portfolio. At September 30, 1996, the cumulative capitalized costs
incurred in pursuit of the 20 Development Rights were approximately $12.1
million, including the capitalized cost of $5.9 million related to the purchase
of land in New Canaan, Connecticut. Many of these apartment homes will offer
features like those offered by the communities currently owned by the Company.
The 20 Development Rights that the Company is currently pursuing are summarized
below.

                           DEVELOPMENT RIGHTS SUMMARY

                                                               TOTAL
                                       ESTIMATED              BUDGETED
                                       NUMBER OF                COST
              LOCATION                   HOMES              ($ MILLIONS)
        ----------------------     ---------------        ----------------
   1.   Fairfax, VA                         234                $     23.2
   2.   Mamaroneck, NY                      227                      37.0 
   3.   Melville-I, NY                      154                      17.8 
   4.   Alexandria, VA                      460                      45.7 
   5.   Freehold, NJ                        452                      37.5 
   6.   Quincy, MA                          171                      15.0 
   7.   New Canaan, CT(1)                   104                      23.2 
   8.   Greenburgh - II, NY                 500                      64.2     
   9.   Greenburgh - III, NY                294                      37.7     
  10.   Darien, CT                          172                      20.7 
  11.   Fort Lee, NJ                        351                      52.6 
  12.   Peabody, MA                         434                      35.5 
  13.   Springfield, NJ                     500                      44.9 
  14.   Hull, MA                            244                      20.3 
  15.   Jersey City, NJ                     221                      38.5 
  16.   New Rochelle, NY                    350                      49.4 
  17.   Easton, CT                          249                      28.2
  18.   Melville-II, NY                     350                      36.7
  19.   Wilmington, MA                      204                      18.0 
  20.   Gaithersburg - II, MD                96                       8.1
                                   =============            ==============
        Total                             5,767                $    654.2
                                   =============            ==============

The table above includes forward looking information within the meaning of the
Private Securities Litigation Reform Act of 1995 regarding the total budgeted
cost of newly developed apartment homes. This information is based on a series
of projections, estimates and local experience with construction practices that
affect construction completion. The Company's ability to achieve these
projections is affected by continued market demand for the company's new
apartment homes, availability of capital as well as other factors discussed
periodically in the company's reports filed with the Securities and Exchange
Commission, including the report on Form 10-Q for the quarter ended June 30,
1996 and the Form 10-K for the year ended December 31, 1995. If the Company's
performance differs materially from these projections, actual results could vary
significantly from the performance projected in the forward looking information.
There can be no assurance that all or any of these communities will proceed to
development.

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




                                       23
<PAGE>   26




PART II           OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         In March 1996, the original contractor, Procida Construction
Corporation, 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. The Company expects total
actual costs to exceed the current $70.5 million budget. 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. No assurance can be provided that
collection efforts will be successful. Management does not believe that the
excess cost, even if no recovery from the original contractor is made, will have
a material adverse impact on the financial condition or results of operations of
the Company.

ITEM 2.  CHANGES IN SECURITIES

         None.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

         None.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS

         None.

ITEM 5.  OTHER INFORMATION

         Not applicable.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

         a)    Not applicable.

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


                                       24
<PAGE>   27




                                     SIGNATURE

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

                                  AVALON PROPERTIES, INC.



Date:  November 12, 1996          By /s/  THOMAS J. SARGEANT
                                     --------------------------
                                  Thomas J. Sargeant, Chief Financial Officer,
                                  Treasurer and Secretary
                                  (Principal Financial and Accounting Officer)




                                      25