<PAGE>   1
================================================================================
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                    FORM 10-Q

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

                  For the quarterly period ended March 31, 1998

                         Commission file number 1-12452

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

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

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

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








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

                               Yes  [X]   No  [ ]

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

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

                43,144,853 shares outstanding as of May 11, 1998.

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



                                      INDEX
<TABLE>
<CAPTION>
PART I     FINANCIAL INFORMATION

Item 1     Financial Statements                                                                Page

<S>        <C>                                                                                <C>
           Condensed Consolidated Balance Sheets as of March 31, 1998
           and December 31, 1997................................................................1

           Condensed Consolidated Statements of Operations for the three months
           ended March 31, 1998 and 1997........................................................2

           Condensed Consolidated Statements of Cash Flows for the three months
           ended March 31, 1998 and 1997........................................................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...................................................................25

Item 2     Changes in Securities...............................................................25

Item 3     Defaults upon Senior Securities.....................................................25

Item 4     Submission of Matters to a Vote of Stockholders.....................................25

Item 5     Other Information...................................................................25

Item 6     Exhibits and Reports on Form 8-K....................................................25

           Signatures..........................................................................26
</TABLE>


<PAGE>   3
Part I  FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

                            AVALON PROPERTIES, INC.
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                  (Unaudited)
                 (Dollars in thousands, except per share data
<TABLE>
<CAPTION>
ASSETS                                                                                03/31/98               12/31/97
                                                                                    ------------           ------------
<S>                                                                                 <S>                  <S>
Real estate
   Land                                                                             $    261,150         $    247,613
   Buildings and improvements                                                          1,190,347            1,120,505
   Furniture, fixtures and equipment                                                      43,090               39,830
                                                                                       ---------            ---------
                                                                                       1,494,587            1,407,948
      Less:  accumulated depreciation                                                    (78,994)             (69,932)
                                                                                       ---------            ---------
   Net operating real estate                                                           1,415,593            1,338,016
   Construction in progress (including land)                                             127,927              127,038
                                                                                       ---------            ---------
            TOTAL REAL ESTATE, NET                                                     1,543,520            1,465,054

Cash and cash equivalents                                                           $      3,497         $      6,722
Cash in escrow                                                                             3,083                4,109
Resident security deposits                                                                 8,448                7,812
Investments in unconsolidated joint ventures                                              18,052               18,315
Deferred financing costs, net                                                              9,891               10,022
Deferred development costs                                                                 8,218                7,207
Prepaid expenses and other assets                                                         16,404               10,462
                                                                                       ---------            ---------
            TOTAL ASSETS                                                            $  1,611,113         $  1,529,703
                                                                                       =========            =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Unsecured Facilities                                                                $     24,000         $     71,500
Unsecured senior notes, net of unamortized discount                                      309,683              209,695
Notes payable                                                                            224,653              224,934
Payables for construction                                                                 13,624               16,311
Accrued expenses and other liabilities                                                    18,561               15,466
Accrued interest payable                                                                   4,974                3,041
Resident security deposits                                                                10,235                9,589
                                                                                        --------             --------
            TOTAL LIABILITIES                                                            605,730              550,536
                                                                                        --------             --------
Minority interest of unitholders in consolidated operating partnerships                   16,167               18,157

Stockholders' equity

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

   Common Stock, $.01 par value; 80,000,000 shares authorized;
       43,140,225 and 41, 975,240 shares issued and outstanding
       at March 31, 1998 and December 31, 1997, respectively                                 431                  420
   Additional paid-in capital                                                          1,021,302              987,540
   Deferred compensation                                                                  (5,967)              (3,265)
   Dividends in excess of accumulated earnings                                           (26,638)             (23,773)
                                                                                       ---------            ---------
            STOCKHOLDERS' EQUITY                                                         989,216              961,010
                                                                                       ---------            ---------
            TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                              $  1,611,113          $ 1,529,703
                                                                                       =========            =========
</TABLE>
     See accompanying notes to condensed consolidated financial statements.

                                   1
<PAGE>   4

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

<TABLE>
<CAPTION>
                                                                                         Three months ended
                                                                                         --------------------
                                                                                         3-31-98      3-31-97
                                                                                         -------      -------
<S>                                                                                   <C>          <C>
Revenue:
   Rental income                                                                       $  55,941    $  37,152
   Management fees                                                                           375          255
   Other income                                                                              136          120
                                                                                         -------      -------
            Total revenue                                                                 56,452       37,527
                                                                                         -------      -------

Expenses:
   Operating expenses                                                                     20,894       13,532
   Interest expense                                                                        6,540        3,717
   Depreciation and amortization                                                           9,285        6,481
   General and administrative expenses                                                     1,400          912
                                                                                         -------      -------
            Total expenses                                                                38,119       24,642
                                                                                         -------      -------

Equity in income of unconsolidated joint ventures                                            651        1,042
Interest income                                                                              296          275
Minority interest                                                                           (411)          94
                                                                                         -------      -------
Income before extraordinary item                                                          18,869       14,296
Extraordinary item                                                                            --       (1,183)
                                                                                         -------      -------
Net income                                                                                18,869       13,113
Dividends attributable to preferred stock                                                 (4,914)      (4,914)
                                                                                         -------      -------
Net income available to common stockholders                                            $  13,955    $   8,199
                                                                                         =======      =======


Per common share:
   Income before extraordinary item - basic                                            $    0.33    $    0.28
                                                                                         =======      =======
   Income before extraordinary item - diluted                                          $    0.33    $    0.28
                                                                                         =======      =======
   Net income - basic                                                                  $    0.33    $    0.24
                                                                                         =======      =======
   Net income - diluted                                                                $    0.33    $    0.24
                                                                                         =======      =======
</TABLE>

See accompanying notes to condensed consolidated financial statements.

                                   2
<PAGE>   5

                            AVALON PROPERTIES, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                                  (Unaudited)
                             (Dollars in thousands)
<TABLE>
<CAPTION>
                                                                                           Three months ended
                                                                                        ----------------------------
                                                                                         3-31-98              3-31-97
                                                                                         -------              -------
<S>                                                                                   <C>                 <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
    Net income                                                                         $  18,869            $  13,113
    Adjustments to reconcile net income to
        cash provided by operating activities:
                Depreciation and amortization                                              9,285                6,481
                Equity in income of unconsolidated joint ventures                            695                  (17)
                Amortization of deferred compensation                                        371                  248
                Income allocated to Minority Interest                                        417                   --
                Extraordinary item                                                            --                1,183
                Decrease in cash in escrow, net                                            1,036                  386
                Increase in prepaid expenses
                      and other assets                                                    (6,953)              (1,763)
                Increase in accrued expenses, other liabilities
                     and accrued interest payable                                          5,731                2,882
                                                                                         -------              -------
                     Total adjustments                                                    10,582                9,400
                                                                                         -------              -------
                     Net cash provided by operating activities                            29,451               22,513
                                                                                         -------              -------
CASH FLOWS USED IN INVESTING ACTIVITIES:
    Investments in unconsolidated joint ventures                                            (432)                (167)
    Decrease in construction payables                                                     (2,687)              (1,491)
    Purchase and development of real estate                                              (87,238)             (90,775)
                                                                                         -------              -------
                     Net cash used in investing activities                               (90,357)             (92,433)
                                                                                         -------              -------
CASH FLOWS FROM FINANCING ACTIVITIES:
    Issuance of common stock, net                                                         29,764                  269
    Dividends paid                                                                       (21,734)             (17,652)
    Borrowings under notes payable                                                        99,976                   --
    Repayments of notes payable                                                             (281)                (321)
    Borrowings under Unsecured Facilities                                                 59,000               83,000
    Repayments of Unsecured Facilities                                                  (106,500)              (6,500)
    Redemption of OP Units                                                                (1,990)                  --
    Distributions to minority partners                                                      (417)                  --
    Payments of deferred financing costs                                                    (137)                 (81)
                                                                                         -------              -------
                     Net cash provided by financing activities                            57,681               58,715
                                                                                         -------              -------
                     Net decrease in cash                                                 (3,225)             (11,205)
Cash and cash equivalents, beginning of period                                             6,722               14,241
                                                                                         -------              -------

Cash and cash equivalents, end of period                                                $  3,497             $  3,036
                                                                                         =======              =======

Cash paid during period for interest, net of amount capitalized                         $  4,189             $  4,858
                                                                                         =======              =======
</TABLE>
      See accompanying notes to condensed consolidated financial statements.

                                       3

<PAGE>   6
                            AVALON PROPERTIES, INC.
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

                 (Dollars in thousands, except per share data)

1.    Organization of the Company and Recent Acquisitions

            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 high
      barrier-to-entry markets of the United States. Additionally, the Company
      provides management services for communities owned by unrelated parties.

            During the three months ended March 31, 1998, the Company purchased
      two apartment communities containing a total of 406 apartment homes for an
      aggregate contract purchase price of approximately $27,625.

            During the three months ended March 31, 1998, the Company purchased
      three tracts of land containing a total of 71.6 acres from unrelated third
      parties for an aggregate purchase price of approximately $6,871.

            On January 9, 1998, the Company purchased a 5-story office building
      located in Alexandria, Virginia for approximately $6,600. The Company has
      relocated its Mid-Atlantic regional office to this location and it
      occupies half of the 60,000 net rentable square feet of this office
      building. The remaining 30,000 square feet is rented to unrelated third
      party tenants at market rents.

            On January 15, 1998, the Company entered into a letter of intent
      with Prudential to purchase the residential component of the Prudential
      Center in Boston Massachusetts. This property contains approximately 779
      apartment homes and related underground parking. Negotiations are ongoing
      and there can be no assurance that these negotiations will be successful.

            On March 9, 1998, the Company entered into a definitive merger
      agreement with Bay Apartment Communities, Inc. ("Bay"), pursuant to which
      the Company will be merged into Bay, with Bay as the surviving entity (the
      "Merger"). Under the terms of the agreement, each outstanding common share
      of the Company will be exchanged for 0.7683 shares of common stock of Bay.
      The holders of the Company's preferred stock will receive one share of
      comparable Bay preferred stock for each share of comparable stock they
      own. The Merger will be accounted for as a purchase of the Company by Bay.
      The Merger is expected to close in June 1998 and is subject to the
      approval of both companies' shareholders and other customary regulatory
      conditions and there can be no assurance that the Merger will be
      consummated and that the required conditions to closing will be met. The
      surviving company, to be renamed Avalon Bay Communities, Inc., will (on a
      pro forma basis as of April 20, 1998) own 141 apartment communities
      containing 40,700 apartment homes (including those under construction) in
      29 markets in 15 states and the District of Columbia.

            On March 9, 1998, the Company announced that it has entered into a
      definitive agreement to acquire selected assets on a presale basis from
      Trammell Crow Residential - Pacific Northwest ("TCR-NW"). The presale
      acquisitions are expected to be completed during the next 24 to 36 months.
      The acquisitions include seven communities in the Seattle, Washington
      market and one community in the

                                       4
<PAGE>   7
      Portland, Oregon market for a total investment by the Company of up to
      $279,000. Together, these eight communities are expected to contain 2,411
      apartment homes. The Company will manage these communities after
      acquiring ownership.

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 and the operating partnerships structured as DownREITs. All
      significant intercompany balances and transactions have been eliminated in
      consolidation.

      Real Estate

            Buildings and improvements are recorded at cost and are
      depreciated on a straight-line basis over their estimated useful lives of
      40 years and 7 years, respectively. If there is an event or change in
      circumstance that indicates an impairment in the value of a community has
      occurred, the Company's policy is to 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 the community. If such
      carrying amounts are in excess of the estimated projected operating cash
      flows of the community, the Company would recognize an impairment loss
      equivalent to an amount required to adjust the carrying amount to its
      estimated fair market value.

            The cost of buildings and improvements include capitalized
      interest, property taxes and insurance incurred during the construction
      period. Furniture and fixtures are stated at cost and depreciated over
      their estimated useful lives of seven years. Expenditures for maintenance
      and repairs are charged to operations as incurred. Significant
      renovations or betterments which extend the economic useful life of the
      assets are capitalized.

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

      Deferred Financing and Development Costs

            Deferred financing costs include fees and costs incurred to obtain
      debt 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. Unamortized financing costs are written-off when
      debt is retired before the maturity date. 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.

      Recently Issued Accounting Pronouncement
           
            On March 19, 1998, the Emerging Issues Task Force of the Financial
     Accounting Standards Board reached a consensus opinion on issue #97-11,
     "Accounting for Internal Costs Relating to Real Estate Property
     Acquisitions" which requires that the internal costs of identifying and
     acquiring an operating property should be expensed as incurred.  The
     adoption of this issue will have no impact on the Company's financial
     condition or results of operations since the Company fully expenses these
     costs.

      Per Common Share Disclosures

            Per common share disclosures for the three months ended March 31,
      1998 and 1997 are based upon the following basic and diluted weighted
      average number of shares of common stock outstanding:

                                       5
<PAGE>   8


<TABLE>
<CAPTION>
                                                               Three months ended
                                                          --------------------------
                                                            03/31/98      03/31/97
                                                          ------------  ------------
<S>                                                       <C>            <C>
Weighted average common shares outstanding- basic          42,618,030    33,478,709
Shares issuable from assumed conversion of:
   Common stock options                                       286,316       264,215
   Operating partnership units                                  1,133            36
                                                          ------------  ------------
Weighted average common shares outstanding- diluted        42,905,479    33,742,960
                                                          ============  ============
</TABLE>

            Operating partnerships units that were issued based on a common
      stock price that was higher than the average price during the quarter are
      excluded from the weighted average calculation, as inclusion of these
      units would be anti-dilutive.

      Interim Financial Statements

            These condensed consolidated financial statements are unaudited and
      were prepared pursuant to the rules and regulations of the Securities and
      Exchange Commission. However, in the opinion of management, all
      adjustments (consisting solely of normal recurring adjustments) necessary
      for a fair presentation of the financial statements have been included.
      The operating results for these periods are not necessarily indicative of
      the operating results that may be attained for the 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,
      1997.

      Reclassifications

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

3.    Senior Participating Mortgage Note

            The Company's ownership of the senior participating mortgage note
      related to the Town Arbor Partnership ("Avalon Arbor") has been accounted
      for as an investment in real estate. The excess of the interest income at
      the pay rate on the mortgage loan over the cash flow from operations
      generated by the community is reflected in minority interest. This excess
      is funded from payments drawn from an escrow account established from
      contributions by the minority partners. At March 31, 1998, the
      partnership had $2,934 of cash from these contributions available to fund
      interest payments. The note bears interest at 10.2%. Upon acquisition,
      the note was restructured to provide for a 9% pay rate. The difference
      between the stated interest and the pay rate is deferred interest and is
      added to the principal. The loan also provides for contingent interest of
      50% of gross revenues, as defined, and is payable prior to any payments
      to the partners. No contingent interest has been paid through March 31,
      1998. The note entitles the holder to a 50% net residual value of the
      property at maturity or upon prior disposition of the property. The note
      may be prepaid subject to stipulated penalties.

4.    Unsecured Facilities

            The Company's unsecured credit facility (the "Unsecured Facility")
      is provided by a consortium of banks that provides for $175,000 in
      short-term credit and is subject to an annual fee of $263. The Unsecured
      Facility expires on March 31, 2000. As of March 31, 1998, approximately
      $12,873 of available capacity was used to provide letters of credit and
      $1,000 was borrowed under the facility.

                                       6
<PAGE>   9


      Accordingly, the balance that remains available at March 31, 1998 to be
      drawn under the Unsecured Facility is $161,127. The Unsecured Facility
      bears interest based upon a LIBOR, Prime or CD rate election at the
      Company's option. The current pricing is LIBOR plus .80%, provided,
      however, that up to $75,000 can be competitively bid at lower pricing if
      market conditions allow. Pricing may be adjusted higher or lower
      depending on the Company's senior unsecured debt ratings.

            The Company's supplemental unsecured credit facility (the
      "Supplemental Unsecured Facility" and together with the Unsecured
      Facility, the "Unsecured Facilities") is provided by First Union National
      Bank in the amount of $50,000 and is subject to an annual facility fee of
      $75. The Supplemental Unsecured Facility expires in March 2000 and bears
      a current interest rate of LIBOR plus .80%. At March 31, 1998, $2,560 of
      available capacity was used to provide letters of credit and $23,000 was
      borrowed under the Supplemental Unsecured Facility. Accordingly, the
      balance that remains available at March 31, 1998 to be drawn under the
      Supplemental Unsecured Facility is $24,440.

            The weighted average effective interest rates (excluding the cost
      of facility fees) on borrowings under the Unsecured Facilities for the
      three months ended March 31, 1998 and 1997 were 6.4% and 6.5%,
      respectively. Including the cost of facility fees, the weighted average
      effective interest rates on borrowings under the Unsecured Facilities for
      the three months ended March 31, 1998 and 1997 were 7.6% and 7.0%,
      respectively.

            The Company, among other things, is subject to certain customary
      covenants under the credit agreements for the Unsecured Facilities
      including maintaining certain maximum leverage ratios, minimum fixed
      charge coverage ratio, minimum unencumbered asset and equity levels and
      is restricted from paying dividends in amounts that exceed 95% of the
      Company's Funds from Operations, as defined.

5.    Stockholders' Equity

            The following summarizes the changes in stockholders' equity for
      the three months ended March 31, 1998:

<TABLE>
<CAPTION>
                                                                                                  Dividends
                                                                    Additional                  in excess of
                                             Preferred     Common     paid-in       Deferred     accumulated
                                               Stock       Stock      capital     compensation    earnings        Total
                                             ---------    -------   ----------    ------------  ------------    ---------
<S>                                          <C>          <C>       <C>            <C>           <C>            <C>
Stockholders' equity, 12-31-97               $      88    $   420   $   987,540    $    (3,265)  $  (23,773)    $ 961,010
Net income                                           -          -             -              -       18,869        18,869
Dividends declared                                   -          -             -              -      (21,734)      (21,734)
Issuance of Restricted Common
   Stock                                             -          1         4,008              -            -         4,009
Deferred compensation,
   net of amortization                               -          -             -         (2,702)           -        (2,702)
Issuance of Common Stock                             -         10        29,754              -            -        29,764
                                             ---------    -------   ----------    ------------  ------------    ---------
Stockholders' equity, 3-31-98                $      88    $   431   $ 1,021,302    $    (5,967)   $ (26,638)    $ 989,216
                                             =========    =======   ==========    ============  ============    =========
</TABLE>

6.    Investments in Unconsolidated Joint Ventures

            At March 31, 1998, investments in unconsolidated joint ventures
      consist of a 50% general partnership interest in Falkland Partners, a 49%
      equity interest in Avalon Run, an 86.5% effective equity interest in Town
      Close Associates (the New Canaan Development Right) and a 50% general
      partnership interest in Avalon Grove. The following is a combined summary
      of the financial position of these joint ventures for the periods
      presented:

                                       7
<PAGE>   10

<TABLE>
<CAPTION>
                                            3-31-98      12-31-97
                                            -------      --------
<S>                                       <C>          <C>
Assets:
    Real estate, net                      $  97,500     $  97,964
    Other assets                              4,533        10,790
                                            -------      --------
Total assets                              $ 102,033     $ 108,754
                                            =======      ========

Liabilities and partners' equity:
    Mortgage notes payable                $  26,000     $  26,000
    Other liabilities                         4,197         4,164
    Partners' equity                         71,836        78,590
                                            -------      --------
Total liabilities and partners' equity    $ 102,033     $ 108,754
                                            =======      ========
</TABLE>

            The following is a combined summary of the operating results of
      these joint ventures for the periods presented:

<TABLE>
<CAPTION>
                                                 Three months ended
                                                ----------------------
                                                3-31-98        3-31-97
                                                -------       --------
<S>                                          <C>             <C>
Rental income                                 $   4,764      $  3,373
Other income                                          7            12
Operating expenses                               (1,289)       (1,128)
Mortgage interest expense                          (197)         (196)
Depreciation and amortization                      (753)         (571)

                                                -------      --------
     Net income                               $   2,532     $   1,490
                                                =======      ========
</TABLE>

7.    Subsequent Events

            On April 30, 1998, the Company purchased a 480 apartment home
      community located in the St. Louis metropolitan area for $29,760.

                                      8
<PAGE>   11


PART I     FINANCIAL INFORMATION (CONTINUED)

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
               
FORWARD-LOOKING STATEMENTS

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

      Certain factors that might cause such differences include, but are not
limited to, the following: the Company may not be successful in managing its
current growth in the number of apartment communities and the related growth of
its business operations; the Company's expansion into new geographic market
areas may not produce financial results that are consistent with its historical
performance; acquisitions of portfolios of apartment communities may result in
the Company acquiring communities that are more expensive to manage and
portfolio acquisitions may not be successfully completed, resulting in charges
to earnings; the Company may fail to secure or may abandon development
opportunities; construction costs of a community may exceed original estimates;
construction and lease-up may not be completed on schedule, resulting in
increased debt service expense and construction costs and reduced rental
revenues; occupancy rates and market rents may be adversely affected by local
economic and market conditions which are beyond management's control; financing
may not be available on favorable terms; the Company's cash flow may be
insufficient to meet required payments of principal and interest; and existing
indebtedness may not be able to be refinanced or the terms of such refinancing
may not be as favorable as the terms of existing indebtedness.

      The following discussion should be read in conjunction with the condensed
consolidated financial statements and notes included in this report.

RECENT DEVELOPMENTS

      Merger and Geographic Expansion. On March 9, 1998, the Company announced
that it has entered into a definitive merger agreement with Bay Apartment
Communities, Inc. ("Bay"), pursuant to which the Company will be merged into
Bay, with Bay as the surviving entity (the "Merger"). Under the terms of the
agreement, each outstanding common share of the Company will be exchanged for
0.7683 shares of common stock of Bay. The holders of the Company's preferred
stock will receive one share of comparable Bay preferred stock for each share
of comparable stock they own. The Merger will be accounted for as a purchase of
the Company by Bay. The Merger is expected to close in June 1998 and is subject
to the approval of both companies' shareholders and other customary regulatory
conditions and there can be no assurance that the Merger will be consummated
and that the required conditions to closing will be met. The surviving company,
to be renamed Avalon Bay Communities, Inc., will (on a pro forma basis as of
April 20, 1998) own 141 apartment communities containing 40,700 apartment homes
in 29 markets in 15 states and the District of Columbia.

      On March 9, 1998, the Company announced that it has entered into a
definitive agreement to acquire selected assets on a presale basis from
Trammell Crow Residential - Pacific Northwest ("TCR-NW"). The presale
acquisitions are expected to be completed during the next 24 to 36 months. The
acquisitions include seven communities in the Seattle, Washington market and
one community in the Portland, Oregon market for a total investment by the
Company of up to $279,000,000. Together, these eight communities are expected
to contain 2,411 apartment homes. The Company will manage these communities
after acquiring ownership.


                                       9

<PAGE>   12

      Possible Sale of Existing Communities. In connection with an agreement
executed by the Company in March 1998 which provided for the buyout of certain
limited partners in DownREIT V Limited Partnership, the Company granted such
partners, or their respective affiliates, the option to purchase two
communities owned by the Company and located in Michigan for an aggregate
purchase price of approximately $43,000,000. The purchase option expires on
July 20, 1998.

      Acquisitions of Existing Communities. On January 7, 1998, the Company
purchased two apartment communities located in the Minneapolis metropolitan
area. Carriage Green, a 246 apartment home community located in Eagan,
Minnesota, and Summer Place, a 160 apartment home community located in
Plymouth, Minnesota, were acquired for $27,625,000.

      On April 30, 1998, the Company purchased a 480 apartment home community
located in the St. Louis metropolitan area for $29,760,000.

      Land Acquisitions for New Development. On February 26, 1998, the Company
purchased a 17.1 acre tract of land in Danbury, Connecticut for $2,100,000.
Construction of a new 268 apartment community, Avalon Valley, commenced in the
second quarter of 1998.

      On February 27, 1998, the Company purchased a 32 acre tract of land in
Danbury, Connecticut for $3,271,000. Construction of a new 135 apartment home
community, Avalon Lake, commenced in the first quarter of 1998.

      On March 25, 1998, the Company purchased a 22.5 acre tract of land in
Wilmington, Massachusetts for $1,500,000. Construction of a new 204 apartment
home community, Avalon Oaks, commenced in the second quarter of 1998.

GENERAL

      The Company's operations consist of the development, construction,
acquisition and operation of apartment communities in the Mid-Atlantic,
Northeast and the Midwest regions of the United States. The Company also
recently announced plans to expand to certain high barrier-to-entry markets of
the Pacific Northwest. As of March 31, 1998, the Company held a fee simple
ownership interest in 55 operating communities (one of which, Avalon at Center
Place, is on land subject to a 149 year land lease), a general partnership
interest in three other operating communities (a 50% interest in Falkland
Chase, a 49% interest in Avalon Run, and a 50% interest in Avalon Grove), a 99%
general partner interest in two partnerships structured as DownREITs (Avalon at
Ballston Quincy and Avalon a Ballston Vermont, which are operated as a single
community, six communities acquired from Trammell Crow Residential - Midwest
and a single community located in Westmont, Illinois) and a 100% interest in a
senior participating mortgage note secured by another operating community
(Avalon Arbor) which is accounted for as an investment in real estate. The
Company also holds a fee simple ownership interest in twelve Development
Communities. The existing DownREITs have been structured so that substantially
all of the economic interests of these partnerships accrue to the benefit of
the Company. The Company believes that it is unlikely that the limited partners
in these partnerships will receive any financial return on their limited
partnership interests other than the stated distributions on their Units of the
Operating Partnerships ("Units") or as a result of the possible future
conversion of their Units into shares of common stock. The DownREIT
partnerships are consolidated for financial reporting purposes.

      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

                                       10
<PAGE>   13
      attained a physical occupancy level of 94% or has been completed for
      one year, whichever occurs earlier. An "Established Community" is a
      Current Community that has been a Stabilized Community with
      stabilized operating costs during the current and the beginning of
      the previous calendar year such that its year-to-date operating
      results are comparable between periods.

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

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

RESULTS OF OPERATIONS

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

      The analysis that follows compares the operating results of the Company
for the three months ended March 31, 1998 and 1997.

      Net income increased $5,756,000 (43.9%) to $18,869,000 for the three
months ended March 31, 1998 compared to $13,113,000 for the comparable period
of the preceding year. The primary reasons for this increase are additional
operating income from communities developed or acquired during 1998 and 1997,
as well as growth in operating income from existing communities.

      Rental income increased $18,789,000 (50.6%) to $55,941,000 for the three
months ended March 31, 1998 compared to $37,152,000 for the comparable period
of the preceding year. Of the increase for the three month period, $1,536,000
relates to rental revenue increases from Established Communities and
$17,253,000 is attributable to the addition of newly completed or acquired
apartment homes.

      Overall Portfolio - The $18,789,000 increase in rental income for the
      three month period is primarily due to increases in the weighted average
      number of occupied apartment homes as well as an increase in the weighted
      average monthly rental income per occupied apartment home. The weighted
      average number of occupied apartment homes increased from 12,252 apartment
      homes for the three months ended March 31, 1997 to 18,082 apartment homes
      for the three months ended March 31, 1998 as a result of the development
      and acquisition of new communities. For the three months ended March 31,
      1998, the weighted average monthly revenue per occupied apartment home
      increased $114 (12.4%) to $1,030 compared to $916 for the comparable
      period of the preceding year.

      Established Communities - Rental revenue increased $1,536,000 due to
      strengthening market conditions and the resulting impact on rents and
      occupancy. Weighted average monthly revenue per occupied apartment home
      increased $44 (4.9%) to $942 compared to $898 for the comparable period of
      the preceding year. The average economic occupancy increased .2% from
      95.5% to 95.7%.


                                       11
<PAGE>   14

      Management fees increased $120,000 (47.1%) to $375,000 for the three
months ended March 31, 1998 compared to $255,000 for the comparable period of
the preceding year. The increase for the three month period is due to certain
third-party management contracts acquired in connection with the purchase of a
portion of the Trammell Crow Residential - Midwest ("TCR/MW) portfolio in
December 1997.

      Operating expenses increased $7,362,000 (54.4%) to $20,894,000 for
the three months ended March 31, 1998 compared to $13,532,000 for the comparable
period of the preceding year.

      Overall Portfolio - This increase is primarily due to the acquisition of
      new communities as well as the completion of Development Communities
      whereby maintenance, property taxes, insurance and other costs are
      expensed as communities move from the initial construction and lease-up
      phase to the stabilized operating phase.

      Established Communities - Operating expenses increased $288,000 (2.9%) to
      $10,123,000 for the three months ended March 31, 1998 compared to
      $9,835,000 for the comparable period of the preceding year. The increase
      was concentrated in the maintenance and property taxes categories.

      Interest expense increased $2,823,000 (75.9%) to $6,540,000 for the three
months ended March 31, 1998 compared to $3,717,000 for the comparable period of
the preceding year. This increase is primarily attributable to the issuance of
$110,000,000 and $100,000,000 unsecured senior notes in December 1997 and
January 1998, respectively, as well as the assumption of approximately
$27,305,000 of variable tax-exempt debt in connection with the purchase of the
TCR/MW portfolio.

      Depreciation and amortization increased $2,804,000 (43.3%) to $9,285,000
for the three months ended March 31, 1998 compared to $6,481,000 for the
comparable period of the preceding year. This increase reflects additional
depreciation expense for the increased number of acquired and developed
communities in 1998 and 1997.

      General and administrative expenses increased $488,000 (53.5%) to
$1,400,000 for the three months ended March 31, 1998 compared to $912,000 for
the comparable period of the preceding year. This increase is primarily due to
staff additions related to the growth of the Company's portfolio and higher
compensation expense under the restricted stock grant program.

      Equity in income of unconsolidated joint ventures decreased $391,000 to
$651,000 for the three months ended March 31, 1998 compared to $1,042,000 for
the comparable period of the preceding year. This decrease is principally the
result of the non-recurring income from the Avalon Grove joint venture in which
the Company was allocated 100% of the lease-up period income prior to the
formation of the partnership in December 1997.

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

                                       12

<PAGE>   15
FUNDS FROM OPERATIONS

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

      The following table presents an analysis of Funds from Operations for the
periods presented (dollars in thousands):

                                       13

<PAGE>   16
 ANALYSIS OF FUNDS FROM OPERATIONS
<TABLE>
<CAPTION>
                                                                          Three months ended
                                                               ----------------------------------------
                                                                     3-31-98              3-31-97
                                                               -------------------   ------------------
<S>                                                             <C>                   <C>
NET INCOME                                                      $          18,869      $        13,113

   Depreciation (real estate related)                                       8,790                6,138
   Joint venture adjustment                                                   177                   81
   Extraordinary item                                                          --                1,183
   Preferred stock dividends                                               (4,914)              (4,914)
                                                               -------------------   ------------------
FUNDS FROM OPERATIONS                                           $          22,922      $        15,601
                                                               ===================   ==================

WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC                            42,618,030           33,478,709
                                                               ===================   ==================
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED                          42,905,479           33,742,960
                                                               ===================   ==================

OTHER CAPITALIZED EXPENDITURES AND OTHER INFORMATION
   Capital expenditures:
       Community level (1)                                      $             522      $           439
       Corporate level (2)                                      $           1,732      $           263
   Loan principal amortization payments                         $             281      $           321
   Capitalized deferred financing costs (3)                     $             137      $            81
</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)  Primarily represents the cost of new offices in Alexandria, Chicago and
     Minnepolis as well as new computer equipment to absorb additional
     communities and to support the merged company.

(3)  Substantially all of the deferred financing costs incurred for the three
     months ended March 31, 1998 relate to the costs incurred on the closing of
     the $100 million unsecured senior notes.

                                       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.
Improvements and upgrades are capitalized only if the item exceeds $15,000,
extends the useful life of the asset and is not related to making an apartment
home ready for the next resident. Under this policy, virtually all capitalized
costs are non-recurring, as recurring make ready costs are expensed as
incurred, including costs of carpet and appliance replacements, floor
coverings, interior painting and other redecorating costs. Purchases of
personal property (such as computers and furniture) are capitalized only if the
item is a new addition (i.e., not a replacement) and only if the item exceeds
$2,500. The application of these policies for the three months ended March 31,
1998 resulted in non-revenue generating capitalized expenditures for Stabilized
Communities of approximately $522,000 or $29 per apartment home. For the three
months ended March 31, 1998, the Company charged to maintenance expense,
including carpet and appliance replacements, a total of approximately
$3,859,000 for Stabilized Communities or $213 per apartment home. Management
anticipates that capitalized costs per apartment home will gradually rise as
the Company's portfolio of communities matures. The table on the following page
is a summary of expenditures for both recurring maintenance costs (expensed)
and community upgrades (capitalized) for the three months ended March 31, 1998.

                                       15

<PAGE>   18
        EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES (CAPITALIZED)
                     AND COMMUNITY MAINTENANCE (EXPENSED)
                 (Dollars in thousands, except per home data)
<TABLE>
<CAPTION>
                                                                             Q1 1998 Capitalized Costs
                                                                        ------------------------------------
                                                                        Acquisitions,
                                                                        Construction       Non-Revenue             Q1 1998
                                                                         and Revenue    Generating Capx       Maintenance Expensed
                                   Number    Balance at    Balance at    Generating     -------------------   --------------------
        Community                 of Homes    12-31-97 (1) 03/31/98(1)     Costs        Total      Per Home   Total       Per Home
-------------------------------   --------   ------------- -----------  ------------    -----      --------   -----       --------
<S>                                 <C>      <C>            <C>          <C>         <C>         <C>       <C>         <C>
STABILIZED
Avalon Watch                           512    $  28,423     $  28,464      $ --        $  41       $  80      $  79      $  154
Avalon Pavilions                       932       56,693        56,717        --           24          26        156         167
Avalon Glen                            238       30,244        30,285        13           28         118         90         378
Avalon Walk I                          430       34,587        34,618        --           31          72         71         165
Avalon Walk II                         334       23,740        23,764        --           24          72         65         195
Avalon View                            288       17,812        17,832        --           20          69         87         302
Avalon Park                            372       19,948        19,956        --            8          22         79         212
Avalon at Ballston - 
  Washington Towers                    344       36,893        36,908        --           15          44         74         215
Avalon at Gayton                       328        9,945        10,034        43           46         140         68         207
Avalon at Hampton I                    186        3,764         3,824        60           --          --         44         237
Avalon at Hampton II                   231        8,229         8,298        69           --          --         39         169
Avalon at Dulles                       236       11,706        11,719        --           13          55         84         356
Avalon Knoll                           300        8,067         8,111         4           40         133         73         243
Avalon Lea                             296       16,130        16,135        --            5          17         61         206
Avalon at Fairway Hills I              192        9,454         9,456         2           --          --         37         193
Avalon Ridge                           432       25,269        25,278         9           --          --         88         204
Avalon at Symphony Glen                174        8,166         8,174         1            7          40         47         270
Avalon at Park Center                  492       37,658        37,658        --           --          --         95         193
4100 Mass. Avenue                      308       34,931        34,931        --           --          --        112         364
Avalon Woods                           268        8,319         8,324        --            5          19         40         149
Avalon at Carter Lake                  259       11,560        11,560        --           --          --         60         232
Avalon Pointe                          140        7,841         7,851        --           10          71         29         207
Avalon Landing                         158        9,303         9,303        --           --          --         48         304
Avalon Birches                         312       13,461        13,567       101            5          16         56         179
Avalon at Lake Arbor                   209       11,950        11,959        --            9          43         58         278
Avalon at Decoverly                    368       31,151        31,154        --            3           8         58         158
Avalon Summit                          245       16,289        16,386        97           --          --         50         204
Avalon Towers                          109       15,943        15,943        --           --          --         76         697
Longwood Towers                        307       21,501        21,501        --           --          --         80         261
Avalon Fields                          192       14,298        14,305        --            7          36         30         156
Avalon West                            120       10,810        10,810        --           --          --         33         275
Avalon Chase                           360       23,661        23,661        --           --          --         77         214
Avalon Pines                           174        8,659         8,664         5           --          --         28         161
Avalon at Fairway Hills II             527       33,924        33,985        61           --          --        102         194
Avalon at Boulders                     284       16,087        16,126        35            4          14         48         169
AutumnWoods                            420       30,631        30,640         1            8          19         73         174
Avalon Run East                        206       16,233        16,233        --           --          --         23         112
Avalon Station                         223       12,001        12,014        --           13          58         55         247
Avalon Cove                            504       90,291        90,347        56           --          --         84         167
Avalon Crossing                        132       13,778        13,867        89           --          --         24         182
Avalon Springs                         102       15,775        15,824        49           --          --         35         343
Avalon at Ballston - 
  Vermont/Quincy                       454       46,722        46,722        --           --          --        114         251
Avalon at Center Place                 225       26,424        27,063       523          116         516         59         262
Avalon at Providence Park              140       11,066        11,069         3           --          --         36         257
Avalon Gates                           340       35,369        35,426        57           --          --         76         224
Avalon at Lexington                    198       14,784        14,816        --           32          --         53         268
Avalon Green                           105       12,439        12,447        --            8          --         51         486
Avalon Commons                         312       31,732        32,442       710           --          --         66         212
Avalon Crescent                        558       56,625        56,752       127           --          --         58         104
Avalon Court                           154       17,231        17,605       374           --          --         33         214
Summerplace (2)                        160           --        10,740    10,740           --          --         33         206
Carriage Green (2)                     246           --        17,775    17,775           --          --         45         183
Village Park of Westmont               400       25,743        25,747         4           --          --        104         260
Village Park of Troy                   544       31,290        31,290        --           --          --        117         215
Avalon Heights                         225       15,308        15,308        --           --          --         45         200
Avalon  at Willow Lake                 230       14,944        15,231       287           --          --         41         178
Avalon at Geist                        146       12,080        12,178        98           --          --         26         178
Avalon at Montgomery                   264       15,153        15,624       471           --          --         40         152
Avalon Devonshire                      498       36,143        36,679       536           --          --        113         227
Avalon at Danada Farms                 295       37,571        37,766       195           --          --         60         203
Avalon at Stratford Green              192       21,572        21,687       115           --          --         39         203
Aspen Meadows                          214       12,435        12,435        --           --          --         34         159
                                  --------   ----------    ----------   -------         -----      ------     -----       --------
                                    18,144    1,329,756     1,362,988    32,710          522          29      3,859         213
                                  --------   ----------    ----------   -------         -----      ------     -----       --------

</TABLE>
                                       16

<PAGE>   19

               EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES
        (CAPITALIZED) AND COMMUNITY MAINTENANCE (EXPENSED) - CONTINUED
                 (Dollars in thousands, except per home data)
<TABLE>
<CAPTION>
                                          Number       Balance at      Balance at
              Community                  of Homes       12-31-97   (1)  3-31-98  (1)
---------------------------------------  ----------   -------------   -------------
<S>                                      <C>           <C>             <C>
NEW DEVELOPMENTS                             3,029         154,762         205,079
----------------                         ----------   -------------   -------------
OTHER
Longwood Towers - Renovation                    --          15,876          17,987
Avalon Arbor (4)                               302          28,461          28,597
Corporate Level Expenditures                    --           6,131           7,863
                                         ==========   =============   =============
Grand Total                                 21,475 (5)   1,534,986       1,622,514
                                         ==========   =============   =============


<CAPTION>
                                                     Q1 1998 Capitalized Costs
                                            ---------------------------------------------

                                             Acquisitions,            Non-Revenue                   Q1 1998
                                              Construction          Generating Capx          Maintenance Expensed
                                              and Revenue       -------------------------  --------------------------
              Community                  Generating Costs       Total       Per Home       Total        Per Home
---------------------------------------    -----------------   ------------   ----------  -------------  -----------
<S>                                          <C>                <C>            <C>          <C>            <C>
NEW DEVELOPMENTS                                     50,317             --           --             83          N/A
----------------                           -----------------   ------------   ----------  -------------  -----------
OTHER
Longwood Towers - Renovation                          2,111 (3)         --           --             --           --
Avalon Arbor (4)                                        136             --          N/A             85          281
Corporate Level Expenditures                          1,732             --          N/A             --           --
                                           =================   ============   ==========  =============  ===========
Grand Total                                          87,006            522          N/A          4,027          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 1998. 

(3) Represents renovation costs incurred.

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

(5) Excludes Falkland Chase, Avalon Run and Avalon Grove, a total of 1,278
    apartment homes owned by joint ventures in which the Company holds a 50%
    interest, 49% interest and 50% interest, respectively.

                                       17
<PAGE>   20
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, occupancy levels and the Company's
expenses with respect to such apartment homes. The 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 $3,036,000 at March 31, 1997 to
$3,497,000 at March 31, 1998 due to the excess of cash provided by financing
and operating activities over cash flow used in investing activities.

          Net cash provided by operating activities increased by $6,938,000 from
      $22,513,000 to $29,451,000 primarily due to an increase in operating
      income from newly developed and acquired communities and Established
      Communities.

          Cash used in investing activities decreased by $2,076,000 from
      $92,433,000 to $90,357,000 primarily due to the acquisition of two
      communities for $45,698,000 in 1997 compared to the acquisition of two
      communities for $27,625,000 in 1998, offset by an increase in construction
      costs.

          Net cash provided by financing activities decreased by $1,034,000 from
      $58,715,000 to $57,681,000 primarily due to an increase in dividends paid
      and a decrease in borrowings under the Unsecured Facilities, offset by the
      net proceeds received from the sale of 923,856 shares of the Company's
      common stock and the issuance of $100,000,000 unsecured senior notes in
      January 1998.

      The Company regularly reviews its short-term liquidity needs and the
adequacy of Funds from Operations and other expected liquidity sources to meet
these needs. The Company believes that its principal 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. Any
short-term liquidity needs not provided by current operating cash flows would
be funded from the Company's Unsecured Facilities. Normal recurring
expenditures for maintenance and repairs (including carpet and appliance
replacements) are funded from the operating cash flows of Stabilized
Communities and are expensed as incurred. Major upgrades or community
improvements are capitalized and depreciated over the expected economic useful
life of the item only if the expenditure exceeds $15,000 per occurrence and
only if the expenditure extends the economic useful life of the community.
Purchases of personal property (such as computers and furniture) are
capitalized only if the item is a new addition (i.e., not a replacement) and
only if the item exceeds $2,500. The application of these policies for the
three month period ended March 31, 1998 resulted in capitalized expenditures
for Stabilized Communities of $29 per apartment home.

      The Company's 7-3/8%, 6-7/8% and 6-5/8% unsecured senior notes will
mature in 2002, 2007 and 2005, respectively. Additionally, mortgage
indebtedness on the Avalon Pines and Avalon Walk II apartment communities will
mature in 2003 and 2004, respectively. Since Management anticipates that no
significant portion of the principal of such indebtedness will be repaid prior
to maturity and if Company does not have funds on hand sufficient to repay such
indebtedness, it will be necessary for the Company to refinance this debt. Such
refinancing could be accomplished through additional debt financing, which may
be collateralized by mortgages on individual communities or groups of
communities, by uncollateralized private or public debt offerings or by
additional equity offerings. There can be no assurance that such additional
debt financing or debt offerings will be available on terms satisfactory to the
Company. Currently, no other permanent indebtedness will require balloon
payments prior to the year 2005.

                                       18
<PAGE>   21


      Capital Resources. To sustain the Company's active development and
acquisitions program, continuous access to the capital markets is required.
Management intends to match the long-term nature of its real estate assets with
long-term cost effective capital. The Company has demonstrated regular and
continuous access to the capital markets since its initial public offering,
raising approximately $1.1 billion and over $345 million in the last 5 months.
Management follows a focused strategy to help facilitate uninterrupted access
to capital. This strategy includes:

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

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

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

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

5. Accounting practices that provide a high level of quality to reported
   earnings; and

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

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

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

Unsecured Facilities

         The Company's unsecured credit facility (the "Unsecured Facility") is
provided by a consortium of banks that provides for $175,000,000 in short-term
credit and is subject to an annual facility fee of $262,500. The Unsecured
Facility expires in March 2000. Borrowings under the Unsecured Facility bear an
interest rate of .80% over LIBOR. A competitive bid option is available for up
to $75,000,000 which may result in lower pricing if market conditions allow. At
March 31, 1998, $1,000,000 was borrowed, $12,873,000 was used to provide
letters of credit and $161,127,000 was available for borrowing under the
Unsecured Facility. The Company will use borrowings under the Unsecured
Facility for capital expenditures, acquisitions of developed or undeveloped
communities, construction, development and renovation costs, credit enhancement
for tax-exempt bonds and for working capital purposes.

         The Company's supplemental unsecured credit facility (the
"Supplemental Unsecured Facility" and together with the Unsecured Facility, the
"Unsecured Facilities") is provided by First Union National Bank in the amount
of $50,000,000 and is subject to an annual fee of $75,000. The Supplemental
Unsecured Facility expires in March 2000 and bears an interest rate of LIBOR
plus .80%. At March 31, 1998, $2,560,000 of available capacity was used to
provide letters of credit, and $23,000,000 was borrowed under the Supplemental
Unsecured Facility. Accordingly, the balance that remains available at March
31, 1998 to be drawn under the Supplemental Unsecured Facility is $24,440,000.

                                       19
<PAGE>   22


Interest Rate Protection Agreements

         In connection with the refinancing of the tax-exempt bonds related to
the Avalon Lea and Avalon Ridge communities in October 1997, the Company
purchased an interest rate cap agreement for $101,000. This agreement
terminates October 31, 2002 and serves to place a ceiling on the interest rate
on the bonds at 6.9%.

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

Financing Commitments/Transactions Completed

         On January 22, 1998, the Company completed a $100,000,000 offering of
unsecured senior notes. The notes bear an interest rate at 6.625% payable
semi-annually on January 15 and July 15 and will mature on January 15, 2005.
The notes were sold at a price of 99.976% par value to yield 6.629% to maturity
or a 111 basis point spread over the then-prevailing 7-year U.S. Treasury Note
rate. The Company used the net proceeds of approximately $99,400,000 to repay
amounts outstanding under the Unsecured Facilities.

         On January 27, 1998, the Company completed the sale of 923,856 shares
of Common Stock to The Prudential Insurance Company of America under its
existing shelf registration statement at a net purchase price of $29.09 per
share. The net proceeds of approximately $26,872,000 were used to retire
indebtedness under the Unsecured Facilities.

Future Financing Needs

         Substantially all of the capital expenditures to complete the
communities currently under construction will be funded from the Unsecured
Facilities and/or issuance of debt or equity securities. Except for Longwood
Towers, the Company has no present plans for any major capital improvements to
any of the Current Communities. The renovation of Longwood Towers is expected
to be completed by the end of June 1998 and is being funded by advances under
the Unsecured Facilities, operating cash flow or other financing sources.
Management expects to continue to fund deferred development costs related to
future developments from Funds from Operations and advances under the Unsecured
Facilities. The Company believes that these sources of capital are adequate to
take each of the proposed communities to the point in the development cycle
where construction can commence.

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

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

                                       20
<PAGE>   23
                             AVALON PROPERTIES, INC.
                             DEBT MATURITY SCHEDULE
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                    Balance Outstanding at
                                                                --------------------------------
                                     All-in          Maturity
           Community               Interest Rate      Date          12-31-97         3-31-98
-----------------------------     --------------   -----------  --------------  ----------------
<S>                               <C>               <C>           <C>             <C>
Tax-Exempt Bonds:

     Fixed Rate

   * Avalon Lea                        8.02%         Jun-2026       $  16,835         $  16,835
   * Avalon Ridge                      8.00%         Jun-2026          26,815            26,815
   * Avalon at Dulles                  7.04%         Jul-2024          12,360            12,360
   * Avalon Hampton II                 7.04%         Jul-2024          11,550            11,550
   * Avalon at Symphony Glen           7.06%         Jul-2024           9,780             9,780
   * Avalon View                       7.55%         Aug-2024          19,315            19,265
   * Avalon at Lexington               6.56%         Feb-2025          15,071            15,015
   * Avalon Knoll                      6.95%         Jun-2026          13,917            13,878
   * Avalon Landing                    6.85%         Jun-2026           6,892             6,872
   * Avalon West                       7.73%         Dec-2036           8,731             8,716
   * Avalon Fields                     7.57%         May-2027          12,019            11,988
                                                                --------------  ----------------
                                                                      153,285           153,074
     Variable Rate

   * Avalon at Fairway Hills I                       Jun-2026          11,500            11,500
   * Avalon at Hampton I                             Jun-2026           8,060             8,060
   * Avalon Pointe                                   Jun-2026           6,387             6,387
   * Avalon Devonshire                               Dec-2025          27,305            27,305
                                                                --------------  ----------------
                                                                       53,252            53,252
Conventional Loans:

     Fixed Rate

     Unsecured Senior Notes            7.375%        Sep-2002          99,892            99,898
     Unsecured Senior Notes            7.035%        Dec-2007         109,803           109,808
     Unsecured Senior Notes            6.625%        Jan-2005              --            99,977
   * Avalon Pines                       8.00%        Dec-2003           5,433             5,416
   * Avalon Walk II                     8.93%        Nov-2004          12,964            12,911
                                                                --------------  ----------------
                                                                      228,092           328,010
     Variable Rate-None                                                   --                --
                                                                --------------  ----------------
Total indebtedness - excluding
      Unsecured Facilities                                           $ 434,629         $ 534,336
                                                                ==============  ================


<CAPTION>
                                                                     Total Maturities
                                ----------------------------------------------------------------------------------

           Community              1998        1999          2000          2001             2002         THEREAFTER
-----------------------------   -------- -------------  -----------  --------------  --------------- -------------
<S>                             <C>       <C>            <C>           <C>            <C>              <C>
Tax-Exempt Bonds:

     Fixed Rate

   * Avalon Lea                   $  --       $    --      $    --         $    --        $      --      $  16,835
   * Avalon Ridge                    --            --           --              --               --         26,815
   * Avalon at Dulles                --            --           --              --               --         12,360
   * Avalon Hampton II               --            --           --              --               --         11,550
   * Avalon at Symphony Glen         --            --           --              --               --          9,780
   * Avalon View                    180           290          330             350              373         17,742
   * Avalon at Lexington            170           240          255             271              288         13,791
   * Avalon Knoll                   124           175          187             200              214         12,978
   * Avalon Landing                  63            89           95             101              108          6,416
   * Avalon West                     31            50           53              57               61          8,464
   * Avalon Fields                   96           137          147             157              169         11,282
                                -------- -------------  -----------  --------------  --------------- --------------
                                    664           981        1,067           1,136            1,213        148,013
     Variable Rate

   * Avalon at Fairway Hills I       --            --           --              --               --         11,500
   * Avalon at Hampton I             --            --           --              --               --          8,060
   * Avalon Pointe                   --            --           --              --               --          6,387
   * Avalon Devonshire               --            --           --              --               --         27,305
                                -------- -------------  -----------  --------------  --------------- --------------
                                     --            --           --              --               --         53,252
Conventional Loans:

     Fixed Rate

     Unsecured Senior Notes          --            --           --              --           99,898             --
     Unsecured Senior Notes          --            --           --              --               --        109,808
     Unsecured Senior Notes          --            --           --              --               --         99,977
   * Avalon Pines                    86           112          121             131              142          4,824
   * Avalon Walk II                 149           221          241             264              288         11,748
                                -------- -------------  -----------  --------------  --------------- --------------
                                    235           333          362             395          100,328        226,357
     Variable Rate-None             --            --           --              --               --             --
                                -------- -------------  -----------  --------------  --------------- --------------
Total indebtedness - excluding
      Unsecured Facilities         $ 899       $ 1,314      $ 1,429         $ 1,531        $ 101,541      $ 427,622
                                ======== =============  ===========  ==============  =============== ==============
</TABLE>

   * Indicates loan is collateralized.

                                       21
<PAGE>   24
BUSINESS STRATEGY; INFLATION

         Management believes that apartment communities present an attractive
investment opportunity compared to other real estate investments because a
broad potential resident base results in relatively stable demand of all phases
of a real estate cycle. The Company intends to pursue appropriate new
investments (both acquisitions of new communities and new developments) where
constraints to new supply exist and where new household formations have
out-paced multifamily permit activity in recent years. The Company has targeted
certain high barrier-to-entry markets in the Northeast, Mid-Atlantic and
Midwest regions of the United States for investment opportunities. Recently,
the Company has begun expanding into selected Pacific Northwest markets and
entered into a merger agreement with Bay that will create a combined company
with assets in the supply constrained markets of the Mid-Atlantic, Northeast,
Midwest and selected West Coast markets. The combined company will have 75% of
its assets located in the top 10 apartment markets of the United States, as
rated by the January/February 1998 issue of Multi-Housing News.

         At March 31, 1998, Management had positioned the Company's portfolio
of Stabilized Communities, excluding communities owned by joint ventures, to a
physical occupancy level of 97.0% and achieved an average economic occupancy of
95.9% for the three months ended March 31, 1998. Average economic occupancy for
the portfolio for the three months ended March 31, 1997 was 95.1%. This
continued high occupancy was achieved through aggressive marketing efforts
combined with limited and targeted pricing adjustments. This positioning has
resulted in overall growth in rental revenue from Established Communities
between periods. It is Management's strategy to maximize total rental revenue
through management of rental rates and occupancy levels. If market and economic
conditions change, Management may adopt a strategy of maximizing rental rates,
which could lead to lower occupancy levels, if Management believes that this
strategy will maximize rental revenue. Given the currently high occupancy level
of the portfolio, Management anticipates that, for the foreseeable future, any
rental revenue and net income gains from currently owned and Established
Communities would be achieved primarily through higher rental rates and
enhanced operating cost leverage provided by high occupancy, rather than
through continued occupancy gains.

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

DEVELOPMENT COMMUNITIES

         At May 5, 1998, 12 Development Communities were under construction.
The total capitalized cost of these Development Communities, when completed, is
currently expected to be approximately $389.2 million. There can be no
assurance that the Company will complete the Development Communities, that the
Company's budgeted costs, leasing, start dates, completion dates, occupancy or
estimates of "EBITDA as % of Total Budgeted Cost" will be realized or that
future developments will realize comparable returns.

         In accordance with GAAP, the Company capitalizes interest expense
during construction until each building obtains a certificate of occupancy,
thereafter, interest for each completed building is expensed. Capitalized
interest for the three months ended March 31, 1998 and 1997 totaled $2,171,000
and $2,511,000, respectively.

         The following page presents a summary of Development Communities:

                                       22
<PAGE>   25

<TABLE>
<CAPTION>
                        DEVELOPMENT COMMUNITIES SUMMARY

                        NUMBER OF   BUDGETED                             ESTIMATED     ESTIMATED      EBITDA AS %
                        APARTMENT     COST     CONSTRUCTION   INITIAL   COMPLETION   STABILIZATION     OF TOTAL
                          HOMES    ($ MILLIONS)   START      OCCUPANCY     DATE        DATE (1)     BUDGETED COST (2)
                        ---------- ----------- ------------- ---------- ------------ -------------- ----------------
<S>                        <C>       <C>         <C>         <C>          <C>           <C>             <C>
Avalon at Fair Lakes
Fairfax, VA                   234    $ 23.3      Q1 1997      Q4 1997     Q2 1998       Q4 1998          10.4%

Avalon at Faxon Park
Quincy, MA                    171      15.8      Q1 1997      Q4 1997     Q2 1998       Q4 1998          12.1%

Avalon Gardens
Nanuel, NY                    504      53.8      Q3 1996      Q2 1997     Q3 1998       Q1 1999          10.8%

Avalon at Cameron Court
Alexandria, VA                460      44.7      Q2 1997      Q1 1998     Q4 1998       Q1 1999          11.0%

Avalon Fields II
Gaithersburg, MD               96       9.2      Q3 1997      Q2 1998     Q4 1998       Q1 1999          10.2%

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

Avalon Crest
Fort Lee, NJ                  351      57.4      Q4 1997      Q2 1999     Q4 1999       Q1 2000          10.1%

Avalon Cove South
Jersey City, NJ               269      51.8      Q1 1998      Q2 1999     Q3 1999       Q4 1999          10.0%

Avalon House
Bronxville, Ny                110      26.4      Q1 1998      Q2 1999     Q3 1999       Q4 1999          9.7%

Avalon Valley
Danbury, CT                   268      26.1      Q1 1998      Q1 1999     Q3 1999       Q1 2000          10.1%

Avalon Lake
Danbury, CT                   135      17.0      Q2 1998      Q2 1999     Q3 1999       Q1 2000          10.1%

Avalon Oaks
Wilmington, MA (3)            204      21.9      Q2 1998      Q1 1999     Q3 1999       Q1 2000          10.3%

                        ---------- -----------                                                      ----------------
Total/Average               3,029    $ 389.2                                                             10.3%
                        ========== ===========                                                      ================
</TABLE>

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

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

(3)  Financed with tax-exempt bonds.
                                       23

<PAGE>   26



DEVELOPMENT RIGHTS

         The Company is considering the development of 18 new apartment
communities. The status of these Development Rights range from land owned or
under contract for which design and architectural planning has just commenced
to land under contract or owned by the Company with completed site plans and
drawings where construction can commence almost immediately. There can be no
assurance that the Company will succeed in obtaining zoning and other necessary
governmental approvals or the financing required to develop these communities,
or that the Company will decide to develop any particular community. Further,
there can be no assurance that construction of any particular community will be
undertaken or, if undertaken, will begin at the expected times assumed in the
financial projections or be completed at the total budgeted cost. Although
there is no assurance that all or any of these communities will proceed to
development, the successful completion of all of these communities would
ultimately add approximately 4,922 institutional-quality apartment homes to the
Company's portfolio. At March 31, 1998, the cumulative capitalized costs
incurred in pursuit of the 18 Development Rights were approximately $14.4
million, including the capitalized cost of $7.5 million related to the purchase
of land in New Canaan, Connecticut. Many of these apartment homes will offer
features like those offered by the communities currently owned by the Company.
The 18 Development Rights that the Company is currently pursuing are summarized
below.

                     DEVELOPMENT RIGHTS SUMMARY

<TABLE>
<CAPTION>
                                                               TOTAL
                                       ESTIMATED              BUDGETED
                                       NUMBER OF                COST
           LOCATION                     HOMES               ($ MILLIONS)
       ------------------          ----------------       --------------
 <S>                                <C>                   <C>
   1.  Peabody, MA                        434                 $ 35.9
   2.  Hull, MA                           162                   17.0
   3.  New Rochelle, NY                   408                   62.7
   4.  Stamford, CT                       195                   30.5
   5.  Freehold, NJ                       452                   38.4
   6.  Herndon, VA                        165                   19.5
   7.  Melville - II, NY                  340                   40.3
   8.  Orange, CT                         172                   15.5
   9.  New Canaan, CT (1)                 104                   24.1
  10.  Darien, CT                         172                   26.1
  11.  Yonkers, NY                        256                   33.7
  12.  Greenburgh - II, NY                500                   74.0
  13.  Greenburgh - III, NY               266                   39.3
  14.  Florham Park, NJ                   270                   37.5
  15.  Ridgefield, CT                     240                   30.2
  16.  Naperville, IL                     200                   22.0
  17.  Westbury, NY                       361                   47.6
  18.  Providence, RI                     225                   26.4

                                   -----------            -----------
       Total                            4,922                 $620.7
                                   ===========            ===========
</TABLE>




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

                                       24
<PAGE>   27



PART II           OTHER INFORMATION

ITEM 1.     LEGAL PROCEEDINGS

      Neither the Company nor any of the communities is presently subject to
any material litigation nor, to the Company's knowledge, is any litigation
threatened against the Company or any of the communities, other than routine
actions for negligence or other claims and administrative proceedings arising
in the ordinary course of business, some of which are expected to be covered by
liability insurance and all of which collectively are not expected to have a
material adverse effect on the business or financial condition of the Company.

ITEM 2.     CHANGES IN SECURITIES

      None.

ITEM 3.     DEFAULTS UPON SENIOR SECURITIES

      None.

ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS

      None.

ITEM 5.     OTHER INFORMATION

      On January 22, 1998, the Company completed a $100,000,000 offering of
unsecured senior notes. The notes bear an interest rate at 6.625% payable
semi-annually on January 15 and July 15 and will mature on January 15, 2005.
The notes were sold at a price of 99.976% par value to yield 6.629% to maturity
or a 111 basis point spread over the 7-year U.S. Treasury Note rate. The
Company used the net proceeds of approximately $99,400,000 to repay amounts
outstanding under the Unsecured Facilities.

      On January 27, 1998, the Company completed the sale of 923,856 shares
of Common Stock to The Prudential Insurance Company of America under its
existing shelf registration statement at a net purchase price of $29.09 per
share. The net proceeds of approximately $26,872,000 were used to retire
indebtedness under the Unsecured Facilities.

ITEM 6.     EXHIBITS AND REPORTS ON FORM 8-K

      a) Exhibit No.          Description

         27.1                 Financial Data Schedule - Q1 1998

         27.2                 Financial Data Schedule - Q1 1997


      b) On January 15, 1998, the Company filed a Current Report on Form 8-K,
         reporting under item (5) the pursuit of certain investment
         opportunities in Boston, Massachusetts and the Pacific Northwest.

         On January 26, 1998, the Company filed a Current Report on Form 8-K
         relating to the offering and sale of $100,000,000 aggregate principal
         amount of the Company's 6 5/8% Senior Notes due 2005.

         On March 10, 1998, the Company filed a Current Report on Form 8-K, as
         amended and restated by Form 8-K/A on March 12, 1998, reporting under
         item (5) the merger agreement between the Company and Bay Apartment
         Communities, Inc.


                                       25

<PAGE>   28
                                   SIGNATURES

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

                                 AVALON PROPERTIES, INC.

Date: May 12, 1998               By      /s/  RICHARD L. MICHAUX
                                    ------------------------------------------
                                 Richard L. Michaux, Chairman of the Board,
                                 Chief Executive Officer and
                                 Director (Principal Executive Officer)


Date: May 12, 1998               By      /s/  THOMAS J. SARGEANT
                                    ------------------------------------------
                                 Thomas J. Sargeant, Chief Financial Officer,
                                 Treasurer and Secretary
                                 (Principal Financial and Accounting Officer)


                                       26