<PAGE>   1
                                                          EXHIBIT 13.1


                         MANAGEMENT'S DISCUSSION & ANALYSIS


OVERVIEW

Associated Estates Realty Corporation (the "Company") is a Real Estate
Investment Trust ("REIT") that currently owns or is a joint venture partner in
84 multifamily properties containing 15,838 suites located in Ohio, Michigan and
western Pennsylvania.

    The following discussion should be read in conjunction with the financial
statements and notes thereto appearing elsewhere in this report. Historical
results and percentage relationships set forth in the Consolidated Statements of
Operations contained in the financial statements, including trends which might
appear, should not be taken as indicative of future operations.

Liquidity and capital resources

    The Company has elected to be taxed as a REIT under Sections 856 through 860
of the Internal Revenue Code of 1986, as amended, commencing with its taxable
year ending December 31, 1994. REITs are subject to a number of organization and
operational requirements including a requirement that 95% of the income that
would otherwise be considered as taxable income be distributed to its
shareholders. Providing the Company continues to qualify as a REIT, it will
generally not be subject to a Federal income tax on net income.

    The Company expects to meet its short-term liquidity requirements generally
through its net cash provided by operations. The Company believes that its net
cash provided by operations will be sufficient to meet both operating
requirements and the payment of dividends in accordance with REIT requirements
in both the short and long term.

Financing

    Sixty-four of the Company's 77 wholly owned properties were unencumbered at
December 31, 1996 with annualized earnings before interest, depreciation and
amortization of approximately $41 million and an historical cost basis of
approximately $374 million. The remaining 13 of the Company's wholly owned
properties have an historical cost basis of $104.2 million and secured property
specific debt of $69 million at December 31, 1996. Unsecured debt, which totaled
$148.8 million at December 31, 1996, consisted of $42.5 in Medium-Term Notes,
Senior Notes of $84.8 million and amounts drawn on the revolving credit facility
of $21.5 million. The Company's proportionate share of the mortgage debt
relating to the seven joint venture properties was $18 million at December 31,
1996. The weighted average interest rate on the secured, unsecured and the
Company's proportionate share of the joint venture debt was 8.0% at December 31,
1996.

    The Company utilizes borrowings under a $75 million unsecured revolving
credit facility (the "Line of Credit") for the acquisition and development of
multifamily properties and working capital purposes. The Line of Credit includes
certain restrictive covenants which, among others, requires the Company to
maintain a minimum level of net worth, to limit dividends to 90% of
Distributable Cash Flow, to restrict the use of its borrowings and to maintain
certain debt coverage ratios. The Line of Credit provides for a scaled reduction
in the LIBOR or prime rate margins and commitment fees based on the Company's
credit ratings. Based on the Company's present credit ratings, the LIBOR margin
is 150 basis points fixed in increments of 30, 60, 90, 120 or 180 days and Prime
Rate borrowings are at the Prime Rate with no margin. An annual commitment fee
of between 25 basis points and 37.5 basis points on the average daily unused
amount of the facility is paid quarterly in arrears. The Line of Credit expires
in September 1997 and the Company has the option to extend the facility for an
additional one year period. At December 31, 1996, $21.5 million was drawn on the
Line of Credit with a weighted average interest rate of 7.5%.

    During the year ended December 31, 1996, the Company issued six Medium-Term
Notes (the "MTN's") aggregating $42.5 million under its $75 million MTN program.
The principal amounts of these MTN's range from $2.5 million to $15 million and
bear interest from 6.60% to 7.93% over terms of between 5 to 30 years. The
holder of a $2.5 million, 30 year 


18
<PAGE>   2
MTN has the option to require payment on March 15, 2003. The net proceeds to the
Company with respect to these issuances were $42 million, of which $32.1 million
was applied to amounts outstanding under the Line of Credit and the remaining
$9.9 million was used to acquire a multifamily property.


                      DEBT TO TOTAL MARKET CAPITALIZATION
                               December 31, 1996
                                  [Pie Chart]


Market Equity                           64.2%
Total Debt                              35.8%


                               COMPONENTS OF DEBT
                               December 31, 1996
                                  [Pie Chart]

Line of Credit                          9.2%
Property Specific - Variable Rate       0.8%
Property Specific - Fixed Rate         35.7%
Medium - Term Notes                    18.1%
Senior Notes                           36.2%

Registration statements filed in connection with financing
 
    The Company has filed two shelf registration statements with the Securities
and Exchange Commission for the registration of up to $250 million and $200
million of debt securities, preferred shares, depositary shares, common shares
and common share warrants in January and December of 1995, respectively. The
Company has $201.4 million of securities under these shelf filings available for
issuance.

Acquisitions, development and dispositions
 
    The Company intends to continue to finance its multifamily property
acquisitions and development with the most appropriate sources of capital, which
may include undistributed Funds From Operations, the issuance of equity
securities, bank and other institutional borrowings, the issuance of debt
securities, the assumption of mortgage indebtedness or through the exchange of
properties. The Company may also determine to raise additional working capital
through one or more of these sources.

    During the year ended December 31, 1996, the Company acquired six
multifamily properties containing 1,289 suites and three parcels of land
consisting of 43 acres for an aggregate purchase price of $59.1 million. The
acquisitions are located in Michigan, Ohio and western Pennsylvania, and were
financed with borrowings under the Line of Credit, the issuance of MTN's and the
assumption of mortgage indebtedness. The Company has also entered into a
contract for the construction of a 324 suite property that will be known as
Bradford at Easton on a 45 acre Columbus, Ohio land parcel owned by the Company
with an estimated completion in the Fall of 1997. The Company is also developing
The Residence at Barrington, a 288 suite multifamily property in Aurora, Ohio,
that will be constructed in two phases with an estimated completion of the first
phase in the Fall of 1997. Construction has also commenced at The Village of
Western Reserve, a 108 suite property located in Streetsboro, Ohio that is
expected to be completed in the Fall of 1997. In addition, the Company owns five
parcels of undeveloped land, two of which are in Ohio and three of which are in
Michigan, containing 84 acres on which an estimated 783 suites could be
developed. Development activities for the construction of 274 suites have
commenced with respect to two of these parcels.

    Subsequent to December 31,1996, the Company acquired a multifamily property
containing 228 suites 


                                                                              19
<PAGE>   3
for an aggregate purchase price of $12.5 million which was financed with
borrowings under the Company's Line of Credit. The multifamily property is
located in Indianapolis, Indiana. The Company is currently under contract to
purchase one multifamily property containing an aggregate of 102 suites and five
parcels of undeveloped land containing an aggregate of 158.5 acres for a total
purchase price of $10.1 million. The multifamily property is located in
Columbus, Ohio while the land parcels are located in Ohio and Michigan. With the
exception of one 37 acre parcel located in Avon, Ohio, the land parcels under
contract are located adjacent to or in the vicinity of multifamily properties
presently owned by the Company. The Company expects to finance the acquisition
of the multifamily property and five land parcels using borrowings under the
Line of Credit. There can be no assurances, however, that the Company will be
successful in acquiring the multifamily property and the land parcels under
contract.

    The Company is exploring opportunities to dispose of several of the
Government-Assisted Properties and has received an expression of interest from a
housing authority that operates Government-Assisted properties in the vicinity
of the properties being considered for disposition. In addition, the Company has
determined that a 90 acre parcel of land, which was one of the assets acquired
by the Company at the time of the IPO that is presently zoned for office and
industrial use, will not be rezoned for multifamily use. The Company intends to
sell the property and has received interest from parties interested in
developing office and industrial buildings on the property. No loss is
anticipated from the aforementioned, potential property dispositions; however,
there can be no assurances that the Company will be successful in disposing of
the Government-Assisted Properties or the parcel of land.

Dividends

    On December 9, 1996, the Company declared a dividend of $0.45 per common
share for the quarter ending December 31, 1996 which was paid on January 31,
1997 to shareholders of record on December 31, 1996. On November 25, 1996, the
Company declared a dividend of $0.60938 per depositary share on its Class A
Cumulative Preferred Shares (the "Perpetual Preferred Shares") which was paid on
December 16, 1996 to shareholders of record on December 5, 1996.

Cash flow sources and applications
 
    Net cash provided by operating activities increased $2,179,000 from
$28,881,500 to $31,060,500 for the year ended December 31, 1996 when compared
with the year ended December 31, 1995. This increase was primarily the result of
collections of outstanding notes and accounts receivable.

    Net cash flows used for investing activities of $75,770,800 for the year
ended December 31, 1996 were primarily used for the acquisition of multifamily
real estate, properties and undeveloped land parcels.

    Net cash flows provided by financing activities of $43,149,000 for the year
ended December 31, 1996 were primarily comprised of borrowings on the Line of
Credit and the issuance of MTN's and the 1,450,000 common shares. Funds were
also used to pay dividends on the Company's common and Perpetual Preferred
Shares as well as repayments on the Line of Credit.

RESULTS OF OPERATIONS

Comparison of the year ended December 31, 1996 to the year ended December 31,
1995

    Overall, total revenue increased $17,491,800 or 22.7% and total expenses
before net income of the joint ventures increased $15,466,600 or 25.8% for the
year. Net income applicable to common shares decreased $221,200 or 1.6%, after
the dividends on the Company's Perpetual Preferred Shares.

    In the following discussion of the comparison of the year ended December
31,1996 to the year ended December 31, 1995, the term Core Portfolio Properties
refers to the 36 wholly owned multifamily properties acquired by the Company at
the time of 


20
<PAGE>   4
the IPO and the 21 properties acquired during 1994 and the acquisition of the
remaining 50% interest in two properties in which the Company was a joint
venture partner at the time of the IPO. Acquired Properties refers to the 21
properties acquired between January 1, 1995 and December 31, 1996.

    During the year ended December 31, 1996, the Acquired Properties generated
total revenues of $24,525,700 while incurring property, operating and
maintenance expenses of $9,534,800.

Rental revenues

    Rental revenues increased $17,929,700 or 25.6% for the year. Rental revenues
from the Acquired Properties increased $15,564,900 for the year. Increases in
occupancy and suite rents at the Core Portfolio Market-rate and Government-
Assisted Properties resulted in a $2,364,800 or 3.9% increase in rental revenue
from these properties. The balance of the increase resulted from increased
rental revenues attributable to office space and other miscellaneous rental
revenue items.

Other revenues

    Property management fees and property management fees - affiliates decreased
$432,800 or 10.3% for the year. This decrease was due in part to a decline in
management fees attributable to a supplemental management fee pursuant to the
terms of the management contract between the Company and a managed property. No
supplemental management fee was earned at this managed property in 1996 due to
an increase in operating and repair and maintenance expenses.

    Painting service revenue and painting service revenue - affiliates increased
$567,300 or 53.2% for the year and reflects an increase in revenue generated
from suite painting and major renovation projects when compared to the previous
year. The increase in painting service and painting service revenue - affiliates
was partially offset by an increase in painting service expenses as discussed
elsewhere herein. 

    Other income decreased $572,300 or 35.4% for the year. The decrease is due
primarily to a reduction in the amount of real estate tax refunds received in
comparison to the prior year as well as a reduction of supervisory management
fees earned for overseeing the improvement of tenant space at the commercial
properties managed by the Company.

Property operating and maintenance expenses

    Property operating and maintenance expenses increased $7,778,900 or 26.6%
for the year. Operating and maintenance expenses at the Acquired Properties
increased $6,780,800 for the year due primarily to the operating and maintenance
expenses incurred at the six properties acquired during 1996 and the recognition
of a full year's operating expenses at the 15 properties acquired during 1995.
Property operating and maintenance expenses at the Core Portfolio Properties
increased $998,100, or 3.8% when compared to the prior 12 month period primarily
due to increases in personnel, utilities and real estate taxes which were
partially offset by a decrease in building and grounds repairs and maintenance
expenses for suite improvements such as the replacement of appliances and
carpeting. Total expenditures for building renovations and suite and common area
refurbishment in the Core Portfolio Properties that were not considered to be
capital in nature averaged $270 per suite for the year ended December 31, 1996
as compared to $301 per suite for the year ended December 31, 1995.

Other expenses

    Depreciation and amortization increased $2,878,200 or 22.7% for the year
primarily due to the increased depreciation and amortization expense recognized
on the Acquired Properties.

    Painting service expenses increased $426,200 or 42.6% for the year. These
increases were primarily the result of payroll related expenses attributable to
the increased sales activity of the painting company.

    General and administrative expenses increased $404,900 or 7.3% for the year.
This increase is primarily attributable to payroll and related expenses.


21
<PAGE>   5
    Interest expense increased $3,978,400 or 34.5% for the year primarily due to
the interest incurred with respect to the additional borrowings under the Line
of Credit that were used for the acquisition of properties.

Net income applicable to common shares

    Net income applicable to common shares is reduced by dividends on the
Perpetual Preferred Shares of $5,484,400.

Comparison of the year ended December 31, 1995 to the year ended December 31,
1994

    Overall, total revenue increased $21,675,800 or 39.2% and total expenses
before the extraordinary item and the net income of the joint ventures increased
$18,817,800 or 45.7% for the year. Net income applicable to common shares
increased $518,900 or 3.8% after the extraordinary item, the Company's interest
in the net income of the joint venture properties and dividends on the Company's
Perpetual Preferred Shares.

    In the following discussion of the comparison of the year ended December
31,1995 to the year ended December 31, 1994, the term Core Portfolio Properties
refers to the 36 wholly owned multifamily properties acquired by the Company at
the time of the IPO. Acquired Properties refers to the 36 properties acquired
between January 1, 1994 and December 31, 1995 and the acquisition of the
remaining 50% interest in two properties in which the Company was a joint
venture partner at the time of the IPO.

    During the year ended December 31, 1995, the Acquired Properties generated
total revenues of $30,727,800 while incurring property, operating and
maintenance expenses of $10,883,300. The net income applicable to common shares
of the Acquired Properties was $2,427,400 for the same period.

Rental revenues

    Rental revenues increased $21,185,800 or 43.4% for the year. Rental revenues
from the Acquired Properties increased $19,520,200 for the same period.
Increases in occupancy and suite rents at the Core Portfolio Market-rate and
Government-Assisted Properties resulted in a $1,516,900 or 4.0% increase in
rental revenue from these properties. The balance of the increase resulted from
increased rental revenues attributable to office space and other miscellaneous
rental revenue items.
 
Other revenues

    Property management fees and property management fees - affiliates increased
$281,800 or 7.2% for the year. This increase was due in part to the increase in
management fees attributable to increased rental revenues in the northeast Ohio
market where all of the managed properties are located and the recognition of
supplemental management fee revenue pursuant to the terms of the management
contract between the Company and a managed property. These increases were offset
by a decline in management fee revenue as a result of the sale of one of the
managed properties to a non-affiliated third party who then terminated the
management contract with the Company.

    Painting service revenue and painting service revenue - affiliates decreased
$203,700 or 16.0% for the year and reflects the decline in revenue generated
from suite painting and major renovation projects when compared to the previous
year. The decrease in painting service and painting service revenue - affiliates
was partially offset by a decline in painting service expenses as discussed
elsewhere herein.

    Other income increased $411,800 or 34.2% for the year. The increase is due
primarily to an increase in real estate tax refunds during 1995 and supervisory
fees received for services provided while overseeing the improvement of tenant
space at the commercial properties managed by the Company. The increase in real
estate tax refunds and supervisory fees was partially offset by a decrease in
interest income in 1995 due primarily to a reduction in the Company's
investments as substantially all available cash is used for the acquisition of
multifamily properties or is applied to the outstanding balance of the Line of
Credit. 


22
<PAGE>   6
Property operating and maintenance expenses 


    Property operating and maintenance expenses increased $8,193,400 or 38.9%
for the year. Operating and maintenance expenses at the Acquired Properties
increased $7,034,800 for the year due primarily to the operating and maintenance
expenses incurred at the 15 properties acquired during 1995 and the recognition
of a full year's operating expenses at the 21 properties acquired during 1994.
Property operating and maintenance expenses at the Core Portfolio Properties
increased $1,158,600 when compared to the prior 12 month period primarily due to
increases in utilities, real estate taxes and building and grounds repair and
maintenance expenses for suite improvements such as the replacement of
appliances and carpeting. Total expenditures for building renovations and suite
and common area refurbishment in the Core Portfolio Properties that were not
considered to be capital in nature averaged $384 per suite for the year ended
December 31, 1995 as compared to $286 per suite for the year ended December 31,
1994.

Other expenses

    Depreciation and amortization increased $4,535,000 or 55.8% for the year
primarily due to the increased depreciation and amortization expense recognized
on the Acquired Properties of $3,882,700 and an increase in the amortization of
financing fees of $382,200, primarily associated with the fees incurred with
respect to the Revolving Credit Facility and the Senior Notes as discussed
elsewhere herein.

    Painting service expenses decreased $255,300 or 20.3% for the year. These
decreases were primarily the result of a reduction in payroll related expenses
attributable to a decline in the sales activity of the painting company.

    General and administrative expenses increased $1,323,600 or 31.6% for the
year. This increase is primarily attributable to (i) payroll and related
expenses and (ii) occupancy costs for the Company's relocated headquarters
facility. 

    Interest expense increased $5,021,100 or 77.3% for the year primarily due to
the interest incurred with respect to the additional borrowings under the
Revolving Credit Facility that were used for the acquisition of properties
subsequent to the Second Offering combined with higher average interest rates.
The weighted average interest rate on credit facility borrowings was 8.18% for
the year ended December 31, 1995 compared to 7.03% for the year ended December
31, 1994. In addition, the Company incurred interest on the $75 million Senior
Notes at an effective rate of 8.48% during 1995. Interest rates declined towards
the end of 1995 and the Company was able to issue $10 million of Senior Notes at
7.10% and, subsequent to December 31, 1995, issued $7.5 million of Medium-Term
Notes at a weighted average interest rate of 6.75%.

Equity in net income of joint ventures

    The combined equity in net income of joint ventures increased $7,800 or
2.6%, and $163,900 or 122.8% for the years ended December 31, 1996 and 1995,
respectively. These increases are primarily attributable to increased rents and
occupancies.

    The following table presents the historical statements of operations of the
Company's beneficial interest in the operations of the joint ventures for the
years ended December 31, 1996, 1995 and 1994 and the pro forma statement of
operations for the year ended December 31, 1994. The pro forma statement of
operations is presented as if the June 30, 1994 acquisition of the remaining 50%
interest in two joint ventures occurred on January 1, 1994.

<TABLE>
<CAPTION>
                                                                              For the year ended December 31,
                                                          Historical         Historical          Pro forma           Historical
                                                             1996               1995               1994                  1994
                                                          ---------------------------------------------------------------------
<S>                                                    <C>                 <C>                  <C>                 <C>
Beneficial interests in
joint venture operations
  Rental revenue                                       $  6,570,679         $ 6,562,882         $ 6,270,045         $ 6,391,578

  Cost of operations                                      3,968,802           3,955,746           3,831,515           3,905,193
                                                       ------------         -----------         -----------         -----------
                                                                                                                      
                                                          2,601,877           2,607,136           2,438,530           2,486,385
  Interest income                                            19,266              22,625              25,302              26,012
  Interest expense                                       (1,782,706)         (1,801,623)         (1,817,597)         (1,850,210)
  Depreciation                                             (483,619)           (481,103)           (477,580)           (479,049)
  Amortization                                              (49,629)            (49,629)            (49,629)            (49,629)
                                                       ------------         -----------         -----------         -----------
  Net income                                           $    305,189         $   297,406         $   119,026         $   133,509
                                                       ============         ===========         ===========         ===========
</TABLE>




                                                                              23
<PAGE>   7
Extraordinary item

    The extraordinary item of $1,097,500 recognized during 1995 primarily
relates to the write off of $911,000 of deferred financing costs in connection
with the extinguishment of the Revolving Credit Facility. The balance of the
extraordinary item recognized during the year relates to the write off of
deferred financing costs in connection with the repayment of certain mortgage
indebtedness.

Net income applicable to common shares

    Net income applicable to common shares is reduced by dividends on the
Perpetual Preferred Shares of $2,132,700.

Outlook

    The following two paragraphs contain forward-looking statements and are
subject to certain risks, trends and uncertainties that could cause actual
results to vary from those projected. Readers are cautioned not to place undue
reliance on forward-looking statements, which are based only on current
judgments and current knowledge. These forward-looking statements are intended
to be covered by the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Investors are cautioned that the Company's forward-looking
statements involve risks and uncertainty, including without limitation risks of
a lessening of demand for the apartments owned by the Company, changes in
government regulations affecting the Government-Assisted Properties, and
expenditures that cannot be anticipated such as utility rate and usage
increases, unanticipated repairs, additional staffing, insurance increases and
real estate tax valuation reassessments.

    Approximately 57% of the Company's multifamily properties are located in
the greater Cleveland/Akron, Ohio area which is the fourteenth largest consumer
market in the United States containing over four million people within a 50 mile
radius of Akron. In central Ohio, Columbus is the only city in the northeast
quadrant of the country that has experienced continuous population growth since
1970, according to Census Bureau data. Columbus, Ohio was selected by the E & Y
Kenneth Leventhal Real Estate Group as one of the 12 best apartment investment
markets in the country because of its well-diversified economic base, strong
rental growth and lower vacancy rates. The Company's Michigan portfolio is
located in eight separate markets having a combined projected population growth
of approximately 4.2%, or 153,000 people, with a projected 8.5% increase in job
growth or an additional 17,000 jobs.

    With an average economic occupancy for the Core Portfolio Market-rate
Properties over 95.2%, and strong market fundamentals, it would appear that
opportunities exist for continued rental growth at the Company's Market-rate
Properties. The Company expects that building and grounds repair and maintenance
expenditures for the Core Portfolio Properties will increase when compared to
the prior year as the Company continues to maintain its properties to maximize
their earnings potential. Real estate tax increases should begin to moderate as
the effect of the reassessed values diminishes over time. Utility expenditures
will vary over prior periods as the effect of weather related usage variances is
factored into the level of utility expense.

Inflation

    Substantially all of the Market-rate residential leases at the properties
allow, at the time of renewal, for adjustments in the rent payable thereunder,
and thus may enable the Company to seek increases in rents. The substantial
majority of these leases are for one year or less and the remaining leases are
for terms up to two years. The short-term nature of these leases generally
serves to reduce the risk to the Company of the adverse effect of inflation.

Contingencies

    There are no recorded amounts resulting from environmental liabilities as
there are no known contingencies with respect thereto. Future claims for
environmental liabilities are not measurable given the uncertainties surrounding
whether there exists a basis for any such claims to be asserted and, if so,
whether any claims will, in fact, be asserted. Furthermore, no condition is
known to exist that would give rise to a liability for site restoration, post
closure and monitoring commitments, or other costs that may be incurred with
respect to the sale or disposal of a property. Phase I environmental audits have
been completed on all of the Company's wholly owned and joint venture
properties. The Company has obtained environmental insurance covering (i)
pre-existing contamination, (ii) on-going third party contamination, (iii) third
party bodily injury and (iv) remediation. The policy is for a five year term and
carries a limit of liability of $2 million per environmental contamination
discovery (with a $50,000 deductible) and has a $10 million policy term
aggregate. Management has no plans to abandon any of the properties and is
unaware of any other material loss contingencies. 


24
<PAGE>   8
                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Shareholders of
Associated Estates Realty Corporation

    In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of Associated
Estates Realty Corporation and its subsidiaries at December 31, 1996 and 1995,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.


PRICE WATERHOUSE LLP


/s/ Price Waterhouse LLP
------------------------
Cleveland, Ohio
February 19, 1997


                                                                              25
<PAGE>   9
                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                    December 31,

                                                                             1996                  1995
-----------------------------------------------------------------------------------------------------------
<S>                                                                     <C>                  <C>
ASSETS
Real estate assets
   Land                                                                 $  44,241,900         $  37,782,564
   Buildings and improvements                                             430,920,893           371,213,067
   Furniture and fixtures                                                  20,286,700            16,714,676
-----------------------------------------------------------------------------------------------------------
                                                                          495,449,493           425,710,307
     Less:  accumulated depreciation                                     (112,102,829)          (97,301,859)
-----------------------------------------------------------------------------------------------------------
                                                                          383,346,664           328,408,448
   Construction in progress                                                18,516,982             8,254,251
-----------------------------------------------------------------------------------------------------------
     Real estate, net                                                     401,863,646           336,662,699
Cash and cash equivalents                                                   1,286,959             2,848,285
Restricted cash and investments                                             5,625,003             5,078,884
Accounts and notes receivable
   Rents                                                                    1,569,907             1,401,655
   Affiliates                                                               1,784,297               731,580
Deferred charges and prepaid expenses                                       5,616,394             4,986,914
-----------------------------------------------------------------------------------------------------------
                                                                        $ 417,746,206         $ 351,710,017
===========================================================================================================

LIABILITIES AND SHAREHOLDERS' EQUITY
Secured debt                                                            $  69,024,253         $  68,909,238
Unsecured debt                                                            148,788,707           102,325,107
-----------------------------------------------------------------------------------------------------------
     Total indebtedness                                                   217,812,960           171,234,345
Accounts payable and accrued expenses                                      14,361,609            12,068,684
Dividends payable                                                           6,895,071             5,963,834
Resident security deposits                                                  4,154,418             3,668,159
Funds held for non-owned properties                                         1,571,219             5,399,836
Accrued interest                                                            2,521,644             1,997,181
Accumulated losses and distributions of joint ventures
   in excess of investment and advances                                    12,413,087            12,208,299
-----------------------------------------------------------------------------------------------------------
     Total liabilities                                                    259,730,008           212,540,338
Commitments and contingencies                                                      --                    --
Shareholders ' equity
   Preferred shares, Class A cumulative, without par value;
     3,000,000 authorized; 225,000 issued and outstanding                  56,250,000
                                                                                                 56,250,000
   Common shares, without par value, $.10 stated value;
     50,000,000 authorized; 15,322,381 and 13,872,381 issued
     and outstanding at December 31, 1996 and 1995, respectively            1,532,238
                                                                                                  1,387,238
   Paid-in capital                                                        133,073,035           102,567,007
   Accumulated dividends in excess of net income                          (32,839,075)          (21,034,566)
-----------------------------------------------------------------------------------------------------------
     Total shareholders' equity                                           158,016,198           139,169,679
-----------------------------------------------------------------------------------------------------------
                                                                        $ 417,746,206         $ 351,710,017
===========================================================================================================
</TABLE>


The accompanying notes are an integral part of these financial statements.

26
<PAGE>   10
                        CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
                                                                      For the year ended December 31,

                                                            1996                1995                 1994
------------------------------------------------------------------------------------------------------------
<S>                                                     <C>                <C>                  <C>
Revenues
   Rental                                               $87,975,036        $ 70,045,335         $ 48,859,511
   Property management fees                                 393,051             416,868              493,861
   Property management fees - affiliates                  3,386,625           3,795,646            3,436,837
   Painting services                                        370,757             246,086              549,741
   Painting services - affiliates                         1,263,085             820,493              720,516
   Other                                                  1,044,514           1,616,846            1,205,005
------------------------------------------------------------------------------------------------------------
                                                         94,433,068          76,941,274           55,265,471

Expenses
   Property operating and maintenance                    37,056,123          29,277,260           21,083,844
   Depreciation and amortization                         15,535,587          12,657,372            8,122,349
   Painting services                                      1,427,243           1,001,029            1,256,359
   General and administrative                             5,921,440           5,516,493            4,192,868
   Interest expense                                      15,493,876          11,515,476            6,494,388
------------------------------------------------------------------------------------------------------------
                                                         75,434,269          59,967,630           41,149,808
------------------------------------------------------------------------------------------------------------

Income before equity in net income of joint
   ventures and extraordinary item                       18,998,799          16,973,644           14,115,663
Equity in net income of joint ventures                      305,189             297,406              133,509
------------------------------------------------------------------------------------------------------------
INCOME BEFORE EXTRAORDINARY ITEM                         19,303,988          17,271,050           14,249,172
Extraordinary item - extinguishment of debt
   (prepayment fees and write off of deferred
   finance costs)                                                --          (1,097,531)            (727,267)
------------------------------------------------------------------------------------------------------------
NET INCOME                                              $19,303,988        $ 16,173,519         $ 13,521,905
============================================================================================================

NET INCOME APPLICABLE TO COMMON SHARES                  $13,819,566        $ 14,040,789         $ 13,521,905
============================================================================================================
Income Per Common Share:
   Income before extraordinary item                     $       .99        $       1.09         $       1.19
============================================================================================================
   Net income                                           $       .99        $       1.01         $       1.13
============================================================================================================

WEIGHTED AVERAGE NUMBER OF COMMON SHARES
   OUTSTANDING                                           13,931,807          13,869,595           11,942,371
============================================================================================================
</TABLE>


The accompanying notes are an integral part of these financial statements.


                                                                              27
<PAGE>   11
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY


<TABLE>
<CAPTION>
                                                                      Class A          Common                         Accumulated
                                                                   Cumulative          Shares                        Dividends in
                                                                    Preferred        (at $.10         Paid - In         Excess of
                                                       Total           Shares   stated value)           Capital        Net Income
---------------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>               <C>              <C>             <C>               <C>
Balance, December 31, 1993                      $ 45,078,671      $         -      $1,086,188      $ 46,882,643      $ (2,890,160)
     Net income                                   13,521,905                -               -                 -        13,521,905
     Issuance of 3,000,000 common shares,
       net of underwriters' discounts and
       offering expenses of $3,843,105            58,031,895                -         300,000        57,731,895                 -
     Additional offering costs of IPO                (54,278)               -               -           (54,278)                -
     Issuance of 7,506 common shares in
       exchange for interests in properties          170,762                -             750           170,012                 -
     Common share dividends declared             (21,851,764)               -               -                 -       (21,851,764)
---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1994                        94,897,191                -       1,386,938       104,730,272       (11,220,019)
     Net income                                   16,173,519                -               -                 -        16,173,519
     Issuance of 3,000 restricted common
       shares                                              -                -             300              (300)                -
     Issuance of 225,000 preferred shares,
       net of underwriters' discounts and
       offering expenses                          54,087,035       56,250,000               -        (2,162,965)               -
     Common share dividends declared             (23,855,336)               -               -                 -       (23,855,336)
     Preferred share dividends declared           (2,132,730)               -               -                 -        (2,132,730)
---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995                       139,169,679       56,250,000       1,387,238       102,567,007       (21,034,566)
     Net income                                   19,303,988                -               -                 -        19,303,988
     Unrealized holding losses on
       investment securities                         (18,500)               -               -           (18,500)                -
     Issuance of 1,450,000 common shares,
       net of underwriters' discounts and
       offering expenses of $1,774,222            30,669,528                -         145,000        30,524,528                 -
     Common share dividends declared             (25,624,075)               -               -                 -       (25,624,075)
     Preferred share dividends declared           (5,484,422)               -               -                 -        (5,484,422)
---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996                      $158,016,198      $56,250,000      $1,532,238      $133,073,035      $(32,839,075)
=================================================================================================================================
</TABLE>

The accompanying notes are an integral part of these financial statements.

28
<PAGE>   12
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                For the year ended December 31,
                                                                            1996               1995              1994
------------------------------------------------------------------------------------------------------------------------
<S>                                                                    <C>               <C>               <C>          
Cash flow from operating activities:
     Net income                                                        $  19,303,988     $  16,173,519     $  13,521,905
     Adjustments to reconcile net income to net cash
       provided by operating activities:
         Depreciation and amortization                                    15,535,587        12,657,372         8,122,349
         Write off of deferred finance costs                                      --         1,096,506           174,791
         Equity in net income of joint ventures                             (305,189)         (297,406)         (133,509)
         Earnings distributed from joint ventures                            423,959           244,625           212,630
         Net change in - Accounts and notes receivable                      (168,252)         (300,914)          943,997
                       - Accounts and notes receivable - affiliates       (1,052,717)          538,260           153,997
                       - Accounts payable and accrued expenses             1,584,630         2,128,390         1,430,703
                       - Other operating assets and liabilities              131,711         1,182,829          (977,123)
                       - Restricted cash                                    (564,619)         (337,538)        2,929,100
                       - Funds held for non-owned properties              (3,828,617)       (4,204,178)        8,101,683
------------------------------------------------------------------------------------------------------------------------
             Total adjustments                                            11,756,493        12,707,946        20,958,618
------------------------------------------------------------------------------------------------------------------------
         Net cash flow provided by operations                             31,060,481        28,881,465        34,480,523
Cash flow from investing activities:
     Acquisition of real estate (net of liabilities assumed)             (74,176,202)      (93,106,549)     (108,611,232)
     Fixed asset additions                                                (1,680,625)       (1,238,134)       (5,039,770)
     Distributions from joint ventures                                        86,018           193,687            84,348
         Net cash flow used for investing activities                     (75,770,809)      (94,150,996)     (113,566,654)
Cash flow from financing activities:
     Principal payments on mortgage notes payable                         (2,921,236)      (22,495,032)      (29,716,349)
     Proceeds from senior and medium-term notes                           42,500,000        84,682,000                --
     Line of credit borrowings                                           170,950,000       110,444,000       102,920,000
     Line of credit repayments                                          (167,050,000)     (132,344,000)      (63,420,000)
     Deferred financing and offering costs                                  (822,030)       (2,571,544)       (1,044,592)
     Common share dividends paid                                         (24,692,838)      (23,439,254)      (16,304,012)
     Preferred share dividends paid                                       (5,484,422)       (2,132,730)               --
     Proceeds from the issuance of common shares, net of
       $1,609,500 and $1,358,757 of underwriting
       commissions and $164,722 and $2,480,961 of
       offering expenses paid in 1996 and 1994, respectively              30,669,528                --        57,215,520
     Proceeds from the issuance of preferred shares, net of
       $1,771,875 of underwriting commissions and $374,333
       of offering expenses paid                                                  --        54,103,792                --
         Net cash flow provided by financing activities                   43,149,002        66,247,232        49,650,567
Increase (decrease) in cash and cash equivalents                          (1,561,326)          977,701       (29,435,564)
Cash and cash equivalents, beginning of period                             2,848,285         1,870,584        31,306,148
Cash and cash equivalents, end of period                               $   1,286,959     $   2,848,285     $   1,870,584
========================================================================================================================
</TABLE>

The accompanying notes are an integral part of these financial statements.

                                                                              29
<PAGE>   13
                          NOTES TO FINANCIAL STATEMENTS


1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Business

   Associated Estates Realty Corporation (the "Company") is a self-administered
and self-managed real estate investment trust ("REIT") which specializes in the
acquisition, development, ownership and management of multifamily properties in
the Great Lakes region. At December 31, 1996, the Company owned or was a joint
venture partner in 84 multifamily properties containing 15,838 suites.
Additionally, the Company managed 40 non-owned properties, 32 of which were
multifamily properties consisting of 7,052 suites and eight of which were
commercial properties containing an aggregate of approximately 825,000 square
feet of gross leasable area. Through special purpose entities, collectively
referred to as the "Service Companies", the Company provides to both owned and
non-owned properties, management, painting and computer services as well as
mortgage origination and servicing.

Principles of Consolidation

   The accompanying consolidated financial statements include the accounts of
the Company, its wholly owned subsidiaries, which own certain of the real estate
properties, and the Service Companies. The Company holds a preferred share
interest in the Service Companies which entitles it to receive 95% of the
economic benefits from operations and which is convertible into a majority
interest in the voting common shares. The outstanding voting common shares of
these Service Companies are held by an executive officer of the Company. The
Service Companies are consolidated because, from a financial reporting
perspective, the Company is entitled to virtually all economic benefits and has
operating control.

   One property included in the financial statements is 33 1/3% owned by third
party investors. As this property has an accumulated deficit, no recognition of
the third party interest is reflected in the financial statements since it is
the Company's policy to recognize minority interest only to the extent that the
third party's investment and accumulated share of income exceeds distributions
and its share of accumulated losses. Investments in joint ventures, which are
50% or less owned by the Company, are presented using the equity method of
accounting. Since the Company intends to fulfill its obligations as a partner in
the joint ventures, the Company has recognized its share of losses and
distributions in excess of its investment (Note 7).

   All significant intercompany balances and transactions have been eliminated
in consolidation.

Use of Estimates

   The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from these estimates.

Cash Equivalents

   The Company considers highly liquid investments with an original maturity of
three months or less when purchased to be cash equivalents.

Real Estate and Depreciation

   Real estate assets are stated at cost less accumulated depreciation. Included
in land are parcels of undeveloped real estate held for future development.
Depreciation is provided on a straight-line basis over the estimated useful
lives of the assets as follows:

<TABLE>
<CAPTION>
<S>                                   <C>
Buildings and improvements            10 - 30 years
Furniture, fixtures and equipment      3 - 10 years
</TABLE>

   Management reviews the carrying value of real estate assets using estimated
future cash flows, including estimated proceeds from disposition,

30
<PAGE>   14
whenever an event or change in circumstances might indicate that the asset value
may not be recoverable.

   Expenditures for maintenance and repairs are charged to operations as
incurred. Betterments that improve or extend the life of the asset beyond its
original condition are capitalized. Costs incurred in connection with resident
turnover such as suite cleaning, painting, carpet cleaning or replacement,
appliance repair or replacement and other associated costs are charged to
operations.

Deferred Leasing and Financing Costs

   Costs incurred in obtaining long-term financing are deferred and amortized
over the life of the associated instrument on a straight-line basis, which
approximates the effective interest method. Costs incurred with respect to shelf
registrations are capitalized and allocated on a pro rata basis to subsequent
offerings thereunder. External costs incurred in the leasing of commercial and
retail space are amortized on a straight-line basis over the terms of the
related lease agreements.

Revenue Recognition

   The Company's residential property leases are for terms of generally one year
or less. Rental income is recognized on the straight-line basis. Retroactive
revenue increases related to budget based Government-Assisted Properties are
recognized based on the applications submitted to the U.S. Department of Housing
and Urban Development ("HUD"). Provision is made for estimated amounts of
revenue increases that may not be granted.

   Revenues earned by the Service Companies are recognized on the accrual basis.

Income Taxes

   The Company has elected to be taxed as a REIT under the Internal Revenue Code
of 1986 (the "Code"), as amended. As a REIT, the Company is entitled to a tax
deduction for dividends paid to its shareholders, thereby effectively subjecting
the distributed net income of the Company to taxation at the shareholder level
only, provided it distributes at least 95% of its taxable income and meets
certain other qualifications.

   At December 31, 1996 and 1995, the Company's net tax basis of properties
exceeds the amount set forth in the Company's Consolidated Balance Sheets by $78
million and $74.5 million, respectively.

Net Income Per Share

   Primary earnings per common share for income before extraordinary item and
net income have been computed by dividing common share dividends declared for
the period by the weighted average number of common shares outstanding plus the
undistributed income before extraordinary item applicable to common shareholders
as appropriate, divided by the weighted average number of common shares
outstanding. Common share equivalents were excluded from the earnings per share
calculation as they were not dilutive.

Reclassifications

   Certain reclassifications have been made to the 1995 and 1994 financial
statements to conform to the 1996 presentation.

2. DEVELOPMENT AND ACQUISITION OF MULTIFAMILY PROPERTIES

   Construction in progress including the cost of land for the development of
multifamily properties was $18,516,982 and $8,254,251 at December 31, 1996 and
1995, respectively. The Company capitalizes interest costs on funds used in
construction, real estate taxes and insurance from the commencement of
development activity through the time the property is ready for leasing.
Interest, real estate taxes and insurance of approximately $1,394,800, $440,000
and $27,500 were capitalized during the years ended December 31, 1996, 1995 and
1994, respectively. The following schedule details construction in progress at
December 31, 1996:

                                                                              31
<PAGE>   15
<TABLE>
<CAPTION>
(dollars in thousands)                                                              Construction
                                                                                           Costs
                                               Number                                   Incurred              Estimated
Property                                    of Suites            Land Cost               to Date             Completion
--------                                    ---------            ---------               -------             ----------
<S>                                           <C>               <C>                    <C>                  <C> 
AURORA, OH
   The Residence at Barrington - Phase I      168               $  1,375               $  4,229               Fall 1997
   The Residence at Barrington - Phase II     120                    982                      -             Winter 1998
                                              288                  2,357                  4,229
ANN ARBOR, MI
   Arbor Landings Apts. II                    160*                   650                    151             Summer 1998
COLUMBUS, OH
   Bradford at Easton                         324                  1,607                  6,564               Fall 1997
FENTON, MI
   Georgetown Park Apts.                      120*                   350                      7                    1998*
GRAND RAPIDS, MI
   Aspen Lakes                                114*                   400                     11                    1998*
STREETSBORO, OH
   The Village of Western Reserve             108                    691                    449               Fall 1997
WESTLAKE, OH
   Westlake                                   300*                   523                     23                    1999*
MT. STERLING, OH
   Muirwood Mt. Sterling                       89*                   100                     13                    1999*
Other                                           -                      -                    391
                                            ---------------------------------------------------
                                            1,503               $  6,678               $ 11,838
                                            ===================================================
</TABLE>
*Estimated

   During the period January 1, 1996 through December 31, 1996, the Company
acquired, in separate purchase transactions, six multifamily properties
containing an aggregate of 1,289 suites and three parcels of land consisting of
43 acres for an aggregate purchase price of $59.1 million, which were financed
with (i) borrowings under the Company's Line of Credit of $46.1 million, (ii)
net proceeds of $9.9 million from the issuance of a Medium-Term Note, and (iii)
the assumption of mortgage indebtedness with a stated value of $3.1 million.
During 1996, the construction and leasing of 116 suites were completed at a
total cost of $6.5 million.

   During the period January 1, 1995 through December 31, 1995, the Company
acquired, in separate purchase transactions, 15 multifamily properties
consisting of 2,276 suites and three parcels of land consisting of 89.7 acres
for an aggregate cost of $106 million. These acquisitions were financed with (i)
$2.5 million of available cash, (ii) $42.2 million of proceeds from the
Perpetual Preferred Share offering (Note 13), (iii) borrowings under the
Revolving Credit Facility and Line of Credit of $37.4 million, and (iv) the
assumption of mortgage indebtedness with a stated value of $23.9 million. The
mortgage indebtedness was adjusted to market value at the date of acquisition,
using interest rates reflecting the Company's incremental borrowing rate. During
1995, the construction and leasing of 132 additional suites adjacent to three of
the Company's properties were completed at a total cost of $6 million.

   During the period January 1, 1994 through December 31, 1994, the Company
acquired, in separate purchase transactions, 21 multifamily properties
consisting of 3,349 suites for an aggregate cost of $139.9 million. These
acquisitions were financed with (i) $42.5 million of available cash, (ii) the
remaining proceeds from the IPO and the Second Offering (Note 13), (iii)
borrowings under the Company's Revolving Credit Facility of $63.7 million, (iv)
the assumption of mortgage indebtedness in the principal amount of $20.5
million, and (v) the issuance of a short-term note of $13.2 million. In July
1994, the construction and leasing of 40 additional suites adjacent to one of
the acquired properties was completed at a total cost of $1.4 million.

32
<PAGE>   16
3. RESTRICTED CASH AND INVESTMENTS

   Restricted cash and investments, some of which are required by HUD for
certain government-subsidized properties, include residents' security deposits,
reserve funds for replacements and other escrows held for the future payment of
real estate taxes and insurance. The reserve funds for replacements are intended
to provide cash to defray future costs that may be incurred to maintain the
associated property. In addition, certain escrows are maintained in connection
with mortgage servicing operations.

   Restricted cash and investments are comprised of the following:

<TABLE>
<CAPTION>
                                    1996            1995
                                    ----            ----
<S>                              <C>             <C>       
Resident security deposits       $  793,160      $  729,939
Escrow and other reserve
  funds required by mortgagee     4,831,843       4,348,945
                                 --------------------------
                                 $5,625,003      $5,078,884
                                 ==========================
</TABLE>

   Debt securities owned with a purchased maturity of less than 18 months are
classified as "held to maturity" and securities with a purchased maturity
greater than 18 months are classified as "available for sale". Investments are
comprised of U.S. treasury bills with maturities of less than 18 months and
collateralized mortgage obligations issued by the Federal Home Loan Mortgage
Company ("FHLMC") maturing in 2023. At December 31, 1996 and 1995, treasury
bills with a cost of $1,976,620 and $998,582 had fair values of $2,008,253 and
$1,013,927, respectively, and are stated at cost in the Consolidated Balance
Sheet. Investments in obligations issued by the FHLMC were stated at their fair
value of $423,000 and $398,000 at December 31, 1996 and 1995, respectively.
Included in additional paid-in capital is $18,500 at December 31, 1996 of
unrealized losses related to available for sale securities. During the fourth
quarter of 1995, the Company reclassified its investment in the FHLMC to
available for sale.

4.  DEFERRED CHARGES AND PREPAID EXPENSES

   Deferred charges and prepaid expenses consist of the following:
<TABLE>
<CAPTION>
                                        1996            1995
                                        ----            ----
<S>                                   <C>            <C>       
Deferred financing and
  leasing costs                       $3,407,556     $3,360,115
Less:  accumulated amortization         (620,093)      (774,193)
                                      -------------------------
                                       2,787,463      2,585,922
Prepaid expenses                       1,393,936      1,065,615
Other assets                           1,434,995      1,335,377
                                      -------------------------
                                      $5,616,394     $4,986,914
                                      =========================
</TABLE>

   Amortization expense was $608,594, $765,404 and $382,187 for the years ended
December 31, 1996, 1995 and 1994, respectively. In 1995, deferred financing
costs were written off upon the early termination of the Revolving Credit
Facility and the repayment of mortgage debt. Deferred financing fees written off
of $1,096,506 and $174,791 for the years ended December 31, 1995 and 1994,
respectively, are reflected as an extraordinary item in the statement of
operations. Further, debt prepayment fees of $1,025 and $552,476 were included
as extraordinary items in 1995 and 1994, respectively.

5.  SECURED DEBT

   Secured debt consists of the following:
<TABLE>
<CAPTION>
                                          1996               1995
                                          ----               ----
<S>                                   <C>               <C>        
Conventional mortgage debt,
  maturing at various dates
  to 2018                             $37,737,709       $40,195,438
Federally insured mortgage
  debt, maturing at various
  dates to 2028                        31,286,544        28,713,800
                                      -----------------------------
                                      $69,024,253       $68,909,238
                                      =============================
</TABLE>

Conventional Mortgage Debt

   Conventional mortgages payable are comprised of six and seven loans
(nonrecourse, fixed rate, project specific loans) at December 31, 1996 and 1995,
respectively, each of which is collateralized by the associated real estate and
resident leases. Mortgages payable are generally due in monthly installments of
principal and/or interest and mature at various dates through August 1, 2018.

                                                                              33
<PAGE>   17
The average interest rate on conventional mortgages was 8.44% at 
December 31, 1996 and 1995.

Federally Insured Mortgage Debt

   Federally insured mortgage debt which encumbered eight and seven of the
properties at December 31, 1996 and 1995, respectively (including one property
which is funded through Industrial Development Bonds), is insured by HUD
pursuant to one of the mortgage insurance programs administered under the
National Housing Act of 1934. These government-insured loans are nonrecourse to
the Company. Payments of principal, interest and HUD mortgage insurance premiums
are made in equal monthly installments and mature at various dates through
August 1, 2028. Seven of the eight federally insured mortgages have a fixed rate
and the remaining mortgage ($1,938,157 at December 31, 1996) has a variable
rate. Interest rates on the HUD-insured indebtedness range from 7.0% to 10.25%
(averaging 8.22% at December 31, 1996).

   Under certain of the mortgage agreements, the Company is required to make
escrow deposits for taxes, insurance and replacement of project assets. The
variable rate mortgage is secured by a letter of credit which is renewed
annually.

   Real estate assets pledged as collateral for all mortgage debt had a net book
value of $65,757,695 and $63,806,533 at December 31, 1996 and 1995,
respectively.

6. UNSECURED DEBT

   Unsecured debt consists of the following:


<TABLE>
<CAPTION>
                                                1996          1995
                                                ----          ----
<S>                                        <C>             <C>         
Senior notes, due 2000 to 2002
  with interest payable quarterly          $ 84,788,707    $ 84,725,107
Medium-Term Notes, due 2001 to
  2026 with interest payable
  quarterly                                  42,500,000               -
Line of Credit, due 1997                     21,500,000      17,600,000
                                           ------------    -------------
                                           $148,788,707    $ 102,325,107
                                           ============    =============
</TABLE>


Senior Notes

   The Senior Notes were issued in 1995, and net proceeds of $83.6 million,
after underwriting commissions, offering expenses and discounts, were applied to
amounts drawn on the Line of Credit. Senior Notes with a principal balance of
$75 million accrue interest at 8.38% and mature in 2000. Senior Notes with a
principal balance of $10 million accrue interest at 7.10% and mature in 2002.

Medium-Term Notes Program

   During 1996, the Company issued six Medium- Term Notes (the "MTN's")
aggregating $42.5 million under its $75 million MTN program. The principal
amounts of these MTN's range from $2.5 million to $15 million and bear interest
from 6.60% to 7.93% over terms of between 5 to 30 years, with a weighted average
maturity of 6.9 years at December 31, 1996. The holder of a $2.5 million, 30
year MTN has the option to require payment on March 15, 2003. The net proceeds
were used to repay amounts outstanding under the Line of Credit and to acquire a
multifamily property.

Line of Credit

   In September 1995, the Company entered into a $75 million unsecured credit
facility (the "Line of Credit") and simultaneously extinguished a $125 million
secured revolving credit facility. The Line of Credit includes certain
restrictive covenants which, among others, requires the Company to (i) maintain
a minimum level of net worth, (ii) limit dividends to 90% of Distributable Cash
Flow, as defined in the agreement, (iii) restrict the use of its borrowings, and
(iv) maintain certain debt coverage ratios. The Line of Credit provides for a
scaled reduction in the LIBOR, prime rate and commitment fee margins based on
the Company's credit ratings. Based on the Company's present credit ratings and
pursuant to a March 1996 interest rate reduction amendment to the Line of
Credit, the LIBOR margin is 150 basis points, fixed in increments of 30, 60, 90,
120 or 180 days or,

34
<PAGE>   18
alternatively, borrowings are at prime rate. An annual commitment fee of 25 to
37.5 basis points on the average daily unused amount of the facility was paid
quarterly in arrears. The Line of Credit expires in September 1997 and the
Company has the option to extend the facility for an additional one year period.
The weighted average interest rate on borrowings outstanding under the Line of
Credit was 7.47% at December 31, 1996.

   As of December 31, 1996, the scheduled maturities of secured and unsecured
indebtedness for each of the next five years and thereafter, are as follows:

<TABLE>
<CAPTION>
<S>                     <C>         
1997                    $ 22,872,505
1998                       1,485,579
1999                       1,608,131
2000                      90,631,655
2001                      22,253,014
Thereafter                78,962,076
                        ------------
                        $217,812,960
                        ============
</TABLE>


7.  INVESTMENTS IN AND ADVANCES TO JOINT VENTURES

   As described in Note 1, the Company's interests in 50% or less owned joint
venture partnerships are included in the financial statements on the equity
basis of accounting.

   At December 31, 1996, the Company's interests in the joint venture
partnerships are as follows:

<TABLE>
<CAPTION>
                           Ownership
                           ---------
<S>                         <C>
   Americana                33 1/3%
   Euclid House             33 1/3%
   Gates Mills Towers       33 1/3%
   Watergate                33 1/3%
   College Towers               50%
   Highland House               50%
   Lakeshore Village            50%
</TABLE>

   Summarized financial information for these joint ventures is as follows:


<TABLE>
<CAPTION>
Balanced sheet data                               1996            1995
                                                  ----            ----
<S>                                        <C>             <C>        
Real estate, net                           $14,928,492     $16,037,491
Other assets                                 3,633,528       3,732,040
                                           $18,562,020     $19,769,531
                                           ===========================

Amounts payable to the Company             $   227,577     $   204,161
Mortgages payable                           51,769,320      52,330,572
Other liabilities                            3,312,635       3,467,035
Accumulated deficit                        (36,747,512)    (36,232,237)
                                           $18,562,020     $19,769,531
                                           ===========================
</TABLE>

<TABLE>
<CAPTION>
Operating data
                                                  1996            1995            1994
                                                  ----            ----            ----
<S>                                        <C>             <C>             <C>        
Rental revenues                            $18,254,406     $18,295,281     $17,731,141
Other revenues                                 127,729         135,488         105,461
Operating and maintenance expenses          11,093,688      10,993,346      10,836,427
Depreciation and amortization                1,493,727       1,486,041       1,477,035
Interest expense                             5,176,499       5,230,842       5,342,542
Net income                                 $   618,221     $   720,540     $   180,598
                                           ===========================================
Company's proportionate interest in:
   Depreciation and amortization           $   533,248     $   530,731     $   528,678
   Interest expense                          1,782,706       1,801,622       1,850,210
   Net income of joint ventures                305,189         297,406         133,509
</TABLE>


   The Company's proportionate share of net distributions was $509,977,
$438,312, and $296,978 for the years ended December 31, 1996, 1995 and 1994,
respectively. Revenues from property management fees-affiliates charged to joint
ventures aggregated $746,514, $745,924 and $737,580 for the years ended December
31, 1996, 1995 and 1994, respectively. The corresponding expenses are included
in the operating and maintenance expenses of the joint ventures, as set forth
above.

   Lakeshore Village is governed by regulations pursuant to the property's rent
subsidy and mortgage insurance programs under HUD, which contain provisions
governing certain aspects of the operations of the property (Note 10). Rent
subsidies of $802,517, $809,032 and $756,098 for the years ended December 31,
1996, 1995 and 1994, respectively, were received by the property.

8.  TRANSACTIONS  WITH AFFILIATES

   The Company provides certain services to (and is reimbursed for certain
expenses incurred on behalf of) certain multifamily properties in which the
Company maintains an equity interest, and certain other affiliated entities for
management, painting, loan servicing, and property and casualty insurance
services.

                                                                              35
<PAGE>   19
Summarized affiliate transaction activity follows:

<TABLE>
<CAPTION>
                                                          1996                1995               1994
                                                          ----                ----               ----
<S>                                                  <C>                 <C>                <C>
Property management fee revenues                     $ 3,386,625         $ 3,795,646        $ 3,436,837
Painting service revenues                              1,263,085             820,493            720,516
Loan origination and servicing revenue                    14,471              14,644             15,339
Expenses incurred on behalf of and reimbursed
  by affiliates(1)                                     7,794,430           7,144,565          7,011,734
Laundry revenue                                          516,868             333,426            316,954
Property and casualty insurance commissions              (34,320)            (30,775)           (25,772)
Corporate office rent(2)                                      --                  --            (58,084)
</TABLE>

 (1) Primarily payroll and employee benefits, reimbursed at cost.
 (2) Prior to June 1994, the Company leased approximately 25,000 square feet of
     office space for its corporate headquarters from an affiliated entity owned
     by certain officers and/or directors of the Company. 

9.  NOTEHOLDER INTEREST

   The Company has a noteholder interest in one multifamily property which,
since 1984, has been unable to generate sufficient cash flow, as defined, to
meet the scheduled interest payments under notes payable to the Company.
Accordingly, the Company is entitled to all cash flows from operations. To the
extent that the cumulative unpaid debt service on the notes is greater than
seven years of aggregate principal and interest amortization (the cumulative
amount of debt service), which occurred in 1995, the Company can exercise its
rights under a security agreement and foreclose on the property. Because, in
substance, the Company will eventually own title to the property, most likely
through foreclosure, the property is presented in the financial statements as if
owned by the Company. Summarized financial information for this property is as
follows:

<TABLE>
<CAPTION>
                                  1996              1995
                                  ----              ----
<S>                         <C>                <C>
Real estate, net              $ 1,484,399        $1,627,592
Other assets                    1,124,209         1,155,449
                              $ 2,608,608        $2,783,041
                              =============================

Mortgage notes payable        $ 4,453,316        $4,600,690
Other liabilities                 419,586           480,626
Accumulated deficit            (2,264,294)       (2,298,275)
                              $ 2,608,608        $2,783,041
                              =============================
</TABLE>



<TABLE>
<CAPTION>
                                               1996              1995        1994
                                               ----              ----        ----
<S>                                         <C>               <C>          <C>
Rental and other revenue                    $2,270,750        $2,250,140   $2,146,625
Property operating and
  maintenance expenses                       1,202,178         1,295,223    1,172,803
Depreciation and amortization                  143,949           143,893      143,893
Interest expense                               335,644           353,334      395,011
Net income                                    $588,979          $457,690   $  434,918
                                              =======================================
</TABLE>

                                              

10.  COMMITMENTS AND CONTINGENCIES

   The Company owns one property which derives part of its rental revenues from
commercial tenants with noncancellable operating leases. Future minimum lease
payments to be received, assuming no new or renegotiated leases, or option
extensions, for each of the next five years and thereafter, are as follows:

<TABLE>
<S>                 <C>
      1997          $  972,228
      1998             966,627
      1999             909,751
      2000             597,000
      2001             278,773
      Thereafter       419,328
                    ----------
                    $4,143,707
                    ==========
</TABLE>


   The Company leases certain equipment under capital leases. Such equipment is
included in property, plant and equipment with a cost of $698,427 and
accumulated depreciation of $247,327 at December 31, 1996. The Company also
leases certain equipment under operating leases. Future minimum lease payments
under all capital and noncancellable operating leases in which the Company is
the lessee, principally for ground leases, for each of the next five years and
thereafter, are as follows:

<TABLE>
<CAPTION>
                    Capital           Operating
                    -------           ---------
<S>               <C>               <C>
      1997        $  214,480        $  129,521
      1998           204,594           127,166
      1999            78,721           101,261
      2000             2,216           101,261
      2001                --           101,261
Thereafter                --         5,377,940
                  ----------------------------
                     500,011        $5,938,410
                                    ==========
Less interest         44,686
                  $  455,325
                  ==========
</TABLE>

36
<PAGE>   20
   Certain of the ground lease agreements contain provisions which, upon
expiration of the lease, require reversion of the land and building to the
lessor. Such provisions exist for nine properties included in the financial
statements and expire at various dates from 2021 to 2086. Rental revenues
derived from such properties were $9,376,871, $9,257,290 and $8,992,670 for the
years ended December 31, 1996, 1995 and 1994, respectively. Furthermore, at the
end of the term of the lease, any remaining replacement reserves revert to the
lessor. Management believes that the replacement reserves will be utilized for
their intended purpose prior to the end of the lease term. Such cash reserves
included in restricted cash were $1,481,538 and $1,390,249 at December 31, 1996
and 1995, respectively. With respect to such leases, the Company incurred ground
rent expense of $101,261, $101,261 and $89,080 for the years ended December 31,
1996, 1995 and 1994, respectively.

   The Company owns one property which is subject to a warranty deed reversion
provision. This provision requires that the assignment of fee simple title shall
expire in 2037. At December 31, 1996, the net book value of this property was
$1,733,470.

   Certain of the Company's properties are governed by regulations pursuant to
rent subsidies or mortgage insurance programs, which contain provisions
governing certain aspects of the operations of the properties. Among other
things, such provisions may include the maintenance of a reserve fund for
replacements, the renting of properties to qualifying residents, and the
requirement to make distributions in accordance with certain regulations.
Certain approvals may be required to encumber properties having rental
subsidies.

   The rent subsidy program provides that HUD will make monthly housing
assistance payments to the Company on behalf of persons who reside in approved
properties and who meet the eligibility criteria. The amount of the total
monthly rental and the subsidy is determined at least annually by HUD. This
arrangement is evidenced by a contract between HUD and the Company. Such
contracts have scheduled expiration dates between October 1997 and November
2018. HUD may abate subsidy payments if the Company defaults on any obligations
under such contract and fails to cure each default after receiving notice
thereof. Rent subsidies of $11,174,488, $10,666,547 and $10,197,314 for the
years ended December 31, 1996, 1995 and 1994, respectively, were received by the
15 wholly owned properties eligible for federal rent subsidies. As discussed in
Note 5, certain obligations are insured by federal mortgage insurance programs.
The Company believes that the contracts will be renewed or that the properties
will be operated as conventional, market-rate apartments upon expiration of the
contracts.

   At December 31, 1996, the Company had entered into construction contracts in
the amount of approximately $31.3 million for the development of multifamily
properties.

11.  DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

   The following disclosures of estimated fair value were determined by
management using available market information and appropriate valuation
methodologies. Considerable judgment is necessary to interpret market data and
develop estimated fair values. Accordingly, the estimates presented herein are
not necessarily indicative of the amounts the Company could realize on
disposition of the financial instruments. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts.

   Rents, accounts and notes receivable, accounts payable, accrued expenses and
other liabilities are carried at amounts which reasonably approximate
corresponding fair values.

   Mortgages and notes payable with an aggregate carrying value of $69,024,253
and $68,909,238 at December 31, 1996 and 1995, respectively, have an estimated
aggregate fair value of approximately $69,029,601 and $71,668,123, respectively.
The Line of Credit is carried at an amount which approximates fair market value.

                                                                              37
<PAGE>   21
     Estimated fair value is based on interest rates currently available to the
Company for issuance of debt with similar terms and remaining maturities.

     Senior and Medium-Term Notes with an aggregate carrying value of
$127,288,707 and $84,725,107 at December 31, 1996 and 1995, respectively, have
an estimated fair value of $130,446,465 and $90,002,644, respectively.

     Disclosure about the fair value of financial instruments is based on
pertinent information available to management as of December 31, 1996 and 1995.
Although management is not aware of any factors that would significantly affect
the fair value amounts, such amounts have not been comprehensively revalued for
purposes of these financial statements since that date and current estimates of
fair value may differ significantly from the amounts presented herein.

12.  SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

     Cash paid for interest for the years ended December 31, 1996, 1995 and 1994
was $16,294,050, $10,430,373 and $6,748,209, respectively, which is net of
capitalized interest.

     The following summarizes the non-cash investing and financing activities of
the Company which are not reflected in the Consolidated Statements of Cash
Flows:

<TABLE>
<CAPTION>
                                                                                   1996              1995              1994
                                                                                   ----              ----              ----
<S>                                                                             <C>              <C>               <C>        
  Assumption of mortgage debt in connection with the acquisition
  of properties (and additional joint venture interests in 1994)                $3,036,251       $25,791,140       $21,739,991
  Issuance of short-term note in connection with the
    acquisition of a property                                                           --                --        13,200,000
Assumption of liabilities in connection with the
    acquisition of properties                                                      923,691         1,081,530         2,266,146
Dividends declared but not paid                                                  6,895,071         5,963,834         5,547,752
Assumption of net liabilities and issuance of common shares
  to certain affiliates to acquire the additional joint venture interests               --                --           817,000
Capital lease obligations                                                          319,802            35,946           342,676
Offering expenses accrued                                                           96,785            58,089           223,766
</TABLE>


13.  PREFERRED AND COMMON SHARES

     On December 11, 1996, the Company completed an offering of 1,300,000 common
shares at $22.375 per share. On December 17, 1996, the underwriters exercised
150,000 shares of the over-allotment option at $22.375 per share. The net
proceeds of approximately $30.7 million were applied to reduce debt.

     On July 25, 1995, the Company completed an offering of 2,000,000 Depositary
Shares, each representing 1/10 of a share of the Company's 9.75% Class A
Cumulative Redeemable Preferred Shares (the "Perpetual Preferred Shares"). On
July 27, 1995, the underwriters exercised 250,000 shares of the over-allotment
option. Each Depositary Share has a $25 liquidation preference ($56.3 million in
the aggregate). Net proceeds to the Company after expenses relating to the
offering and underwriting discounts and commissions were approximately $54.1
million. Dividends on the Perpetual Preferred Shares are cumulative from the
date of issue and are payable quarterly. Except in certain circumstances
relating to the preservation of the Company's status as a REIT, the Perpetual
Preferred Shares are not redeemable prior to July 25, 2000. On and after July
25, 2000, the Perpetual Preferred Shares will be redeemable for cash at the
option of the Company.

     The Company is authorized to issue 3,000,000 Class B Cumulative Preferred
Shares, without par value, and 3,000,000 Noncumulative Preferred Shares, without
par value.

     On August 23, 1994, the Company completed an underwritten offering of
3,000,000 common shares at $20.63 per share. Substantially all of the net
proceeds of $58.4 million were applied to reduce debt.

14.  DIVIDENDS PER SHARE

     Total dividends declared per common share and the related components for
the years ended December 31, 1996 and 1995, as reported for income tax purposes,
were as follows:


38
<PAGE>   22
<TABLE>
<CAPTION>
                         For the year ended December 31, 1996
                         ------------------------------------
                              Ordinary     Non-Taxable
               Date Paid       Income    Return of Capital   Dividends
               -------------------------------------------------------

<S>             <C>            <C>       <C>                  <C>
1st quarter     5/1/96         $ .32          $ .13             $ .45
2nd quarter     8/1/96           .32            .13               .45
3rd quarter     11/1/96          .32            .13               .45
4th quarter     1/31/97          .32            .13               .45
               -------------------------------------------------------
                               $1.28          $ .52             $1.80
               =======================================================
</TABLE>

<TABLE>
<CAPTION>
                         For the year ended December 31, 1995
                         ------------------------------------
                              Ordinary     Non-Taxable
               Date Paid       Income    Return of Capital   Dividends
               -------------------------------------------------------

<S>             <C>            <C>       <C>                  <C>

1st quarter     5/1/95         $  .32        $  .11            $  .43
2nd quarter     8/1/95            .32           .11               .43
3rd quarter     11/1/95           .32           .11               .43
4th quarter     1/31/96           .32           .11               .43
               -------------------------------------------------------
                               $ 1.28        $  .44            $ 1.72
               =======================================================
</TABLE>

15. EMPLOYEE BENEFIT PLANS

         The Company sponsors a defined contribution retirement plan pursuant to
Section 401(k) of the Internal Revenue Code, whereby eligible employees may
elect to contribute between 1% and 10% of their gross wages. The Company matches
such contributions at a rate of 25% up to a maximum participant contribution of
4%. The Company made contributions to this plan, net of reimbursements from
managed but non-owned properties, of $46,555, $39,827 and $31,280 for the years
ended December 31, 1996, 1995 and 1994, respectively. Additionally, the Company
offers medical, dental and life insurance benefits to employees.

         Effective October 14, 1993, the Company established an incentive and
nonqualified stock option plan under which 543,093 of the Company's common
shares are reserved for awards of share options to eligible key employees.
Options may be granted at per share prices not less than fair market value at
the date of grant, and in the case of incentive options, must be exercisable
within ten years thereof. Option awards granted are vested in equal annual
increments over no fewer than three years, beginning on the first anniversary of
the date of grant, and accordingly, 346,599, 216,379 and 113,800 options were
exercisable at December 31, 1996, 1995 and 1994, respectively. Activity under
the Plan is summarized as follows (all options were granted at $22 per share
except 25,000 shares issued in 1996 were granted at $20.25 per share):

<TABLE>
<CAPTION>
                                                           Granted and
                                        Authorized         Outstanding          Available
                                        -------------------------------------------------

<S>                                     <C>                <C>                  <C>
Balance at December 31, 1993             543,093             364,850             178,243
   Granted                                  --                 5,000              (5,000)
   Forfeited                                --                (5,000)              5,000
                                        -------------------------------------------------
Balance at December 31, 1994             543,093             364,850             178,243
   Granted                                  --                 5,000              (5,000)
                                        -------------------------------------------------
Balance at December 31, 1995             543,093             369,850             173,243
   Granted                                  --                30,000             (30,000)
                                        -------------------------------------------------
Balance at December 31, 1996             543,093             399,850             143,243
                                        =================================================
</TABLE>

         In 1995, the Company's shareholders approved a long-term incentive
compensation plan (the "Long-Term Plan") and an equity-based incentive
compensation plan (the "Equity Plan"). Participants in the Long-Term Plan will
earn incentive compensation over a three year period (the "Plan Period") based
on specific levels of Funds From Operations, as defined, per share that are
established at the outset of the Plan Period. Initial awards under the Long-Term
Plan will be based on the Plan Period beginning January 1, 1995 and ending
December 31, 1997. Beginning with the calendar year 1998, a new three year Plan
Period will begin each year. Payment of the incentive compensation earned under
the Long-Term Plan may be made in cash, restricted shares of the Company's
common shares or a combination thereof as determined by the board of directors.
The first payment under the Long-Term Plan will be made in 1998, the second
payment in 2001, and then it is anticipated that payments will be made each year
thereafter until the Long-Term Plan terminates in 2005.

         The Equity Plan provides for the grant to participants of options to
purchase common shares, awards of common shares subject to restrictions on
transfer, awards of common shares issuable in the future upon satisfaction of
certain conditions, rights to purchase common shares and other awards based on
common shares. The option price with respect to the grant of options to purchase
common shares will be determined at the time of the grant but will not be less
than 100% of the fair market


                                                                              39
<PAGE>   23
value of the common shares at the date of the grant or 110% in the case of a
participant who, at the date of grant, owns shares with more than 10% of the
total combined voting power of all classes of stock of the Company. The rights
to purchase common shares will enable a participant to purchase common shares
(i) at the fair market value of such shares on the date of such grant or (ii) at
85% of such fair market value on such date if the grant is made in lieu of cash
compensation. Under the terms of the Equity Plan, these grants and awards may
not aggregate more than 1,400,000 common shares and no participating employee
may receive awards with respect to more than 250,000 common shares during any
calendar year.

         In December 1995, a total of 3,000 restricted shares were issued to two
officers and four directors. Deferred compensation of $41,000 and $61,500 at
December 31, 1996 and 1995, respectively, has been reflected as a reduction of
paid-in capital in the accompanying financial statements.

         The Company has an employment agreement with the President and Chief
Executive Officer for an initial three-year term which commenced November 18,
1993 and is automatically extended for an additional year at the end of each
year of the agreement. Annual base salary under the agreement was $440,000 for
1996, $385,000 for 1995, and $350,000 for 1994. The initial agreement provided
for an annual cash bonus equal to 15% to 100% of the base salary if the
Company's Distributable Cash Flow, as defined, per common share, for any year
exceeds, by 5% to 20% or more, the amount for the immediate preceding year.
Under the bonus plan, no incentive compensation was earned in 1994 and $101,000
was earned in 1995. This employment agreement was amended in January, 1996 to
provide for a performance bonus based upon annual performance benchmarks tied to
Funds From Operations per Share. The incentive amounts are set at the beginning
of each fiscal year commensurate with the responsibilities of a CEO. In 1996,
$227,854 in incentive compensation was earned.

         The Company does not recognize compensation cost for stock options when
the option exercise price equals or exceeds the market value on the date of the
grant. Had compensation cost for the Company's stock-based compensation plans
been determined based on the fair values of the options granted at the grant
dates, consistent with the method of FASB Statement 123, the Company's net
income and earnings per share would have been as follows:
<TABLE>
<CAPTION>
                                                 1996                      1995
<S>                                    <C>                       <C>         
Net income applicable
to common shares
As reported                            $   13,819,566            $   14,040,789
Pro forma                              $   13,809,049            $   14,030,289
Income per common share
As reported                            $          .99            $         1.01
Pro forma                              $          .99            $         1.01
</TABLE>

         The pro forma effect on net income for 1996 and 1995 is not
representative of the pro forma effect on net income in future years because it
does not take into consideration pro forma compensation expense related to
grants made prior to 1995.

16.  QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
                                                                           1996
                                             ----------------------------------------------------------------
                                             First Quarter    Second Quarter   Third Quarter   Fourth Quarter
                                             ----------------------------------------------------------------

<S>                                            <C>              <C>              <C>             <C>
Revenues                                       $21,920,407      $23,425,393       $24,025,193     $25,062,075
Income before extraordinary item                 4,791,177        4,924,206         4,984,243       4,604,362
Net income                                       4,791,177        4,924,206         4,984,243       4,604,362
Net income applicable to
  common shares                                  3,420,072        3,553,101         3,613,138       3,233,255

Income before extraordinary
  item per common share                        $       .25      $       .25       $       .26     $       .23
Net income per common share                    $       .25      $       .25       $       .26     $       .23
Weighted average number of
  shares outstanding (in thousands)                 13,872           13,872            13,872          14,109
</TABLE>
<TABLE>
<CAPTION>
                                                                          1995
                                             ----------------------------------------------------------------
                                             First Quarter    Second Quarter   Third Quarter   Fourth Quarter
                                             ----------------------------------------------------------------

<S>                                            <C>              <C>                 <C>               <C>
Revenues                                       $17,230,815      $18,307,125       $19,628,351     $21,774,983
Income before extraordinary item                 4,131,334        4,091,683         4,341,876       4,706,157
Extraordinary item                                      --               --            911,093        186,438

Net income                                       4,131,334        4,091,683          3,430,783      4,519,719
Net income applicable to 
  common shares                                  4,131,334        4,091,683          2,669,158      3,148,614

Income before extraordinary
 item per common share                         $       .30      $       .29        $       .26    $       .24
Net income per common share                    $       .30      $       .29        $       .19    $       .23
Weighted average number of shares        
  outstanding (in thousands)                        13,869           13,869             13,869         13,870
</TABLE>

40
<PAGE>   24
17.  PRO FORMA CONDENSED FINANCIAL
     INFORMATION (UNAUDITED)

         As more fully described in Note 2, during the years ended December 31,
1996, 1995 and 1994, the Company completed the acquisition of six, 15 and 21
multifamily properties (the "Acquired Properties") with total suites of 1,289,
2,276 and 3,349, respectively, and three land parcels consisting of 43 acres
during 1996 and three land parcels consisting of 89.7 acres during 1995, for an
aggregate purchase price of $59.1 million, $106 million and $139.9 million at
December 31, 1996, 1995 and 1994, respectively. The multifamily property
acquisitions are summarized as follows:

<TABLE>
<CAPTION>
                                                                                  Year Built or          Month Acquired
Multifamily Property                                  Location                    Renovated (r)  Suites  by the Company
-----------------------------------------------------------------------------------------------------------------------

<S>                                               <C>                             <C>          <C>       <C>
1994 Acquisitions:
   Bedford Commons                                Columbus, Ohio                       1987        112         December
   Bentley Station                                Columbus, Ohio                       1993         96           August
   Bolton Estates                                 Columbus, Ohio                       1992        196             July
   Central Park Place                             Grand Rapids, Michigan               1988        216         December
   Edgewater Landing                              Cleveland, Ohio                      1988(r)     241            April
   Georgetown Park Apartments                     Fenton, Michigan                     1987-94     288         December
   Heathermoor                                    Worthington, Ohio                    1989        280           August
   Lake Forest                                    Columbus, Ohio                       1994        192             July
   Muirwood Village at Bennell                    Columbus, Ohio                       1988        140            March
   Muirwood Village at Gemstar                    Columbus, Ohio                       1988         24            March
   Muirwood Village at London                     London, Ohio                         1989        112            March
   Muirwood Village at Mt. Sterling               Mt. Sterling, Ohio                   1990         48            March
   Muirwood Village at Zanesville                 Zanesville, Ohio                     1991        128            March
   Pendleton Lakes                                Columbus, Ohio                       1993        160            March
   Residence at Christopher Wren                  Gahanna, Ohio                        1993        264            March
   Residence at Turnberry                         Pickerington, Ohio                   1991        216            March
   Sheffield at Sylvan                            Circleville, Ohio                    1989         88            March
   Sterling Park                                  Grove City, Ohio                     1994        128           August
   The Residence at Newark                        Newark, Ohio                         1993         72            March
   Williamsburg at Greenwood Village              Sagamore Hills, Ohio                 1990        260         February
   Wyndemere                                      Franklin, Ohio                       1991         88        September
                                                                                                  ----
                                                                                                 3,349
1995 Acquisitions:
   Arbor Landings Apartments                      Ann Arbor, Michigan                  1990        168          January
   Arrowhead Station                              Columbus, Ohio                       1987        102            March
   Cloisters                                      Toledo, Ohio                         1990        188        September
   Colony Bay East - Phase I                      Columbus, Ohio                       1994         96         February
   Country Place Apartments                       Mt. Pleasant, Michigan               1987-89     144             June
   Colony Bay East - Phase II                     Columbus, Ohio                       1995         60             July
   Kensington Grove                               Westerville, Ohio                    1995         76             July
   Kensington Village                             Toledo, Ohio                         1985-90     190        September
   Mallard's Crossing                             Medina, Ohio                         1990        192         February
   Muirwood Village at Circleville                Circleville, Ohio                    1989         48             July
    (located adjacent to Sheffield at Sylvan)
   Oaks at Hampton                                Rochester Hills, Michigan            1986-88     272           August
   Woods at Hampton                               Rochester Hills, Michigan            1986-88     272           August
   The Landings at the Preserve                   Battle Creek, Michigan               1990-91     190        September
   Treetops                                       Toledo, Ohio                         1988-89     128        September
   Vantage Villa                                  Toledo, Ohio                         1974        150          October
                                                                                                 -----
                                                                                                 2,276
</TABLE>

continued


                                                                              41
<PAGE>   25
<TABLE>
<CAPTION>
                                                                                  Year Built or           Month Acquired
Multifamily Property                                  Location                    Renovated (r)   Suites  by the Company
-----------------------------------------------------------------------------------------------------------------------

<S>                                               <C>                             <C>          <C>        <C>
1996 Acquisitions:
   Aspen Lakes                                    Grand Rapids, Michigan            1981          144        September
   Chestnut Ridge                                 Pittsburgh, Pennsylvania          1986          468            March
   Perimeter Lakes                                Dublin, Ohio                      1992          189        September
   The Residence at Washington                    Washington Ct. House, Ohio        1995           72         February
   Spring Brook Apartments                        Holland, Michigan                 1986          168             June
   Summer Ridge Apartments                        Kalamazoo, Michigan               1989-91       248            April
                                                                                                -----
                                                                                                1,289
                                                                                                6,914
                                                                                                =====
</TABLE>

         The operating results of the Acquired Properties and additional joint
venture interests are included in the results of operations of the Company from
the dates of acquisition.

         The following unaudited supplemental pro forma operating data for 1996
is presented to reflect the effects of: (i) the six property and three land
parcel acquisitions completed in 1996, (ii) the offering of 1,450,000 shares of
Common Stock, and (iii) the issuance of Medium-Term Notes, as if such
transactions had occurred on January 1, 1996. The unaudited supplemental pro
forma operating data for 1995 is presented to reflect the effects of: (i) the
issuance of the Senior and Medium-Term Notes, (ii) the offering of 2,250,000
Depositary Shares, each representing 1/10th of a share of the Company's 9.75%
Class A Cumulative Redeemable Preferred Shares, (iii) the 15 property and three
land parcel acquisitions completed in 1995, (iv) the issuance of 3,000
restricted shares in 1995, (v) the six property and three land parcel
acquisitions completed in 1996, and (vi) the offering of 1,450,000 shares of
Common Stock completed in 1996, as if such transactions had occurred on January
1, 1995. The unaudited supplemental pro forma operating data for 1994 is
presented to reflect the effects of: (i) the issuance of the Senior Notes, (ii)
the Second Offering, (iii) the offering of 2,250,000 Depositary Shares, each
representing 1/10th of a share of the Company's 9.75% Class A Cumulative
Redeemable Preferred Shares, (iv) the 21 property acquisitions and the
acquisition of the two joint venture interests completed in 1994, and (v) the 15
property and three land parcel acquisitions completed in 1995, as if such
transactions had occurred on January 1, 1994.

(in thousands, except per share amounts)
<TABLE>
<CAPTION>

                                                        December 31,
                                           -------------------------------------
                                              1996           1995           1994
                                           -------------------------------------
<S>                                        <C>            <C>            <C>
Revenues                                   $97,658        $93,163        $78,845
*Net income                                 21,045         19,301         19,597
*Net income applicable to
  common shares                             15,560         13,817         15,166
*Net income per common share               $  1.02        $   .90        $  1.09
Weighted average common shares
  outstanding                               15,322         15,322         13,869
*Before extraordinary item
</TABLE>


         The 1994 pro forma financial information does not include the revenue
and expenses for Sterling Park Apartments, Lake Forest Apartments, Colony Bay
East Phase I and II, or Kensington Grove for the period January 1 through
December 31, 1994. The 1995 pro forma financial information does not include the
revenue and expenses for Colony Bay East Phase I and II, or Kensington Grove for
the period January 1, 1995 through the date the property was acquired by the
Company. The revenue and expenses of the aforementioned properties were excluded
from the pro forma financial information for the periods as mentioned as they
were under construction for substantially all of the periods prior to their
acquisition.

         The unaudited pro forma condensed statement of operations is not
necessarily indicative of what the actual results of operations of the Company
would have been assuming the transactions had been completed as set forth, nor
does it purport to represent the


42
<PAGE>   26
results of operations of future periods of the Company.

18.  SUBSEQUENT EVENTS

         From January 1 through February 19, 1997, the Company acquired one
multifamily property containing 228 suites for an aggregate purchase price of
$12.5 million. This acquisition was financed with borrowings under the Company's
Line of Credit. The Company is currently under contract to purchase five parcels
of undeveloped land consisting of 158.5 acres and one additional property
consisting of 102 suites for a total cost of $10.1 million. The Company expects
to finance these acquisitions using borrowings under the Line of Credit. There
can be no assurance, however, that the Company will be successful in acquiring
the properties and land parcel under contract.

         The Company is considering the disposition of six Government-Assisted
Properties with a net book value of $3.7 million at December 31, 1996 and net
operating income of $2.6 million for the year then ended. Management believes
that the disposition value will exceed the book value of the assets and as a
result, such assets are stated at cost in the Consolidated Balance Sheet. The
six properties receive federal rent subsidies from HUD. The Company intends to
acquire conventional, market-rate properties with the value received from the
disposition of these properties.

                                                                              43
<PAGE>   27
                              SHAREHOLDER INFORMATION



Corporate Headquarters

Associated Estates Realty Corporation
5025 Swetland Court
Richmond Heights, Ohio 44143-1467
216-261-5000

Annual Meeting

The annual meeting of shareholders of Associated Estates Realty Corporation will
be held on Thursday, May 8, 1997 at 10:00 a.m. E.D.T. at:

The Forum
One Cleveland Center
1375 East 9th Street
Cleveland, Ohio 44114

Independent Accountants

Price Waterhouse LLP
Cleveland, Ohio

Legal Counsel

Baker & Hostetler LLP
Cleveland, Ohio

Transfer Agent, Registrar and Dividend
Disbursing Agent

National City Bank
Corporate Trust Department
P.O. Box 92301
Cleveland, Ohio 44193-0900
Telephone: 800-622-6757

Dividend Reinvestment and Stock Purchase Plan

The Company maintains a Dividend Reinvestment and Stock Purchase Plan for
registered shareholders.  Details of the Plan are available by contacting the
Company or the transfer agent.

Investor Relations

Additional information may be obtained by contacting the Company's investor
relations department in writing at the corporate headquarters address above, by
telephone at 216-473-8798, or through the Company's web site on the Internet at
http://www.aecrealty.com. 

New York Stock Exchange

AEC:     Common Shares
AECPRA:  Class A Cumulative Redeemable Preferred Shares

The number of holders of record of the Company's common shares at December 31,
1996 was 327. The high and low closing sale prices of the Company's common
shares for each quarter in 1996 and 1995 as reported by the New York Stock
Exchange are shown below. 

<TABLE>
<CAPTION>
                                     Price Range                                Dividends Declared
                            1996                    1995                            Per Share

                        High           Low          High           Low          1996          1995
                      ----------------------------------------------------------------------------
<S>                   <C>           <C>            <C>            <C>            <C>           <C>
First Quarter         $21 7/8        $20 1/2        $21 3/8        $18 5/8        $  .45        $  .43
Second Quarter         21 1/2         20 1/8         21 7/8         19 1/8           .45           .43
Third Quarter          21 1/8             20         21 1/2         19 5/8           .45           .43
Fourth Quarter             24         20 1/8         21 1/2         18 3/4           .45           .43
                                                                                  --------------------
                                                                                  $ 1.80        $ 1.72
                                                                                  ====================
</TABLE>

                                       44