With the exception of assumed mortgage loans in 2008 on 15 of its hotel properties, substantially all of the purchases were funded with proceeds of the Company’s best-efforts offering of Units, which was completed in April 2008. The Company leases all of its hotels to its wholly-owned taxable REIT subsidiaries under hotel lease agreements. The Company also used the proceeds of its offering to pay $19.0 million, representing 2% of the gross purchase price for these hotels, as a commission to Apple Suites Realty Group, Inc. (“ASRG”), 100% owned by Glade M. Knight, the Company’s Chairman and Chief Executive Officer. No hotels have been purchased since December 2008, and there are no outstanding purchase contracts for additional hotels as of March 31, 2011.
As of March 31, 2011, the Company owned 51 hotels with 5,909 rooms. The Company’s portfolio of hotels owned is unchanged since 2008. Hotel performance is impacted by many factors, including economic conditions in the United States, as well as each locality. During the period from the second half of 2008 through 2010, the overall weakness in the U.S. economy has had a considerable negative impact on both consumer and business travel. As a result, lodging demand in most markets in the United States has declined from levels of 2007 and the first half of 2008. Economic conditions are showing evidence of improvement. While the Company expects 2011 revenue and operating income for the industry and the Company to improve over 2010 results, it is not expected that revenue and operating income will reach pre-recession levels. Although slightly below overall industry averages for the first quarter of 2011, the Company’s hotels have shown results consistent with the industry and brand averages for the period of ownership.
The Company separately evaluates the performance of each of its hotel properties. Due to the significance of the New York, New York hotel, the Company has two reportable segments.
For the three months ended March 31, 2011, the hotels achieved combined average occupancy of approximately 66%, ADR of $106 and RevPAR of $70. The New York hotel had average occupancy of 77%, ADR of $232 and RevPAR of $179. For the three months ended March 31, 2010, the hotels achieved combined average occupancy of approximately 65%, ADR of $105 and RevPAR of $68. For the same period, the New York hotel had average occupancy of 82%, ADR of $211 and RevPAR of $173. ADR is calculated as room revenue divided by the number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR. Since the beginning of 2010 the Company has experienced an increase in demand as demonstrated by the slight improvement in average occupancy. In addition, also signifying a stabilizing economy, the Company experienced a modest increase in average room rates versus the same period of 2010. The occupancy and ADR increases resulted in a three percent increase in RevPAR during the first quarter of 2011, as compared to the first quarter of 2010. With demand improvement and expected rate improvement, the Company and industry anticipate percentage revenue growth for the remainder of 2011 in the mid single digits, as compared to 2010. Although overall, the Company was behind the industry revenue growth rate in the first quarter of 2011 as compared to the same period in 2010, the Company does expect to approximate the industry growth rate for the full year of 2011. While reflecting the impact of post-recessionary levels of single-digit growth in national economic activity, the Company’s hotels also continue to be leaders in their respective markets. The Company’s average Market Yield for the first three months of 2011 and 2010 was 132 and 134. The Market Yield is a measure of each hotel’s RevPAR compared to the average (100) in its local market. The index excludes hotels under renovation.
The RevPAR Index for the New York hotel was 125 for the three months ending March 31, 2011, an increase of 9% from 115 for the first three months of 2010. The Company believes there is more
opportunity for market penetration and continues to work with Marriott management to increase the RevPAR Index for the New York hotel.
Expenses
For the three months ended March 31, 2011 and 2010, hotel operating expenses of the Company’s hotels totaled $25.7 million or 64% of total revenue (the New York hotel had direct expenses of $2.7 million or 66% of its total revenue for the quarter) and $24.9 million or 63% of total revenue (the New York hotel had direct expenses of $2.5 million or 62% of its total revenue for the quarter). Hotel operating expenses consist of operating expense, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. The Company continues its efforts to control costs, however, certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature, and cannot be curtailed or eliminated. The Company has been successful in reducing certain labor costs, food and supply costs and utility costs by continually monitoring and sharing utilization data across its hotels and management companies. The increase as a percentage of revenue in the first quarter of 2011 as compared to the same period in 2010 is due primarily to increased sales and marketing costs incurred to increase revenue and repair and maintenance costs incurred at the New York hotel. The Company anticipates these costs for the full year of 2011 to approximate 2010 as a percentage of revenue.
Taxes, insurance, and other expense for the three months ended March 31, 2011 and 2010 totaled $2.4 million, or 6% of total revenues, and $2.6 million, or 7% of total revenues (of which approximately $147,000 and $137,000 related to the New York hotel). Decreases in these expenses for the comparable three month periods ending March 31, 2011 and 2010 reflect lower real estate property tax assessments at selected hotels, including the results of successful appeals of assessments for some locations. In addition, the Company has experienced lower property insurance expense for most hotel properties, in comparison to insurance rates in effect during 2010.
Land lease expense was $1.6 million for both three months ended March 31, 2011 and 2010. This expense represents the expense incurred by the Company to lease land for five hotel properties. Land lease expense for the New York hotel was $1.5 million for both the first quarter of 2011 and 2010.
General and administrative expense for the three months ended March 31, 2011 and 2010 was $1.1 million and $1.2 million. The principal components of general and administrative expense are advisory fees and reimbursable expenses, legal fees, accounting fees, reporting expense, and the Company’s share of loss from its investment in Apple Air Holding LLC.
Depreciation expense was $8.8 million for the first quarter of 2011 and $8.7 million for the first quarter of 2010. These expenses include $1.6 million in each period for the New York hotel. Depreciation expense represents depreciation expense of the Company’s hotel buildings and related improvements, and associated furniture, fixtures and equipment, for the respective periods owned.
In the first quarter of 2010, the Company sold its equity securities in a publicly traded real estate investment trust, resulting in realized gains and other investment income of $3.0 million.
Interest expense, net for the first quarter of 2011 and 2010 was $2.7 million and $2.1 million. Interest expense for both periods includes interest expense on 15 mortgages assumed in 2008 and the Company’s credit facility and term loan. Interest expense in the first quarter of 2010 was reduced by capitalized interest of $101,000 related to the renovation of two hotel properties.
Liquidity and Capital Resources
In October 2010 the Company entered into a $75.0 million unsecured revolving credit facility which expires in October 2012. The credit facility, which effectively extended the Company’s existing credit facility, was obtained for general corporate purposes, including capital expenditures, redemptions and distributions. With the availability of this credit facility, the Company maintains little cash on hand, accessing the line as necessary. As a result, cash on hand was $0 at March 31, 2011. The outstanding
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balance on the credit facility was $68.7 million at March 31, 2011. Also in October 2010 the Company entered into a $25 million term loan secured by two hotels. Interest on the loans is due monthly, interest is based on LIBOR with a floor of 3.5%, the interest rate for both loans was 3.5% at March 31, 2011, and the principal is due at maturity which is October 2012. Both loans have quarterly financial covenants which the Company was in compliance with at March 31, 2011. Although the Company anticipates maintaining compliance with these covenants, there can be no assurances that a default will not occur and the loans become immediately payable.
In March 2011 the Company requested the loans secured by the Winston-Salem, North Carolina Courtyard, Tampa, Florida TownePlace Suites, Greenville, South Carolina Residence Inn and Suffolk, Virginia TownePlace Suites and Courtyard to be placed with a special servicer to negotiate the terms of the loans. To have the loans placed with the special servicer the Company suspended making its scheduled monthly debt payments beginning in March 2011. The Company has received default notices from the lenders and does not know the timing and resolution of the anticipated negotiations. The total outstanding balance including unpaid interest of the five loans at March 31, 2011 was approximately $37.0 million. The net book value of the properties securing these loans at March 31, 2011 was approximately $52.8 million. If the Company is unable to renegotiate the loans, it may be more cost beneficial to pursue a deed in lieu of foreclosure with the lender(s). If the Company did pursue a deed in lieu of foreclosure it would record an impairment loss of the difference between the property’s carrying value and fair value, which could range from $7 million to $11 million based on estimated values at March 31, 2011.
The Company anticipates that cash flow from operations and the revolving credit facility will be adequate to meet its anticipated liquidity requirements, including required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), capital expenditures and debt service in 2011. The Company intends to maintain a relatively stable distribution rate instead of raising and lowering the distribution rate with varying economic cycles. With the depressed financial results of the Company and the lodging industry as compared to pre-recession levels, the Company will attempt to utilize additional financing to achieve this objective. Although the Company has relatively low levels of debt, there can be no assurances it will be successful with this strategy and may need to reduce its distributions to required levels. If the Company were unable to extend maturing debt or if it were to default on its debt, it may be unable to make distributions.
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions in the first three months of 2011 totaled $18.2 million and were paid monthly at a rate of $0.064167 per common share. For the same three month period, the Company’s cash generated from operations was approximately $4.7 million. This shortfall includes a return of capital and was funded primarily by additional borrowings under the Company’s credit facility. The Company intends to continue paying distributions on a monthly basis. However, since there can be no assurance of the ability of the Company’s properties to provide income at this level, there can be no assurance as to the classification or duration of distributions at the current monthly rate. The Board of Directors monitors the Company’s distribution rate relative to the performance of the hotels on an ongoing basis and may make adjustments to the distribution rate as determined to be prudent in relation to other cash requirements of the Company.
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements, and under certain loan agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. As of March 31, 2011, the Company held $8.4 million in reserve for capital expenditures. Total capital expenditures in the first three months of 2011 for all renovations and items recurring in nature were approximately $0.7 million. Total capital expenditures for 2011 are anticipated to be in the range of $12 million to $14 million.
In the second quarter of 2008, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a convenient and cost effective way to increase shareholder investment in the Company by reinvesting dividends to purchase additional Units of the Company. The uses of the proceeds from this plan may include purchasing Units under the Company’s Unit Redemption Program, enhancing properties,
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satisfying financing obligations and other expenses, increasing working capital, funding various corporate operations, and acquiring hotels. The Company has registered 10 million Units for potential issuance under the plan. During the first three months of 2011 and 2010, approximately 0.6 million Units were issued under the plan in each period representing approximately $6.5 million. Since inception of the plan through March 31, 2011, the Company has issued approximately 6.9 million Units representing approximately $75.4 million.
The Company has a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year. Shareholders may request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any 12-month period is three percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. The Company reserves the right to change the purchase price for redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. During the three months ended March 31, 2011, the Company redeemed approximately 733,000 Units in the amount of $8.0 million under the program. For the first three months of 2010, the Company redeemed approximately 216,000 Units in the amount of $2.2 million. Since inception of the program through March 31, 2011, the Company has redeemed approximately 3.5 million Units representing approximately $37.0 million. As contemplated by the program, beginning with the January 2011 redemption, the Company redeemed Units on a pro-rata basis with approximately 61% of the amount requested redeemed.
Related Party Transactions
The Company has significant transactions with related parties. These transactions cannot be construed to be arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to these contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during 2011. The Board of Directors is not required to approve each individual transaction that falls under a related party relationship, however under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company is party to an advisory agreement with A8A, pursuant to which A8A provides management services to the Company. An annual fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable for these services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $0.3 million for both the three months ended March 31, 2011 and 2010.
In addition to the fees payable to A8A, the Company reimbursed A8A or paid directly to Apple REIT Six, Inc. (“AR6”) on behalf of A8A approximately $0.4 million and $0.5 million for the three months ended March 31, 2011 and 2010. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AR6. The costs are actual costs with no markup or profit to AR6. Also, as part of this arrangement, the day to day transactions may result in amounts due to or from the noted related parties. To efficiently manage cash disbursements, the individual companies may make payments for any or all of the related companies. The amounts due to or from the related individual companies are reimbursed or collected and are not significant in amount.
A8A is 100% owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company. Mr. Knight is also Chairman and Chief Executive Officer of AR6, Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. Members of the Company’s Board of Directors are also on the boards of Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
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The Company has a 24% ownership interest in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Nine, Inc. Through its ownership interest the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s ownership interest was $2.2 million at both March 31, 2011 and December 31, 2010. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the three months ended March 31, 2011 and 2010, the Company recorded a loss of approximately $49,000 and $110,000 in each period as its share of the net loss of Apple Air, which primarily relates to depreciation of the aircraft. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
Subsequent Events
In April 2011, the Company declared and paid approximately $6.1 million in distributions to its common shareholders, or $0.064167 per outstanding common share. Under the Company’s Dividend Reinvestment Plan, $2.2 million were reinvested, resulting in the issuance of approximately 197,000 Units.
In April 2011, the Company redeemed approximately 729,000 Units in the amount of $8.0 million under its Unit Redemption Program. As contemplated in the Program, the Company redeemed Units on a pro-rata basis. The redemption was approximately 48% of the requested redemption amount.
On April 19, 2011, the Company entered into a Loan Agreement (the “Loan Agreement”) with Bank of America, N.A. The Loan Agreement provides for a revolving credit facility of $20 million and a maturity date of April 19, 2012. Interest will be payable quarterly on the outstanding balance based on an annual rate of One Month LIBOR plus 2.0%. Under the terms and conditions of the Loan Agreement, the Company may make voluntary prepayments in whole or in part, at any time. The Loan Agreement is guaranteed by Glade M. Knight, the Company’s Chairman and Chief Executive Officer and is secured by assets of Mr. Knight. Mr. Knight will not receive any consideration in exchange for providing this guaranty and security. Proceeds of the loan will be used by the Company for general working capital purposes, including the payment of redemptions and distributions. The independent directors of the Company’s Board of Directors approved Mr. Knight providing a guaranty under the Loan Agreement.
Impact of Inflation
Operators of hotels, in general, possess the ability to adjust room rates daily to reflect the effects of inflation. Competitive pressures may, however, limit the operators’ ability to raise room rates. Currently the Company is not experiencing any material impact from inflation.
Business Interruption
Being in the real estate industry, the Company is exposed to natural disasters on both a local and national scale. Although management believes there is adequate insurance to cover this exposure, there can be no assurance that such events will not have a material adverse effect on the Company’s financial position or results of operations.
Seasonality
The hotel industry historically has been seasonal in nature. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. As a result, there may be quarterly fluctuations in results of operations. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize available credit to make distributions.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
With the exception of one interest rate swap transaction entered into in October 2010, the Company has not engaged in transactions in derivative financial instruments or derivative commodity instruments. The Company entered into the interest rate swap, with a notional amount at March 31, 2011 of $6.9 million, and based on the London InterBank Offered Rate (“LIBOR”), to increase stability related to interest expense on a variable rate loan. The swap is not designated as a hedge, therefore the changes in the fair market value of this transaction are recorded in earnings. The Company recognized a gain of $43,000 in the first quarter of 2011 from the change in fair value of this derivative.
As of March 31, 2011, the Company’s financial instruments were not exposed to significant market risk due to foreign currency exchange risk, commodity price risk or equity price risk. The Company will be exposed to interest rate risk due to possible changes in short term interest rates as it invests its cash or borrows on its credit facility and due to its variable interest rate term loans. The Company had an outstanding balance of $68.7 million on its $75 million credit facility at March 31, 2011, and to the extent it utilizes the credit facility, the Company will be exposed to changes in short-term interest rates. The outstanding balance of the Company’s variable rate term loans was $42.6 million at March 31, 2011. Based on these outstanding balances at March 31, 2011, every 100 basis point change in interest rates will impact the Company’s annual net income by $1.1 million, all other factors remaining the same. The Company’s cash balance at March 31, 2011 was $0.
Item 4. Controls and Procedures
Senior management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation process, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective and that there have been no changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Since that evaluation process was completed there have been no significant changes in internal controls or in other factors that could significantly affect these controls.
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PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Unit Redemption Program
The Company has instituted a Unit Redemption Program to provide its shareholders who have held their Units for at least one year with the benefit of limited interim liquidity, by presenting for redemption all or any portion of their Units. As of March 31, 2011, shareholders may request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The Company reserves the right to change the purchase price of redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. In January 2011, the first scheduled redemption date of 2011, the Company redeemed in accordance with the Unit Redemption Program on a pro-rata basis approximately 61% of the requested redemptions, or a total of $8.0 million. See the Company’s complete consolidated statements of cash flows for the three months ended March 31, 2011 and 2010 included in the Company’s interim financial statements in Item 1 of this Form 10-Q for a description of the sources and uses of the Company’s cash flows. The following is a summary of redemptions during the first quarter of 2011 (no redemptions occurred in February and March 2011):
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Issuer Purchases of Equity Securities |
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Period | | Total Number
of Units
Purchased | | Average Price Paid
per Unit | | Total Number of
Units Purchased as
Part of Publicly
Announced Plans
or Programs | | Maximum Number
of Units that May
Yet Be Purchased
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Programs | |
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January 2011 | | | 732,647 | | $ | 10.92 | | 3,508,129 | | (1) | |
(1) The maximum number of Units that may be redeemed in any 12 month period is limited to up to three percent (3.0%) of the weighted average number of Units outstanding from the beginning of the 12 month period, subject to the Company’s right to change the number of Units to be redeemed.
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Item 6. Exhibits
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Exhibit
Number | | Description of Documents |
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3.1 | | Articles of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007) |
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3.2 | | Bylaws of the Registrant, as amended. (Incorporated by reference to Exhibit 3.2 to amendment no. 1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007) |
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31.1 | | Certification of the Company’s Chief Executive Officer pursuant to Rule 13a – 14(a) and Rule 15d – 14(a) of the Securities Exchange Act, as amended (FILED HEREWITH). |
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31.2 | | Certification of the Company’s Chief Financial Officer pursuant to Rule 13a – 14(a) and Rule 15d – 14(a) of the Securities Exchange Act, as amended (FILED HEREWITH). |
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32.1 | | Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH). |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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Apple REIT Eight, Inc. | | |
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By: | /s/ GLADE M. KNIGHT | | | Date: May 6, 2011 |
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| Glade M. Knight,
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer) | | | |
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By: | /s/ BRYAN PEERY | | | Date: May 6, 2011 |
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| Bryan Peery,
Chief Financial Officer
(Principal Financial and Principal Accounting Officer) | | | |
