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This filing is made pursuant
to Rule 424(b)(3) under
the Securities Act of
1933 in connection with
Registration No. 333-41683
PROSPECTUS
1,000,000 SHARES
SUNSTONE HOTEL INVESTORS, INC.
COMMON STOCK
______________________
This Prospectus relates to the offer and sale by certain holders (the
"Selling Stockholders") of up to 1,000,000 shares (the "Offered Shares") of
common stock, par value $.01 per share ("Common Stock"), of Sunstone Hotel
Investors, Inc., a Maryland corporation ("Sunstone" or the "Company"). The
Selling Stockholders have acquired or will acquire the Offered Shares upon
redemption of units (the "Units") of limited partnership interests in Sunstone
Hotel Investors, L.P., a Delaware limited partnership (the "Partnership"), of
which the Company is the sole general partner. The Partnership issued the Units
to the Selling Stockholders in connection with the purchase of certain hotel
properties. Pursuant to the Second Amended and Restated Agreement of Limited
Partnership of the Partnership (the "Partnership Agreement"), the holders of the
Units may tender such Units to the Partnership for redemption at any time. In
such event, the Partnership may elect to acquire directly such Units tendered
for redemption in exchange for shares of Common Stock, on a one-for-one basis
(subject to adjustment for stock splits, reverse stock splits, stock dividends,
recapitalizations and the like), or for cash. The Offered Shares have been or
will be issued to the extent that the Company has or will acquire Units for
Common Stock. For Units that the Partnership or the Company acquires for cash,
the related Offered Shares will not be issued.
The Company is a leading self-administered equity real estate
investment trust that owns mid-price and upscale hotels located primarily in
the Pacific and Mountain regions of the western United States. The hotels
operate under nationally recognized franchises, including brands affiliated
with Holiday Hospitality Corporation, Marriott International, Inc. and Promus
Hotel Corporation. The Company will not receive any cash proceeds from the
sale of the Offered Shares, but the Partnership has agreed to bear certain
expenses of registration of the Offered Shares under federal and state
securities laws. All of the Offered Shares the Selling Stockholders may sell
from time to time are being registered under the Securities Act of 1933, as
amended, in accordance with the Partnership Agreement.
The Common Stock is traded on the New York Stock Exchange (the "NYSE")
under the symbol "SSI." On December 17, 1997, the last reported sale price of
Common Stock on the NYSE was $17.0625 per share. To ensure compliance with
certain requirements related to the Company's qualification as a real estate
investment trust ("REIT") under the Internal Revenue Code of 1986, as amended,
the Company's Articles of Incorporation limits the number of shares of Common
Stock that may be owned by any single person or affiliated group to no more than
9.8% of the outstanding shares of Common Stock (the "Ownership Limitation") and
restricts the transferability of Common Stock if the purported transfer would
prevent the Company from qualifying as a REIT. See "Risk Factors--Limitation on
Acquisition and Change in Control" and "Description of Common Stock--Provisions
of Maryland Law and of the Company's Articles of Incorporation and Bylaws."
SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SECURITIES
OFFERED HEREBY.
______________________
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
______________________
The date of this Prospectus is December 17, 1997.
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AVAILABLE INFORMATION
The Company is subject to the information requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in
accordance therewith files reports, proxy statements and other information with
the Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information filed by the Company can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at
regional offices of the Commission located at 7 World Trade Center, 13th Floor,
New York, New York 10048 and Citicorp Corp. Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661-2511. Copies of such material can be
obtained by mail from the Public Reference Section of the Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549 at prescribed rates. The Commission also
maintains a web site that contains reports, proxy and information statements
and other information regarding registrants that file electronically with the
Commission, such as the Company, and the address is http://www.sec.gov. The
Company's Common Stock is listed on the NYSE, and reports, proxy statements and
other information concerning the Company can be inspected at the offices of The
New York Stock Exchange, Inc., 20 Broad Street, New York, New York 10005.
The Company has filed with the Commission a Registration Statement on
Form S-3 under the Securities Act of 1933, as amended (the "Securities Act"),
and the rules and regulations promulgated thereunder, with respect to the
Offered Shares. This Prospectus, which is part of the Registration Statement,
does not contain all of the information set forth in the Registration Statement
and the exhibits thereto. For further information concerning the Company and
the Offered Shares, reference is made to the Registration Statement and the
exhibits and schedules filed therewith, which may be obtained as described
above.
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INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
The following documents, which have been filed with the Commission,
are hereby incorporated by reference:
1. Annual Report (i) on Form 10-K of the Company for the fiscal
year ended December 31, 1996; and (ii) on Form 10-K/A filed
with the Commission on March 24, 1997;
2. Quarterly Reports (i) on Form 10-Q for the quarters ended
March 31, 1997, June 30, 1997 and September 30, 1997; and (ii)
on Form 10-Q/A filed with the Commission on August 26, 1997;
3. Current Reports (i) on Form 8-K filed with the Commission on
January 9, 1997, March 26, 1997, May 1, 1997, June 26, 1997,
July 17, 1997, August 14, 1997, October 9, 1997 and October
15, 1997; and (ii) on Form 8-K/A filed with the Commission on
January 7, 1997 and August 22, 1997; and
4. The description of the Common Stock of the Company included in
the Company's Registration Statement on Form 8-A, filed with
the Commission on June 26, 1995; and on Form 8-A/A, filed with
the Commission on July 19, 1996.
In addition, all reports and other documents subsequently filed by the
Company with the Commission pursuant to Section 13, 14 or 15(d) of the Exchange
Act after the date of this Prospectus and prior to the termination of the
offering shall be deemed to be incorporated by reference in this Prospectus and
to be a part hereof from the date of the filing of such documents (such
documents, and the documents enumerated above, being herein referred to as
"Incorporated Documents"; provided however, that the documents enumerated above
or subsequently filed by the Company pursuant to Section 13, 14 or 15(d) of the
Exchange Act prior to the filing by the Company of any subsequent Annual Report
on Form 10-K with the Commission shall not be Incorporated Documents or be
incorporated by reference in this Prospectus or be a part hereof from and after
any such filing of an Annual Report on Form 10-K). Any statement contained in
a document incorporated or deemed to be incorporated by reference herein shall
be deemed to be modified or superseded for purposes of this Prospectus to the
extent that a statement contained herein (or in any other subsequently filed
document which also is or is deemed to be incorporated by reference herein)
modifies or supersedes such statement. Any statements so modified or
superseded shall not be deemed to constitute a part of this Prospectus, except
as so modified or superseded.
The Company will provide without charge to each person to whom this
Prospectus is delivered, upon written or oral request of such person, a copy of
any or all of the documents referred to above which have been or may be
incorporated by reference in this Prospectus (other than certain exhibits to
such documents). Requests for such documents should be directed to Sunstone
Hotel Investors, Inc., 115 Calle de Industrias, Suite 201, San Clemente,
California 92672, Attention: Secretary (telephone: (714) 361-3900).
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more
detailed information and financial statements and the notes thereto appearing
elsewhere herein or incorporated by reference herein. Unless the context
otherwise indicates, all references herein to the "Company" include Sunstone
Hotel Investors, Inc. and the Partnership. This Prospectus, including the
Incorporated Documents, may contain forward-looking statements within the
meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. The Company's actual results could differ materially from those set forth
in any such forward-looking statements. Certain factors that might cause such
a difference are discussed in the sections entitled "Risk Factors" commencing
on page 6 of this Prospectus and in certain of the Incorporated Documents. The
Company cautions the reader, however, that the factors discussed in those
sections may not be exhaustive.
THE COMPANY
The Company is a leading self-administered equity real estate
investment trust ("REIT") that owns mid-price and upscale hotels located
primarily in the Pacific and Mountain regions of the western United States (the
"Primary Region"), which includes the states of California, Utah, Colorado,
Arizona, Washington, Idaho, Oregon, Montana and New Mexico. The Company also
operates a number of hotels outside the Primary Region, in geographic markets
where opportunities exist for the Company to implement its growth strategy.
The hotels operate primarily under national franchises that are among the most
widely recognized in the lodging industry, including brands affiliated with
Holiday Hospitality Corporation, Marriott International, Inc. and Promus Hotel
Corporation.
The Company's growth strategy is to maximize shareholder value by (i)
acquiring underperforming hotels within the Primary Region that are in
attractive locations with significant barriers to entry and (ii) improving such
hotels' financial performance by renovating, redeveloping, repositioning and
rebranding the hotels, and through the implementation of focused sales and
marketing programs.
The Company believes that its recently completed and planned future
renovation, redevelopment, repositioning and rebranding activities, as well as
improvements in management and marketing, will continue to fuel growth of
revenue per available room ("REVPAR") at its hotels, thereby increasing
percentage lease revenue to the Company. In addition, the Company believes that
there will continue to be substantial acquisition, renovation, redevelopment,
repositioning and rebranding opportunities in the mid-price and upscale hotel
markets in the Primary Region. The Company believes these opportunities will
result from the aging of a significant portion of the nation's hotel supply and
the imposition of capital improvement requirements by certain national hotel
franchisors on the owners of franchised hotels, many of which are small
independent hotel companies or private hotel owners that may be unwilling or
unable to satisfy such requirements.
The Company was incorporated as a Maryland corporation in 1995 and is
structured as a REIT. The Company's principal executive offices are located at
115 Calle de Industrias, Suite 201, San Clemente, CA 92672, and its telephone
number is (714) 361-3900.
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RECENT DEVELOPMENTS
THE KAHLER ACQUISITION
On October 15, 1997, the Company acquired all of the outstanding
shares (the "Kahler Acquisition") of Kahler Realty Corporation, a Minnesota
corporation ("Kahler"), for an aggregate purchase price of approximately $322
million. Kahler owned and operated 17 hotels with 4,255 rooms (the "Kahler
Hotels"), principally in two markets, the Mountain region states of Utah,
Idaho, Montana and Arizona (11 hotels) and Rochester, Minnesota (four hotels).
The largest number of rooms of the Kahler Hotels are concentrated in Rochester,
Minnesota, with four hotels and 1,329 rooms, three of which are connected by an
underground walkway to the internationally renown Mayo Clinic, and in the Salt
Lake City area of Utah, with six hotels and 1,509 rooms. The Company intends
to (i) brand or rebrand a number of the hotels and (ii) undertake an extensive
renovation program, both of which the Company expects will increase its return
on investment by increasing the revenues of the hotels. The Company may sell
or exchange the Kahler Hotels located in Texas and West Virginia as they are
inconsistent with the Company's geographic focus.
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RISK FACTORS
In addition to the other information contained in this Prospectus, the
following factors should be considered carefully in evaluating an investment in
the Common Stock being offered by this Prospectus. This Prospectus may contain
forward-looking statements which involve risks and uncertainties, and actual
results could differ materially from those discussed in any such
forward-looking statements. Certain of the factors that could cause actual
results to differ materially are discussed below.
MULTIPLE-HOTEL ACQUISITION RISKS
The Company has increasingly emphasized, and intends to continue to
emphasize, acquisitions of multiple hotels in a single transaction in order to
reduce acquisition expenses per hotel and enable the Company to more rapidly
expand its hotel portfolio. Consistent with this emphasis, in October 1997, the
Company completed the Kahler Acquisition which almost doubled the Company's
room total. Multiple-hotel acquisitions, such as the Kahler Acquisition are,
however, more generally complex than single-hotel acquisitions and the risk
that a multiple-hotel acquisition will not close may be greater than in a
single-hotel acquisition.
Such portfolio acquisitions, whether by stock or asset purchase, may
also result in the Company owning hotels in geographically dispersed markets.
For instance, several of the Kahler Hotels are located in areas geographically
removed from the Company's current portfolio. This geographic diversity will
place significant additional demands on the Company's ability to manage such
operations. In addition, the Company's costs for a hotel portfolio acquisition
that does not close are generally greater than for an individual hotel
acquisition which does not close. If the Company fails to close multiple-hotel
acquisitions, its ability to increase cash available for distribution on its
Common Stock will be limited. Another risk associated with multiple-hotel
acquisitions is that a seller may require that a group of hotels be purchased
as a package, even though one or more of the hotels in the package does not
meet the Company's investment criteria. In such cases, the Company may
purchase the group of hotels with the intent to re-sell those which do not meet
its criteria. In such circumstances, however, there can be no assurance as to
how quickly the Company could sell or exchange such hotels or the terms on
which they could be sold or exchanged. Such hotels might reduce cash available
for distribution on its Common Stock ("Cash Available for Distribution") if
they operate at a loss during the time the Company owns them, or if the Company
sells them at a loss. In addition, any gains on the sale of such hotels within
four years of the date of acquisition could be subject to a 100% tax. See
"Federal Income Tax Considerations."
The Company may finance multiple-hotel acquisitions by issuing shares
of Common Stock or Units in the Partnership which are convertible into Common
Stock. Such issuance may have an adverse effect on the market price of Common
Stock.
FAILURE TO INTEGRATE KAHLER SUCCESSFULLY
The acquisition of Kahler will place significant demands on the
Company's management and other resources. There can be no assurances that the
Kahler Hotels and other business operations can be integrated successfully,
that there will be any operating efficiencies between the Kahler Hotels and the
Company's other hotels or that the combined businesses can be operated
profitably. The failure to integrate and operate the Kahler Hotels
successfully could have a material adverse effect on the Company's business and
future prospects. Also, certain of the Kahler Hotels are in the same
geographic regions as certain of the other hotels of the Company and may,
therefore, compete with the other hotels of the Company. There can be no
assurance that the Kahler Acquisition will not adversely affect the operations,
revenues or prospects of the Company's other hotels located in such geographic
areas. See "Recent Developments -- The Kahler Acquisition."
GEOGRAPHIC CONCENTRATION OF KAHLER HOTELS; NEW MARKETS
The concentration of four Kahler Hotels in Rochester, Minnesota and
six Kahler Hotels in and around the Salt Lake City area of Utah, makes these
Kahler Hotels dependent on factors such as the local economy, local
competition, increases in local real and personal property tax rates and local
catastrophes. The results of operations of the Kahler Hotels in Rochester,
Minnesota, are also dependent on the level of demand generated by the Mayo
Clinic for hotel accommodations by patients and by medical conferences
organized by the Mayo Clinic. Significant
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disruption in these local markets that result in decreased operating
performance of the Kahler Hotels will have a material adverse effect on the
Company's results of operations and Cash Available for Distribution.
In connection with the Kahler Acquisition, the Company expanded its
operations beyond the Primary Region into Minnesota, Texas and West Virginia.
The Company may make other selective acquisitions in markets outside of the
Primary Region from time to time should the appropriate opportunities arise.
The Company's historical experience is in the Primary Region, and it is
possible that the Company's expertise in the Primary Region may not assist it
in operating the Kahler Hotels located in Rochester, Minnesota or any other
hotels that the Company operates or may operate in the future outside of the
Primary Region. In such event, the Company may be exposed to, among others,
risks associated with (i) a lack of market knowledge and understanding of the
local economy, (ii) an inability to access land and property acquisition
opportunities, (iii) an inability to obtain construction tradespeople and (iv)
an unfamiliarity with local governmental procedures.
EARNINGS AND PROFITS DISTRIBUTION RISK
In order to preserve the Company's status as a REIT, the accumulated
earnings and profits of Kahler from its inception in 1917 needed to be
eliminated by way of a distribution prior to December 31, 1997. Prior to the
Kahler Acquisition, Kahler made a distribution to its stockholders in the
amount of such earnings and profits, of approximately $28.75 million, as
computed by Kahler's auditors based upon information provided by Kahler and
subsequently reviewed by the auditors for the Company. This computation of the
earnings and profits is based on certain assumptions and is not binding on the
Internal Revenue Service (the "IRS"). There can be no assurance that the IRS
will not successfully assert that the earnings and profits of Kahler exceeded
the amount so computed, which may in turn result in the Company being
disqualified as a REIT.
The Company has applied for a ruling from the IRS that the
above-described distribution to the Westbrook Funds depleted the historical
earnings and profits of Kahler. However, there can be no assurance that a
favorable ruling will be issued or that such ruling will be issued during 1997.
If a favorable ruling is not issued prior to December 31, 1997, the Company
will, on or before December 31, 1997, make an additional distribution to its
shareholders sufficient to eliminate such earnings and profits, which could be
as much as $28.5 million. The Company would be required to incur debt or issue
additional stock in order to fund any such distribution, which in either event
will have a material adverse effect on the per-share financial performance of
the Company, incapable of quantification at this time. In addition, if the
Company becomes obligated to make such additional distribution but fails to do
so, such failure may result in the Company being disqualified as a REIT.
IMPEDIMENTS TO GROWTH AND INCREASING CASH AVAILABLE FOR DISTRIBUTION
The Company's ability to increase Cash Available for Distribution will
depend significantly on the Company's ability to acquire or develop additional
hotels at attractive prices. Risks associated with this growth strategy
include:
Competition For Future Acquisitions. There will continue to be
competition for investment opportunities in mid-price and upscale hotels from
entities organized for purposes substantially similar to the Company's
objectives as well as other purchasers of hotels. The Company is competing for
such hotel investment opportunities with numerous entities, many of whom have
substantially greater financial resources than the Company or better
relationships with franchisors, sellers or lenders. These entities may also
generally be able to accept more risk than the Company prudently can manage.
Competition may generally reduce the number of suitable hotel investment
opportunities offered to the Company and increase the bargaining power of
property owners seeking to sell.
Renovation and Redevelopment Risks. The Company faces risks arising
from its strategy of acquiring hotels in need of substantial renovation or
redevelopment, particularly the risk that the cost or time to complete the
renovation or redevelopment will exceed the budgeted amount. Such delays or
cost overruns may arise from shortages of materials or skilled labor, a change
in the scope of the original project, the need to comply with building code or
other legal requirements, the discovery of structural or other latent defects
with a hotel once construction has commenced and other risks inherent in the
construction process. In particular, renovation and redevelopment must comply
with the Americans with Disabilities Act of 1990 (the "ADA"), which provides
that all public accommodations meet certain federal requirements related to
access and use by disabled persons. The Company may be required to make
substantial modifications at the hotels to comply with the ADA. Delays or cost
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overruns in connection with renovations or redevelopments could have a material
adverse effect on Cash Available for Distribution.
Development Risks. A component of the Company's growth strategy is to
develop new hotels in markets where room supply and other competitive factors
justify new construction or to purchase such hotels from unaffiliated
developers after they have been completed. New project development will
increase the Company's indebtedness and is subject to a number of other risks,
including risks of construction delays or cost overruns, the risk that required
zoning, occupancy and other government permits might not be obtained, and the
risk that projects might not be completed. Additional risks of development
projects include the risks associated with effectively marketing a hotel in
order to ramp-up occupancy at projected room rates after the hotel has been
opened. Any failure to complete a development project in a timely manner and
within budget or to ramp-up occupancy after completion of the project could
have a material adverse effect on Cash Available for Distribution.
TOTAL DEPENDENCE ON THE LESSEE AND PAYMENTS UNDER THE PERCENTAGE LEASES
Certain tax rules relating to the qualification of a REIT prohibit the
Company and the Partnership from operating hotels. Therefore, the Company
enters into leases (the "Percentage Leases") with the Lessee, and the Lessee
operates the hotels and pays rent to the Company based, in large part, on the
revenues from the hotels. Consequently, the Company relies entirely on the
Lessee to effectively operate the Company's hotels in a manner which generates
sufficient cash flow to enable the Lessee to timely make the rent payments
under the applicable Percentage Leases. Ineffective operation of the hotels
may result in the Lessee's being unable to pay rent at the higher tier level
necessary for the Company to fund distributions to shareholders because payment
of base rent alone is insufficient for such purposes. In the event that all or
a portion of such higher tier rent is not received by the Company, the Company
may not be able to make such distributions to its shareholders. There can be
no assurance that the Company will receive such higher tier rent from the
Lessee or that the Lessee will even be able to pay base rent. The Lessee
controls the daily operations of the hotels under the Percentage Leases, which
have non-cancelable initial terms of ten years. The Company selected the
Lessee without consideration of other lessees because Mr. Alter and Mr.
Biederman, who own the Lessee, owned and were involved in the management of a
number of the hotels contributed to the Company in connection with its initial
public offering in 1995 (the "IPO") and because Mr. Alter and Mr. Biederman own
significant units in the Partnership and options to acquire Common Stock of the
Company, and therefore have an incentive to cause the Lessee to maximize rents.
Except as set forth in the Percentage Leases, neither the Company nor the
Partnership has the authority to require the Lessee to operate the hotels in a
manner that results in a maximization of rent to the Company. Other than
working capital to operate the hotels, the Lessee only has nominal assets,
which will likely be insufficient to satisfy any claims the Company may have if
the Lessee defaults under the Percentage Leases. Mr. Alter and Mr. Biederman
have entered into an agreement (the "Third Party Pledge Agreement"), whereby
the obligations of the Lessee under the Percentage Leases are secured with a
pledge of Mr. Alter's and Mr. Biederman's units, up to 481,955 units. This
may limit the Company's ability to recover in full for any claims it may have
against the Lessee for defaults under the Percentage Leases. Certain
amendments to the Third Party Pledge Agreement have subordinated the Company's
lien on the majority of Mr. Alter's units to the lien in favor of an
institutional lender providing a working capital line to the Lessee guaranteed
by Mr. Alter and secured by a pledge of a significant portion of Mr. Alter's
units. The obligations of the Lessee under the Percentage Leases are not
secured by any additional security deposits or guarantees by third parties.
The Lessee has historically been able to meet its rent obligations under the
Percentage Leases.
CONFLICTS OF INTEREST BETWEEN THE COMPANY AND CERTAIN OFFICERS AND DIRECTORS
Because of Mr. Alter's and Mr. Biederman's ownership in and positions
with the Company and the Lessee and Mr. Alter's ownership of the company that
manages the hotels (the "Management Company"), there are inherent conflicts of
interest between the Lessee, the Management Company and the Company in the
leasing, acquisition, disposition, operation and management of the Company's
hotels. Accordingly, the interests of shareholders are not always aligned with
the Company and may not have been, and in the future may not be, reflected
fully in all decisions made or actions taken by the officers and directors of
the Company. In the event revenues from the Company's hotels increase
significantly over prior periods and operating expenses with respect thereto
are less than historical or projected operating expenses, the Lessee could
disproportionately benefit. In addition, there may be conflicts of interest in
connection with the sale of certain hotels. Unrealized gain from the sale to
the Company of certain hotels contributed to the Company in connection with its
IPO is specially allocated to Mr. Alter and Mr. Biederman and any sale of such
hotels by the Partnership may cause adverse tax consequences to them. In
addition,
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the reduction of mortgage indebtedness by the Partnership at any time below
certain levels would create adverse tax consequences to Mr. Alter and Mr.
Biederman. These conflicts may result in decisions relating to the sale of
certain hotels and/or the incurrence or repayment of indebtedness which do not
reflect solely the interests of the Company and the shareholders. In addition,
the Company will generally be required under the Percentage Leases to pay a
lease termination fee to the Lessee if the Company elects to sell a hotel and
not replace it with another hotel. The payment of a termination fee to the
Lessee, which is owned by Mr. Alter and Mr. Biederman, may also result in
decisions regarding the sale of a hotel which do not reflect solely the
interests of the Company and its shareholders.
RELIANCE ON MR. ALTER AND OTHER KEY PERSONNEL
The Company's future success and its ability to manage future growth
depends in large part upon the efforts of its senior management and its ability
to attract and retain key executive officers and other highly qualified
personnel. In particular, the Company places substantial reliance on the hotel
industry knowledge and experience and the continued services of Robert A.
Alter, the Company's Chairman and President. Competition for such personnel is
intense and there can be no assurance that the Company will be successful in
attracting and retaining such personnel. Accordingly, there can be no
assurance that the Company's senior management will be able to successfully
execute or implement the Company's growth and operating strategies. In
addition, the loss of Mr. Alter's services or the Company's inability to
attract and retain highly qualified personnel may adversely affect the
operations of the Company and Cash Available for Distribution.
HOTEL INDUSTRY RISKS
Operating Risks and Competition. Many of the Company's competitors
have substantially greater marketing and financial resources than the Company
and the Lessee. In addition, the Company's hotels are subject to all operating
risks common to the hotel industry. The hotel industry has experienced
volatility in the past, as have the Company's hotels. Hotel industry risks
include, among other things, competition from other hotels; over-building in
the hotel industry which has adversely affected occupancy, average daily rate
("ADR") and REVPAR increases in operating costs due to inflation and other
factors, which may not necessarily be offset by increased room rates;
dependence on business and commercial travelers and tourism; strikes and other
labor disturbances of hotel employees for hotels owned by the Company;
increases in energy costs and other expenses of travel; and adverse effects of
general and local economic conditions. These factors could decrease room
revenues of the hotels and adversely affect the Lessee's ability to make
payments of rent under the Percentage Leases to the Company, and therefore
reduce Cash Available for Distribution.
Seasonality of Hotel Business and the Company's Hotels. The hotel
industry is seasonal in nature. Generally, revenues for the Company's hotels
are greater in the first and third quarters than in the second and fourth
quarters. This seasonality can be expected to cause quarterly fluctuations in
the Company's Percentage Lease revenues which may be insufficient to provide
all of the Cash Available for Distribution necessary to pay dividends in a
given quarter.
Increased Competition Resulting From Overbuilding. The hotel industry
has historically experienced cycles of overbuilding in certain geographic
markets and product segments. Such overbuilding increases competition for
hotel guests, resulting in lower occupancies and lower ADRs, thereby reducing
the profitability of the hotels affected by the increased competition. While
the Company's investment strategy is to acquire underperforming hotels or
hotels where there are significant barriers to entry, there can be no assurance
that the current hotel development activities, particularly in the Company's
limited service segment, will not create additional significant competition for
the Company's hotels. Such increased competition would reduce the revenue
generated by the Lessee, thus reducing percentage rent paid to the Company and
Cash Available for Distribution.
IMPACT OF INCREASED OPERATING COSTS AND CAPITAL EXPENDITURES
Hotels in general, including the Company's hotels, have an ongoing
need for renovations and other capital improvements, including periodic
replacement of furniture, fixtures and equipment. In this regard, the Company
may spend significant dollars renovating, repositioning or rebranding a number
of the Kahler Hotels to maximize financial performance; however, the Company is
unable to estimate the amounts to be expended at this time. In addition, the
franchise agreements under which the Company's hotels are operated impose
specified operating standards and may permit the franchisor to condition the
continuation of a franchise agreement on the completion
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of capital improvements. Under the terms of the Percentage Leases, the Company
is also obligated to pay the cost of certain capital expenditures at its hotels
and to pay for furniture, fixtures and equipment. The ability of the Company
to fund these and other capital expenditures and periodic replacement of
furniture, fixtures and equipment will depend in part on the financial
performance of the Lessee and the hotels. If these expenses exceed the
Company's estimate, the additional expenses could have an adverse effect on
Cash Available for Distribution. Furthermore, any inability or failure to fund
these expenditures could have a material adverse effect on occupancy rates,
ADRs and REVPAR and may constitute a breach under the franchise agreements.
HAWTHORN SUITES DEVELOPMENT RISKS
The Company entered into a five-year master development agreement with
U.S. Franchise Systems, Inc. and Hawthorn Suites Franchising, Inc. on March 10,
1997 to permit the Company to franchise properties operated under the Hawthorn
Suites brand. Pursuant to the agreement, the Company will have the right to
obtain franchise licenses in several major urban markets on the West Coast.
Under the agreement, certain development rights may terminate if the Company
does not establish a certain minimum number of licenses for Hawthorn Suites
during each year. This timetable may cause the Company to overcommit to
building and owning Hawthorn Suites at the expense of other growth
opportunities. As a franchise with a limited number of hotels currently
operating, the Company's focus on this brand subjects it to greater risks than
a more diversified approach.
FRANCHISE RISKS
The majority of the Company's hotels are operated pursuant to
franchise or license agreements and additional hotels may become subject to
franchise arrangements. The Lessee will hold the franchise or license
agreements for the hotels and will be responsible for complying with the terms
of these agreements. Such franchise or license arrangements often provide
marketing and room reservation services to the hotels, but these arrangements
also impose financial obligations on hotels generally related to maintaining
the condition of hotels and the payment of franchise fees. Continuation of
such franchises is subject to specified operating standards and other terms and
conditions. Franchisors periodically inspect franchised hotels to confirm
compliance. In addition, franchisors may require the Company to fund
significant capital improvements to the hotels in the future to maintain such
franchises. The failure of a franchisee to maintain standards or adhere to
terms and conditions imposed by the franchisor may result in the loss of a
license or termination of the franchise or damages as a result of the breach.
It is possible that a franchisor could condition the continuation of a
franchise on the completion of capital improvements or replacements of
furniture, fixtures and equipment which the Board of Directors determines are
too expensive or otherwise unwarranted in light of general economic conditions
or operating results or prospects of the affected hotel. The loss of a
franchise could have a material adverse effect upon the operation, financing or
value of the hotel subject to the franchise because of the loss of associated
name recognition, marketing support and centralized reservation systems. There
can be no assurance that an alternative franchise arrangement can be obtained
or that significant expenditures might not be imposed as a condition to
obtaining a new franchise. The loss of a franchise for one or more of the
hotels could have a material adverse effect on the Company's revenues under the
Percentage Leases and Cash Available for Distribution to its shareholders.
DEPENDENCE ON ACQUISITIONS TO INCREASE CASH AVAILABLE FOR DISTRIBUTION
The Company's success in implementing its growth plan will depend
significantly on the Company's ability to acquire additional hotels at
attractive prices. After the ramp-up of certain of the hotels which were
recently redeveloped or renovated and repositioned or which are expected to be
redeveloped or renovated and repositioned in the near future, internal growth
in ADR and occupancy for the hotels is not expected to provide as much growth
in Cash Available for Distribution as will acquisition of additional hotels.
However, since the Company intends to borrow funds to purchase, redevelop or
renovate and reposition hotels, the Company will be subject to the risks
associated with increased indebtedness, such as paying debt service even if
cash flow from such additional hotels is not sufficient to cover such costs.
FAILURE TO MAINTAIN REIT STATUS
The Company intends to operate so as to be taxed as a REIT under
Sections 856-860 of the Internal Revenue Code of 1986, as amended (the "Code").
As long as the Company qualifies for taxation as a REIT, with certain
exceptions, the Company will not be taxed at the corporate level on its taxable
income that is distributed to its shareholders. A REIT is subject to a number
of organizational and operational requirements, including
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requirements as to the nature of its income and assets, distribution
requirements, diversity of stock ownership requirements and record-keeping
requirements. While the Company intends to satisfy all of these requirements
for treatment as a REIT, it is possible that the Company may in the future fail
to satisfy one or more of these requirements. Failure to qualify as a REIT
would render the Company subject to tax (including any applicable minimum tax)
on its taxable income at regular corporate rates and distributions to the
shareholders in any such year would not be deductible by the Company. Unless
entitled to relief under certain Code provisions, the Company also would be
disqualified from treatment as a REIT for the four taxable years following the
year during which qualification was lost. Even if the Company qualifies for
taxation as a REIT, the Company may be subject to certain state and local taxes
on its income and property.
In order for the Company to be taxed as a REIT, the Partnership must
also be classified as a partnership for federal income tax purposes. If the
Partnership were to be taxable as a corporation, because the Company's
ownership interest in the Partnership constitutes more than 10% of the
Partnership's voting securities and exceeds 5% of the value of the Company's
assets, the Company would cease to qualify as a REIT. The imposition of
corporate income tax on the Company and the Partnership would substantially
reduce the amount of Cash Available for Distribution.
See "Federal Income Tax Considerations" for a discussion of the
material tax consequences and risks of an investment in the Company.
OWNERSHIP LIMITATION RESULTING IN LOSS OF REIT STATUS
In order for the Company to maintain its qualification as a REIT, not
more than 50% in value of its outstanding stock may be owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities). Furthermore, if any shareholder or group of shareholders of
the Lessee owns, actually or constructively, 10% or more of the stock of the
Company, the Lessee could become a related party tenant of the Partnership,
which likely would result in loss of REIT status for the Company. For the
purpose of preserving the Company's REIT qualification, the Company's Articles
of Incorporation prohibit direct or indirect ownership of more than 9.8% of the
outstanding shares of any class of the Company's stock by any person or group
(the "Ownership Limitation"). Generally, the capital stock owned by affiliated
owners will be aggregated for purposes of the Ownership Limitation. Subject to
certain exceptions, any transfer of Common or Preferred Stock that would
prevent the Company from continuing to qualify as a REIT under the Code will be
designated as "Shares-in-Trust" and transferred automatically to a trust (the
"Share Trust") effective on the day before the purported transfer of such
Common Stock or Preferred Stock. The record holder of the shares of Common
Stock or Preferred Stock that are designated as Shares-in-Trust will be
required to submit such number of Common Stock or Preferred Stock to the Share
Trust and the beneficiary of the Share Trust will be one or more charitable
organizations that are named by the Company.
REAL ESTATE INVESTMENT RISKS IN GENERAL
The Company's hotels will be subject to varying degrees of risk
generally incident to the ownership of real property. Income from the hotels
may be adversely affected by changes in national and local economic conditions,
changes in interest rates and in the availability, cost and terms of mortgage
funds, the impact of present or future environmental legislation and compliance
with environmental laws, the ongoing need for capital improvements, changes in
real estate tax rates and other operating expenses, changes in governmental
rules (such as those requiring upgrades for disabled persons) and fiscal
policies, civil unrest, acts of God, including earthquakes, hurricanes and
other natural disasters (which may result in uninsured losses), acts of war,
changes in zoning laws, and other factors which are beyond the control of the
Company. In addition, real estate investments are relatively illiquid, and the
ability of the Company to vary its portfolio in response to changes in economic
and other conditions will be limited.
POSSIBLE LIABILITY RELATING TO ENVIRONMENTAL MATTERS
Under various federal, state and local environmental laws, ordinances
and regulations, a current or previous owner or operator of real property may
become liable for the costs of removal or remediation of hazardous or toxic
substances on, under or in such property. Such laws often impose liability
without regard to whether the owner or operator knew of, or was responsible
for, the presence of such hazardous or toxic substances. The presence of
hazardous or toxic substances, or the failure to properly remediate such
substances when present, may adversely affect the owner's ability to sell or
rent such real property or to borrow using such real property as
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collateral. Persons who arrange for the disposal or treatment of hazardous or
toxic wastes may be liable for the costs of removal or remediation of such
wastes at the disposal or treatment facility, regardless of whether such
facility is owned or operated by such person. Other federal, state and local
laws, ordinances and regulations require abatement or removal of certain
asbestos containing materials in the event of demolition or certain renovations
or remodeling and govern emissions of and exposure to asbestos fibers in the
air. The operation and subsequent removal of certain underground storage tanks
also are regulated by federal and state laws.
DISTRIBUTION OF SUBSTANTIALLY ALL OF CASH AVAILABLE FOR DISTRIBUTION;
DISTRIBUTIONS INCLUDE RETURN OF CAPITAL
Consistent with the Company's practice of acquiring properties in need
of renovation or redevelopment, the Company's annual distributions to
shareholders have constituted a high percentage of the Company's Cash Available
for Distribution. If this continues, the Company will retain little or no cash
from the rent payments under the Percentage Leases, and expenditures for
additional acquisitions or future capital improvements would have to be funded
from borrowings, or from proceeds from the sale of assets (including the
hotels), or debt or equity securities. In addition, a percentage of the
estimated annual distribution has constituted a return of capital rather than a
distribution of retained earnings. Consequently, there is a risk that the
distribution rate has been set too high and may not be sustainable.
ADVERSE EFFECT OF SHARES AVAILABLE FOR FUTURE ISSUANCE AND SALE ON MARKET PRICE
OF COMMON STOCK
The Company's Articles of Incorporation authorize the Board of
Directors to issue up to 60,000,000 shares of capital stock, consisting of
50,000,000 shares of Common Stock and 10,000,000 shares of Preferred Stock. As
of December 4, 1997, the Board of Directors was able to reclassify and issue
an aggregate of approximately 11,020,029 unissued or unreserved shares of
Common Stock and to classify and issue all 9,750,000 unissued shares of
Preferred Stock. The Company's acquisition strategy depends in part on access
to additional capital through sales and issuances of equity securities. The
market price of the Common Stock may be adversely affected by the availability
for future sale and issuance of such unissued and unreserved shares of Common
Stock and Preferred Stock and the consequent dilutive effect of such issuances.
In addition, the market price of the Common Stock may also be
adversely affected by the availability for future sale and issuance of shares
of Common Stock that could be issued upon the redemption of units of the
Partnership, including the Units. The filing of this registration statement
will give certain limited partners of the Partnership the ability to sell
shares of Common Stock issued upon redemption of Units. In addition, the
former stockholders of Kahler were granted certain registration rights in
connection with the shares being issued to them in the Kahler Acquisition.
RISK OF DILUTION
As hotel acquisition opportunities arise from time to time, the
Company may issue additional shares of Common Stock or Preferred Stock to raise
the capital necessary to finance the hotel acquisitions or may issue Common
Stock or Preferred Stock or Partnership units which are redeemable on a
one-to-one basis for Common Stock to acquire hotels. Such issuances could
result in dilution of shareholders' equity.
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SECURITIES OFFERED
All of the Offered Shares of the Company's Common Stock that may be
offered and sold pursuant to this Prospectus are being sold by the Selling
Stockholders. None of the Offered Shares are being sold by the Company. The
Offered Shares are shares of the Company's Common Stock received by the Selling
Stockholders upon the redemption of their Units in the Partnership.
USE OF PROCEEDS
The Company will not receive any of the proceeds from the sale of
Offered Shares by the Selling Stockholders.
SELLING STOCKHOLDERS
The following table sets forth the number of shares of Common Stock
beneficially owned by each of the Selling Stockholders. Except as indicated,
none of the Selling Stockholders has had a material relationship with the
Company within the past three years other than as a result of the ownership of
the Common Shares or other securities of the Company. Because the Selling
Stockholders may offer all or some of the Common Stock which they hold, or have
the right to acquire, pursuant to the offering contemplated by this Prospectus,
and because there are currently no agreements, arrangements or understandings
with respect to the sale of any of the Offered Shares, no estimate can be given
as to the number of shares that will be held by the Selling Stockholders after
completion of this offering. See "Distribution or Sale of the Shares." The
1,000,000 Shares covered by this Prospectus may be offered from time to time by
the Selling Stockholders named below who have acquired, or will acquire, an
aggregate of 764,793 shares of Common Stock pursuant to the redemption of Units,
as well as by other limited partners of the Partnership who may from time to
time redeem Units for up to an aggregate of 235,207 shares of Common Stock.
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NUMBER OF
NUMBER OF SHARES PERCENT OF
SHARES BENEFICIALLY REGISTERED OUTSTANDING
NAME OF SELLING STOCKHOLDER OWNED FOR SALE HEREBY SHARES
- --------------------------- ------------------- --------------- ------------
MYPC Partners(1) 58,446 58,446 *
Flagstaff Hotel Assets Inc. 274,488 274,488 *
Tucson Desert Assets Inc. 431,859 431,859 *
Others 235,207 235,207 *
--------- ---------
TOTAL 1,000,000 1,000,000
- --------------------- ========= =========
* Less than 1% as of December 17, 1997.
(1) An affiliate of NationsBanc Montgomery Securities, Inc. In connection with
the IPO, MYPC acquired 24,500 Units and warrants to purchase 33,946 Units
which were subsequently exercised, for a total of 58,446 Units. Such Units
were redeemed for an equal number of shares of Common Stock in September,
1997.
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DESCRIPTION OF COMMON STOCK AND PREFERRED STOCK
The following summary description of Common Stock of the Company is
subject to and qualified in its entirety by reference to Maryland law described
herein, and to the Articles of Incorporation and Bylaws of the Company (and any
amendments or supplements thereto) which are filed as exhibits to, or
incorporated by reference in, the Registration Statement of which this
Prospectus is a part.
GENERAL
The Articles of Incorporation of the Company provide that the Company may
issue up to 60,000,000 shares of capital stock, consisting of 50,000,000 shares
of Common Stock, $0.01 par value per share, and 10,000,000 shares of preferred
stock, $0.01 par value per share (the "Preferred Stock"). As of December 4,
1997, (i) 32,241,986 shares of Common Stock were issued and outstanding, (ii)
946,226 shares of Common Stock were reserved for issuance under the Company's
Dividend Reinvestment and Stock Purchase Plan, (iii) 1,191,174 shares of Common
Stock were reserved for issuance under the Company's 1994 Stock Incentive Plan,
(iv) 121,310 shares of Common Stock were reserved for issuance under the 1994
Directors Plan, (v) 1,699,605 shares of Common Stock were reserved for issuance
upon the conversion of Preferred Stock, (vi) 2,747,328 shares of Common Stock
were reserved for issuance upon the conversion of units into Common Stock, and
(vii) 32,342 shares of Common Stock were reserved for issuance upon the
conversion of warrants or for other purposes.
The Common Stock is listed on the NYSE under the symbol "SSI." ChaseMellon
Shareholder Services LLC is the Company's registrar and transfer agent for the
Common Stock and Partnership Stock.
COMMON STOCK
All shares of Common Stock that may be offered from time to time by the
Selling Stockholders are, or will be, when issued, duly authorized, fully paid
and nonassessable. Subject to the preferential rights of any other shares,
series or class of shares of capital stock that may from time to time come into
existence, and to the provisions of the Company's Articles of Incorporation
regarding owning shares in excess of the Ownership Limitation holders of Common
Stock will be entitled to receive dividends on such Common Stock if, as and
when authorized and declared by the Board of Directors of the Company out of
assets legally available therefor and to share ratably in the assets of the
Company legally available for distribution to its shareholders in the event of
its liquidation, dissolution or winding-up after payment of, or adequate
provision for, all known debts and liabilities of the Company. The Company
intends to continue its practice of paying regular quarterly dividends to the
holders of its Common Stock.
Holders of the Company's Common Stock can elect to participate in the
Company's Dividend Reinvestment and Stock Purchase Plan (the "Plan") and have
all or part of their dividends reinvested in additional shares of Common Stock.
Participants in the Plan can also purchase additional shares of Common Stock
with cash (subject to certain limitations). The terms of the Plan are
described in a separate prospectus which may be obtained by calling the Plan
administrator, Mellon Bank, N.A., at (888) 261-6776.
Subject to the provisions of the Articles of Incorporation regarding
owning shares in excess of the Ownership Limitation, each outstanding share of
Common Stock entitles the holder to one vote on all matters submitted to a vote
of shareholders, including the election of directors, and, except as otherwise
required by law or except as provided with respect to any other class or series
of shares of stock, the holders of such shares of Common Stock will possess the
exclusive voting power. There is no cumulative voting in the election of
directors, which means that the holders of a majority of the outstanding shares
of Common Stock can elect all of the directors then standing for election and
the holders of the remaining shares, if any, will not be able to elect any
directors.
Holders of Common Stock have no conversion, sinking fund, redemption
rights or any preemptive rights to subscribe for any securities of the Company,
nor do they have any preference, appraisal or exchange rights.
Subject to limitations prescribed by Maryland law and the Company's
Articles of Incorporation, the Board of Directors is authorized to classify and
reclassify any unissued portion of the authorized shares of capital stock to
provide for the issuance of shares in other classes or series, including other
classes or series of Common Stock or classes or series of Preferred Stock to
establish the number of shares in each class or series and to fix the
designation and any preferences, conversion and other rights, voting powers,
restrictions, limitations as to dividends, qualifications and terms and
conditions of redemption of such class or series. The rights, preferences,
privileges and restrictions of such class or series will be fixed by Articles
Supplementary to the Company's Articles of Incorporation relating to such class
or series.
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PREFERRED STOCK
Subject to limitations prescribed by Maryland law and the Company's
Articles of Incorporation, the Board of Directors is authorized to issue, from
the 9,750,000 authorized but unissued shares of capital stock of the Company,
Preferred Stock in such classes or series as the Board of Directors may
determine and to establish from time to time the number of shares of Preferred
Stock to be included in any such class or series and to fix the designation and
any preferences, conversion and other rights, voting powers, restrictions,
limitations as to dividends, qualifications and terms and conditions of
redemption of the shares of any such class or series, and such other subjects
or matters as may be fixed by resolution of the Board of Directors. An
aggregate of 250,000 shares of Class A Preferred Stock were issued in
connection with the Kahler Acquisition. The issuance of Preferred Stock may
have the effect of delaying, deferring or preventing a change in control of the
Company or other transaction in which holders of shares of Common Stock might
receive a premium for such shares over the market price.
7.9% Class A Cumulative Convertible Preferred Stock
In connection with the Kahler Acquisition the Company issued 250,000
shares of its newly designated 7.9% Class A Cumulative Convertible Preferred
Stock. The holders of the Class A Preferred Stock are entitled to one vote for
each share of Common Stock into which such holder's Class A Preferred Stock
could then be converted, and with respect to such vote, such holder shall have
full voting rights and powers equal to the voting rights and powers of the
holders of Common Stock. The holders of Class A Preferred Stock shall be
entitled to vote, together with holders of Common Stock as a single class.
Subject to preferences that may be applicable to any future class of Preferred
Stock, the holders of Class A Preferred Stock are entitled to receive, ratably,
a dividend equal to the greater of (i) 7.9% per share per annum or (ii) the
percentage dividend that would be paid on the Common Stock into which the Class
A Preferred Stock is convertible. In the event of a liquidation, dissolution or
winding up of the Company, subject to the rights of future classes of Preferred
Stock, the holders of Class A Preferred Stock are entitled to receive, prior
and in preference to the holders of Common Stock, an amount per share equal to
$100.00 for each outstanding share of Class A Preferred Stock, plus accrued and
unpaid dividends. The Class A Preferred Stock has no preemptive rights.
Each share of Class A Preferred Stock is convertible at the option of the
holder at any time into a number of shares of Common Stock that is equal to the
quotient obtained by dividing $100 by $14.7093, subject to adjustment for stock
splits, stock dividends, recapitalizations and the like. On or at any time
after the fifth anniversary of issuance of the Class A Preferred Stock, the
Company may, at its option, redeem the Class A Preferred Stock in whole or in
part by paying an amount equal to the redemption percentage of $100.00 per
share then in effect (as adjusted for any stock dividends, combinations or
splits), plus all accrued but unpaid dividends on such shares. The redemption
percentage declines one percent per year, from 105% to par commencing in 2002.
There are no sinking fund provisions applicable to the Class A Preferred Stock.
All outstanding shares of Class A Preferred Stock will, upon issuance, be fully
paid and non-assessable.
Terms of Future Classes of Preferred Stock
The terms of any future class or series of Preferred Stock which may be
issued will be set forth in Articles Supplementary to the Company's Articles of
Incorporation which will be filed with the Maryland Department of Assessments
and Taxation and as an exhibit to (or incorporated by reference in) a report
filed with the Commission in connection with the Company's Exchange Act
reporting obligations.
RESTRICTIONS ON OWNERSHIP OF COMMON STOCK OR PREFERRED STOCK
The following is a description of the restrictions on ownership of the
Common Stock and Preferred Stock. There may be additional provisions that
further restrict ownership and transfer, which will be described in any
applicable Prospectus Supplement. Such description is, and will be, qualified
in its entirety by any supplements to the Articles of Incorporation or Bylaws
filed as exhibits to, or incorporated by reference in, the Registration
Statement of which this Prospectus is a part.
For the Company to qualify as a REIT under the Code, it must meet certain
requirements concerning the ownership of its outstanding shares of capital
stock. Specifically, not more than 50% in value of the Company's outstanding
shares may be owned, directly or indirectly, by five or fewer individuals (as
defined in the Code to include certain entities) during the last half of a
taxable year, and the Company must be beneficially owned by 100
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or more persons during at least 335 days of a taxable year of 12 months or
during a proportionate part of a shorter taxable year. See "Federal Income Tax
Considerations -- Requirements for Qualification." In addition, the Company
must meet certain requirements regarding the nature of its gross income in
order to qualify as a REIT. One such requirement is that at least 75% of the
Company's gross income for each year must consist of rents from real property
and income from certain other real property investments. The rents received by
the Partnership from the Lessee would not qualify as rents from real property,
which would result in loss of REIT status for the Company, if the Company were
at any time to own, directly or constructively, 10% or more of the ownership
interests in the Lessee within the meaning of Section 856(d)(2)(B) of the Code.
See "Federal Income Tax Considerations -- Requirements for Qualification --
Income Tests."
Because the Board of Directors believes it is essential for the Company to
qualify as a REIT, the Articles of Incorporation, subject to certain exceptions
described below, provides that no person may own, or be deemed to own by virtue
of the constructive ownership provisions of the Code, a number or value of
shares in excess of the Ownership Limitation, defined as more than 9.8% of the
lesser in value of the total number or value of the outstanding shares of
Common Stock or the outstanding shares of Preferred Stock. The constructive
ownership rules of the Code are complex and may cause shares owned actually or
constructively by two or more related individuals and/or entities to be
constructively owned by one individual or entity. As a result, the acquisition
of less than 9.8% of the outstanding shares of Common Stock or 9.8% of the
shares of Preferred Stock (or the acquisition of an interest in an entity which
owns the shares) by an individual or entity could cause that individual or
entity (or another individual or entity) to own constructively in excess of
9.8% of the outstanding shares of Common Stock or 9.8% of the outstanding
shares of Preferred Stock, and thus subject such shares to the Ownership
Limitation provisions of the Articles of Incorporation. The Ownership
Limitation also prohibits any transfer of Common Stock or Preferred Stock that
would (i) result in the Common Stock and Preferred Stock being owned by fewer
than 100 persons (determined without reference to any rules of attribution),
(ii) result in the Company being "closely held" within the meaning of Section
856(h) of the Code, or (iii) cause the Company to own, directly or
constructively, 10% or more of the ownership interests in a tenant of the
Company's real property, within the meaning of Section 856(d)(2)(B) of the
Code. Except as otherwise provided below, any such acquisition or transfer of
the Company's capital stock (including any constructive acquisition or transfer
of ownership) shall be null and void, and the intended transferee or owner will
acquire no rights to, or economic interests in, the shares.
Subject to certain exceptions described below, any purported transfer of
Common Stock or Preferred Stock that would (i) result in any person owning,
directly or indirectly, Common Stock or Preferred Stock in excess of the
Ownership Limitation, (ii) result in the Common Stock and Preferred Stock being
owned by fewer than 100 persons (determined without reference to any rules of
attribution), (iii) result in the Company being "closely held" within the
meaning of Section 856(h) the Code, or (iv) cause the Company to own, directly
or constructively, 10.0% or more of the ownership interests in a tenant of the
Company's or the Partnership's real property, within the meaning of Section
856(d)(2)(B) of the Code, will be designated as "Shares-in-Trust" and
transferred automatically to a Share Trust effective on the day before the
purported transfer of such Common Stock or Preferred Stock. The record holder
of the Common Stock or Preferred Stock that are designated as Shares-in-Trust
(the "Prohibited Owner") will be required to submit such number of shares of
Common Stock or Preferred Stock to the Share Trust for designation in the name
of a trustee to be designated by the Company (the "Share Trustee"). The
beneficiary of the Share Trust (the "Beneficiary") will be one or more
charitable organizations that are named by the Company.
Shares-in-Trust will remain issued and outstanding Common Stock or
Preferred Stock and will be entitled to the same rights and privileges as all
other shares of the same class or series. The Share Trust will receive all
dividends and distributions on the Shares-in-Trust and will hold such dividends
or distributions in trust for the benefit of the Beneficiary. The Share
Trustee will vote all Shares-in-Trust. The Share Trustee will designate a
permitted transferee of the Shares-in-Trust, provided that the permitted
transferee (i) purchases such Shares-in-Trust for valuable consideration and
(ii) acquires such Shares-in-Trust without such acquisition resulting in a
transfer to another Share Trust.
The Prohibited Owner with respect to Shares-in-Trust will be required to
repay to the Share Trust the amount of any dividends or distributions received
by the Prohibited Owner (i) that are attributable to any Shares-in-Trust and
(ii) for which the record date was on or after the date that such shares became
Shares-in-Trust. The Prohibited Owner generally will receive from the Share
Trustee the lesser of (i) the price per share such Prohibited Owner paid for
the Common Stock or Preferred Stock that were designated as Shares-in-Trust
(or, in the case of a gift or devise, the market price (based on a five day
trading average) per share on the date of such transfer) and (ii) the price per
share received by the Share Trustee from the sale or other disposition of such
Shares-in-Trust. Any amounts received
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by the Share Trustee in excess of the amounts to be paid to the Prohibited
Owner will be distributed to the Beneficiary.
The Shares-in-Trust will be deemed to have been offered for sale to the
Company, or its designee, at a price per share equal to the lesser of (i) the
price per share in the transaction that created such Shares-in-Trust (or, in
the case of a gift or devise, the market price per share on the date of such
transfer) or (ii) the market price per share on the date that the Company, or
its designee, accepts such offer. The Company will have the right to accept
such offer for a period of ninety days after the later of (i) the date of the
purported transfer which resulted in such Shares-in-Trust and (ii) the date the
Company determines in good faith that a transfer resulting in such
Shares-in-Trust occurred.
Any person who acquires or attempts to acquire Common Stock or Preferred
Stock in violation of the foregoing restrictions, or any person who owned
shares of Common Stock or Preferred Stock that were transferred to a Share
Trust, will be required (i) to give immediately written notice to the Company
of such event and (ii) to provide to the Company such other information as the
Company may request in order to determine the effect, if any, of such transfer
on the Company's status as a REIT.
All persons who own, directly or indirectly, more than 5% (or such lower
percentages as required pursuant to regulations under the Code) of the
outstanding shares of Common Stock and Preferred Stock must within 30 days
after January 1 of each year, provide to the Company a written statement or
affidavit stating the name and address of such direct or indirect owner, the
number of shares of Common Stock and Preferred Stock owned directly or
indirectly, and a description of how such shares are held. In addition, each
direct or indirect shareholder shall provide to the Company such additional
information as the Company may request in order to determine the effect, if
any, of such ownership on the Company's status as a REIT and to ensure
compliance with the Ownership Limitation.
The Ownership Limitation generally will not apply to the acquisition of
shares of Common Stock or Preferred Stock by an underwriter that participates
in a public offering of such shares. In addition, the Board of Directors, upon
receipt of a ruling from the IRS or an opinion of counsel and upon such other
conditions as the Board of Directors may direct, may exempt a person from the
Ownership Limitation under certain circumstances. The foregoing restrictions
will continue to apply until the Board of Directors, with the approval of the
holders of at least two-thirds of the outstanding shares of all votes entitled
to vote on such matter at a regular or special meeting of the shareholders of
the Company, determines to terminate its status as a REIT.
The Ownership Limitation will not be automatically removed even if the
REIT provisions of the Code are changed so as to remove any ownership
concentration limitation. Any change of the Ownership Limitation would require
an amendment to the Articles of Incorporation. Such amendment requires the
affirmative vote of holders holding at least two-thirds of the outstanding
shares entitled to vote on the matter. In addition to preserving the Company's
status as a REIT, the Ownership Limitation may have the effect of delaying,
deferring, discouraging or preventing a transaction or a change in control of
the Company without the approval of the Board of Directors.
Any certificates representing shares of Common Stock or Preferred Stock
will bear a legend referring to the restrictions described above.
CERTAIN PROVISIONS OF MARYLAND LAW
AND OF THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The following summary of certain provisions of Maryland law and of the
Articles of Incorporation and Bylaws of the Company does not purport to be
complete and is qualified in its entirety by reference to Maryland law and the
Articles of Incorporation and Bylaws of the Company (and any amendments and
supplements thereto) which are filed as exhibits to, or incorporated by
reference in, the Registration Statement of which this Prospectus is a part.
ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE COMPANY'S
ARTICLES OF INCORPORATION AND BYLAWS
The provisions in the Articles of Incorporation regarding the Ownership
Limitation and the classification of the Board of Directors, the business
combination provisions of the Maryland General Corporation Law ("MGCL"), the
control shares acquisition provisions of the MGCL, and the advance notice
provisions of the Bylaws could have the
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effect of delaying, deferring, discouraging or preventing a transaction or a
change in control of the Company in which holders of some, or a majority, of
the capital stock of the Company might receive a premium for their shares over
the then prevailing market price or which such holders might believe to be
otherwise in their best interest. Certain significant provisions which might
have this effect are described below.
CLASSIFICATION OF THE BOARD OF DIRECTORS
The Bylaws provide that the number of directors of the Company may be
established by the Board of Directors but may not be fewer than three nor more
than nine. The directors may increase the number of directors by a vote of a
least 80% of the members of the Board of Directors, provided that the number of
directors shall never be less than the number required by Maryland law and that
the tenure of office of a director shall not be affected by any decrease in the
number of directors. Any vacancy will be filled, including a vacancy created
by an increase in the number of directors, at any regular meeting or at any
special meeting called for that purpose, by a majority of the remaining
directors, except that a vacancy resulting from an increase in the number of
directors must be filled by a majority of the entire Board of Directors.
Pursuant to the Articles of Incorporation the Board of Directors will be
divided into three classes of directors. As the term of each class expires,
directors in that class will be elected by the shareholders of the Company for
a term of three years and until their successors are duly elected and qualify.
Classification of the Board of Directors is intended to assure the continuity
and stability of the Company's business strategies and policies as determined
by the Board of Directors. Shareholders will have no right to cumulative
voting in the election of directors. Consequently, at each annual meeting of
shareholders, the holders of a majority of the shares of Common Stock present
in person or by proxy at such meeting will be able to elect all of the
successors of the class of directors whose terms expire at that meeting.
The classified board provision could have the effect of making the
replacement of incumbent directors more time consuming and difficult, which
could delay, defer, discourage or prevent an attempt by a third party to obtain
control of the Company or other transaction, even though such an attempt or
other transaction might be beneficial to the Company and its shareholders. At
least two annual meetings of shareholders, instead of one, will generally be
required to effect a change in a majority of the Board of Directors. Thus, the
classified board provision could increase the likelihood that incumbent
directors will retain their positions.
REMOVAL OF DIRECTORS
The Articles of Incorporation provide that a director may be removed with
or without cause by the affirmative vote of at least two-thirds of the votes
entitled to be cast in the election of directors. This provision, when coupled
with the provision in the Bylaws authorizing the Board of Directors to fill
vacant directorships, could preclude shareholders from removing incumbent
directors except upon the existence of a substantial affirmative vote and by
filling the vacancies created by such removal with their own nominees upon the
affirmative vote of a majority of the votes entitled to be cast in the election
of directors.
LIMITATION OF LIABILITY AND INDEMNIFICATION
The Articles of Incorporation and Bylaws limit the liability of the
Company's directors and officers for money damages to the Company and its
shareholders to the fullest extent permitted from time to time by Maryland law.
Maryland law presently permits the liability of directors and officers to a
corporation or its shareholders for monetary damages to be limited, except to
the extent that (i) it is proved that the director or officer actually received
an improper benefit or profit, or (ii) a judgment or other final adjudication
is entered in a proceeding based on a finding that the director's or officer's
action, or failure to act, was the result of active and deliberate dishonesty
and was material to the cause of action, as adjudicated in the proceeding.
This provision does not limit the ability of the Company or its shareholders to
obtain other relief, such as an injunction or rescission.
The Articles of Incorporation and Bylaws require the Company to indemnify
its directors and officers to the fullest extent permitted from time to time by
Maryland law. The Company's Articles of Incorporation and Bylaws also permit
the Company to indemnify employees, agents and other persons acting on behalf
of or at the request of the Company. The MGCL generally permits a corporation
to indemnify its directors, officers and certain other parties against
judgments, penalties, fines, settlements and reasonable expenses actually
incurred by them in connection with any proceeding to which they may be made a
party by reason of their service to or at the request
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of the Company. Indemnification under the provisions of the MGCL is not deemed
exclusive to any other rights, by indemnification or otherwise, to which an
officer or director may be entitled under the Articles of Incorporation or
Bylaws, or under resolutions of shareholders or directors, contract or
otherwise. It is the position of the Commission that indemnification of
directors and officers for liabilities arising under the Securities Act is
against public policy and is unenforceable pursuant to Section 14 of the
Securities Act.
BUSINESS COMBINATIONS
Under the MGCL, certain "business combinations" (including a merger,
consolidation, share exchange or, in certain circumstances, an asset transfer
or issuance or reclassification of equity securities) between a Maryland
corporation and any person who beneficially owns ten percent or more of the
voting power of such corporation's shares or an affiliate of such corporation
who, at any time within the two-year period prior to the date in question, was
the beneficial owner of ten percent or more of the voting power of the
then-outstanding voting shares of such corporation (an "Interested
Shareholder") or an affiliate thereof are prohibited for five years after the
most recent date on which the Interested Shareholder became an Interested
Shareholder. Thereafter, any such business combination must be recommended by
the board of directors of such corporation and approved by the affirmative vote
of at least (a) 80% of the votes entitled to be cast by holders of outstanding
voting shares of such corporation and (b) two-thirds of the votes entitled to
be cast by holders of voting shares of such corporation other than shares held
by the Interested Shareholder with whom (or with whose affiliate) the business
combination is to be effected, unless, among other things, such corporation's
shareholders receive a minimum price (as defined in the MGCL) for their shares
and the consideration is received in cash or in the same form as previously
paid by the Interested Shareholder for its shares. These provisions of
Maryland law do not apply, however, to business combinations that are approved
or exempted by the board of directors of a corporation prior to the time that
the Interested Shareholder becomes an Interested Shareholder. The Board of
Directors has exempted from these provisions of the MGCL any business
combination with certain officers and directors of the Company, and all present
or future affiliates or associates of, or any other person acting in concert or
as a group with, any of the foregoing persons and any other business
combination which may arise in connection with the Company formation
transactions generally.
CONTROL SHARE ACQUISITIONS
The MGCL provides that "control shares" of a Maryland corporation acquired
in a "control share acquisition" have no voting rights except to the extent
approved by a vote of two-thirds of the votes entitled to be cast on the
matter, excluding shares owned by the acquiror, by officers or by directors who
are employees of a corporation. "Control Shares" are voting shares which, if
aggregated with all other such shares previously acquired by the acquiror, or
in respect of which the acquiror is able to exercise or direct the exercise of
voting power (except solely by virtue of a revocable proxy), would entitle the
acquiror to exercise voting power in electing directors within one of the
following ranges of voting power: (i) one-fifth or more but less than one-third
(ii) one-third or more but less than a majority, or (iii) a majority or more of
all voting power. Control Shares do not include shares the acquiring person is
then entitled to vote as a result of having previously obtained shareholder
approval. A "control share acquisition" means the acquisition of control
shares, subject to certain exceptions.
A person who has made or proposes to make a control share acquisition,
upon satisfaction of certain conditions (including an undertaking to pay
expenses), may compel the board of directors of a corporation to call a special
meeting of shareholders to be held within 50 days of demand to consider the
voting rights of the shares. If no request for a meeting is made, the
corporation may itself present the question at any shareholders meeting.
If voting rights are not approved at the meeting or if the acquiring
person does not deliver an acquiring person statement as required by the
statute, then, subject to certain conditions and limitations, a corporation may
redeem any or all of the control shares (except those for which voting rights
have previously been approved) for fair value determined, without regard to the
absence of voting rights for the control shares, as of the date of the last
control share acquisition by the acquiror or of any meeting of shareholders at
which the voting rights of such shares are considered and not approved. If
voting rights for control shares are approved at a shareholders meeting and the
acquiror becomes entitled to vote a majority of the shares entitled to vote,
all other shareholders may exercise appraisal rights. The fair value of the
shares as determined for purposes of such appraisal rights may not be less than
the highest price per share paid by the acquiror in the control share
acquisition, and certain limitations and restrictions otherwise applicable to
the exercise of dissenters' rights do not apply in the context of a control
share acquisition.
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The control share acquisition statute does not apply to shares acquired in
a merger, consolidation or share exchange, if the corporation is a party to the
transaction, or to acquisitions approved or exempted by the articles of
incorporation or bylaws of a corporation.
The Bylaws of the Company contain a provision exempting from the control
share acquisition statute any and all acquisitions by any person of the
Company's Common Stock or Preferred Stock. There can be no assurance that such
provision will not be amended or eliminated in the future.
AMENDMENTS TO THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The Articles of Incorporation may only be amended by the affirmative vote
of the holders of not less than a majority of the votes entitled to be cast on
the matter, except that any proposal (i) to permit cumulative voting in the
election of directors, (ii) to alter provisions of the Articles of
Incorporation requiring a majority of the directors to be independent directors
or provisions of the Articles of Incorporation relative to the classification
of the Company's Board of Directors into three classes, removal of directors,
preemptive rights, indemnification of corporate agents and limitation of
liability of officers and directors, or (iii) that would terminate the
Company's status as a REIT for tax purposes, may not be amended, altered,
changed or repealed without the affirmative vote of at least two-thirds of all
of the votes entitled to be cast on the matter. Subject to the right of the
Company's shareholders to adopt, alter or repeal the Bylaws, the Bylaws may be
amended by the Board of Directors, except for provisions of the Bylaws relating
to the sale of certain hotels and transactions involving the Company in which
an advisor, director or officer has an interest, which may be altered or
repealed only upon the vote of shareholders holding at least two-thirds of the
outstanding shares of stock entitled to vote generally in the election of
directors.
DISSOLUTION OF THE COMPANY
Pursuant to the Articles of Incorporation, the dissolution of the Company
must be approved and advised by the Board of Directors and approved by the
affirmative vote of the holders of a majority of all of the votes entitled to
be cast on the matter.
OPERATIONS
The Company is generally prohibited from engaging in certain activities,
including incurring consolidated indebtedness, in the aggregate, in excess of
50% of the Company's investment in hotels at cost, and acquiring or holding
property or engaging in any activity that would cause the Company to fail to
qualify as a REIT.
FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of material federal income tax considerations
that may be relevant to a prospective holder of the Common Stock. The
discussion contained herein does not address all aspects of taxation that may
be relevant to particular holders of the Common Stock in light of their
personal investment or tax circumstances, or to certain types of holders
(including insurance companies, tax-exempt organizations, financial
institutions or broker-dealers, foreign corporations, and persons who are not
citizens or residents of the United States) subject to special treatment under
the federal income tax laws.
This discussion as to tax consequences is based on current provisions of
the Code, existing, temporary, and currently proposed Treasury Regulations
promulgated under the Code, the legislative history of the Code, existing
administrative rulings and practices of the Service, and judicial decisions.
No assurance can be given that future legislative, judicial, or administrative
actions or decisions, which may be retroactive in effect, will not affect the
accuracy of any statements in this Prospectus with respect to the transactions
entered into or contemplated prior to the effective date of such changes.
EACH PROSPECTIVE PURCHASER IS ADVISED TO CONSULT HIS OWN TAX ADVISOR
REGARDING THE SPECIFIC TAX CONSEQUENCES TO HIM OF THE PURCHASE, OWNERSHIP, AND
SALE OF THE COMMON STOCK AND OF THE COMPANY'S ELECTION TO BE TAXED AS A REIT,
INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN, AND OTHER TAX CONSEQUENCES OF
SUCH PURCHASE, OWNERSHIP, SALE, AND ELECTION, AND OF POTENTIAL CHANGES IN
APPLICABLE TAX LAWS.
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TAXATION OF LIMITED PARTNERS OF UNITS UPON RECEIPT OF COMMON STOCK
The exchange of units for Common Stock will be a fully taxable transaction
to the exchanging Limited Partner. The Limited Partner will recognize gain or
loss upon the receipt of the Common Stock based on the difference between (i)
the sum of the fair market value of the Common Stock received and the Limited
Partner's deemed share of the Partnership's indebtedness and (ii) the Limited
Partner's tax basis in the exchanged units. Any gain so realized will
generally be capital gain (provided the Limited Partner held his or her units
as a capital asset) except to the extent of any gain attributable to the
Limited Partner's share of the Partnership's assets described in Section 751 of
the Code (including inventory and unrealized receivables). The Limited Partner
will commence a new holding period for the Common Stock upon the exchange and
will have a tax basis in the Common Stock equal to its fair market value.
TAXATION OF THE COMPANY
The Company has elected to be taxed as a REIT under Sections 856 through
860 of the Code, effective for each of its taxable years ended since December
31, 1996. The Company's qualification and taxation as a REIT depends upon the
Company's ability to meet, on a continuing basis, the various qualification
tests imposed under the Code discussed below. No assurance can be given that
the actual results of the Company's operation have or will satisfy all of the
requirements for qualification as a REIT.
The sections of the Code relating to qualification and operation as a REIT
are highly technical and complex. The following discussion sets forth the
material aspects of the Code sections that govern the federal income tax
treatment of a REIT and its shareholders. The discussion is qualified in its
entirety by the applicable Code provisions, Treasury Regulations promulgated
thereunder, and administrative and judicial interpretations thereof, all of
which are subject to change prospectively or retrospectively.
Assuming the Company qualifies for taxation as a REIT, it generally will
not be subject to federal corporate income tax on its net income that is
distributed currently to its shareholders. That treatment substantially
eliminates the "double taxation" (i.e., taxation at both the corporate and
shareholder levels) that generally results from investment in a corporation.
However, the Company will be subject to federal income tax in the following
circumstances. First, the Company will be taxed at regular corporate rates on
any undistributed REIT taxable income, including undistributed net capital
gains. Furthermore, under certain circumstances, the Company may be subject to
the "alternative minimum tax" on its items of tax preference. Third, if the
Company has (i) net income from the sale or other disposition of "foreclosure
property" that is held primarily for sale to customers in the ordinary course
of business or (ii) other nonqualifying income from foreclosure property, it
will be subject to tax at the highest corporate rate on such income. Fourth,
if the Company has net income from prohibited transactions (which are, in
general, certain sales or other dispositions of property (other than
foreclosure property) held primarily for sale to customers in the ordinary
course of business), such income will be subject to a 100% tax. Fifth, if the
Company should fail to satisfy the 75% gross income test or the 95% gross
income test (as discussed below), and has nonetheless maintained its
qualification as a REIT because certain other requirements have been met, it
will be subject to a 100% tax on the net income attributable to the greater of
the amount by which the Company fails the 75% or 95% gross income test. Sixth,
if the Company should fail to distribute during each calendar year at least the
sum of (i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT
capital gain net income for such year, and (iii) any undistributed taxable
income from prior periods, the Company would be subject to a 4% excise tax on
the excess of such required distribution over the amounts actually distributed.
Seventh, if the Company acquires any asset from a C corporation (i.e., a
corporation generally subject to full corporate- level tax) in a transaction in
which the basis of the asset in the Company's hands is determined by reference
to the basis of the asset (or any other asset) in the hands of the C
corporation and the Company recognizes gain on the disposition of such asset
during the 10-year period beginning on the date on which such asset was
acquired by the Company, then the Company would be taxable to the extent of
such asset's "built- in-gain." Such taxation of the Company on "built-in
gains" will be applicable to gain on the disposition of assets which were
received by the Company upon the liquidation of Kahler and its subsidiaries.
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REQUIREMENTS FOR QUALIFICATION
Earnings and Profits
In order to maintain its REIT status, any earnings and profits that the
Company acquired as a result of the Kahler Acquisition must be distributed on
or before December 31, 1997. The Company has received a computation from the
auditors for Kahler that, subject to certain assumptions set forth therein, the
pre-acquisition earnings and profits of Kahler were $28,500,000 million (not
considering the cash distribution described immediately below), and the
Company's auditors have reviewed and approved this computation. However, the
certification is not binding on the IRS, and there can be no assurance that it
will not be successfully challenged.
Kahler made a $28,750,000 cash distribution to its shareholders
immediately prior to the Kahler Acquisition (the "Distribution"). The Company
has applied to the IRS for a private letter ruling confirming that the
Distribution will be treated as a "dividend" for tax purposes, and thus
eliminated Kahler's pre-acquisition earnings and profits. Based on a
pre-submission conference held with the IRS and subsequent conversations with
I.R.S. personnel, the Company anticipates the receipt of a favorable private
letter ruling from the IRS prior to December 31, 1997. The Company has
committed to make an extraordinary distribution to its shareholders by December
31, 1997, in an amount intended to eliminate Kahler's pre-acquisition earnings
and profits, if a favorable ruling is not received prior to that date.
Based on the foregoing, the Company anticipates that it will have no
non-REIT earnings and profits as of the end of its 1997 taxable year. In the
event, however, that the Company has such non-REIT earnings and profits, it
would be disqualified as a REIT in 1997 and thereafter.
Other Requirements
The Code defines a REIT as a corporation, trust or association (i) that is
managed by one or more trustees or directors; (ii) the beneficial ownership of
which is evidenced by transferable shares, or by transferable certificates of
beneficial interest; (iii) that would be taxable as a domestic corporation, but
for Sections 856 through 860 of the Code; (iv) that is neither a financial
institution nor an insurance company subject to certain provisions of the Code;
(v) the beneficial ownership of which is held by 100 or more persons; (vi) not
more than 50% in value of the outstanding shares of which is owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities) during the last half of each taxable year (the "5/50 Rule");
(vii) that makes an election to be a REIT (or has made such election for a
previous taxable year) and satisfies all relevant filing and other
administrative requirements established by the Service that must be met in
order to elect and to maintain REIT status; (viii) that uses a calendar year
for federal income tax purposes and complies with the recordkeeping
requirements of the Code and Treasury Regulations promulgated thereunder; and
(ix) that meets certain other tests, described below, regarding the nature of
its income and assets. The Company's Articles of Incorporation provide for
restrictions regarding transfer of the Company's stock that are intended to
assist the Company in continuing to satisfy the share ownership requirements
described in (v) and (vi) above. See "Description of Common Stock --
Restrictions on Ownership of Common Stock or Preferred Stock."
In the case of a REIT that is a partner in a partnership, Treasury
Regulations provide that the REIT will be deemed to own its proportionate share
of the assets of the partnership and will be deemed to be entitled to the gross
income of the partnership attributable to such share. In addition, the assets
and gross income of the partnership will retain the same character in the hands
of the REIT as in the partnership for purposes of Section 856 of the Code,
including satisfying the gross income and asset tests, described below. Thus,
assuming the Partnership is classified as a partnership rather than as a
corporation for tax purposes, the Company's proportionate share of the assets,
liabilities and items of income of the Partnership will be treated as assets
and gross income of the Company for purposes of applying the requirements
described herein.
Income Tests
In order for the Company to maintain its qualification as a REIT, there
are three requirements relating to the Company's gross income that must be
satisfied annually. First, at least 75% of the Company's gross income
(excluding gross income from prohibited transactions) for each taxable year
must consist of defined types of income derived directly or indirectly from
investments relating to real property or mortgages on real property (including
"rents from real property" and, in certain circumstances, interest) or
temporary investment income. Second, at least
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95% of the Company's gross income (excluding gross income from prohibited
transactions) for each taxable year must be derived from such real property or
temporary investments, and from dividends, other types of interest, and gain
from the sale or disposition of stock or securities, or from any combination of
the foregoing. Third, not more that 30% of the Company's gross income
(including gross income from prohibited transactions) for each taxable year may
be gain from the sale or other disposition of (i) stock or securities held for
less than one year, (ii) dealer property that is not foreclosure property, and
(iii) certain real property held for less than four years (apart from
involuntary conversions and sales of foreclosure property). The 30% test will
not apply in taxable years after 1997. The specific application of these tests
to the Company is discussed below.
Rents received by the Company will qualify as "rents from real property"
in satisfying the gross income requirements for a REIT described above only if
several conditions are met. First, the amount of rent must not be based in
whole or in part on the income or profits of any person. However, an amount
received or accrued generally will not be excluded from the term "rents from
real property" solely by reason of being based on a fixed percentage or
percentages of receipts or sales. Second, rents received from a tenant will
not qualify as "rents from real property" in satisfying the gross income tests
if the Company, or an owner of 10% or more of the Company, directly or
constructively owns 10% or more of such tenant (a "Related Party Tenant").
Third, if rent attributable to personal property leased in connection with a
lease of real property is greater than 15% of the total rent received under the
lease, then the portion of rent attributable to such personal property will not
qualify as "rents from real property." Finally, for rents received to qualify
as "rents from real property," the Company generally must not operate or manage
the property or furnish or render services to the tenants of such property,
other than through an "independent contractor" who is adequately compensated
and from whom the Company derives no revenue. The "independent contractor"
requirement, however, does not apply to the extent the services provided by the
Company are "usually or customarily rendered" in connection with the rental of
space for occupancy only and are not otherwise considered "rendered to the
occupant."
Pursuant to percentage leases (the "Percentage Leases"), Sunstone Hotel
Properties, Inc., a Colorado corporation (the "Lessee") has leased from the
Partnership the land, buildings, improvements, furnishings and equipment
comprising the hotels for a 10-year period. The Percentage Leases provide that
the Lessee is obligated to pay to the Partnership (i) the greater of base rent
("Base Rent") or percentage rent ("Percentage Rent," and with Base Rent,
collectively, the "Rents") and (ii) certain other additional charges (the
"Additional Charges"). The Percentage Rent is calculated by multiplying fixed
percentages by the room revenues for each of the hotels in excess of certain
levels. Both the Base Rent and the threshold room revenue amount in each
Percentage Rent formula will be adjusted for inflation. The adjustment will be
calculated at the beginning of each calendar year based on the change in the
CPI during the prior calendar year. The Base Rent accrues and is required to
be paid monthly and the Percentage Rent (if any) accrues and is required to be
paid quarterly. In order for the Base Rent, the Percentage Rent and the
Additional Charges to constitute "rents from real property," the Percentage
Leases must be respected as "true leases" for federal income tax purposes and
not treated as service contracts, joint ventures or some other type of
arrangement.
While the Company believes that the Percentage Leases should be treated as
true leases for tax purposes, investors should be aware that there are no
controlling Treasury Regulations, published rulings, or judicial decisions
involving leases with terms substantially the same as the Percentage Leases
that discuss whether such leases constitute true leases for federal income tax
purposes. If the Percentage Leases were recharacterized as service contracts
or partnership agreements, rather than true leases, part or all of the payments
that the Partnership receives from the Lessee would not be considered rent or
would not otherwise satisfy the various requirements for qualification as
"rents from real property." In that case, the Company would not be able to
satisfy either the 75% or 95% gross income tests and, as a result, would lose
its REIT status.
As stated above, in order for the Rents to constitute "rents from real
property," the Rents attributable to personal property leased in connection
with the lease of the real properties comprising a hotel must not be greater
than 15% of the Rents received under the Percentage Lease. The portion of the
Rents attributable to the personal property in a hotel is the amount that bears
the same ratio to total Rent for the taxable year as the average of the
adjusted bases of the personal property in the hotel at the beginning and at
the end of the taxable year bears to the average of the aggregate adjusted
bases of both the real and personal property comprising the hotel at the
beginning and at the end of such taxable year (the "Adjusted Basis Ratio").
The Company has determined that the amount of any Rent attributable to personal
property and not qualifying as "rents from real property" has not and will not
be of a significant magnitude (together with other disqualified income) to
cause the Company to fail the 95% gross income test or 75% gross income test as
described above. In addition, Ernst & Young LLP has provided an analysis
confirming this representation for operations through 1997. There can be no
firm assurance, however, that the
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amount of the Company's gross income not qualifying as "rents from real
property" under the 15% adjusted basis ratio test described above will not be
of a sufficient magnitude to cause the Company to fail to satisfy the 95% or
75% gross income test and thus lose its REIT status.
Another requirement for qualification of the Rents as "rents from real
property" is that the Percentage Rent must not be based in whole or in part on
the income or profits of any person. The Percentage Rent, however, will
qualify as "rents from real property" if it is based on percentages of receipts
or sales and the percentages (i) are fixed at the time the Percentage Leases
are entered into, (ii) are not renegotiated during the term of the Percentage
Leases in a manner that has the effect of basing Percentage Rent on income or
profits, and (iii) conform with normal business practice. More generally, the
Percentage Rent will not qualify as "rents from real property" if, considering
the Percentage Leases and all the surrounding circumstances, the arrangement
does not conform with normal business practice, but is in reality used as a
means of basing the Percentage Rent on income or profits. The Company has and
will structure all of its Percentage Leases in such a manner that (i) the
Percentage Rent will be based at all times on revenues from the hotels that are
established in the Percentage Leases, (ii) the Percentage Rent will not be
renegotiated during the terms of the Percentage Leases in a manner that has the
effect of basing the Percentage Rent on income or profits and (ii) the
Percentage Leases and the Percentage Rent will conform with normal business
practice. Furthermore, with respect to other hotels that the Company acquires
in the future, the Company will not charge rent for any property that is based
in whole or in part on the income or profits of any person (except by reason of
being based on a fixed percentage of gross revenues, as described above). In
the event that it were to be determined that any of the foregoing requirements
relatin to the Company's Percentage Ratio were not satisfied, the Company could
fail or cease to qualify as a REIT.
A further requirement for qualification of the Rents as "rents from real
property" is that the Company must not own, directly or constructively, 10% or
more of the Lessee. The constructive ownership rules generally provide that,
if 10% or more in value of the shares of the Company are owned, directly or
indirectly, by or for any person, the Company is considered as owning the
shares of the Lessee owned, directly or indirectly, by or for such person. The
Company has not and will not at any time directly or indirectly own any stock
of the Lessee. However, because Mr. Alter and Mr. Biederman each owns more
than 10% of the stock of the Lessee, the Company would be deemed to own more
than 10% of the stock of the Lessee if either Mr. Alter or Mr. Biederman at any
time owns, directly, indirectly or constructively, 10% or more in value of the
shares of the Company's stock. The Partnership Agreement provides that a
redeeming Limited Partner will receive cash, rather than shares of Common
Stock, at the election of the Company or if the acquisition of shares of Common
Stock by such partner would result in such partner or any other person owning,
directly or constructively, more than 9.8% of the Company for purposes of the
related party tenant rule. Thus, neither Mr. Alter nor Mr. Biederman will ever
be entitled to acquire a 10% interest in the Company, and the Company should
never own, directly or constructively, 10% of more of the Lessee. Furthermore,
the Company will not rent any hotels that it acquires in the future to a
related party tenant.
A further requirement for qualification of the Rents as "rents from real
property" is that the Company cannot furnish or render noncustomary services to
the Lessee (or tenants of the hotels), or manage or operate the hotels or any
leased properties, other than through an independent contractor who is
adequately compensated and from whom the Company itself does not derive or
receive any income. Provided that the Percentage Leases are respected as true
leases, the Company should satisfy that requirement because neither the Company
nor the Partnership will be performing any services other than customary ones
for the Lessee. With respect to other hotels that the Company acquires in the
future, the Company will not perform noncustomary services with respect to the
tenant of the property and will not be managing or operating such hotels. As
described above, if the Percentage Leases were recharacterized as service
contracts or partnership agreements, the Rents likely would be disqualified as
"rents from real property" because the Company would be considered to furnish
or render nonqualifying services to the occupants of the hotels and to manage
or operate the hotels other than through an independent contractor who is
adequately compensated and from whom the Company derives or receives no income.
If the Rents from a hotel do not qualify as "rents from real property"
because the rents attributable to personal property exceed 15% of the total
Rents for a taxable year, the portion of the Rents from that hotel that is
attributable to personal property will not be qualifying income for purposes of
either the 75% or 95% gross income tests. The Company would lose its REIT
status in this event only if the Rents attributable to personal property in all
of its hotels (plus any other nonqualifying income) during a taxable year
exceed 5% of the Company's gross income during the year. If, however, the
Rents do not qualify as "rents from real property" because either (i) the
Percentage Rent is considered based on income or profits of the Lessee, (ii)
the Company owns, directly or constructively, 10% or more of the Lessee, or
(iii) the Company furnishes noncustomary services to the Lessee or tenants of
the hotels, or
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manages or operates the hotels other than through a qualifying independent
contractor, none of the Rents would qualify as "rents from real property." In
that case, the Company would lose its REIT status because it would be unable to
satisfy either the 75% or 95% gross income tests.
In addition to the Rents, the Lessee is required to pay to the Partnership
the Additional Charges. To the extent that the Additional Charges represent
either (i) reimbursements of amounts paid by the Partnership to third parties
that the Lessee is obligated to bear or (ii) penalties for nonpayment or late
payment of such amounts, the Additional Charges should qualify as "rents from
real property." To the extent, however, that the Additional Charges represent
interest that is accrued on the late payment of the Rents or the Additional
Charges, the Additional Charges should not qualify as "rents from real
property," but instead should be treated as interest that qualifies for the 95%
gross income test.
Any gross income derived from a prohibited transaction is taken into
account in applying the 30% income test necessary to qualify as a REIT for
taxable years through 1997. In addition, the net income from that transaction
is subject to a 100% tax. The term "prohibited transaction" generally includes
a sale or other disposition of property (other than foreclosure property) that
is held primarily for sale to customers in the ordinary course of a trade or
business. The Company and the Partnership believe that no asset owned by the
Company or the Partnership has or will be held for sale to customers in the
ordinary course of business of the Company or the Partnership. Whether
property is held "primarily for sale to customers in the ordinary course of a
trade or business" will depend, however, on the facts and circumstances from
time to time. The Company and the Partnership will attempt to comply with the
terms of safe-harbor provisions in the Code prescribing when asset sales will
not be characterized as prohibited transactions. Complete assurance cannot be
given, however, that the Company or the Partnership can comply with the
safe-harbor provisions of the Code or avoid owning property that may be
characterized as property held "primarily for sale to customers in the ordinary
course of a trade or business."
If the Lessee defaults on its obligations under a Percentage Lease for a
hotel, the Company terminates the Lessee's leasehold interest, and the Company
is unable to find a qualifying replacement lessee for such hotel within 90 days
of such termination, gross income from hotel operations conducted by the
Company from such hotel would cease to qualify for the 75% and 95% gross income
tests. In such event, the Company likely would be unable to satisfy the 75%
and 95% gross income tests and, thus, would fail to qualify as a REIT.
If the Company fails to satisfy one or both of the 75% or 95% gross income
tests for any taxable year, it may nevertheless qualify as a REIT for such year
if it is entitled to relief under certain provisions of the Code. Those relief
provisions will be generally available if the Company's failure to meet such
tests is due to reasonable cause and not due to willful neglect, the Company
attaches a schedule of the sources of its income to its return, and any
incorrect information on the schedule was not due to fraud with intent to evade
tax. It is not possible, however, to state whether in all circumstances the
Company would be entitled to the benefit of these relief provisions. As
discussed above in "-- Taxation of the Company," even if those relief
provisions apply, a 100% tax would be imposed with respect to the amount by
which it fails the 75% or 95% gross income tests. No such relief is available
for violations of the 30% income test, which is applicable for taxable years
through 1997.
Asset Tests
The Company, at the close of each quarter of its taxable year, also must
satisfy two tests relating to the nature of its assets. First, at least 75% of
the value of the Company's total assets must be represented by cash or cash
items (including certain receivables), government securities, "real estate
assets," or, in cases where the Company raises new capital through share or
long-term (at least five-year) debt offerings, temporary investments in stock
or debt instruments during the one-year period following the Company's receipt
of such capital. The term "real estate assets" includes interests in real
property, interests in mortgages on real property to the extent the mortgage
balance does not exceed the value of the associated real property, and shares
of other REITs. For purposes of the 75% asset test, the term "interest in real
property" includes an interest in land and improvements thereon, such as
buildings or other inherently permanent structures (including items that are
structural components of such buildings or structures), a leasehold in real
property, and an option to acquire real property (or a leasehold in real
property). Second, of the investments not included in the 75% asset class, the
value of any one issuer's securities owned by the Company may not exceed 5% of
the value of the Company's total assets and the Company may not own more than
10% of any one issuer's outstanding voting securities (except for its ownership
interest in the stock of a qualified REIT subsidiary).
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For purposes of the asset requirements, the Company will be deemed to own
its proportionate share of the assets of the Partnership, rather than its
partnership interest in the Partnership, assuming that the Partnership is
treated as a partnership and not as a corporation for tax purposes. The
Company has represented that at all times since the commencement of its taxable
year ended December 31, 1995, (i) at least 75% of the value of its total assets
were represented by assets qualifying under the 75% asset test, and (ii) it has
not owned any securities that do not satisfy the 75% asset test. The Company
has represented that it has not and will not acquire or dispose, or cause the
Partnership to acquire or dispose, of assets during 1995, 1996, 1997 or in
later years in a way that would cause it to violate the asset tests for REIT
status.
Distribution Requirements
The Company, in order to qualify as a REIT, is required to distribute
dividends (other than capital gain dividends) to its shareholders in an amount
at least equal to (i) the sum of (A) 95% of its "REIT taxable income"(computed
without regard to the dividends paid deduction and its net capital gain) and
(B) 95% of the net income (after tax), if any, from foreclosure property, minus
(ii) the sum of certain items of noncash income. Such distributions must be
paid in the taxable year to which they relate, or in the following taxable year
if declared before the Company timely files its tax return for such year and if
paid on or before the first regular dividend payment after such declaration.
To the extent that the Company does not distribute all of its net capital gain
or distributes at least 95%, but less than 100%, of its "REIT taxable income,"
as adjusted, it will be subject to tax thereon at regular ordinary and capital
gains corporate tax rates. Furthermore, if the Company should fail to
distribute during each calendar year at least the sum of (i) 85% of its REIT
ordinary income for such year, (ii) 95% of its REIT capital gain income for
such year, and (iii) any undistributed taxable income from prior periods, the
Company would be subject to a 4% nondeductible excise tax on the excess of such
required distribution over the amounts actually distributed. For its taxable
years ended December 31, 1995 and 1996, the Company has represented that it
made distributions sufficient to satisfy the foregoing distribution
requirements. The Company intends in the future to make timely distributions
sufficient to satisfy all annual distribution requirements. However, there can
be no assurance that the Company will at all times have sufficient available
cash to satisfy such distribution requirements.
Recordkeeping Requirement
Pursuant to applicable Treasury Regulations, in order to qualify as a
REIT, the Company must maintain certain records and request on an annual basis
certain information from its shareholders designed to disclose the actual
ownership of its outstanding shares. The Company has represented that it
complied with these requirements on a timely basis for its taxable years ended
December 31, 1995 and 1996 and intends to comply with such requirements in the
future. For taxable years through 1997, the penalty for failure to obtain
information as to actual ownership is disqualification as a REIT. For 1998 and
thereafter, monetary penalties of up to $50,000 apply.
Anti-Abuse Regulations
The Treasury Regulations authorize the Service, in certain "abusive"
transactions involving partnerships, to disregard the form of the transaction
and recast it for federal tax purposes as the Service deems appropriate (the
"Anti-Abuse Regulations"). The Anti-Abuse Regulations apply where a
partnership is formed or utilized in connection with a transaction (or series
of related transactions) with a principal purpose of substantially reducing the
present value of the partners' aggregate federal tax liability in a manner
inconsistent with the intent of the partnership provisions of the Code. The
Company does not believe that the Anti-Abuse Regulations will have any adverse
impact on the Company's ability to qualify as a REIT. However, because the
Anti-Abuse Regulations are extremely broad in scope and would be applied based
on an analysis of all of the facts and circumstances, there can be no assurance
that the Service will not successfully apply the Anti-Abuse Regulations to the
Company.
FAILURE TO QUALIFY
If the Company fails to qualify for taxation as a REIT in any taxable
year, and the relief provisions do not apply, the Company will be subject to
tax (including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to the shareholders in any year in
which the Company fails to qualify will not be deductible by the Company nor
will they be required to be made. In such event, to the extent of current and
accumulated earnings and profits, all distributions to shareholders will be
taxable as ordinary income and, subject to certain limitations of the Code,
corporate distributees may be eligible for the dividends received deduction.
Unless entitled to relief under specific statutory provisions, the Company also
will be disqualified from taxation as a REIT
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for the four taxable years following the year during which the Company ceased
to qualify as a REIT. It is not possible to state whether in all circumstances
the Company would be entitled to such statutory relief.
TAXATION OF TAXABLE SHAREHOLDERS
As long as the Company qualifies as a REIT, distributions made to the
Company's taxable shareholders out of current or accumulated earnings and
profits (and not designated as capital gain dividends) will be taken into
account by such shareholders as ordinary income and will not be eligible for
the dividends received deduction generally available to corporations.
Distributions that are designated as capital gain dividends will be taxed as
long-term capital gains (to the extent they do not exceed the Company's actual
net capital gain for the taxable year) without regard to the period for which
the shareholder has held his shares of Common Stock. However, corporate
shareholders may be required to treat up to 20% of certain capital gain
dividends as ordinary income. Distributions in excess of current and
accumulated earnings and profits will not be taxable to a shareholder to the
extent that they do not exceed the adjusted basis of the shareholder's Common
Stock, but rather will reduce the adjusted basis of such shares. To the extent
that distributions in excess of current and accumulated earnings and profits
exceed the adjusted basis of a shareholder's Common Stock, such distributions
will be included in income as capital gain assuming the shares of Common Stock
are capital assets in the hands of the shareholder. In addition, any
distribution declared by the Company in October, November, or December of any
year and payable to a shareholder of record on a specified date in any such
month shall be treated as both paid by the Company and received by the
shareholder on December 31 of such year, provided that the distribution is
actually paid by the Company during January of the following calendar year.
For a taxable year of the Company commencing in 1998 and thereafter, a
Company shareholder at the close of the taxable year must include, in computing
his or her long-term capital gains for his or her taxable year in which the
last day of the Company's taxable year falls, the amount (if any) of
undistributed net capital gains of the Company that the Company designates by
written notice to the shareholder ("Designated Retained Capital Gains"). The
shareholder will be deemed to have paid his or her share of the taxes paid by
the Company on the Designated Retained Capital Gains. The shareholder's basis
in the Company's shares will be increased by the amount of the Designated
Retained Capital Gains in excess of the taxes deemed paid by the shareholder.
Shareholders may not include in their individual income tax returns any
net operating losses or capital losses of the Company. Instead, such losses
would be carried over by the Company for potential offset against its future
income (subject to certain limitations). Taxable distributions from the Company
and gain from the disposition of the Common Stock will not be treated as
passive activity income and, therefore, shareholders generally will not be able
to apply any "passive activity losses" (such as losses from certain types of
limited partnerships in which the shareholder is a limited partner) against
such income. In addition, taxable distributions from the Company and gain from
the disposition of shares of Common Stock generally will be treated as
investment income for purposes of the investment interest limitations. The
Company will notify shareholders after the close of the Company's taxable year
as to the portions of the distributions attributable to that year that
constitute ordinary income, return of capital, and capital gain.
TAXATION OF SHAREHOLDERS ON THE DISPOSITION OF THE COMMON STOCK
In general, any gain or loss realized upon a taxable disposition of the
Common Stock by a shareholder who is not a dealer in securities will be treated
as capital gain or loss. In the case of individuals, the maximum rate of
federal income tax applicable to capital gains is 28% in the case of assets
held for more than one year but 18 months or less and 20% in the case of assets
held for more than 18 months. No preferential rate of capital gains tax
applies in the case of corporations. Any loss upon a sale or exchange of
shares of Common Stock by a shareholder who has held such shares for six months
or less (after applying certain holding period rules), will be treated as a
long-term capital loss to the extent of distributions from the Company and
Designated Retained Capital Gains required to be treated by such shareholder as
long-term capital gain. All or a portion of any loss realized upon a taxable
disposition of the shares of Common Stock may be disallowed if the shares of
Common Stock are purchased within 30 days before or after the disposition.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING
The Company will generally report to its shareholders and the Service the
amount of distributions paid during each calendar year, and the amount of tax
withheld, if any. Under the backup withholding rules, a shareholder may
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be subject to backup withholding at the rate of 31% with respect to
distributions paid unless such holder (i) is a corporation or comes within
certain other exempt categories and, when required, demonstrates this fact or
(ii) provides a taxpayer identification number, certifies as to no loss of
exemption from backup withholding, and otherwise complies with the applicable
requirements of the backup withholding rules. A shareholder who does not
provide the Company with his correct taxpayer identification number also may be
subject to penalties imposed by the Service. Any amount paid as backup
withholding will be creditable against the shareholder's income tax liability.
In addition, the Company may be required to withhold a portion of capital gain
distributions to any shareholders who fail to certify their nonforeign status
to the Company.
TAXATION OF TAX-EXEMPT SHAREHOLDERS
Tax-exempt entities, including qualified employee pension and profit
sharing trusts and individual retirement accounts ("Exempt Organizations"),
generally are exempt from federal income taxation. However, they are subject
to taxation on their unrelated business taxable income ("UBTI"). While many
investments in real estate generate UBTI, the Service has issued a published
ruling that dividend distributions by a REIT to an exempt employee pension
trust do not constitute UBTI, provided that the shares of the REIT are not
otherwise used in an unrelated trade or business of the exempt employee pension
trust. Thus, amounts distributed by the Company to Exempt Organizations
generally should not constitute UBTI. However, if an Exempt Organization
finances its acquisition of the Common Stock with debt, a portion of its income
from the Company will constitute UBTI pursuant to the "debt-financed property"
rules. Furthermore, social clubs, voluntary employee benefit associations,
supplemental unemployment benefit trusts, and qualified group legal services
plans that are exempt from taxation under paragraphs (7), (9), (17), and (20),
respectively, of Code Section 501(c) are subject to different UBTI rules, which
generally will require them to characterize distributions from the Company as
UBTI. In addition, in certain circumstances a pension trust that owns more
than 10% of the Company's shares is required to treat a percentage of the
dividends from the Company as UBTI (the "UBTI Percentage"). The UBTI
Percentage is the gross income derived from an unrelated trade or business
(determined as if the Company were a pension trust) divided by the gross income
of the Company for the year in which the dividends are paid. The UBTI rule
applies only if (i) the UBTI Percentage is at least 5%, (ii) the Company
qualifies as a REIT by reason of the modification of the 5/50 Rule that allows
the beneficiaries of the pension trust to be treated as holding shares of the
Company in proportion to their actuarial interests in the pension trust, and
(iii) either (A) one pension trust owns more than 25% of the value of the
Company's shares or (B) a group of pension trusts individually holding more
than 10% of the value of the Company's shares collectively own more than 50% of
the value of the Company's shares.
While an investment in the Company by an Exempt Organization generally is
not expected to result in UBTI except in the circumstances described in the
preceding paragraph, any UBTI that does arise from such an investment will be
combined with all other UBTI of the Exempt Organization for a taxable year.
Any net UBTI will be subject to tax. If the gross income taken into account in
computing UBTI exceeds $1,000, the Exempt Organization is obligated to file a
tax return for such year on IRS Form 990-T. Neither the Company, the Board of
Directors, nor any of their Affiliates expects to undertake the preparation or
filing of IRS Form 990-T for any Exempt Organization in connection with an
investment by such Exempt Organization in the Common Stock being offered by
this Prospectus.
OTHER TAX CONSEQUENCES
State or Local Taxes
The Company, the Partnership, or the Company's shareholders may be subject
to state or local taxation in various state or local jurisdictions, including
those in which it or they own property, transact business, or reside. The
state and local tax treatment of the Company and its shareholders may not
conform to the federal income tax consequences discussed above. CONSEQUENTLY,
PROSPECTIVE SHAREHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS REGARDING THE
EFFECT OF STATE AND LOCAL TAX LAWS ON AN INVESTMENT IN THE COMPANY.
Dividend Reinvestment Program
Under the Company's Dividend Reinvestment and Stock Purchase Plan,
shareholders participating in the program will be deemed to have received the
gross amount of any cash distributions which would have been paid by the
Company to such shareholders had they not elected to participate. These deemed
distributions will be treated
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as actual distributions from the Company to the participating shareholders and
will retain the character and tax effect applicable to distributions from the
Company generally. See "-- Taxation of Shareholders." Shares of Common Stock
received under the program will have a holding period beginning with the day
after purchase, and a tax basis equal to the gross amount of the deemed
distribution.
TAX ASPECTS OF THE PARTNERSHIP
Classification as a Partnership
The Company will be entitled to include in its income its distributive
share of the Partnership's income and to deduct its distributive share of the
Partnership's losses only if the Partnership is classified for federal income
tax purposes as a partnership rather than as association taxable as a
corporation. No assurance can be given that the Service will not challenge the
status of the Partnership as a partnership for federal income tax purposes. If
such challenge were sustained by a court, the Partnership would be treated as a
corporation for federal income tax purposes.
Under Section 7704 of the Code, a partnership is treated as a corporation
for federal income tax purposes if it is a "publicly traded partnership"
(except in situations in which 90% or more of the partnership's gross income is
of a specified type). A partnership is deemed to be publicly traded if its
interests are either (i) traded on an established securities market, or (ii)
readily tradable on a secondary market (or the substantial equivalent thereof).
While the Partnership Units will not be traded on an established securities
market, they could possibly be deemed to be traded on a secondary market or its
equivalent due to the redemption rights enabling the partners to dispose of
their Units.
The Treasury Department has issued regulations (the "PTP Regulations")
governing the classification of partnerships under Section 7704. These
regulations provide that the classification of partnerships is generally based
on a facts and circumstances analysis. However, the regulations also provide
limited "safe harbors" which preclude publicly traded partnership status.
Pursuant to one of those safe harbors, interests in a partnership will not be
treated as readily tradable on a secondary market or the substantial equivalent
thereof if (i) all interests in the partnership were issued in a transaction
(or transactions) that was not required to be registered under the Securities
Act, and (ii) the partnership does not have more than 100 partners at any time
during the partnership's taxable year. In determining the number of partners
in a partnership for this purpose, a person owning an interest in a
flow-through entity (i.e., a partnership, grantor trust, or S corporation) that
owns an interest in the partnership is treated as a partner in such partnership
only if (x) substantially all of the value of the person's interest in the
flow-through entity is attributable to the flow-through entity's interest
(direct or indirect) in the partnership and (y) a principal purpose of the use
of the tiered arrangement is to permit the partnership to satisfy the
100-partner limitation. Furthermore, pursuant to Notice 88-75 issued by the
IRS, through the year 2005, an existing partnership may qualify for
non-publicly traded status if it has less than 500 partners (looking through to
the ultimate owners in the case of flow-through entities), does not issue any
Units registered under the Securities Act and does not enter into a substantial
new line of business.
The Partnership currently has less than 100 actual partners and less than
500 partners calculated on a "lookthrough" basis. The Partnership has not
issued any Units required to be registered under the Securities Act. Thus, the
Partnership presently qualifies for the safe harbors provided in Notice 88-75
and the PTP Regulations. However, there is no assurance that the Partnership
will at all times in the future be able to avoid treatment as a publicly traded
partnership.
Even if the Partnership were ever to be classified as a publicly traded
partnership, it would nevertheless be treated as a partnership for federal
income tax purposes (rather than an association taxable as a corporation) if at
least 90% of its gross income in each taxable year (commencing with the year in
which it is treated as a publicly traded partnership) consists of "qualifying
income" within the meaning of Section 7704(c)(2) of the Code (including
interest, dividends, "real property rents" and gains from the disposition of
real property). The Partnership has represented that, if in any taxable year
the Partnership falls outside of an applicable safe harbor from publicly traded
partnership status, it will satisfy the gross income test set forth in Section
7704(c)(2) of the Code in that taxable year and each subsequent taxable year.
Among other things, this will require that the President of the Company, Mr.
Robert A. Alter (or any other shareholder of the Lessee who owns at least 10%
of the stock of the Lessee) own less than a 5% interest in the Partnership in
the particular taxable year. The Company anticipates that if the Partnership
is ever
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treated as a publicly traded partnership, it will satisfy the qualifying income
test of Section 7704(c)(2) of the Code in the taxable year in which such
treatment commences and all years thereafter.
If for any reason the Partnership were taxable as a corporation, rather
than as a partnership, for federal income tax purposes, the Company would not
be able to satisfy the income and asset requirements for REIT status. Thus the
Company would be subject to tax as a regular corporation and would not receive
a deduction for dividends paid to its shareholders. See "-- Requirements for
Qualification -- Income Tests" and "-- Requirements for Qualification -- Asset
Tests." In addition, any change in the Partnership's status for tax purposes
might be treated as a taxable event, in which case the Company might incur a
tax liability without any related cash distribution. Further, items of income
and deduction of the Partnership would not pass through to its partners, and
its partners would be treated as shareholders for tax purposes. Consequently,
the Partnership would be required to pay income tax at corporate tax rates on
its net income, and distributions to its partners would constitute dividends
that would not be deductible in computing the Partnership's taxable income.
Income Taxation of the Partnership and Its Partners
The following discussion assumes that the Partnership will be treated as a
partnership for federal income tax purposes.
Partners, Not the Partnership, Subject to Tax. A partnership is not a
taxable entity for federal income tax purposes. Rather, the Company will be
required to take into account its allocable share of the Partnership's income,
gains, losses, deductions, and credits for any taxable year of the Partnership
ending within or with the taxable year of the Company, without regard to
whether the Company has received or will receive any distribution from the
Partnership.
Tax Allocations With Respect to Contributed Properties. Pursuant to
Section 704(c) of the Code, income, gain, loss, and deduction attributable to
appreciated or depreciated property that is contributed to a partnership in
exchange for an interest in the partnership must be allocated for federal
income tax purposes in a manner such that the contributor is charged with, or
benefits from, the unrealized gain or unrealized loss associated with the
property at the time of the contribution. The amount of such unrealized gain
or unrealized loss is generally equal to the difference between the fair market
value of the contributed property at the time of contribution and the adjusted
tax basis of such property at the time of contribution. The Treasury
Department has issued regulations requiring partnerships to use a "reasonable
method" for allocating items affected by Section 704(c) of the Code and
outlining certain reasonable allocation methods.
Under the Partnership Agreement, depreciation or amortization deductions
of the Partnership generally will be allocated among the partners in accordance
with their respective interests in the Partnership, except to the extent
required under Code Section 704(c). In addition, gain on sale of a hotel will
be specially allocated to the Partners who contributed the hotel to the
Partnership to the extent of any "built-in" gain with respect to such hotel for
federal income tax purposes.
Basis in Partnership Interest. The Company's adjusted tax basis in its
Partnership interest in the Partnership generally will be equal to (i) the
amount of cash and the basis of any other property contributed to the
Partnership by the Company, (ii) increased by (A) its allocable share of the
Partnership's income and (B) its allocable share of indebtedness of the
Partnership, and (iii) reduced, but not below zero, by (A) the Company's
allocable share of the Partnership's loss and (B) the amount of cash
distributed to the Company (including deemed distributions as a result of
reductions in the Company's allocable share of indebtedness of the
Partnership).
Treatment of Partnership Distributions. Partnership distributions to the
Company will not generally constitute taxable distributions. However, to the
extent that Partnership distributions, or any decrease in the Company's share
of the indebtedness of the Partnership (such decrease being considered a
constructive cash distribution to the partners), exceeds the Company's adjusted
tax basis in its Partnership interest, such distributions (including such
constructive distributions) would constitute taxable income to the Company.
Such distributions and constructive distributions normally would be
characterized as capital gain.
Sale of the Partnership's Property. Generally, any taxable gain realized
by the Partnership on the sale of property by the Partnership will be capital
gain or gain described in Section 1231 of the Code, except for any portion of
such gain that is treated as depreciation or cost recovery recapture or
attributable to inventory or property held
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for sale to customers in the ordinary course of business. Any taxable gain
recognized by the Partnership on the disposition of any hotels originally
contributed to the Partnership by the Partners will generally be allocated
first to the contributing Partners under Section 704(c) of the Code to the
extent of their "built-in gain" on those hotels for federal income tax
purposes. Any remaining taxable gain recognized by the Partnership on the
disposition of the hotels will generally be allocated among the partners in
accordance with their respective percentage interests in the Partnership.
The Company's share of any gain realized by the Partnership on the sale of
any property held by the Partnership as inventory or other property held
primarily for sale to customers in the ordinary course of the Partnership's
trade or business will be treated as income from a prohibited transaction that
is subject to a 100% penalty tax. Such prohibited transaction income also may
have an adverse effect upon the Company's ability to satisfy the income tests
for REIT status. The Company, however, does not presently intend to allow the
Partnership to acquire or hold any property that represents inventory or other
property held primarily for sale to customers in the ordinary course of the
Company's or the Partnership's trade or business. See "-- Requirements for
Qualification -- Income Tests."
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING
The Company will report to its U.S. stockholders and to the Service the
amount of distributions paid during each calendar year, and the amount of tax
withheld, if any. Under the backup withholding rules, a stockholder may be
subject to backup withholding at the rate of 31% with respect to distributions
paid unless such holder (i) is a corporation or comes within certain other
exempt categories and, when required, demonstrates this fact, or (ii) provides
a taxpayer identification number, certifies as to no loss of exemption from
backup withholding, and otherwise complies with the applicable requirements of
the backup withholding rules. A stockholder who does not provide the Company
with his correct taxpayer identification number also may be subject to
penalties imposed by the Service. Any amount paid as backup withholding will be
creditable against the stockholder's income tax liability. In addition, the
Company may be required to withhold a portion of capital gain distributions to
any stockholders who fail to certify their nonforeign status to the Company.
PLAN OF DISTRIBUTION
The Offered Shares are being offered directly by the Selling Stockholders.
The Company will not receive any proceeds from the sale of any of the Offered
Shares by the Selling Stockholders. The sale of the Offered Shares may be
effected by the Selling Stockholders from time to time in transactions in the
over-the-counter market, on the NYSE, in negotiated transactions, or a
combination of such methods of sale, at fixed prices which may be changed, at
market prices prevailing at the time of sale, at prices related to prevailing
market prices or at negotiated prices. The Selling Stockholders may effect
such transactions by selling the Offered Shares to or through broker-dealers,
and such broker-dealers may receive compensation in the form of discounts,
concessions or commissions from the Selling Stockholders and/or the purchasers
of the Shares for whom such broker-dealers may act as agents or to whom they
sell as principals, or both (which compensation as to a particular
broker-dealer might be in excess of customary commissions).
In order to comply with the securities laws of certain states, if
applicable, the Offered Shares will be sold in such jurisdictions only through
registered or licensed brokers or dealers. In addition, in certain states the
Offered Shares may not be sold unless they have been registered or qualified
for sale in the applicable state or an exemption from the registration or
qualification requirement is available and is complied with by the Company and
the Selling Stockholders.
The Selling Stockholders and any broker-dealers, agents or underwriters
that participate with the Selling Stockholders in the distribution of the
Offered Shares may be deemed to be "underwriters" within the meaning of Section
2(11) of the Securities Act, and any commissions received by them and any
profit on the resale of the Offered Shares purchased by them may be deemed to
be underwriting commissions or discounts under the Securities Act.
Under applicable rules and regulations under the Exchange Act, any person
engaged in the distribution of the Offered Shares may not simultaneously engage
in market making activities with respect to the Common Stock of the Company for
a period of two business days prior to the commencement of such distribution.
In addition and without limiting the foregoing, each Selling Stockholder will
be subject to applicable provisions of the Exchange Act
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and the rules and regulations thereunder, including, without limitation,
Regulation M, which provisions may limit the timing of purchases and sales of
shares of the Company's Common Stock by the Selling Stockholders.
The Company has agreed to register the Shares under the Securities Act and
the Partnership has agreed to indemnify and hold certain Selling Stockholders
harmless against certain liabilities under the Securities Act that could arise
in connection with the sale by the Selling Stockholders of the Offered Shares.
LEGAL MATTERS
The validity of the Offered Shares will be passed upon for the Company by
Brobeck, Phleger & Harrison LLP, Newport Beach, California. In rendering its
opinions, Brobeck, Phleger & Harrison LLP will rely on the opinion of Ballard
Spahr Andrews & Ingersoll, Baltimore, Maryland, as to certain matters of
Maryland law. Roger Cohen, a partner at Brobeck, Phleger & Harrison LLP, is
Assistant Secretary of the Company and owns 2,576 shares of Common Stock and
has been granted options to purchase 3,000 shares of Common Stock. In
addition, the description of federal income tax consequences contained in the
section of this Prospectus entitled "Federal Income Tax Considerations" and
certain federal income tax matters pertaining to the Company's status as a REIT
will be based on the opinion of the Company's tax advisor.
EXPERTS
The following financial statements have been audited by Coopers & Lybrand
L.L.P., independent auditors, as set forth in their reports thereon included
therein and incorporated herein by reference: (1) the consolidated financial
statements of Sunstone Hotel Investors, Inc. as of December 31, 1996 and 1995,
and for the year ended December 31, 1996, and the period August 16, 1995
(inception) through December 31, 1995, and the combined financial statements of
Sunstone Initial Hotels (Predecessor) for the period January 1, 1995 through
August 15, 1995, and for the year ended December 31, 1994, the financial
statements of Sunstone Hotel Properties, Inc. (the Lessee) as of December 31,
1996 and 1995, and for the year ended December 31, 1996 and the period August
16, 1995 (inception) through December 31, 1995, all appearing in the Company's
Annual Report (Form 10-K) for the year ended December 31, 1996; (2) the
financial statements of Markland Hotel, Inc. as of May 31, 1997 and for the
year then ended, the financial statements of the Gateway Center Group, as of
December 31, 1996 and for the year then ended, the financial statements of the
Holiday Inn Mission Valley Stadium Hotel, as of May 31, 1997 and for the period
from June 12, 1996 (date of acquisition) to May 31, 1997, and the financial
statements of TSB Crystal Partnership, as of December 31, 1996 and for the year
then ended, which reports appear in the Company's Current Report on Form 8-K/A
filed August 22, 1997; and, (3) the financial statements of Ventura Hospitality
Partners L.P. as of December 31, 1995 and July 31, 1996, and for the period
from July 22, 1995 (inception) to December 31, 1995, and the seven months ended
July 31, 1996, appearing in the Company's Current Report on Form 8-K/A filed
January 7, 1997. Such financial statements are incorporated herein by reference
in reliance upon such reports given upon the authority of such firm as experts
in accounting and auditing.
The consolidated financial statements of Kahler Realty Corporation and
subsidiaries as of December 31, 1996, December 31, 1995, and January 1, 1995
and for the years then ended have been included in the Registration Statement
of Sunstone Hotel Investors, Inc. dated as of August 25, 1997, in reliance upon
the reports of KPMG Peat Marwick LLP, independent certified public accountants,
appearing elsewhere herein, and upon the authority of said firm as experts in
accounting and auditing.
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NO PERSONS HAVE BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED OR INCORPORATED BY REFERENCE IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITIES OTHER THAN THOSE TO WHICH IT RELATES, OR AN OFFER OR SOLICITATION
WITH RESPECT TO THOSE SECURITIES TO WHICH IT RELATES TO ANY PERSONS IN ANY
JURISDICTION WHERE SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL. THE DELIVERY
OF THIS PROSPECTUS AT ANY TIME DOES NOT IMPLY THAT THE INFORMATION CONTAINED OR
INCORPORATED BY REFERENCE HEREIN AT ITS DATE IS CORRECT AS OF ANY TIME
SUBSEQUENT TO ITS DATE.
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TABLE OF CONTENTS
PAGE
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Available Information . . . . . . . . . . . . . . . . . . . . . . . 2
Incorporation of Certain Information by Reference . . . . . . . . 3
Prospectus Summary . . . . . . . . . . . . . . . . . . . . . . . . 4
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Securities Offered . . . . . . . . . . . . . . . . . . . . . . . . 13
Use of Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Selling Stockholders . . . . . . . . . . . . . . . . . . . . . . . 13
Description of Common Stock and Preferred Stock . . . . . . . . . . 15
Certain Provisions of Maryland Law and of the
Company's Articles of Incorporation and Bylaws . . . . . . . . . 18
Federal Income Tax Considerations . . . . . . . . . . . . . . . . . 21
Plan of Distribution . . . . . . . . . . . . . . . . . . . . . . . 32
Legal Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Experts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
1,000,000 SHARES
SUNSTONE HOTEL INVESTORS, INC.
COMMON STOCK
_______________
PROSPECTUS
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DECEMBER 17, 1997