SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the Fiscal Year Ended December 31, 1995
OR
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ______________ to ______________
Commission File Number 1-11527
HOSPITALITY PROPERTIES TRUST
(Exact name of registrant as specified in its charter)
Maryland 04-3262075
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(State or other jurisdiction (IRS Employer Identification No.)
of incorporation)
400 Centre Street, Newton, Massachusetts 02158
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(Address of principal executive offices) (Zip Code)
617-964-8389
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
- --------------------------------------- ------------------------
Common Shares of Beneficial Interest New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock of the registrant held
by non-affiliates was $222,318,750 based on the $26.625 closing price per share
for such stock on the New York Stock Exchange on March 25, 1996. For purposes of
this calculation, 250,000 Common Shares of Beneficial Interest, $.01 par value
("Shares") held by HRPT Advisors, Inc. ("Advisors"), 4,000,000 Shares held by
Health and Retirement Properties Trust ("HRP"), and an aggregate of 900 shares
held by the trustees of the registrant, have been included in the number of
shares held by affiliates.
Number of the registrant's Shares, outstanding as of March 25, 1996:
12,600,900
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Annual Report on Form 10-K is incorporated herein by
reference from the definitive Proxy Statement of Hospitality Property Trust (the
"Company") for its annual meeting of shareholders currently scheduled to be held
on May 21, 1996.
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CERTAIN IMPORTANT FACTORS
The Company's Annual Report on Form 10-K contains statements which
constitute forward looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. Those statements appear in a number of
places in this Form 10-K and include statements regarding the intent, belief or
expectations of the Company, its Trustees or its officers with respect to the
declaration or payment of dividends, the consummation of additional
acquisitions, policies and plans of the Company regarding investments,
dispositions, financings, conflicts of interest or other matters, the Company's
qualification and continued qualification as a real estate investment trust or
trends affecting the Company's or any hotel's financial condition or results of
operations. Readers are cautioned that any such forward looking statements are
not guarantees of future performance and involve risks and uncertainties, and
that actual results may differ materially from those contained in the forward
looking statement as a result of various factors. Such factors include without
limitation changes in financing terms, seasonality, the Company's ability or
inability to complete acquisitions and financing transactions, results of
operations of the Company's hotels and general changes in economic conditions
not presently contemplated. The accompanying information contained in this Form
10-K, including the information under the headings "Business" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations",
identifies other important factors that could cause such differences.
THE AMENDED AND RESTATED DECLARATION OF TRUST OF THE COMPANY, DATED AUGUST 21,
1995 A COPY OF WHICH, TOGETHER WITH ALL AMENDMENTS THERETO (THE "DECLARATION"),
IS DULY FILED IN THE OFFICE OF THE DEPARTMENT OF ASSESSMENTS AND TAXATION OF THE
STATE OF MARYLAND, PROVIDES THAT THE NAME "HOSPITALITY PROPERTIES TRUST" REFERS
TO THE TRUSTEES UNDER THE DECLARATION COLLECTIVELY AS TRUSTEES, BUT NOT
INDIVIDUALLY OR PERSONALLY, AND THAT NO TRUSTEE, OFFICER, SHAREHOLDER, EMPLOYEE
OR AGENT OF THE TRUST SHALL BE HELD TO ANY PERSONAL LIABILITY, JOINTLY OR
SEVERALLY, FOR ANY OBLIGATION OF, OR CLAIM AGAINST, THE TRUST. ALL PERSONS
DEALING WITH THE TRUST, IN ANY WAY, SHALL LOOK ONLY TO THE ASSETS OF THE TRUST
FOR THE PAYMENT OF ANY SUM OR THE PERFORMANCE OF ANY OBLIGATION.
HOSPITALITY PROPERTIES TRUST
1995 FORM 10-K ANNUAL REPORT
Table of Contents
Part I
Page
Item 1. Business..................................................... 1
Item 2. Properties................................................... 19
Item 3. Legal Proceedings............................................ 20
Item 4. Submission of Matters to a Vote of Security Holders.......... 20
Part II
Item 5. Market for the Registrant's Common Stock and
Related Stockholders Matters ............................. 20
Item 6. Selected Financial Data..................................... 22
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 23
Item 8. Financial Statements and Supplementary Data................ 25
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................... 25
Part III
To be incorporated by reference from the Company's definitive
Proxy Statement for the annual meeting of shareholders
currently scheduled to be held on May 21, 1995, which is
expected to be filed not later than 120 days after the end of
the Company's fiscal year.
Part IV
Item 14. Exhibits, Financial Statement Schedules
and Report on Form 8-K.................................. 25
Item 1. Business
The Company. The Company was formed in February 1995 as a
subsidiary of Health and Retirement Properties Trust ("HRP"), which is in the
primary business of owning and leasing retirement living centers and nursing
homes. In March 1995, the Company acquired 21 Courtyard by Marriott(R) Hotels
for approximately $179.4 million. In August 1995, the Company completed an
initial public offering of 8,325,000 common shares of beneficial interest, $.01
par value per share ("Shares") at an initial public offering price of $25.00 per
Share, raising gross proceeds of $208.1 million which were principally used to
repay indebtedness due to HRP and to acquire an additional 16 Courtyard by
Marriott(R) Hotels for approximately $149.6 million (collectively, the "Initial
Hotels"). The Company and HRP are managed by HRPT Advisors, Inc. ("Advisors").
In connection with the Company's formation and its initial public offering, HRP
invested $100 million in the Company in exchange for 4,000,000 Shares at a price
of $25.00 per Share, and Advisors invested $6.25 million in the Company in
exchange for 250,000 Shares at a price of $25.00 per Share.
The Company is organized as a Maryland real estate investment
trust. The Company's principal place of business is 400 Centre Street, Newton,
Massachusetts 02158, and its telephone number is (617) 964-8389.
As of December 31, 1995 the Company's 37 Courtyard by
Marriott(R) hotels, located in 20 states, represented an aggregate investment of
$332.6 million as follows:
Total Investment at
Numbers of Number of December 31, 1995
State Hotels Rooms (dollars in thousands)
Arizona 2 279 $ 15,295
California 4 577 35,172
Delaware 1 152 12,419
Florida 1 152 12,292
Georgia 5 732 43,736
Indiana 1 149 8,802
Maryland 1 152 13,661
Massachusetts 7 963 60,473
Michigan 1 148 6,580
Minnesota 1 149 8,783
Missouri 2 298 16,687
New Jersey 1 146 12,463
North Carolina 3 412 23,897
Pennsylvania 1 152 9,965
South Carolina 1 108 5,795
Tennessee 1 109 9,318
Texas 1 160 8,680
Virginia 1 149 8,270
Washington 1 152 11,723
Wisconsin 1 147 8,561
--- ----- ----------
37 5,286 $332,572
The Initial Hotels, Leases and Management Agreements. The
Initial Hotels are leased to a special purpose subsidiary (the "Lessee") of Host
Marriott Corporation ("Host") and are managed by a subsidiary (the "Manager") of
Marriott International Inc. ("Marriott"). The annual rent payable to the Company
for the Initial Hotels totals $32.9 million in base rent plus percentage rent
equal to 5% of increases in Total Hotel Sales (as defined below) over 1994
levels. In addition, 5% of Total Hotel Sales is required to be escrowed
periodically by the Lessee or the Manager as a reserve for renovations and
refurbishment of the Initial Hotels. "Total Hotel Sales" means all revenues and
receipts of every kind derived from guests or customers related to the operation
1
of the Initial Hotels and has the same meaning as "Gross Revenues" under the
Company's leases. The Initial Hotels have an average age of approximately five
years and, for the fifty-two weeks ended December 29, 1995, had average
occupancy of 81.1% and an average daily rate per room ("ADR") of $72.23.
Under the leases and management agreements, the Initial Hotels
are currently operated as Courtyard by Marriott(R) hotels. Courtyard by
Marriott(R) hotels are designed to attract both business and leisure travelers.
A typical Courtyard by Marriott(R) hotel has 145 guest rooms. The guest rooms
are larger than those in most other moderately priced hotels and predominately
offer king sized beds. Most Courtyard by Marriott(R) hotels are situated on well
landscaped grounds and typically are built around a courtyard containing a
patio, pool and socializing area that may be glass enclosed depending upon
location. Most of these hotels have lounges or lobbies, meeting rooms, an
exercise room, a small laundry room available to guests and a restaurant or
coffee shop. Generally, the guest rooms are similar in size and furnishings to
guest rooms in full service Marriott(R) hotels. In addition, many of the same
amenities as would be available in full service Marriott(R) hotels are available
in Courtyard by Marriott(R) hotels, except that restaurants may be open only for
breakfast buffets or serve limited menus, room service is generally not
available and meeting and function rooms are limited in size and number.
According to Marriott, as of December 31, 1995, 253 Courtyard by Marriott(R)
hotels were open and operating nationally. The Company believes that the
Courtyard by Marriott(R) brand is a leading brand in the limited service segment
of the United States hotel industry.
The principal features of the Company's leases and management agreement
for the Initial Hotels are as follows:
o Each of the Initial Hotels is the subject of a separate lease. However,
in the event any of these leases is defaulted, the Company may declare
all of these leases to be in default.
o The initial term of all of these leases originally expired on December
31, 2006. In connection with its agreements to acquire the Additional
Hotels discussed below under "--Developments Since December 31, 1995,"
such expiration date was recently extended to December 31, 2012.
o At the end of the initial lease term, the Lessee has renewal options.
Originally the leases of the Initial Hotels provided for one seven year
renewal term followed by up to three ten year renewal terms. In
connection with the modifications to the initial term referred to
above, such renewal options were changed to provide for three
consecutive 12 year renewal terms. Renewal options may be exercised
only on an all or none basis for all Initial Hotels.
o The leases of the Initial Hotels require minimum rent payments
aggregating $32.9 million per year.
o In addition to minimum rents, the leases of the Initial Hotels require
percentage rents equal to 5% of Total Hotel Sales in excess of Total
Hotel Sales in 1994. Percentage rents are calculated on a combined
basis for all 37 Initial Hotels.
o Both the leases and management agreements for the Initial Hotels
require that 5% of Total Hotel Sales be escrowed periodically to fund
refurbishments and renovations to these hotels. Funds in this FF&E
Reserve are pooled for all Initial Hotels and generally may be
withdrawn only for capitalized improvements. Funds in the FF&E Reserve
and property purchased with those funds are the property of the Company
and payments into this FF&E Reserve are recorded by the Company under
generally accepted accounting principles as rents.
o Under certain circumstances, the Company may be required to fund major
repairs to the Initial Hotels, in which event base rents will be
increased by a minimum of 10% of the amount funded.
o A security deposit equal to a full year's base rent is retained by the
Company as security for the Lessee's obligations under the leases of
the Initial Hotels. Provided that the Lessee does not default under any
of such leases, the Company must repay the security deposit to the
Lessee at the expiration of the leases, including renewal terms. No
interest will be paid by the Company on the security deposit and it
will not be escrowed.
2
o The leases of the Initial Hotels are net leases requiring the Lessee to
pay all operating expenses, including taxes and insurance and any
applicable ground rent. Under the management agreements for the Initial
Hotels, substantially all of the Lessee's operating responsibilities
have been delegated to the Manager.
o The management agreements for the Initial Hotels may be canceled by the
Lessee (with the consent of the Company) on a hotel by hotel basis if
specified performance levels are not achieved by the Manager.
Similarly, in the event that the leases for individual Initial Hotels
were terminated, the Company or the successor lessee would be able to
cancel the corresponding management agreements on a hotel by hotel
basis if specified performance levels are not achieved.
o The management agreements for the Initial Hotels are not cross
defaulted with each other nor with the leases for these hotels.
Accordingly, if one or more of such management agreements were
defaulted and terminated, the Lessee and the Company will be able to
continue the affiliation with Marriott and use the Courtyard by
Marriott(R) brand name and chain services under the remaining
agreements. Also, if the leases for these Initial Hotels were defaulted
and terminated, the Company and any successor lessee will be able to
continue the affiliation with Marriott and use the Courtyard by
Marriott(R) brand name and chain services under existing management
agreements.
o The management agreements for the Initial Hotels originally were to
expire in 2013, but in connection with the Company's agreements to
acquire the Additional Hotels, such expiration date was changed to
December 31, 2012. Such management agreements provided for up to three
consecutive renewal terms of ten years each, which terms were changed
in connection with such modification to the initial expiration date to
up to three consecutive 12 year terms.
o Giving effect to recent modifications to the management agreements for
the Initial Hotels, borrowings in respect of each of the Initial Hotels
are limited in accordance with a formula set forth in such management
agreements to no more than 70% of the allocable purchase price of each
Initial Hotel in the case of a borrowing secured by a single Initial
Hotel, or 60% of the aggregate allocable purchase prices of the Initial
Hotels in the case of a borrowing secured by two or more of the Initial
Hotels on a combined basis.
o Management fees payable to the Manager for operation of the Initial
Hotels are subordinated to minimum rents due to the Company. All
related company charges payable by the Lessee to Host or affiliates of
Host are likewise subordinated to rents due to the Company.
In the event any Initial Hotel is damaged by fire, explosion or other
casualty as a result of which such Initial Hotel cannot be operated in the good
faith judgment of the Lessee or Manager on a commercially practicable basis for
its permitted use and it cannot reasonably be expected to be restored within
specified periods following such damage, either the Company or the Lessee may
terminate the applicable lease. If either (i) the damage is not extensive enough
to give rise to an option to terminate a lease or (ii) neither the Company nor
the Lessee elects to terminate the lease, the Lessee is obligated promptly to
repair and replace the improvements to the extent of available insurance
proceeds. During any period of reconstruction or repair of any Initial Hotel,
the Lessee is required to operate its businesses at such Initial Hotel to the
extent practicable, without abatement of rent. In the event that there are
inadequate insurance proceeds to pay for the cost of restoration and the Lessee
elects not to fund the deficiency, the Company may, at its option, finance the
shortfall for all such repairs, and base rent under the applicable lease will
increase by a minimum of 10% per annum of the amount financed.
In the event that any Initial Hotel or any substantial portion thereof
is taken or condemned or sold by the Company in lieu thereof, the applicable
lease will terminate, and any related award is to be paid to the Company, the
Lessee or the Manager, as appropriate. In the event only a part of any Initial
Hotel is taken or condemned but such Initial Hotel or the part remaining can
still be used for its prior purpose, the applicable lease will not terminate and
the Lessee is required to repair and restore the remaining improvements,
provided the cost of such repair and restoration does not exceed the amount of
the related award. If the cost of such repair exceeds such amount and the Lessee
is unwilling to pay the amount of such deficiency, the Lessee may request that
the Company fund the amount of the deficiency, in which event base rent
increases by a minimum of 10% per annum of the amount so funded. If neither
party elects to fund the deficiencies, either party may terminate the affected
lease.
3
The ground leases for five of the Initial Hotels contain provisions
relating to the obligation of the Company to maintain insurance, restore the
premises following a casualty or a taking and apply in a specified manner
proceeds received by the Company in connection with a casualty or a taking, all
of which obligations are required to be performed by the applicable Lessee
pursuant to the leases of such Initial Hotel. In instances where a material
casualty has occurred prior to the last five years of a ground lease, however,
the Company may be obligated under certain ground leases to restore the property
although the Lessee has terminated the applicable lease as a result of a
casualty and regardless of whether the proceeds received are adequate to effect
restoration. In addition, in certain limited circumstances the lenders holding
mortgages on the land underlying certain of such ground leased Initial Hotels
may have the right to require that insurance proceeds or condemnation awards be
applied to repayment of debt secured by such mortgage.
Developments Since December 31, 1995. As previously announced, in
February 1996, the Company entered into agreements to acquire 11 Wyndham
Garden(R) hotels for approximately $135.3 million, 18 Residence Inn by
Marriott(R) hotels for approximately $172.2 million and an additional 16
Courtyard by Marriott(R) hotels for approximately $176.4 million (collectively,
the "Additional Hotels").
On March 22, 1995, the Company acquired 5 of these Residence Inn by
Marriott(R) hotels and 3 of these Courtyard by Marriott(R) hotels pursuant to
these agreements for an aggregate net cash purchase price of $91.6 million.
Such Additional Hotels are leased to the Lessee and are managed by the
Manager, in the case of the Courtyard by Marriott(R) hotels, or leased to
another special purpose subsidiary of Host and managed by another subsidiary of
Marriott, in the case of the Residence Inn by Marriott hotels. Leases and
management agreements with respect to the Additional Hotels acquired by the
Company which are Courtyard by Marriott(R) hotels are treated as part of a
single group of cross-defaulted leases, and grouped for purposes of security
deposits, FF&E Reserves and exercise of renewal options with the Initial Hotels.
See "--The Initial Hotels, Leases and Management Agreements."
In February 1996, the Company and DLJ Mortgage Capital, Inc. ("DLJMC")
entered into an agreement to expand the existing $200 million line of credit
arrangement ("Line of Credit") from DLJMC to the Company by an additional $250
million (the "Expanded Credit Facility") in order to facilitate the acquisition
of the Additional Hotels. See "Management's Discussion and Analysis of Results
of Operations and Financial Condition -- Liquidity and Capital Resources".
On March 5, 1996, the Company filed a Registration Statement on Form
S-11 with the Securities and Exchange Commission regarding a proposed public
offering of 12 million Shares and up to 1.8 million additional Shares for the
exercise of an underwriters' overallotment option.
Investment Policy and Method of Operation. The Company's strategy for
increasing Cash Available for Distribution (as defined below) per Share is to
provide capital to unaffiliated hotel operators who wish to divest their
properties while remaining in the hotel business as tenants. Most other public
hotel REITs seek to control the operations of hotels in which they invest by
leasing those properties to affiliated tenants. To achieve its objectives, the
Company seeks to operate as follows: maintain a strong capital base of
shareholders' equity; invest in high quality properties operated by unaffiliated
hotel operating companies; use moderate debt leverage to fund additional
investments which increase Cash Available for Distribution per Share because of
positive spreads between the Company's cost of investment capital and rent
yields; design leases which require minimum rents and provide an opportunity to
participate in a percentage of increases in gross revenues at the Company's
hotels; when market conditions permit, refinance debt with additional equity or
long term debt; and pursue diversification so that the Company's Cash Available
for Distribution is received from diverse properties and operators. "Cash
Available for Distribution" as used herein means net income from operations,
plus depreciation and amortization (all computed in accordance with generally
accepted accounting principles) and less Company owned funds escrowed for
renovations and refurbishments ("FF&E Reserves") and adjusted for non-recurring
items, if any.
The Company's day-to-day operations are conducted by HRPT Advisors,
Inc. ("Advisors"), the Company's investment advisor. Advisors originates and
presents investment opportunities to the Company's Board of Trustees.
As a REIT, the Company may not operate hotels. The Company has entered
into leases (the "Leases") with the Lessee and management agreements (the
"Management Agreements") with the Manager for operation of the Initial Hotels.
4
The Company's Leases require the Lessee to pay all operating expenses, including
taxes and insurance and to pay to the Company minimum rents plus percentage
rents based upon increases in gross revenues at the Initial Hotels. The
Company's Leases require the Lessee to post security deposits in amounts equal
to one year of base rent and to set aside 5% of gross sales as a FF&E Reserve to
fund renovations and refurbishments to the Initial Hotels. The Company's Leases
of multiple Initial Hotels are also subject to cross default provisions, and
Lease renewals of Initial Hotels are permitted only on an all or none basis.
Acquisition Policy. The Company is committed to pursuing growth through
the acquisition of additional hotels and intends to pursue acquisition
opportunities in addition to the Additional Hotels. Generally, the Company
prefers to purchase and lease multiple hotels in one transaction because the
Company believes cross default covenants and all or none renewal rights for
multiple hotels enhance the credit characteristics of its leases and the
security of its investments. In implementing its acquisition strategy, the
Company considers a range of factors relating to proposed hotel purchases
including: (i) historical and projected cash flows; (ii) the competitive market
environment and the current or potential market position of each proposed hotel;
(iii) the availability of a qualified lessee; (iv) the physical condition of the
proposed hotel and its potential for redevelopment or expansion; (v) the
estimated replacement cost and proposed acquisition price of the proposed hotel;
(vi) the price segment in which the proposed hotel is operated; and (vii) the
strength of the particular national hotel organization, if any, with which the
proposed hotel is or may become affiliated. In determining the competitive
position of a prospective hotel, the Company examines the proximity of the
proposed hotel to business, retail, academic and tourist attractions and
transportation routes, the number and characteristics of competitive hotels
within the proposed hotel's market and the existence of any barriers to entry
within that market, including zoning restrictions and financing constraints.
While the Company focuses on the acquisition of moderately priced hotel
properties, it also considers acquisitions in all segments of the hotel
industry.
An important part of the Company's acquisition strategy is to identify
and select qualified and experienced hotel lessees and managers. The Company
intends to continue to select hotels for acquisition which will enhance the
diversity of its portfolio in respect to location, brand name, lessees and
managers. The Company has no policies which would limit the purchase price or
the percentage of its assets which may be invested in any individual hotel or
invested in hotels leased to a single lessee or managed by a single manager or
operated with a single franchise affiliation.
Other Investments in Real Estate. Although the Company emphasizes
direct wholly owned investments in its hotels, it may, in its discretion, invest
in joint ventures, mortgages and other real estate interests, consistent with
its qualification as a REIT. The Company may invest in real estate joint
ventures if it concludes that by doing so it may benefit from the participation
of coventurers or that the opportunity of the Company to participate in the
investment is contingent on the use of a joint venture structure. The Company
may invest in participating, convertible or other types of mortgages if it
concludes that by doing so it may benefit from the cash flow or any appreciation
in the value of the subject property. Convertible mortgages are similar to
equity participation because they permit the lender to either participate in
increasing revenues from the property or convert some or all of that mortgage
into equity ownership interests. At all times, the Company intends to make its
investments in such a manner as to be consistent with the requirements of the
Internal Revenue Code of 1986, as amended (the "Code") to qualify as a REIT.
Disposition Policies. The Company has no current intention to dispose
of any of the Initial Hotels, although it reserves the right to do so. The
Company currently anticipates that disposition decisions, if any, will be made
by the Company based on (but not limited to) factors such as the following: (i)
potential opportunities to increase revenues and property values by reinvesting
sale proceeds; (ii) the proposed sale prices; (iii) the strategic fit of the
hotel with the rest of the Company's portfolio; (iv) the potential for, or the
existence of, any environmental or regulatory problems; (v) the existence of
alternative uses or needs for capital; and (vi) the maintenance of the Company's
qualification as a REIT. For a description of certain tax consequences arising
from disposition of hotels, see "Taxation of the Company."
Financing Policies. The Company currently intends to employ
conservative financial policies in pursuit of its growth strategies. Although
there are no limitations in the Company's organizational documents on the amount
of indebtedness it may incur, the Company currently intends to pursue its growth
strategies while maintaining a capital structure under which its debt will not
exceed 50% of its total market capitalization. The Company may from time to time
re-evaluate and modify its current borrowing policies in light of then current
5
economic conditions, relative costs of debt and equity capital, market values of
properties, growth and acquisition opportunities and other factors and may
increase or decrease its ratio of debt to total market capitalization
accordingly.
The Board of Trustees of the Company may determine to obtain a
replacement for its current credit facilities or to seek additional capital
through additional equity offerings, debt financings, securitizations, retention
of cash flow (subject to satisfying the Company's distribution requirements
under the REIT rules) or a combination of these methods. To the extent that the
Board of Trustees decides to obtain additional debt financing, the Company may
do so on a secured or unsecured basis. Any mortgages may be recourse,
non-recourse or cross collateralized and may contain cross default provisions.
The Company has not established any limit on the number or amount of mortgages
that may be placed on any single property or on its portfolio as a whole. The
Company may also seek to obtain other lines of credit (both secured or
unsecured) or to issue securities senior to the Shares, including preferred
shares of beneficial interest and debt securities (either of which may be
convertible into Shares or be accompanied by warrants to purchase Shares) or to
engage in securitization transactions which may involve a sale or other
conveyance of the Company's hotels to subsidiaries or to unaffiliated special
purpose entities. The Company may also finance acquisitions through an exchange
of properties or through the issuance of additional Shares or other securities.
The proceeds from any financings by the Company may be used to pay
distributions, to provide working capital, to refinance existing indebtedness or
to finance acquisitions and expansions of existing or new properties.
Advisors. Advisors is a Delaware corporation owned by Barry M. Portnoy
and Gerard M. Martin. Advisors' principal place of business is 400 Centre
Street, Newton, Massachusetts and its telephone number is (617) 332-3990.
Advisors provides management services and investment advice to the Company.
Advisors also acts as the investment advisor to HRP and has other business
interests. The Directors of Advisors are Gerard M. Martin, Barry M. Portnoy and
David J. Hegarty. The officers of Advisors are David J. Hegarty, President and
Secretary, John G. Murray, Executive Vice President and Chief Financial Officer,
John A. Mannix, Vice President, Adam D. Portnoy, Vice President and Ajay Saini,
Treasurer. Effective April 1, 1995 Mark J. Finkelstein resigned as President and
Director to pursue his interests in operating nursing homes and became president
of Subacute Management Corporation of America, Inc. Mr. Murray and Adam D.
Portnoy are also officers of the Company.
In the ordinary course of their business, Advisors is occasionally
involved in litigation. Early in 1995, HRP commenced a foreclosure action to
enforce indemnities given in connection with the surrender of certain leaseholds
to, and the purchase of certain properties by, HRP in 1992. In May 1995, the
defendants in the foreclosure action and parties related to HRP's former tenants
and sellers asserted cross claims against HRP, Advisors, Messrs. Portnoy and
Martin and others, including Sullivan & Worcester (which is counsel to HRP,
Advisors and the Company). The same cross-claim defendants were served in late
February 1996, in an additional action in a federal court. The cross claims and
separate claims allege, among other things, fraud (including violations of
federal securities laws), conflicts of interest, breach of fiduciary duties,
legal malpractice, civil conspiracy and violations of 18 U.S.C. ss.1962 (RICO)
in connection with the leasehold surrenders, the transactions and indemnities
underlying the foreclosure action and certain related transactions, and that the
foreclosure defendants and third party plaintiffs suffered substantial damages
as a result. HRP, Advisors and other parties to this dispute have sought
arbitration of all arbitrable claims arising from this dispute pursuant to the
contract under which the dispute originated and an arbitration proceeding is now
underway. Although the outcome of this litigation is currently indeterminable,
the Company has been advised that each of the third party defendants believes
the claims against it are without merit and intends to defend and deny the
allegations in these cross claims and separate claims, and that HRP intends to
pursue the original foreclosure action. The Company is not a party to this
litigation.
Employees. The Company is an advised REIT and has no employees.
Services which would otherwise be provided by employees are provided by Advisors
pursuant to the Advisory Agreement (described below) and by the Managing
Trustees and officers of the Company. Although officers of the Company do not
receive any cash compensation from the Company, they may be entitled to receive
incentive share awards under the Company's Incentive Share Award Plan.
Competition. The hotel industry is highly competitive. Each of the
Initial Hotels is located in an area that includes other hotels. Increases in
the number of hotels in a particular area could have a material adverse effect
on occupancy rates and average daily rates of the Initial Hotels located in that
area. The management agreement with the Manager for the Initial Hotels restricts
the right of the Manager and its affiliates (including Marriott) until September
25, 1999, to own, build, operate, franchise or manage any other Courtyard by
Marriott(R) hotel within various specified areas around the Company's Initial
6
Hotels. Neither the Manager nor its affiliates (including Marriott) are
restricted from operating other branded hotels in the market areas of any of the
Initial Hotels, and after September 25, 1999, the Manager and its affiliates may
also compete with the Courtyard by Marriott(R) Hotels by opening, managing or
franchising additional hotels under the same brand name in direct competition
with the Company's Initial Hotels.
The Company expects to compete for hotel acquisition and financing
opportunities with entities which may have substantially greater financial
resources than the Company, including, without limitation, other publicly owned
REITs, banks, insurance companies, pension plans and public and private
partnerships. These entities may be able to accept more risk than the Company
can prudently manage, including risks with respect to the creditworthiness of
hotel operators. Such competition may reduce the number of suitable hotel
acquisition or financing opportunities available to the Company and increase the
bargaining power of hotel owners seeking to sell or finance their properties.
Regulatory Matters. Hotel properties are subject to various laws,
ordinances and regulations, including regulations relating to restaurants and
other food and beverage operations and recreational facilities such as swimming
pools, activity centers and other common areas. The Company believes that each
of its Initial Hotels has the necessary permits and approvals required to enable
the Lessee and or Manager to operate the Initial Hotels in the manner
contemplated by the Leases and the Management Agreements.
Under various environmental laws, a current or previous owner or
operator of real property may be liable for the costs of removal or remediation
of hazardous or toxic substances on, under, in or emanating from such property.
Such laws often impose liability whether or not the owner or operator knew of,
or was responsible for, the presence of such hazardous or toxic substances, and
the liability under such laws has been interpreted to be strict, meaning that
liability is imposed without regard to fault. Liability under such laws has also
been interpreted to be joint and several, meaning that any current or previous
owner or operator or other responsible party might be liable for the entire
amount of the cleanup and remediation costs for a contaminated site. In
addition, the presence of hazardous or toxic substances, or the failure to
remediate such property properly, may adversely affect the market value of the
property, as well as the owner's ability to sell or lease the property or to
borrow using such property as collateral. Persons who arrange for the disposal
or treatment of hazardous or toxic substances may also be liable for the costs
of removal or remediation of such substances at the disposal or treatment
facility, whether or not such facility is or ever was owned or operated by such
person. In addition, certain environmental laws and common law principles govern
the responsibility for the removal, encapsulation or disturbance of asbestos
containing materials ("ACMs") when these ACMs are in poor condition or when a
property with ACMs is undergoing renovation or demolition. Such laws could also
be used to impose liability upon owners or operators of real properties for
release of ACMs into the air that cause personal injury or other damage.
The Company received a Phase I environmental assessment report for each
of the Initial Hotels. The purpose of these reports is to identify, to the
extent reasonably possible and based on reasonably available information, any
existing and potential conditions resulting from hazardous or toxic substances,
including petroleum products and ACMs, at the Initial Hotels. The scope of the
Phase I environmental assessments generally include: (i) a review of available
maps, aerial photographs and past and present uses of the site; (ii) an
inspection of appropriate public records; and (iii) in certain cases, limited
inquiries of governmental agencies having jurisdiction over certain
environmental matters. Each Phase I environmental assessment also includes an on
site visual inspection of the Initial Hotel to assess visual evidence of past or
present on site waste disposal, visible surface contamination, potential sources
of soil and groundwater contamination, above surface and subsurface storage
tanks, visible drums, barrels and other storage containers, current waste
streams and management practices, ACMs and polychlorinated biphenyl
transformers. In addition, as part of the Phase I environmental assessment,
abutting properties and nearby sources of potential contamination are identified
through publicly available information and evaluated for potential impact on the
Initial Hotels, to the extent reasonably possible. In some instances, the
Company also caused additional investigations to be conducted with respect to
certain of the Initial Hotels.
Some of the Initial Hotels are located on or near properties with
former or existing underground or above ground storage tanks used to store
petroleum or other hazardous products, or on which activities involving
hazardous substances have been or currently are being conducted. The Company is
aware of petroleum contaminated soil and/or groundwater at several Initial
Hotels from former or existing on-site or nearby service stations, leaking
underground storage tanks or storage drums. In addition, the Company believes
that two of the Initial Hotels may have been constructed on sites at which fill
materials containing hazardous substances were used and that one of the
7
Initial Hotels was constructed over abandoned oil and gas wells. The Company is
also aware of several Initial Hotels that are located in an area of regional
groundwater contamination. The Company does not believe that these instances of
on-site or regional contamination and historical or current activities will have
a material adverse effect on the Company's business or results of operations.
However, the Company cannot predict whether modifications of existing laws or
regulations, the adoption of new laws or regulations or changes in conditions at
the Initial Hotels may have a material adverse effect on the Company's business
or results of operations in the future.
Except as described above, the Company is not aware of any
environmental condition with respect to the Initial Hotels that could have a
material adverse effect on the Company's business or results of operations. No
assurances can be given, however, that the Phase I environmental assessments
undertaken with respect to the Initial Hotels have revealed all potential
environmental liabilities, that any prior owner or operator of the real property
on which the Initial Hotels are located did not create any material
environmental condition not known to the Company, or that a material
environmental condition does not otherwise exist as to any one or more of the
Initial Hotels.
Under Title III of the Americans with Disabilities Act ("ADA"), a hotel
with more than five rooms for rent is considered both a "public accommodation"
and a "commercial facility." Under the public accommodations provisions of the
ADA, the Company, as owner of the Initial Hotels, is obligated to make
reasonable accommodations to patrons who have physical, mental or other
disabilities. This includes the obligation to remove architectural and
communication barriers at the Initial Hotels when doing so is "readily
achievable" and to ensure that alterations to the Initial Hotels performed after
January 26, 1992 conform to the specific requirements of the ADA implementing
regulations. The Leases require the Lessee to comply with the ADA with respect
to the Initial Hotels. The Lessee will also generally be obligated to remedy any
ADA compliance matters from the applicable FF&E Reserve, its own funds,
financing by third parties or financing provided by the Company (which would
increase base rent under the Leases).
Taxation of the Company. Based upon certain representations described
below, in the opinion of Sullivan & Worcester LLP, counsel to the Company
("Company Counsel"), the Company has been organized in conformity with the
requirements for qualification as a REIT beginning with its taxable year ending
December 31, 1995, and its proposed method of operation as represented by the
Company will enable it to satisfy the requirements for such qualification. This
opinion is conditioned upon the assumption that the Leases, the Company's
Declaration and Bylaws and all other legal documents to which the Company is a
party will be complied with by all parties thereto and upon certain
representations made by the Company as to certain factual matters relating to
the Company's organization and intended or expected manner of operation. In
addition, this opinion is based on the law existing and in effect on the date
hereof. The Company's qualification and taxation as a REIT will depend upon the
Company's ability to meet on a continuing basis, through actual operating
results, asset composition, distribution levels and diversity of stock
ownership, the various qualification tests imposed under the Code discussed
below. While the Company has represented that it will operate in a manner so as
to satisfy on a continuing basis the various REIT qualification tests, Company
Counsel will not review compliance with these tests on a continuing basis, and
no assurance can be given that the Company will satisfy such tests on a
continuing basis.
In brief, if certain detailed conditions imposed by the REIT provisions
of the Code are met, entities, such as the Company, that invest primarily in
real estate and that otherwise would be treated for federal income tax purposes
as corporations, are generally not taxed at the corporate level on their "REIT
taxable income" that is currently distributed to Shareholders. This treatment
substantially eliminates the "double taxation" that generally results from the
use of corporations.
If the Company fails to qualify as a REIT in any year, however, it will
be subject to federal income taxation as if it were a domestic corporation, and
its Shareholders will be taxed in the same manner as shareholders of ordinary
corporations. In such an event, the Company could be subject to potentially
significant tax liabilities, and therefore the amount of cash available for
distribution to its Shareholders would be reduced or eliminated.
The Company currently expects to elect REIT status for the taxable year
ended December 31, 1995 and will continue to operate in a manner that permits it
to retain REIT status in each taxable year thereafter. There can be no
assurance, however, that this expectation will be fulfilled, since qualification
as a REIT depends on the Company's continuing to satisfy numerous asset, income
and distribution tests described below, which in turn will be dependent in part
on the Company's operating results.
8
The following summary is based on existing law, is not exhaustive of
all possible tax considerations and does not give a detailed discussion of any
state, local, or foreign tax considerations, nor does it discuss all of the
aspects of federal income taxation that may be relevant to a Shareholder in
light of his or her particular circumstances or to certain types of Shareholders
(including insurance companies, tax-exempt entities, financial institutions,
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.
General. In any year in which the Company qualifies as a REIT, in
general it will not be subject to federal income tax on that portion of its REIT
taxable income or capital gain which is distributed to Shareholders. The Company
may, however, be subject to tax at normal corporate rates upon any taxable
income or capital gain not distributed.
Notwithstanding its qualification as a REIT, the Company may also be
subject to taxation in certain other circumstances. If the Company should fail
to satisfy either the 75% or the 95% gross income test (as discussed below), and
nonetheless maintains its qualification as a REIT because certain other
requirements are met, it will be subject to a 100% tax on the greater of the
amount by which the Company fails either the 75% or the 95% gross income test,
multiplied by a fraction intended to reflect the Company's profitability. The
Company will also be subject to a tax of 100% on net income from any "prohibited
transaction" as described below, and if the Company has (i) net income from the
sale or other disposition of "foreclosure property" which is held for sale to
customers in the ordinary course of business or (ii) other nonqualifying income
from foreclosure property, it will be subject to tax on such income from
foreclosure property at the highest corporate rate. In addition, 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
years, the Company would be subject to a 4% excise tax on the excess of such
required distribution over the amounts actually distributed. The Company may
also be subject to tax in certain circumstances if it disposes within ten years
of their acquisition of assets acquired in a tax-free reorganization (although
no such transaction is currently contemplated). The Company may also be subject
to the corporate alternative minimum tax. The Company will use the calendar year
both for federal income tax purposes, and for financial reporting purposes.
In order to qualify as a REIT, the Company must meet, among others, the
following requirements:
Share Ownership Tests. The Company's Shares must be held by a minimum
of 100 persons for at least 335 days in each taxable year (or a proportional
number of days in any short taxable year). In addition, at all times during the
second half of each taxable year, no more than 50% in value of the outstanding
Shares of the Company may be owned, directly or indirectly and by applying
certain constructive ownership rules, by five or fewer individuals, which for
this purpose includes certain tax-exempt entities. However, for purposes of this
test, any Shares held by a qualified domestic pension or other retirement trust
will be treated as held directly by its beneficiaries in proportion to their
actuarial interest in such trust rather than by such trust. These share
ownership requirements need not be met until the second taxable year of the
Company for which a REIT election is made.
In order to ensure compliance with the foregoing share ownership tests,
the Company has placed certain restrictions on the transfer of its Shares to
prevent additional concentration of Share ownership. Moreover, to evidence
compliance with these requirements, under Treasury Regulations the Company must
maintain records which disclose the actual ownership of its outstanding Shares.
In fulfilling its obligations to maintain records, the Company must and will
demand written statements each year from the record holders of designated
percentages of its capital stock disclosing the actual owners of such Shares (as
prescribed by the Treasury Regulations). A list of those persons failing or
refusing to comply with such demand must be maintained as a part of the
Company's records. A Shareholder failing or refusing to comply with the
Company's written demand must submit with his tax return a similar statement
disclosing the actual ownership of Shares of the Company and certain other
information. In addition, the Company's Declaration provides restrictions
regarding the transfer of its Shares that are intended to assist the Company in
continuing to satisfy the Share ownership requirements.
Asset Tests. At the close of each quarter of the Company's taxable
year, the Company must satisfy two tests relating to the nature of its assets
(determined in accordance with generally accepted accounting principles). First,
at least 75% of the value of the Company's total assets must be represented by
interests in real property, interests in mortgages on real property, shares in
other REITs, cash, cash items, government securities and qualified temporary
investments. Second, although the remaining 25% of the Company's assets
9
generally may be invested without restriction, securities in this class may not
exceed (i) in the case of securities of any one non-government issuer, 5% of the
value of the Company's total assets or (ii) 10% of the outstanding voting
securities of any one such issuer.
Where a failure to satisfy the 25% asset test results from an
acquisition of securities or other property during a quarter, the failure can be
cured by disposition of sufficient non-qualifying assets within 30 days after
the close of such quarter. The Company intends to maintain adequate records of
the value of its assets to maintain compliance with the 25% asset test, and to
take such action as may be required to cure any failure to satisfy the test
within 30 days after the close of any quarter.
Gross Income Tests. The Company must satisfy three source of income
tests in each taxable year. The three tests are as follows:
The 75% Test. At least 75% of the Company's gross income for the
taxable year must be "qualifying income." Qualifying income generally includes
(i) rents from real property (as defined below); (ii) interest on obligations
secured by mortgages on, or interests in, real property; (iii) gains from the
sale or other disposition of interests in real property and real estate
mortgages, other than gain from property held primarily for sale to customers in
the ordinary course of the Company's trade or business ("dealer property"); (iv)
dividends or other distributions on shares in other REITs, as well as gain from
the sale of such shares; (v) abatements and refunds of real property taxes; (vi)
income from the operation, and gain from the sale, of property acquired at or in
lieu of a foreclosure of the mortgage secured by such property ("foreclosure
property"); (vii) commitment fees received for agreeing to make loans secured by
mortgages on real property or to purchase or lease real property; and (viii)
qualified temporary investment income. When the Company receives new capital in
exchange for its Shares or other capital stock (other than dividend reinvestment
amounts) or in a public offering of five-year or longer debt instruments, income
attributable to the temporary investment of such new capital in stock or a debt
instrument, if received or accrued within one year of the Company's receipt of
the new capital, is qualifying temporary investment income.
Rents received by the Company will qualify as "rents from real
property" in satisfying the gross income requirements only if several conditions
are met. Rents received from a tenant will not qualify as rents from real
property if the Company, or an owner of 10% or more of the Company, directly or
constructively owns 10% or more of such tenant. Thus, in order for gross income
from an Initial Hotel to qualify as rents from real property, the Company must
not own, directly or constructively (applying constructive ownership rules under
the Code), 10% or more of any lessee (the "10% ownership test"). Such
constructive ownership rules generally provide that, if 10% or more in value of
the Shares of the Company is owned, directly or indirectly, by or for any
person, the Company is considered as owning the stock owned, directly or
indirectly, by or for such Person. With respect to the 10% ownership test, the
Company does not own and does not intend to acquire, directly or constructively,
stock of any lessee. There can be no assurance, however, that the Company will
be able to monitor and enforce such restrictions, nor will Shareholders
necessarily be aware of shareholdings attributed to them under the attribution
rules. The Company has represented (which representation Company Counsel has
relied upon in rendering its opinion herein on REIT qualification) that it will
satisfy the 10% ownership test.
If rent attributable to personal property leased in connection with a
lease of real property is greater than 15% of the total rent for the taxable
year under or in connection with the lease, then the portion of rent
attributable to such personal property will not qualify as rents from real
property. Accordingly, the rents attributable to the Company's personal property
leased under or in connection with a lease of the real property comprising a
hotel must not be greater than 15% of the rents received under the applicable
lease. The rent attributable to the Company's personal property for a hotel is
the amount that bears the same ratio to total rent for the taxable year as (i)
the average of the adjusted bases of the Company's personal property of such
hotel at the beginning and at the end of the taxable year bears to (ii) the
average of the aggregate adjusted bases of both the Company's real and personal
property of such hotel at the beginning and at the end of such taxable year (the
"Adjusted Basis Ratio"). The Company has represented (which representation
Company Counsel has relied upon in rendering its opinion herein on REIT
qualification) that the allocation of purchase price with respect to each
Initial Hotel is accurate and that not more than 15% of the rent for each
taxable year with respect to each of the Initial Hotels or any other hotel
property acquired by the Company in the future will be attributable to the
Company's personal property under the foregoing rules. In addition, the Company
intends not to acquire additional personal property for any Initial Hotels if
such acquisition would cause the Adjusted Basis Ratio for such Initial Hotels to
exceed 15%. While the Company believes that the allocation for tax purposes of
the purchase price for the Initial Hotels to the personal property is
10
accurate, there can be no assurance that the Service will not assert that a
different allocation is appropriate and that more than 15% of the rents received
under a Lease is attributable to personal property under the foregoing rules, or
that a court would not uphold such assertion. If such a challenge were
successfully asserted, the Company could fail the 15% Adjusted Basis Ratio as to
one or more of its leases, which in turn could cause it to fail to satisfy the
75% or 95% gross income test and to fail to qualify as a REIT.
An amount received or accrued, directly or indirectly with respect to
any real or personal property, will not qualify as "rents from real property"
for purposes of the 75% or the 95% gross income test if the determination of
such amount depends in whole or in part on the income or profits derived by any
person from such property (except that an amount so derived or accrued generally
will not be excluded from "rents from real property" solely by reason of being
based on a fixed percentage or percentages of receipts or sales).
In addition, the Company must not manage the property or furnish or
render services to the tenants of such property, except through an independent
contractor from whom the company derives no income. There is an exception to
this rule permitting a REIT to perform certain customary tenant services of the
sort which a tax-exempt organization could perform without being considered in
receipt of "unrelated business taxable income."
The 95% Test. In addition to deriving 75% of its gross income from the
sources listed above, at least 95% of the Company's gross income for the taxable
year must be derived from the above described qualifying income, dividends,
interest, or gains from the sale or other disposition of stock, securities and
real property that is not dealer property. Dividends and interest on any
obligations not collateralized by an interest in real property are included for
purposes of the 95% gross income test, but not for purposes of the 75% gross
income test.
For purposes of determining whether the Company complies with the 75%
and the 95% gross income tests, gross income does not include income from
prohibited transactions. A "prohibited transaction" is a sale of dealer property
(excluding foreclosure property); however, it does not include a sale of
property if such property is held by the Company for at least four years and
certain other requirements (relating to the number of properties sold in a year,
their tax bases, and the cost of improvements made thereto) are satisfied. See
"-- Taxation of the Company -- General" above. Gain realized by the Company on
the sale of any dealer property generally will be treated as income from a
prohibited transaction that is subject to a 100% penalty tax. Under existing
law, whether property is dealer property is a question of fact that depends on
all the facts and circumstances with respect to the particular transaction. The
Company intends to hold the Initial Hotels for investment with a view to
long-term appreciation, to engage in the business of acquiring, owning and
developing the Initial Hotels and other hotel properties acquired by the Company
in the future, and to make such occasional sales of such hotels as are
consistent with the Company's investment objectives. Based upon the Company's
investment objectives, the Company believes that overall, the Initial Hotels
should not be considered dealer property and that the amount of income from
prohibited transactions, if any, will not be material.
The Company believes that, for purposes of both the 75% and the 95%
gross income tests, its investment in the Initial Hotels will generally give
rise to qualifying income in the form of rents, and that gains on sales of the
Initial Hotels generally will also constitute qualifying income. The Company
also believes that, for purposes of the 95% gross income test, if the portion of
rent attributable in any case to furniture, furnishings, equipment and operating
equipment were to be recharacterized as payments from a deemed financing of such
items, any gross income attributable to such payments would be qualifying gross
income in the form of interest and such interest income would not cause the
Company to be unable to satisfy the 75% gross income test.
Even if the Company fails to satisfy one or both of the 75% or the 95%
gross income tests for any taxable year, it may still qualify as a REIT for such
year if it is entitled to relief under certain provisions of the Code. These
relief provisions will generally be available if: (i) the Company's failure to
comply was due to reasonable cause and not to willful neglect; (ii) the Company
reports the nature and amount of each item of its income included in the tests
on a schedule attached to its tax return; and (iii) any incorrect information on
such schedule is not due to fraud with intent to evade tax. If these relief
provisions apply, however, the Company will nonetheless be subject to a 100% tax
on the greater of the amount by which it fails either the 75% or the 95% gross
income test, multiplied by a fraction intended to reflect the Company's
profitability.
The 30% Test. The Company must derive less than 30% of its gross income
for each taxable year from the sale or other disposition of (i) real property
held for less than four years (other than foreclosure property and involuntary
11
conversions); (ii) stock or securities (including certain interest rate swap or
cap agreements) held for less than one year; and (iii) property in a prohibited
transaction. The Company does not anticipate that it will have difficulty in
complying with this test. However, if extraordinary circumstances were to occur
that gave rise to dispositions of Initial Hotels within four years after the
respective dates of the Company's acquisition thereof, the Company may be unable
to satisfy the 30% test.
The Company may temporarily invest working capital in short term
investments, which may include shares in other REITs. Although the Company will
use its best efforts to ensure that its income generated by these investments
will be of a type which satisfies the 75% and 95% gross income tests, there can
be no assurance in this regard (see discussion above of the "new capital" rule
under the 75% test). Moreover, the Company may realize short-term capital gain
upon sale or exchange of such investments, and such short-term capital gain
would be subject to the limitations imposed by the 30% gross income test.
Foreclosure Property. The Company will be subject to tax at the maximum
corporate rate (currently 35%) on income from any "foreclosure property," other
than income that would be qualified income under the 75% gross income test, less
expenses directly connected with the production of such income. However, gross
income from any such foreclosure property will qualify under the 75% and the 95%
gross income tests.
Foreclosure property is defined as any real property (including
interests in real property) and any personal property incident to such real
property, acquired by a REIT as the result of a REIT having bid in such property
at foreclosure, or having otherwise reduced such property to ownership or
possession by agreement or process of law, after there was a default (or default
was imminent) on a lease of such property or on an indebtedness which such
property secured and for which the REIT makes a proper election to treat such
property as foreclosure property. However, a REIT will not be considered to have
foreclosed on a property where it takes control of the property as a mortgagee
in possession and cannot receive any profit or sustain any loss except as a
creditor of the mortgagor. Under the Code, property generally ceases to be
foreclosure property with respect to a REIT on the date which is two years after
the date such REIT acquired such property (or longer if an extension is granted
by the Secretary of the Treasury). However, the foregoing grace period is
terminated and foreclosure property ceases to be foreclosure property on the
first day (i) on which a lease is entered into with respect to such property
which, by its terms, will give rise to income which does not qualify under the
75% gross income test or any amount is received or accrued, directly or
indirectly, pursuant to a lease entered into on or after such day which will
give rise to income which does not qualify under the 75% gross income test, (ii)
on which any construction takes place on such property (other than completion of
a building, or completion of any other improvement, where more than 10% of the
construction of such building or other improvement was completed before default
became imminent), or (iii) which is more than 90 days after the day on which
such property was acquired by the REIT and the property is used in a trade or
business which is conducted by the REIT (other than through an independent
contractor from whom the REIT itself does not derive or receive any income).
As a result of the rules with respect to foreclosure property, if a
Lessee defaults on its obligations under a Lease for an Initial Hotel and the
respective Manager is not available to manage such Initial Hotel after the
Company terminates the Lessee's leasehold interest therein, and the Company is
unable to find a replacement lessee for such Initial Hotel within 90 days of
such foreclosure and unable to find an independent contractor to manage it,
gross income from hotel operations conducted by the Company from such property
would cease to qualify for the 75% and the 95% gross income tests. (Advisors
should qualify as an independent contractor which could operate foreclosure
property for up to two years.) In such event, the Company might be unable to
satisfy the 75% or the 95% gross income test, resulting in its failure to
qualify as a REIT.
Annual Distribution Requirements. In order to qualify as a REIT the
Company is required to distribute dividends (other than capital gain dividends)
to its Shareholders with respect to each year in an amount at least equal to (A)
the sum of (i) 95% of the Company's REIT taxable income (computed without regard
to the dividends paid deduction and the Company's net capital gain) and (ii) 95%
of the net income (after tax), if any, from foreclosure property, minus (B) the
sum of certain items of noncash income (from certain imputed rental income and
income from transactions inadvertently failing to qualify as like-kind
exchanges). 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 on
12
the undistributed amount at regular capital gains or ordinary corporate tax
rates, as the case may be. The Company will also be required to distribute
currently as a dividend an amount equal to the earnings and profits of any
corporation it may acquire in a tax-free reorganization (although no such
transaction is currently contemplated).
The Company intends to make timely distributions sufficient to satisfy
the annual distribution requirements described in the first and last sentences
of the preceding paragraph. It is possible that the Company may not have
sufficient cash or other liquid assets to meet the 95% distribution requirement,
due to timing differences between the actual receipt of income and actual
payment of expenses on the one hand, and the inclusion of such income and
deduction of such expenses in computing the Company's REIT taxable income on the
other hand. To avoid any problem with the 95% distribution requirement, the
Company will closely monitor the relationship between its REIT taxable income
and cash flow and intends, if necessary, to borrow funds in order to satisfy the
distribution requirement. However, there can be no assurance that such borrowing
would be available at such time.
If the Company fails to meet the 95% distribution requirement as a
result of an adjustment to the Company's tax return by the Service, the Company
may retroactively cure the failure by paying a "deficiency dividend" (plus
applicable penalties and interest) within a specified period.
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 Shareholders in any
year in which the Company fails to qualify as a REIT will not be deductible by
the Company, nor generally will they be required to be made under the Code. 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 in 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 reelecting
taxation as a REIT for the four taxable years following the year during which
qualification was lost.
Other Issues. In the case of certain sale leaseback arrangements, the
Service could assert that the Company realized prepaid rental income in the year
of purchase to the extent that the value of a leased property exceeds the
purchase price paid by the Company for that property. In litigated cases
involving sale leasebacks which have considered this issue, courts have
concluded that buyers have realized prepaid rent where both parties acknowledged
that the purported purchase price for the property was substantially less than
fair market value and the purported rents were substantially less than the fair
market rentals. Because of the lack of clear precedent, complete assurance
cannot be given that the Service could not successfully assert the existence of
prepaid rental income.
Depreciation of Properties. For tax purposes, the Company's real
property generally is depreciated on a straight line basis over 40 years and
personal property owned by the Company generally is depreciated over nine years.
Taxation of Shareholders.
Taxation of Taxable Domestic Shareholders. As long as the Company
qualifies as a REIT, distributions made to the Company's taxable domestic
Shareholders out of current or accumulated earnings and profits (and not
designated as capital gain dividends) will be taken into account by them as
ordinary income and will not be eligible for the dividends received deduction
for 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 its Shares. However, corporate
Shareholders may be required to treat up to 20% of certain capital gain
dividends as ordinary income. To the extent that the Company makes distributions
in excess of current and accumulated earnings and profits, these distributions
are treated first as a tax-free return of capital to the Shareholder, reducing
the tax basis of a Shareholder's Shares by the amount of such excess
distribution (but not below zero), with distributions in excess of the
Shareholder's tax basis being taxed as capital gains (if the Shares are held as
a capital asset). In addition, any dividend declared by the Company in October,
November or December of any year and payable to a Shareholder of record on a
specific 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
dividend is actually paid by the Company during January of the following
calendar year. Shareholders may not include in their individual income tax
13
returns any net operating losses or capital losses of the Company. Federal
income tax rules may also require that certain of the Company's minimum tax
adjustments and preferences be apportioned to Shareholders.
In general, any loss upon a sale or exchange of Shares 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 required to be treated by such Shareholder as
long-term capital gains.
Investors (other than certain corporations) who borrow funds to finance
their acquisition of Shares in the Company could be limited in the amount of
deductions allowed for the interest paid on the indebtedness incurred in such an
arrangement. Under Section 163(d) of the Code, interest paid or accrued on
indebtedness incurred or continued to purchase or carry property held for
investment is generally deductible only to the extent of the taxpayer's net
investment income. An investor's net investment income will include the dividend
and (if the investor so elects) capital gain dividend distributions he receives
from the Company; however, distributions treated as a nontaxable return of the
Shareholder's basis will not enter into the computation of net investment
income.
Under Section 469 of the Code, taxpayers (other than certain
corporations) generally will not be entitled to deduct losses from so-called
passive activities except to the extent of their income from passive activities.
For purposes of these rules, distributions received by a Shareholder from the
Company will not be treated as income from a passive activity and thus will not
be available to offset a Shareholder's passive activity losses.
Taxation of Tax-Exempt Shareholders. The Service has ruled that amounts
distributed by a REIT to a tax-exempt employees' pension trust do not constitute
unrelated business taxable income ("UBTI"). Subject to the discussion below
regarding a "pension-held REIT," based upon such ruling and the statutory
framework of the Code, distributions by the Company to a Shareholder that is a
tax-exempt entity would not constitute UBTI, provided that the tax-exempt entity
has not financed the acquisition of its Shares with "acquisition indebtedness"
within the meaning of the Code, that the Shares are not otherwise used in an
unrelated trade or business of the tax-exempt entity, and that the Company,
consistent with its present intent, does not hold a residual interest in a
REMIC.
If any pension or other retirement trust that qualifies under Section
401(a) of the Code ("qualified pension trust") holds more than 10% by value of
the interests in a "pension-held REIT" at any time during a taxable year, a
portion of the dividends paid to the qualified pension trust by such REIT may
constitute UBTI. For these purposes, a "pension-held REIT" is defined as a REIT
if (i) such REIT would not have qualified as a REIT but for the provisions of
the Code which look through such a qualified pension trust in determining
ownership of shares of the REIT and (ii) at least one qualified pension trust
holds more than 25% by value of the interests of such REIT or one or more
qualified pension trusts (each owning more than a 10% interest by value in the
REIT) hold in the aggregate more than 50% by value of the interests in such
REIT.
Information Reporting and Backup Withholding Tax. The Company will
report to its domestic Shareholders and to the Service the amount of dividends
paid for each calendar year, and the amount of tax withheld, if any, with
respect thereto. Under the back-up withholding rules, a Shareholder may be
subject to backup withholding at the rate of 31% with respect to dividends paid
unless such Shareholder (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 applicable requirements of the backup
withholding rules. A Shareholder that does not provide the Company with its
correct taxpayer identification number may also be subject to penalties imposed
by the Service. Any amount paid as backup withholding is available as a credit
against the Shareholder's income tax liability. In addition, the Company may be
required to withhold a portion of capital gain distributions made to any
Shareholders who fail to certify their non-foreign status to the company. See
"Certain United States Tax Considerations for Non-U.S. Holders of Shares."
Backup withholding is not an additional tax. Rather, the tax liability
of persons subject to backup withholding will be reduced by the amount of tax
withheld. If withholding results in an overpayment of taxes, a refund may be
obtained provided that the required information is furnished to the Service.
14
Other Tax Considerations.
Possible Legislative or Other Actions Affecting Tax Consequences.
Prospective Shareholders should recognize that the present federal income tax
treatment of investment in the Company may be modified by legislative, judicial
or administrative action at any time and that any such action may affect
investments and commitments previously made. The rules dealing with federal
income taxation are constantly under review by persons involved in the
legislative process and by the Service and the Treasury Department, resulting in
revisions of regulations and revised interpretations of established concepts as
well as statutory changes. No assurance can be given as to the form or content
(including with respect to effective dates) of any tax legislation which may be
enacted. Revisions in federal tax laws and interpretations thereof could
adversely affect the tax consequences of investment in the Company.
State and Local Taxes. The Company and its Shareholders may be subject
to state or local taxation, and the Company may be subject to state or local tax
withholding requirements, in various jurisdictions, including those in which it
or they 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 Shares.
Certain United States Tax Considerations Non-U.S. Holders Of Shares.
The following is a discussion of certain anticipated U.S. federal income and
U.S. federal estate tax consequences of the ownership and disposition of Shares
applicable to non-U.S. Shareholders of such Shares. The discussion is based on
current law and is for general information only. The discussion does not address
either aspects of U.S. federal taxation other than income and estate taxation or
all aspects of U.S. federal income and estate taxation. The discussion does not
consider any specific facts or circumstances that may apply to a particular
non-U.S. Shareholder.
In general, a non-U.S. Shareholder will be subject to regular United
States income tax with respect to its investment in the Company if such
investment is "effectively connected" with the non-U.S. Shareholder's conduct of
a trade or business in the United States, or if the non-U.S. Shareholder is a
nonresident alien individual who is present in the United States for 183 days or
more during the taxable year. A corporate non-U.S. Shareholder that receives
income that is (or is treated as) effectively connected with a U.S. trade or
business may also be subject to the branch profits tax under Section 884 of the
Code, which is payable in addition to regular United States corporate income
tax. The following discussion will apply to non-U.S. Shareholders whose
investment in the Company is not so effectively connected and who are not
individuals present in the U.S. for 183 days or more during the taxable year.
A distribution by the Company that is not deemed to be attributable to
gain from the sale or exchange by the Company of a United States real property
interest and that is not designated by the Company as a capital gain dividend
will be treated as an ordinary income dividend to the extent that it is made out
of current or accumulated earnings and profits. A distribution by the Company
that is designated as a capital gain dividend will generally not be subject to
withholding except to the extent that such dividend is attributable to the sale
or exchange by the Company of United States real property interests, as
described below. Generally, an ordinary income dividend will be subject to a
United States withholding tax equal to 30% of the gross amount of the dividend
unless such withholding is reduced by an applicable tax treaty. A distribution
of cash in excess of the Company's earnings and profits will be treated first as
a nontaxable return of capital that will reduce a non-U.S. Shareholder's basis
in its Shares (but not below zero) and then as gain from the disposition of such
Shares, the tax treatment of which is described under the rules discussed below
with respect to disposition of Shares. A distribution in excess of the Company's
earnings and profits may be subject to 30% dividend withholding if at the time
of the distribution it cannot be determined whether the distribution will be in
an amount in excess of the Company's current and accumulated earnings and
profits. If it is subsequently determined that such distribution is, in fact, in
excess of current and accumulated earnings and profits, the non-U.S. Shareholder
may seek a refund from the Service. The Company expects to withhold United
States income tax at the rate of 30% on the gross amount of any such
distributions made to a non-U.S. Shareholder in any tax year unless (i) a lower
tax treaty applies and the required form evidencing eligibility for that reduced
rate for such tax year is filed with the Company or (ii) the non-U.S.
Shareholder files IRS Form 4224 for such tax year with the Company claiming that
the distribution is "effectively connected" income.
15
For any year in which the Company qualifies as a REIT, distributions by
the Company that are attributable to gain from the sale or exchange of a United
States real property interest will be taxed to a non-U.S. Shareholder in
accordance with the Foreign Investment in Real Property Tax Act of 1980
("FIRPTA"). Under FIRPTA, such distributions are taxed to a non-U.S. Shareholder
as if such distributions were gains "effectively connected" with a United States
trade or business. Accordingly, a non-U.S. Shareholder will be taxed at the
normal capital gain rates applicable to a U.S. Shareholder (subject to any
applicable alternative minimum tax and a special alternative minimum tax in the
case of non-resident alien individuals). Distributions subject to FIRPTA may
also be subject to a 30% branch profits tax in the hands of a foreign corporate
Shareholder that is not entitled to treaty exemption. The Company will be
required to withhold from distributions to non-U.S. Shareholders, and remit to
the Service, 35% of the amount of any distribution that could be designated as
capital gain dividends to the extent that such dividends are attributable to the
sale or exchange by the Company of United States real property interests.
Tax treaties may reduce the Company's withholding obligations. If the
amount of tax withheld by the Company with respect to a distribution to a
non-U.S. Shareholder exceeds the Shareholder's United States liability with
respect to such distribution, the non-U.S. Shareholder may file for a refund of
such excess from the Service. In this regard, it should be noted that the 35%
withholding tax rate on capital gain dividends corresponds to the maximum income
tax rate applicable to corporations but is higher than the 28% maximum rate on
capital gains of individuals.
If the Shares fail to constitute a "United States real property
interest" within the meaning of FIRPTA, a sale of the Shares by a non-U.S.
Shareholder generally will not be subject to United States taxation unless (i)
investment in the Shares is effectively connected with the non-U.S.
Shareholder's United States trade or business, in which case, as discussed
above, the non-U.S. Shareholder would be subject to the same treatment as U.S.
Shareholders on such gain or (ii) the non-U.S. Shareholder is a nonresident
alien individual who was present in the United States for 183 days or more
during the taxable year, in which case the nonresident alien individual will be
subject to a 30% tax on the individual's capital gains.
The Shares will not constitute a United States real property interest
if the Company is a "domestically controlled REIT." A domestically controlled
REIT is a REIT in which at all times during a specified testing period less than
50% in value of its shares is held directly or indirectly by non-U.S.
Shareholders. It is currently anticipated that the Company will be a
domestically controlled REIT, and therefore that the sale of Shares will not be
subject to taxation under FIRPTA. However, because the Shares will be publicly
traded, no assurance can be given that the Company will continue to be a
domestically controlled REIT. If the Company did not constitute a domestically
controlled REIT, whether a non-U.S. Shareholder's sale of Shares would be
subject to tax under FIRPTA as a sale of a United States real property interest
would depend on whether the Shares were "regularly traded" (as defined by
applicable Treasury Regulations) on an established securities market (e.g., the
NYSE, on which the Shares will be listed) and on the size of the selling
Shareholder's interest in the Company. If the gain on the sale of the Shares
were subject to taxation under FIRPTA, the non-U.S. Shareholder would be subject
to the same treatment as a U.S. Shareholder with respect to such gain (subject
to applicable alternative minimum tax and a special alternative minimum tax in
the case of nonresident alien individuals). In any event, a purchaser of Shares
from a non-U.S. Shareholder will not be required under FIRPTA to withhold on the
purchase price if the purchased Shares are "regularly traded" on an established
securities market or if the Company is a domestically controlled REIT.
Otherwise, under FIRPTA, the purchaser of Shares may be required to withhold 10%
of the purchase price and to remit such amount to the Service.
Federal Estate Tax. Shares owned or treated as owned by an individual
who is not a citizen or resident (as defined for United States federal estate
tax purposes) of the United States at the time of death will be includible in
the individual's gross estate for United States federal estate tax purposes
unless an applicable estate tax treaty provides otherwise.
Backup Withholding and Information Reporting Requirements. The Company
must report annually to the Service and to each non-U.S. Shareholder the amount
of dividends paid to and the tax withheld with respect to such holder. These
information reporting requirements apply regardless of whether withholding was
reduced or eliminated by an applicable tax treaty. Copies of these information
returns may also be made available under the provisions of a specific treaty or
agreement to the tax authorities in the country in which the non-U.S.
Shareholder resides. United States backup withholding tax (which generally is a
withholding tax imposed at the rate of 31% on certain payments to persons that
16
fail to furnish the information required under the United States information
reporting requirements) will generally not apply to dividends paid on Shares to
a non-U.S. Shareholder at an address outside the United States.
The payment of the proceeds from the disposition of Shares to or
through the United States office of a broker will be subject to information
reporting and backup withholding at a rate of 31% unless the owner, under
penalties of perjury, certifies, among other things, its status as a non-U.S.
Shareholder, or otherwise establishes an exemption. The payment of the proceeds
from the disposition of Shares to or through a non-U.S. office of a broker
generally will not be subject to backup withholding and information reporting.
In the case of proceeds from a disposition of Shares paid to or through a
non-U.S. office of a U.S. broker or paid to or through a non-U.S. office of a
non-U.S. broker that is (i) a "controlled foreign corporation" for United States
federal income tax purposes or (ii) a person 50% or more of whose gross income
from all sources for a certain three-year period was effectively connected with
a United States trade or business, (a) backup withholding will not apply unless
the broker has actual knowledge that the owner is not a non-U.S. Shareholder,
and (b) information reporting will not apply if the broker has documentary
evidence in its files that the owner is a non-U.S. Shareholder (unless the
broker has actual knowledge to the contrary).
Any amounts withheld under the backup withholding rules from a payment
to a non-U.S. Shareholder will be refunded by the Service (or credited against
the non-U.S. Shareholder's United States federal income tax liability, if any),
provided that the required information is furnished to the Service.
Other Tax Consequences. The Company and its Shareholders may be subject
to state or local taxation in various state or local jurisdictions, including
those in which it or they transact business or reside.
There may be other federal, state, local or foreign income, or estate
and gift, tax considerations applicable to the circumstances of a particular
investor. Shareholders should consult their own tax advisors with respect to
such matters.
Erisa Plans, Keogh Plans and Individual Retirement Accounts.
General Fiduciary Obligations. Fiduciaries of a pension, profit-sharing
or other employee benefit plan subject to Title I of the Employee Retirement
Income Security Act of 1974, as amended ("ERISA") ("ERISA Plan") must consider
whether their investment in the Company's Shares satisfies the diversification
requirements of ERISA, whether the investment is prudent in light of possible
limitations on the marketability of the Shares, whether such fiduciaries have
authority to acquire such Shares under the appropriate governing instrument and
Title I of ERISA, and whether such investment is otherwise consistent with their
fiduciary responsibilities. Any ERISA Plan fiduciary should also consider
ERISA's prohibition on improper delegation of control over or responsibility for
"plan assets." Trustees and other fiduciaries of an ERISA plan may incur
personal liability for any loss suffered by the plan on account of a violation
of their fiduciary responsibilities. In addition, such fiduciaries may be
subject to a civil penalty of up to 20% of any amount recovered by the plan on
account of such a violation (the "Fiduciary Penalty"). Also, fiduciaries of any
Individual Retirement Account ("IRA"), Keogh Plan or other qualified retirement
plan not subject to Title I of ERISA because it does not cover common law
employees ("Non-ERISA Plan") should consider that such an IRA or Non-ERISA Plan
may only make investments that are authorized by the appropriate governing
instrument. Fiduciary Shareholders should consult their own legal advisers if
they have any concern as to whether the investment is inconsistent with any of
the foregoing criteria.
Prohibited Transactions. Fiduciaries of ERISA Plans and persons making
the investment decision for an IRA or other Non-ERISA Plan should also consider
the application of the prohibited transaction provisions of ERISA and the Code
in making their investment decision. Sales and certain other transactions
between an ERISA Plan, IRA, or other Non-ERISA Plan and certain persons related
to it are prohibited transactions. The particular facts concerning the
sponsorship, operations and other investments of an ERISA Plan, IRA, or other
Non-ERISA Plan may cause a wide range of other persons to be treated as
disqualified persons or parties in interest with respect to it. A prohibited
transaction, in addition to imposing potential personal liability upon
fiduciaries of ERISA Plans, may also result in the imposition of an excise tax
under the Code or a penalty under ERISA upon the disqualified person or party in
interest with respect to the ERISA or Non-ERISA Plan or IRA. If the disqualified
person who engages in the transaction is the individual on behalf of whom an IRA
is maintained (or his beneficiary), the IRA may lose its tax-exempt status and
its assets may be deemed to have been distributed to such individual in a
17
taxable distribution (and no excise tax will be imposed) on account of the
prohibited transaction. Fiduciary Shareholders should consult their own legal
advisers if they have any concern as to whether the investment is a prohibited
transaction.
Special Fiduciary and Prohibited Transactions Considerations. The
Department of Labor ("DOL"), which has certain administrative responsibility
over ERISA Plans as well as over IRAs and other Non-ERISA Plans, has issued a
regulation defining "plan assets." The regulation generally provides that when
an ERISA or Non-ERISA Plan or IRA acquires a security that is an equity interest
in an entity and that security is neither a "publicly offered security" nor a
security issued by an investment company registered under the Investment Company
Act of 1940, the ERISA or Non-ERISA Plan's or IRA's assets include both the
equity interest and an undivided interest in each of the underlying assets of
the entity, unless it is established either that the entity is an operating
company or that equity participation in the entity by benefit plan investors is
not significant.
The regulation defines a publicly offered security as a security that
is "widely held," "freely transferable" and either part of a class of securities
registered under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), or sold pursuant to an effective registration statement under the
Securities Act (provided the securities are registered under the Exchange Act
within 120 days after the end of the fiscal year of the issuer during which the
offering occurred). The Company's Shares will be registered under the Exchange
Act.
The regulation provides that a security is "widely held" only if it is
part of a class of securities that is owned by 100 or more investors independent
of the issuer and of one another. However, a security will not fail to be
"widely held" because the number of independent investors falls below 100
subsequent to the initial public offering as a result of events beyond the
issuer's control.
The regulation provides that whether a security is "freely
transferable" is a factual question to be determined on the basis of all
relevant facts and circumstances. The regulation further provides that, where a
security is part of an offering in which the minimum investment is $10,000 or
less, certain restrictions ordinarily will not, alone or in combination, affect
a finding that such securities are freely transferable. The restrictions on
transfer enumerated in the regulation as not affecting that finding include: any
restriction on or prohibition against any transfer or assignment which would
result in a termination or reclassification of the Company for federal or state
tax purposes, or would otherwise violate any state or federal law or court
order; any requirement that advance notice of a transfer or assignment be given
to the Company and any requirement that either the transferor or transferee, or
both, execute documentation setting forth representations as to compliance with
any restrictions on transfer which are among those enumerated in the regulation
as not affecting free transferability, including those described in the
preceding clause of this sentence; any administrative procedure which
establishes an effective date, or an event prior to which a transfer or
assignment will not be effective; and any limitation or restriction on transfer
or assignment which is not imposed by the issuer or a person acting on behalf of
the issuer. The Company believes that the restrictions imposed under the
Company's Declaration and Bylaws on the transfer of Shares do not result in the
failure of the Shares to be "freely transferable." Furthermore, the Company
believes that at present there exist no other facts or circumstances limiting
the transferability of the Shares which are not included among those enumerated
as not affecting their free transferability under the regulation, and the
Company does not expect or intend to impose in the future (or to permit any
person to impose on its behalf) any limitations or restrictions on transfer
which would not be among the enumerated permissible limitations or restrictions.
However, the final regulation only establishes a presumption in favor of a
finding of free transferability, and no guarantee can be given that the DOL or
the Treasury Department will not reach a contrary conclusion.
Assuming that the Shares will be "widely held" and that no other facts
and circumstances exist which restrict transferability of the Shares, the
Company has received an opinion from Company Counsel that the Shares should not
fail to be "freely transferable" for purposes of the regulation due to the
restrictions on transfer of the Shares under the Company's Declaration and
Bylaws and that under the regulation the Shares are publicly offered securities
and the assets of the Company will not be deemed to be "plan assets" of any
ERISA Plan, IRA or other Non-ERISA Plan that invests in the Shares.
If the assets of the Company are deemed to be plan assets under ERISA:
(i) the prudence standards and other provisions of Part 4 of Title I of ERISA
would be applicable to investments made by the Company; (ii) the person or
persons having investment discretion over the assets of ERISA Plans which invest
in the Company would be liable under the aforementioned Part 4 of Title I of
18
ERISA for investments made by the Company which do not conform to such ERISA
standards unless Advisors registers as an investment adviser under the
Investment Advisers Act of 1940 and certain other conditions are satisfied; and
(iii) certain transactions that the Company might enter into in the ordinary
course of its business and operation might constitute "prohibited transactions"
under ERISA and the Code.
Item 2. Properties
General. The Initial Hotels consist of 37 Courtyard by Marriott(R)
hotels (the "Initial Hotels"), with 5,286 rooms in 20 states. These hotels have
an average age of approximately five years and the Company believes that the
physical plant of each hotel in which it has invested is suitable and adequate
for its present and any currently proposed uses. At December 31, 1995, the
Company had total hotel investments of approximately $332.6 million. The Initial
Hotels are all leased to the Lessee and operated by the Manager. See "Business
- -- The Initial Hotels, Leases and Management Agreements."
The following table summarizes certain information about the properties
as of December 31, 1995. All dollar figures are in thousands.
Numbers of Number of Total Investment at Annual Base
State Hotels Rooms December 31, 1995 Rent
- ----- ------ ----- ----------------- ----
Arizona 2 279 $ 15,295 $ 1,510
California 4 577 35,172 3,480
Delaware 1 152 12,419 1,210
Florida 1 152 12,292 1,210
Georgia 5 732 43,736 4,330
Indiana 1 149 8,802 880
Maryland 1 152 13,661 1,340
Massachusetts 7 963 60,473 6,030
Michigan 1 148 6,580 650
Minnesota 1 149 8,783 880
Missouri 2 298 16,687 1,620
New Jersey 1 146 12,463 1,240
North Carolina 3 412 23,897 2,360
Pennsylvania 1 152 9,965 970
South Carolina 1 108 5,795 580
Tennessee 1 109 9,318 920
Texas 1 160 8,680 860
Virginia 1 149 8,270 820
Washington 1 152 11,723 1,160
Wisconsin 1 147 8,561 850
--- ---- ---------- --------
37 5,286 $332,572 $32,900
Certain of the Initial Hotels are currently and from time to time may
be made subject to mortgages securing the Company's lines of credit or other
secured borrowings. See "Management's Discussion and Analysis of Results of
Operations and Financial Condition -- Liquidity and Capital Resources."
The land underlying five of the Initial Hotels is subject to ground
leases. The leases with respect to the ground leased Initial Hotels are subject
to early termination if the applicable ground lease terminates. Assuming the
exercise of all renewal options, one ground lease will expire in 2067, one in
2066, two in 2041 and one in 2039. The ground leases expiring in 2041 and 2039
will expire approximately two years and four years, respectively, prior to the
date the applicable Initial Lease would otherwise expire if fully renewed.
19
Moreover, the landlord under the ground lease which expires in 2039 has the
right to terminate the ground lease at any time after January 1, 1999 provided
it agrees not to use the premises as a commercial lodging facility, complies
with a right of first refusal granted to the Company and pays to the Company an
amount equal to the fair market value of the Company's interest under the ground
lease. The landlords under the ground leases which expire in 2041 have the right
to purchase the Company's leasehold interest in the event that the Company
changes the use of the premises from a hotel use or in the event that Host
Marriott Corporation, its affiliates or another agreed upon suitable operator
ceases to lease or manage the applicable Initial Hotel. Any pledge of the
Company's interests in a ground lease may also require the consent of the
applicable ground lessor and the lenders thereto. The ground leased land
underlying three of the Initial Hotels is encumbered by certain mortgages.
Subject to the Company's satisfaction of certain conditions, the foreclosure of
such mortgages will not result in the termination of the applicable ground
lease.
Item 3. Legal Proceedings
Although in the ordinary course of business the Company is or may
become involved in legal proceedings, the Company has a limited operating
history and is not aware of any material pending legal proceeding affecting any
of the Hotels for which it might become liable.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of shareholders during the fourth
quarter of the year covered by this Form 10-K.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Company's Shares are traded on the New York Stock Exchange (symbol:
HPT). The following table sets forth for the periods indicated the high and low
closing sale prices for the Shares as reported in the New York Stock Exchange
Composite Transactions reports since the Company's initial public offering.
1995 High Low
---- ---- ---
Third Quarter (since August 15, 1995).............. 26 7/8 24 5/8
Fourth Quarter..................................... 26 3/4 24 3/4
The closing price of the Shares on the New York Stock Exchange on March 25, 1996
was $26.625.
As of March 25, 1996, there were 295 Shareholders of record and the
Company estimates that as of such date there were approximately 12,000
beneficial owners of the Shares.
Dividends declared with respect to each period for the recent fiscal
year and the respective annualized rates are set forth in the following table.
Annualized
Dividend Dividend
Per Share Rate
--------- -----------
August 22, 1995 to
September 30, 1995.......................... $ .24 $2.20
Fourth Quarter, 1995........................ .55 2.20
All dividends declared have been paid. The Company intends to continue to
declare and pay future dividends on a quarterly basis.
Concurrent with the IPO, the Company paid a dividend of $879,000 to HRP,
representing retained earnings from inception to the IPO.
20
In order to qualify for the beneficial tax treatment accorded to REITs by
Sections 856 through 860 of the Code, the Company is required to make
distributions to shareholders which annually will be at least 95% of the
Company's "real estate investment trust taxable income" (as defined in the
Code). All distributions will be made by the Company at the discretion of the
Board of Trustees and will depend on the earnings of the Company, cash available
for distribution, the financial condition of the Company and such other factors
as the Board of Trustees deems relevant. The Company intends to distribute
substantially all of its "real estate investment trust taxable income" to its
shareholders.
21
Item 6. Selected Financial Data
The following table sets forth selected financial and operating data on an
historical and a pro forma basis for the Company for the year ended December 31,
1995. The pro forma data for the 37 Initial Hotels are unaudited and presented
as if the Company's formation transactions, primarily the acquisition and
leasing of the Initial Hotels and the Company's initial public offering of
Shares, and certain other transactions had been consummated as of the date or
for the period presented. The pro forma data are not necessarily indicative of
what the actual financial position or results of operations would have been, nor
do they purport to represent the financial position or results of operations for
future periods. The following selected and pro forma financial and operating
data should be read in conjunction with the financial statements and the notes
thereto included beginning at page F-1 of this Report on Form 10-K.
Historical Pro Forma
-------------------------- --------------------------
February 7, 1995
(Inception) to
December 31, Year Ended
1995(1) December 31, 1995
(In thousands, except per Share data)
Operating Data:
Revenues:
Rental income................................ $ 19,531 $ 33,308
FF&E reserve income.......................... 4,037 6,424
Interest income.............................. 74 144
--------- --------
Total revenues............................ 23,642 39,876
Expenses:
Interest to HRP.............................. 5,039 --
Depreciation and amortization................ 5,844 9,229
General administrative and advisory.......... 1,410 2,616
--------- ---------
Total expense:............................ 12,293 11,845
--------- ---------
Net income..................................... $ 11,349 $ 28,031
========= =========
Net income per share........................... $ 2.51 $ 2.22
Weighted average shares outstanding............ 4,515 12,601
Balance Sheet Data (as of December 31,
1995):
Real estate properties, net.................... $ 326,752 $ 326,752
Total assets................................... 338,947 338,947
Total debt..................................... -- --
Shareholders' equity........................... 297,951 297,951
Other Data:
Cash available for distribution(2)............. $ 13,156 $ 30,836
Cash provided by operating activities(3)....... 14,140 31,820
Cash used in investing activities(3)........... 303,652 303,652
Cash provided by financing activities(3)....... 291,647 268,481
Cash available for Distribution per share (2).. $ 2.91 $ 2.45
- ---------------
<FN>
(1) From inception on February 7, 1995 until completion of its initial public
offering on August 22, 1995, the Company was a 100% owned subsidiary of HRP.
It was initially capitalized with $1.0 million of equity and $163.3 million
of debt. The debt was provided by HRP at rates which were lower than the
market rates which the Company would have paid on a stand alone basis.
Accordingly, the Company does not believe that its results of operations
while it was a wholly owned subsidiary are comparable to subsequent periods.
22
(2) Some REITs use funds from operations ("FFO"), representing net income,
calculated in accordance with generally accepted accounting principles,
adjusted for non-recurring items, before real estate depreciation and
amortization as a measure of financial performance. Because of the impact of
FF&E Reserves on the Company's calculation of FFO which results from the
fact that the FF&E Reserves from the Initial Leases are included in FFO (and
escrowed by the Company), the Company does not believe FFO represents a
meaningful measure of its performance or offers a meaningful basis for
comparison of its performance with that of other public hotel REITs.
Instead, the Company believes that the best measure of its financial
performance is Cash Available for Distribution, which it defines as net
income from operations, plus depreciation and amortization and less Company
income reserved for renovations and refurbishment (i.e., the FF&E Reserves)
and adjusted for non-recurring items, if any. Moreover, the Company believes
that Cash Available for Distribution provides a meaningful basis for
comparison of the Company's performance with the performance of other public
hotel REITs provided that appropriate amounts are reserved for renovations
and refurbishment in all cases.
(3) Amounts are computed on a pro forma basis in accordance with GAAP, except
that cash provided by (used in) operating activities excludes the effect on
cash resulting from changes in current assets and current liabilities. The
Company does not believe that these excluded items are material to net cash
provided by operating activities.
</FN>
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Overview
The Company was organized on February 7, 1995 and commenced operations on
March 24, 1995 with the acquisition of the first 21 of its 37 Initial Hotels.
The Company completed its initial public offering of shares and acquired the 16
remaining Initial Hotels on August 22, 1995. Since it has been recently formed
and has limited historical financial data, the Company believes it is meaningful
to an understanding of its present and ongoing operations to discuss the
Company's pro forma results of operations as well as its historical results of
operations.
The following discussion should be read in conjunction with the selected
financial data above and the financial statements and the notes thereto included
elsewhere herein. Pro forma results and percentage relationships set forth in
the financial highlights section and in such financial statements may not be
indicative of the future operations of the Company.
Historical and Pro Forma Results of Operations
February 7, 1995 (Inception) Through December 31, 1995
Total revenues for the period from February 7, 1995 (inception) through
December 31, 1995 were $23.6 million, which included base and percentage rent of
$19.5 million and FF&E reserve income of $4.0 million. Total expenses for the
period were $12.3 million, including interest expense and depreciation and
amortization of $5.0 million and $5.8 million, respectively. Net income for the
period was $11.3 million ($2.51 per share) and cash available for distribution
for the period was $13.2 million ($2.91 per share), based in both cases on
average outstanding shares for the period of 4,515,000.
From inception until completion of its initial public offering on August
22, 1995, the Company was a 100% owned subsidiary of HRP and was initially
capitalized with $1 million of equity and $163.3 million of debt. The debt was
provided by HRP at rates which were lower than the market rates which the
Company would have paid on a stand alone basis. Accordingly, the Company does
not believe that its results of operations while it was a wholly owned
subsidiary of HRP are comparable to subsequent periods.
Cash flow provided by (used for) operating, investing and financing
activities were $14.1 million, ($303.7 million) and $291.6 million,respectively,
for the year ended December 31, 1995.
Pro Forma Year Ended December 31, 1995
The pro forma results of operations for the 37 Initial Hotels assumes
that the Company's formation transactions, the initial public offering of shares
and the acquisition and leasing of the 37 Initial Hotels and certain related
23
transactions all occurred on January 1, 1995, and demonstrates the Company's
rate of operations since becoming a separate public company. On this pro forma
basis, total revenues would have been $39.9 million (principally base and
percentage rents of $33.3 million and FF&E reserve income of $6.4 million).
Total expenses would have been $11.8 million (including depreciation and
amortization of $9.2 million and general, administrative and advisory expenses
of $2.6 million). Net income would have been $28.0 million or $2.22 per share,
and Cash Available for Distribution would have been $30.8 million or $2.45 per
share, based in both cases upon 12,600,900 shares outstanding.
Liquidity and Capital Resources
The Company's primary source of cash to fund its dividends and day to day
operations is the base and percentage rents it receives. Base rents are paid
monthly in advance and percentage rents are paid either monthly or quarterly in
arrears. This flow of funds from rents has historically been sufficient for the
company to pay dividends and meet day to day operating expenses.
In order to fund acquisitions and to accommodate occasional cash needs
which may result from timing differences between the receipt of rents and the
need to pay dividends or operating expenses, the Company has entered into a line
of credit arrangement (the "Line of Credit") with DLJ Mortgage Capital, Inc.
("DLJMC"). The Line of Credit is for up to $200 million, of which up to $20
million is available for general business purposes. Drawings under the line of
credit are secured by first mortgage liens on certain of the Company's hotels.
Funds may be drawn, repaid and redrawn until maturity, and no principal
repayment is due until maturity. The line of credit matures on December 31,
1998; however, upon the request of the Company and subject to certain terms and
conditions, DLJMC has the right (but not the obligation) to convert amounts
outstanding at maturity, if any, into an amortizing mortgage loan due on
December 31, 2008. Interest on borrowings under the line of credit are payable
until maturity at a spread above one month LIBOR; and interest during the
extended term, if any, will be set at market rates at the time the loan is
extended. At March 22, 1996, $115.7 million dollars was drawn under the Line of
Credit and had been principally used to fund deposits for the Additional Hotels
discussed below and to pay the purchase price for the 5 Residence Inn by
Marriott(R) and 3 Courtyard by Marriott(R) hotels acquired on such date.
The Company entered into agreements to acquire the Additional Hotels for
approximately $484 million. The net funding required to accomplish these
acquisitions after taking into account the hold back security deposits and
related expenditures and expenses will be approximately $445 million. In order
to enhance the ability of the Company to acquire the Additional Hotels, the
Company and DLJMC have entered into an agreement to expand the funds
availability under the Line of Credit by up to an additional $250 million (the
"Expanded Credit Facility"). The Expanded Credit Facility will have the same
rate of interest as the Line of Credit. Borrowings under the Expanded Credit
Facility will be unsecured, except that the Company is required to provide
collateral for any such borrowings outstanding after December 31, 1996. The
Expanded Credit Facility matures on March 31, 1997. In the event that amounts
drawn under the Expanded Credit Facility are not repaid at maturity, DLJMC has
the right to require that the Company enter into a securtized mortgage
transaction by which these obligations may be publicly sold.
The Company expects to use borrowings under the Line of Credit, advances
under the Expanded Credit Facility and/or net proceeds of an offering of equity
securities to fund the acquisition of the Additional Hotels. To the extent,
after giving effect to the acquisition of the Additional Hotels, borrowings
remain outstanding on the Expanded Credit Facility or Line of Credit, the
Company intends to explore alternatives to repay such amounts. Such alternatives
may include incurring long term debt. Although the Company has not received
commitments for equity or debt financing to repay borrowings on the Expanded
Credit Facility or Line of Credit, the Company believes that its improved
financial position resulting from the acquisition of the Additional Hotels and
the consummation of any offering of equity securities will enable it to complete
such long term debt financing during 1996. The Company believes it will in the
future have access to various types of financing, including debt or equity
securities offerings, with which to finance its continued operations and future
acquisitions. However, there can be no assurance that the Company will
consummate any debt or equity security offerings.
Seasonality
The Initial Hotels have historically experienced seasonal differences
typical of the hotel industry with higher revenues in the second and third
quarters of calendar years compared with the first and fourth quarters. This
seasonality is not expected to cause fluctuations in the Company's rental income
24
because the Company believes that the revenues generated by its hotels will be
sufficient for the lessees to pay rents on a regular basis notwithstanding
seasonal fluctuations.
Inflation
The Company believes that inflation should not have a material adverse
effect on the Company. Although increases in the rate of inflation may tend to
increase interest rates which the Company may be required to pay for borrowed
funds, the Company has a policy of obtaining interest rate caps in appropriate
circumstances to protect it from interest rate increases. In addition, the
Company's leases provided for the payment of percentage rent to the Company
based on increases in total sales, and such rent should increase with inflation.
Certain Considerations
The discussions above and elsewhere herein contain statements which
constitute forward looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 and are other than statements of
historical fact. Readers are cautioned that important factors, such as interest
rates and the Company's tax status as a REIT, among others, may have affected
and in the future could affect the Company's actual results. Actual future
results could differ, possibly materially, from those expressed in any forward
looking statements contained herein as a result of such factors as changes in
financing terms, seasonality, the Company's ability, or not, to complete
acquisitions and financing transactions, results of hotel operations and general
changes in economic conditions not presently contemplated.
Item 8. Financial Statements and Supplementary Data
The financial statements, related notes, schedule and reports of
independent public accountants for the Company are included following Part IV,
beginning on page F-1, and identified in the index appearing at Item 14(a). The
financial statements for HMH HPT Courtyard, Inc. as of December 29, 1995 and for
the period March 24, 1995 (inception) through December 29, 1995 and the report
of independent public accountants begin on page F-13. The financial statements
for the Initial Hotels for the period ended on the date of their acquisition by
the Company and the report of independent public accountants begin on Page F-24.
Item 9. Changes in and Disagreements on Accounting and Financial Disclosure
None.
PART III
The information in Part III (Items, 10, 11, 12 and 13) is incorporated by
reference to the Company's definitive Proxy Statement, which is expected to be
filed not later than 120 days after the end of the Company's fiscal year.
Item 14. Exhibits, Financial Statements, Schedule and Reports on Form 8-K.
(a) Index to Financial Statements and Financial Statement Schedules
Hospitality Properties Trust Financial Statements:
Report of Independent Public Accountants.............................. F-1
Balance Sheet as of December 31, 1995................................. F-2
Statement of Income for the period February 7, 1995
(inception) to December 31, 1995...................................... F-3
Statement of Shareholders' Equity for the period February 7 , 1995
(inception) to December 31, 1995...................................... F-4
25
Statement of Cash Flows for the Period February 7, 1995
(inception) to December 31, 1995...................................... F-5
Notes to Financial Statements......................................... F-6
Report of Independent Public Accountants.............................. F-10
Schedule III - Real Estate and Accumulated Depreciation............... F-11
HMH HPT Courtyard, Inc. Financial Statements:
Report of Independent Public Accountants.............................. F-13
Balance Sheet as of December 29, 1995................................. F-14
Statement of Income for the period March 24, 1995 (inception)
through December 29, 1995............................................. F-15
Statement of Shareholder's Equity for the period March 24, 1995
(inception) to December 29, 1995...................................... F-16
Statement of Cash Flows for the period March 24, 1995
(inception) to December 29, 1995...................................... F-17
Notes to Financial Statements......................................... F-18
Initial Hotels Combined Financial Statements
Report of Independent Public Accountants.............................. F-24
Combined Statements of Assets, Liabilities and Net Investment and
Advances as of December 30, 1994 and August 22, 1995.................. F-25
Combined Statements of Revenues and Expenses Excluding Income
Taxes for the fiscal years ended December 31, 1993, December 30, 1994
and the thirty-four weeks ended August 22, 1995....................... F-26
Combined Statements of Cash Flows for the fiscal years ended
December 31, 1993, December 30, 1994 and the thirty-four weeks
ended August 22, 1995................................................. F-27
Notes to Combined Financial Statements................................ F-28
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
Exhibits:
3.1* Amended and Restated Declaration of Trust dated
August 21, 1996...................................................
3.2* Bylaws............................................................
10.1* Advisory Agreement (+)............................................
10.2* Hospitality Properties Trust 1995 Incentive Share Award Plan (+)..
10.3* Purchase-Sale and Option Agreement dated as of February 3,
1995 by and among HMH Courtyard Properties, Inc. HMH
Properties, Inc. and Hospitality Properties, Inc., as amended.....
26
10.4** Fifth Amendment to Purchase-Sale and Option Agreement dated
February 26, 1996, by and between HPT and HMH Properties,
Inc...............................................................
10.5* Form of Courtyard Management Agreement between HMH
Courtyard Properties, Inc., d/b/a HMH Properties, Inc. and
Courtyard Management Corporation..................................
10.6* Form of First Amendment to Courtyard Management Agreement
between Courtyard Management Corporation and Hospitality
Properties, Inc. and Consolidation Letter Agreement by and
between Courtyard Management Corporation and Hospitality
Properties, Inc...................................................
10.7* Form of Lease Agreement between Hospitality Properties, Inc.
and HMH HPT Courtyard, Inc........................................
10.8* Form of Assignment and Assumption of Leases, Contracts and
Agreements in favor of Hospitality Properties, Inc................
10.9** Purchase and Sale Agreement, by and between Garden Hotel
Associates Limited Partnership and Hospitality Properties Trust...
10.10** Purchase, Sale and Exchange Agreement dated February 26,
1996 by and between HMH Properties, Inc. and Hospitality
Properties Trust..................................................
10.11** Agreement to Lease dated February 26, 1996 by and between
HMH HPT Residence, Inc. and Hospitality Properties Trust..........
10.12** Form of Lease Agreement between HMH HPT Residence Inn,
Inc. and Hospitality Properties Trust.............................
10.13** Amended and Restated Revolving Credit Agreement, dated as
of December 29, 1995 by and between DLJ Mortgage Capital,
Inc. and Hospitality Properties Trust.............................
10.14** Amendment No. 1 to Acquisition Line Credit Agreement, as
amended and restated February 29, 1996............................
10.15** Revolving Credit Agreement, dated as of February 28, 1996, by
and between DLJ Mortgage Capital, Inc. and Hospitality
Property Trust....................................................
10.16** Form of Residence Inn Management Agreement between HMH
Properties, Inc. and Residence Inn by Marriott, Inc...............
21.1 Schedule of Subsidiaries.............................filed herewith
23.1 Consents of Arthur Andersen LLP......................filed herewith
24.1 Power of Attorney....................................filed herewith
27.1 Financial Data Schedule..............................filed herewith
- --------------------------------------
Each exhibit marked by an (*) is incorporated by reference to the corresponding
document or instrument filed as an exhibit to the Company's Registration
Statement on Form S-11 (File No. 33-93330) in the form in which it was declared
effective by the Securities and Exchange Commission on August 16, 1995. Each
exhibit marked by an (**) is incorporated by reference to the corresponding
document or instrument filed as an exhibit to the Company's Registration
Statement on Form S-11 (File No. 333-1433) as filed with the Commission on March
5, 1996 and amended on March 13, 1996.
(+) Management contract or agreement.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of the
period covered by this report.
27
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Trustees and Shareholders of
Hospitality Properties Trust:
We have audited the accompanying balance sheet of Hospitality Properties
Trust (the "Company") as of December 31, 1995, and the related statements of
income, shareholders' equity and cash flows for the period from February 7, 1995
(inception) to December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Hospitality Properties Trust
as of December 31, 1995, and the results of its operations and its cash flows
for the period from February 7, 1995 (inception) to December 31, 1995 in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Washington, D.C.
January 19, 1996
F-1
HOSPITALITY PROPERTIES TRUST
BALANCE SHEET
(Dollars in thousands)
As of
December 31,
1995
ASSETS
Real estate properties, at cost:
Land $ 62,311
Buildings and improvements.................................................................. 270,261
------------
332,572
Less accumulated depreciation............................................................... 5,820
------------
326,752
Cash and cash equivalents........................................................................ 2,135
Rent receivable.................................................................................. 322
FF&E reserve (restricted cash)................................................................... 5,342
Other assets, net................................................................................ 4,396
------------
$ 338,947
LIABILITIES AND SHAREHOLDERS' EQUITY
Security deposits................................................................................ $ 32,900
Dividends payable................................................................................ 6,930
Advisory fee to affiliate........................................................................ 770
Accounts payable and accrued expenses............................................................ 396
Shareholders' equity:
Preferred shares of beneficial interest, no par value, 100,000,000 shares authorized, none
issued................................................................................... --
Common shares of beneficial interest, $.01 par value, 100,000,000 shares authorized,
12,600,900 shares issued and outstanding................................................. 126
Additional paid-in capital....................................................................... 297,962
Cumulative net income............................................................................ 11,349
Dividends (paid or declared)..................................................................... (11,486)
------------
Total shareholders' equity............................................................. 297,951
------------
$ 338,947
See accompanying notes.
F-2
HOSPITALITY PROPERTIES TRUST
STATEMENT OF INCOME
FEBRUARY 7, 1995 (INCEPTION) TO DECEMBER 31, 1995
(Dollars in thousands)
February 7, 1995
(Inception) to
December 31, 1995
Revenues:
Rental income........................... $ 19,531
FF&E reserve income..................... 4,037
Interest income......................... 74
-----------------
Total revenues..................... 23,642
Expenses:
Interest to HRP......................... 5,039
Depreciation and amortization........... 5,844
General, administrative and advisory 1,410
-----------------
Total expenses..................... 12,293
-----------------
Net income................................... $ 11,349
=================
Weighted average Shares outstanding.......... 4,515
Net income per Share......................... $ 2.51
==================
See accompanying notes.
F-3
HOSPITALITY PROPERTIES TRUST
STATEMENT OF SHAREHOLDERS' EQUITY
FEBRUARY 7, 1995 (INCEPTION) TO DECEMBER 31, 1995
(Dollars in thousands)
Additional Cumulative
Number Of Common Paid In Net
Shares Shares Capital Income Dividends Total
Initial capitalization as of February 7,
1995 (inception)...................... 40,000 -- $ 960 -- -- $ 960
Issuance of Common Shares of
Beneficial Interest, net.............. 12,560,000 126 296,980 97 -- 297,106
Stock grants............................. 900 -- 22 -- -- 22
Net income............................... -- -- -- 11,349 -- 11,349
Dividends (paid or declared)............. -- -- -- (11,486) (11,486)
------------ ------- ---------- --------- --------- ----------
Balance at December 31, 1995............. 12,600,900 $ 126 $297,962 $ 11,349 $(11,486) $297,951
========== ======= ======== ========= ========= ========
See accompanying notes.
F-4
HOSPITALITY PROPERTIES TRUST
STATEMENT OF CASH FLOWS
(Dollars in thousands)
February 7, 1995
(Inception) to
December 31, 1995
Cash flows from operating activities:
Net income...................................................................... $ 11,349
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization................................................. 5,844
Funding of FF&E reserve....................................................... (4,037)
Changes in assets and liabilities:
Increase in rent receivable and other assets............................... (182)
Increase in accounts payable and accrued expenses.......................... 396
Increase in due to affiliate............................................... 770
------------------
Cash provided by operating activities.................................... 14,140
-----------------
Cash flows from investing activities:
Real estate acquisitions........................................................ (328,148)
Increase in security deposits................................................... 32,900
Payments for purchase option.................................................... (4,500)
Purchase of FF&E reserve........................................................ (3,904)
------------------
Cash used in investing activities........................................ (303,652)
-----------------
Cash flows from financing activities:
Proceeds from issuance of shares, net........................................... 198,088
Borrowings and advances from HRP................................................ 165,241
Payments on borrowings and advances from HRP.................................... (65,241)
Dividends (including $2,491 to HRP)............................................. (4,556)
Financing costs................................................................. (1,885)
------------------
Cash provided by financing activities.................................... 291,647
-----------------
Increase in cash and cash equivalents.............................................. $ 2,135
Cash and cash equivalents at beginning of period................................... --
-----------------
Cash and cash equivalents at end of period......................................... $ 2,135
=================
Supplemental cash flow information:
Interest paid................................................................... $ 5,039
Non-cash activities:
Issuance of shares to HRP....................................................... $ 100,000
Cancellation of indebtedness to HRP............................................. (100,000)
Purchases of fixed assets with FF&E reserve..................................... (2,424)
See accompanying notes.
F-5
HOSPITALITY PROPERTIES TRUST
NOTES TO FINANCIAL STATEMENTS
(Dollars in thousands, except per Share data)
1. Organization and Commencement of Operations
Hospitality Properties Trust (the Company) was incorporated in the state of
Delaware on February 7, 1995. Subsequently, the Company became a Maryland real
estate investment trust and effected a 400-for-1 split of its common shares of
beneficial interest (the Shares). The Company, which invests in income producing
hotel and lodging related real estate, was a 100% owned subsidiary of Health and
Retirement Properties Trust (HRP) from its inception through August 22, 1995
when it completed its initial public offering of Shares (the IPO). HRP remains
an affiliate of the Company.
The Company commenced operations on March 24, 1995 by acquiring 21 hotels
and related replacement and refurbishment reserves (the FF&E Reserves) for
approximately $179,400 from affiliates of Host Marriott Corporation. The
properties are leased to a subsidiary (Host II) of Host Marriott Corporation and
are managed by a subsidiary (Marriott) of Marriott International, Inc. The
acquisition was substantially funded by advances from HRP (the HRP loan).
On August 22, 1995, the Company received net proceeds of approximately
$178,000 from its IPO of 7,500,000 shares to the public and 250,000 shares to
HRPT Advisors, Inc. and the concurrent placement of 3,960,000 shares to HRP
which canceled $99,000 in indebtedness due to HRP. On September 18, 1995, the
Company received additional net proceeds of approximately $19,900 from the sale
of 850,000 Shares in connection with the exercise of the underwriters'
over-allotment option. The proceeds were used to repay remaining loan amounts
due to HRP and to acquire 16 additional hotel properties (together with the 21
properties acquired on March 24, 1995, the Initial Hotels) and related FF&E
reserves for $149,600. The Initial Hotels are leased to Host and managed by
Marriott.
2. Summary of Significant Accounting Policies
Real estate properties. Real estate properties are recorded at cost.
Depreciation is provided for on a straight-line basis over the estimated useful
lives ranging up to 40 years.
Cash and cash equivalents. Highly liquid investments with maturities of
three months or less at date of purchase are considered to be cash equivalents.
The carrying amount of cash and cash equivalents is a reasonable estimate of
fair value.
Deferred interest and finance costs. Costs incurred to secure certain
borrowings are capitalized and amortized over the terms of their respective
loans.
Revenue recognition. Rental income from operating leases is recognized on a
straight line basis over the life of the lease agreements. Additional rent and
interest revenue is recognized as earned.
Net income per share. Net income per share is computed using the weighted
average number of shares outstanding during the period.
Use of estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect reported amounts. Actual results could
differ from those estimates.
F-6
Income taxes. The Company elected to be taxed as a Real Estate Investment
Trust (REIT) under Sections 856 through 860 of the Internal Revenue Code of 1986
(the "Code"), commencing with its first taxable year ended December 31, 1995,
and intends to conduct its operations so as to continue to qualify as a REIT
under the Code. As a REIT, the Company generally will not be subject to Federal
income tax on its net income that it currently distributes to shareholders.
Qualifications and taxation as a REIT depends on the Company's ability to meet
certain dividend distribution tests, stock ownership requirements and various
qualification tests prescribed in the Code.
The dividends paid by the Company during 1995 were taxable as ordinary
income.
3. Real estate properties.
The Company's 37 hotel properties are leased pursuant to long term
operating leases expiring in 2006. The leases provide for four automatic renewal
terms totaling 37 years unless the lessee (Host II) properly notifies the
Company in accordance with the leases. Each lease is a triple net lease and
generally requires the lessee to pay: base rent, totaling $32,900 annually for
the 37 hotels; percentage rent, equal to 5% of increases in total hotel sales
over 1994 sales, FF&E reserve rent, equal to 5% of total hotel sales and all
operating costs associated with the leased property. Host II has posted a
security deposit equal to one year's base rent. The FF&E reserve may be used by
Marriott and Host II to maintain the properties in good working order and
repair. If the FF&E reserve is not available to fund such expenditures, Host II
may require the Company to fund such expenditures, in which case annual base
rent will be increased by 10% of the amount so funded.
Under the management agreements with Marriott, borrowings secured by the
Initial Hotels are limited, according to a formula, to amounts less than 70% of
the allocable purchase price of the applicable Initial Hotels.
The Company also has options to purchase and/or rights of first refusal and
rights of first negotiation to acquire certain additional properties from Host
Marriott Corporation. The option and rights are carried at cost and included in
other assets in the accompanying financial statements. The option and rights
agreements expire at dates beginning June 30, 1996 and running through August
31, 2002.
Future minimum lease payments to be received by the Company during the
remaining initial term of the leases are as follows:
1996......... $ 32,900
1997......... 32,900
1998......... 32,900
1999......... 32,900
2000......... 32,900
Thereafter... 197,400
---------
$361,900
4. Indebtedness
The Company has entered into a $200,000 revolving acquisition credit
facility which provides for borrowings at LIBOR plus 150 basis points.
Borrowings, if any, may be repaid and reborrowed as necessary until December 31,
1998, at which time outstanding balances may, at the Company's option (subject
to lender consent), be either repaid or converted into a 10-year term loan. As
of December 31, 1995, the Company had not drawn on the credit facility.
F-7
Substantially all of the funding for the acquisition of the 21
Initial Hotels plus closing costs and the cost of the option was provided to the
Company by HRP from borrowings under HRP's revolving credit facility. The
Company was a full and unconditional guarantor of HRP's obligations for payments
of interest and principal under HRP's revolving credit facility until the
Company's IPO in August 1995. The loan from HRP was repaid in 1995 using
proceeds from the IPO and the guarantee was released. Interest incurred on the
HRP loan and paid to HRP totaled $5,039 for the period ended December 31, 1995.
5. Transactions with Affiliates
The Company has an agreement with HRPT Advisors, Inc. ("Advisors") whereby
Advisors provides investment, management and administrative services to the
Company. Advisors is owned by Gerard M. Martin and Barry M. Portnoy. Messrs.
Martin and Portnoy are Managing Trustees of HPT and HRP. Mr. Portnoy is also a
partner in the law firm which provides legal services to the Company. The
Company's officers are also employees of the Advisor.
Advisors is compensated at an annual rate equal to 0.7% of HPT's average
real estate investments up to the first $250,000 of such investments and 0.5%
thereafter. Advisory fees earned for the period February 7, 1995 (inception)
through December 31, 1995 were $1,292. Advisors owns 250,000 shares of HPT which
it acquired at the IPO for $6,250.
HRP owns 4,000,000 shares of HPT, 3,960,000 shares of which it received in
consideration of cancellation of a loan receivable totaling $99,000 from the
Company.
Under the provisions of the Company's Incentive Share Award Plan, 100,000
Common Shares have been reserved for issuance to officers of the Company,
consultants to the Company and Independent Trustees of the Company. On December
21, 1995 each of the three Independent Trustees were awarded 300 shares under
this plan.
6. Concentration
At December 31, 1995, all of the Company's real estate properties net, were
leased to Host II and managed by Marriott.
The Company's 37 hotels contain 5,286 rooms and are located in 20 states.
The following table sets forth those states where base rent exceeds 5% of total
annual base rent due to the Company:
State Percentage of Annual Base Rent
Massachusetts..... 18%
Georgia........... 13
California........ 11
North Carolina.... 7
7. Pro forma information (unaudited)
The following unaudited pro forma income statement gives effect to: (i) the
completion of the Company's initial public offering and the concurrent placement
to HRP and HRPT Advisors, Inc.; (ii) the acquisition of the Initial Hotels and
the commencement of the related leases; (iii) repayment of amounts due HRP; (iv)
and the exercise of the underwriters' over-allotment option as though such
transactions occurred on January 1, 1995.
In the opinion of management, all adjustments necessary to reflect the
effects of the transactions discussed above have been reflected in the pro forma
data.
F-8
The following unaudited pro forma data is not necessarily indicative of
what the actual results of operations for the Company would have been for the
year, nor does it purport to represent the results of operations for the Company
for future periods.
Pro Forma Income Statement Data:
Year Ended
December 31, 1995
Revenues:
Rental income..................................... $ 33,308
FF&E reserve income............................... 6,424
Interest income................................... 144
-----------------
Total revenues............................... 39,876
-----------------
Expenses:
Interest.......................................... --
Depreciation and amortization..................... 9,229
General, administrative and advisory.............. 2,616
-----------------
Total expenses............................... 11,845
-----------------
Net income $ 28,031
=================
Weighted average Shares outstanding (In thousands)..... 12,601
Net income per Share................................... $ 2.22
================
8. Subsequent Events (unaudited)
In February 1996, the Company entered into letters of intent for
three transactions totaling $484,600 to acquire and lease 45 hotels (the
Additional Hotels). One transaction will involve 11 Wyndham Garden(R) Hotels
with 1,940 guest rooms in seven states which will be acquired for $135,320. The
initial lease term is expected to be 17 years. The second transaction will
involve 18 Residence Inn Hotels with 2,178 guest suites in 14 states which will
be acquired for $172,200. The initial lease term is expected to be 15 years. The
third transaction will involve 16 Courtyard by Marriott hotels with 2,299 guest
rooms in 10 states which will be acquired for $176,400. The initial lease term
is expected to be 17 years. Minimum annual base rent payable to the Company in
connection with the above transactions will total $48,500 and the leases will
include provision for security deposits equal to one year's base rent, reserves
for capital expenditures at 5% of total revenue and participating rent based on
a percentage of increases in total revenue. The participating rent percentage
and base year are 8% and 1996, 7.5% and 1996, and 5% and 1995 for the Wyndham,
Residence Inn, and Courtyard by Marriott transactions, respectively. While the
Company expects to complete these transactions during the first or second
quarter of 1996, no assurance can be given as to the actual timing or that they
will be completed. In addition, as the permanent financing for these
transactions has not been finally determined, the ultimate impact on the
Company's financial position and results of operations has not yet been
determined. In order to accommodate the Company's acquisition of the Additional
Hotels, the Company has entered into an agreement to expand the funding
availability under its revolving credit facility by up to an additional
$250,000.
F-9
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Trustees and Shareholders of
Hospitality Properties Trust:
We have audited in accordance with generally accepted auditing standards
the financial statements of Hospitality Properties Trust and have issued our
report thereon dated January 19, 1996. Our audit was made for the purpose of
forming an opinion on those statements taken as a whole. The schedule on pages
F-11 and F-12 are the responsibility of Hospitality Properties Trust's
management and are presented for the purpose of complying with the Securities
and Exchange Commission's rules and are not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, fairly
states in all material respects the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Washington, D.C.
January 19, 1996
F-10
HOSPITALITY PROPERTIES TRUST
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1995
(Dollars in millions)
Gross Amount at
Initial Costs December 31, 1995
Subsequent
Buildings & Costs Buildings & Accumulated Date Depreciation
Description: Debt Land Improvements Capitalized Land Improvements Total Depreciation Acquired Life
37 Courtyard
Hotels........ -- $ 62 $ 269 $ 2 $ 62 $ 271 $ 333 $ (6) 1995 9-40 years
The accompanying notes are an integral part of this schedule.
F-11
HOSPITALITY PROPERTIES TRUST
NOTES TO SCHEDULE III
DECEMBER 31, 1995
(In thousands)
(A) The change in total cost of properties for the period from February 7,
1995 (inception) to December 31, 1995 is as follows:
Balance at February 7,1995............................... $ --
Additions: Hotel acquisitions and capital expenditures... 332,572
---------
Balance at December 31, 1995............................. $332,572
========
(B) The change in accumulated depreciation for the period from February 7,
1995 (inception) to December 31, 1995 is as follows:
Balance at February 7, 1995.............................. $ --
Additions: Hotel acquisitions and capital expenditures... 5,820
-------
Balance at December 31, 1995............................. $5,820
======
F-12
Report of Independent Public Accountants
To HMH HPT Courtyard, Inc.:
We have audited the accompanying balance sheet of HMH HPT Courtyard, Inc. (a
Delaware corporation, "Host II") as of December 29, 1995, and the related
statements of income, shareholder's equity and cash flows for the period March
24, 1995 (inception) through December 29, 1995. These financial statements are
the responsibility of Host II's management. Our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
in accordance with generally accepted auditing standards. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion. In our opinion, the financial
statements referred to above present fairly, in all material respects, the
financial position of HMH HPT Courtyard, Inc., as of December 29, 1995, and the
results of its operations and its cash flows for the period March 24 (inception)
through December 29, 1995, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Washington, D.C.,
February 23, 1996
F-13
HMH HPT Courtyard, Inc. (Host II)
Balance Sheet
Assets
As of
December 29, 1995
-----------------
(in thousands
Advances to manager $ 3,984
Due from Marriott International, Inc. 2,218
Security deposit 32,900
--------
Total assets $39,102
========
Liabilities and Shareholder's Equity
Accrued expenses $ 45
Percentage rent payable 141
Deferred gain 12,908
Due to Host Marriott Corporation 1,322
-------
Total liabilities 14,416
Shareholder's equity:
Common Stock, no par value, 100 shares authorized, issued and outstanding
-
Additional paid-in capital 25,406
Retained deficit (720)
-------
Total liabilities and shareholder's equity $39,102
=======
The accompanying notes are an integral part of this balance sheet.
F-14
HMH HPT Courtyard, Inc. (Host II)
Statement of Income
Period March 24, 1995
(Inception) through
December 29, 1995
---------------------
(in thousands)
Total Hotel Sales (Note 1) $76,192
=========
Revenues (Note 1) $37,813
---------
Expenses:
Base rent 19,108
Percentage rent 271
FF&E contribution expense 3,810
Base management fee 1,524
Incentive management fee 3,632
Other expenses 5,859
---------
Total expenses 34,204
---------
Amortization of deferred gain 675
Corporate expenses (1,059)
---------
Income before taxes 3,225
Provision for income taxes (1,322)
---------
Net income $ 1,903
=========
The accompanying notes are an integral part of this balance sheet.
F-15
HMH HPT Courtyard, Inc. (Host II)
Statement of Shareholder's Equity
Period March 24, 1995 (Inception) through
December 29, 1995
-------------------------------------------
(in thousands)
Additional
Common Paid-In Retained
Stock Capital Deficit
-------- ------------ ---------
Initial capitalization $ - $21,451 $ -
Capital contribution - 3,955 -
Cash transferred to Host Marriott Corporation - - (2,623)
Net income - - 1,903
-------- -------- --------
Balance, December 29, 1995 $ - $25,406 $ (720)
======== ======== ========
The accompanying notes are an integral part of this balance sheet.
F-16
HMH HPT Courtyard, Inc. (Host II)
Statement of Cash Flows
Period March 24, 1995
(Inception) through
December 29, 1995
--------------------
(in thousands)
Cash flows from operating activities:
Net income $ 1,903
Adjustments to reconcile net income to cash provided by operating
activities:
Amortization of deferred gain (675)
Changes in operating accounts:
Decrease in prepaid rent 2,531
(Increase) in due from Marriott International, Inc. (2,218)
Increase in percentage rent payable 141
(Decrease) in accrued expenses (381)
Increase in due to Host Marriott Corporation 1,322
---------
Cash provided by operations 2,623
---------
Cash flows from financing activities:
Cash transferred to Host Marriott Corporation (2,623)
Increase in cash and cash equivalents -
Cash and cash equivalents at beginning of period -
---------
Cash and cash equivalents at end of period $ -
=========
Supplemental information, non-cash activity-
Balances transferred to Host II by Parent upon commencement of leases
related to 37 Courtyard by Marriott hotels-
Advances to manager $ 3,984
Prepaid rent 2,531
Other assets 32,900
Accrued expenses (426)
Deferred gain (13,583)
---------
Net capital contributed by Parent $ 25,406
=========
The accompanying notes are an integral part of this balance sheet.
F-17
HMH HPT Courtyard, Inc. (Host II)
Notes to Financial Statements
As of December 29, 1995
NOTE 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES:
Organization and Initial Capitalization
HMH HPT Courtyard, Inc. ("Host II") was incorporated in Delaware on February 7,
1995 as a wholly-owned indirect subsidiary of Host Marriott Corporation ("Host
Marriott"). On February 2, 1995, Host II issued 100 shares of no par common
stock to its parent and sole shareholder ("Parent"), a wholly-owned, indirect
subsidiary of Host Marriott. Host II had no operations prior to March 24, 1995
(the "Commencement Date" or "Inception"). As a result, the accompanying
statements of income, cash flows and shareholder's equity present activity of
Host II from the Commencement Date through December 29, 1995. On the
Commencement Date, affiliates of Host Marriott (the "Sellers") sold 21 Courtyard
by Marriott hotel properties to Hospitality Properties Trust ("HPT"), a
wholly-owned subsidiary of Health and Retirement Properties Trust. On August 22,
1995, HPT acquired an additional 16 Courtyard by Marriott hotel properties from
the Sellers, increasing the total properties sold to 37 Courtyards by Marriott
(the "Hotels"). The Sellers contributed to Host II its assets and liabilities
related to the operations of such properties, including working capital advances
to the hotel manager, prepaid rent under leasing arrangements (the "Leases") and
rights to other assets as described in Note 3. Such assets have been accounted
for at the Parent's carryover basis.
Fiscal Year
Host II operates on a fiscal year which ends on the Friday closest to December
31. The fiscal year is divided into thirteen accounting periods of four weeks
each.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
F-18
Hotel Sales and Revenues
Total Hotel Sales ("Hotel Sales") represents all revenues and receipts of every
kind derived from guests or other customers related to Marriott International
Inc.'s, the manager of the hotels (the "Manager"), operation of the Hotels.
Total Hotel Sales are presented in the accompanying statement of income for the
purpose of providing supplemental information regarding the gross sales volume
of the Hotels which is used for purposes of calculating Percentage Rent (as
defined below) and the FF&E Reserve under the Leases and Management Agreements
(as defined below), respectively (See Note 2). As owner and lessor of the
Hotels, HPT has no interest in the sales and operating results of the Hotels.
Revenues in the accompanying statement of income represent house profit from the
Hotels because Host II has delegated substantially all of the operating
decisions relating to the generation of house profit from the Hotels to the
Manager. House profit reflects the net revenues flowing to Host II as lessee and
represents total hotel sales less property level expenses excluding depreciation
and amortization, system fees, real and personal property taxes, ground rent,
insurance and management fees. The system fees (included in other expenses) and
management fees presented on the accompanying statement of income and the
expenses detailed below represent all the costs incurred directly, allocated or
charged by the Manager to the Hotels.
The following table presents the detail of house profit for the period from
March 24, 1995 (Inception) to December 29, 1995:
(in thousands)
Hotel Sales:
Rooms $66,968
Food and beverage 6,225
Other 2,999
-------
Total Hotel Sales 76,192
-------
Expenses:
Departmental direct costs-
Rooms (A) 14,713
Food and beverage (B) 5,044
Other operating departments (C) 827
General and administrative (D) 7,768
Utilities (E) 2,955
Repairs, maintenance and accidents (F) 2,899
Marketing and sales (G) 1,121
Chain services (H) 3,052
-------
Total expenses 38,379
-------
Revenues (House Profit) $37,813
=======
(A) Includes expenses for linen, cleaning supplies, laundry, guest supplies,
reservations costs, travel agents' commissions, walked guest expenses and
wages, benefits and bonuses for employees of the rooms department.
(B) Includes costs of food and beverages sold, china, glass, silver, paper, and
cleaning supplies and wages, benefits and bonuses for employees of the food
and beverage department.
F-19
(C) Includes expenses related to operating the telephone department.
(D) Includes management and hourly wages, benefits and bonuses, credit and
collection expenses, employee relations, guest relations, bad debt
expenses, office supplies and miscellaneous other expenses.
(E) Includes electricity, gas and water at the properties.
(F) Includes cost of repairs and maintenance and the cost of accidents at the
properties.
(G) Includes management and hourly wages, benefits and bonuses, promotional
expense and local advertising.
(H) Includes charges from the Manager for Chain Services as allowable under the
Management Agreements.
Corporate Expenses
As a wholly owned indirect subsidiary of Host Marriott, Host II shares certain
general and administrative functions with Host Marriott and its other
subsidiaries. The functions generally include accounting, data processing,
payroll, human resources, legal and other administrative services. The expenses
related to these functions are generally allocated between Host Marriott and its
subsidiaries based on gross sales. From the period March 24, 1995 (Inception)
through December 29, 1995, corporate expenses allocated to Host II totaled
$1,059,000.
NOTE 2. COMMITMENTS AND CONTINGENCIES:
The Leases
On the Commencement Date, Host II entered into leases for 21 Courtyard by
Marriott properties. On August 22, 1995, Host II entered into leases for an
additional 16 Courtyard by Marriott properties (collectively, the "Leases"). The
initial term of the Leases expires at the end of fiscal 2006. Thereafter, the
Leases automatically renew for one seven-year term and three consecutive
ten-year terms, unless Host II properly notifies HPT in accordance with the
Leases. The Leases require Host II to pay rents equal to aggregate minimum
annual rent of $32,900,000 ("Base Rent"), and percentage rent equal to 5% of the
excess of Total Hotel Sales, as defined, over 1994 Total Hotel Sales
("Percentage Rent"). A pro rata portion of Base Rent is due and payable in
advance on the first day of thirteen predetermined accounting periods.
Percentage Rent is due and payable quarterly in arrears.
F-20
The Leases also require Host II to make payments when due on behalf of HPT for
real estate taxes and other taxes, assessments and similar charges arising from
or related to the Hotels and their operation, utilities, premiums on required
insurance coverage, rents due under ground and equipment leases and all amounts
due under the terms of the Management Agreements described below. Host II is
also required to provide the Manager with working capital to meet the operating
needs of the Hotels. The Sellers had previously made such advances related to
the Hotels in the amount of $3,984,000 and transferred their interest in such
amounts to Host II on the Commencement Date.
The Leases require Host II to escrow, or cause the Manager to escrow, an amount
equal to 5% of the annual Total Hotel Sales into an HPT-owned reserve (the "FF&E
Reserve"), which amount shall be available for the cost of required replacements
and renovation. Any requirements for funds in excess of amounts in the FF&E
Reserve shall be provided by HPT ("HPT Fundings") at the request of Host II. In
the event of HPT Fundings, Base Rent shall be adjusted upward by an amount equal
to 10% of HPT Fundings.
The Leases require Host II to maintain a minimum net worth, as defined, equal to
one year's base rent. For purposes of this covenant, the deferred gain is
excluded from the calculation of net worth.
Management Agreements
As part of the sale of the Hotels, the Sellers' rights and obligations under
management agreements (the "Management Agreements") with the Manager, with an
initial term expiring in 2013, were transferred to HPT, and the Manager has the
option to extend the Management Agreement on all of the Hotels for up to three
10-year terms.
The Management Agreements provide that the Manager be paid a system fee equal to
3% of Hotel Sales, a base management fee of 2% of Hotel Sales ("Base Management
Fee") and an incentive management fee equal to 50% of available cash flow, not
to exceed 20% of operating profit, as defined ("Incentive Management Fee"). In
addition, the Manager is reimbursed for each Hotel's pro rata share of the
actual costs and expenses incurred in providing certain services on a central or
regional basis to all Courtyard by Marriott hotels operated by the Manager.
Base Rent is to be paid prior to payment of Base Management Fees and Incentive
Management Fees. To the extent Base Management Fees are so deferred, they must
be paid in future periods. If available cash flow is insufficient to pay
Incentive Management Fees, no Incentive Management Fees are earned by the
Manager.
NOTE 3. SECURITY DEPOSIT:
Pursuant to the terms of the agreement for the sale of the Hotels, HPT held
$32,900,000 as a security deposit for the obligations of Host II under the
Leases (the "Security Deposit"). The Security Deposit is due upon termination of
the Leases, including renewal terms.
F-21
NOTE 4. INCOME TAXES:
Host II and Host Marriott are members of a consolidated group for federal income
tax purposes and have agreed that Host II will not be responsible for any tax
liability associated with the Security Deposit and, accordingly, no such
deferred tax liability has been reflected in the accompanying balance sheet.
The components of Host II's effective income tax rate follow:
Statutory Federal tax rate 35%
State income tax, net of Federal tax benefit 6
----
41%
====
There is no difference between the basis of assets and liabilities for income
tax and financial reporting purposes other than for the Security Deposit.
NOTE 5. OPERATING LEASE COMMITMENTS:
As of December 29, 1995, future minimum annual rental commitments for the Leases
on the Hotels and other non-cancelable leases entered into by Host II, or by the
Manager on behalf of Host II, including the ground leases described below, are
as follows (in thousands):
Other
Fiscal Year Leases Operating
(See Note 2) Leases
1996 $ 32,900 $1,506
1997 32,900 1,220
1998 32,900 929
1999 32,900 335
2000 32,900 132
Thereafter 197,400 2,750
--------- --------
Total minimum lease payments $361,900 $6,872
========= ========
The land under five of the Hotels is leased from third parties. The ground
leases have remaining terms (including all renewal options) expiring between the
years 2039 and 2067. The ground leases provide for rent based on specific
percentages of certain sales categories subject to minimum amounts. The minimum
rentals are adjusted at various anniversary dates throughout the lease terms, as
defined in the agreements.
F-22
NOTE 6. SUBSEQUENT EVENT (UNAUDITED):
On February 1, 1996, HPT entered into a letter of intent to acquire 16
additional Courtyard by Marriott hotels from the Sellers for approximately
$176.4 million. It is expected that subsequent to the acquisition, the hotels
will be leased to Host II through December 31, 2012 under terms substantially
similar to the existing leases between HPT and Host II. Annual Base Rent payable
by Host II will be increased by approximately $1,357,000. Also in February 1996,
the existing leases between HPT and Host II were amended to among other things,
extend the lease terms through December 2012.
Each of the 16 properties to be acquired, as with the 37 currently owned by HPT
are subject to management agreements with the Manager. It is expected that all
management agreements will be amended in conjunction with the transaction to,
among other things extend the agreement terms through December 31, 2015, and to
require exercise of renewal options and calculation of FF&E Reserve and Base and
Incentive Management Fees on a consolidated basis for all Courtyard by Marriott
hotels owned by HPT.
W hile the transaction is expected to be completed by June 30, 1996, no
assurance can be given as to the actual timing or that it will be completed.
F-23
Report of Independent Public Accountants
To the Owners of the Initial Hotels (as defined in Note 1):
We have audited the accompanying combined statements of assets, liabilities and
net investment and advances of the Initial Hotels, as defined in Note 1, as of
August 22, 1995 and December 30, 1994, and the related combined statements of
revenues and expenses excluding income taxes, and cash flows for the thirty-four
weeks ended August 22, 1995, and each of the two fiscal years in the period
ended December 30, 1994. These financial statements are the responsibility of
the Host Marriott Corporation's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
The accompanying financial statements have been prepared for the purpose of
complying with the rules and regulations of the Securities and Exchange
Commission (for inclusion in the Form 10-K of Hospitality Properties Trust) as
described in Note 1 and are not intended to be a complete presentation of the
Initial Hotels' assets, liabilities and net investment and advances, revenues
and expenses or cash flows.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the assets, liabilities and net investment and advances
of the Initial Hotels as of August 22, 1995 and December 30, 1994, and their
revenues and expenses excluding income taxes, and their cash flows for the
thirty-four weeks ended August 22, 1995, and each of the two fiscal years in the
period ended December 30, 1994, in conformity with generally accepted accounting
principles.
As explained in Note 3 to the combined financial statements, in 1993 the Initial
Hotels changed their method of accounting for assets held for sale.
ARTHUR ANDERSEN LLP
Washington, D.C.,
February 23, 1996
F-24
Initial Hotels
Combined Statements of Assets, Liabilities
And Net Investment and Advances
Assets
As of As of
December 30, August 22,
1994 1995
------------- -------------
(in thousands)
Property and equipment, net $ 316,736 $
-
Due from Marriott International 898 -
Advances to Marriott International 3,658 -
--------- ---------
$321,292 $ -
========= =========
Liabilities and Net Investment and Advances
Accrued expenses $ 642 $ -
Net investment and advances 320,650 -
--------- ---------
$321,292 $ -
The accompanying notes are an integral part of these combined statements.
F-25
Initial Hotels
Combined Statements of Revenues and Expenses Excluding Income Taxes
For the Fiscal Years Ended December 31, 1993 and December 30, 1994
and the Thirty-Four Weeks Ended August 22, 1995
Thirty-Four
Weeks Ended
Fiscal Years Ended August 22,
-------------------
1993 1994 1995
------ ------ ------
(in thousands)
Total Hotel Sales (Note 1) $ 113,356 $ 120,897 $52,280
========= ========= =======
Revenues (Note 1) $ 49,850 $ 58,186 $26,311
Expenses:
Depreciation and amortization 13,775 13,729 6,337
Courtyard system fee 3,401 3,627 1,568
Property taxes 4,701 3,864 1,740
Incentive management fee -- 2,825 2,242
Writedown of property to net realizable value -- -- 3,000
Other 2,303 2,181 477
---------- --------- --------
Total expenses 24,180 26,226 15,364
---------- --------- --------
Revenues over expenses excluding income taxes before
cumulative effect of change in accounting principle
25,670 31,960 10,947
Cumulative effect of change in accounting for assets held for
sale (14,500) - -
---------- --------- --------
Revenues over expenses excluding income taxes $ 11,170 $ 31,960 $ 10,947
========== ========= ========
Unaudited pro forma data:
Pro forma income tax expense $ 4,468 $ 13,104 $ 4,488
---------- --------- --------
Pro forma net income after taxes $ 6,702 $ 18,856 $ 6,459
========== ========= ========
The accompanying notes are an integral part of these combined statements.
F-26
Initial Hotels
Combined Statements of Cash Flows
For the Fiscal Years Ended December 31, 1993 and December 30, 1994
and the Thirty-Four Weeks Ended August 22, 1995
Thirty-Four
Weeks Ended
Fiscal Years Ended August 22,
-------------------
1993 1994 1995
------ ------ ------
(in thousands)
Cash flows from operating activities:
Revenues over expenses, excluding income taxes
$ 11,170 $ 31,960 $ 10,947
Noncash items:
Depreciation and amortization 13,775 13,729 6,337
Writedown of property to net realizable value
- - 3,000
Cumulative effect of change in accounting for assets
held for sale 14,500 - -
Changes in operating accounts:
Due from Marriott International (229) (669) 898
Advances to Marriott International (3,658) - 3,658
Accrued expenses 753 (381) (642)
--------- --------- ---------
Cash provided by operations 36,311 44,639 24,198
--------- --------- ---------
Cash flows from investing activities:
Additions to property and equipment (1,460) (4,212) (4,301)
Change in property improvement fund (697) 697 -
--------- --------- ---------
Cash used in investing activities
(2,157) (3,515) (4,301)
--------- --------- ---------
Cash flows from financing activities:
Changes in net investment and advances (34,154) (41,124) (19,897)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents - - -
Cash and cash equivalents at beginning of year - - -
--------- --------- ---------
Cash and cash equivalents at end of year $ - $ - $ -
========= ========= =========
The accompanying notes are an integral part of these combined statements.
F-27
Initial Hotels
Notes to Combined Financial Statements
As of December 30, 1994 and August 22, 1995
NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION:
Organization
Hospitality Properties Trust (the "Company") is a Maryland real estate
investment trust which was established to acquire, own and lease hotel
properties. The Company completed its initial public offering (the "Offering")
in August 1995, and operates as a real estate investment trust under the
Internal Revenue Code.
Basis of Presentation
Host Marriott Corporation ("Host Marriott") or a subsidiary thereof designed,
constructed or acquired certain Courtyard by Marriott Hotels, including the 37
properties listed below (collectively, the "Initial Hotels" and, individually,
the "Hotel" or "Hotels").
Group A Hotels Group B Hotels
- --------------------------------- ---------------------------------------
Phoenix, AZ Camarillo, CA
Scottsdale, AZ Huntington Beach/Fountain Valley, CA
Atlanta Airport North, GA Los Angeles Airport, CA
Atlanta-Cumberland Center, GA San Jose Airport, CA
Atlanta-Jimmy Carter Blvd., GA Wilmington, DE
Atlanta-Midtown, GA Boca Raton, FL
Indianapolis, IN Macon, GA
Danvers, MA Columbia, MD
Foxborough, MA Norwood, MA
Milford, MA Woburn, MA
Lowell, MA Kansas City Airport, MO
Stoughton, MA Fayetteville, NC
Detroit/Auburn Hills, MI Charlotte-University Research Park, NC
Minneapolis/Eden Prairie, MN Chattanooga, TX
South Kansas City, MO Dallas/Northpark, TX
Mahwah, NJ Milwaukee/Brookfield, WI
Raleigh/Durham Airport, NC
Philadelphia Airport, PA
Spartanburg, SC
Fairfax, VA
Bellevue, WA
All of the Initial Hotels are included in the accompanying combined financial
statements for all periods presented except information for 21 Initial Hotels
(Group A) which is excluded for the period between March 25, 1995 and August 22,
1995.
F-28
The Group A Hotels were acquired by the Company on March 24, 1995 for
approximately $179.4 million from affiliates of Host Marriott. As a result, as
of March 24, 1995, the ownership of the Group A Hotel assets are reflected in
the financial statements of the Company and the results of operations of the
Group A Hotels are reflected in the financial statements of a subsidiary HMH HPT
Courtyard, Inc. ("Host II") of Host Marriott. The accompanying combined
financial statements include the results of operations, financial position and
cash flows of the Group A Hotels through March 24, 1995. Substantially all of
the funding for this acquisition was provided to the Company by Health and
Retirement Properties Trust ("HRP") as a demand loan. The Group B Hotels were
acquired by the Company from a subsidiary of Host Marriott for approximately
$149.6 million with a portion of the proceeds of the Offering. As a result, as
of August 23, 1995, the Ownership of the Group B Hotel assets are reflected in
the financial statements of the Company and the results of operations are
reflected in the financial statements of Host II. The accompanying combined
financial statements include the results of operations, financial position and
cash flows of the Group B Hotels through August 22, 1995. All of the Initial
Hotels have been leased by the Company to Host II, and managed by a subsidiary
("Marriott" or the "Manager") of Marriott International, Inc. The management
agreements (the "Management Agreements") described in Note 4 between Host
Marriott and Marriott related to the Initial Hotels have been assigned to the
Company.
The Initial Hotels include the buildings, improvements and equipment for each of
the Hotels, the land on which 32 of the Hotels are located and the leasehold
interest in the land under five of the Hotels. Assets and liabilities of the
Initial Hotels have been stated at Host Marriott's historical cost basis.
The accompanying combined financial statements have been prepared for the
purpose of complying with the rules and regulations of the Securities and
Exchange Commission for inclusion in the Form 10-K of the Company. The Initial
Hotels, for the periods presented, were a lesser component of Host Marriott, and
historically operated as an integral part of Host Marriott. Host Marriott has
not historically allocated or charged individual units for interest on net
advances and no such expenses are reflected in the accompanying combined
financial statements. The accompanying combined financial statements also
include no provision or assets or liabilities related to federal or state income
taxes because the Initial Hotels did not pay income taxes and Host Marriott does
not allocate or charge these expenses to its individual units. Accordingly, the
accompanying combined financial statements are not intended to be a complete
presentation of the Initial Hotels' assets, liabilities and net investment and
advances, revenues and expenses or cash flows.
There are no allocations of interest, taxes, overhead, general and
administrative or other corporate costs made by Host Marriott to the Initial
Hotels. Changes in net investment and advances represent the combined revenues
and expenses excluding income taxes of the Initial Hotels adjusted for cash
transferred between Host Marriott and the Initial Hotels and, for the
thirty-four weeks ended August 22, 1995, the effects of the transfer of net
assets related to the sale of the Group A and Group B Hotels to the Company.
F-29
An analysis of the activity in this balance for the two fiscal years ended
December 30, 1994 and the thirty-four weeks ended August 22, 1995 is as follows:
(in thousands)
Balance January 1, 1993 $ 352,798
Revenues over expenses excluding income taxes 11,170
Net cash transferred to Host Marriott (34,154)
Balance December 31, 1993 329,814
Revenues over expenses excluding income taxes 31,960
Net cash transferred to Host Marriott (41,124)
Balance December 30, 1994 320,650
Revenues over expenses excluding income taxes 10,947
Net cash transferred to Host Marriott (19,897)
Transfer of net assets related to the sale of
the Group A and Group B Hotels (311,700)
----------
Balance August 22, 1995 $ -
==========
The average net investment and advances for fiscal years 1993 and 1994 and the
thirty-four weeks ended August 22, 1995, was approximately $351 million, $327
million and $160 million, respectively.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Hotel Sales and Revenues
Total Hotel Sales are presented in the accompanying combined statements of
revenues and expenses excluding income taxes for the purpose of providing
supplemental information regarding the gross sales volume of the Initial Hotels
which is used for purposes of calculating percentage rent and the FF&E Reserve
(as defined below) under the Leases with Host II and the Management Agreements,
respectively. As owner and lessor of the Initial Hotels, the Company has no
interest in the sales or operating results of the Initial Hotels. Total Hotel
Sales represents all revenues and receipts of every kind derived from guests or
other customers related to Marriott's operation of the Initial Hotels.
Revenues in the accompanying combined statements of revenues and expenses
excluding income taxes represent house profit from the Initial Hotels. House
profit represents Total Hotel Sales less property level expenses excluding
depreciation and amortization, system fees, real and personal property taxes,
ground rent, insurance and management fees. The system fees and management fees
presented on the accompanying combined statements of revenues and expenses
excluding income taxes and the expenses detailed below represent all the costs
incurred directly, allocated or charged by the Manager (as defined below) to the
Initial Hotels. The detail of Total Hotel Sales and a reconciliation to revenue
follows:
F-30
Thirty-Four
Weeks Ended
Fiscal Years Ended August 22,
-------------------
1993 1994 1995
------ ------ ------
(in thousands)
Hotel sales:
Rooms $ 95,899 $104,293 $45,814
Food and beverage 12,990 11,702 4,445
Other 4,467 4,902 2,021
--------- -------- -------
Total Hotel Sales 113,356 120,897 52,280
--------- -------- -------
Expenses:
Departmental direct costs
Rooms (A) 21,961 23,074 10,000
Food and beverage (B) 10,054 9,136 3,551
Other operating departments (C)
1,481 1,529 588
General and administrative (D)
12,205 12,095 5,110
Utilities (E) 5,226 5,042 2,088
Repairs, maintenance and
accidents (F) 5,381 4,882 2,087
Marketing and sales (G) 2,437 2,292 782
Chain services (H) 4,761 4,661 1,763
--------- -------- -------
Total expenses 63,506 62,711 25,969
--------- -------- -------
Revenues (House Profit) $ 49,850 $ 58,186 $26,311
========= ========= =======
<FN>
(A) Includes expenses for linen, cleaning supplies, laundry, guest supplies,
reservations costs, travel agents commissions, walked guest expenses and
wages, benefits and bonuses for employees of the rooms department.
(B) Includes costs of food and beverages sold, china, glass, silver, paper, and
cleaning supplies and wages, benefits and bonuses for employees of the food
and beverage department.
(C) Includes expenses related to operating the telephone department.
(D) Includes management and hourly wages, benefits and bonus, credit and
collection expenses, employee relations, guest relations, bad debt
expenses, office supplies and miscellaneous other expenses.
(E) Includes electricity, gas and water at the properties.
(F) Includes cost of repairs and maintenance and the cost of accidents at the
properties.
(G) Includes management and hourly wages, benefits and bonuses, promotional
expense and local advertising.
(H) Includes charges from the Manager for Chain Services as allowable under the
Management Agreements.
</FN>
F-31
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
General
On October 8, 1993 (the "Distribution Date"), Marriott Corporation's operations
were divided into two separate companies: Host Marriott Corporation and Marriott
International, Inc. On December 29, 1995, Host Marriott Corporation's operations
were divided into two separate companies: Host Marriott Corporation ("Host
Marriott") and Host Marriott Services Corporation. Fiscal Year
The Initial Hotel's fiscal year ends on the Friday nearest to December 31. The
fiscal year is divided into 13 accounting periods of four weeks each.
Property and Equipment
Property and equipment is recorded at cost, including interest and real estate
taxes incurred during development and construction. Replacements and
improvements are capitalized. Depreciation is computed using the straight line
method over the estimated useful lives of the assets, generally 40 years for
buildings and improvements and 3 to 10 years for furniture and equipment. In
cases where management is holding for sale particular lodging properties, Host
Marriott assesses impairment based on whether the net realizable value
(estimated sales price less costs of disposal) of each individual property to be
sold is less than the net book value. A lodging property is considered to be
held for sale when Host Marriott has made the decision to dispose of the
property. Otherwise, Host Marriott assesses impairment of its real estate
properties based on whether it is probable that undiscounted future cash flows
from each individual property will be less than its net book value.
Amortization - Pre-Opening Costs
Costs of an operating nature incurred prior to opening of the Hotels are
deferred and amortized over twelve months. Amortization expense was $94,000 in
1993. Pre-opening costs were fully amortized in 1993.
Cash and Cash Equivalents
The Initial Hotels consider all highly liquid investments with a maturity of
three months or less at date of purchase to be cash equivalents. Cash and cash
equivalents generated by the Hotels is transferred to Host Marriott. Operating
expenses, capital expenditures and other cash requirements of the Initial Hotels
are paid by Host Marriott and charged directly to the Initial Hotels.
F-32
New Statement of Financial Accounting Standards
The Initial Hotels are required to adopt Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of" no later than their fiscal year
ending December 28, 1996. Management anticipates that adoption of SFAS No. 121
will not have a material effect on the Initial Hotels' financial statements.
Unaudited Pro Forma Data
The accompanying combined statements of revenues and expenses excluding income
taxes present unaudited pro forma income taxes for each period presented based
upon the effective combined Federal and state tax rates of 40% for fiscal year
1993 and 41% for fiscal year 1994 and for the thirty-four weeks ended August 22,
1995. NOTE 3. PROPERTY AND EQUIPMENT:
Property and equipment consists of the following (in thousands):
December 30,
1994
------------
Land and land improvements $ 71,014
Buildings and leasehold improvements 251,149
Furniture and equipment 49,706
Construction in progress 666
---------
372,535
Less- accumulated depreciation 55,799
---------
Property and equipment, net $316,736
=========
Most hotels developed by Host Marriott since the early 1980s were reported as
assets held for sale prior to 1992. In early 1992, Host Marriott decided it was
no longer appropriate to view sales of lodging properties, subject to operating
agreements, as a primary means of long-term financing. Accordingly, Host
Marriott discontinued classification of these properties as assets held for
sale. Following discussions with the Staff of the Securities and Exchange
Commission, in the second quarter of 1993, Host Marriott changed its method of
determining net realizable value of assets held for sale. Host Marriott
previously determined net realizable value of such assets on an aggregate basis,
in the case of Courtyard by Marriott hotels. Beginning in the second fiscal
quarter of 1993 and thereafter, under Host Marriott's new accounting policy, net
realizable value of all assets held for sale is determined on a
property-by-property basis. The cumulative pre-tax effect of this change on
periods prior to the second quarter of 1993 of $14.5 million is reflected as a
cumulative effect of a change in accounting for assets held for sale in the
accompanying combined statement of revenues and expenses excluding income taxes,
for the fiscal year ended December 31, 1993. In 1995, Host Marriott adjusted, in
accordance with its accounting policy, the carrying value of one property
included in the Initial Hotels by approximately $3.0 million to reflect the
property's net realizable value based on sales price. The reductions in the
annual depreciation charge as a result of the accounting change and the
writedown were approximately $295,000 and $75,000, respectively.
F-33
NOTE 4. MANAGEMENT AGREEMENTS:
Subsequent to the Distribution Date, the Manager operates the Initial Hotels
pursuant to long term management agreements with initial terms expiring in 2013.
The Manager has the option to extend the agreement on one or more Hotels for up
to 3 consecutive 10 year terms. The Management Agreements provided for a
Courtyard by Marriott system fee equal to 3% of Total Hotels Sales. In addition,
Marriott is reimbursed for each Hotel's pro rata share of the actual costs and
expenses incurred in providing certain services ("Chain Services") on a central
or regional basis to all hotels operated by Marriott. These arrangements
regarding the Courtyard by Marriott system fee and Chain Services existed prior
to the Distribution Date and as such, for the two fiscal years ended December
30, 1994, the Initial Hotels paid a Courtyard by Marriott system fee of
$3,401,000 and $3,627,000 and reimbursed Marriott for $4,761,000 and $4,661,000
of Chain Services. The system fee and reimbursement of Chain Services for the
thirty-four weeks ended August 22, 1995 were $1,568,000 and $1,763,000,
respectively.
In addition, Marriott is entitled to an incentive management fee equal to 50% of
available cash flow, not to exceed 20% of operating profit, as defined,
calculated on a combined basis for all Courtyard by Marriott hotels owned by
Host Marriott. Available cash flow is defined as revenues less base management
fees, Courtyard by Marriott system fee, property taxes, other expenses and a
stated annual priority amount. Incentive management fees were not earned by
Marriott from the Distribution Date through December 31, 1993, due to the fact
that there was no available cash flow, as defined. The incentive management fees
earned by Marriott of $2,825,000 and $2,242,000 for fiscal years 1994 and 1995,
respectively, have been allocated to the Initial Hotels in the accompanying
financial statements based on Total Hotel Sales.
The Management Agreements provided that Marriott was to be entitled to a base
fee equal to 2% of Total Hotel Sales. However, this fee has been waived as more
fully described in Note 5, below.
Host Marriott is required to provide Marriott with working capital to meet the
operating needs of the Hotels. Marriott as the manager converts cash advanced by
Host Marriott into other forms of working capital consisting primarily of
operating cash, inventories, and trade receivables and payables which are
maintained and controlled by Marriott International, Inc. The individual
components of working capital controlled by Marriott are not reflected in the
accompanying combined statements of assets, liabilities and net investment and
advances (see Note 1).
The Management Agreements provided for the establishment of a property
improvement fund (the "FF&E Reserve") for the Hotels. Contributions to the FF&E
Reserve are 5% of Total Hotel Sales, beginning on the Distribution Date.
Contributions to the FF&E Reserve from the Distribution Date Through December
31, 1993 were $1,873,000 and for the fiscal year ended December 30, 1994, were
$6,249,000. For the thirty-four weeks ended August 22, 1995, contributions were
$2,614,000.
During 1994, the Management Agreements were amended and $2,540,000, representing
the entire then remaining balance of the FF&E Reserve, was returned to Host
Marriott. It was agreed that future contributions (until the time of sale of any
of the Initial Hotels) would be retained by Host Marriott and advanced to the
Initial Hotels at such time as improvements are made to the properties. Such
amounts have been included in the change in net investment and advances in the
accompanying combined statements of cash flows.
F-34
NOTE 5. CONSOLIDATION AGREEMENT:
The Initial Hotels are subject to the terms of a consolidation agreement
("Consolidation Agreement") between Host Marriott and Marriott International,
Inc. pursuant to which (i) incentive fees payable under the Management
Agreements are determined on a consolidated basis for all lodging facilities of
the same type and (ii) base fees payable under the Management Agreements are
waived in return for payment upon the sale of or certain refinancings of such
facilities and as such, no base management fees expense (equal to 2% of Total
Hotel Sales) is reflected in the accompanying combined statements of revenues
and expenses excluding income taxes.
After the sale of any of the Initial Hotels, the Consolidation Agreement is no
longer applicable to the Initial Hotels and as such, base fees equal to 2% of
Total Hotel Sales is payable under the Management Agreements after the sale of
the Initial Hotels.
F-35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HOSPITALITY PROPERTIES TRUST
By: /S/John G. Murray
John G. Murray
President and Chief Operating Officer
Dated: March 29, 1995
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons, or by their
attorney-in-fact, in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/S/John G. Murray President and March 29, 1996
John G. Murray Chief Operating Officer
/S/ Thomas M. O'Brien Treasurer and Chief March 29, 1996
Thomas M. O'Brien Financial Officer
/S/ John L. Harrington* Trustee March 29, 1996
John L. Harrington
/S/Arthur G. Koumantzelis* Trustee March 29, 1996
Arthur G. Koumantzelis
/S/William J. Sheehan* Trustee March 29, 1996
William J. Sheehan
Trustee March 29, 1996
Gerard M. Martin
/S/ Barry M. Portnoy* Trustee March 29, 1996
Barry M. Portnoy
*By/s/ John G. Murray as
Attorney-in-fact
F-36