UNITED STATES
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
For the Fiscal Year Ended December 31, 1997
OR
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE EXCHANGE ACT OF 1934
Commission File Number 1-11527
HOSPITALITY PROPERTIES TRUST
Maryland 04-3262075
(State of incorporation) (IRS Employer Identification No.)
400 Centre Street, Newton, Massachusetts 02158
617-964-8389
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Class on 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 $1,286,258,190 based on the $35.00 closing price per share
for such stock on the New York Stock Exchange on March 11, 1998. For purposes of
this calculation, 280,526 Common Shares of Beneficial Interest, $0.01 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 10,037
shares held by the trustees and officers of the registrant, have been included
in the number of shares held by affiliates.
Number of the registrant's Shares, outstanding as of March 11, 1998:
41,040,797
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 Properties Trust
(the "Company") dated March 31, 1998 for its annual meeting of shareholders
currently scheduled to be held on May 19, 1998.
---------------
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, 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
1997 FORM 10-K ANNUAL REPORT
Table of Contents
Part I
Page
Items 1. & 2. Business and Properties...................................................... 1
Item 3. Legal Proceedings............................................................ 21
Item 4. Submission of Matters to a Vote of Security Holders.......................... 21
Part II
Item 5. Market for the Registrant's Common Equity and Related Stockholders Matters... 21
Item 6. Selected Financial Data...................................................... 23
Item 7. Management's Discussion and Analysis of Results of Operations and Financial
Condition.................................................................... 24
Item 8. Financial Statements and Supplementary Data.................................. 28
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................... 28
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 19, 1998, 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 Reports on Form 8-K.............. 29
Items 1. and 2. Business and Properties
The Company. Hospitality Properties Trust (the "Company") is a real
estate investment trust ("REIT") formed in 1995 to acquire, own and lease hotels
to unaffiliated hotel operators. At December 31, 1997, the Company owned or had
commitments to acquire 135 hotels with 18,497 rooms or suites located in 35
states, for approximately $1,375 million. The Company is organized as a Maryland
real estate investment trust; its principal place of business is 400 Centre
Street, Newton, Massachusetts 02158, and its telephone number is (617) 964-8389.
The Company's principal growth strategy is to expand its investments in
hotels and to set minimum rents which produce income in excess of the Company's
cost of raising capital. The Company seeks to provide capital to unaffiliated
hotel operators who wish to divest their properties while remaining in the hotel
business as tenants and in doing so, ensure stability of cash flow through
dependable and diversified revenue sources. The Company believes that its
operating philosophy affords it opportunities to find high quality hotel
investment opportunities on attractive terms. In addition, the Company's
internal growth strategy is to participate through percentage rents in increases
in total hotel sales (including gross revenues from room rentals, food and
beverage sales and other services) at the Company's hotels.
Properties
As of December 31, 1997, the Company owned or had commitments to purchase 135 hotels, located in 35
states.
No. of No. of Investment No. of No. of Investment
State Hotels Rooms (in thousands) State Hotels Rooms (in thousands)
----- ------ ----- -------------- ----- ------ ----- --------------
Alabama 3 340 $ 25,312 Nebraska 1 131 $ 6,201
Arizona 12 1,669 104,641 Nevada 1 120 9,093
California 14 1,982 151,254 New Jersey 4 572 47,767
Colorado 1 130 6,670 New Mexico 2 237 23,433
Delaware 1 152 12,100 New York 3 403 28,500
Florida 4 504 42,017 North Carolina 5 657 41,684
Georgia 11 1,473 106,971 Ohio 3 308 24,943
Illinois 3 514 38,076 Oklahoma 1 122 10,414
Indiana 2 271 18,523 Pennsylvania 7 911 71,210
Iowa 1 108 7,800 Rhode Island 1 148 10,200
Kansas 2 188 9,674 South Carolina 1 108 5,800
Kentucky 1 77 5,305 Tennessee 4 499 39,054
Louisiana 1 231 27,663 Texas 13 1,780 143,527
Maryland 4 526 44,851 Utah 3 601 58,278
Massachusetts 8 1,072 69,700 Virginia 7 936 77,349
Michigan 3 402 20,784 Washington 3 522 43,529
Minnesota 2 358 18,086 Wisconsin 1 147 8,500
---- ------ -----------
Missouri 2 298 16,200 Total (35 states) 135 18,497 $1,375,109
=== ====== ==========
Upon completion of the acquisitions described below, which include six
hotels which have not been acquired as of March 11, 1998, the Company will have
investments totaling $1,375 million in 135 hotels, with 18,479 rooms, located in
35 states.
The Company's hotels are leased to and managed by special purpose
subsidiaries of unaffiliated public companies. Each of the Company's tenants are
herein referred to as "Lessees" and each of the Company's operators are herein
referred to as "Managers." The annual rent payable to the Company for its 135
hotels ("Hotels") totals $137.8 million in base rent plus percentage rent
ranging from 5% to 10% of increases in total hotel sales over a base year level.
In addition, a percentage (generally 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 Hotels.
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Under the leases and management agreements, the Hotels are currently
operated as Courtyard by Marriott(R), Residence Inn by Marriott(R), Wyndham
Garden(R), Wyndham(R), Sumner Suites(R) or Candlewood(R) hotels.
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 may not be
available and meeting and function rooms are limited in size and number.
According to Marriott, as of December 31, 1997, 330 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 Company has invested or agreed to invest a total of $621 million in
63 Courtyard by Marriott(R) hotels which have 8,982 rooms. As of March 11, 1998
three of these hotels with an acquisition cost of $37 million have not been
purchased but are expected to be purchased periodically throughout the remainder
of 1998. The 1997 average daily rate ("ADR"), occupancy and revenue per
available room ("RevPAR') for the Company's 53 Courtyard by Marriott(R) hotels
which were open throughout 1997 were as follows:
ADR............................................ $84.29
Occupancy...................................... 81.1%
RevPAR......................................... $68.36
RESIDENCE INN BY MARRIOTT(R) HOTELS
Residence Inn by Marriott(R) hotels are designed to attract business,
governmental and family travelers who stay more than five consecutive nights.
Residence Inn by Marriott(R) hotels generally have between 80 to 130 studios,
one-bedroom and two-bedroom suites. Most Residence Inn by Marriott(R) hotels are
designed as a cluster of residential style buildings with landscaped walkways,
courtyards and recreational areas. Residence Inn by Marriott(R) hotels do not
have restaurants. All offer complimentary continental breakfast and most provide
a complimentary evening hospitality hour. In addition, each suite contains a
fully equipped kitchen and many have fireplaces. Most Residence Inn by
Marriott(R) hotels also contain swimming pools, exercise rooms, business centers
and guest laundries. According to Marriott, as of December 31, 1997, 248
Residence Inn by Marriott(R) hotels were open and operating nationally. The
Company believes that the Residence Inn by Marriott(R) brand is the leading
brand in the extended stay segment of the United States hotel industry.
The Company has invested or agreed to invest a total of $335 million in
31 Residence Inn by Marriott(R) hotels which have 3,961 suites. As of March 11,
1998 two of these hotels with an acquisition cost of $44 million have not been
purchased but are expected to be purchased periodically throughout the remainder
of 1998. The 1997 ADR, occupancy and RevPAR for the Company's 18 Residence Inn
by Marriott(R) hotels which were open through 1997 were as follows:
ADR............................................ $99.96
Occupancy...................................... 83.3%
RevPAR......................................... $83.27
WYNDHAM GARDEN(R) HOTELS
Wyndham Garden(R) hotels are mid-size, full service hotels located
primarily near suburban business centers and airports which are designed to
attract business travelers and small business groups in suburban markets. Each
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hotel contains 140 to 250 rooms and approximately 1,500 to 5,000 square feet of
meeting space. The amenities and services provided at these hotels are designed
to meet the needs of the upscale business traveler. Amenities and services in
each room include desks large enough to accommodate personal computers, longer
phone cords, high wattage light bulbs for reading, room service and access to
24-hour telecopy and mail/package service. The meeting facilities at Wyndham
Garden(R) hotels generally can accommodate groups of between 10 and 200 people
and include a flexible meeting room design, exterior views, additional phone
lines and audiovisual equipment. Wyndham Garden(R) hotels also feature a lobby
lounge, most of which have a fireplace, a library typically overlooking a
landscaped garden and a swimming pool. In addition, many Wyndham Garden(R)
hotels contain a whirlpool and an exercise facility. Each Wyndham Garden(R)
hotel contains a cafe restaurant that serves a full breakfast, lunch and dinner
menu. The Company believes that the Wyndham Garden(R) brand is one of the
leading brands in the full service suburban segment of the United States hotel
industry. The one additional Wyndham(R) hotel owned by the Company is a full
service hotel located in downtown Salt Lake City adjacent to the Salt Lake City
Salt Palace Convention Center. This hotel includes 381 rooms, 14,469 square feet
of meeting space and two restaurants/lounges. The Company believes this hotel is
a leading convention hotel in Salt Lake City.
The 11 Wyndham Garden(R) hotels owned by the Company represent a total
investment of $135 million and contain 1,940 rooms. These hotels had 1997 ADR,
occupancy and RevPAR as follows:
ADR............................................ $90.07
Occupancy...................................... 77.1%
RevPAR......................................... $69.44
The Company purchased the Wyndham(R) hotel in Salt Lake City in January
1997 for $44.0 million and in January 1998 provided $3.3 million for renovations
to this hotel. The ADR, occupancy and RevPAR for this hotel in 1997 were $94.75,
70.8% and $67.08, respectively.
SUMNER SUITES(R) HOTELS
Sumner Suites(R) hotels are all suite hotels that cater to
value-oriented business travelers. Sumner Suites(R) hotels compete in the all
suite segment of the lodging industry against such brands as Embassy Suites(R),
Hampton Inns and Suites(R) and Amerisuites(R). Each Sumner Suites(R) guest room
offers an efficient space for working which includes two phones with data ports
and voice mail, a living area which includes a coffee maker, microwave,
mini-refrigerator, sleeper-sofa and 25-inch television, and a separate bedroom
area with either one king or two double beds. Each Sumner Suites(R) hotel has an
attractive lobby lounge where free continental breakfast is provided in the
mornings and cocktails are generally available in the early evening. In
addition, all Sumner Suites(R) hotels have meeting rooms that can accommodate up
to 150 persons, fitness facilities and a pool. Sumner Suites(R) hotels are
generally high-rise hotels of six or seven stories and are of masonry
construction.
The Company has invested $140 million in its 14 Sumner Suites(R) hotels
which include 1,641 guest suites. Twelve of these hotels were built and opened
between April 1996 and August 1997, one of these hotels opened in late 1995 and
one recently re-flagged hotel has recently undergone extensive renovations. The
Company believes that the current performance of its Sumner Suites(R) hotels is
not indicative of their operating potential because of their recent development
or renovation; the ADR, occupancy and RevPAR for the 12 Sumner Suites(R) hotels
which were open for at least six months of 1997 were $72.81, 60.8% and $44.27,
respectively during 1997.
CANDLEWOOD(R) HOTELS
Candlewood(R) hotels are extended stay hotels which offer studio and
one bedroom suites that cater to business travelers expecting to stay five or
more days. Candlewood(R) hotels compete in the mid-priced extended stay segment
of the lodging industry against such other brands as Sierra Suites by
Summerfield(R), Towne Place Suites by Marriott(R) and MainStay Suites(R). Each
Candlewood(R) suite contains a kitchen area, combination living and work area
and a sleeping area. The kitchen includes a full-size microwave, full-size
refrigerator, stove, dishwasher and coffee maker. The living area contains a
convertible sofa, recliner, 25-inch television, videocassette player and compact
disc player. The work area includes an oversized desk and executive chair, two
phone lines, voice mail and a speaker phone. Each Candlewood(R) suite contains a
king size bed. Other amenities offered at each
3
Candlewood(R) hotel include a fitness center, free guest laundry facilities and
a Candlewood Cupboard area where guests can purchase light meals, snacks and
other refreshments. The Company believes that Candlewood(R) will become one of
the leading brands in the mid-priced, extended stay segment of the United States
hotel industry.
The Company has agreed to invest $100 million to acquire 15 Candlewood
hotels which include 1,592 suites. One of these hotels was opened during 1998,
13 of these hotels were opened during 1997 and one was opened in May 1996. As of
March 11, 1998 one of these hotels with an acquisition cost of approximately $8
million has not been purchased but is expected to be purchased during the first
half of 1998. The Company believes that the current performance of the
Candlewood hotels is not indicative of their operating potential because of
their recent development; the ADR, occupancy and RevPAR for the three Candlewood
hotels acquired by the Company which were open for at least three quarters of
1997 were $50.62, 66.1% and $33.46, respectively during the fourth quarter of
1997.
PRINCIPAL LEASE FEATURES
The principal features of the Company's leases for the 135 Hotels are
as follows:
o In the event a lease for any Hotel is defaulted, the Company may
declare all of the leases with such Lessee to be in default.
o The initial lease terms expire between 2008 and 2014.
o At the end of the initial lease terms, each Lessee has 2 to 5
consecutive 10 to 15 year renewal options totaling 20 to 50 years.
Renewal options may be exercised only on an all or none basis for all
Hotels leased to a particular Lessee.
o The leases require minimum rent payments aggregating $137.5 million per
year.
o In addition to minimum rents, the leases of the Hotels require
percentage rents equal to 5% to 10% of total hotel sales in excess of
total hotel sales established in a base year.
o The leases for the Hotels require that a percentage (generally 5%) of
total hotel sales be escrowed periodically to fund refurbishments and
renovations to these Hotels ("FF&E Reserves"). Funds in the FF&E
Reserves are pooled for all Hotels leased to a particular Lessee and
generally may be withdrawn only for capital improvements.
o A security deposit equal to a full year's minimum rent is retained by
the Company as security for each Lessee's obligations under the leases
of the 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, if any. No
interest will be paid by the Company on security deposits, and such
deposits are not escrowed.
o The leases of the Hotels are net leases requiring the Lessee to pay all
operating expenses, including taxes and insurance and any applicable
ground rent. Certain Lessees, under the management agreements for the
Hotels, have delegated substantially all of the Lessees' operating
responsibilities to the Managers.
o Management fees payable to the Managers for operation of the Hotels are
subordinated to minimum rents due to the Company.
The right to occupy the land underlying 10 of the Hotels was acquired
by an assignment of leasehold interest under long-term ground leases. In each
case, the remaining term of the ground lease (including renewal options) is in
excess of 41 years, and the ground lessors are unrelated to the sellers and the
Company.
Ground rent payable under the 10 ground leases is the responsibility of
the Company's Lessees and is generally calculated as a percentage of hotel
revenues. Eight of the 10 ground leases require minimum annual rent
4
ranging from approximately $90,000 to $502,900 per year. If a ground lease
terminates, the lease with respect to the hotel on such ground-leased land will
also terminate. If a Lessee does not perform such obligations under the ground
lease or elects not to renew any ground lease, the Company must perform such
obligations under the ground lease or renew such ground lease in order to
protect its investments in the affected hotel. Any pledge of the Company's
interests in a ground lease may also require the consent of the applicable
ground lessor and its lenders.
INVESTMENT AND OPERATING POLICY
In order to benefit from potential property appreciation, the Company
generally prefers to own and lease properties rather than make mortgage
investments. 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 December 31, 1997, all of the Company's investments were in owned
properties. The Company provides 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 their properties to affiliated tenants. These
other hotel REITs generally design their affiliated leases to capture
substantially all net operating revenues from their hotels as rent. The
Company's leases are designed so that net operating revenues from its Hotels
exceed its rents by considerable coverage margins. The Company believes that
these differences in operating philosophy afford it a competitive advantage over
other hotel REITs in finding high quality hotel investment opportunities on
attractive terms and increase the dependability of the Company's cash flows used
to pay dividends.
The Company's investment objectives include increasing per share
dividends and cash available for distribution ("CAD") from dependable and
diverse resources. To achieve these 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 CAD 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 CAD is received from diverse properties and operators.
The Company's day-to-day operations are conducted by REIT Management
and Research, Inc. ("RMR"), the Company's investment advisor. RMR 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 arrangements for operation of the Hotels. 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 Hotels.
ACQUISITION POLICY
The Company is committed to pursuing growth through the acquisition of
additional hotels and intends to pursue acquisition opportunities. 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
5
particular national hotel management organization, if any, with which the
proposed hotel is or may become affiliated; and (viii) the hotel brand under
which the hotel operates or is expected to operate. 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 upscale limited service,
extended stay and full service hotel properties, it also considers acquisitions
in all segments of the hospitality industry.
An important part of the Company's acquisition strategy is to identify
and select qualified and experienced hotel lessees. The Company intends to
continue to select hotels for acquisition which will enhance the diversity of
its portfolio in respect to location, brand name, and lessee/operator.
DISPOSITION POLICIES
The Company has no current intention to dispose of any 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 "Federal Income Tax Considerations."
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 economic conditions,
relative availability 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 (the "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, 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
an unsecured basis (or a secured basis, subject to limitations which may be
present in existing financing or other arrangements) and may seek to obtain
other lines of credit 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 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 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.
Investment Advisor. Prior to January 1, 1998 the Company had an
agreement with HRPT Advisors, Inc. ("Advisors") whereby Advisors provided
investment and administrative services to the Company. Effective January 1,
1998, the Company entered into an agreement with REIT Management & Research,
Inc. ("RMR") whereby RMR provides investment and administrative services to the
Company. Advisors and RMR are Delaware corporations 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 also acted and RMR acts as the investment advisor to Health and
Retirement Properties Trust (NYSE:"HRP"), the holder of 4,000,000 Shares and has
other business interests. The directors of RMR are Gerard M. Martin, Barry M.
Portnoy and David J.
6
Hegarty. The officers of RMR are David J. Hegarty, President and Secretary, John
G. Murray, Executive Vice President, John A. Mannix, Vice President, Thomas M.
O'Brien, Vice President, Ajay Saini, Vice President, John C. Popeo, Treasurer,
and David M. Lepore, Vice President. Mr. Murray and Mr. O'Brien are also
officers of the Company.
Employees. The Company is an advised REIT and has no employees.
Services which would otherwise be provided by employees are provided by RMR
pursuant to the Advisory Agreement (described below) and by the Managing
Trustees and officers of the Company. RMR, which administers the day-to-day
operations of the Company, has 125 full-time employees and three active
directors.
Competition. The hotel industry is highly competitive. Each of the
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 hotels located in that area. Agreements
with the operators of the Hotels restrict the right of each operator and its
affiliates for a limited period of time to own, build, operate, franchise or
manage any other hotel of the same brand within various specified areas around
the Company's Hotels. Neither the operator nor its affiliates are restricted
from operating other branded hotels in the market areas of any of the Hotels,
and after such limited period of time, the operators and their affiliates may
also compete with the Hotels by opening, managing or franchising additional
hotels under the same brand name in direct competition with the Company's
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.
Seasonality. The effects of seasonality, if any, are discussed in
Management's Discussion and Analysis.
FEDERAL INCOME TAX CONSIDERATIONS
The Company has elected to be taxed as a REIT commencing with its
taxable year ending December 31, 1995. As used in this discussion of "Federal
Income Tax Consequences" and in "Erisa Plans, Keogh Plans and Individual
Retirement Accounts" below, "REIT" means a Real Estate Trust under Sections 856
through 860 of the Internal Revenue Code of 1986, as amended and in effect from
time to time (the "Code"). The Company believes it has been organized and has
operated in a manner that qualifies it to be taxed under the Code as a REIT
commencing with that taxable year, and the Company intends to continue to
operate in a manner to so qualify. No assurance can be given, however, that the
manner in which the Company has operated or will operate qualified or will
qualify the Company to be taxed as a REIT.
The Company has obtained legal opinions from its counsel Sullivan &
Worcester LLP that the Company has been organized in conformity with the
requirements for qualification as a REIT, has qualified as a REIT for its 1995,
1996 and 1997 taxable years, and that its current and anticipated investments
and its plan of operation will enable it to continue to meet the requirements
for qualification and taxation as a REIT under the Code. These opinions are
conditioned upon the assumption that the leases, the Declaration and the
Company's Bylaws, and all other legal documents to which the Company is or has
been a party have been and will be complied with by all parties thereto, upon
the accuracy and completeness of the factual matters described in this Annual
Report, and upon representations made by the Company as to certain factual
matters relating to the Company's organization and operations and its expected
manner of operation. In addition, such opinions are based on the law then
existing and in effect on the date thereof. Opinions of counsel are not binding
on the Internal Revenue Service ("IRS"), or a court and there can be no
assurance that the IRS or a court will not take a position different from that
expressed by counsel.
7
The Company's actual 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 REIT qualification tests imposed under the Code,
discussed below. While the Company has represented that it has operated and will
operate in a manner so as to satisfy on a continuing basis the various REIT
qualification tests, Sullivan & Worcester LLP has not reviewed and will not
review compliance with these tests on a continuing basis, and no assurance can
be given that the Company has satisfied or will satisfy such tests on a
continuing basis. If the Company fails to qualify as a REIT in any year, 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 following summary is based on existing law, is limited to investors
who will hold the Shares as "capital assets" within the meaning of Section 1221
of the Code (generally, property held for investment), is not exhaustive of all
possible tax considerations, and does not discuss any state, local, or foreign
tax considerations. Additionally, the following summary does not discuss the
particular tax consequences that might be relevant to holders of Shares who may
be subject to special rules under the federal income tax law, such as life
insurance companies, regulated investment companies, financial institutions,
brokers or dealers in securities or foreign currency, persons that have a
functional currency other than the U.S. dollar, persons who acquired Shares or
options to acquire Shares in connection with their employment or other
performance of services, persons subject to alternative minimum tax, persons who
hold Shares as part of a straddle, hedging transaction, or conversion
transaction or, except as specifically described herein, tax-exempt entities and
foreign persons. The sections of the Code that govern the federal income tax
qualification and treatment of a REIT and its shareholders are highly technical
and complex. The following summary is thus qualified in its entirety by the
applicable Code provisions, the rules and regulations promulgated thereunder,
and the administrative and judicial interpretations thereof, all of which are
subject to change, possibly with retroactive effect. Thus, no assurance can be
given that future legislative, judicial, or administrative actions or decisions
will not affect the accuracy of any statements in this summary. In addition, no
ruling has been or is expected to be sought from the IRS with respect to any
matter discussed herein, and there can be no assurance that the IRS or a court
will agree with the statements made herein. Accordingly, each shareholder is
urged to consult his own tax advisor with respect to the federal income tax and
other tax consequences of the purchase, holding and sale of Shares.
Taxation of the Company. If the Company qualifies for taxation as a
REIT and distributes to its shareholders at least 95% of its "real estate
investment trust taxable income" (determined by excluding any net capital gain
and before taking into account any dividends paid deduction), it generally will
not be subject to federal corporate income taxes on the amount distributed. This
deduction for dividends paid to shareholders substantially eliminates the
federal "double taxation" on earnings (once at the corporate level and again at
the shareholder level) that generally results from an investment in a
corporation.
However, even if the Company qualifies for federal income taxation as a
REIT, it may be subject to federal tax in certain circumstances. First, the
Company will be taxed at regular corporate rates on any undistributed "real
estate investment trust taxable income," including undistributed net capital
gains. Second, under certain circumstances, the Company may be subject to the
corporate "alternative minimum tax" on its items of tax preference, if any.
Third, if the Company has (i) net income from the sale or other disposition of
"foreclosure property" (generally, property acquired by the Company through
foreclosure or otherwise after a default on a loan secured by the property or on
a lease of the property) that is held primarily for sale to customers in the
ordinary course of business or (ii) other nonqualifying income from foreclosure
property, then the Company will be subject to tax on such income at the highest
regular corporate rate (currently 35%). Fourth, if the Company has net income
from prohibited transactions (generally, certain sales or other dispositions of
inventory or property held primarily for sale to customers in the ordinary
course of business, other than foreclosure property), such income will be
subject to tax at a 100% rate. Fifth, if the Company should fail to satisfy the
75% gross income test or the 95% gross income test (discussed below), but
nonetheless maintains its qualification as a REIT because certain other
requirements are met, the Company will be subject to tax at a 100% rate on the
greater of the amount by which the Company fails the 75% or the 95% test,
multiplied by a fraction intended to reflect the Company's profitability. Sixth,
if the Company should fail to distribute for any calendar year at least the sum
of (i) 85% of its REIT ordinary
8
income for such year, (ii) 95% of its REIT capital gain net income for such
year, and (iii) any undistributed taxable income from prior periods, the Company
will be subject to a 4% excise tax on the excess of such required distribution
over the amounts actually distributed. Seventh, if the Company acquires any
asset from a C corporation (generally, a corporation subject to full corporate
level tax) in a transaction in which the basis of the asset in the Company's
hands is determined by reference to the basis of the asset in the hands of the C
corporation, and if the Company subsequently recognizes gain on the disposition
of such asset during the ten-year period beginning on the date on which the
asset was acquired by the Company, then the Company will pay tax at the highest
regular corporate tax rate (currently 35%) on the lesser of (i) the excess of
the fair market value of the asset over the Company's basis in the asset on the
date acquired by the Company and (ii) the gain recognized by the Company.
If the Company should invest in properties in foreign countries, the
Company's profits from such investments will generally be subject to tax in the
countries where such properties are located. The nature and amount of any such
taxation will depend on the laws of the countries where the properties are
located. If the Company satisfies the annual distribution requirements for
federal income tax qualification as a REIT and is therefore not subject to
federal corporate income tax on that portion of its ordinary income and capital
gain that is currently distributed to its shareholders, the Company will
generally not be able to recover the cost of any foreign tax imposed on profits
from its foreign investments by claiming foreign tax credits against its federal
income tax liability on such profits. Moreover, a REIT is not able to pass
through to its shareholders any foreign tax credits.
The Company's Wholly-Owned Subsidiaries. Section 856(i) of the Code
provides that a corporation that is a qualified REIT subsidiary (defined as any
corporation 100% of whose stock is held by the REIT at all times during the
period the corporation is in existence) shall not be treated as a separate
corporation, and all assets, liabilities, and items of income, deduction, and
credit of a qualified REIT subsidiary shall be treated as assets, liabilities
and items of income, deduction, and credit of the REIT. (For the Company's
taxable years commencing on or after January 1, 1998, a wholly-owned corporation
qualifies as a qualified REIT subsidiary even though there was a period of time
during which the Company did not own 100% of its stock; such corporation will be
treated for federal income tax purposes as though liquidated into the Company at
the time the Company acquired 100% ownership, and then reincorporated by the
Company as a qualified REIT subsidiary.) The Company believes that each of its
direct and indirect wholly-owned subsidiaries qualifies either as a qualified
REIT subsidiary within the meaning of Section 856(i) of the Code, or as a
noncorporate entity that for federal income tax purposes is not treated as
separate from its owner pursuant to Treasury Regulations under Section 7701 of
the Code. Thus, in applying all the federal income tax REIT qualification
requirements discussed herein, the Company's direct and indirect wholly-owned
subsidiaries are ignored, and all assets, liabilities, and items of income,
deduction and credit of those subsidiaries are treated as assets, liabilities
and items of income, deduction and credit of the Company.
The Company's Investments through Partnerships. The Company in the
future may invest in real estate through one or more limited or general
partnerships or limited liability companies that is treated as a partnership for
federal income tax purposes. In the case of a REIT that is a partner in a
partnership, Treasury Regulations provide that for purposes of the REIT
qualification requirements regarding income and assets discussed below, the REIT
is deemed to own its proportionate share of the assets of the partnership
corresponding to the REIT's proportionate capital interest in such partnership
and is deemed to be entitled to the income of the partnership attributable to
such proportionate share. In addition, for these purposes, the character of the
assets and gross income of the partnership generally retain the same character
in the hands of the REIT. Accordingly, the Company's proportionate share of the
assets, liabilities, and items of income of each partnership in which it is a
partner are treated as assets, liabilities, and items of income of the Company
for purposes of the income tests and asset tests discussed below. However, for
purposes of the REIT's distribution requirement discussed below, a REIT must
take into account as a partner its distributive share of the partnership's
income as determined under the general federal income tax rules governing
partners and partnerships under Sections 701 et seq. of the Code.
REIT Qualification Requirements--Generally. Section 856(a) of the Code
defines a REIT as a corporation, trust or association: (1) which is managed by
one or more trustees or directors; (2) the beneficial ownership of which is
evidenced by transferable shares or by transferable certificates of beneficial
interest; (3) which would be taxable, but for Sections 856 through 859 of the
Code, as a domestic corporation; (4) which is neither a financial institution
nor an insurance company subject to certain provisions of the Code; (5) the
beneficial ownership of which is held by 100 or more persons; (6) which is not
"closely held" as determined under the personal holding
9
company stock ownership test (as applied with modifications); and (7) which
meets certain other tests regarding income, assets, and distributions, as
described below. Section 856(b) of the Code provides that conditions (1) to (4),
inclusive, must be met during the entire taxable year and that condition (5)
must be met during at least 335 days of a taxable year of 12 months, or during a
proportionate part of a taxable year of less than 12 months. It is the Company's
belief and expectation that it has had and will have at least 100 shareholders
during the requisite period for each of its taxable years since its election to
be taxed as a REIT. There can, however, be no assurance in this connection and,
if the Company has fewer than 100 shareholders during the requisite period,
condition (5) described above will not be satisfied, and the Company would not
qualify as a REIT during such taxable year.
By reason of the "closely held" condition (6) above, the Company will
fail to qualify as a REIT for a taxable year if at any time during the last half
of such year more than 50% in value of its outstanding Shares is owned directly
or indirectly by five or fewer individuals. To help maintain conformity with
condition (6), the Declaration contains certain provisions restricting transfers
of Shares and giving the Trustees the power to redeem Shares involuntarily. For
its taxable years commencing on or after January 1, 1998, if the Company
complies with Treasury Regulations for ascertaining the ownership of its
outstanding Shares and does not know or, exercising reasonable diligence would
not have known, whether it failed condition (6), then the Company will be
treated as satisfying condition (6). Also, for its taxable years commencing on
or after January 1, 1998, the Company's failure to comply with the Treasury
Regulations for ascertaining ownership of its outstanding Shares may result in a
penalty of $25,000 ($50,000 for intentional violations). Accordingly, the
Company will, pursuant to the Treasury Regulations, request annually from record
holders of certain significant percentages of its Shares certain information
regarding the ownership of such Shares. Under the Declaration, shareholders are
required to respond to such requests for information.
The rule that an entity will fail to qualify as a REIT for a taxable
year if at any time during the last half of such year more than 50% in value of
its outstanding shares is owned directly or indirectly by five or fewer
individuals is relaxed in the case of certain pension trusts owning shares in a
REIT. Shares in a REIT held by such a pension trust are treated as held directly
by its beneficiaries in proportion to their actuarial interests in the pension
trust. Consequently, five or fewer pension trusts could own more than 50% of the
interests in an entity without jeopardizing its federal income tax qualification
as a REIT. However, as discussed below, if the REIT is a "pension-held REIT,"
each pension trust holding more than 10% of its shares (by value) generally will
be taxable on a portion of the dividends it receives from the REIT, based on the
ratio of the REIT's gross income for the year which would be unrelated trade or
business income if the REIT were a qualified pension trust to the REIT's total
gross income for the year.
To qualify as a REIT under the Code, the Company must elect to be so
treated and must meet other requirements, certain of which are summarized below,
including percentage tests relating to the sources of its gross income, the
nature of its assets, and the distribution of its income to shareholders. The
Company made such an election for 1995 and such election, assuming continuing
compliance with the federal income tax qualification tests discussed herein,
continues in effect for subsequent years.
Income Tests. There are three gross income requirements, only two of
which apply to the Company for its taxable years commencing on or after January
1, 1998. First, at least 75% of the Company's gross income (excluding gross
income from certain sales of property held primarily for sale) must be derived
directly or indirectly from investments relating to real property (including
"rents from real property"), mortgages on real property, or shares in other
REITs. When the Company receives new capital in exchange for its Shares (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 income under the
75% test. Second, at least 95% of the Company's gross income (excluding gross
income from certain sales of property held primarily for sale) must be derived
from such real property investments, dividends, interest, certain payments under
interest rate swap or cap agreements (and for the Company's taxable years
commencing on or after January 1, 1998, certain payments under options, futures
contracts, forward rate agreements, or similar financial instruments), and gain
from the sale or disposition of stock, securities, or real property, or from any
combination of the foregoing. Third, for the Company's taxable years ending on
or before December 31, 1997, short-term gain from the sale or other disposition
of stock or securities (including, without limitation, stock in other REITs),
dispositions of interest rate swap or cap
10
agreements, and gain from certain prohibited transactions or other dispositions
of real property held for less than four years (apart from involuntary
conversions and sales of foreclosure property) must have represented less than
30% of the Company's gross income. For purposes of these three gross income
rules, income derived from a "shared appreciation provision" in a mortgage loan
is generally treated as gain recognized on the sale of the property to which it
relates. Even though the Company does not own mortgage loans that contain shared
appreciation provisions, the Company may in the future make such mortgage loans.
The Company temporarily invests working capital in short-term investments,
including shares in other REITs. Although the Company will use its best efforts
to ensure that the income generated by its investments will be of a type which
satisfies the 75% and 95% gross income tests, there can be no assurance in this
regard.
In order to qualify as "rents from real property," several requirements
must be met. First, the amount of rent received generally must not be determined
from the income or profits of any person, but may be based on receipts or sales.
Second, the Code provides that rents will not qualify as "rents from real
property" in satisfying the gross income tests if the REIT owns 10% or more of
the tenant, whether directly or under certain attribution rules. The Company
intends not to lease property to any party if rents from such property would not
so qualify. Application of the 10% ownership rule is, however, dependent upon
complex attribution rules and upon circumstances beyond the control of the
Company. Ownership, directly or by attribution, by an unaffiliated third party
of more than 10% of the Shares and more than 10% of the stock of a lessee would
result in lessee rents not qualifying as "rents from real property." The
Declaration provides that transfers or purported acquisitions, directly or by
attribution, of Shares that could result in disqualification of the Company as a
REIT are null and void and permits the Trustees to repurchase Shares to the
extent necessary to maintain the Company's status as a REIT. Nevertheless, there
can be no assurance such provisions in the Declaration will be effective to
prevent the Company's REIT status from being jeopardized under the 10% lessee
affiliate rule. Furthermore, there can be no assurance 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. Third,
in order for its rents to qualify as "rents from real property," 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." For the Company's taxable years commencing on or after
January 1, 1998, a de minimis amount of noncustomary services will not
disqualify income as rents from real property so long as the value of the
impermissible services does not exceed 1% of the gross income of the property.
Fourth, if rent attributable to personal property leased in connection with a
lease of real property is greater than 15% of the total rent received under the
lease, then the portion of rent attributable to such personal property will not
qualify as "rents from real property." The portion of rental income treated as
attributable to personal property is determined according to the ratio of the
tax basis of the personal property to the total tax basis of the property which
is rented. Substantially all of the gross income of the Company has been and is
expected to be attributable to rental income. The Company believes that all or
substantially all such rents have qualified and will continue to qualify as
"rents from real property" for purposes of Section 856 of the Code, but if for
some reason a significant amount of such rents do not so qualify, it may be
difficult or impossible for the Company to meet the 95% or 75% gross income
tests and to qualify as a REIT for federal income tax purposes.
In order to qualify as mortgage interest on real property for purposes
of the 75% test, interest must derive from a mortgage loan secured by real
property with a fair market value at least equal to the amount of the loan. If
the amount of the loan exceeds the fair market value of the real property, the
interest will be treated as interest on a mortgage loan in a ratio equal to the
ratio of the fair market value of the real property to the total amount of the
mortgage loan.
Any gain realized by the Company on the sale of any property held as
inventory or other property held primarily for sale to customers in the ordinary
course of business will be treated as income from a prohibited transaction that
is subject to a penalty tax at a 100% rate. This prohibited transaction income
also may have an adverse effect upon the Company's ability to satisfy the 75%
and 95% gross income tests for federal income tax qualification as a REIT. Under
existing law, whether property is held as inventory or primarily for sale to
customers in the ordinary course of a trade or business is a question of fact
that depends on all the facts and circumstances with respect to the particular
transaction. The Company intends to hold its real estate assets for
11
investment with a view to long-term appreciation, to engage in the business of
developing, owning and operating its existing real estate assets and acquiring,
developing, owning and operating other real estate assets, and to make
occasional dispositions of real estate assets as is consistent with the
Company's investment objectives. There can be no assurance, however, that the
IRS might not contend that one or more dispositions is subject to the 100%
penalty tax.
If the Company fails to satisfy one or both of the 75% or 95% gross
income tests for any taxable year, it may nevertheless qualify as a REIT for
such year if (i) the Company's failure to meet such test was due to reasonable
cause and not due to willful neglect, (ii) the Company reported the nature and
amount of each item of its income included in the 75% or 95% gross income tests
(as the case may be) for such taxable year on a schedule attached to its return,
and (iii) any incorrect information on the schedule was not due to fraud with
intent to evade tax. No similar provision provides relief if the Company failed
the 30% gross income test for the taxable years such test was applicable, and it
is not possible to state whether in all circumstances the Company would be
entitled to the benefit of the relief provisions for the 75% and 95% gross
income tests. As discussed above, even if these relief provisions do apply, a
special tax equal to 100% is imposed upon the greater of the amount by which the
Company failed the 75% test or the 95% test, multiplied by a fraction intended
to reflect the Company's profitability.
Asset Tests. At the close of each quarter of the Company's taxable
year, it must also satisfy three tests relating to the nature of its assets.
First, at least 75% of the value of the Company's total assets must consist of
real estate assets (which for this purpose includes stock or debt instruments
held for not more than one year purchased with proceeds of a stock offering or a
long-term (at least five years) debt offering of the Company), cash, cash items,
shares in other REITs, and government securities. Second, not more than 25% of
the Company's total assets may be represented by securities (other than those
includible in the foregoing 75% asset class). Third, of the investments included
in the foregoing 25% asset class, the value of any one issuer's securities owned
by the Company may not exceed 5% of the value of the Company's total assets, and
the Company may not own more than 10% of any one issuer's outstanding voting
securities. President Clinton has proposed legislation that would expand this
last prohibition so that the Company would not be permitted to own more than
10%, either by vote or by value, of any one issuer's outstanding securities.
Where a failure to satisfy the foregoing asset tests results from an
acquisition of securities or other property during a quarter, the failure can be
cured by disposition of sufficient nonqualifying 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 foregoing asset tests, and
to take such action as may be required to cure any failure to satisfy the tests
within 30 days after the close of any quarter.
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 each year in an amount at least equal to the excess of (A)
the sum of (i) 95% of the Company's "real estate investment trust taxable
income" (computed without regard to the dividends paid deduction and net capital
gain) and (ii) 95% of the net income (after tax), if any, from foreclosure
property, over (B) the sum of certain noncash income (e.g., certain imputed
rental income or certain 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 earlier taxable year and if
paid on or before the first regular dividend payment after such declaration.
Also, dividends declared in October, November, or December and paid during the
following January will be treated as having been paid and received on December
31. A distribution which is not pro rata within a class of beneficial interest
in the Company entitled to a dividend, or which is not consistent with the
rights to distributions between classes of beneficial interests in the Company,
is a preferential dividend that is not taken into consideration for purposes of
the distribution requirement, and accordingly the payment of a preferential
dividend could affect the Company's ability to meet the distribution
requirement. Taking into account the Company's distribution policies (including
its dividend reinvestment plan), the Company believes that it has not made and
expects that it will not make any such preferential dividend. The distribution
requirements may be waived by the IRS if the REIT establishes that it failed to
meet them by reason of distributions previously made to meet the requirements of
the 4% excise tax discussed below. To the extent that the Company does not
distribute all of its net capital gain and all of its "real estate investment
trust taxable income," as adjusted, it will be subject to tax thereon.
12
In addition, the Company will be subject to a 4% excise tax to the
extent it fails within a calendar year to make "required distributions" to its
shareholders of 85% of its ordinary income and 95% of its capital gain net
income plus the excess, if any, of the "grossed up required distribution" for
the preceding calendar year over the amount treated as distributed for such
preceding calendar year. For this purpose, the term "grossed up required
distribution" for any calendar year is the sum of the taxable income of the
Company for the calendar year (without regard to the deduction for dividends
paid) and all amounts from earlier years that are not treated as having been
distributed under the provision.
It is possible that the Company, from time to time, may not have
sufficient cash or other liquid assets to meet the 95% distribution requirements
due to timing differences between (i) the actual receipt of income and actual
payment of deductible expenses or distributions and (ii) the inclusion of such
income and deduction of such expenses or distributions in arriving at "real
estate investment trust taxable income" of the Company. The problem of
inadequate cash to make required distributions could also occur as a result of
the repayment in cash of principal amounts due on the Company's outstanding
debt, particularly in the case of "balloon" repayments or as a result of capital
losses on short-term investments of working capital. Therefore, the Company
might find it necessary to arrange for short-term or possibly long-term
borrowing, or for new equity financing, to provide funds for required
distributions, or else its REIT status for federal income tax purposes could be
jeopardized. There can be no assurance that such borrowing or financing would be
available on favorable terms.
Under certain circumstances, the Company may be able to rectify a
failure to meet the distribution requirement for a year by paying "deficiency
dividends" to shareholders in a later year, which may be included in the
Company's deduction for dividends paid for the earlier year, although an
interest charge would be imposed upon the Company for the delay in distribution.
Although the Company may thus be able to avoid being taxed on amounts
distributed as deficiency dividends, the Company may in certain circumstances
remain liable for the 4% excise tax discussed above.
For its taxable years ending on or before December 31, 1997, the
Company was required to request annually from record holders of certain
significant percentages of its Shares certain information regarding the
ownership of such Shares, in order to qualify for the deduction for dividends
paid to its shareholders. As discussed above, for taxable years commencing on or
after January 1, 1998, the Company will continue to request such information in
order to comply with the REIT qualification requirement regarding ownership
concentration of its Shares.
Federal Income Tax Treatment of Leases. The availability to the Company
of, among other things, depreciation deductions with respect to the facilities
owned and leased by the Company will depend upon the treatment of the Company as
the owner of the facilities and the classification of the leases of the
facilities as true leases, rather than as sales or financing arrangements, for
federal income tax purposes. As to the approximately 10% of the Company's leased
facilities which constitutes personal property, it is not entirely clear that
the Company will be treated as the owner of such personal property and that the
leases will be treated as true leases with respect to such property. The Company
plans to insure its compliance with the 95% distribution requirement (and the
excise tax "required distribution" requirement) by making distributions on the
assumption that it is not entitled to depreciation deductions for the 10% of the
leased facilities which constitute personal property, but to perform all its tax
reporting by taking into account such depreciation.
In the case of certain sale-leaseback arrangements, the IRS 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 IRS could not successfully assert the existence of
prepaid rental income.
Additionally, Section 467 of the Code applies to a lease which provides
for rents that increase from one period to the next. Section 467 of the Code
provides that in the case of a so-called "disqualified leaseback agreement,"
rental income must be accrued at a constant rate. If such constant rent accrual
were required, the
13
Company could recognize rental income in excess of cash rents and, as a result,
may fail to meet the 95% dividend distribution requirement. "Disqualified
leaseback agreements" include leaseback transactions where a principal purpose
for providing increasing rent under the agreement is the avoidance of federal
income tax. Because Section 467 of the Code directs the Treasury to issue
regulations providing that rents will not be treated as increasing for tax
avoidance purposes where the increases are based upon a fixed percentage of
lessee receipts, and because regulations proposed to be effective for
"disqualified leaseback agreements" entered into after June 3, 1996 adopt this
rule, the additional rent provisions of the Company's leases generally should
not cause the leases to be "disqualified leaseback agreements." In addition, the
legislative history of Section 467 of the Code indicates that the Treasury
should issue regulations under which leases providing for fluctuations in rents
by no more than a reasonable percentage from the average rent payable over the
term of the lease will be deemed not motivated by tax avoidance, and the
proposed regulations permit a 10% fluctuation.
Depreciation of Properties. For federal income tax purposes, the
Company generally depreciates its real property on a straight-line basis over 40
years and its personal property over 9 years.
Failure to Qualify. If the Company fails to qualify for federal income
taxation as a REIT in any taxable year, and any potentially applicable relief
provisions do not apply, the Company will be subject to tax on its taxable
income at regular corporate rates (plus any applicable minimum tax).
Distributions to shareholders in any year in which the Company fails to qualify
will not be deductible by the Company nor will they be required to be made. In
such event, to the extent of the Company's current and accumulated earnings and
profits, all distributions to shareholders will be taxable as ordinary income,
and subject to certain limitations in the Code will be eligible for the
dividends received deduction for corporations. Unless entitled to relief under
specific statutory provisions, the Company will also be disqualified from
federal income taxation as a REIT for the following four taxable years. It is
not possible to state whether in all circumstances the Company would be entitled
to statutory relief from such disqualification. Failure to qualify for even one
year could result in the Company's incurring substantial indebtedness (to the
extent borrowings are feasible) or liquidating substantial investments in order
to pay the resulting taxes.
Taxation of U.S. Shareholders--Generally. As used herein, the term
"U.S. Shareholder" means a beneficial holder of Shares that is for federal
income tax purposes (i) a citizen or resident of the United States, (ii) a
corporation or partnership (or other entity treated as a corporation or
partnership for federal income tax purposes) created or organized in or under
the laws of the United States or of any political subdivision thereof (unless
otherwise provided by Treasury Regulations), (iii) an estate the income of which
is subject to federal income taxation regardless of its source, or (iv) a trust
if a court within the United States is able to exercise primary supervision over
the administration of the trust and one or more United States persons have the
authority to control all substantial decisions of the trust (or certain electing
trusts in existence on August 20, 1996 to the extent provided in Treasury
Regulations). As used herein, the term "Non-U.S. Shareholder" means a beneficial
holder of Shares that is not a U.S. Shareholder.
As long as the Company qualifies as a REIT for federal income tax
purposes, distributions (including reinvestments pursuant to the Company's
dividend reinvestment plan) made to the Company's U.S. Shareholders out of
current or accumulated earnings and profits will be taken into account by them
as ordinary income (but will not be eligible for the dividends received
deduction for corporations). Distributions that are properly designated by the
Company as capital gain dividends will be taxed as long-term capital gains (as
discussed below) to the extent they do not exceed the Company's actual net
capital gain for the taxable year, although corporate U.S. Shareholders may be
required to treat up to 20% of any such capital gain dividend as ordinary income
pursuant to Section 291 of the Code. For the Company's taxable years commencing
on or after January 1, 1998, the Company may elect to retain amounts
representing its net capital gain income. In that case, the Company will be
taxed at regular corporate capital gains tax rates on such amounts, each U.S.
Shareholder will be taxed on its proportionate share of the net capital gains
retained by the Company as though such amount were distributed and designated a
capital gain dividend, and each such U.S. Shareholder will receive a credit for
a proportionate share of the tax paid by the Company. Additionally, each U.S.
Shareholder will increase the adjusted basis in its Shares by the excess of the
amount of its proportionate share of these net capital gains over its
proportionate share of the tax paid by the Company, and both the Company and its
corporate U.S. Shareholders will make commensurate adjustments in their
respective earnings and profits for federal income tax purposes. If the Company
should elect to retain its net capital
14
gain in this fashion, it will notify each U.S. Shareholder of the relevant tax
information within 60 days after the close of the Company's taxable year.
For certain noncorporate U.S. Shareholders, long-term capital gains
taken into account after May 7, 1997 are taxed at varying maximum rates of 20%,
25%, or 28%, depending upon the type of property disposed of and the holding
period in such property at the time of disposition. If the Company designates a
dividend as a capital gain dividend for any taxable year of the Company ending
after May 7, 1997 (or elects to retain a portion of its net capital gain and
have such amount treated as a distributed and designated capital gain dividend
in the manner described above), the Company may also designate the portion of
such capital gain dividend which is taxed to certain noncorporate U.S.
Shareholders at the varying maximum rates of 20%, 25%, or 28%, based upon the
type and holding period of the property disposed of by the Company. If the
Company does not make such a designation, the entire capital gain dividend will
be treated as long-term capital gain subject to the maximum 28% rate to the
noncorporate U.S. Shareholders (without regard to the period for which the U.S.
Shareholder held its Shares).
For purposes of computing the Company's earnings and profits,
depreciation on real estate is generally computed on a straight-line basis over
40 years. Distributions in excess of current or accumulated earnings and profits
will not be taxable to a U.S. Shareholder to the extent that they do not exceed
the adjusted basis of the U.S. Shareholder's Shares, but will reduce the U.S.
Shareholder's basis in such Shares. To the extent that such distributions exceed
the adjusted basis of a U.S. Shareholder's Shares, they will be included in
income as long-term capital gain (or short-term capital gain if the shares have
been held for not more than one year), with such long-term gain taxed to certain
noncorporate U.S. Shareholders at varying maximum rates of 20% or 28% depending
upon the U.S. Shareholder's holding period in the Shares. U.S. Shareholders may
not include in their respective income tax returns any net operating losses or
capital losses of the Company.
Dividends declared by the Company in October, November or December of a
taxable year to shareholders of record on a date in such month, will be deemed
to have been received by such shareholders on December 31, provided the Company
actually pays such dividends during the following January. For tax purposes, the
Company's dividends paid in 1995, 1996 and 1997 aggregated $.79, $2.34 and $2.45
respectively, of which $.000, $.344 and $.341, respectively, represented a
return of capital.
The sale or exchange of Shares will result in recognition of gain or
loss to the U.S. Shareholder in an amount equal to the difference between the
amount realized and its adjusted basis in the Shares sold or exchanged. Such a
gain or loss will be capital gain or loss, and will be long-term capital gain or
loss if the U.S. Shareholder's holding period in the Shares exceeded one year.
Long-term capital gains may be taxed to certain noncorporate U.S. Shareholders
at varying maximum rates of 20% or 28% depending upon the U.S. Shareholder's
holding period in the Shares. In addition, any loss upon a sale or exchange of
Shares by a U.S. Shareholder who has held such Shares for not more than six
months (after applying certain rules), will generally be treated as a long-term
capital loss to the extent of distributions from the Company required to be
treated by such U.S. Shareholders as long-term capital gain (including, for this
purpose, amounts constructively distributed as long-term capital gain by the
Company electing to retain its net capital gain in the manner described above).
U.S. Shareholders (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 investor's net
investment income. A U.S. Shareholder's net investment income will include
dividend distributions and, if an appropriate election is made, capital gain
dividend distributions it receives from the Company; however, distributions
treated as a nontaxable return of the U.S. Shareholder's basis will not enter
into the computation of net investment income. Under Section 469 of the Code,
U.S. Shareholders (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 U.S. Shareholder from the Company will not be
treated as income from a passive activity and thus will not be available to
offset a U.S. Shareholder's passive activity losses.
15
Tax preference and other items which are treated differently for
regular and alternative minimum tax purposes are to be allocated between a REIT
and its shareholders under regulations which are to be prescribed. It is
possible that these regulations would require tax preference items to be
allocated to the Company's shareholders with respect to any accelerated
depreciation claimed by the Company; however, the Company has not claimed
accelerated depreciation with respect to its existing properties.
Taxation of Certain Tax-Exempt U.S. Shareholders. In Revenue Ruling
66-106, the IRS ruled that amounts distributed by a REIT to a tax-exempt
employees' pension trust did not constitute "unrelated business taxable income,"
even though the REIT may have financed certain of its activities with
acquisition indebtedness. Although Revenue Rulings are interpretive in nature
and subject to revocation or modification by the IRS, based upon Revenue Ruling
66-106 and the analysis therein, distributions made by the Company to U.S.
Shareholders that are qualified pension plans (including individual retirement
accounts) or certain other tax-exempt entities should not constitute unrelated
business taxable income, unless such U.S. Shareholder has financed the
acquisition of its Shares with "acquisition indebtedness" within the meaning of
the Code, or the Shares are otherwise used in an unrelated trade or business
conducted by the U.S. Shareholder.
Special rules apply to certain tax-exempt pension trusts (including
so-called 401(k) plans but excluding individual retirement accounts or
government pension plans) that own more than 10% by value of a "pension-held
REIT" at any time during a taxable year commencing after December 31, 1993. Such
a pension trust may be required to treat a certain percentage of all dividends
received from the pension-held REIT during the year as unrelated business
taxable income. Such percentage is equal to the ratio of the pension-held REIT's
gross income (less direct expenses related thereto) derived from the conduct of
unrelated trades or businesses (determined as if the pension-held REIT were a
tax-exempt pension fund), to the pension-held REIT's gross income (less direct
expenses related thereto) from all sources, except that such percentage shall be
deemed to be zero unless it would otherwise equal or exceed 5%. A REIT will be
treated as a pension-held REIT only if (i) the REIT is "predominantly held" by
tax-exempt pension trusts, and (ii) the REIT would otherwise fail to satisfy the
"closely held" ownership condition discussed above if the stock or beneficial
interests in the REIT held by such tax-exempt pension trusts were viewed as held
by such tax-exempt pension trusts rather than their respective beneficiaries. A
REIT is predominantly held by tax-exempt pension trusts if at least one
tax-exempt pension trust holds more than 25% by value of the REIT's stock or
beneficial interests, or if one or more tax-exempt pension trusts (each owning
more than 10% by value of the REIT's stock or beneficial interests) own in the
aggregate more than 50% by value of the REIT's stock or beneficial interests.
Given the restrictions in its Declaration regarding ownership of its Shares, the
Company believes that it has not been, and expects that it will not be, a
pension-held REIT. However, because the Shares of the Company will be publicly
traded, no assurance can be given that the Company will not become a
pension-held REIT.
Taxation of Non-U.S. Shareholders. The rules governing the federal
income taxation of Non-U.S. Shareholders (generally, nonresident alien
individuals, foreign corporations, foreign partnerships, and foreign trusts and
estates) are highly complex, and the following discussion is intended only as a
summary of such rules. Non-U.S. Shareholders should consult with their own tax
advisors to determine the impact of federal, state, local, and foreign tax laws,
including any reporting requirements, with respect to their investment in the
Company. In general, a Non-U.S. Shareholder will be subject to regular federal
income tax in the same manner as a U.S. Shareholder with respect to its
investment in Shares if such investment is "effectively connected" with the
Non-U.S. Shareholder's conduct of a trade or business in the United States. In
addition, a corporate Non-U.S. Shareholder that receives income that is (or is
deemed) effectively connected with a trade or business in the United States may
also be subject to the 30% branch profits tax under Section 884 of the Code,
which is payable in addition to regular federal corporate income tax. The
following discussion addresses only Non-U.S. Shareholders whose investment in
Shares is not effectively connected with the conduct of a trade or business in
the United States.
A distribution by the Company to a Non-U.S. Shareholder that is not
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. Generally, such a
dividend will be subject to federal income withholding tax on the gross amount
thereof at the rate of 30%, or such lower rate that may be specified by treaty
if the Non-U.S. Shareholder has in the manner prescribed by the IRS demonstrated
to the Company its entitlement to treaty benefits.
16
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 discussed below. A
distribution in excess of the Company's earnings and profits may be subject to
30% (or lower treaty rate) 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 IRS. The Company expects to withhold federal income withholding tax at
the rate of 30% on the gross amount of any distributions on Shares made to a
Non-U.S. Shareholder unless a lower tax treaty applies and the required IRS form
evidencing eligibility for that reduced rate is filed with the Company.
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 are taxed to a Non-U.S. Shareholder as if such
distributions were gains "effectively connected" with a trade or business in the
United States conducted by the Non-U.S. Shareholder. Accordingly, a Non-U.S.
Shareholder will be taxed on such amounts 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 nonresident alien
individuals). Such distributions may also be subject to a 30% branch profits tax
under Section 884 of the Code in the hands of a corporate Non-U.S. Shareholder
that is not entitled to treaty relief or exemption. The Company will be required
to withhold from distributions to Non-U.S. Shareholders, and remit to the IRS,
35% of the maximum amount of any distribution that could be designated as a
capital gain dividend. In addition, for purposes of this withholding rule, if
the Company designates prior distributions as capital gain distributions, then
subsequent distributions, up to the amount of such prior distributions, will be
treated as capital gain dividends. The amount of any tax withheld is creditable
against the Non-U.S. Shareholder's federal income tax liability, and any amount
of tax withheld in excess of that tax liability may be refunded provided that an
appropriate claim for refund is filed with the IRS.
Tax treaties may reduce the Company's withholding obligations. Under
certain treaties, however, rates below 30% generally applicable to dividends
from United States corporations may not apply to dividends from a REIT. If the
amount of tax withheld by the Company with respect to a distribution to a
Non-U.S. Shareholder exceeds such shareholder's federal income tax liability
with respect to such distribution, the Non-U.S. Shareholder may file for a
refund of such excess from the IRS. 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 corporate Non-U.S. Shareholders but is higher than
the 20%, 25%, and 28% maximum rates on capital gains generally applicable to
noncorporate Non-U.S. Shareholders. Treasury Regulations issued on October 6,
1997 (the "New Regulations") alter the withholding rules on dividends paid to a
Non-U.S. Shareholder, generally effective with respect to dividends paid after
December 31, 1999. Under the New Regulations, to obtain a reduced rate of
withholding under an income tax treaty, a Non-U.S. Shareholder generally will be
required to provide an Internal Revenue Service Form W-8 certifying such
Non-U.S. Shareholder's entitlement to benefits under the treaty. The New
Regulations also provide special rules to determine whether, for purposes of
determining the applicability of a tax treaty, dividends paid to a Non-U.S.
Shareholder that is an entity should be treated as paid to the entity or to
those holding an interest in that entity, and whether such entity or such
holders in the entity are entitled to benefits under the tax treaty. The New
Regulations also alter the information reporting and backup withholding rules
applicable to Non-U.S. Shareholders and, among other things, provide certain
presumptions under which a Non-U.S. Shareholder is subject to backup withholding
and information reporting until the Company receives certification from such
shareholder of its Non-U.S. Shareholder status.
If the Shares fail to constitute a "United States real property
interest" within the meaning of Section 897 of the Code, gain on sale of the
Shares by a Non-U.S. Shareholder generally will not be subject to federal income
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 such gain.
17
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 the preceding five-year period less
than 50% in value of its shares is held directly or indirectly by foreign
persons. It is believed that the Company has been and will continue to be a
domestically controlled REIT, and therefore that the sale of Shares by a
Non-U.S. Shareholder will not be subject to federal income taxation. However,
because the Shares are publicly traded, no assurance can be given that the
Company has been and will continue to be a domestically controlled REIT. If the
Company is not a domestically controlled REIT, whether a Non-U.S. Shareholder's
gain on sale of Shares would be subject to federal income tax as a sale of a
United States real property interest would depend upon whether the Shares were
"regularly traded" (as defined by applicable Treasury Regulations) on an
established securities market (e.g., the New York Stock Exchange, on which the
Shares are listed) and upon the size of the selling Non-U.S. Shareholder's
interest in the Company. If the gain on the sale of the Shares were subject to
federal income taxation, 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 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, the purchaser of
Shares may be required to withhold 10% of the purchase price paid to the
Non-U.S. Shareholder and to remit such amount to the IRS.
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
will report to its U.S. Shareholders and to the IRS the amount of dividends paid
during each calendar year and the amount of tax withheld, if any. Under the
backup withholding rules, a U.S. Shareholder may be subject to backup
withholding at the rate of 31% with respect to dividends paid unless the U.S.
Shareholder (a) is a corporation or comes within certain other exempt categories
and, when required, demonstrates that fact or (b) provides a taxpayer
identification number, certifies as to no loss of exemption from backup
withholding rules and otherwise complies with applicable requirements of the
backup withholding rules. A U.S. Shareholder that does not provide the Company
with its correct taxpayer identification number may be subject to penalties
imposed by the IRS. In addition, the Company may be required to withhold a
portion of capital gain distributions to any U.S. Shareholder that fails to
certify its non-foreign status to the Company. Any amounts withheld under the
foregoing rules will be creditable against the U.S. Shareholder's federal income
tax liability provided that the required information is furnished to the IRS.
The Company will report to its Non-U.S. Shareholders and to the IRS
the amount of dividends paid during each calendar year and the amount of tax
withheld, if any. 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. As discussed above,
withholding tax rates of 30% and 35% may apply to distributions on Shares to
Non-U.S. Shareholders, and the New Regulations will when effective alter the
information reporting and withholding rules applicable to Non-U.S. Shareholders.
Among other things, the New Regulations provide certain presumptions under which
a Non-U.S. Shareholder would be subject to backup withholding and information
reporting until the Company receives certification from such shareholder of its
Non-U.S. Shareholder status. As noted, the New Regulations are generally
effective with respect to dividends paid after December 31, 1999.
The payment of the proceeds from the disposition of Shares to or
through the United States office of a broker will generally 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-United States 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-United States office of a United States broker or paid to or
through a non-United States office of a non-United States broker that is (i) a
"controlled foreign corporation" for 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
18
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 beneficial owner is a
Non-U.S. Shareholder unless the broker has actual knowledge to the contrary.
Under the New Regulations (generally effective for payments made after December
31, 1999), in the case of proceeds from a disposition of Shares paid to or
though a non-United States office of a United States broker or paid to or
through a non-United States office of a non-United States broker that is (i) a
"controlled foreign corporation" for federal income tax purposes, (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, (iii) a
foreign partnership with one or more partners who are United States persons and
who in the aggregate hold more than 50% of the income or capital interest in the
partnership, or (iv) a foreign partnership engaged in the conduct of a trade or
business in the United States, (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 Non-U.S. Shareholder certifies
its status as a Non-U.S. Shareholder and further certifies that it has not been,
and at the time the certificate is furnished reasonably expects not to be,
present in the United States for a period aggregating 183 days or more during
each calendar year to which the certification pertains.
Any amounts withheld from a payment to a Non-U.S. Shareholder will
generally be refunded (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 IRS.
Other Tax Considerations. Holders of Shares should recognize that the
present federal income tax treatment of the Company may be modified by future
legislative, judicial, or administrative actions at any time, which may be
retroactive in effect, and, as a result, any such action or decision 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 IRS and the Treasury Department, resulting in
statutory changes as well as promulgation of new regulations, revisions to
existing regulations, and revised interpretations of established concepts. No
prediction can be made as to the likelihood of passage of any new tax
legislation or other provisions either directly or indirectly affecting the
Company or its shareholders. Revisions in federal income tax laws and
interpretations thereof could adversely affect the tax consequences of
investment in the Shares.
The Company and its shareholders may also be subject to state or local
taxation in various state or local 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, holders should consult their own tax
advisors regarding the effect of state and local tax laws on an investment in
the Shares.
THE FOREGOING IS A SUMMARY DESCRIPTION OF CERTAIN MATERIAL FEDERAL
INCOME TAX CONSEQUENCES OF THE TAXATION OF THE COMPANY AND ITS SHAREHOLDERS,
WITHOUT CONSIDERATION OF THE PARTICULAR FACTS AND CIRCUMSTANCES OF ANY
PARTICULAR SHAREHOLDER. IN PARTICULAR, IT DOES NOT ADDRESS THE STATE, LOCAL OR
FOREIGN TAX ASPECTS OF THE TAXATION OF THE COMPANY AND ITS SHAREHOLDERS. THE
DISCUSSION IS BASED ON CURRENTLY EXISTING PROVISIONS OF THE CODE, EXISTING AND
PROPOSED TREASURY REGULATIONS THEREUNDER AND CURRENT ADMINISTRATIVE RULINGS AND
COURT DECISIONS. ALL OF THE FOREGOING ARE SUBJECT TO CHANGE AND ANY SUCH CHANGE
COULD AFFECT THE CONTINUING VALIDITY OF THE DISCUSSION. THE COMPANY AND ITS
SHAREHOLDERS MAY ALSO BE SUBJECT TO STATE OR LOCAL TAXATION IN VARIOUS STATE OR
LOCAL JURISDICTIONS, INCLUDING THOSE IN WHICH IT OR THEY TRANSACT BUSINESS OR
RESIDE. EACH HOLDER OF SHARES OF THE COMPANY SHOULD CONSULT HIS OR HER OWN TAX
ADVISOR AS TO THE SPECIFIC TAX CONSEQUENCES OF THE TAXATION OF THE COMPANY AND
ITS SHAREHOLDERS, INCLUDING THE APPLICATION AND EFFECT OF FEDERAL, STATE, LOCAL
AND FOREIGN TAX LAWS.
ERISA PLANS, KEOGH PLANS AND INDIVIDUAL RETIREMENT ACCOUNTS
19
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 ("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"). 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
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, or sold pursuant to an
effective registration statement under the Securities Act of 1933 (provided the
securities are registered under the Securities Exchange Act of 1934 within 120
days after the end of the fiscal year of the issuer during which the offering
occurred). The Shares have been registered under the Securities Exchange Act of
1934.
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
20
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
Declaration 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 of 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 Declaration 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
ERISA for investments made by the Company which do not conform to such ERISA
standards unless the Advisor 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 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 the
Company or any of the Hotels for which it might become liable.
Item 4. Submission of Matters to a Vote of Security Holders
None.
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.
21
1995 High Low
---- ---- ---
August 22 to September 30 $ 27 $ 24 1/2
Fourth Quarter 26 3/4 24 3/8
1996 High Low
---- ---- ---
First Quarter $ 27 7/8 $ 25 1/2
Second Quarter 27 24 5/8
Third Quarter 26 7/8 25
Fourth Quarter 29 1/2 25
1997 High Low
---- ---- ---
First Quarter $ 33 $ 28 3/8
Second Quarter 32 1/8 29 3/8
Third Quarter 35 15/16 30 7/16
Fourth Quarter 38 5/16 33 1/16
The closing price of the Shares on the New York Stock Exchange on March
11, 1998, was $35.00 per Share.
As of March 6, 1998, there were 1,007 Shareholders of record and the
Company estimates that as of such date there was an excess of 75,000 beneficial
owners of the Shares.
Information about the Company's dividends paid is summarized in the
table below. Dividends are generally paid in the quarter following the quarter
to which they relate.
Dividend Annualized
Per Share Dividend Rate
--------- -------------
1995
----
Third Quarter $0.24 $2.20
Fourth Quarter 0.55 2.20
1996
----
First Quarter $0.58 $2.32
Second Quarter 0.58 2.32
Third Quarter 0.59 2.36
Fourth Quarter 0.59 2.36
1997
----
First Quarter $0.59 $2.36
Second Quarter 0.61 2.44
Third Quarter 0.62 2.48
Fourth Quarter 0.63 2.52
All dividends declared have been paid. The Company intends to continue to
declare and pay future dividends on a quarterly basis.
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
22
deems relevant. The Company intends to distribute substantially all of its "real
estate investment trust taxable income" to its shareholders.
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 years ended December
31, 1997, 1996 and 1995. The pro forma data for 1995 is unaudited and presented
as if the Company's formation transactions, primarily the acquisition and
leasing of the 37 hotels acquired in 1995, the Company's initial public offering
of Shares, and certain other transactions described below had been consummated
as of the date or for the period presented. The pro forma data is 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.
Historical Historical Historical Pro Forma
---------------------------------------------------------------------------------
February 7, 1995
Year Ended Year Ended (Inception) to Year Ended
December 31, 1997 December 31, 1996 December 31, 1995 (1) December 31, 1995
(In thousands, except per Share data)
Operating Data:
Revenues:
Rental income $ 98,561 $ 69,514 $ 19,531 $ 33,308
FF&E reserve income 14,643 12,169 4,037 6,424
Interest income 928 946 74 144
---------- ---------- ---------- ----------
Total revenues 114,132 82,629 23,642 39,876
Expenses:
Interest 15,534 5,646 5,063 --
Depreciation and amortization 31,949 20,398 5,820 9,229
General and administrative 7,496 4,921 1,410 2,616
---------- ---------- ---------- ----------
Total expenses 54,979 30,965 12,293 11,845
---------- ---------- ---------- ----------
Net income $ 59,153 $ 51,664 $ 11,349 $ 28,031
========== ========== ========== ==========
Per Share Data:
Net income per Share $ 2.15 $ 2.23 $ 2.51 $ 2.22
Weighted average Shares outstanding 27,530 23,170 4,515 12,601
Balance Sheet Data (as of December 31):
Real estate properties, net $1,207,868 $ 816,469 $ 326,752 $ 326,752
Total assets 1,313,256 871,603 338,947 338,947
Total debt 125,000 125,000 -- --
Shareholders' equity 1,007,893 645,208 297,951 297,951
- ---------
<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. The Company 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.
</FN>
23
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 its first 21 hotels. The Company completed its
initial public offering of shares and acquired an additional 16 hotels on August
22, 1995. Because the Company did not operate for the entire year 1995, the
Company believes it is meaningful to an understanding of its operations to
discuss the Company's 1995 pro forma results of operations as well as its
historical results of operations.
The following discussion should be read in conjunction with the financial
statements and the notes thereto included elsewhere herein. Pro forma results
and percentage relationships set forth herein may not be indicative of the
future operations of the Company.
Historical and Pro Forma Results of Operations
Year Ended December 31, 1997 versus Year Ended December 31, 1996
The Company's assets increased to $1,313 million as of December 31, 1997 from
$872 million as of December 31, 1996. The increase resulted primarily from hotel
acquisitions completed in 1997.
In January 1997 the Company purchased a full service hotel in Salt Lake City,
Utah for $44.0 million. In March 1997 the Company agreed to acquire 10 Residence
Inn by Marriott(R) hotels (1,276 suites) and four Courtyard by Marriott(R)
hotels (543 rooms) for $149 million and acquired all these properties in 1997
after they opened. In September 1997 the Company agreed to acquire from Marriott
six Courtyard by Marriott(R) hotels (829 rooms) and three Residence Inn by
Marriott(R)) hotels (507 suites) for $129 million. As of March 11, 1998, four of
these hotels have been acquired; the remaining five are expected to be acquired
periodically during the remainder of 1998. In November 1997 the Company acquired
14 Sumner Suites(R) hotels (1,641 suites) for $140 million. In November 1997 the
Company agreed to acquire 15 Candlewood(R) hotels for $100 million. Five of
these 15 Candlewood(R) hotels were acquired in 1997. An additional nine
properties were acquired in January and March 1998. The remaining hotel is
expected to be acquired during 1998. These acquisitions were funded through the
use of cash on hand, borrowings on the Company's line of credit, and the net
proceeds from the offering of 12,000,000 common shares of beneficial interest
("Shares") in December 1997.
Total revenues in 1997 were $114.1 million versus 1996 revenues of $82.6
million. Total revenues were comprised principally of base and percentage rent
of $98.6 million and FF&E reserve income of $14.6 million in 1997 versus $69.5
million and $12.2 million, respectively, in the 1996 period. The Company's
results are reflective of the full year impact of 45 hotels acquired in 1996 and
the impact of the 1997 completion of 37 of the 53 hotel acquisitions announced
in 1997. During 1997 the Company earned percentage rent revenue of $2.5 million
($0.09/Share) versus $1.1 million ($0.05/Share) in 1996, as a result of
increases in gross hotel revenues at the Company's hotels.
Total expenses in 1997 were $55.0 million (including interest expense and
depreciation and amortization of real estate assets of $15.5 and $31.9 million,
respectively) versus 1996 expenses of $31.0 million (including interest expense
and depreciation and amortization of $5.6 million and $20.4 million,
respectively). A portion of the hotels purchased in 1997 were temporarily
financed with proceeds from the Company's line of credit which was ultimately
repaid with the proceeds of the Company's 12,000,000 Share offering in December
1997. These line of credit proceeds, plus the amounts outstanding on certain
prepayable mortgage notes issued by a subsidiary of the Company, gave rise to
interest expense of $15.5 million in 1997 versus $5.6 million in 1996 when
amounts outstanding under the Company's line of credit were smaller, were
outstanding for shorter periods and during which the Company's mortgage notes
were not in place for the entire period. The substantial increase in the number
of hotels owned by the Company has also proportionately increased the Company's
general expense levels, including depreciation and general and administrative
expenses. The Company incurred $713,000 of costs in 1997 in connection with a
terminated acquisition attempt.
24
Net income in 1997 was $59.2 million ($2.15/Share) and cash available for
distribution ("CAD") was $79.3 million ($2.88/Share) versus $51.7 million ($2.23
per Share) and CAD of $60.8 million ($2.62/Share). Growth in net income and CAD
is primarily related to the effects of acquisitions in 1996 and 1997.
Cash flow provided by (used for) operating, investing and financing activities
was $81.2 million, ($347.3 million) and $309.7 million, respectively, for the
year ended December 31, 1997.
Year Ended December 31, 1996 versus Pro Forma Year Ended December 31, 1995
The Company's assets increased to $871.6 million as of December 31, 1996 from
$338.9 million at December 31, 1995. The increase primarily resulted from three
hotel portfolio acquisitions completed during 1996. In March and April of 1996,
the Company acquired 16 Courtyard by Marriott(R) hotels for $176.4 million and
18 Residence Inn(R) by Marriott hotels for $172.2 million. In May 1996, the
Company acquired 11 Wyndham Garden(R) hotels for $135.3 million. These
acquisitions were funded through the use of cash on hand, borrowings on the
Company's line of credit, and the net proceeds from the offering of 14,250,000
Shares in April 1996.
Total revenues in 1996 were $82.6 million versus pro forma 1995 revenue of $39.9
million. Total revenues were comprised principally of base and percentage rent
of $69.5 million and FF&E reserve income of $12.2 million in 1996 versus $33.3
million and $6.4 million, respectively, in the pro forma period. The Company's
results of operations in 1996 are reflective of the growth in the number of
owned hotels to 82, from 37 at year end 1995. The leases for the Company's 82
hotels at December 31, 1996 call for base rent of $81.3 million annually, versus
$32.9 million for the 37 hotels owned at December 31, 1995. During 1996, the
Company earned revenue of approximately $1.1 million ($0.05/Share) in percentage
rents from its portfolio of 53 Courtyard hotels, reflective of continued
increases in Total Hotel Sales at these properties.
Total expenses in 1996 were $31.0 million, including interest expense and
depreciation and amortization of $5.6 million and $20.4 million, respectively,
versus pro forma 1995 expenses of $11.8 million, including depreciation and
amortization of $9.2 million. A portion of the hotels purchased in 1996 were
financed with proceeds from the Company's line of credit which was ultimately
repaid with prepayable floating rate mortgages. Such debt financing in 1996 gave
rise to the $5.6 million of interest expense referred to above, versus zero for
pro forma 1995, when the Company did not use third-party debt. The substantial
increase in the number of hotels owned by the Company has also proportionately
increased the Company's general expense levels, including depreciation and
amortization and general and administrative expenses.
Net income in 1996 was $51.7 million ($2.23 per Share) and CAD for the period
was $60.8 million ($2.62 per Share), based in both cases on average outstanding
Shares for the period of 23,170,000. This compares with pro forma 1995 net
income of $28.0 million ($2.22 per Share) and CAD of $30.8 million ($2.45 per
Share), based in both cases upon 12,600,900 outstanding Shares. This 7% growth
in CAD is primarily related to the effects of the Company's 1996 hotel
acquisitions and related financing activity as well as growth in percentage rent
to $1.1 million in 1996 from $0.4 million in the 1995 pro forma period. During
April 1996, the Company completed an offering of 14,250,000 Shares raising net
proceeds of approximately $358 million to fund its acquisitions and more than
doubling its equity capitalization and shares outstanding.
Cash flow provided by (used for) operating, investing and financing activities
was $61.7 million, ($448.7 million) and $422.9 million, respectively, for the
year ended December 31, 1996.
February 7, 1995 (Inception) Through December 31, 1995
Total revenues from 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 CAD 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.
25
From Inception until completion of its initial public offering on August 22,
1995, the Company was a 100% owned subsidiary of Health and Retirement
Properties Trust ("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
was $14.1 million, ($303.7 million) and $291.6 million, respectively, for the
year ended December 31, 1996.
Pro Forma Year Ended December 31, 1995
The pro forma results of operations assume that the Company's formation
transactions, the initial public offering of Shares and the acquisition and
leasing of the 37 hotels and related transactions all occurred on January 1,
1995. 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 and administrative
expenses of $2.6 million). Net income would have been $28.0 million or $2.22 per
Share, and CAD 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, interest and day to
day operations is the base and percentage rent it receives. Base rent is paid
monthly in advance and percentage rent is paid either monthly or quarterly in
arrears. This flow of funds from rent has historically been sufficient for the
Company to pay dividends, interest and meet day to day operating expenses. The
Company believes that its operating cash flow will be sufficient to meet its
operating expenses, interest and dividend payments.
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 with DLJ Mortgage Capital, Inc. ("DLJMC"). The line of credit (the
"DLJMC Line of Credit") is for up to $200 million, all of which was available at
December 31, 1997. During 1997 the Company expanded its credit facilities with
DLJMC temporarily to provide up to $455 million. Drawings under the DLJMC 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 DLJMC Line of Credit matures on December
31, 1998. Interest on borrowings under the DLJMC Line of Credit are payable
until maturity at a spread above LIBOR; and interest during the extended term,
if any, will be set at market rates at the time the loan is extended.
During 1996, subsidiaries of the Company issued $125 million of mortgage notes
(the "Secured Notes") secured by such subsidiaries' assets, including 18
Residence Inn by Marriott(R) and 11 Wyndham Garden(R) hotels. The mortgage loan
was financed by the issuance of $125 million commercial mortgage pass-through
certificates through a trust created by another of the Company's subsidiaries.
The certificates were sold in a Rule 144A private placement to institutional
investors. The Secured Notes carried interest that floated with one-month LIBOR
plus a spread and were due December 1, 2001, but could be prepaid by the Company
at any time without penalty. In connection with this issuance of the Secured
Notes, the Company entered into interest rate cap agreements for $125 million
(notional amount) with a major financial institution which limit the Company's
maximum interest rate exposure to 7.6925% on this debt. On March 2, 1998, the
Secured Notes were prepaid in full.
The Company expects to use existing cash balances, borrowings under the DLJMC
Line of Credit or other lines of credit and/or net proceeds of offerings of
equity or debt securities to fund future hotel acquisitions. To the extent the
Company borrows on a line of credit, the Company will explore various
alternatives in both the timing and method of repayment of such amounts. Such
alternatives may include incurring long term debt. On January 15, 1997, the
Company's shelf registration statement for up to $2 billion of securities,
including debt securities, was declared effective by the Securities and Exchange
Commission (the "SEC"). An effective shelf registration statement enables the
26
Company to issue specific securities to the public on an expedited basis by
filing a prospectus supplement with the SEC.
In February 1998 the Company issued $150 million of 7.0% senior unsecured notes
due 2008. Net proceeds to the Company of approximately $148 million were used
for general business purposes and, on March 2, 1998 to repay the Secured Notes
in full.
Also in February 1998 the Company issued an aggregate 2,146,571 Shares in
connection with three separate unit investment trust arrangements established by
investment banks. These Shares were sold at market prices less an underwriting
discount. The aggregate net proceeds of these Shares offerings ($71.1 million)
will be used for the acquisition of additional hotels and for general business
purposes.
At March 11, 1998 the Company had total commitments to purchase property of
$88.7 million. Also at March 11, 1998 the Company had cash and cash equivalents
of approximately $110 million.
The Company is in the process of negotiating with a commercial bank for an
unsecured revolving credit facility. The Company expects to conclude
negotiations and documentation during the first half of 1998, enter into a new
unsecured revolving line of credit and terminate the DLJMC Line of Credit. No
assurance can be given that a new credit facility will be available to the
Company on acceptable terms.
Although there can be no assurance that the Company will consummate any debt or
equity security offerings or other financings, the Company believes it will have
access to various types of financing in the future, including debt or equity
securities offerings, with which to finance future acquisitions.
Recent Developments
On March 19, 1998 the Company closed a new unsecured revolving credit facility
of $250 million, arranged and fully underwritten by a commercial bank. The
facility has a 4 year term and bears interest at LIBOR plus a spread based on
the Company's senior debt ratings. The facility contains financial covenants
requiring the Company to, among other things, maintain a debt to Asset Value (as
defined) of no more than 50% and meet certain debt service coverage ratios (as
defined).
On March 20, 1998 the Company completed a $240 million acquisition of 15
Summerfield Suites(R) hotels, containing 1,822 suites (2,766 rooms). These
hotels are leased to the seller under a lease with an initial term through 2015
and four renewal terms of 12 years each. The lease requires base rent of $25
million annually and additional rent equal to a percentage of gross revenue
increases beginning in 1999. The acquisition was funded with a $125 million
borrowing under the Company's unsecured credit line discussed above and cash on
hand.
Seasonality
The Company's 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 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 provide for the payment of percentage rent to the Company based
on increases in total sales, and such rent should increase with inflation.
27
Certain Considerations
The discussion and analysis of the Company's financial condition and results of
operations requires the Company to make certain estimates and assumptions and
contains certain statements of the Company's beliefs, intent or expectation
concerning projections, plans, future events and performance. The estimates,
assumptions and statements, such as those relating to the Company's ability to
expand its portfolio, performance of its assets, the ability to pay dividends,
its tax status as a "real estate investment trust," the ability to appropriately
balance the use of debt and equity and to access capital markets, depend upon
various factors over which the Company and/or the Company's lessees have or may
have limited or no control. Those factors include, without limitation, the
status of the economy, capital markets (including prevailing interest rates),
compliance with the changes to regulations within the hospitality industry,
competition, changes to federal, state and local legislation and other factors.
The Company cannot predict the impact of these factors, if any. However, these
factors could cause the Company's actual results for subsequent periods to be
different from those stated, estimated or assumed in this discussion and
analysis of the Company's financial condition and results of operations. The
Company believes that its estimates and assumptions are reasonable and prudent
at this time.
Item 8. Financial Statements and Supplementary Data
The information required by this item is incorporated herein by reference
to the consolidated financial statements and schedule of Hospitality Properties
Trust included in Item 7 of the Company's Current Report on Form 8-K dated
February 11, 1998. The financial statements for HMH HPT Courtyard, Inc., a
significant lessee as of January 3, 1997 and January 2, 1998 and for the two
fiscal years ended January 2, 1998 and the period from March 24, 1995
(inception) to December 29, 1995, begin on Page F-1.
Item 9. Changes in and Disagreements with Accountants 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.
28
PART IV
Item 14. Exhibits, Financial Statements, Schedule and Reports on Form 8-K.
(a) Index to Financial Statements and Financial Statement Schedules
The following financial statements HMH HPT Courtyard, Inc. a significant lessee
of Company assets are included herein on the pages indicated.
Page
Report of Independent Public Accountants......................................... F-1
Balance Sheet as of January 3, 1997 and January 2, 1998.......................... F-2
Statement of Income for the period from inception through December 29, 1995
and the fiscal years ended January 3, 1997 and January 2, 1998................... F-3
Statement of Shareholder's Equity for the period from inception to December
29, 1995 and the fiscal years ended January 3, 1997 and January 2, 1998.......... F-4
Statement of Cash Flows for the period from inception
to December 29, 1995 and the fiscal years ended January 3, 1997 and
January 2, 1998.................................................................. F-5
Notes to Financial Statements.................................................... F-6
The following consolidated financial statements and schedule of Hospitality
Properties Trust are incorporated herein by reference to the Company's Current
Report on Form 8-K dated February 11, 1998, page references are to such Current
Report:
Report of Independent Public Accountants......................................... F-2
Consolidated Balance Sheet as of December 31, 1997 and December 31, 1996......... F-3
Consolidated Statement of Income for the years ended December 31, 1997 and
1996 and the period February 7, 1995 (inception) to December 31, 1995............ F-4
Consolidated Statement of Shareholders' Equity for the years ended
December 31, 1997 and 1996 and the period February 7, 1995 (inception) to
December 31, 1995................................................................ F-5
Consolidated Statement of Cash Flows for the for the years ended
December 31, 1997 and 1996 and the period February 7, 1995 (inception) to
December 31, 1995................................................................ F-6
Notes to Consolidated Financial Statements....................................... F-7
Report of Independent Public Accountants on Schedule III......................... F-11
Schedule III - Real Estate and Accumulated Depreciation.......................... F-12
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.
29
Exhibits:
3.1 Conformed Amended and Restated Declaration of Trust dated August 21,
1995 (Filed herewith)
3.2 Conformed Amendment dated June 2, 1997 (Filed herewith)
3.3 Conformed Articles Supplementary dated June 2, 1997 (Filed herewith)
3.4 Bylaws of the Registrant (Incorporated by reference to the Company's
Registration Statement on Form S-11 (File No. 33-92330))
4.1 Form of Share Certificate (Incorporated by reference to the Company's
Registration Statement on Form S-11 (File No. 33-92330))
4.2 Rights Agreement, dated as of May 20, 1997, between Hospitality
Properties Trust and State Street Bank and Trust Company, as Rights
Agent (including the form of Rights Certificate and the form of
Articles Supplementary designating the Junior Participating Preferred
Shares) (Incorporated by reference to the Company's Current Report on
Form 8-K dated May 20, 1997)
4.3 Indenture dated as of February 25, 1998, between the Company and State
Street Bank and Trust Company (Filed herewith)
4.4 Supplemental Indenture No. 1 dated as of February 25, 1998, between the
Company and State Street Bank and Trust Company (Filed herewith)
8.1 Opinion of Sullivan & Worcester LLP as to certain tax matters (Filed
herewith)
10.1 Advisory Agreement(+) (Incorporated by reference to the Company's
Registration Statement on Form S-11 (File No. 33-92330))
10.2 Advisory Agreement by and between REIT Management & Research, Inc. and
Hospitality Properties Trust dated January 1, 1998 (+) (Incorporated by
reference to the Company's Current Report on Form 8-K dated February
11, 1998)
10.3 Hospitality Properties Trust 1995 Incentive Share Award Plan(+)
(Incorporated by reference to the Company's Registration Statement on
Form S-11 (File No. 33-92330))
10.4 Form of Revolving Credit Agreement by and between the Company and DLJ
Mortgage Capital, Inc., as amended and restated on December 29, 1995,
as further amended by Amendment No. 1, dated February 26, 1996
(Incorporated by reference to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1996)
10.5 Amendment, dated November 25, 1996 to the Revolving Credit Agreement,
amended and restated on December 29, 1995, by and between the Company
and DLJ Mortgage Capital, Inc. 1996 (Incorporated by reference to the
Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1996)
10.6 Amendment No. 3, dated November 14, 1997, to the Amended and Restated
Credit Agreement, dated as of December 29, 1995, as amended, between
the Company and DLJ Mortgage Capital, Inc. (Incorporated by reference
to the Company's Current Report on Form 8-K dated November 21, 1997)
10.7 First Supplemental Credit Agreement, dated as of November 14, 1997,
between the Company, as borrower, and DLJ Mortgage Capital, Inc. as
lender (Incorporated by reference to the Company's Current Report on
Form 8-K dated November 21, 1997)
10.8 Second Supplemental Credit Agreement, dated as of November 14, 1997,
between the Company, as borrower, and DLJ Mortgage Capital, Inc., as
lender (Incorporated by reference to the Company's Current Report on
Form 8-K dated November 21, 1997)
10.9 Promissory Note in the amount of $125,000,000 dated as of November 25,
1996 from HPTRI Corporation and HPTWN Corporation to Column Financial
Inc. (Incorporated by reference to the Company's Current Report on Form
8-K dated December 4, 1996)
10.10 Loan Agreement dated as of November 25, 1996 by and between HPTRI
Corporation and HPTWN Corporation, as borrowers, and Column Financial
Inc., as lender. (Incorporated by reference to the Company's Current
Report on Form 8-K dated December 4, 1996)
10.11 Form of Deed of Trust, Assignment of Leases and Rents and Security
Agreement from HPTRI Corporation, as Trustor, to Chicago Title
Insurance Company, as Trustee, for benefit of Column Financial, Inc.
(Incorporated by reference to the Company's Current Report on Form 8-K
dated December 4, 1996)
30
10.12 Trust and Servicing agreement dated as of November 25, 1996 by and
among Hospitality Properties Mortgage Acceptance Corp., as Depositor,
AMRESCO Management, Inc., as Servicer, and The Chase Manhattan Bank, as
Trustee (Incorporated by reference to the Company's Current Report on
Form 8-K dated December 4, 1996)
10.13 Revolving Credit Agreement, dated as of March 19, 1998, among the
Company, as borrower, the institutions party thereto from time to time
as lenders, and Dresdner Bank AG, New York Branch and Grand Cayman
Branch, as Agent (Filed herewith)
10.14 Investment Manager's Subordination Agreement, dated as of March 19,
1998, among REIT Management & Research, Inc., the Company and Dresdner
Bank AG, New York Branch and Grand Cayman Branch (Filed herewith)
10.15 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 (Incorporated by reference to
the Company's Registration Statement on Form S-11 (File No. 33-92330))
10.16 Fifth Amendment to Purchase-Sale and Option Agreement dated February
26, 1996, by and between IIIT and IIMII Properties, Inc. (Incorporated
by reference to the Company's Registration Statement on Form S-11 (File
No. 333-1433))
10.17 Form of Courtyard Management Agreement between HMH Courtyard
Properties, Inc., d/b/a HMH Properties, Inc. and Courtyard Management
Corporation (Incorporated by reference to the Company's Registration
Statement on Form S-11 (File No. 33-92330))
10.18 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. (Incorporated by reference
to the Company's Registration Statement on Form S-11 (File No.
33-92330))
10.19 Form of Lease Agreement between Hospitality Properties, Inc. and HMH
HPT Courtyard, Inc. (Incorporated by reference to the Company's
Registration Statement on Form S-11 (File No. 33-92330))
10.20 Form of Lease Agreement between HMH HPT Residence Inn, Inc. and
Hospitality Properties Trust (Incorporated by reference to the
Company's Registration Statement on Form S-11 (File No. 333-1433))
10.21 Form of Residence Inn Management Agreement between HMH Properties, Inc.
and Residence Inn by Marriott(R), Inc. (Incorporated by reference to
the Company's Registration Statement on Form S-11 (File No. 333-1433))
10.22 Lease Agreement by and between HPTSLC Corporation, as landlord, and
WIIC Salt Lake Corporation, as tenant, dated January 1996
(Incorporated by reference to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1996)
10.23 Purchase and Sale Agreement by and among Residence Inn by Marriott,
Inc. and Courtyard Management Corporation, as sellers, and Hospitality
Properties Trust, as purchaser, dated April 3, 1997 (Incorporated by
reference to the Company's Current Report on Form 8-K dated April 3,
1997)
10.24 Form of Courtyard Lease Agreement by and between HPTMI Corporation and
CR14 Corporation (Incorporated by reference to the Company's Current
Report on Form 8-K dated April 3, 1997)
10.25 Form of Residence Inn Lease Agreement by and between HPTMI Corporation
and CR14 Corporation (Incorporated by reference to the Company's
Current Report on Form 8-K dated April 3, 1997)
10.26 Limited Rent Guaranty, dated April 3, 1997, by and among Marriott
International, Inc., as guarantor, and Hospitality Properties Trust and
HPTMI Corporation, as landlord (Incorporated by reference to the
Company's Current Report on Form 8-K dated April 3, 1997)
10.27 Purchase and Sale Agreement, dated November 19, 1997, by and among
Candlewood Hotel Company, Inc. and certain of its affiliates, as
sellers, and the Company, as purchaser (Incorporated by reference to
the Company's Current Report on Form 8-K dated November 21, 1997)
10.28 Form of Candlewood Lease Agreement by and between a subsidiary of the
Company, as landlord, and Candlewood Leasing No. 1 Inc., as tenant
(Incorporated by reference to the Company's Current Report on Form 8-K
dated November 21, 1997)
31
10.29 Form of Guaranty Agreement by and among Candlewood Hotel Company, Inc.,
a subsidiary of the Company and the Company (Incorporated by reference
to the Company's Current Report on Form 8-K dated November 21, 1997)
10.30 Purchase and Sale Agreement, dated as of October 24, 1997, by and among
ShoLodge, Inc. and certain of its affiliates, as sellers, and the
Company, as purchaser (Incorporated by reference to the Company's
Current Report on Form 8-K dated November 21, 1997)
10.31 Lease Agreement, dated as of November 19, 1997, by and between HPT
Suite Properties Trust, as landlord, and Suite Tenant, Inc., as tenant
(Incorporated by reference to the Company's Current Report on Form 8-K
dated November 21, 1997)
10.32 Limited Guaranty Agreement, dated as of November 19, 1997, by and among
Sholodge, Inc., HPT Suite Properties Trust and the Company
(Incorporated by reference to the Company's Current Report on Form 8-K
dated November 21, 1997)
10.33 Purchase Agreement, dated as of October 10, 1997, by and among
Residence Inn by Marriott, Inc. and Courtyard management Corporation,
as sellers, and the Company, as purchaser (Incorporated by reference to
the Company's Current Report on Form 8-K dated November 21, 1997)
10.34 Form of Residence Inn Lease Agreement by and between HPTMI II
Properties Trust and CR9 Tenant Corporation (Incorporated by reference
to the Company's Current Report on Form 8-K dated November 21, 1997)
10.35 Form of Courtyard Lease Agreement by and Between HPTMI II Properties
Trust and CR9 Tenant Corporation (Incorporated by reference to the
Company's Current Report on Form 8-K dated November 21, 1997)
10.36 Limited Rent Guaranty, dated as of October 10, 1997, by and among
Marriott International, Inc., the Company and HPTMI II Properties Trust
(Incorporated by reference to the Company's Current Report on Form 8-K
dated November 21, 1997)
10.37 Agreement of Purchase and Sale, dated as of March 18, 1998, between
Patriot American Hospitality Partnership, L.P. and Chatsworth
Summerfield Associates, L.P. (Filed herewith)
10.38 Assignment of Rights under Agreements of Purchase and Sale, dated as of
March 18, 1998, by Patriot American Hospitality Partnership, L.P. to
and for the benefit of HPTSHC Properties Trust (Filed herewith)
10.39 Agreement to Lease dated as of March 20, 1998 by and between HPTSHC
Properties Trust and Summerfield HPT Lease Company, L.P. (Filed
herewith)
12 Ratio of Earnings to Fixed Charges (Filed herewith)
21 Subsidiaries of the Registrant (Filed herewith)
23.1 Consents of Arthur Andersen LLP (Filed herewith)
23.2 Consent of Sullivan & Worcester LLP (included in Exhibit 8.1 to this
Annual Report)
99 The Company's Current Report on Form 8-K dated February 11, 1998 (Filed
herewith)
- ------------------
(+) Management contract or compensatory plan or agreement.
(b) During the fourth quarter of 1997, the Company filed the
following Current Reports on Form 8-K:
(i) Current Report on Form 8-K dated November 11, 1997
relating to an agreement to acquire fifteen hotels
(Items 5 and 7)
(ii) Current Report on Form 8-K dated December 12, 1997
relating to (a) certain financial statements, (b) an
underwriting agreement and (c) an opinion of counsel
relating to certain tax matters (Item 7)
32
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To HMH HPT Courtyard, Inc.:
We have audited the accompanying balance sheets of HMH HPT Courtyard,
Inc. (the "Company") as of January 2, 1998 and January 3, 1997, and the related
statements of operations, shareholder's equity and cash flows for the fiscal
years ended January 2, 1998 and January 3, 1997 and for the period March 24,
1995 (inception) through December 29, 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 audits.
We conducted our audits 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 audits provide 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 the Company, as of
January 2, 1998 and January 3, 1997, and the results of its operations and its
cash flows for the fiscal years ended January 2, 1998 and January 3, 1997 and
for the period March 24, 1995 (inception) through December 29, 1995, in
conformity with generally accepted accounting principles.
Arthur Andersen LLP
Washington, D.C.
February 27, 1998
F-1
HMH HPT COURTYARD, INC.
BALANCE SHEETS
January 2, 1998 and January 3, 1997
(in thousands, except share data)
1997 1996
---- ----
ASSETS
Advances to manager $ 5,100 $ 5,100
Due from Marriott International, Inc. 3,233 3,481
Security deposit 50,540 50,540
-------- --------
Total assets $ 58,873 $ 59,121
======== ========
LIABILITIES AND SHAREHOLDER'S EQUITY
Due to Host Marriott Corporation $ 5,888 $ 4,793
Deferred gain 36,670 39,570
-------- --------
Total liabilities 42,558 44,363
-------- --------
Shareholder's equity
Common stock, no par value 100 shares authorized, issued and outstanding -- --
Additional paid-in capital 15,295 15,478
Retained earnings (deficit) 1,020 (720)
-------- --------
Total shareholder's equity 16,315 14,758
-------- --------
$ 58,873 $ 59,121
======== ========
See Notes to Financial Statements.
F-2
HMH HPT COURTYARD, INC.
STATEMENTS OF OPERATIONS
For the Fiscal Years Ended January 2, 1998
and January 3, 1997 and for the Period from March
24, 1995 (inception) through December 29, 1995
(in thousands)
Period from March 24, 1995
(inception)
Fiscal Year through December 29, 1995
---------------------- -------------------------
1997 1996
---- ----
REVENUES $ 108,416 $ 94,161 $ 37,813
--------- --------- ---------
EXPENSES:
Rent 52,335 46,495 19,379
FF&E contribution expense 10,595 9,289 3,810
Base and incentive management fees paid to Marriott
International, Inc. 23,323 18,318 5,156
Property taxes 7,491 6,287 2,597
Other expenses 4,583 3,390 3,262
--------- --------- ---------
Total operating expenses 98,327 83,779 34,204
--------- --------- ---------
OPERATING PROFIT BEFORE AMORTIZATION OF
DEFERRED GAIN AND CORPORATE EXPENSES 10,089 10,382 3,609
Amortization of deferred gain 2,900 2,351 675
Corporate expenses (1,991) (2,235) (1,059)
--------- --------- ---------
INCOME BEFORE INCOME TAXES 10,998 10,498 3,225
Provision for income taxes (4,400) (4,199) (1,322)
--------- --------- ---------
NET INCOME $ 6,598 $ 6,299 $ 1,903
========= ========= =========
See Notes to Financial Statements.
F-3
HMH HPT COURTYARD, INC.
STATEMENTS OF SHAREHOLDER'S EQUITY
For the Fiscal Years Ended January 2, 1998
and January 3, 1997 and for the Period from March
24, 1995 (inception) through December 29, 1995
(in thousands)
Additional Retained
Common Paid-In Earnings
Stock Capital (Deficit)
----- ------- ---------
Net assets contributed by Host Marriott Corporation $ -- $ 25,406 $ --
Dividend to Host Marriott Corporation -- -- (2,623)
Net income -- -- 1,903
-------- -------- --------
Balance, December 29, 1995 -- 25,406 (720)
Net liabilities contributed by Host Marriott Corporation -- (9,928) --
Dividend to Host Marriott Corporation -- -- (6,299)
Net income -- -- 6,299
-------- -------- --------
Balance, January 3, 1997 -- 15,478 (720)
Adjustment to 1996 capital contribution by
Host Marriott Corporation -- (183) --
Dividend to Host Marriott Corporation -- -- (4,858)
Net income -- -- 6,598
-------- -------- --------
Balance at January 2, 1998 $ -- $ 15,295 $ 1,020
======== ======== ========
See Notes to Financial Statements.
F-4
HMH HPT COURTYARD, INC.
STATEMENTS OF CASH FLOWS
Fiscal Years Ended January 2, 1998 and
January 3, 1997 and for the Period from March 24,
1995 (inception) through December 29, 1995
(in thousands)
Period from March 24, 1995
(inception)
Fiscal Year through December 29, 1995
---------------------- -------------------------
1997 1996
---- ----
OPERATING ACTIVITIES:
Net income $ 6,598 $ 6,299 $ 1,903
Adjustments to reconcile net income to cash
provided by operating activities:
Amortization of deferred gain (2,900) (2,351) (675)
Changes in operating accounts:
Increase in due to Host Marriott Corporation 1,095 3,285 1,082
Decrease in prepaid rent -- 329 2,531
Decrease (increase) in due from Marriott
International, Inc. 65 (1,263) (2,218)
------- ------- -------
Cash provided by operations 4,858 6,299 2,623
------- ------- -------
FINANCING ACTIVITIES:
Dividend to Host Marriott Corporation (4,858) (6,299) (2,623)
------- ------- -------
CASH AND CASH EQUIVALENTS, end of year $ -- $ -- $ --
======= ======= =======
SUPPLEMENTAL INFORMATION, NONCASH ACTIVITY
Balances transferred to the Company by Host Marriott
Corporation upon commencement of leases
Advances to manager $ 1,116 $ 3,984
Prepaid rent 329 2,531
Security deposits 17,640 32,900
Accrued expenses -- (426)
Deferred gain (29,013) (13,583)
-------- --------
Net (liabilities) assets contributed by Host Marriott
Corporation $ (9,928) $ 25,406
======== ========
See Notes to Financial Statements.
F-5
HMH HPT COURTYARD, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
HMH HPT Courtyard, Inc. (the "Company") was incorporated in Delaware on
February 7, 1995 as a whollyowned indirect subsidiary of Host Marriott
Corporation ("Host Marriott"). The Company had no operations prior to March 24,
1995 (the "Commencement Date").
On the Commencement Date, affiliates of Host Marriott (the "Sellers")
sold 21 Courtyard properties to Hospitality Properties Trust ("HPT"). On August
22, 1995, HPT purchased an additional 16 Courtyard properties from the Sellers.
On March 22, 1996 and April 4, 1996, a total of 16 additional Courtyard
properties were purchased by HPT for a total of 53 Courtyard hotels (the
"Hotels"). The Sellers contributed the assets and liabilities related to the
operations of such properties to the Company, including working capital advances
to the manager, prepaid rent under leasing arrangements and rights to other
assets as described in Note 2. Such assets have been accounted for at the
historical cost.
Fiscal Year
The Company's fiscal year ends on the Friday nearest to December 31.
Full year results for 1996 include 53 weeks versus 52 weeks for 1997.
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.
Revenues
Revenues represent house profit from the Hotels because the Company has
delegated substantially all of the operating decisions relating to the
generation of house profit from the Hotels to Marriott International, Inc. (the
"Manager" or "Marriott International"). House profit reflects the net revenues
flowing to the Company as lessee and represents total hotel sales less property
level expenses excluding depreciation and amortization, real and personal
property taxes, lease payments, insurance, contributions to the property
improvement fund and management fees.
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Company is assessing the impact of EITF 97-2 on its policy of
excluding the property-level revenues and operating expenses of its hotels from
its statements of operations (see Note 6). If the Company concludes that EITF
97-2 should be applied to its hotels, it would include operating results of
those managed operations in its financial statements. Application EITF 97-2 to
financial statements as of and for the 52 weeks ended January 2, 1998, would
have increased both revenues and operating expenses by approximately $103
million and would have had no impact on operating profit or net income.
F-6
Corporate Expenses
The Company operates as a unit of Host Marriott, utilizing Host
Marriott's employees, centralized system for cash management, insurance and
administrative services. The Company has no employees. All cash received by the
Company is deposited in and commingled with Host Marriott's general corporate
funds. Operating expenses and other cash requirements of the Company are paid by
Host Marriott and charged directly or allocated to the Company. Certain general
and administrative costs of Host Marriott are allocated to the Company,
principally based on Host Marriott's specific identification of individual cost
items and otherwise based upon estimated levels of effort devoted by its general
and administrative departments to individual entities. In the opinion of
management, the methods for allocating corporate, general and administrative
expenses and other direct costs are reasonable. It is not practicable to
estimate the costs that would have been incurred by the Company if it had been
operated on a stand-alone basis, however, management believes that these
expenses are comparable to the expected allocations by Host Marriott of general
and administrative costs on a forward-looking basis.
Concentration of Credit Risk
The Company's largest asset is the security deposit (see Note 3) which
constitutes 86% of the Company's total assets as of January 2, 1998. The
security deposit is not collateralized and is due from HPT at the termination of
the Lease.
Deferred Gain
Host Marriott contributed to the Company deferred gains relating to the
sale of the 53 Courtyard properties to HPT in 1995 and 1996. The Company is
amortizing the deferred gain over the initial term of the Lease, as defined
below.
NOTE 2. LEASE COMMITMENTS
On the Commencement Date, the Company entered into a lease for 21
Courtyard properties. On August 22, 1995, the Company entered into a lease for
an additional 16 Courtyard properties. On March 22, 1996 and April 4, 1996, the
Company entered into a lease for an additional 16 Courtyard properties
(collectively, the "Lease"). The initial term of the Lease expires in 2012.
Thereafter, the Lease automatically renews for consecutive twelveyear terms at
the option of the Company.
The Company is required to pay rents equal to aggregate minimum annual
rent of $50,635,000 ("Base Rent"), and percentage rent equal to 5% of the excess
of total hotel sales over base year 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. Additionally, the Company is required 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. The Company is also required to provide the Manager
with working capital to meet the operating needs of the Hotels. The Sellers had
previously made advances related to the Hotels and transferred their interest in
such amounts to the Company in the amount of $3,984,000 and $1,116,000 in 1995
and 1996, respectively.
The Lease also requires the Company to escrow, or cause the Manager to
escrow, an amount equal to 5% of the annual total hotel sales into an HPTowned
furniture, fixture and equipment reserve (the "FF&E Reserve"), which is
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 the Company. In the event of HPT Fundings,
Base Rent shall be adjusted upward by an amount equal to 10% of HPT Fundings.
The Company is required to maintain a minimum net worth equal to one
year's base rent. For purposes of this covenant, net worth is defined as
shareholder's equity plus the deferred gain.
As of January 2, 1998, future minimum annual rental commitments for the
Lease on the Hotels and other noncancelable leases, including the ground leases
described below, are as follows (in thousands):
F-7
Operating
Other
Lease Leases
----- ------
1998 $ 50,635 $ 304
1999 50,635 151
2000 50,635 68
2001 50,635 30
2002 50,635 15
Thereafter 506,350 6
-------- --------
Total minimum lease payments $759,525 $ 574
======== ========
The land under eight 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 subject to minimum amounts. The minimum
rentals are adjusted at various anniversary dates throughout the lease terms, as
defined in the agreements. Total minimum lease payments exclude Percentage Rent
which was $1,771,000, $716,000 and $271,000 for 1997 and 1996 and the period
March 24, 1995 through December 29, 1995, respectively.
NOTE 3. SECURITY DEPOSIT
HPT holds $50,540,000 as a security deposit for the obligations of the
Company under the Leases (the "Security Deposit"). The Security Deposit is due
upon termination of the Lease.
NOTE 4. INCOME TAXES
The Company and Host Marriott are members of a consolidated group for
federal income tax purposes. Host Marriott has contributed the Security Deposit
and deferred gain without contributing their related tax attributes and have
agreed that the Company will not be responsible for any tax liability or benefit
associated with the Security Deposit or deferred gain. Accordingly, no deferred
tax balances are reflected in the accompanying balance sheets. There is no
difference between the basis of assets and liabilities for income tax and
financial reporting purposes other than for the Security Deposit and the
deferred gain.
The components of the Company's effective income tax rate follow:
1997 1996 1995
---- ---- ----
Statutory Federal tax rate 35.0% 35.0% 35.0%
State income tax, net of Federal
tax benefit 5.0 5.0 6.0
----- ----- -----
40.0% 40.0% 41.0%
===== ===== =====
The provision for income taxes consists of the following (in
thousands):
1997 1996 1995
---- ---- ----
Current - Federal $ 3,849 $ 3,674 $ 1,129
- State 551 575 193
------- ------- -------
$ 4,400 $ 4,199 $ 1,322
======= ======= =======
All current tax provision amounts are included in due to Host Marriott
Corporation on the accompanying balance sheets.
F-8
NOTE 5. MANAGEMENT AGREEMENTS
The Sellers' rights and obligations under management agreements (the
"Agreements") with the Manager, were transferred to HPT and then through the
Leases to the Company. The Agreement has an initial term expiring in 2013 with
an option to extend the Agreement on all of the Hotels for up to 30 years. The
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.
Pursuant to the terms of the Agreements, the Manager is required to
furnish the hotels with certain services ("Chain Services") which are generally
provided on a central or regional basis to all hotels in the Marriott
International hotel system. Chain Services include central training, advertising
and promotion, a national reservation system, computerized payroll and
accounting services, and such additional services as needed which may be more
efficiently performed on a centralized basis. Costs and expenses incurred in
providing such services are allocated among all domestic hotels managed, owned
or leased by Marriott International or its subsidiaries. In addition, the Hotels
participate in Marriott Rewards and Marriott's Courtyard Club programs.
The cost of these programs are charged to all hotels in the system.
The Company is obligated to provide the Manager with sufficient funds
to cover the cost of (a) certain non-routine repairs and maintenance to the
Hotels which are normally capitalized; and (b) replacements and renewals to the
Hotels' property and improvements. Under certain circumstances, the Company will
be required to establish escrow accounts for such purposes under terms outlined
in the Agreements.
Pursuant to the terms of Agreements, the Company is required to provide
Marriott International with funding for working capital to meet the operating
needs of the hotels. Marriott International converts cash advanced by the
Company into other forms of working capital consisting primarily of operating
cash, inventories and trade receivables. Under the terms of the Agreements,
Marriott International maintains possession of and sole control over the
components of working capital and accordingly, the Company reports the total
amounts so advanced to Marriott International as advances to manager in the
accompanying balance sheet. Upon termination of the Agreements, the working
capital will be returned to the Company.
NOTE 6. REVENUES
As discussed in Note 1, hotel revenues reflect house profit from the
Company's hotel properties. House profit reflects the net revenues flowing to
the Company as lessee and represents all gross hotel operating revenues, less
all gross property-level expenses, excluding depreciation, management fees, real
and personal property taxes, lease payments, insurance, contributions to the
property improvement fund and certain other costs, which are classified as
operating costs and expenses.
F-9
The following table presents the detail of house profit for 1997, 1996
and from March 24, 1995 (inception) through December 29, 1995 (in thousands):
1997 1996 1995
---- ---- ----
Hotel Sales:
Rooms $189,426 $164,738 $ 66,968
Food and beverage 14,789 14,167 6,225
Other 7,674 7,138 2,999
-------- -------- --------
Total Hotel Sales 211,889 186,043 76,192
-------- -------- --------
Expenses:
Rooms (A) 39,280 34,858 14,713
Food and beverage (B) 12,657 12,133 5,044
Other operating departments (C) 2,245 1,904 827
General and administrative (D) 22,536 19,956 7,768
Utilities (E) 8,046 7,200 2,955
Repairs, maintenance and accidents (F) 8,613 6,930 2,899
Marketing and sales (G) 2,281 2,290 1,121
Chain services (H) 7,815 6,611 3,052
-------- -------- --------
Total expenses 103,473 91,882 38,379
-------- -------- --------
Revenues (House Profit) $108,416 $ 94,161 $ 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.
(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 Agreements.
F-10
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 30, 1998
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 30, 1998
John G. Murray Chief Operating Officer
/s/Thomas M. O'Brien Treasurer and Chief March 30, 1998
Thomas M. O'Brien Financial Officer
Trustee March __, 1998
John L. Harrington
/s/Arthur G. Koumantzelis Trustee March 30, 1998
Arthur G. Koumantzelis
/s/William J. Sheehan Trustee March 30, 1998
William J. Sheehan
/s/Gerard M. Martin Trustee March 30, 1998
Gerard M. Martin
/s/Barry M. Portnoy Trustee March 30, 1998
Barry M. Portnoy