| HIGHLAND HOSPITALITY CORP Item 1A Risk Factors Risks Related to Our Organization and Structure Our failure to qualify as a REIT under the federal tax laws would result in adverse tax consequences |
| The US federal income tax laws governing REITs are complex |
| We intend to operate in a manner that will qualify us as a real estate investment trust, or REIT, under the US federal income tax laws |
| The REIT qualification requirements are extremely complex, however, and interpretations of the US federal income tax laws governing qualification as a REIT are limited |
| Accordingly, we cannot be certain that we will be successful in operating so we can qualify as a REIT At any time, new laws, interpretations, or court decisions may change the federal tax laws or the US federal income tax consequences of our qualification as a REIT Failure to qualify as a REIT would subject us to US federal income tax and would subject us and our stockholders to other adverse consequences |
| We believe that we have qualified for taxation as a REIT for federal income tax purposes commencing with our taxable year ended December 31, 2003 |
| We intend to continue to operate as a REIT during future years, however, no assurance can be provided that we will qualify as a REIT As a REIT, we generally will not be subject to federal income tax on our income that we distribute currently to our stockholders |
| Many of the REIT requirements are highly technical and complex |
| The determination that we are a REIT requires an analysis of various factual matters and circumstances that may not be totally within our control |
| For example, to qualify as a REIT, at least 95prca of our gross income must come from sources that are itemized in the REIT tax laws |
| We generally are prohibited from owning more than 10prca of the voting securities or more than 10prca of the value of the outstanding securities of any one issuer, subject to certain exceptions, including an exception with respect to certain debt instruments and corporations electing to be taxable REIT subsidiaries |
| We are also required to distribute to stockholders at least 90prca of our REIT taxable income (excluding capital gains) |
| The fact that we hold most of our assets through the Operating Partnership further complicates the application of the REIT requirements |
| Even a technical or inadvertent mistake could jeopardize our REIT status |
| Furthermore, Congress or the Internal Revenue Service might make changes to the tax laws and regulations, or the courts might issue new rulings that make it more difficult, or impossible, for us to remain qualified as a REIT If we fail to qualify as a REIT for federal income tax purposes, and are unable to avail ourselves of certain savings provisions set forth in the Internal Revenue Code, we would be subject to federal income tax at regular corporate rates |
| As a taxable corporation, we would not be allowed to take a deduction for distributions to stockholders in computing our taxable income or pass through long term capital gains to individual stockholders at favorable rates |
| We also could be subject to the federal alternative minimum tax and possibly increased state and local taxes |
| We would not be able to elect to be taxed as a REIT for four years following the year we first failed to qualify unless the IRS were to grant us relief under certain statutory provisions |
| If we failed to qualify as a REIT, we would have to pay significant income taxes, which would reduce our net earnings available for investment or distribution to our stockholders |
| This likely would have a significant adverse effect on our results of operations and the value of our common shares |
| In addition, we would no longer be required to pay any distributions to stockholders and all of our distributions to stockholders would be taxable as regular corporate dividends to the extent of our current and accumulated earnings and profits |
| This means that stockholders taxed as individuals currently would be taxed on those dividends at capital gains rates and corporate stockholders generally would be entitled to the dividends received deduction with respect to such dividends, subject in each case, to applicable limitations under the Internal Revenue Code |
| If we fail to qualify as a REIT for federal income tax purposes and are able to avail ourselves of one or more of the statutory savings provisions in order to maintain our REIT status, we would nevertheless be required to pay penalty taxes of dlra50cmam000 or more for each such failure |
| Failure to make required distributions would subject us to US federal income tax |
| In order to qualify as a REIT, each year we must pay out to our stockholders in distributions at least 90prca of our taxable income, other than any net capital gains |
| To the extent that we satisfy this distribution requirement, 11 ______________________________________________________________________ [36]Table of Contents but distribute less than 100prca of our taxable income, we will be subject to federal corporate income tax on our undistributed taxable income |
| In addition, we will be subject to a 4prca nondeductible excise tax if the actual amount that we pay out to our stockholders in a calendar year is less than a minimum amount specified under federal tax laws |
| Our only source of funds to make these distributions comes from distributions that we receive from our Operating Partnership |
| Accordingly, we may be required to borrow money or sell assets to make distributions sufficient to enable us to pay out enough of our taxable income to satisfy the distribution requirement and to avoid corporate income tax and the 4prca nondeductible excise tax in a particular year |
| Our taxable REIT subsidiary lessees are subject to federal, state, local and, where applicable, foreign income taxes |
| HHC TRS Holding Corporation, the sole owner of all of the lessees of our hotel properties organized as limited liability companies, or TRS lessees, is subject to US federal income tax on its taxable income, which will consist of the revenues from the hotels leased by the TRS lessees, net of the operating expenses for such hotels and rent payments to us |
| Accordingly, although our ownership of the TRS lessees, through HHC TRS Holding Corporation, will allow us to participate in the operating income from our hotels in addition to receiving rent, that operating income will be fully subject to US federal income tax |
| The after-tax net income of HHC TRS Holding Corporation is available for distribution to us |
| We will incur a 100prca excise tax on transactions with our TRS lessees that are not conducted on an arm’s-length basis |
| For example, to the extent that the rent paid by one of our TRS lessees to us exceeds an arm’s-length rental amount, such amount potentially will be subject to the excise tax |
| We intend that all transactions between us and our TRS lessees will be conducted on an arm’s-length basis and, therefore, that the rent paid by our TRS lessees to us will not be subject to the excise tax |
| If our hotel leases are not respected as true leases for US federal income tax purposes, we would fail to qualify as a REIT To qualify as a REIT, we must satisfy two gross income tests, under which specified percentages of our gross income must be passive income, like rent |
| For the rent paid pursuant to the leases, which constitutes substantially all of our gross income, to qualify for purposes of the gross income tests, the leases must be respected as true leases for US federal income tax purposes and not be treated as service contracts, joint ventures or some other type of arrangement |
| We believe that the leases will be respected as true leases for US federal income tax purposes |
| There can be no assurance, however, that the Internal Revenue Service will agree with this view |
| If HHC TRS Holding Corporation fails to qualify as a taxable REIT subsidiary, we would fail to qualify as a REIT We are able to lease our hotel properties to the TRS lessees, relying on an exception from the general prohibition against leasing to a related-party tenant |
| This exception permits a REIT to lease hotel properties to its taxable REIT subsidiaries |
| As our TRS lessees are wholly owned by HHC TRS Holding Corporation, they are disregarded as separate entities for US federal income tax purposes and the leases are treated as if made with HHC TRS Holding Corporation |
| So long as HHC TRS Holding Corporation qualifies as a taxable REIT subsidiary of ours, we can lease the hotel properties to HHC TRS Holding Corporation and receive rents that qualify as rents from real property for the REIT gross income test purposes |
| We believe that HHC TRS Holding Corporation qualifies to be treated as a taxable REIT subsidiary for US federal income tax purposes |
| We cannot assure you, however, that the Internal Revenue Service will not challenge its status as a taxable REIT subsidiary for US federal income tax purposes, or that a court would not sustain such a challenge |
| If the Internal Revenue Service were successful in disqualifying HHC TRS Holding Corporation from treatment as a taxable REIT subsidiary, we would fail to meet the asset tests applicable to REITs and substantially all of our income would fail to qualify for the gross income tests and, accordingly, we would fail to qualify as a REIT 12 ______________________________________________________________________ [37]Table of Contents Despite our REIT status, we remain subject to various taxes |
| Notwithstanding our status as a REIT, we are subject, through our ownership interest in our Operating Partnership and HHC TRS Holding Corporation, to certain US federal, state, local and foreign taxes on our income and property |
| Moreover, if we have net income from “prohibited transactions,” that income will be subject to a 100prca tax |
| In general, prohibited transactions are sales or other dispositions of property held primarily for sale to customers in the ordinary course of business |
| The determination as to whether a particular sale is a prohibited transaction depends on the facts and circumstances related to that sale |
| While we will undertake sales of assets if those assets become inconsistent with our long-term strategic or return objectives, we do not believe that those sales should be considered prohibited transactions, but there can be no assurance that the IRS would not contend otherwise |
| The need to avoid prohibited transactions could cause us to forego or defer sales of properties that might otherwise be in our best interest to sell |
| If our Operating Partnership failed to qualify as a partnership for US federal income tax purposes, we would cease to qualify as a REIT and suffer other adverse consequences |
| We believe that our Operating Partnership qualifies to be treated as a partnership for US federal income tax purposes |
| As a partnership, it is not subject to US federal income tax on its income |
| Instead, each of its partners, including us, is required to pay tax on its allocable share of the Operating Partnership’s income |
| No assurance can be provided, however, that the Internal Revenue Service will not challenge its status as a partnership for US federal income tax purposes, or that a court would not sustain such a challenge |
| If the Internal Revenue Service were successful in treating our Operating Partnership as a corporation for tax purposes, we would fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, cease to qualify as a REIT Also, the failure of our Operating Partnership to qualify as a partnership would cause it to become subject to US federal and state corporate income tax, which would reduce significantly the amount of cash available for debt service and for distribution to its partners, including us |
| Provisions of our charter may limit the ability of a third party to acquire control of our company |
| Our ownership limitations may restrict or prevent you from engaging in certain transfers of our common stock |
| In order to maintain our REIT qualification, no more than 50prca in value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the US federal income tax laws to include various kinds of entities) during the last half of any taxable year |
| To preserve our REIT qualification, our charter contains an aggregate share ownership limit and a common share ownership limit |
| Generally, any shares of our stock owned by affiliated owners will be added together for purposes of the aggregate share ownership limit, and any shares of common stock owned by affiliated owners will be added together for purposes of the common share ownership limit |
| Our charter provides that no person may directly or indirectly own more than 9dtta9prca of the value of our outstanding shares of stock or more than 9dtta9prca of the number of our outstanding shares of common stock |
| These ownership limitations may prevent an acquisition of control of our company by a third party without our board of directors’ approval, even if our stockholders believe the change of control is in their interest |
| If anyone transfers shares in a way that would violate the aggregate share ownership limit or the common share ownership limit, or prevent us from continuing to qualify as a REIT under the US federal income tax laws, we will consider the transfer to be null and void from the outset, and the intended transferee of those shares will be deemed never to have owned the shares or those shares instead will be transferred to a trust for the benefit of a charitable beneficiary and will be either redeemed by us or sold to a person whose ownership of the shares will not violate the aggregate share ownership limit or the common share ownership limit |
| Anyone who acquires shares in violation of the aggregate share ownership limit, the common share ownership limit or the other restrictions on transfer in our charter bears the risk of suffering a financial loss when the shares are redeemed or sold if the market price of our stock falls between the date of purchase and the date of redemption or sale |
| Our charter authorizes our board of directors to issue up to 500cmam000cmam000 shares of common stock and up to 100cmam000cmam000 shares of preferred stock, to classify or reclassify any unissued shares of common stock or preferred stock and to set the preferences, rights and other terms of the classified or reclassified shares |
| Issuances of additional shares of stock may have the effect of delaying or preventing a change in control of our company, including transactions at a premium over the market price of our stock, even if stockholders believe that a change of control is in their interest |
| Provisions of Maryland law may limit the ability of a third party to acquire control of our company |
| Certain provisions of the Maryland General Corporation Law, or the MGCL, may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could provide the holders of shares of our common stock with the opportunity to realize a premium over the then prevailing market price of such shares, including: • “business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10prca or more of the voting power of our shares or an affiliate thereof) for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter imposes special appraisal rights and special stockholder voting requirements on these combinations; and • “control share” provisions that provide that “control shares” of our company (defined as shares which, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares |
| We have opted out of these provisions of the MGCL, in the case of the business combination provisions of the MGCL by resolution of our board of directors, and in the case of the control share provisions of the MGCL pursuant to a provision in our bylaws |
| However, our board of directors may by resolution elect to opt in to the business combination provisions of the MGCL and we may, by amendment to our bylaws, opt in to the control share provisions of the MGCL in the future |
| Additionally, Title 3, Subtitle 8 of the MGCL permits our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement takeover defenses (for example, a classified board) |
| These provisions may have the effect of inhibiting a third party from making an acquisition proposal for our company or of delaying, deferring or preventing a change in control of our company under the circumstances that otherwise could provide the holders of our common stock with the opportunity to realize a premium over the then current market price |
| Risks Related to Our Business The ability of our board of directors to change our major corporate policies may not be in your interest |
| Our board of directors determines our major corporate policies, including our acquisition, financing, growth, operations and distribution policies |
| Our board may amend or revise these and other policies from time to time without the vote or consent of our stockholders |
| Our success depends on key personnel whose continued service is not guaranteed |
| We depend on the efforts and expertise of our President and Chief Executive Officer, our Executive Vice President and Chief Investment Officer, our Executive Vice President, General Counsel and Corporate Secretary and our Executive Vice President, Chief Financial Officer and Treasurer to manage our day-to-day operations and strategic business direction |
| The loss of any of their services could have an adverse effect on our operations |
| 14 ______________________________________________________________________ [39]Table of Contents We have conflicts of interest that may have affected the terms of our acquisition of our three initial properties and the related management agreements, as well as other management agreements we have subsequently entered into |
| We will have conflicts going forward with our chairman and one other director with respect to the management of our hotels by Barcelo Crestline and the disposition of hotels acquired from Barcelo Crestline |
| There were conflicts of interest relating to the negotiation of the agreements pursuant to which we acquired interests in our three initial properties from Barcelo Crestline |
| Bruce D Wardinski, our chairman, was also the President and Chief Executive Officer of Barcelo Crestline and served on an advisory committee of Barcelo Corporacion Empresarial, SA, the parent company of Barcelo Crestline |
| James L Francis, another director and our President and Chief Executive Officer, was also the Chief Operating Officer and Chief Financial Officer of Barcelo Crestline |
| In addition, two of our other senior executive officers were employees of Barcelo Crestline at the time we negotiated and executed our agreements with Barcelo Crestline to acquire our three initial properties, all of which are managed by a wholly owned subsidiary of Barcelo Crestline under management contracts with our TRS lessees |
| Since then, subsidiaries of Barcelo Crestline have also entered into similar agreements with our subsidiaries to manage 10 of our other 21 hotel properties |
| As a result, the agreements pursuant to which we acquired our initial properties and Barcelo Crestline has agreed to manage the properties were not negotiated in an arm’s-length manner and the terms may be less favorable to us than we could have received from a third party |
| Additionally, at the time of our IPO, we entered into a seven-year strategic alliance agreement with Barcelo Crestline that requires Barcelo Crestline, subject to certain exceptions, to refer to us, on an exclusive basis, any hotel investment opportunity which is presented to Barcelo Crestline, and requires us to offer Barcelo Crestline the opportunity to manage US hotels that we acquire in the future unless a majority of our independent directors conclude in good faith for valid business reasons that another management company should manage one or more of such hotels |
| Wardinski, W Reeder Glass, who became a director following the completion of the initial public offering, was at the time of his appointment and is also currently a director of Barcelo Crestline and serves as Barcelo Crestline’s designee pursuant to its right to nominate one director under the strategic alliance agreement |
| As a result, our board of directors may experience similar conflicts of interest with respect to any future acquisition of a hotel property by us from Barcelo Crestline or its affiliates or in considering whether to engage Barcelo Crestline to manage any of our hotel properties in the future |
| In addition, because Barcelo Crestline would receive a special allocation of taxable gain under the US federal income tax rules relating to contributions of appreciated property to a partnership, if we dispose of one of more of our three initial properties in a taxable transaction, our board of directors may experience conflicts of interest with respect to any disposition of one or more of our three initial properties |
| Our returns depend on management of our hotels by third parties |
| In order to qualify as a REIT, we cannot operate our hotel properties or participate in the decisions affecting the daily operations of our hotels |
| Our TRS lessees may not operate the leased hotels and, therefore, they must enter into management agreements with eligible independent contractors which are not our subsidiaries or otherwise controlled by us to manage the hotels |
| Thus, independent hotel operators, under a management agreement with our TRS lessees, will control the daily operations of our hotels |
| Under the terms of the management agreements that we have entered into with these management companies to-date, our ability to participate in operating decisions regarding the hotels is limited |
| We depend on these independent management companies to adequately operate our hotels as provided in the management agreements |
| We do not have the authority to require any hotel to be operated in a particular manner or to govern any particular aspect of the daily operations of any hotel (for instance, setting room rates) |
| Thus, even if we believe our hotels are being operated inefficiently or in a manner that does not result in satisfactory occupancy rates, revenue per available room, or RevPAR, and average daily rates, we may not be able to force the management company to change its method of operation of our hotels |
| We can only seek redress if a management company violates the terms of the applicable management agreement with a TRS lessee, and then only to the extent of the remedies provided for under the terms of the management agreement |
| As a result, failure 15 ______________________________________________________________________ [40]Table of Contents by our hotel managers to fully perform the duties agreed to in our management agreements could adversely affect our results of operations |
| In addition, our hotel managers manage, and in some cases own or have invested in, hotels that compete with our hotels, which may result in conflicts of interest |
| As a result, our hotel managers have in the past made and may in the future make decisions regarding competing lodging facilities that are not or would not be in our best interests |
| Additionally, in the event that we need to replace any of our management companies, we may be required by the terms of the management agreement to pay substantial termination fees and may experience significant disruptions at the affected hotels |
| Our TRS lessee structure subjects us to the risk of increased hotel operating expenses |
| Our leases with our TRS lessees will provide for the payment of rent based in part on revenues from our hotels |
| Our operating risks include not only changes in hotel revenues and changes to our lessee’s ability to pay the rent due under the leases, but also increased hotel operating expenses, including but not limited to the following: • wage and benefit costs; • repair and maintenance expenses; • energy costs; • property taxes; • insurance costs; and • other operating expenses |
| Any increases in these operating expenses can have a significant adverse impact on our earnings and cash flow |
| Operating our hotels under franchise agreements could adversely affect our distributions to our stockholders |
| Our hotels will operate under franchise agreements, and we are subject to the risks that are found in concentrating our hotel investments in several franchise brands |
| These risks include reductions in business following negative publicity related to one of our brands |
| The maintenance of the franchise licenses for our hotels is subject to our franchisors’ operating standards and other terms and conditions |
| Our franchisors periodically inspect our hotels to ensure that we and our lessees and management companies follow their standards |
| Failure by us, one of our TRS lessees or one of our management companies to maintain these standards or other terms and conditions could result in a franchise license being canceled |
| If a franchise license terminates due to our failure to make required improvements or to otherwise comply with its terms, we may also be liable to the franchisor for a termination payment, which varies by franchisor and by hotel |
| As a condition of our continued holding of a franchise license, a franchisor could also possibly require us to make capital expenditures, even if we do not believe the capital improvements are necessary or desirable or will result in an acceptable return on our investment |
| Nonetheless, we may risk losing a franchise license if we do not make franchisor-required capital expenditures |
| If a franchisor terminates the franchise license, we may try either to obtain a suitable replacement franchise or to operate the hotel without a franchise license |
| The loss of a franchise license could materially and adversely affect the operations or the underlying value of the hotel because of the loss of associated name recognition, marketing support and centralized reservation systems provided by the franchisor |
| A loss of a franchise license for one or more hotels could materially and adversely affect our revenues |
| This loss of revenues could, therefore, also adversely affect our financial condition, results of operations and cash available for distribution to stockholders |
| Our ability to make distributions to our stockholders may be affected by factors in the lodging industry |
| Operating risks |
| Our hotel properties are subject to various operating risks common to the lodging industry, many of which are beyond our control, including the following: • competition from other hotel properties in our markets; 16 ______________________________________________________________________ [41]Table of Contents • over-building of hotels in our markets, which adversely affects occupancy and revenues at our hotels; • dependence on business and commercial travelers and tourism; • increases in energy costs and other expenses affecting travel, which may affect travel patterns and reduce the number of business and commercial travelers and tourists; • increases in operating costs due to inflation and other factors that may not be offset by increased room rates; • changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance with laws and regulations, fiscal policies and ordinances; • adverse effects of international, national, regional and local economic and market conditions; • adverse effects of a downturn in the lodging industry; and • risks generally associated with the ownership of hotel properties and real estate, as we discuss in detail below |
| These factors could reduce the net operating profits of our TRS lessees, which in turn could adversely affect our ability to make distributions to our stockholders |
| We face competition for the acquisition of hotels, and we may not be able to complete acquisitions that we have identified |
| One component of our business strategy is expansion through acquisitions, and we may not be successful in completing acquisitions that are consistent with our strategy |
| We compete with institutional pension funds, private equity investors, other REITs, owner-operators of hotels, franchise-owned hotels and others who are engaged in the acquisition of hotels |
| These competitors may affect the supply/demand dynamics and, accordingly, increase the price we must pay for hotels we seek to acquire, and these competitors may succeed in acquiring those hotels themselves |
| Also, our potential acquisition targets may find our competitors to be more attractive acquirors because they may have greater marketing and financial resources, may be willing to pay more, or may have a more compatible operating philosophy |
| In addition, the number of entities competing for suitable hotels may increase in the future, which would increase demand for these hotels and the prices we must pay to acquire them |
| If we pay higher prices for hotels, our profitability may be reduced |
| Also, once we have identified potential acquisitions, such acquisitions are subject to the satisfactory completion of due diligence, the negotiation and execution of definitive agreements and the satisfaction of customary closing conditions, and we cannot assure you that we will be able to reach acceptable terms with the sellers or that these conditions will be satisfied |
| Seasonality of hotel business |
| The hotel industry is seasonal in nature |
| This seasonality can be expected to cause quarterly fluctuations in our revenues |
| Our quarterly earnings may be adversely affected by factors outside our control, including weather conditions and poor economic factors |
| As a result, we may have to enter into short-term borrowings in certain quarters in order to offset these fluctuations in revenues and to make distributions to our stockholders |
| Investment concentration in particular segments of single industry |
| Therefore, a downturn in the lodging industry, in general, and the segments in which we operate, in particular, will have a material adverse effect on our lease revenues and the net operating profits of our TRS lessees and amounts available for distribution to our stockholders |
| Capital expenditures |
| Our hotel properties have an ongoing need for renovations and other capital improvements, including replacements, from time to time, of furniture, fixtures and equipment |
| The franchisors of our hotels also require 17 ______________________________________________________________________ [42]Table of Contents periodic capital improvements as a condition of keeping the franchise licenses |
| In addition, our lenders require that we set aside annual amounts for capital improvements to our hotel properties |
| These capital improvements may give rise to the following risks: • possible environmental problems; • construction cost overruns and delays; • a possible shortage of available cash to fund capital improvements and the related possibility that financing for these capital improvements may not be available to us on affordable terms; and • uncertainties as to market demand or a loss of market demand after capital improvements have begun |
| The costs of all these capital improvements could adversely affect our financial condition and amounts available for distribution to our stockholders |
| Our rebranding and renovation efforts could be subject to higher than anticipated costs and unexpected delays, which would adversely affect our investment returns, harm our operating results and reduce funds available for distributions to our stockholders |
| Since inception in December 2003, we have completed these initiatives with respect to four of our properties and have three initiatives underway |
| We expect to invest approximately dlra60dtta0 million on these seven initiatives, of which approximately dlra38 million had been invested through December 31, 2005 |
| We expect to continue to evaluate similar rebranding and renovation opportunities and will engage in them where we feel the economics are attractive |
| These opportunities are subject to the risks that we may: • not complete the projects on schedule or within budgeted amounts; • underestimate the costs or time necessary to bring the property up to the standards established for its intended market position; or • encounter delays or refusals in obtaining all necessary zoning, land use, building, occupancy and other required governmental permits and authorizations |
| Any of the foregoing circumstances could cause us to realize a lower return on our hotel investment than expected, thereby potentially reducing our revenue, harming our operating results or reducing funds available for distributions to our stockholders, which could result in a decline in the value of our common stock |
| The increasing use of Internet travel intermediaries by consumers may adversely affect our profitability |
| Some of our hotel rooms will be booked through Internet travel intermediaries such as Travelocity |
| As these Internet bookings increase, these intermediaries may be able to obtain higher commissions, reduced room rates or other significant contract concessions from us and our management companies |
| Moreover, some of these Internet travel intermediaries are attempting to offer hotel rooms as a commodity, by increasing the importance of price and general indicators of quality (such as “three-star downtown hotel”) at the expense of brand identification |
| These agencies hope that consumers will eventually develop brand loyalties to their reservations system rather than to our lodging brands |
| Although most of the business for our hotels is expected to be derived from traditional channels, if the amount of sales made through Internet intermediaries increases significantly, room revenues may flatten or decrease and our profitability may be adversely affected |
| The threat of terrorism has harmed the hotel industry generally, including our results of operations and these harmful effects may continue or worsen, particularly if there are further terrorist events |
| The threat of terrorism has had a negative impact on hotel operations and caused a significant decrease in hotel occupancy and average daily rates due to disruptions in business and leisure travel patterns and concerns 18 ______________________________________________________________________ [43]Table of Contents about travel safety |
| Hotels in major metropolitan areas and near airports, such as many of our hotels, have been harmed due to concerns about air travel safety and a significant overall decrease in the amount of air travel, particularly transient business travel, which includes the corporate and premium business segments that generally pay the highest average room rates |
| Future terrorist acts in the US and abroad, terrorism alerts or outbreaks of hostilities could have a negative effect on travel, and correspondingly, on our business |
| The attacks of September 11, 2001 had a dramatic adverse impact on business and leisure travel, hotel occupancy and RevPAR While there have been recent improvements, the uncertainty associated with the continuing war on terrorism, the US-led military action in Iraq and Afghanistan, and the possibility of future attacks may continue to hamper business and leisure travel patterns and, accordingly, the performance of our business |
| Uninsured and underinsured losses could adversely affect our operating results and our ability to make distributions to our stockholders |
| We maintain comprehensive insurance on each of our hotel properties, including terrorism, liability, fire and extended coverage, of the type and amount we believe are customarily obtained for or by hotel owners |
| There are no assurances that current coverage will continue to be available at reasonable rates |
| Because various types of catastrophic losses, such as those that may arise out of earthquakes and floods, may not be insurable at reasonable rates, we may not always obtain insurance against these losses |
| In the event of a substantial loss, our insurance coverage, if any, may not be sufficient to cover the full current market value or replacement cost of our lost investment |
| Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a hotel or resort, as well as the anticipated future revenue from the hotel or resort |
| In that event, we might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property |
| Inflation, changes in building codes and ordinances, environmental considerations and other factors might also keep us from using insurance proceeds to replace or renovate a hotel after it has been damaged or destroyed |
| Under those circumstances, the insurance proceeds we receive might be inadequate to restore our economic position on the damaged or destroyed property |
| Noncompliance with governmental regulations could adversely affect our operating results |
| Environmental matters |
| Our hotel properties are subject to various federal, state and local environmental laws |
| Under these laws, courts and government agencies have the authority to require us, as owner of a contaminated property, to clean up the property, even if we did not know of or were not responsible for the contamination |
| These laws also apply to persons who owned a property at the time it became contaminated |
| In addition to the costs of cleanup, environmental contamination can affect the value of a property and, therefore, an owner’s ability to borrow funds using the property as collateral or to sell the property |
| Under the environmental laws, courts and government agencies also have the authority to require that a person who sent waste to a waste disposal facility, such as a landfill or an incinerator, pay for the clean-up of that facility if it becomes contaminated and threatens human health or the environment |
| A person that arranges for the disposal or transports for disposal or treatment a hazardous substance at a property owned by another may be liable for the costs of removal or remediation of hazardous substances released into the environment at that property |
| Furthermore, various court decisions have established that third parties may recover damages for injury caused by property contamination |
| For instance, a person exposed to asbestos while staying in a hotel may seek to recover damages if he or she suffers injury from the asbestos |
| Lastly, some of these environmental laws restrict the use of a property or place conditions on various activities |
| An example would be laws that require a business using chemicals (such as swimming pool chemicals at a hotel property) to manage them carefully and to notify local officials that the chemicals are being used |
| We could be responsible for the costs discussed above |
| The costs to clean up a contaminated property, to defend against a claim, or to comply with environmental laws could be material and could adversely affect the 19 ______________________________________________________________________ [44]Table of Contents funds available for distribution to our stockholders |
| We may have material environmental liabilities of which we are unaware |
| We can make no assurances that (1) future laws or regulations will not impose material environmental liabilities or (2) the current environmental condition of our hotel properties will not be affected by the condition of the properties in the vicinity of our hotel properties (such as the presence of leaking underground storage tanks) or by third parties unrelated to us |
| Americans with Disabilities Act and other changes in governmental rules and regulations |
| Under the Americans with Disabilities Act of 1990, or the ADA, all public accommodations must meet various federal requirements related to access and use by disabled persons |
| Compliance with the ADA’s requirements could require removal of access barriers, and non-compliance could result in the US government imposing fines or in private litigants winning damages |
| If we are required to make substantial modifications to our hotels, whether to comply with the ADA or other changes in governmental rules and regulations, our financial condition, results of operations and ability to make distributions to our stockholders could be adversely affected |
| Unanticipated expenses and insufficient demand for hotels we open in new geographic markets could adversely affect our profitability and our ability to make distributions to our stockholders |
| As part of our business plan, we may develop or acquire new hotels in geographic areas in which our management may have little or no operating experience and in which potential customers may not be familiar with our franchise brands |
| As a result, we may have to incur costs relating to the opening, operation and promotion of those new hotel properties that are substantially greater than those incurred in other areas |
| These hotels may attract fewer customers than our existing hotels, while at the same time, we may incur substantial additional costs with these new hotel properties |
| As a result, the results of operations at new hotel properties may be less than those of our existing hotels |
| Unanticipated expenses and insufficient demand at a new hotel property, therefore, could adversely affect our profitability and our ability to make distributions to our stockholders |
| Our ability to maintain distributions to our stockholders is subject to fluctuations in our financial performance, operating results and capital improvements requirements |
| As a REIT, we are required to distribute at least 90prca of our taxable income (excluding net capital gains) each year to our stockholders |
| In the event of future downturns in our operating results and financial performance or unanticipated capital improvements to our hotels, including capital improvements which may be required by our franchisors, we may be unable to declare or pay distributions to our stockholders |
| The timing and amount of distributions are in the sole discretion of our board of directors which will consider, among other factors, our financial performance, debt service obligations and debt covenants, and capital expenditure requirements |
| We cannot assure you that we will continue to generate sufficient cash in order to fund distributions |
| Among the factors which could adversely affect our results of operations and our distributions to stockholders are the failure of our TRS lessees to make required rent payments because of reduced net operating profits or operating losses; increased debt service requirements and capital expenditures at our hotels, including capital expenditures required by the franchisors of our hotels |
| Among the factors which could reduce the net operating profits of our TRS lessees are decreases in hotel revenues and increases in hotel operating expenses |
| Hotel revenue can decrease for a number of reasons, including increased competition from new supply of hotel rooms and decreased demand for hotel rooms |
| These factors can reduce both occupancy and room rates at our hotels |
| These TRS lessees are subject to hotel operating risks, including risks of sustaining operating losses after payment of hotel operating expenses, including management fees |
| These risks can affect adversely the net operating profits of our TRS lessees, our operating expenses, and our ability to make distributions to our stockholders |
| 20 ______________________________________________________________________ [45]Table of Contents The hotel business is capital intensive and our inability to obtain financing could limit our growth |
| Our hotel properties will require periodic capital expenditures and renovation to remain competitive |
| Acquisitions or development of additional hotel properties will require significant capital expenditures |
| We may not be able to fund capital improvements or acquisitions solely from cash provided from our operating activities because we must distribute at least 90prca of our taxable income (net of capital gains) each year to maintain our REIT tax status |
| As a result, our ability to fund capital expenditures, acquisitions or hotel development through retained earnings is very limited |
| Consequently, we rely upon the availability of debt or equity capital to fund hotel acquisitions and improvements |
| Our ability to grow through acquisitions or development of hotels could be hampered by a number of factors, many of which are outside of our control, including, without limitation, declining general market conditions, unfavorable market perception of our growth potential, decreases in our current and estimated future earnings, excessive cash distributions or decreases in the market price of our common stock |
| In addition, our ability to access additional capital may also be limited by the terms of our existing indebtedness, which, among other things, restricts our incurrence of debt and the payment of distributions |
| The occurrence of any of these above-mentioned factors, individually or in combination, could prevent us from being able to obtain the external capital we require on terms that are acceptable to us or at all and the failure to obtain necessary external capital could have a material adverse affect on our ability to finance our future growth |
| General Risks Related to the Real Estate Industry Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition |
| Because real estate investments are relatively illiquid, our ability to promptly sell one or more hotel properties in our portfolio in response to changing economic, financial and investment conditions is limited |
| The real estate market is affected by many factors that are beyond our control, including: • adverse changes in international, national, regional and local economic and market conditions; • changes in interest rates and in the availability, cost and terms of debt financing; • changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance with laws and regulations, fiscal policies and ordinances; • the ongoing need for capital improvements, particularly in older structures; • changes in operating expenses; and • civil unrest, acts of God, including earthquakes, floods and other natural disasters, which may result in uninsured losses, and acts of war or terrorism, including the consequences of the terrorist acts such as those that occurred on September 11, 2001 |
| We cannot predict whether we will be able to sell any hotel property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us |
| We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a hotel property |
| We may be required to expend funds to correct defects or to make improvements before a hotel property can be sold |
| We cannot assure you that we will have funds available to correct those defects or to make those improvements |
| In acquiring a hotel property, we may agree to lock-out provisions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property |
| These factors and any others that would impede our ability to respond to adverse changes in the performance of our properties could have a material adverse effect on our operating results and financial condition, as well as our ability to pay distributions to stockholders |
| 21 ______________________________________________________________________ [46]Table of Contents Increases in our property taxes would adversely affect our ability to make distributions to our stockholders |
| These taxes on our hotel properties may increase as tax rates change and as the properties are assessed or reassessed by taxing authorities |
| If property taxes increase, our ability to make distributions to our stockholders would be adversely affected |
| Future debt service obligations could adversely affect our overall operating results and may require us to sell assets to meet our payment obligations |
| While we have adopted a target debt level of 40-50prca of historical asset cost, because neither our charter nor our bylaws limits the amount of debt that we can incur, our board of directors may change this debt policy at any time without stockholder approval |
| We and our subsidiaries may be able to incur substantial additional debt, including secured debt, in the future |
| Incurring debt could subject us to many risks, including the risks that: • our cash flow from operations will be insufficient to make required payments of principal and interest; • our debt may increase our vulnerability to adverse economic and industry conditions; • we may be required to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing cash available for distribution to our stockholders, funds available for operations and capital expenditures, future business opportunities or other purposes; and • the terms of any refinancing will not be as favorable as the terms of the debt being refinanced |
| If we violate covenants in our future indebtedness agreements, we could be required to repay all or a portion of our indebtedness before maturity at a time when we might be unable to arrange financing for such repayment on attractive terms, if at all |
| If we obtain debt in the future and do not have sufficient funds to repay our debt at maturity, it may be necessary to refinance this debt through additional debt financing, private or public offerings of debt securities, or additional equity financings |
| If, at the time of any refinancing, prevailing interest rates or other factors result in higher interest rates on refinancings, increases in interest expense could adversely affect our cash flow, and, consequently, cash available for distribution to our stockholders |
| If we are unable to refinance our debt on acceptable terms, we may be forced to dispose of hotel properties on disadvantageous terms, potentially resulting in losses adversely affecting cash flow from operating activities |
| We may place mortgages on our hotel properties to secure our line of credit or other debt |
| To the extent we cannot meet our debt service obligations, we risk losing some or all of those properties to foreclosure |
| Also, covenants applicable to our debt could impair our planned strategies and, if violated, result in a default of our debt obligations |
| Higher interest rates could increase debt service requirements on our floating rate debt and could reduce the amounts available for distribution to our stockholders, as well as reducing funds available for our operations, future business opportunities, or other purposes |
| We may obtain in the future one or more forms of interest rate protection—in the form of swap agreements, interest rate cap contracts or similar agreements—to “hedge” against the possible negative effects of interest rate fluctuations |
| However, we cannot assure you that any hedging will adequately relieve the adverse effects of interest rate increases or that counterparties under these agreement will honor their obligations thereunder |
| Adverse economic conditions could also cause the terms on which we borrow to be unfavorable |
| We could be required to liquidate one or more of our hotel investments at times which may not permit us to receive an attractive return on our investments in order to meet our debt service obligations |
| Our ability to pay dividends on our common stock may be limited or prohibited by the terms of our indebtedness |
| We have an unsecured revolving credit facility with a syndicate of banks, which provides for a maximum borrowing of up to dlra150 million with an option to increase the amount of the facility by up to dlra50 million |
| The 22 ______________________________________________________________________ [47]Table of Contents facility matures on February 23, 2009 and has a one-year extension option |
| The facility contains financial covenants that could limit our ability to pay dividends on our common stock |
| Under the terms of the facility, provided no event of default has occurred, we may pay dividends on, or repurchase, shares of our common stock so long as the payments, together with the previous such cash payments in the same fiscal year, are not in excess of the greater of (i) 95prca of our funds from operations during such fiscal year, and (ii) the amount required (on an annualized basis) for us to maintain our status as a REIT The facility’s financial covenants could adversely affect our financial condition |
| In addition, we and our subsidiaries, including our Operating Partnership, are, and may in the future become, parties to loan agreements and other arrangements which further restrict or prevent the payment of dividends on our classes and series of capital stock before certain financial or operational thresholds are met |
| Market interest rates may affect the price of shares of our common stock |
| We believe that one of the factors that investors consider important in deciding whether to buy or sell shares of a REIT is the distribution rate on the shares, considered as a percentage of the price of the shares, relative to market interest rates |
| If market interest rates increase, prospective purchasers of REIT shares may expect a higher distribution rate |
| Thus, higher market interest rates could cause the market price of our shares to go down |