| SUPERTEL HOSPITALITY INC Item 1A RISK FACTORS The following risk factors describe various risks that may affect our business, financial condition and operations |
| Our failure to qualify as a REIT under the federal tax laws would result in adverse tax consequences |
| However, the REIT qualification requirements are extremely complicated and interpretations of the federal income tax laws governing qualification as a REIT are limited |
| Accordingly, we cannot be certain that we have been or will continue to be successful in operating as a REIT At any time, new laws, interpretations or court decisions may change the federal tax laws or the federal income tax consequences of qualification as a REIT 7 ______________________________________________________________________ [32]Table of Contents If we fail to qualify as a REIT in any taxable year, we would be required to pay federal income tax on our taxable income and our taxable income would be computed without a dividends paid deduction |
| We might need to borrow money or sell assets in order to pay the tax |
| Our payment of income tax likely would substantially decrease the amounts available to be paid out to our shareholders |
| In addition, we no longer would be required to distribute substantially all of our taxable income to our shareholders |
| Unless our failure to qualify as a REIT is excused under the federal income tax laws, we could not re-elect REIT status until the fifth calendar year following the year in which we fail to qualify |
| An economic recession and industry downturn could adversely affect our results of operations |
| If room supply outpaces demand, our operating margins may deteriorate and we may be unable to execute our business plan |
| In addition, if this trend continues, we may be unable to continue to meet our debt service obligations or to obtain necessary additional financing |
| We have restrictive debt covenants that could adversely affect our ability to run our business |
| As of September 30, 2004, we requested and received a loan-to-value and a debt service ratio waiver with respect to a term loan with First National Bank of Omaha NA On February 17, 2005, the bank agreed to a covenant modification effective through June 30, 2006, providing for a lower loan-to-value ratio and debt service coverage ratio |
| Weakness in the economy, and the lodging industry at large, may result in our non-compliance with our loan covenants |
| Such non-compliance with our covenants may result in our lenders restricting the use of our operating funds for capital improvements to our existing hotels, including improvements required by our franchise agreements |
| We cannot assure you that our loan covenants will permit us to maintain our historic business strategy |
| Our restrictive debt covenants may jeopardize our tax status as a REIT To maintain our REIT tax status, we generally must distribute at least 90prca of our taxable income annually |
| In addition, we are subject to a 4prca non-deductible excise tax if the actual amount distributed to shareholders in a calendar year is less than a minimum amount specified under the federal income tax laws |
| We have previously announced a general dividend policy of paying out approximately 100prca of annual REIT taxable income |
| In the event we do not comply with our debt service obligations, our lenders may limit our ability to make distributions to our shareholders, which could adversely affect our REIT tax status |
| Our failure to have distributed old Supertel Hospitality, Inc |
| ’s earnings and profits may compromise our tax status |
| At the end of any taxable year, a REIT may not have any accumulated earnings and profits (described generally for federal income tax purposes as cumulative undistributed net income) from a non-REIT corporation |
| In October 1999, our company and the old Supertel Hospitality, Inc |
| Prior to the effective time of the merger between our company and old Supertel Hospitality, Inc, old Supertel paid a dividend to its stockholders of record in the amount of its accumulated earnings and profits for federal income tax purposes |
| Accordingly, we should not have succeeded to any of the then current and accumulated earnings and profits of Supertel |
| However, the determination of accumulated earnings and profits for federal income tax purposes is extremely complex and Supertel’s computations of its accumulated earnings and profits are not binding upon the Internal Revenue Service |
| Should the IRS successfully assert that the old Supertel’s accumulated earnings and profits were greater than the amount distributed by Supertel, we may fail to qualify as a REIT 8 ______________________________________________________________________ [33]Table of Contents Our sale of assets acquired in a 1999 merger within ten years of the merger will result in tax |
| In connection with our election to be taxed as a REIT, we have elected to be subject to the “built-in gain” rules |
| Under these rules, taxes may be payable at the time and to the extent that the net unrealized gains on assets acquired, which included hotels, in the 1999 merger with the old Supertel Hospitality, Inc |
| are recognized in taxable dispositions of such assets in the subsequent ten-year period |
| This ten-year period expires October 2009 |
| We recognized built-in gains taxes of dlra286cmam000 due to dispositions of five of those hotels in 2004 |
| Our debt service obligations could require us to liquidate our properties and may reduce cash available for distribution to our shareholders |
| As of December 31, 2005, we had approximately dlra92dtta0 million of existing indebtedness with maturity dates ranging from November 2006 to 2024 |
| Approximately dlra5dtta4 million of principal is due in 2006 and dlra12dtta4 million is due in 2007 |
| We cannot assure you that we will be able to re-finance or repay such debt when due or that the terms of any new debt financings will be as favorable to us as the terms of our existing debt financing |
| Adverse economic conditions could result in higher interest rates and other unfavorable terms on our current and future borrowings |
| Higher interest rates could increase debt service requirements on floating rate debt and could reduce the amounts available for distribution to our shareholders |
| In the past, we have obtained, and 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 relieve the adverse effects of interest rate fluctuations |
| In order to meet our debt service obligations, we may have to sell additional hotel investments, potentially at a loss or at times that prohibit us from achieving attractive returns |
| Failure to pay our indebtedness when due or failure to cure covenant defaults could result in higher interest rates during the period of such loan defaults, and could ultimately result in the loss of our hotels through lender foreclosure |
| Our ability to make distributions to our shareholders is subject to fluctuations in our financial performance and operating results as well as capital improvement requirements |
| In the event of downturns in our operating results and financial performance, or unanticipated capital improvements to our hotels, including capital improvements that may be required by our franchisors, we may need to reduce the amount of distributions to our shareholders |
| The amount and timing of distributions are in the sole discretion of our board of directors |
| We cannot assure you that we will be able to generate sufficient cash in order to fund future distributions or that any future distributions are likely to be at the same rate as our historical distributions |
| Among the factors that could adversely affect our results of operations and our distributions to shareholders are: decreased revenue per available room and reduced net operating profits or operating losses; increased debt service requirements, including those resulting from higher interest rates on our variable rate indebtedness; and capital expenditures at our hotels, including capital expenditures required by the franchisors of our hotels |
| Hotel revenue can decrease for a number of reasons, including increased competition from new hotel rooms and decreased demand for hotel rooms |
| These factors can reduce both occupancy and room rates at our hotels |
| Our returns depend on management of our hotels by third parties |
| In order to qualify as a REIT, we cannot operate any hotel or participate in the decisions affecting the daily operations of any hotel |
| However, TRS Lessee may not operate the leased hotels and, therefore, must enter into management agreements with third-party eligible independent contractors to manage the hotels |
| Thus, an independent operator under a management agreement with TRS Lessee controls the daily operations of each of our hotels |
| 9 ______________________________________________________________________ [34]Table of Contents Under the terms of such management agreement, our ability to participate in operating decisions regarding the hotels is limited |
| We depend on Royal Host Management to adequately operate our hotels as provided in the management agreement |
| 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 and average daily rates, we may not be able to force Royal Host Management 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 TRS lessee, and then only to the extent of the remedies provided for under the terms of the management agreement |
| Additionally, in the event that we need to replace our management company, we may experience decreased occupancy and other significant disruptions at our hotels and in our operations generally |
| Our ability to make distributions to our shareholders may be affected by factors in the hotel industry that are beyond our control |
| Operating Risks Our hotels are subject to various operating risks found throughout the hotel industry |
| These include, among other things, the following: • our hotels compete with other hotel properties in their respective geographic markets, and many of our competitors have substantially greater marketing and financial resources than we do; • over-building in our markets, which adversely affects occupancy and revenues at our hotels; • dependence on business and commercial travelers and tourism; • terrorist incidents which may deter travel; • increases in energy costs, airline fares and other expenses, which may affect travel patterns and reduce the number of business and commercial travelers and tourists; and • adverse effects of general, regional and local economic conditions |
| These factors could adversely affect the amount of rent we receive from leasing our hotels and reduce the net operating profits of TRS Lessee, which in turn could adversely affect our ability to make distributions to our shareholders |
| Decreases in room revenues of our hotels will result in reduced operating profits for TRS Lessee and decreased lease revenues to our company under our current percentage leases with TRS Lessee |
| Competition for Acquisitions We compete for investment opportunities with entities that have substantially greater financial resources than we do |
| These entities generally may be able to accept more risk than we can manage wisely |
| This competition may generally limit the number of suitable investment opportunities offered to us |
| This competition may also increase the bargaining power of property owners seeking to sell to us, making it more difficult for us to acquire new properties on attractive terms |
| Seasonality of Hotel Business The hotel industry is seasonal in nature |
| Generally, occupancy rates and hotel revenues are greater in the 10 ______________________________________________________________________ [35]Table of Contents second and third quarters than in the first and fourth quarters, with the exception of our hotels located in Florida |
| This seasonality can be expected to cause quarterly fluctuations in our lease revenues |
| Our quarterly earnings may be adversely affected by factors outside our control, including bad weather conditions and poor economic factors |
| As a result, we may have to enter into short-term borrowings in our first and fourth quarters in order to offset these fluctuations in revenues |
| Our investment strategy is to acquire interests in limited service hotel properties |
| Therefore, a downturn in the hotel industry in general and the limited service segment in which we operate in particular will have a material adverse effect on our lease revenues and amounts available for distribution to our shareholders |
| Capital Expenditures Our hotels 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 periodic capital improvements as a condition of keeping the franchise licenses |
| The costs of all of these capital improvements could adversely affect our financial condition and reduce the amounts available for distribution to our shareholders |
| These renovations may give rise to the following risks: • possible environmental problems; • construction cost overruns and delays; • a possible shortage of available cash to fund renovations and the related possibility that financing for these renovations may not be available to us on affordable terms; and • uncertainties as to market demand or a loss of market demand after renovations have begun |
| For the twelve months ended December 31, 2005, we spent approximately dlra4dtta9 million for capital improvements to our hotels |
| Investment risks in the real estate industry generally may adversely affect our ability to make distributions to our shareholders |
| General Risks of Investing in Real Estate Our investments in hotels are subject to varying degrees of risk that generally arise from the ownership of real property |
| The underlying value of our real estate investments, and our income and ability to make distributions to our shareholders depends on maintaining or increasing room revenues and operating income of our hotels |
| Both income from our hotels and our ability to make distributions to our shareholders may be adversely affected by changes beyond our control, TRS Lessee’s control and the hotels’ managers’ control, including the following: • adverse changes in national 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; 11 ______________________________________________________________________ [36]Table of Contents • changes in operating expenses; • civil unrest, acts of war and acts of God, including earthquakes, floods and other natural disasters, which may result in uninsured and underinsured losses; and • the relative illiquidity of real estate investments |
| Uninsured and Underinsured Losses We maintain comprehensive insurance on each of our hotels, including liability, fire and extended coverage of the type and amount we believe are customarily obtained for or by hotel owners |
| However, various types of catastrophic losses, like earthquakes, floods and wars, may not be insurable or may not be economically insurable |
| In the event of a substantial loss, our insurance coverage may not be able to cover the full current market value or replacement cost of our lost investment |
| 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 |
| Our insurance premiums may increase significantly in the future, which may have a materially adverse impact on our cash flow |
| Furthermore, we may not be able to purchase policies in the future with coverage limits and deductibles similar to those purchased for the year 2006 |
| Because it is impossible to determine what kind of policies will be available in the future and at what prices, we are unable to determine whether we will be able to maintain insurance coverage levels similar to those secured for 2006 |
| Our real property insurance policies put into effect on December 31, 2004 include limited terrorism coverage, except for acts of war |
| Increases in property taxes could adversely affect our cash flow |
| Real and personal property taxes on our current and future hotel properties may increase as property tax rates change and as the properties are assessed or reassessed by taxing authorities |
| An increase in property taxes could have an adverse effect on our ability to make distributions to shareholders |
| Increases in occupancy taxes and other local taxes could adversely affect our cash flow |
| The cities and counties in which our hotels operate periodically attempt to increase their revenue by imposing additional local taxes, which may be assessed both on the room charges to our customers and on a per diem basis |
| Because of our negotiated room rates for some customers and market circumstances generally, we may not be able to fully pass on these charges to our customers, and so an increase in these taxes could have an adverse effect on our cash flow and our ability to make distributions to shareholders |
| Operating our hotels under franchise agreements could adversely affect distributions to our shareholders |
| Seventy Five of our hotels operate under franchise agreements and we are subject to the risks of concentrating our hotel investments in several franchise brands |
| These risks include reductions in business following negative publicity related to one of our particular brands |
| Risks associated with our brands could adversely affect our lease revenues and the amounts available for distribution to our shareholders |
| 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 TRS Lessee follow their standards |
| Failure to maintain these standards or other terms and conditions could result in a franchise license being canceled |
| 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 |
| 12 ______________________________________________________________________ [37]Table of Contents 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 |
| As of December 31, 2005, TRS Lessee holds all of the franchise licenses for our hotels |
| 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 cash available for distribution to shareholders |
| Our inability to obtain financing could limit our growth |
| We are required to distribute at least 90prca of our REIT taxable income to our shareholders each year in order to continue to qualify as a REIT Our debt service obligations and distribution requirements limit our ability to fund capital expenditures, acquisitions and hotel development through retained earnings |
| Our ability to grow through acquisitions or development of hotels will be limited if we cannot obtain debt or equity financing |
| Neither our articles of incorporation nor our bylaws limit the amount of debt we can incur |
| Our board can implement and modify a debt limitation policy without shareholder approval |
| We cannot assure you that we will be able to obtain additional equity financing or debt financing or that we will be able to obtain any financing on favorable terms |
| 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 the owner of a contaminated property to clean up the property, even if the owner did not know of or was 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, contamination can affect the value of a property and, therefore, an owner’s ability to borrow funds using the property as collateral |
| Under these environmental laws, courts and government agencies also have the authority to require that a person who sent waste to a waste disposal facility, like a landfill or an incinerator, pay for the clean-up of that facility if it becomes contaminated and threatens human health or the environment |
| Furthermore, 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 suffers injury from the asbestos |
| Lastly, some of these environmental laws restrict the use of a property or place conditions on various activities at a property |
| One example is laws that require a business using chemicals to manage them carefully and to notify local officials that the chemicals are being used |
| Our company could be responsible for the costs discussed above if it found itself in one or more of these situations |
| The costs to clean up a contaminated property, to defend against a claim, or to comply with environmental laws could be material and could affect the funds available for distribution to our shareholders |
| To determine whether any costs of this nature might be required, we commissioned Phase I environmental site assessments, or “ESAs” before we acquired our hotels, and in 2002, commissioned new ESAs for 32 of our hotels in conjunction with a refinancing of the debt obligations of those hotels |
| These studies typically included a review of historical information and a site visit, but not soil or groundwater testing |
| We obtained the ESAs to help us identify whether we might be responsible for cleanup costs or other costs in connection with our hotels |
| The ESAs on our hotels did not reveal any environmental conditions that are likely to have a material adverse effect on our business, assets, results of operations or liquidity |
| However, ESAs do not always identify all potential problems or environmental liabilities |
| Consequently, we may have material environmental liabilities of which we are unaware |
| 13 ______________________________________________________________________ [38]Table of Contents 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 obtaining damages |
| If we were required to make substantial modifications to our hotels, whether to comply with the ADA or other changes in governmental rules and regulations, our ability to make distributions to our shareholders and meet our other obligations could be adversely affected |
| Mold claims could adversely affect our financial condition |
| Public consciousness regarding mold has recently been elevated and if mold is detected in any of our hotels, we may be subject to adverse publicity, which could adversely affect our operations and financial results from that hotel |
| Such claims could require us to spend significant time and money in litigation or pay significant damages |
| In addition, we may be required to close all or portions of the affected hotel during mold remediation operations, which under certain conditions may be difficult to eradicate |
| We may be required to remove and replace moldy materials in the hotel, or perform extensive facility repairs, and the presence of mold in any hotel also could adversely impact the fair market value of that hotel |
| Provisions of our articles of incorporation and Virginia law may limit the ability of a third party to acquire control of our company |
| Ownership Limitation Our articles of incorporation provide that no person may directly or indirectly own more than 9dtta9prca of our common stock or 9dtta9prca of any series of our preferred stock |
| This may prevent an acquisition of control of our company by a third party without our board’s approval, even if our shareholders believe the change of control is in their interest |
| Authority to Issue Preferred Stock Our articles of incorporation authorize our board to issue up to 10cmam000cmam000 shares of preferred stock and to establish the preferences and rights of any shares issued |
| The issuance of shares of preferred 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 capital stock, even if shareholders believe that a change of control is in their interest |
| Virginia Anti-Takeover Statutes As a Virginia corporation, we are subject to various anti-takeover laws found in the Virginia Stock Corporation Act |
| These laws place restrictions and require compliance with various procedures designed to protect the shareholders of Virginia corporations against unfair or coercive mergers and acquisitions |
| These restrictions and procedural requirements may discourage takeover offers for, or changes in control of, our company, including transactions at a premium over the market price of our capital stock, even if shareholders believe that a change of control is in their interest |
| Our ownership limitation may prevent you from engaging in certain transfers of our capital stock |
| In order to maintain our REIT qualification, no more than 50prca in value of our outstanding capital stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the federal income tax laws to include various kinds of entities) during the last half of any taxable year |
| In addition, if any shareholder or group of related or affiliated shareholders of our lessee owns, actually or constructively, 10prca or more of our stock, we likely would lose our REIT status |
| Our articles of incorporation contain the ownership limitation, which prohibits both direct and indirect ownership of more than 9dtta9prca of the outstanding shares of our common stock or 9dtta9prca of any series of our preferred stock by any person, subject to several exceptions |
| Generally, any shares of our capital stock owned by affiliated owners will be added together for purposes of the ownership limitation |
| 14 ______________________________________________________________________ [39]Table of Contents If anyone transfers shares in a way that would violate the ownership limitation or prevent us from continuing to qualify as a REIT under the 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 |
| Those shares instead will be transferred to a trust for the benefit of a charitable beneficiary and will be either redeemed by our company or sold to a person whose ownership of the shares will not violate the ownership limitation |
| Anyone who acquires shares in violation of the ownership limitation or the other restrictions on transfer in our articles of incorporation bears the risk that he will suffer 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 |
| We may not be able to complete development of new hotels on time or within budget |
| We may develop hotel properties as suitable opportunities arise |
| New project development is subject to a number of risks that could cause increased costs or delays in our ability to generate revenue from any development hotel, reducing our cash available for distribution to shareholders |
| These risks include: • construction delays or cost overruns that may increase project costs; • competition for suitable development sites; • receipt of zoning, land use, building, construction, occupancy and other required governmental permits and authorizations; and • substantial development costs in connection with projects that are not completed |
| We may not be able to complete the development of any projects we begin and, if completed, our development and construction activities may not be completed in a timely manner or within budget |
| We may also rehabilitate hotels that we believe are underperforming |
| These rehabilitation projects will be subject to the same risks as development projects |
| Hotels that we develop have no operating history and may not achieve levels of occupancy that result in levels of operating income that provide us with an attractive return on our investment |
| These hotels, both during the start-up period and after they have stabilized, may not achieve anticipated levels of occupancy, average daily room rates, or gross operating margins, and could result in operating losses and reduce the amount of distributions to our shareholders |
| Property ownership through joint ventures and partnerships could limit our control of those investments |
| Joint ventures or partnerships involve risks not otherwise present for investments we make on our own |
| It is possible that our co-venturers or partners may have different interests or goals than we do at any time and that they may take actions contrary to our requests, policies or objectives, including our policy with respect to maintaining our qualification as a REIT Other risks of joint venture investment include impasses on decisions, because no single co-venturer or partner has full control over the joint venture or partnership |
| Joint ventures may include other restrictions on us, including requirements that we provide the joint venture with the right of first offer or right of first refusal to acquire any new property we consider acquiring directly |
| 15 ______________________________________________________________________ [40]Table of Contents Our business could be disrupted if we need to find a new manager upon termination of an existing management agreement |
| If Royal Host Management fails to materially comply with the terms of their management agreement, we have the right to terminate such management agreement |
| Upon termination, we would have to find another manager to manage the property |
| We cannot operate the hotels directly due to federal income tax restrictions |
| We cannot assure you that we would be able to find another manager or that, if another manager were found, we would be able to enter into a new management agreement favorable to us |
| Our franchisors may require us to make substantial capital improvements to the hotels prior to their approval, if required, of a new manager |
| There would be disruption during any change of hotel management that could adversely affect our operating results and reduce our distributions to our shareholders |
| If we decide to sell hotels, we may not be able to sell those hotels on favorable terms |
| We may decide to sell additional hotels in the future |
| We may not be able to sell such hotels on favorable terms, and such hotels may be sold at a loss |
| As with acquisitions, we face competition for buyers of our hotel properties |
| Other sellers of hotels may have the financial resources to dispose of their hotels on unfavorable terms that we would be unable to accept |
| If we cannot find buyers for any properties that are designated for sale, we will not be able to implement our divestiture strategy |
| In the event that we cannot fully execute our divestiture strategy or realize the benefits therefrom, we will not be able to fully execute our growth strategy |
| We depend on key personnel |
| We depend on the efforts and expertise of our Chief Executive Officer and Chief Financial Officer to drive our day-to-day operations and strategic business direction |
| The loss of any of their services could have an adverse effect on our operations |
| Our ability to replace key individuals may be difficult because of the limited number of individuals with the breadth of skills and experience needed to excel in the hotel industry |
| There can be no assurance that we would be able to hire, train, retain or motivate such individuals |