| WINSTON HOTELS INC Item 1A RISK FACTORS An investment in our securities involves various risks |
| You should carefully consider the following risk factors in conjunction with the other information contained herein before purchasing our securities |
| The risks discussed herein can adversely affect our business, liquidity, operating results, prospects, and financial condition |
| This could cause the market price of our securities to decline and could cause you to lose all or part of your investment |
| The risk factors described below are not the only risks that may affect us |
| Additional risks and uncertainties not presently known to us also may adversely affect our business, liquidity, operating results, prospects, and financial condition |
| Risks Relating to Our Business Our ability to make distributions to our shareholders depends upon the ability of our hotel managers to operate our hotels effectively |
| In order to qualify as a REIT, we cannot operate any hotel, or directly participate in the decisions affecting the daily operations of any hotel |
| Our third-party managers under management agreements have direct control of the daily operations of our hotels |
| We do not have the authority to directly control any particular aspect of the daily operations of any hotel (eg, setting room rates) |
| Thus, even if we believe our hotels are being operated in an inefficient or sub-optimal manner, we may not be able to require a change to the method of operation |
| Our only alternative for changing the operation of our hotels may be to replace the third party manager of one or more hotels in situations where the applicable management agreement permits us to terminate the existing manager |
| Our ability to make distributions to our shareholders depends on the ability of our hotel managers to generate sufficient revenues from our hotels in excess of operating expenses |
| Our managers will be affected by factors beyond their control, such as changes in the level of demand for rooms and related services of our hotels, their ability to maintain and increase gross revenues and operating margins at our hotels, and other factors |
| As of December 31, 2005, 42 of our hotels were managed by Alliance and six of our hotels were managed by Marriott International |
| Therefore, any operating difficulties or other factors specifically affecting Alliance’s or Marriott International’s ability to maintain and increase gross revenues and operating margins at our hotels could significantly adversely affect our financial condition and results of operations |
| In addition, our growth strategy contemplates additional hotel acquisitions that meet our investment criteria and selective development of hotels as market conditions warrant |
| Our ability to grow depends, in part, upon the ability of our third-party managers to manage our current and future hotels effectively |
| If the third-party managers are not able to operate additional hotels at current staffing levels and office locations, they may need to hire additional personnel, engage additional third party managers and/or operate in new geographic locations |
| If the third-party managers fail to operate the hotels effectively, our ability to generate income from the hotels would be adversely affected |
| Additional terrorist attacks, such as the events of September 11, 2001 and the threat of additional terrorist attacks could have an adverse effect on our results of operations |
| The terrorist attacks of September 11, 2001, combined with the effects of the resulting recession and weak economic recovery, led to a substantial reduction in business and leisure travel throughout the United States |
| We cannot predict the extent to which additional terrorist attacks and/or concerns about possible additional terrorist attacks will continue to directly or indirectly impact the hotel industry or our operating results in the future |
| Additional terrorist attacks could have further material adverse effects on the hotel industry and our operations |
| We may not have access to financing for acquiring or developing additional hotels, or for providing hotel loans |
| Our ability to pursue our growth strategy depends, in part, on our ability to finance additional hotel acquisitions and development and additional hotel loans |
| We may not be able to fund growth solely from cash provided from operating activities because we must distribute at least 90prca of our taxable income to our shareholders each year to maintain our tax status as a REIT We normally distribute 100prca in order to avoid paying corporate income tax and 11 _________________________________________________________________ excise tax on undistributed income |
| Consequently, we rely upon the availability of debt or equity capital to fund hotel acquisitions and improvements and hotel loans |
| We cannot assure you that we will be successful in attracting sufficient debt or equity financing at an acceptable cost to fund future growth |
| We are subject to restrictions that may limit our ability to take advantage of expansion opportunities that we believe are attractive |
| Our ability to raise additional equity capital will depend on market conditions |
| We cannot assure you that we will be able to raise funds through a public or private offering at a time when we need access to funds |
| We may seek alternative methods of funding expansion, such as joint venture development; however, we cannot assure you that such opportunities will be available when we need them or on acceptable terms |
| We have a significant level of debt that may limit our ability to take certain actions |
| We currently have a significant amount of debt |
| As of December 31, 2005, we had dlra157dtta9 million and dlra99dtta9 million outstanding under our lines of credit and mortgage loans, respectively |
| Our level of debt could have important consequences to you |
| For example, it could: • impair our ability to obtain additional financing, if needed, for working capital, capital expenditures, acquisitions or other purposes in the future; • require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing our funds available for operations, future business opportunities and other purposes; • place us at a disadvantage compared to competitors that have less debt; • restrict our ability to adjust rapidly to changing market conditions; and • increase our vulnerability to adverse economic, industry and business conditions |
| If we do not have sufficient funds to repay our debt at maturity, it may be necessary for us to refinance our debt through additional debt financing, private or public offerings of debt securities or additional equity offerings |
| 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 shareholders |
| If we are unable to refinance our debt on acceptable terms, we may be forced to dispose of hotels or other assets on disadvantageous terms, potentially resulting in losses and adverse effects on cash flow from operating activities |
| If we are unable to make required payments of principal and interest on debt collateralized by our hotels, one or more of those properties could be foreclosed upon by the lender with a consequent loss of revenue and asset value |
| Our indebtedness imposes limitations on our operations and subjects us to risk of default |
| On March 11, 2005, the Company, through its wholly owned subsidiary, Winston SPE II LLC (“SPE II”), entered into the GE Line |
| The GE Line limits our borrowing availability to an amount based primarily upon the net operating income of the hotels that serve as collateral for the GE Line |
| If the net operating income of the hotels provided as collateral declines, and our resulting availability under the GE Line is less than the balance outstanding, we must repay the total outstanding advances to the extent required to eliminate the excess or provide additional collateral, which may not be available, to increase our borrowing availability to the total amount of debt we need, up to a maximum amount of dlra215 million |
| Forty-three of our wholly owned hotels have been pledged as collateral for our debt facilities, 29 against the GE Line and 14 against the GE Capital CMBS loan |
| As of March 14, 2006, five of the Company’s wholly owned properties were unencumbered and remained eligible to be pledged as collateral for increased borrowing availability under the GE Line |
| The GE Line contains customary special purpose restrictions on SPE II and includes usual and customary events of default for facilities of this nature |
| The GE Line further provides that, upon and during the continuation of an event of default, including our inability to repay the excess debt over our borrowing availability or provide additional collateral to increase our borrowing availability, all outstanding loans under the line of credit may be accelerated, the lender’s commitments to make any further loans may be terminated and the lender may foreclose on the collateral |
| In addition, upon the occurrence of certain insolvency or bankruptcy related events of default, all outstanding loans under the GE Line will automatically become due and payable and the lender’s commitment to make any further loans will automatically terminate |
| 12 _________________________________________________________________ Rising interest rates could adversely affect our cash flow |
| Our borrowings under the GE Line bear interest at a variable rate |
| Although we have entered into an interest rate cap agreement that limits our interest rate exposure to increases in 30-day LIBOR over 6dtta14prca on the outstanding debt under the GE Line, increases in interest rates up to this limit could increase our interest expense and adversely affect our cash flow |
| Thus, in a period of rising interest rates, our interest expense would increase, while the interest we earn on our fixed-rate debt investments would not change, adversely affecting our profitability |
| In addition, the value of our fixed rate hotel loans would be impaired if market interest rates rose, which would make it difficult for us to sell the loans |
| We also may incur debt in the future that bears interest at a variable rate or we may be required to refinance our existing debt at higher interest rates, both of which could also increase our interest expense and adversely affect our cash flow |
| We may not be able to complete development of new hotels on time or within budget |
| We intend to develop additional 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 and/or the emergence of unanticipated competition from other hotels; • uncertainties as to market demand or deterioration in market demand after commencement of development; • 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 also intend to 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 |
| Property ownership through joint ventures could limit our control of those investments |
| Hotel investments through joint ventures 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 |
| Each of our venture partners for our existing joint venture properties has the right, after the first twelve months of the hotel’s operation, to sell the hotel developed by the joint venture to us, or, if we elect not to purchase, to sell such hotel to a third party |
| In addition, future 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 |
| Our business could be disrupted if we need to find a new manager upon termination of an existing management agreement |
| If our managers fail to materially comply with the terms of their management agreements, we have the right to terminate such management agreements |
| 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 13 _________________________________________________________________ we would be able to find another manager or that, if another manager were found, we would be able to enter into new management agreements favorable to us |
| There would be disruption during any change of hotel management that could adversely affect our operating results |
| If we decide to sell hotels, we may not be able to sell those hotels on favorable terms |
| We sold nine hotels during the past four years, four in 2002, two in 2004 and three in 2005 |
| On November 4, 2005, the Company’s Board of Directors adopted a formal plan to sell the two hotels for which impairment charges were taken during the third quarter |
| 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 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 there from, we will not be able to fully execute our growth strategy |
| If third parties for whom we develop hotels default on their loans, we may be required to complete the development of those hotels at our own expense |
| In certain cases where we are offering third party hotel development services in exchange for fees, we may elect to provide the hotel owner/developer with a construction completion guaranty on the particular hotel under development |
| In those cases, if the owner/developer were in default under the terms and conditions of its senior loans, its senior lenders might seek to compel us to complete the development of the particular hotel with our own funds, which could materially adversely affect our business, financial condition and results of operations |
| We may face conflicts of interest relating to sales of hotels acquired from affiliates |
| We have acquired 12 hotels in the past from related parties of our affiliates, which include Robert Winston, our Chief Executive Officer, and Charles Winston, our Chairman of the Board of Directors for consideration that included units of limited partnership interest in the Partnership |
| Robert Winston and Charles Winston in the aggregate own approximately 95prca of the limited partnership interests in the Partnership |
| The limited partners of the Partnership, including Robert Winston and Charles Winston, may have unrealized gains associated with their interests in these hotels |
| Our sale of any of those hotels may cause adverse tax consequences to the limited partners |
| Therefore, our interests could conflict with the interests of the limited partners in connection with the disposition of one or more of those 12 hotels, including limited partners who may be board members or otherwise in a position to exert influence over other board members who will determine whether we sell these hotels, which could result in decisions that are not in the best interest of all shareholders |
| We depend on key personnel, the loss of which could have a material adverse effect on our Company |
| We depend on the efforts and expertise of our Chief Executive Officer, President and Chief Financial Officer, Chief Accounting Officer and Chief Development 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 |
| Risks Related to Hotel Lending Program The hotel mortgage loans that we originate and purchase are subject to the risks of delinquency and foreclosure, which could result in losses to us |
| Some of our mortgage loans are collateralized by the property and are subject to risks of delinquency and foreclosure, and risks of loss |
| Typically we have no recourse to the personal assets of our borrowers |
| The ability of a borrower to repay a loan collateralized by an income-producing property typically is dependent primarily upon the successful operation of the property rather than upon the existence of independent income or assets of the borrower |
| If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired |
| Net operating income of an income-producing property can be affected by the risks particular to real property described below, as well as, among other things: • increased costs imposed on hotel owners by franchisors such as hot and cold breakfasts, new linens and other required improvements; 14 _________________________________________________________________ • property management decisions; • property location and condition; • competition from comparable types of properties; • changes in specific industry segments; • declines in regional or local real estate values, or occupancy rates; and • increases in interest rates, real estate tax rates and other operating expenses |
| In the event of any default under a mortgage loan held directly by us, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan, which could have a material adverse effect on our cash flow from operations and limit amounts available for distribution to our shareholders |
| In the event of the bankruptcy of a mortgage loan borrower, the mortgage loan to that borrower will be deemed to be collateralized only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law |
| Foreclosure of a mortgage loan can be an expensive and lengthy process that could have a substantial negative effect on our anticipated return on the foreclosed mortgage loan |
| We may also be forced to foreclose on properties outside of our traditional hotel investment expertise, be unable to sell these properties and be forced to incur substantial expenses to improve operations at the hotel |
| The B-Notes in which we invest may be subject to additional risks relating to the privately negotiated structure and terms of the transaction, which may result in losses to us |
| A B-Note is a mortgage loan typically (i) collateralized by a first mortgage on a single hotel or group of related properties and (ii) subordinated to an A-Note collateralized by the same first mortgage on the same collateral |
| As a result, if a borrower defaults, there may not be sufficient funds remaining for B-Note holders after payment to the A-Note holders |
| B-Notes reflect similar credit risks to comparably rated commercial mortgage backed securities |
| However, since each transaction is privately negotiated, B-Notes can vary in their structural characteristics and risks |
| For example, the rights of holders of B-Notes to control the process following a borrower default may be limited in certain investments |
| We cannot predict the terms of each B-Note investment |
| Further, B-Notes typically are collateralized by a single property, and so reflect the increased risks associated with a single property |
| B-Notes may also be illiquid, thus we may be unable to dispose of underperforming or non-performing investments |
| The higher risks associated with our subordinate position in our B-Note investments could subject us to increased risk of losses |
| Investments in mezzanine loans involve greater risks of loss than senior loans collateralized by income producing properties |
| Investments in mezzanine loans take the form of subordinated loans collateralized by second mortgages on the underlying property or subordinate loans collateralized by a pledge of the ownership interests in the entity that directly or indirectly owns the property |
| These types of investments involve a higher degree of risk than a senior mortgage loan because the investment may become unsecured as a result of foreclosure by the senior lender |
| In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of the property owning entity, or the assets of the entity may not be sufficient to satisfy our mezzanine loan |
| If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt is paid in full |
| In addition, mezzanine loans may have higher loan to value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal |
| Our hotel loan program subjects us to the unique risks of a mezzanine lender |
| A mezzanine lender has some of the same risks as a traditional real estate lender, such as lender liability for improperly exercising control over the borrower and environmental risks as a potentially responsible party liable for environmental damage in connection with the property owned by the borrower |
| A mezzanine lender may enhance these risks by pursuing remedies on default that afford greater control over the operations of the borrower, especially if the mezzanine lender exercises its authority as a managing or co-managing member |
| Courts have discretion to decline to enforce loan features which purport to limit or modify a mortgagor’s right to redeem real estate after a mortgage default and before foreclosure by paying off the loan, and thus some remedies specified in our mezzanine loans may be unavailable to us |
| In addition a borrower may allege that being in the position to control the 15 _________________________________________________________________ borrowing entity creates duties by the lender to the borrower, including fiduciary-like duties that may conflict with the lender’s ability to exercise its remedies |
| Finally, to be able to protect its mezzanine loan, a mezzanine lender may have to advance additional funds to cure defaults on senior loans |
| We may not have the ability to improve the operations of the hotel property once we exercise our control rights |
| In some cases, we have made loans to hotels that do not fit our traditional investment criteria and may not have the appropriate expertise to manage these properties |
| We may incur additional costs and resources which divert attention from our core operations |
| Risks Relating to the Real Estate Industry Our performance and the value of our stock are subject to risks associated with the hotel industry |
| Our hotels are subject to operating risks of the hotel industry that could reduce our revenue, gross operating margins, and ability to make distributions to shareholders |
| Our hotels are subject to all operating risks common to the hotel industry |
| These factors could adversely affect the ability of our hotels to generate operating income and therefore affect our ability to make distributions to our shareholders |
| These risks include, but are not limited to: • competition for guests from other hotels, many of which have substantial marketing and financial resources; • faster growth in room supply than in room demand growth in our markets; • increases in operating costs due to inflation and other factors which may not be offset in the future by increased room rates; • seasonality, with higher hotel revenues occurring in the second and third calendar quarters; • increases in energy costs, airline fares and other expenses related to travel, which may deter traveling; • terrorist incidents, which may also deter traveling; • adverse effects of general and local economic conditions; • a general inability to control costs, thereby resulting in lower gross operating profit; and • risks generally associated with the ownership of hotels and real estate, as discussed below |
| Our entire business is concentrated in particular segments of a single industry |
| Our investment strategies include acquiring additional hotels, or ownership interests in hotels, with strong national franchise affiliations in the “full service,” “extended stay,” “mid-scale without food and beverage,” “upscale,” and “upper upscale” market segments, or hotel properties with the potential to obtain such franchise affiliations |
| Therefore, a downturn in the hotel industry, in general, and the segments in which we operate, in particular, will have a material adverse effect on our income and the amounts available for distribution to our shareholders |
| Large-scale military deployments may adversely impact the occupancy rates and revenues from our two hotels located in communities that have a large military population |
| Currently, we own two hotels located in communities with a large military presence; one near Fort Bragg in Fayetteville, North Carolina and one near Camp Lejeune in Jacksonville, North Carolina |
| Over the last four years in Fayetteville, the reservists and National Guard troops have been called into Fayetteville to operate the base |
| Now, most all of the reservists and guardsmen are stationed in the Middle East and the troops stationed at Fort Bragg are living at home |
| Only small groups are being deployed from Fayetteville at this time and they are no longer being replaced with reservists or guardsmen |
| Also, the few reservists and guardsmen that remain have been given options to relocate from hotels to apartments |
| The occupancy rate for the Comfort Inn in Fayetteville, North Carolina was adversely affected and decreased to 62dtta3prca for the year ended December 31, 2005 compared to 84dtta8prca for the year ended December 31, 2004 |
| Primarily as a result of the decreased military business, the Company temporarily closed a portion of the Comfort Inn in Fayetteville, reducing the number of rooms from 176 to 123 |
| In Jacksonville, our military business is dependent upon the ships that are transporting troops back and forth to many destinations, not just the Middle East |
| The occupancy rate for the Hampton Inn in Jacksonville, North Carolina was positively affected and increased to 81dtta9prca for the year ended December 31, 2005 compared to 72dtta6prca for the year ended December 31, 2004 |
| 16 _________________________________________________________________ With a large number of military personnel deployed away from their permanent duty stations for an extended period as is currently happening with the war on terror, we expect that occupancy rates and RevPAR at those two hotels will continue to be affected |
| We cannot predict the extent to which additional deployments will continue to impact the operating results of our two hotels |
| We may incur higher costs as a result of the proximity of our hotels to the coast |
| Several of our hotels are located near the Atlantic Ocean and are exposed to more severe weather than hotels located inland |
| Hurricanes could cause a loss of revenues from these hotels, which could have an adverse effect on us as a result of our assets on the coast |
| These hotels are also exposed to salt water and humidity, which can increase or accelerate wear on the hotels’ weatherproofing and mechanical, electrical and other systems |
| As a result, we may incur additional operating costs and expenditures for capital improvements |
| Our hotel concentration in the Southeastern United States subjects us to increased risks than if our portfolio were more geographically diversified |
| At December 31, 2005, 28 out of our 49 wholly owned hotels were located in the five eastern seaboard states ranging from Virginia to Florida, including 16 hotels located in North Carolina |
| Adverse events in these areas, such as economic recessions, hurricanes or other natural disasters, could cause a loss of revenues from these hotels, which could have a greater adverse effect on us as a result of our concentration of assets in this area |
| Our geographic concentration also exposes us to risks of oversupply and competition in our principal markets |
| A number of additional hotel rooms will continue to be built in the markets in which our hotels are located, which could result in too many hotel rooms in those regions |
| Significant increases in the supply of hotel rooms without corresponding increases in demand can have a severe adverse effect on our business, financial condition and results of operations |
| Conditions of franchise agreements could adversely affect us |
| Of the 56 hotels in which the Company holds an ownership interest, 55 are operated under franchises from nationally recognized franchisors including Marriott International, Inc, Hilton Hotels Corporation, Intercontinental Hotels Group PLC, (formerly Six Continents PLC) and Choice Hotels International |
| In addition, hotels in which we subsequently invest may be operated pursuant to franchise agreements |
| A hotel’s failure to adhere to the terms and conditions of the franchise agreement could result in the loss or cancellation of its franchise license |
| We rely on our managers to conform to such franchisor standards |
| The franchise agreements generally contain specific standards for, and restrictions and limitations on, the operation and maintenance of a hotel in order to maintain uniformity within the franchisor’s system |
| These standards are subject to change over time, in some cases at the discretion of the franchisor, and may restrict our ability to make improvements or modifications to a hotel without the consent of the franchisor |
| In addition, compliance with these standards could require us to incur significant expenses or 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 |
| Recently our franchisors have required improvements to our hotels, such as the provision of hot breakfasts and higher quality linens |
| These improvements have proven costly but have not necessarily marginally increased our RevPAR, or revenue per available room |
| Our cash available for distribution could be adversely affected if we must incur substantial costs to maintain a franchise license |
| If a franchise license terminates due to our failure to make required improvements or to otherwise comply with its terms, we may be liable to the franchisor for a termination payment |
| These termination payments would vary by franchise agreement and by hotel |
| The loss of a number of franchise licenses and the related termination payments could have a material adverse effect on our business, financial condition and results of operations |
| The franchise agreements provide for termination at the franchisor’s option upon the occurrence of certain events, including the Company’s failure to pay royalties and fees or perform its other covenants under the franchise agreement, bankruptcy, abandonment of the franchise, commission of a felony, assignment of the franchise without the consent of the franchisor, or failure to comply with applicable law or maintain applicable standards in the operation and condition of the relevant hotel |
| The franchise agreements will not renew automatically upon expiration |
| The 55 hotels’ franchise licenses, including six joint venture hotels, expire as follows: 17 _________________________________________________________________ Year of Expiration Number of Hotels Year of Expiration Number of Hotels 2007 3 2016 2 2008 4 2017 11 2009 3 2018 5 2010 2 2019 6 2011 2 2020 1 2012 2 2022 3 2013 4 2023 1 2014 1 2024 3 2015 1 2025 1 The Company has recently received written notification from two franchisors that the franchise license agreements for three of its hotels, which expire in November 2007, January 2008 and March 2009, will not be renewed |
| On November 4, 2005, the Company’s Board of Directors adopted a formal plan to sell the two hotels, including one for which the franchise will not be renewed |
| Regarding the other two hotels the Company may decide to change the brand of the hotels prior to the expiration date |
| This situation is not expected to have a material impact on the Company’s results of operations in the future |
| There can be no assurance that other licenses will be renewed upon the expiration thereof |
| Such future non-renewals could have a material adverse effect on the Company |
| Operating costs and capital expenditures could adversely affect our cash flow |
| Hotels have an ongoing need for renovations and other capital improvements, particularly in older structures, including periodic replacement of furniture, fixtures and equipment |
| We are obligated to pay the cost of certain capital expenditures at the hotels and to pay for furniture, fixtures and equipment |
| Franchisors also may require periodic capital improvements to our hotels as a condition of retaining the franchise licenses |
| In addition, we intend to invest selectively in hotels that require significant renovation |
| Renovation of hotels involves certain risks, including: • the possibility of environmental problems; • construction cost overruns and delays; • uncertainties as to market demand or deterioration in market demand after commencement of renovation; • the emergence of unanticipated competition from other hotels; and • displacement of room revenues due to rooms being out of order |
| If any of these costs exceed our estimates, the additional costs could have an adverse effect on our cash available for distribution |
| We must compete with larger entities for acquisition and franchising opportunities |
| We compete for acquisition 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 prudently manage, including risks with respect to the creditworthiness of a hotel operator or the geographic proximity of its investments, and may have better relations with franchisors |
| Competition may reduce the number of suitable investment opportunities available to us and increase the bargaining power of sellers |
| In addition, other potential buyers who do not need to use a lessee or a third party operator to operate the hotel may be able to offer a higher price for a property than we are able to pay |
| Our performance and value are subject to the condition of the real estate industry |
| We may not be able to sell hotels when appropriate |
| Real estate investments generally cannot be sold quickly |
| We may not be able to vary our portfolio promptly in response to changes in economic and other conditions |
| Because we are a REIT, federal income tax laws limit our ability to sell properties in some situations when it may be economically advantageous to do so |
| As a result, returns to our shareholders could be adversely affected |
| In addition, we cannot assure you that the market value of any of our hotels will not decrease in the future, and therefore we may not be able to sell our hotels on favorable terms |
| 18 _________________________________________________________________ We may not be able to defer taxes on gains from sales of hotels |
| Selling older, underperforming hotels or hotels that no longer meet the Company’s yield objectives and investing the funds in acquisitions of hotels or hotel loans is one of the Company’s growth strategies |
| Under IRC section 1031, a taxpayer is allowed to postpone the recognition of gain on the disposition of qualifying realty to the extent that it uses the proceeds from the sale of the disposed property to acquire qualifying “like-kind” replacement property within a specific period of time |
| By reinvesting the sale proceeds, a taxpayer can defer the tax on the capital gain and any IRC section 1250 depreciation recapture, which is taxable at a 25prca rate, associated with the property |
| However, the taxpayer will recognize gain on the transaction to the extent that the taxpayer actually or constructively receives any non-like-kind property in exchange for the relinquished real property |
| The Company generally will attempt to structure its dispositions of real property as qualifying like-kind exchanges |
| However, there can be no assurance that the Company will be successful in so structuring its dispositions of real property |
| A significant tax gain on the sale of property could have an adverse effect on our results of operations if the tax associated with such gain cannot be deferred |
| Compliance with the FASB issued Interpretation Nodtta 47, “Accounting for Conditional Asset Retirement Obligations,” an interpretation of SFAS Nodtta 143, “Accounting for Asset Retirement Obligations” and other changes in accounting rules and regulations could adversely affect our results of operations |
| In March 2005, the FASB issued FIN 47 an interpretation of SFAS 143 |
| The interpretation clarifies that a legal obligation to perform an asset retirement activity that is conditional on a future event is within the scope of SFAS 143 |
| Accordingly, an entity is required to recognize a liability for the fair value of an ARO that is conditional on a future event if the liability’s fair value can be reasonably estimated |
| The interpretation also provides additional guidance for evaluating whether sufficient information is available to make a reasonable estimate of the fair value |
| The Company adopted the interpretation effective December 31, 2005 |
| As a result of adopting FIN 47, the Company recorded AROs and increased the value of its recorded assets to recognize the associated conditional retirement obligation of removing ACMs from certain properties |
| The Company used an expected cash flow approach to measure these obligations |
| The retirement liability is accreted through interest expense to the estimated payouts that would be made in the future if settlement of the liability were to occur |
| The increased asset value is depreciated following the Company’s policy for the hotel |
| Previously, the Company did not accrue any retirement liability for the expected retirement costs on these hotels due to the uncertainty associated with the timing and amount of payment |
| We recorded AROs with respect to known future remediation obligations at our hotels |
| We can make no assurance that the current environmental condition of our other hotel properties will not be affected by the condition of the properties in the vicinity of our hotel properties or by third parties unrelated to us or that additional remediation will not otherwise be required, which could require us to record further AROs |
| We can also make no assurance that the timing of the future abatement of ACMs or other AROs or other estimates used in calculating the AROs will not change, affecting our results of operations and financial position |
| We can also not predict the affects of any new accounting standards to our results of operations and financial position |
| Liability for environmental matters could adversely affect our financial condition |
| Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of investigation and removal or remediation of hazardous or toxic substances on, under, originating at or in the property, including fixtures, structures and other improvements located on the property |
| These laws often impose liability whether or not the owner or operator knew of (or should have known of), or caused, the presence of contaminants |
| Although Phase I ESAs were obtained on all of the hotels, the Phase I ESAs did not include invasive procedures, such as soil sampling or groundwater analysis |
| While the Phase I ESA reports have not revealed any environmental condition, liability or compliance concern that the Company believes would have a material adverse effect on the Company’s business, assets or results of operations, it is possible that these reports do not reveal all environmental conditions, liabilities or compliance concerns or that there are material environmental conditions, liabilities or compliance concerns of which the Company is unaware that arose at a hotel after the related Phase I ESA report was completed |
| 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 distributions to shareholders |
| Clean-up costs and the owner’s or operator’s liability generally are not limited under these laws and could exceed the value of the property and/or the aggregate assets of the owner or operator |
| In addition, the presence of, or failure to properly remediate, contaminants may adversely affect the owner’s ability to sell or rent the property or borrow using the real property as collateral |
| Persons who arrange for 19 _________________________________________________________________ the disposal or treatment of hazardous or toxic substances may also be liable for the clean-up costs of the substances at the disposal or treatment facility, whether or not the facility is or ever was owned or operated by that person |
| Environmental, health and safety laws and common law principles also govern the presence, effects, maintenance and removal of hazardous substances, including asbestos-containing materials, or ACMs |
| Laws and regulations govern indoor and outdoor air quality including those that can require the abatement or removal of ACMs in the event of damage, demolition, renovation or remodeling and also govern emissions of and exposure to asbestos fibers in the air |
| ACMs have been found in four of our hotels and asbestos or other hazardous substances may be found in other hotels we own or acquire in the future |
| Many such laws permit third parties, including employees and independent contractors, to seek recovery from owners or operators of real properties for personal injury or property damage associated with exposure to released hazardous substances, including ACMs |
| In connection with the ownership of the hotels, we may be considered an owner or operator and therefore may be potentially liable for any such costs, which could adversely affect our financial condition |
| Black mold claims could adversely affect our financial condition |
| Recent publicity regarding families abandoning their homes because of the presence of stachyhotrys chartarum (“black mold”) has raised public consciousness regarding black mold |
| Black mold is a greenish-black fungus found worldwide that grows in such places as dry wall, carpet, wall paper, fiber-board, ceiling tiles, and thermal insulation when the relative humidity is above 55prca |
| While the scientific community lacks consensus on the health threat, if any, posed by exposure to black mold, if black 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, generally consisting of a thorough cleaning with chlorine bleach and water |
| Under certain conditions, black mold may be difficult to eradicate and require us to remove and replace moldy materials in the hotel |
| In extreme cases, it may be necessary to perform extensive facility repairs |
| The presence of black mold in any hotel also could adversely impact the fair market value of that hotel |
| Because black mold is a naturally occurring fungus, the spores of which can be transported by outside air currents, there can be no assurances that black mold will not enter and grow in the Company’s hotel properties |
| Liability for underground storage tanks could adversely affect our financial condition |
| Portions of the soil and groundwater under the Durham, NC Hampton Inn have been contaminated by one or more leaking underground storage tanks from an adjacent property owned by a third-party |
| The North Carolina Department of Environment and Natural Resources classified the adjacent property as “low risk” and issued a “No Further Action” determination in November 2003 |
| A Phase II ESA file review was conducted in February 2005 to review and obtain regulatory files related to the leaking underground tanks on the adjacent property |
| The Phase II file review indicated that the Durham, NC Hampton Inn is restricted from use of groundwater and recommended additional investigation to determine the extent of contamination, if any, from the leaking tanks |
| We conducted an investigation in August 2005, which identified benzene in groundwater as the only volatile organic compound that exceeded the permitted concentration limits |
| We believe liability for future cleanup, if any, of this subsurface contamination most likely would be imposed on the third-party owner of the leaking underground storage tanks and not us |
| We could, however, be responsible for cleanup of this site if, for instance, the owner of the leaking tanks refused or were financially unable to conduct a cleanup |
| 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 |
| 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 funds available for distribution to our shareholders |
| We can make no assurances that (i) future laws or regulations will not impose material environmental liabilities or (ii) 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 |
| 20 _________________________________________________________________ Liability for uninsured and underinsured losses could adversely affect our financial condition and results of operations |
| In the event of a substantial loss, our insurance coverage may not be sufficient to pay the full current market value or current replacement cost of our lost investment |
| Certain types of losses, such as mold, terrorist acts, earthquakes, floods, hurricanes, and other acts of God, may be uninsurable or not economically insurable |
| In addition, we may not be able to use insurance proceeds to replace a damaged or destroyed property as a result of changes in building codes and ordinances, environmental considerations or other factors |
| In these circumstances, any insurance proceeds we receive might not be adequate to restore our economic position with respect to the damaged or destroyed property and we would be required to seek separate financing for repair and replacement costs, which may not be available on acceptable terms or at all, or face a loss on our investment |
| The cost of compliance with the Americans with Disabilities Act and other changes in governmental rules and regulations could adversely affect our cash flow |
| Under the Americans with Disabilities Act of 1990, or the ADA, all public accommodations are required to meet certain federal requirements related to access and use by disabled persons |
| A determination that we are not in compliance with the ADA could result in imposition of fines or an award of damages to private litigants |
| In addition, other governmental rules and regulations or enforcement policies affecting the use and operation of the hotels could change, including changes to building codes and fire and life safety codes |
| If we are required to spend money to comply with the ADA or other changes in governmental rules and regulations, our ability to make distributions to shareholders could be adversely affected |
| 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 |
| Risks Relating to an Investment in our Capital Stock The price of our securities may be affected by changes in market interest rates |
| One of the factors that may influence the price of our common stock or preferred stock in public trading markets is the annual yield from distributions on our common stock or preferred stock as compared to yields on other financial instruments |
| Thus, an increase in market interest rates will result in higher yields on other financial instruments, which could adversely affect the market price of our common stock or preferred stock |
| The ability of our shareholders to effect a change in control is limited |
| Stock ownership limitations could inhibit changes in control |
| Our articles of incorporation provide that no shareholder may own, directly or indirectly, more than 9dtta9prca of any class of our outstanding stock without the approval of our Board of Directors |
| This limitation may have the effect of precluding an acquisition of control by a third party without the approval of our Board of Directors even if a change in control were in our shareholders’ best interest |
| Our ability to issue preferred stock could inhibit changes in control |
| Our articles of incorporation authorize the Board of Directors to issue up to 5cmam000cmam000 shares of preferred stock and to establish the preferences and rights of any shares of preferred stock issued |
| Currently, there are 3cmam680cmam000 shares of preferred stock outstanding |
| Issuing additional preferred stock could have the effect of delaying or preventing a change in control even if a change in control were in our shareholders’ best interest |
| 21 _________________________________________________________________ Risks Relating to REIT Status We are subject to tax risks as a result of our REIT status |
| We have operated and intend to continue to operate so as to qualify as a REIT for federal income tax purposes |
| Our continued qualification as a REIT will depend on our continuing ability to meet various requirements concerning the ownership of our outstanding stock, the nature of our assets, the sources of our income, and the amount of distributions to our shareholders |
| In order to qualify as a REIT, we generally are required each year to distribute to our shareholders at least 90prca of our taxable income, other than any net capital gain and any taxable income of our TRS Lessees (except to the extent that our TRS Lessees distribute their taxable income to us) |
| To the extent that we meet the 90prca distribution requirement, but distribute less than 100prca of our taxable income, we will be required to pay income tax on our undistributed income |
| In addition, we will be subject to a 4prca nondeductible excise tax if the actual amount we pay out to our shareholders in a calendar year is less than a minimum amount specified under the federal tax laws |
| Our TRS Lessees will incur corporate income tax on their taxable income, but will not be subject to any distribution requirement |
| The requirement to distribute a substantial portion of our net taxable income could cause us to distribute amounts that otherwise would be spent on future acquisitions, unanticipated capital expenditures or repayment of debt, which would require us to borrow funds or to sell assets to fund the costs of such items |
| We have made, and intend to continue to make, distributions to our shareholders to comply with the 90prca distribution requirement and to avoid corporate income tax and the nondeductible excise tax |
| Our income consists of our share of the income of the Partnership, and our cash available for distribution consists of our share of cash distributions from the Partnership, less capital expenditures and principal debt payments |
| Differences in timing between the recognition of taxable income and the receipt of cash available for distribution due to the seasonality of the hotel industry could require us to borrow funds on a short-term basis to meet the 90prca distribution requirement and to avoid income tax and the nondeductible excise tax |
| If we were to fail to qualify as a REIT for any taxable year, we would not be allowed to deduct our distributions to our shareholders in computing our taxable income |
| Furthermore, we would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates |
| Unless we are entitled to relief under the federal income tax laws, we also would be disqualified from treatment as a REIT for the four taxable years following the year during which we lost our qualification |
| As a result, our cash available for distribution would be reduced for each of the years involved |
| Although we currently operate and intend to continue to operate in a manner designed to qualify as a REIT, it is possible that future economic, market, legal, tax or other considerations may cause our Board of Directors, with the consent of shareholders holding at least two-thirds of the common stock entitled to vote, to revoke the REIT election |