Filed Pursuant to Rule 424(b)5
Registration No. 333-138038
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED NOVEMBER 28, 2006)
7,200,000 SHARES
[HERSHA LOGO]
COMMON SHARES OF BENEFICIAL INTEREST
----------------
We are offering 7,200,000 common shares of beneficial interest to be sold in
this offering. We will receive all of the net proceeds from the sale of such
common shares.
Our common shares are traded on the American Stock Exchange under the symbol
"HT." The last reported sale price of our common shares on December 4, 2006
was $11.43 per share.
Ownership of our common shares is subject to ownership limitations contained
in our declaration of trust intended to assist us in maintaining our
qualification as a real estate investment trust, or REIT, for federal income
tax purposes.
INVESTING IN OUR COMMON SHARES INVOLVES A HIGH DEGREE OF RISK. BEFORE BUYING
ANY OF THESE COMMON SHARES YOU SHOULD CAREFULLY READ THE DISCUSSION OF
MATERIAL RISKS OF INVESTING IN OUR COMMON SHARES IN "RISK FACTORS" BEGINNING
ON PAGE S-3 OF THIS PROSPECTUS SUPPLEMENT, ON PAGE 3 OF THE ACCOMPANYING
PROSPECTUS AND IN OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 2005, AS AMENDED, FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus supplement or the accompanying prospectus is truthful or
complete. Any representation to the contrary is a criminal offense.
PER
SHARE TOTAL
----- -----
Public offering price ......................... $11.20 $80,610,000
Underwriting discounts and commissions ........ $ 0.56 $ 4,032,000
Proceeds, before expenses, to us .............. $10.64 $76,608,000
The underwriters may also purchase up to 1,080,000 additional shares from us
at the public offering price, less the underwriting discounts and commissions,
within 30 days from the date of this prospectus supplement. The underwriters
may exercise this option only to cover over-allotments, if any. If the
underwriters exercise this option in full, the total underwriting discounts
and commissions will be $4,636,800 and total proceeds to us, before expenses,
will be $88,099,200.
The underwriters are offering the common shares as set forth under
"Underwriting." Delivery of the shares will be made on or about December 11,
2006.
Joint Book-Running Managers
UBS INVESTMENT BANK WACHOVIA SECURITIES
----------------
Lead Manager
RAYMOND JAMES
----------------
Co-Managers
ROBERT W. BAIRD & CO. STIFEL NICOLAUS
The date of this prospectus supplement is December 5, 2006
You should rely only on the information contained in or incorporated by
reference in this prospectus supplement and the accompanying prospectus. We
have not authorized anyone to provide you with different information. We are
not making an offer of these securities in any state where the offer is not
permitted. You should not assume that the information contained in this
prospectus supplement and the accompanying prospectus or the documents
incorporated therein is accurate as of any date other than the date of this
prospectus supplement, the accompanying prospectus or such documents.
References to "our company," "we," and "our" in this prospectus supplement
and the accompanying prospectus mean Hersha Hospitality Trust, including,
unless the context otherwise requires (including the discussion of the federal
income tax treatment of Hersha Hospitality Trust and its shareholders), our
operating partnership and other direct and indirect subsidiaries. Our
"operating partnership" refers to Hersha Hospitality Limited Partnership, a
Virginia limited partnership. "HHMLP" refers to Hersha Hospitality Management,
L.P. and its subsidiaries, which are the entities that manage all of our
wholly owned hotels and some of the hotels owned by our joint ventures.
"Common shares" means our common shares of beneficial interest, par value
$0.01 per share.
TABLE OF CONTENTS
PAGE
----
PROSPECTUS SUPPLEMENT
About this Prospectus Supplement ........................................ ii
Forward Looking Information ............................................. ii
Where You Can Find More Information ..................................... ii
Incorporation of Certain Documents by Reference ......................... ii
The Company ............................................................. S-1
Risk Factors ............................................................ S-3
Use of Proceeds ......................................................... S-5
Dividend Policy and Price Range of Common Shares ........................ S-6
Capitalization .......................................................... S-7
Management's Discussion and Analysis of Financial Condition and Results
of Operations.......................................................... S-8
Additional Federal Income Tax Considerations ............................ S-22
Underwriting ............................................................ S-27
Notice to Investors ..................................................... S-30
Legal Matters ........................................................... S-30
Experts ................................................................. S-31
PROSPECTUS
About this Prospectus ................................................... 1
Cautionary Statement Concerning Forward-Looking Statements .............. 1
Certain Definitions ..................................................... 1
The Company ............................................................. 2
Risk Factors ............................................................ 3
Ratio of Earnings to Fixed Charges and of Earnings to Combined Fixed
Charges and Preferred Share Dividends.................................. 14
Use of Proceeds ......................................................... 14
Description of Shares of Beneficial Interest ............................ 15
Legal Ownership of Securities ........................................... 22
Certain Provisions of Maryland Law and of Our Declaration of Trust and
Bylaws................................................................. 25
Partnership Agreement ................................................... 28
Federal Income Tax Consequences of Our Status as a REIT ................. 32
Plan of Distribution .................................................... 50
Legal Matters ........................................................... 52
Experts ................................................................. 52
How to Obtain More Information .......................................... 53
Incorporation of Information Filed with the SEC ......................... 53
i
ABOUT THIS PROSPECTUS SUPPLEMENT
This document is in two parts. The first part is this prospectus supplement,
which describes the specific terms of the offering and certain other matters
relating to us. The second part, the accompanying prospectus, gives more
general information about securities we may offer from time to time. If the
description of the offering varies between this prospectus supplement and the
accompanying prospectus, you should rely on the information in this prospectus
supplement. This prospectus supplement incorporates by reference important
business and financial information about our company that is not included in
or delivered with this prospectus supplement.
You should rely only on the information contained or incorporated by
reference in this prospectus supplement and the accompanying prospectus. We
have not authorized anyone to provide you with information that is different.
This prospectus supplement may be used only where it is legal to sell these
securities. You should not assume that the information contained or
incorporated by reference in this prospectus supplement is correct at any date
other than the date of the document containing the information.
FORWARD LOOKING INFORMATION
This prospectus supplement and the accompanying prospectus contain forward-
looking statements within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934, or the Exchange
Act. These statements relate to future events or our future financial
performance and involve known and unknown risks, uncertainties and other
factors, all of which are difficult to predict and many of which are beyond
our control, that may cause our or our industry's actual results, levels of
activity, performance or achievements to be materially different from any
future results, levels of activity, performance or achievements expressed or
implied by these forward-looking statements. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "intends," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential," "continue," "our future success depends," "seek to
continue" or the negative of these terms or other comparable terminology.
These statements are only predictions. Actual events or results may differ
materially. Important factors that could cause actual results to differ
materially from those in our forward looking statements in this prospectus
include, but are not limited to, the factors discussed in the section entitled
"Risk Factors" and the filings made by us with the SEC that are incorporated
in this prospectus. Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the Securities and Exchange Commission. You may read and copy
any reports, statements, or other information we file with the SEC at its
public reference room in Washington, D.C. (450 Fifth Street, N.W. 20549).
Please call the SEC at 1-800-SEC-0330 for further information on the public
reference room. Our filings are also available to the public on the internet,
through a database maintained by the SEC at http://www.sec.gov. In addition,
you can inspect and copy reports, proxy statements and other information
concerning Hersha Hospitality Trust at the offices of the American Stock
Exchange, Inc., 86 Trinity Place, New York, New York 10006, on which our
common shares (symbol: "HT") are listed.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The SEC allows us to "incorporate by reference" the information we file with
them, which means that we can disclose important information to you by
referring you to those documents. The information incorporated by reference is
considered to be part of this prospectus supplement and the accompanying
prospectus, and later information filed with the SEC will update and supersede
this information. We incorporate by reference the documents listed below and
any future filings made with the SEC under Section 13(a), 13(c), 14 or 15(d)
of the Exchange Act prior to the completion of this offering.
o Annual Report on Form 10-K for the year ended December 31, 2005, filed
March 22, 2006, as amended by Amendment No. 1 thereto filed on March 31,
2006;
ii
o Quarterly Reports on Form 10-Q for the quarter ended March 31, 2006,
filed May 10, 2006; the quarter ended June 30, 2006, filed August 9, 2006
and for the quarter ended September 30, 2006, filed November 9, 2006; and
o Current Reports on Form 8-K filed January 9, 2006, January 23, 2006,
January 25, 2006, February 14, 2006 (as amended by Amendment No. 1
thereto filed on April 10, 2006), February 21, 2006 (as amended by
Amendment No. 1 thereto filed on April 6, 2006), April 27, 2006, May 8,
2006, May 30, 2006, July 17, 2006, September 13, 2006, September 19,
2006, October 4, 2006 and November 21, 2006; and
o Our Proxy Statement relating to our 2006 annual meeting of shareholders
filed on April 24, 2006.
You may request a copy of these filings (other than exhibits and schedules
to such filings, unless such exhibits or schedules are specifically
incorporated by reference into this prospectus supplement or the accompanying
prospectus), at no cost, by writing or calling us at the following address:
Hersha Hospitality Trust
510 Walnut Street, 9th Floor
Philadelphia, Pennsylvania 19106
Phone: (215) 238-1046
All brand names, trademarks and service marks appearing in this prospectus
supplement are the property of their respective owners. This prospectus
supplement contains registered trademarks owned or licensed to companies other
than us, including but not limited to Comfort Inn(R), Comfort Suites(R),
Courtyard(R) by Marriott(R), DoubleTree(R), Doubletree Suites(R), Fairfield
Inn(R) by Marriott(R), Hampton Inn(R), Hilton Hotels(R), Hilton Garden Inn(R),
Holiday Inn(R), Holiday Inn Express(R), Homewood Suites by Hilton(R), Mainstay
Suites(R), Marriott Hotels & Resorts(R), Residence Inn(R) by Marriott(R),
Sheraton Four Points(R), Springhill Suites by Marriott(R) and Sleep Inn(R),
none of which, in any way, are participating in or endorsing this offering and
shall not in any way be deemed an issuer or underwriter of the securities
issued under this prospectus supplement, and shall not have any liability or
responsibility for any financial statements or other financial information
contained or incorporated by reference in this prospectus.
iii
THE COMPANY
ABOUT THE COMPANY
Hersha Hospitality Trust is a self-advised Maryland real estate investment
trust that was organized in 1998 and completed its initial public offering in
January of 1999. We focus primarily on owning and operating high quality,
upper-upscale, upscale and mid-scale limited service and extended-stay hotels
in established markets. Our primary strategy is to continue to acquire high
quality, upper-upscale, upscale, mid-scale and extended-stay hotels in
metropolitan markets with high barriers-to-entry. Our common shares are traded
on the American Stock Exchange under the symbol "HT."
As of September 30, 2006, our portfolio consisted of 45 wholly-owned limited
and full service hotels and joint venture investments in 18 hotels with a
total of 7,940 rooms located in New York, New Jersey, Pennsylvania, Maryland,
Delaware, Massachusetts, Connecticut, Rhode Island, Virginia and Georgia (60
hotels and 7,696 rooms giving effect to the sale of the Atlanta, Georgia
hotels described below under "Recent Developments"). Our hotels operate under
leading brands, such as Marriott Hotels & Resorts(R), Hilton Hotels(R),
Courtyard by Marriott(R), Residence Inn(R), Hilton Garden Inn(R), Springhill
Suites(R), Hampton Inn(R), Holiday Inn(R), Holiday Inn Express(R), Comfort
Inn(R), Comfort Suites(R) and Four Points by Sheraton(R).
We are structured as an umbrella partnership REIT, or UPREIT, and we own our
hotels through our operating partnership, Hersha Hospitality Limited
Partnership, for which we serve as general partner. All of our wholly-owned
hotels are managed by an independent third party qualified management company
or Hersha Hospitality Management, L.P., or HHMLP, a private management company
owned by certain of our trustees, officers and other third party investors.
Our hotels owned through joint venture interests are managed by independent
third party qualified management companies or HHMLP. We have a wholly-owned
taxable REIT subsidiary, or TRS, to which we lease all of our wholly-owned
hotels. All of the hotels we own through joint ventures are leased (1) to
joint ventures, in which we hold our equity interest through a TRS, or (2) to
a TRS wholly-owned or substantially-owned by the joint venture.
Since our initial public offering in 1999, we have acquired, wholly or
through joint ventures, a total of 64 hotels, including 19 hotels acquired
from entities controlled by our officers or trustees. Of the 19 acquisitions
from these entities, 16 were newly-constructed or newly-renovated by these
entities prior to our acquisition. Because we do not develop properties, we
take advantage of our relationships with these development entities to
identify development and renovation projects that may be attractive to us.
While these entities bear all the construction risks of development, we often
provide secured development loans and bear economic risks through these
development loans. In many instances, we maintain a first right of refusal or
first right of offer to purchase the hotels for which we have provided
development loan financing. We intend to continue to acquire hotels from these
entities if approved by our independent trustees.
In addition to the direct acquisition of hotels, we may make investments in
hotels through joint ventures with strategic partners or through equity
contributions, sales and leasebacks, or secured and mezzanine loans. We seek
to identify acquisition candidates located in markets with economic,
demographic and supply dynamics favorable to hotel owners and operators.
Through our extensive due diligence process, we select those acquisition
targets where we believe selective capital improvements and intensive
management will increase the hotel's ability to attract key demand segments,
enhance hotel operations and increase long-term value.
Our principal executive office is located at 510 Walnut Street, 9th Floor,
Philadelphia, Pennsylvania 19106. Our telephone number is (215) 238-1046.
RECENT DEVELOPMENTS
Since September 30, 2006, we have not closed on the acquisition of any
hotels.
We have previously announced our intention to exit the Atlanta, Georgia
market where we owned four hotels. On November 15, 2006, we closed on the sale
of the 68-room Holiday Inn Express and the 85-room Comfort Suites located in
Duluth, Georgia for an aggregate purchase price of $8.4 million. On
November 30, 2006, we closed on the sale of the 91-room Hampton Inn located in
Newnan, Georgia for an aggregate
S-1
purchase price of $6.15 million. We expect to close on the sale of the 61-room
Hampton Inn located in Peachtree City, Georgia during December 2006.
OUR STRATEGY
Increase Same Hotel Performance.
Our operating strategy focuses on increasing same hotel performance for our
portfolio. The key elements of this strategy are:
o working together with our hotel management companies to increase
occupancy levels and revenue per available room, or "RevPAR," through
active property-level management, including intensive marketing efforts
to tour groups, corporate and government extended stay customers and
other wholesale customers and expanded yield management programs, which
are calculated to better match room rates to room demand; and
o positioning our hotels to capitalize on increased demand in the high
quality, upper-upscale, upscale, mid-scale and extended-stay lodging
segment, which we believe can be expected to follow from improving
economic conditions, by managing costs and thereby maximizing earnings.
Pursue Quality Acquisitions in Cluster Markets with High Barriers to Entry.
Our primary growth strategy is to selectively acquire high quality, upper-
upscale, upscale, mid-scale and extended-stay hotels in metropolitan markets
with high barriers-to-entry. We believe that current market conditions are
creating opportunities to acquire hotels at attractive prices. In executing
our disciplined acquisition program, we intend to acquire hotels that meet the
following additional criteria:
o nationally-franchised hotels operating under popular brands, such as
Marriott Hotels & Resorts, Hilton Hotels, Courtyard by Marriott,
Residence Inn by Marriott, Spring Hill Suites by Marriott, Hilton Garden
Inn, Homewood Suites by Hilton, Hampton Inn, Sheraton Hotels & Resorts,
DoubleTree, Embassy Suites and Holiday Inn Express;
o hotels in locations with significant barriers-to-entry, such as high
development costs, limited availability of land and lengthy entitlement
processes; and
o hotels in our target markets where we can realize operating efficiencies
and economies of scale.
In the ordinary course of our business, we are actively considering hotel
acquisition opportunities.
Utilize Leverage Prudently.
The relative stability of the mid-scale and upscale segment of the limited
service lodging industry allows us to increase returns to our shareholders
through the prudent application of leverage. Our debt policy is to limit
consolidated indebtedness to less than 67% of the fair market values for the
hotels in which we invest. We may employ a higher amount of leverage at a
specific hotel to achieve a desired return when warranted by that hotel's
historical operating performance and may use modestly greater leverage across
our portfolio if and when warranted by prevailing market conditions.
S-2
RISK FACTORS
You should carefully consider the risk factors and other information
included or incorporated by reference in this prospectus supplement and the
accompanying prospectus before you decide to buy our common shares. You should
also consider the information contained in the section entitled "Rick Factors"
beginning on page 3 of the accompanying prospectus and in the sections
entitled "Risk Factors" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in our most recent Annual Report on
Form 10-K, as amended, which was filed with the Securities and Exchange
Commission on March 22, 2006 and is incorporated by reference into this
prospectus supplement and the accompanying prospectus. For more information,
see the section entitled, "Where You Can Find More Information" in this
prospectus supplement.
WE MAY BE UNABLE TO INVEST THE NET PROCEEDS RAISED IN THIS OFFERING ON
ACCEPTABLE TERMS OR AT ALL, WHICH WOULD HARM OUR FINANCIAL CONDITION AND
OPERATING RESULTS.
The portion of the net proceeds of this offering not used to repay
indebtedness will be approximately $38.7 million, and will be available for
future investments in hotel assets and for general corporate purposes. Until
we identify hotel investments consistent with our investment criteria, we
intend to invest that portion of the net proceeds of this offering in money
market funds. We cannot assure you that we will be able to identify hotel
investments that meet our investment criteria, that we will be successful in
completing any investment we identify or that any investment we complete using
the net proceeds of this offering will produce a return on our investment.
Moreover, because we have not identified any future investments at the time of
this offering, we will have broad authority to invest the net proceeds of this
offering not used to repay indebtedness in any hotel investments that we may
identify in the future.
OUR SHARE PRICE COULD BE VOLATILE AND COULD DECLINE, RESULTING IN A
SUBSTANTIAL OR COMPLETE LOSS ON OUR SHAREHOLDERS' INVESTMENT.
The stock markets, including the American Stock Exchange, which is the
exchange on which we list our common shares, have experienced significant
price and volume fluctuations. As a result, the market price of our common
shares could be similarly volatile, and investors in our common shares may
experience a decrease in the value of their shares, including decreases
unrelated to our operating performance or prospects. The price of our common
shares could be subject to wide fluctuations in response to a number of
factors, including:
o our operating performance and the performance of other similar companies;
o actual or anticipated differences in our operating results;
o changes in our revenues or earnings estimates or recommendations by
securities analysts;
o publication of research reports about us or our industry by securities
analysts;
o additions and departures of key personnel;
o strategic decisions by us or our competitors, such as acquisitions,
divestments, spin-offs, joint ventures, strategic investments or changes
in business strategy;
o the passage of legislation or other regulatory developments that
adversely affect us or our industry;
o speculation in the press or investment community;
o actions by institutional shareholders;
o changes in accounting principles;
o terrorist acts; and
o general market conditions, including factors unrelated to our
performance.
S-3
In the past, securities class action litigation has often been instituted
against companies following periods of volatility in their stock price. This
type of litigation could result in substantial costs and divert our
management's attention and resources.
FUTURE SALES OF OUR COMMON SHARES MAY DEPRESS THE PRICE OF OUR COMMON SHARES.
We cannot predict whether future issuance of our common shares or the
availability of shares for resale in the open market will decrease the market
price per share of our common shares. Any sales of a substantial number in the
public market, including upon the redemption of operating partnership units,
or the perception that such sales might occur, may cause the market price of
our shares to decline. Upon completion of the offering, all common shares sold
in the offering will be freely tradable without restriction (other than any
restrictions set forth in our charter relating to our qualification as a
REIT).
The exercise of the underwriters' over-allotment option, the redemption of
operating partnership units for common shares, the exercise of any options or
the vesting of any restricted stock granted to directors, executive officers
and other employees, the issuance of our common shares or operating
partnership units in connection with property, portfolio or business
acquisitions and other issuances of our common shares could have an adverse
effect on the market price of the common shares, and the existence of
operating partnership units, options and our common shares reserved for
issuance as restricted shares of our common shares or upon redemption of
operating partnership units or exercise of options may adversely affect the
terms upon which we may be able to obtain additional capital through the sale
of equity securities. In addition, future sales of our common shares may be
dilutive to existing shareholders.
S-4
USE OF PROCEEDS
We estimate that the net proceeds to us from the sale of the 7,200,000
common shares offered hereby will be approximately $76.5 million, after
deducting underwriting discounts and commissions and the estimated expenses of
this offering payable by us. If the underwriters exercise their over-allotment
option in full, we estimate that our net proceeds will be approximately
$87.9 million.
As required by the partnership agreement of our operating partnership, we
will contribute all of the net proceeds to our operating partnership in
exchange for additional partnership interests. Our operating partnership
intends to use the net proceeds of this offering to repay indebtedness
outstanding under our $100.0 million revolving credit line (which on a pro
forma basis as of September 30, 2006 was approximately $37.8 million), a
substantial portion of which was drawn to fund our purchase of the remaining
two-thirds interest in our joint venture with CNL Hospitality Partners. Any
remaining proceeds will be used to fund development loans, to make future
investments, if any, in hotel assets and for general corporate purposes.
Outstanding balances on our $100.0 million revolving credit line currently
accrue interest at an annual rate equal to the Wall Street Journal prime rate
less 0.75% per annum and must be repaid on or prior to December 31, 2008.
S-5
DIVIDEND POLICY AND PRICE RANGE OF COMMON SHARES
Our common shares began trading on theAmerican Stock Exchange on January 21,
1999 under the symbol "HT." As of December 4, 2006, the last reported closing
price per common share on the American Stock Exchange was $11.43. The
following table sets forth the high and low sales price per common share
reported on the American Stock Exchange and the dividends paid on the common
shares for each of the quarters indicated.
PRICE RANGE CASH DIVIDEND
-------------- -------------
YEAR ENDED DECEMBER 31, 2006: HIGH LOW PER SHARE
------ ----- -------------
Fourth quarter (through December 4, 2006)................... $11.99 $9.47 $ (1)
Third quarter............................................... 10.17 8.83 0.18
Second quarter.............................................. 9.80 8.76 0.18
First quarter............................................... 10.00 8.89 0.18
YEAR ENDED DECEMBER 31, 2005: HIGH LOW PER SHARE
------ ----- -------------
Fourth quarter.............................................. $11.63 $8.00 $0.18
Third quarter............................................... 10.49 9.51 0.18
Second quarter.............................................. 10.49 9.50 0.18
First quarter............................................... 12.11 9.21 0.18
YEAR ENDED DECEMBER 31, 2004: HIGH LOW PER SHARE
------ ----- -------------
Fourth quarter.............................................. $11.67 $8.81 $0.18
Third quarter............................................... 10.45 9.15 0.18
Second quarter.............................................. 11.07 8.99 0.18
First quarter............................................... 11.75 9.84 0.18
---------------
(1) Not yet declared by our Board of Trustees as of the date of this prospectus
supplement.
We intend to continue to distribute to our shareholders each year on a
quarterly basis sufficient amounts of our net taxable income to avoid paying
corporate income tax and excise tax on our earnings (other than the earnings
of our TRSs, which are subject to tax at regular corporate rates) and to
maintain our qualification as a REIT under the Code. See "Additional Federal
Income Tax Considerations" in this prospectus supplement and "Federal Income
Tax Consequences of Our Status as a REIT" in the accompanying prospectus.
The actual amounts, timing and frequency of our distributions will be at the
discretion of our Board of Trustees and will depend on our actual results of
operations and actual cash flow, as well as projected future cash needs, and
other factors that our Board of Trustees may deem relevant.
S-6
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 2006:
(1) on an actual basis;
(2) on a pro forma basis to give effect to the dispositions that
occurred since September 30, 2006 as described above under "The
Company -- Recent Developments"; and
(3) on a pro forma basis to give effect to the transactions described
under (2) above, the sale of the common shares in this offering and
the use of the net proceeds from this offering.
The information set forth below should be read in conjunction with the
section captioned "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our financial statements and related notes
incorporated by reference in this prospectus supplement and the accompanying
prospectus.
AS OF SEPTEMBER 30, 2006
---------------------------------------
COMMON STOCK
OFFERING
DISPOSITIONS PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
-------- ------------ ------------
(DOLLARS IN THOUSANDS)
Cash.................................................................................... $ 16,273 $ 22,079 $ 60,719
Debt:
Lines of credit........................................................................ 37,768 37,768 --
Mortgages payable...................................................................... 449,808 449,808 449,808
Capital lease payable.................................................................. 656 656 656
Liabilities Related to Hotel Assets Held for Sale...................................... 10,201 1,898 1,898
-------- -------- --------
Total debt.............................................................................. 498,433 490,130 452,362
Minority interest (1)................................................................... 32,660 32,660 29,290
Shareholders' equity (2):
Preferred shares, $0.01 par value, 10,000,000 shares authorized, 2,400,000 Series A
Preferred Shares issued and outstanding ($60,000,000 aggregate liquidation preference) 24 24 24
Class A common shares, $0.01 par value, 50,000,000 shares authorized, 32,391,287 shares
issued and outstanding, 39,591,287 shares issued and outstanding, as adjusted......... 324 324 396
Class B common shares, $0.01 par value, 50,000,000 shares authorized, no shares issued
and outstanding....................................................................... -- -- --
Other Comprehensive Income.............................................................. 356 356 356
Additional paid-in capital (1).......................................................... 290,801 290,801 370,557
Distributions in excess................................................................. (41,835) (41,835) (41,835)
-------- -------- --------
Total shareholders' equity.............................................................. $249,670 $249,670 $329,498
-------- -------- --------
Total capitalization.................................................................... $780,763 $772,460 $811,150
======== ======== ========
---------------
(1) On a pro forma basis, includes a $3.4 million adjustment to decrease
minority interest and increase additional paid-in capital which results
from the accounting treatment for the contribution of the net proceeds of
this offering to our operating partnership.
(2) Does not include:
o 1,080,000 common shares that may be issued by us upon exercise of the
underwriters' over-allotment option; and
o 3,835,586 common shares issuable upon redemption of outstanding limited
partnership units in our operating partnership owned by management,
trustees and other contributors or properties to our operating
partnership, which units are currently redeemable.
S-7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis should be read in connection with our
financial statements as of and for the three and nine month periods ending
September 30, 2006 and other information contained in our Quarterly Report on
Form 10-Q filed with the Securities and Exchange Commission on November 9,
2006.
All statements contained in this section that are not historical facts are
based on current expectations. Words such as "believes", "expects",
"anticipates", "intends", "plans" and "estimates" and variations of such words
and similar words also identify forward-looking statements. Our actual results
may differ materially, including the following: economic conditions generally
and the real estate market specifically; the effect of threats of terrorism
and increased security precautions on travel patterns and demand for hotels;
the threatened or actual outbreak of hostilities and international political
instability; governmental actions; legislative/regulatory changes, including
changes to laws governing the taxation of REITs; level of proceeds from asset
sales; cash available for capital expenditures; availability of capital;
ability to refinance debt; rising interest rates; rising insurance premiums;
competition; supply and demand for hotel rooms in our current and proposed
market areas, including the existing and continuing weakness in business
travel and lower-than expected daily room rates; other factors that may
influence the travel industry, including health, safety and economic factors;
and changes in generally accepted accounting principles, policies and
guidelines applicable to REITs. Additional risks are discussed in the
Company's filings with the Securities and Exchange Commission. We caution you
not to place undue reliance on any such forward-looking statements. We assume
no obligation to update any forward-looking statements as a result of new
information, subsequent events or any other circumstances.
GENERAL
As of September 30, 2006, we owned interests in 63 hotels in the eastern
United States including 18 hotels owned through joint ventures. For purposes
of the REIT qualification rules, we cannot directly operate any of our hotels.
Instead, we must lease our hotels. In 2001, the REIT rules were modified,
allowing a hotel REIT to lease its hotels to a taxable REIT subsidiary, or
TRS, provided that the TRS engages an eligible independent contractor to
manage the hotels. Accordingly, as of September 30, 2006, we have leased 44 of
our hotels to a wholly-owned TRS, which pays qualifying rent, and the TRS has
entered into management contracts with HHMLP with respect to those hotels. We
intend to lease all newly acquired hotels to a TRS. As of September 30, 2006,
we also owned interests in 18 hotels through joint ventures and those hotels
are leased to TRSs that are wholly owned by those joint ventures or to
entities that are owned jointly by our TRS Lessee and our partners in the
joint venture. The hotels owned by the joint ventures are managed, pursuant to
the terms of certain management agreements, by HHMLP or management companies
affiliated with our joint venture partners. As all of our hotels have been
leased to the TRS Lessee or a joint venture TRS, we are participating more
directly in the operating performance of our hotels. The TRSs directly receive
all revenue from, and are required to fund all expenses relating to, hotel
operations. The TRSs are also subject to income tax on their earnings.
OPERATING RESULTS
The following table outlines operating results for the Company's portfolio
of wholly owned hotels and those owned through joint venture interests that
are consolidated in our financial statements for the three and nine months
ended September 30, 2006 and 2005.
S-8
CONSOLIDATED HOTELS:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------- ----------------------------------------
2006 2005 % VARIANCE 2006 2005 % VARIANCE
----------- ----------- ---------- ------------ ----------- ----------
Rooms Available ............................. 407,923 263,120 1,142,861 662,539
Rooms Occupied .............................. 326,215 205,532 855,139 480,950
Occupancy ................................... 79.97% 78.11% 2.4% 74.82% 72.59% 3.1%
Average Daily Rate (ADR) .................... $ 117.94 $ 109.56 7.6% $ 111.53 $ 102.58 8.7%
Revenue Per Available Room (RevPAR) ......... $ 94.31 $ 85.58 10.2% $ 83.45 $ 74.47 12.1%
Room Revenues ............................... $38,472,206 $22,518,441 $ 95,369,544 $49,336,823
Food & Beverage ............................. $ 1,307,143 $ 1,431,254 $ 5,181,254 $ 4,126,026
Other Revenues .............................. $ 953,264 $ 623,209 $ 2,265,805 $ 1,180,365
----------- ----------- ------------ -----------
Total Revenues .............................. $40,732,634 $24,572,904 $102,816,603 $54,643,214
Discontinued Assets ......................... $ 1,493,055 $ 2,049,003 $ 5,042,370 $ 7,689,981
The following table outlines operating results for the three and nine months
ended September 30, 2006 and 2005 for hotels we own through an unconsolidated
joint venture interest. These operating results reflect 100% of the operating
results of the property including our interest and the interests of our joint
venture partners and minority interests.
UNCONSOLIDATED JOINT VENTURES:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------- --------------------------------------
2006 2005 %VARIANCE 2006 2005 %VARIANCE
----------- ----------- --------- ----------- ----------- ---------
Rooms Available ................................ 234,603 97,193 657,828 173,937
Rooms Occupied ................................. 171,119 77,300 471,279 138,552
Occupancy ...................................... 72.94% 79.53% -8.3% 71.64% 79.66% -10.1%
Average Daily Rate (ADR) ....................... $ 137.36 $ 129.59 6.0% $ 132.79 $ 130.68 1.6%
Revenue Per Available Room (RevPAR) ............ $ 100.19 $ 103.07 -2.8% $ 95.13 $ 104.10 -8.6%
Room Revenues .................................. $23,505,484 $10,017,401 $62,579,820 $18,106,640
Food & Beverage ................................ $ 4,941,637 $ 1,754,363 $15,927,400 $ 2,360,671
Other Revenues ................................. $ 1,932,007 $ 765,795 $ 5,550,315 $ 919,682
----------- ----------- ----------- -----------
Total Revenues ................................. $30,379,128 $12,537,560 $84,057,535 $21,386,993
The following table outlines operating results for the three and nine months
ended September 30, 2006 and 2005 for our entire portfolio of hotels, which
includes wholly owned hotels, hotels we own through joint venture interests
that are consolidated in our financial statements, and hotels we own through
an unconsolidated joint venture interest. These operating results reflect 100%
of the operating results of the property including our interest and the
interests of our joint venture partners and minority interests.
S-9
ALL HOTELS (INCLUDES CONSOLIDATED HOTELS AND UNCONSOLIDATED JOINT VENTURE
ASSETS):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------- ----------------------------------------
2006 2005 % VARIANCE 2006 2005 % VARIANCE
----------- ----------- ---------- ------------ ----------- ----------
Rooms Available ............................. 642,526 360,313 1,800,689 836,476
Rooms Occupied .............................. 497,334 282,832 1,326,418 619,502
Occupancy ................................... 77.40% 78.50% -1.4% 73.66% 74.06% -0.5%
Average Daily Rate (ADR) .................... $ 124.62 $ 115.04 8.3% $ 119.20 $ 108.90 9.5%
Revenue Per Available Room (RevPAR) ......... $ 96.46 $ 90.30 6.8% $ 87.80 $ 80.65 8.9%
Room Revenues ............................... $61,977,690 $32,535,842 $157,949,364 $67,443,463
Food & Beverage ............................. $ 6,248,780 $ 3,185,616 $ 21,108,654 $ 6,486,697
Other Revenues .............................. $ 2,885,271 $ 1,389,004 $ 7,816,120 $ 2,100,047
----------- ----------- ------------ -----------
Total Revenues .............................. $71,111,741 $37,110,462 $186,874,138 $76,030,207
Discontinued Assets ......................... $ 1,493,055 $ 2,049,003 $ 5,042,370 $ 7,689,981
COMPARISON OF THE THREE MONTH PERIOD ENDED SEPTEMBER 30, 2006 TO SEPTEMBER 30,
2005 (IN THOUSANDS, EXCEPT PER SHARE DATA).
REVENUE
Our total revenues for the three month period ended September 30, 2006
consisted of hotel operating revenues for hotels leased to our wholly owned
TRS, 44 New England, and hotels owned through joint venture interests which
are consolidated in our financial statements. Our total revenues were
approximately $41,278 representing an increase of $16,705 or 67.98% compared
to total revenues of $24,573 for the three month period ended September 30,
2005. The increase in revenues is primarily attributable to the acquisitions
consummated since the comparable period in 2005 and improved performance at
certain of our hotels. Since September 30, 2005, the Company has acquired
interests in the following eighteen hotels:
BRAND
----- LOCATION ROOMS ACQUISITION DATE
-------------------- ----- ------------------
Hampton Inn........................ Chelsea/New York, NY 144 September 29, 2006
Courtyard.......................... Alexandria 203 September 29, 2006
Hampton Inn........................ Farmingville, NY 161 September 6, 2006
Holiday Inn Express................ Hauppauge, NY 133 September 1, 2006
Residence Inn...................... Norwood, MA 96 July 27, 2006
Holiday Inn Express................ Cambridge, MA 112 May 3, 2006
Residence Inn...................... North Dartmouth, MA 96 May 1, 2006
Comfort Inn........................ North Dartmouth, MA 84 May 1, 2006
Hawthorne Suites................... Franklin, MA 100 April 25, 2006
Hilton Garden Inn.................. JFK Airport, NY 188 February 16, 2006
Hampton Inn........................ Philadelphia, PA 250 February 15, 2006
Residence Inn...................... Tysons Corner, VA 96 February 2, 2006
Courtyard.......................... Scranton, PA 120 February 1, 2006
Courtyard.......................... Langhorne, PA 118 January 3, 2006
Fairfield Inn...................... Mt. Laurel, NJ 118 January 3, 2006
Fairfield Inn...................... Bethlehem, PA 103 January 3, 2006
Residence Inn...................... Williamsburg, VA 108 November 22, 2005
Springhill Suites.................. Williamsburg, VA 120 November 22, 2005
Revenues for all eighteen hotels were recorded from the date of acquisition
as Hotel Operating Revenues. As of July 1, 2006, we entered into an agreement
to lease the Holiday Inn Conference Center to an unrelated third party.
Revenues from the operation of this property were included in Hotel Operating
Revenues in the three months ended September 30, 2005. For the three months
ended September 30, 2006, only Hotel Lease Revenue is included in Total
Revenues.
S-10
During the nine months ended September 30, 2006, we acquired two parcels of
land which are being leased to hotel developers. The leases are fixed rate
triple net leases. During the three months ended September 30, 2006, we earned
$408 from these leases, which is included in total revenues.
The income from our unconsolidated joint ventures is accounted for utilizing
the equity method of accounting, and our portion of the net income from the 15
hotels in these joint ventures is recorded as "Income from Unconsolidated
Joint Venture Investments" in our Statement of Operations. Our joint venture
agreements contain provisions that define the cash distributions and
liquidating distributions and income is allocated to us consistent with those
provisions. Income from unconsolidated joint venture investments increased
$1,251 from $522 for the three months ended September 30, 2005 to $1,773 for
the three months ended September 30, 2006. Since September 30, 2005, we have
acquired unconsolidated joint venture interests in the following properties:
HERSHA
PREFERRED
OWNERSHIP EQUITY
JOINT VENTURE BRAND NAME ROOMS % RETURN ACQUISITION DATE
----------------------------------- ------------------- ---------------- ----- --------- --------- ----------------
PRA Suites at Glastonbury, LLC ..... Homewood Suites Glastonbury, CT 136 40.0% 10.00% June 15, 2006
Mystic Partners, LLC ............... Marriott Hartford, CT 409 15.0% 8.50% February 8, 2006
SB Partners, LLC ................... Holiday Inn Express South Boston, MA 118 50.0% 10.00% October 7, 2005
Mystic Partners, LLC ............... Hilton Hartford, CT 393 8.8% 8.50% October 6, 2005
Further, the third quarter of 2006 included income from unconsolidated joint
ventures for a full quarter related to the following seven hotels that were
purchased during the three months ended September 30, 2005:
HERSHA
PREFERRED
OWNERSHIP EQUITY
JOINT VENTURE BRAND NAME ROOMS % RETURN ACQUISITION DATE
------------------------------------ ----------------- --------------- ----- --------- --------- ------------------
Mystic Partners, LLC ................ Marriott Mystic, CT 285 66.7% 8.50% August 9, 2005
Mystic Partners, LLC ................ Courtyard Norwich, CT 144 66.7% 8.50% August 9, 2005
Mystic Partners, LLC ................ Courtyard Warwick, RI 92 66.7% 8.50% August 9, 2005
Mystic Partners, LLC ................ Residence Inn Danbury, CT 78 66.7% 8.50% August 9, 2005
Mystic Partners, LLC ................ Residence Inn Southington, CT 94 44.7% 8.50% August 9, 2005
Mystic Partners, LLC ................ Springhill Suites Waterford, CT 80 66.7% 8.50% August 9, 2005
Mystic Partners, LLC ................ Residence Inn Mystic, CT 133 66.7% 8.50% September 15, 2005
For the three months ended September 30, 2006, interest income increased
$287 compared to the same period in 2005. This increase was a result of an
increase in development loans outstanding with unrelated parties. Interest
Income -- Development Loans for the three months ended September 30, 2006
decreased $324 from $1,163 for the three months ended September 30, 2005 to
$839 during the same period in 2006, due primarily to a decrease in the
average balance development loans receivable to related parties during the
period. Other revenue increased approximately $107 for the three months ended
September 30, 2006 compared to the same period in 2005 as a result of fees
earned for asset management services provided to properties owned by some of
our unconsolidated joint ventures.
EXPENSES
Total hotel operating expenses increased 61.2% to approximately $22,627 for
the three month period ended September 30, 2006 from $14,034 for the three
month period ended September 30, 2005. Consistent with the increase in hotel
operating revenues, hotel operating expenses increased primarily due to the
acquisitions consummated since the comparable period in 2005 as mentioned
above. The acquisitions also resulted in an increase in depreciation and
amortization from $2,853 for the three months ended September 30, 2005 to
$5,256 for the three months ended September 30, 2006. Similarly, real estate
and personal property tax and property insurance increased $519, or 45.0%, in
the three months ended September 30, 2006 when compared to the same period in
2005.
General and administrative expense increased by approximately $254 from
$1,096 in 2005 to $1,350 in 2006. General and administrative expenses
increased primarily due to higher compensation expense related to our increase
in asset management and accounting staff. This increase in cost has been
partially offset by the
S-11
reduction in initial costs related to establishing our process to evaluate
internal controls that were incurred during the three months ended
September 30, 2005.
NET INCOME
Net income applicable to common shareholders for the three month period
ended September 30, 2006 was approximately $4,580 compared to net income
applicable to common shareholders of $1,741 for the same period in 2005.
Operating income for the three months ended September 30, 2006 was $10,151
compared to operating income of $5,329 during the same period in 2005. The
$4,822, or 90.5%, increase in operating income resulted from improved
performance of our portfolio and acquisitions that have increased the scale of
our operations enabling us to leverage the absorption of administrative costs.
The increase in our operating income was partially offset by increases in
interest expense, which increased $2,681 from $4,284 for the three months
ended September 30, 2005 to $6,965 for the three months ended September 30,
2006. The increase in interest expense is the result of mortgages placed on
newly acquired properties.
Net income applicable to common shareholders was also negatively impacted by
a full quarter of preferred dividends resulting from our issuance of 8.0%
Series A cumulative redeemable preferred shares in the third quarter of 2005.
Preferred dividends for the full three months ended September 30, 2006 were
$1,200 versus $720 for the three months ended September 30, 2005.
Included in net income applicable to common shareholders for the three
months ended September 30, 2006 is $179 income from discontinued operations
compared to $176 loss during the same period in 2005. Discontinued operations
results from the operations of hotel properties that we have sold and the
hotel properties we have committed to sell.
COMPARISON OF THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2006 TO SEPTEMBER 30,
2005.
REVENUE
Our total revenues for the nine month period ended September 30, 2006
consisted of hotel operating revenues for hotels leased to our wholly owned
TRS, 44 New England, and hotels owned through joint venture interests which
are consolidated in our financial statements. Our total revenues for the nine
month period ended September 30, 2006 also included hotel lease revenue for
the lease of the Holiday Inn Conference Center, New Cumberland, Pennsylvania
which was leased to unrelated third party beginning on July 1, 2006. Our total
revenues were approximately $103,362 representing an increase of $48,719 or
89.2% compared to total revenues of $54,643 for the nine month period ended
September 30, 2005. The increase in revenues is primarily attributable to the
acquisitions consummated since the comparable period in 2005 and improved
performance at certain of our hotels. As noted above, we have acquired
interests in eighteen hotels since September 30, 2005. Revenues for all
eighteen hotels were recorded from the date of acquisition as Hotel Operating
Revenues. Further, hotel operating revenue for the nine months ended
September 30, 2006 included revenues for a full nine months related to three
hotels that were purchased in June 2005, three hotels that were purchased in
May 2005, one hotel that was purchased in April 2005 and one hotel that was
purchased in January of 2005.
During the nine months ended September 30, 2006, we acquired two parcels of
land which are being leased to hotel developers. The leases are fixed rate
triple net leases. During the nine months ended September 30, 2006, we earned
$408 from these leases, which is included in total revenues.
Income from unconsolidated joint venture investments increased $582 from
$850 for the nine months ended September 30, 2005 to $1,432 for the nine
months ended September 30, 2006. Since September 30, 2005, we have acquired
unconsolidated joint venture interests in four properties.
For the nine months ended September 30, 2006, interest income increased $666
compared to the same period in 2005. This increase was the result of an
increase in development loans outstanding with unrelated parties, interest
earned on proceeds from the offering of our common stock, which was completed
in the
S-12
second quarter of 2006, and an increase in interest income on our escrow
deposits. Interest Income - Development Loans for the nine months ended
September 30, 2006 decreased $1,512 from $3,074 for the nine months ended
September 30, 2005 to $1,562 during the same period in 2006, due primarily to
a decrease in the average balance of development loans receivable during the
period.
Other revenue increased approximately $352 for the nine months ended
September 30, 2006 compared to the same period in 2005 as a result of fees
earned for asset management services provided to hotels owned by some of our
unconsolidated joint ventures.
EXPENSES
Total hotel operating expenses increased 81.8% to approximately $59,977 for
the nine months ended September 30, 2006 from $32,987 for the nine month
period ended September 30, 2005. Consistent with the increase in hotel
operating revenues, hotel operating expenses increased primarily due to the
acquisitions consummated since the comparable period in 2005 as mentioned
above. The acquisitions also resulted in an increase in depreciation and
amortization from $6,605 for the nine months ended September 30, 2005 to
$13,661 for the nine months ended September 30, 2006. Similarly, real estate
and personal property tax and property insurance increased $1,855, or 67.1%,
in the nine months ended September 30, 2006 when compared to the same period
in 2005.
General and administrative expense increased by approximately $1,117 from
$3,209 in 2005 to $4,326 in 2006. General and administrative expenses
increased primarily due to higher compensation expense related to our increase
in asset management and accounting staff. This increase in cost has been
partially offset by the reduction in initial costs related to establishing our
process to evaluate internal controls that were incurred during the three
months ended September 30, 2005.
NET INCOME
Net income applicable to common shareholders for the nine months ended
September 30, 2006 was approximately $1,672 compared to net income applicable
to common shareholders of $4,515 for the same period in 2005.
Operating income for the nine months ended September 30, 2006 was $20,179
compared to operating income of $8,753 during the same period in 2005. The
$11,426, or 130.5%, increase in operating income resulted from improved
performance of our portfolio and acquisitions that have increased the scale of
our operations enabling us to leverage the absorption of administrative costs.
The increase in our operating income was partially offset by increases in
interest expense, which increased $9,963 from $8,543 for the nine months ended
September 30, 2005 to $18,506 for the nine months ended September 30, 2006.
The increase in interest expense is the result of our issuance of $51,548 of
notes payable in the second quarter of 2005 and mortgages placed on newly
acquired properties. Also in the nine months ended September 30, 2006, we
refinanced $56,125 in variable rate debt, replacing it with $62,800 fixed rate
debt, and replaced our line of credit with an increased credit facility. As a
result of terminating the variable rate debt and line of credit, we incurred
$1,163 in debt extinguishment expense due to early termination fees and to
write-off deferred loan costs associated with the retired debt and credit
facility.
Net income applicable to common shareholders was also negatively impacted by
$3,600 in preferred dividends resulting from our issuance of 8.0% Series A
cumulative redeemable preferred shares in the third quarter of 2005, compared
to $720 in preferred dividends for the same period in 2005.
Included in net income applicable to common shareholders for the nine months
ended September 30, 2006 is $300 income from discontinued operations compared
to a $171 loss during the same period in 2005. Discontinued operations results
from the operations of two properties that were sold in June of 2005 and April
2006 and the hotel properties we have committed to sell. Also included in net
income applicable to common shareholders for the nine months ended
September 30, 2006 is a gain of $436 resulting from the sale of the Holiday
Inn Express in Hartford, CT which had been held for sale. Included in net
income applicable to common shareholders for the nine months ended
September 30, 2005 is a gain of $1,161 resulting from the sale of Doubletree
Club, Jamaica, NY and the Holiday Inn Express, Hunters Point, NY.
S-13
LIQUIDITY AND CAPITAL RESOURCES
We expect to meet our short-term liquidity requirements generally through
net cash provided by operations, existing cash balances and, if necessary,
short-term borrowings under our line of credit. We believe that the net cash
provided by operations will be adequate to fund the Company's operating
requirements, debt service and the payment of dividends in accordance with
REIT requirements of the federal income tax laws. We expect to meet our long-
term liquidity requirements, such as scheduled debt maturities and property
acquisitions, through long-term secured and unsecured borrowings, the issuance
of additional equity securities or, in connection with acquisitions of hotel
properties, the issuance of units of operating partnership interest in our
operating partnership subsidiary.
In the second quarter of 2005, HHLP issued two junior subordinated notes
payable in the aggregate amount of $51,548 to the Hersha Statutory Trusts,
pursuant to indenture agreements. The $25,774 note issued to Hersha Statutory
Trust I will mature on June 30, 2035, but may be redeemed at HHLP's option, in
whole or in part, beginning on June 30, 2010 in accordance with the provisions
of the indenture agreement. The $25,774 note issued to Hersha Statutory Trust
II will mature on July 30, 2035, but may be redeemed at our option, in whole
or in part, beginning on July 30, 2010 in accordance with the provisions of
the indenture agreement. The note issued to Hersha Statutory Trust I bears
interest at a fixed rate of 7.34% per annum through June 30, 2010 and the note
issued to Hersha Statutory Trust II bears interest at a fixed rate of 7.173%
per annum through July 30, 2010. Subsequent to June 30, 2010 for notes issued
to Hersha Statutory Trust I and July 30, 2010 for notes issued to Hersha
Statutory Trust II holders, the notes bear interest at a variable rate of
LIBOR plus 3.0% pre annum. Interest expense on the notes in the amount of $940
and $935 was recorded during the three months ended September 30, 2006 and
2005, respectively, and $2,810 and $1,336 for the nine months ended
September 30, 2006 and 2005, respectively.
On August 5, 2005, we completed a public offering of 2,400,000 of 8.00%
Series A Cumulative Redeemable Preferred Shares of Beneficial Interest,
liquidation preference $25.00 per share. Net proceeds of the offering, less
expenses and underwriters commissions, were approximately $57,750. Proceeds
from the offering were used to finance the acquisition of the Company's
interests in Mystic Partners, LLC ("Mystic") and SB Partners, LLC ("SB
Partners"). The remaining net proceeds have been principally allocated to fund
secured development loans and for general corporate purposes.
On April 28, 2006, we completed a public offering of 6,520,000 common shares
at $9.00 per share. On May 9, 2006, the underwriter exercised its over-
allotment option with respect to this offering, and we issued an additional
977,500 common shares at $9.00 per share. Proceeds to the Company, net of
underwriting discounts and commissions and expenses, were approximately
$63,400. Immediately upon closing the offering, the Company contributed all of
the net proceeds of the offering to the Partnership in exchange for additional
Partnership interests. Of the net offering proceeds, approximately $30,000 was
used to repay indebtedness and approximately $19,500 was used to fund property
acquisitions.
On September 19, 2006, we completed a public offering of 3,775,000 common
shares at $9.75 per share. On September 28, 2006, the underwriter exercised
its over-allotment option with respect to this offering, and we issued an
additional 566,250 common shares at $9.75 per share. Proceeds to us, net of
underwriting discounts and commissions and expenses, were approximately
$39,960. Immediately upon closing the offering, we contributed all of the net
proceeds of the offering to the Partnership in exchange for additional
Partnership interests. The net offering proceeds were used to repay
indebtedness.
On January 17, 2006, we entered into a revolving credit loan and security
agreement with Commerce Bank, N.A. with a maximum amount of $60,000. On
July 28, 2006, we amended our Commerce Line of Credit to increase the maximum
borrowing amount from $60,000 to $85,000 (in certain conditions to $100,000)
and modified the interest rate terms to the option of either the bank's prime
rate of interest minus 0.75% or LIBOR available for the periods of 1,2,3, or 6
months plus 2.00%. On September 26, 2006, we amended our Commerce Line of
Credit to increase the maximum borrowing amount from $85,000 to $100,000 and
added an affiliate of Raymond James & Associates, Inc. as a lender under the
line of credit.
The line of credit is collateralized by a first lien-security interest in
all existing and future assets of HHLP, and title-insured, first-lien
mortgages on the Holiday Inn Express, Harrisburg, PA, the Mainstay Suites
S-14
and Sleep Inn, King of Prussia, PA, the Fairfield Inn, Laurel, MD, the Hampton
Inn, Philadelphia, PA, the Residence Inn, Norwood, MA and collateral
assignment of all hotel management contracts from which HHLP or its affiliates
derive revenue. The line of credit includes certain financial covenants and
requires that we maintain (1) a minimum tangible net worth of $110.0 million;
(2) a maximum accounts and other receivables from affiliates of $75.0 million;
and (3) certain financial ratios. The Company is in compliance with each of
these covenants as of September 30, 2006. The line of credit replaced a line
of credit with Sovereign Bank and expires on December 31, 2008. This revolving
credit loan replaced both the secured and unsecured lines of credit that we
previously maintained. As a result of the termination of the Sovereign Bank
Line of Credit, we expensed $255 in unamortized deferred costs related to the
origination of the Sovereign Bank Line of Credit.
In the second quarter of 2006, we refinanced $56,125 in variable rate debt,
replacing it with $62,800 fixed rate debt.
We intend to invest in additional hotels only as suitable opportunities
arise and adequate sources of financing are available. Our bylaws require the
approval of a majority of our Board of Trustees, including a majority of the
independent trustees, to acquire any additional hotel in which one of our
trustees or officers, or any of their affiliates, has an interest (other than
solely as a result of his status as our trustee, officer or shareholder). We
expect that future investments in hotels will depend on and will be financed
by, in whole or in part, our existing cash, the proceeds from additional
issuances of common shares, issuances of operating partnership units or other
securities or borrowings. We make available to the TRS of our hotels 4% (6%
for full service properties) of gross revenues per quarter, on a cumulative
basis, for periodic replacement or refurbishment of furniture, fixtures and
equipment at each of our hotels. We believe that a 4% (6% for full service
hotels) reserve is a prudent estimate for future capital expenditure
requirements. We intend to spend amounts in excess of the obligated amounts if
necessary to comply with the reasonable requirements of any franchise license
under which any of our hotels operate and otherwise to the extent we deem such
expenditures to be in our best interests. We are also obligated to fund the
cost of certain capital improvements to our hotels. We will use undistributed
cash or borrowings under credit facilities to pay for the cost of capital
improvements and any furniture, fixture and equipment requirements in excess
of the set aside referenced above.
CASH FLOW ANALYSIS
Net cash provided by operating activities for the nine months ended
September 30, 2006 and 2005 was $18,019 and $3,790 respectively. The increase
in net cash provided by operating activities was primarily the result of an
increase in the number of hotels owned and operated over the same period in
2005. Also, operating cash distributions from unconsolidated joint ventures of
$1,834 were received during the nine months ended September 30, 2006.
Net cash used in investing activities forthe nine months ended September 30,
2006 and 2005 increased $39,834 from $191,373 in the nine months ended
September 30, 2005 compared to $231,307 for the nine months ended September 30,
2006. Net cash used for the purchase of hotel properties and advances and
capital contributions for unconsolidated joint ventures increased $53,086 in
the nine months ended September 30, 2006 over the same period in 2005. In
addition, capital expenditures increased $5,966 as part of our on going
acquisition and renovation programs. These uses of cash were partially offset
by a decrease in advances of development loans receivable, net of repayments,
of $16,753.
Net cash provided by financing activities for the nine months ended
September 30, 2006 was $220,781 compared to cash provided by financing
activities of $186,444 for the nine month period ended September 30, 2005.
This was, in part the result of $103,357 in net proceeds from our offerings of
common stock in the second and third quarters of 2006, compared to proceeds of
$57,855 from our offering of preferred stock during the nine months ended
September 30, 2005. Also, net borrowings under our line of credit were $37,768
during the nine months ended September 30, 2006, compared to net of repayments
under our line of credit of $888 during the same period in 2005. The increase
in net cash provided by financing activities for the nine months ended
September 30, 2006 was partially offset by a decrease in net proceeds from
mortgages and notes payable of $55,702 in 2006 when compared to net proceeds
from mortgages and notes payable in
S-15
2005. In the second quarter of 2005, the company entered into $51,548 of notes
payable with Hersha Statutory Trust I and Hersha Statutory Trust II. Also,
dividends paid of $3,600 were paid in the nine months ended September 30, 2006
compared to $720 during the same period in 2005 due to the issuance of
preferred shares in the third quarter of 2005.
FUNDS FROM OPERATIONS
The National Association of Real Estate Investment Trusts ("NAREIT")
developed Funds from Operations ("FFO") as a non-GAAP financial measure of
performance of an equity REIT in order to recognize that income-producing real
estate historically has not depreciated on the basis determined under GAAP. We
calculate FFO applicable to common shares and Partnership units in accordance
with the April 2002 National Policy Bulletin of NAREIT, which we refer to as
the White Paper. The White Paper defines FFO as net income (loss) (computed in
accordance with GAAP) excluding extraordinary items as defined under GAAP and
gains or losses from sales of previously depreciated assets, plus certain non-
cash items, such as depreciation and amortization, and after adjustments for
unconsolidated partnerships and joint ventures. Our interpretation of the
NAREIT definition is that minority interest in net income (loss) should be
added back to (deducted from) net income (loss) as part of reconciling net
income (loss) to FFO. Our FFO computation may not be comparable to FFO
reported by other REITs that do not compute FFO in accordance with the NAREIT
definition, or that interpret the NAREIT definition differently than we do.
The GAAP measure that we believe to be most directly comparable to FFO, net
income (loss) applicable to common shares, includes depreciation and
amortization expenses, gains or losses on property sales, minority interest
and preferred dividends. In computing FFO, we eliminate these items because,
in our view, they are not indicative of the results from our property
operations.
FFO does not represent cash flows from operating activities in accordance
with GAAP and should not be considered an alternative to net income as an
indication of Hersha's performance or to cash flow as a measure of liquidity
or ability to make distributions. We consider FFO to be a meaningful,
additional measure of operating performance because it excludes the effects of
the assumption that the value of real estate assets diminishes predictably
over time, and because it is widely used by industry analysts as a performance
measure. We show both FFO from consolidated hotel operations and FFO from
unconsolidated joint ventures because we believe it is meaningful for the
investor to understand the relative contributions from our consolidated and
unconsolidated hotels. The display of both FFO from consolidated hotels and
FFO from unconsolidated joint ventures allows for a detailed analysis of the
operating performance of our hotel portfolio by management and investors. We
present FFO applicable to common shares and Partnership units because our
Partnership units are redeemable for common shares. We believe it is
meaningful for the investor to understand FFO applicable to all common shares
and Partnership units.
S-16
The following table reconciles FFO for the periods presented to the most
directly comparable GAAP measure, net income, for the same periods.
(in thousands, except share data)
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------------------- ---------------------------------------
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------ ------------------ ------------------
Net income applicable to common shares ...... $ 4,580 $ 1,741 $ 1,672 $ 4,515
Income allocated to minority interest ...... 868 370 543 526
Income (loss) of discontinued operations
allocated to minority interest............ 24 (24) 42 (24)
(Income) from unconsolidated joint ventures (1,773) (522) (1,432) (850)
(Gain) on sale of assets ................... -- -- (436) (1,161)
Depreciation and amortization .............. 5,256 3,153 13,920 7,527
FFO related to the minority interests in
consolidated joint ventures (1)........... (154) (81) (324) (296)
----------- ----------- ----------- -----------
FUNDS FROM CONSOLIDATED HOTEL OPERATIONS
APPLICABLE TO COMMON SHARES AND PARTNERSHIP
UNITS...................................... 8,801 4,637 13,985 10,237
Income from Unconsolidated Joint Ventures ... 1,773 522 1,432 850
Depreciation and amortization of purchase
price in excess of historical cost (2).... 448 159 1,369 159
Interest in depreciation and amortization
of unconsolidated joint ventures (3)...... 1,202 1,502 3,775 2,018
----------- ----------- ----------- -----------
FUNDS FROM UNCONSOLIDATED JOINT VENTURES
OPERATIONS APPLICABLE TO COMMON SHARES AND
PARTNERSHIP UNITS.......................... 3,423 2,183 6,576 3,027
----------- ----------- ----------- -----------
FUNDS FROM OPERATIONS APPLICABLE TO COMMON
SHARES AND PARTNERSHIP UNITS............... $ 12,224 $ 6,820 $ 20,561 $ 13,264
=========== =========== =========== ===========
Weighted Average Common Shares and Units
Outstanding
Basic ...................................... 32,137,978 23,136,264 28,219,775 23,135,164
Diluted .................................... 32,280,728 23,207,264 28,322,839 23,166,893
---------------
(1) Adjustment made to deduct FFO related to the minority interest in our
consolidated joint ventures. Represents the portion of net income and
depreciation allocated to our joint venture partners.
(2) Adjustment made to add depreciation of purchase price in excess of
historical cost of the assets in the unconsolidated joint venture at the
time of our investment.
(3) Adjustment made to add our interest in real estate related depreciation and
amortization of our unconsolidated joint ventures. Allocation of
depreciation and amortization is consistent with allocation of income and
loss.
FFO was $12,224 for the three month period ended September 30, 2006, which
was an increase of $5,404, over FFO in the comparable period in 2005, which
was $6,820. FFO was $20,561 for the nine month period ended September 30,
2006, which was an increase of $7,297, over FFO in the comparable period in
2005, which was $13,264. The increase in FFO was primarily a result of a
strengthened economy; the benefits of acquiring assets and interests in joint
ventures since September 30, 2005; continued stabilization
S-17
and maturation of the existing portfolio; an increase in business travel and
continued attention to the average daily rate.
FFO was negatively impacted by increases in our interest expense and
dividends paid to our preferred shareholders and debt extinguishment charges
incurred during the period ended September 30, 2006.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities.
On an on-going basis, all estimates are evaluated by us, including those
related to carrying value of investments in hotel properties. All estimates
are based upon historical experience and on various other assumptions we
believe to be reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our
consolidated financial statements:
REVENUE RECOGNITION
We directly recognize revenue and expense for all consolidated hotels as
"Hotel Operating Revenue" and "Hotel Operating Expense" when earned and
incurred. Included in hotel operating revenues is primarily room revenues and
revenue from other hotel operating departments. These revenues are recorded
net of any sales or occupancy taxes collected from our guests. All revenues
are recorded on an accrual basis, as earned. We participate in frequent guest
programs sponsored by the brand owners of our hotels and we expense the
charges associated with those programs, as incurred.
STOCK COMPENSATION
We apply Statement of Financial Accounting Standards No. 123R, "Share-Based
Payments" (SFAS 123R) whereby we measure the cost of employee service received
in exchange for an award of equity instruments based on the grant -date fair
value of the award. The cost is recognized over the period during which an
employee is required to provide service in exchange for the award.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Accounts receivable are charged to bad debt expense when they are determined
to be uncollectible based upon a periodic review of the accounts by
management. Accounting principles generally accepted in the United States of
America require that the allowance method be used to recognize bad debts. Our
evaluation of the adequacy of the allowance for doubtful accounts is based on
known or inherent credit risks, economic conditions in the markets our hotels
operate, past experience, and other factors. This evaluation requires judgment
and is inherently subjective. Deterioration in the quality of our hotel
accounts receivable or other receivables could require us to record additional
allowance.
DERIVATIVES
The Company's objective in using derivatives is to add stability to interest
expense and to manage its exposure to interest rate movements or other
identified risks. To accomplish this objective, the Company primarily uses
interest rate swaps as part of its cash flow hedging strategy. Interest rate
swaps designated as cash flow hedges involve the receipt of variable-rate
amounts in exchange for fixed-rate payments over the life of the agreements
without exchange of the underlying principal amount. Interest rate caps
designated as cash flow hedges limit the Company's exposure to increased cash
payments due to increases in variable
S-18
interest rates. During the three and nine months ended September 30, 2006,
these derivatives were used to hedge the variable cash flows associated with
existing variable-rate debt.
As of September 30, 2006, no derivatives were designated as fair value
hedges or hedges of net investments in foreign operations. Additionally, the
Company does not use derivatives for trading or speculative purposes and
currently does not have any derivatives that are not designated as hedges.
INVESTMENT IN UNCONSOLIDATED JOINT VENTURES
The equity method of accounting is used for joint ventures in which we have
the ability to exercise significant influence. Under the equity method, we
recognize our share of net earnings or losses of the joint venture based on
our ownership interest in the joint venture and our rights to distributions of
the joint venture.
EVALUATION OF CONSOLIDATION CRITERIA FOR INVESTMENTS IN JOINT VENTURES AND
OTHER CONTRACTUAL RELATIONSHIPS
We evaluate our investments and contractual relationships to determine (a)
if the investment or relationship is with a Variable Interest Entitie (VIE)
and (b) if the entity is required to be consolidated with us in accordance
with the Financial Accounting Standards Board issued FASB Interpretation
No. 46, ("FIN 46R") "Consolidation of Variable Interest Entities (VIE's), an
interpretation of Accounting Research Bulletin No. 51 (ARB No. 51)," as
amended. FIN 46R addresses how a business enterprise should evaluate whether
it has a controlling financial interest in any VIE through means other than
voting rights, and accordingly, should include the VIE in its consolidated
financial statements.
In addition to other contractual relationships, our investments in
development loans receivable and joint ventures are evaluated to determine
whether they meet the guidelines of consolidation in accordance with FIN 46R:
Our examination consists of reviewing the sufficiency of equity at risk,
controlling financial interests, voting rights, and the obligation to absorb
expected losses and expected gains, including residual returns. The estimation
of an entities expected future losses, expected gains, and residual returns
requires significant judgment. We will continue to evaluate each of our
investments and contractual relationships to determine if consolidation is
required based upon the provisions of FIN 46R.
IMPAIRMENT OF LONG-LIVED ASSETS.
We review the carrying value of each hotel property in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 144 to determine if
circumstances exist indicating an impairment in the carrying value of the
investment in the hotel property or if depreciation periods should be
modified. Long-lived assets are reviewed for impairment whenever events or
changes in business circumstances indicate that the carrying amount of the
assets may not be fully recoverable. We perform undiscounted cash flow
analyses to determine if an impairment exists. If an impairment is determined
to exist, any related impairment loss is calculated based on fair value. Hotel
properties held for sale are presented at the lower of carrying amount or fair
value less cost to sell.
We would record an impairment charge if we believe an investment in hotel
property has been impaired such that future undiscounted cash flows would not
recover the book basis of the investment in the hotel property. Future adverse
changes in market conditions or poor operating results of underlying
investments could result in losses or an inability to recover the carrying
value of the investments that may not be reflected in an investment's carrying
value, thereby possibly requiring an impairment charge in the future. We have
reviewed each of our hotel properties at September 30, 2006 for impairment
and, based on our estimate of each hotel's future undiscounted cash flows,
determined that no impairment existed at any of our hotels.
INFLATION
Operators of hotels in general possess the ability to adjust room rates.
However, competitive pressures may limit the hotel operator's ability to raise
room rates in the face of inflation.
S-19
SEASONALITY
Our hotels' operations historically have been seasonal in nature, reflecting
higher occupancy rates during the second and third quarters. This seasonality
can be expected to cause fluctuations in our quarterly lease revenue to the
extent that we receive percentage rent.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk exposure is to changes in interest rates on our
variable rate Line of Credit and other floating rate debt. At September 30,
2006, we maintained a balance of $37,768 under our Line of Credit. The total
floating rate mortgages payable of $38,188 had a current weighted average
interest rate of 8.23%. The total fixed rate mortgages payable of $421,821 had
a current weighted average interest rate of 6.47%.
Our interest rate risk objectives are to limit the impact of interest rate
fluctuations on earnings and cash flows and to lower our overall borrowing
costs. To achieve these objectives, we manage our exposure to fluctuations in
market interest rates for a portion of our borrowings through the use of fixed
rate debt instruments to the extent that reasonably favorable rates are
obtainable with such arrangements. We may enter into derivative financial
instruments such as interest rate swaps or caps and treasury options or locks
to mitigate our interest rate risk on a related financial instrument or to
effectively lock the interest rate on a portion of our variable rate debt.
Currently, we have one interest rate swap related to debt on the Four Points
by Sheraton, Revere. We do not intend to enter into derivative or interest
rate transactions for speculative purposes.
Approximately 91.7% of our outstanding mortgages payable are subject to
fixed rates, including the debt whose rate is fixed through a derivative
instrument, while approximately 8.3% of our outstanding mortgages payable are
subject to floating rates. The total weighted average interest rate on our
debt and Line of Credit as of September 30, 2006 was approximately 6.67%. If
the interest rate for our Line of Credit and other variable rate debt was 100
basis points higher or lower during the period ended September 30, 2006, our
interest expense for the three month and nine month period ended September 30,
2006 would have been increased or decreased by approximately $144 and $478,
respectively.
As of September 30, 2006, mortgages and notes payable and liabilities
related to hotel assets held for sale included fixed-rate debt, with a
carrying value of approximately $421.8 million. Changes in market interest
rates on our fixed-rate debt impact the fair value of the debt, but it has no
impact on interest incurred for cash flow. If interest rates raise 100 basis
points and our fixed rate debt balance remains constant, we expect the fair
value of our debt to decrease, the same way the price of a bond declines as
interest rates rise. The sensitivity analysis related to our fixed-rate debt
assumes an immediate 100 basis point move in interest rates from their
September 30, 2006 levels, with all other variables held constant. A 100 basis
point increase in market interest rates would result in the fair value of our
fixed-rate debt approximating $380 million, and a 100 basis point decrease in
market interest rates would result in the fair value of our fixed-rate debt
approximating $470 million.
We regularly review interest rate exposure on our outstanding borrowings in
an effort to minimize the risk of interest rate fluctuations. For debt
obligations outstanding at September 30, 2006, the following table presents
expected principal repayments and related weighted average interest rates by
expected maturity dates (in thousands):
2006 2007 2008 2009 2010 THEREAFTER TOTAL
Fixed Rate Debt......................................... $ 820 $6,043 $21,713 $29,851 $29,388 $334,007 $421,822
Average Interest Rate................................... 6.47% 6.45% 6.46% 6.45% 6.28% 6.28% 6.40%
Floating Rate Debt...................................... $ 144 $ 593 $13,873 $ 8,596 $12,366 $ 2,615 $ 38,187
Average Interest Rate................................... 8.24% 8.24% 7.83% 8.00% 8.00% 8.00% 8.05%
The table incorporates only those exposures that existed as of September 30,
2006 and does not consider exposure or positions that could arise after that
date. As a result, our ultimate realized gain or loss with respect to interest
rate fluctuations will depend on the exposures that arise during the future
period, prevailing interest rates, and our hedging strategies at that time.
S-20
At September 30, 2006, the fair value of the interest rate swap was $41 and
is included in other assets on the face of the consolidated balance sheets. At
December 31, 2005, the fair value of the interest rate cap was $23 and is
included in other assets and the fair value of the interest rate swap was $0.
The change in net unrealized gains/losses was a loss of $122 and a gain of
$167 for the three months ended September 30, 2006 and 2005, respectively, for
derivatives designated as cash flow hedges and the change in net unrealized
gains/losses was a loss of $87 and a gain of $267 for the nine months ended
September 30, 2006 and 2005, respectively, for derivatives designed as cash
flow hedges. Hedge ineffectiveness of $3 and $4 on cash flow hedges was
recognized in unrealized gain/loss on derivatives during the three months
ended September 30, 2006 and 2005, respectively. Hedge ineffectiveness of $10
and $11 on cash flow hedges was recognized in unrealized gain/loss on
derivatives during the nine months ended September 30, 2006 and 2005,
respectively. Hedge ineffectiveness is included in interest expense on the
face of the consolidated statements of operations. On June 12, 2006, we
terminated the interest rate cap due to the refinancing of the associated
interest rate debt instrument to a fixed rate. We received $79 in cash and
reclassified $58 in reduction to interest expense as a result of the
termination of this cap.
S-21
ADDITIONAL FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of certain federal income tax considerations with
respect to the ownership of our common shares. For additional information, see
"Federal Income Tax Consequences of Our Status as a REIT," beginning on page
32 of the accompanying prospectus.
TAXATION OF TAXABLE U.S. SHAREHOLDERS
As used herein, the term "U.S. shareholder" means a holder of our common
shares that for U.S. federal income tax purposes is:
o a citizen or resident of the United States;
o a corporation (including an entity treated as a corporation for federal
income tax purposes) created or organized in or under the laws of the
United States, any of its states or the District of Columbia;
o an estate whose income is subject to federal income taxation regardless
of its source; or
o any trust if (1) a U.S. court is able to exercise primary supervision
over the administration of such trust and one or more U.S. persons have
the authority to control all substantial decisions of the trust or (2) it
has a valid election in place to be treated as a U.S. person.
If a partnership, entity or arrangement treated as a partnership for U.S.
federal income tax purposes holds our common shares, the federal income tax
treatment of a partner in the partnership will generally depend on the status
of the partner and the activities of the partnership. If you are a partner in
a partnership holding our common shares, you should consult your tax advisor
regarding the consequences of the ownership and disposition of our common
shares by the partnership.
As long as we qualify as a REIT, a taxable U.S. shareholder must generally
take into account as ordinary income distributions made out of our current or
accumulated earnings and profits that we do not designate as capital gain
dividends or retained long-term capital gain. For purposes of determining
whether a distribution is made out of our current or accumulated earnings and
profits, our earnings and profits will be allocated first to our preferred
share dividends and then to our common share dividends.
Dividends paid to corporate U.S. shareholders will not qualify for the
dividends received deduction generally available to corporations. In addition,
dividends paid to a U.S. shareholder generally will not qualify for the 15%
tax rate for "qualified dividend income." Legislation enacted in 2003 and 2006
reduced the maximum tax rate for qualified dividend income from 38.6% to 15%
for tax years 2003 through 2010. Without future congressional action, the
maximum tax rate on qualified dividend income will be 39.6% in 2011. Qualified
dividend income generally includes dividends paid to most domestic non-
corporate taxpayers by domestic C corporations and certain qualified foreign
corporations. Because we are not generally subject to federal income tax on
the portion of our net taxable income distributed to our shareholders (see
"Federal Income Tax Consequences of Our Status as a REIT -- Taxation of Our
Company" in the accompanying prospectus), our dividends generally will not be
eligible for the 15% rate on qualified dividend income. As a result, our
ordinary dividends will continue to be taxed at the higher tax rate applicable
to ordinary income, which currently is a maximum rate of 35%. However, the 15%
tax rate for qualified dividend income will apply to our ordinary dividends to
the extent attributable (i) to dividends received by us from non-REIT
corporations, such as a TRS, and (ii) to income upon which we have paid
corporate income tax (e.g., to the extent that we distribute less than 100% of
our taxable income). In general, to qualify for the reduced tax rate on
qualified dividend income, a shareholder must hold our common shares for more
than 60 days during the 121-day period beginning on the date that is 60 days
before the date on which our common shares become ex-dividend.
A U.S. shareholder generally will take into account as long-term capital
gain any distributions that we designate as capital gain dividends without
regard to the period for which the U.S. shareholder has held our common
shares. We generally will designate our capital gain dividends as either 15%
or 25% rate distributions. See "-- Capital Gains and Losses." A corporate U.S.
shareholder, however, may be required to treat up to 20% of certain capital
gain dividends as ordinary income.
S-22
We may elect to retain and pay income tax on the net long-term capital gain
that we receive in a taxable year. In that case, to the extent that we
designate such amount in a timely notice to such shareholder, a U.S.
shareholder would be taxed on its proportionate share of our undistributed
long-term capital gain. The U.S. shareholder would receive a credit for its
proportionate share of the tax we paid. The U.S. shareholder would increase
the basis in its stock by the amount of its proportionate share of our
undistributed long-term capital gain, minus its share of the tax we paid.
To the extent that we make a distribution in excess of our current and
accumulated earnings and profits, such distribution will not be taxable to a
U.S. shareholder to the extent that it does not exceed the adjusted tax basis
of the U.S. shareholder's common shares. Instead, such distribution will
reduce the adjusted tax basis of such shares. To the extent that we make a
distribution in excess of both our current and accumulated earnings and
profits and the U.S. shareholder's adjusted tax basis in its common shares,
such shareholder will recognize long-term capital gain, or short-term capital
gain if the common shares have been held for one year or less, assuming the
common shares are capital assets in the hands of the U.S. shareholder. In
addition, if we declare a distribution in October, November, or December of
any year that is payable to a U.S. shareholder of record on a specified date
in any such month, such distribution shall be treated as both paid by us and
received by the U.S. shareholder on December 31 of such year, provided that we
actually pay the distribution during January of the following calendar year.
Shareholders may not include in their individual income tax returns any of
our net operating losses or capital losses. Instead, we would carry over such
losses for potential offset against our future income. Taxable distributions
from us and gain from the disposition of our common shares will not be treated
as passive activity income, and therefore, shareholders generally will not be
able to apply any "passive activity losses," such as losses from certain types
of limited partnerships in which the shareholder is a limited partner, against
such income. In addition, taxable distributions from us and gain from the
disposition of our common shares generally may be treated as investment income
for purposes of the investment interest limitations (although any capital
gains so treated will not qualify for the lower 15% tax rate applicable to
capital gains of most domestic non-corporate investors). We will notify
shareholders after the close of our taxable year as to the portions of the
distributions attributable to that year that constitute ordinary income,
return of capital, and capital gain.
TAXATION OF U.S. SHAREHOLDERS ON THE DISPOSITION OF COMMON SHARES
In general, a U.S. shareholder who is not a dealer in securities must treat
any gain or loss realized upon a taxable disposition of our common shares as
long-term capital gain or loss if the U.S. shareholder has held the common
shares for more than one year and otherwise as short-term capital gain or
loss. However, a U.S. shareholder must treat any loss upon a sale or exchange
of common shares held by such shareholder for six months or less as a long-
term capital loss to the extent of any actual or deemed distributions from us
that such U.S. shareholder previously has characterized as long-term capital
gain. All or a portion of any loss that a U.S. shareholder realizes upon a
taxable disposition of common shares may be disallowed if the U.S. shareholder
purchases other common shares within 30 days before or after the disposition.
CAPITAL GAINS AND LOSSES
A taxpayer generally must hold a capital asset for more than one year for
gain or loss derived from its sale or exchange to be treated as long-term
capital gain or loss. The highest marginal individual income tax rate is 35%.
However, the maximum tax rate on long-term capital gain applicable to most
domestic non-corporate taxpayers is 15% (after December 31, 2010, the maximum
rate is scheduled to increase to 20%). The maximum tax rate on long-term
capital gain from the sale or exchange of "section 1250 property," or
depreciable real property, is 25% computed on the lesser of the total amount
of the gain or the accumulated Section 1250 depreciation. With respect to
distributions that we designate as capital gain dividends and any retained
capital gain that we are deemed to distribute, we generally may designate
whether such a distribution is taxable to our non-corporate shareholders at a
15% or 25% rate. Thus, the tax rate differential between capital gain and
ordinary income for non-corporate taxpayers may be significant. In addition,
the characterization of income as capital gain or ordinary income may affect
the deductibility of capital losses. A non-corporate taxpayer may deduct
capital losses not offset by capital gains against its ordinary income only
S-23
up to a maximum annual amount of $3,000. A non-corporate taxpayer may carry
forward unused capital losses indefinitely. A corporate taxpayer must pay tax
on its net capital gain at ordinary corporate rates. A corporate taxpayer may
deduct capital losses only to the extent of capital gains, with unused losses
being carried back three years and forward five years.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING
We will report to our shareholders and to the Internal Revenue Service the
amount of distributions we pay during each calendar year, and the amount of
tax we withhold, if any. Under the backup withholding rules, a shareholder may
be subject to backup withholding at the rate of 28% with respect to
distributions unless such holder:
o is a corporation or comes within certain other exempt categories and,
when required, demonstrates this fact; or
o provides a taxpayer identification number, certifies as to no loss of
exemption from backup withholding, and otherwise complies with the
applicable requirements of the backup withholding rules.
A shareholder who does not provide us with its correct taxpayer
identification number also may be subject to penalties imposed by the Internal
Revenue Service. Any amount paid as backup withholding will be creditable
against the shareholder's income tax liability. In addition, we may be
required to withhold a portion of capital gain distributions to any
shareholders who fail to certify their non-foreign status to us. See "--
Taxation of Non-U.S. Shareholders."
TAXATION OF TAX-EXEMPT SHAREHOLDERS
Tax-exempt entities, including qualified employee pension and profit sharing
trusts and individual retirement accounts and annuities, generally are exempt
from federal income taxation. However, they are subject to taxation on their
unrelated business taxable income. While many investments in real estate
generate unrelated business taxable income, the Internal Revenue Service has
issued a published ruling that dividend distributions from a REIT to an exempt
employee pension trust do not constitute unrelated business taxable income,
provided that the exempt employee pension trust does not otherwise use the
shares of the REIT in an unrelated trade or business of the pension trust.
Based on that ruling, amounts that we distribute to tax-exempt shareholders
generally should not constitute unrelated business taxable income. However, if
a tax-exempt shareholder were to finance its acquisition of our common shares
with debt, a portion of the income that it receives from us would constitute
unrelated business taxable income pursuant to the "debt-financed property"
rules. Furthermore, social clubs, voluntary employee benefit associations,
supplemental unemployment benefit trusts, and qualified group legal services
plans that are exempt from taxation under special provisions of the federal
income tax laws are subject to different unrelated business taxable income
rules, which generally will require them to characterize distributions that
they receive from us as unrelated business taxable income. Finally, in certain
circumstances, a qualified employee pension or profit sharing trust that owns
more than 10% of our shares of beneficial interest is required to treat a
percentage of the dividends that it receives from us as unrelated business
taxable income. Such percentage is equal to the gross income that we derive
from an unrelated trade or business, determined as if we were a pension trust,
divided by our total gross income for the year in which we pay the dividends.
That rule applies to a pension trust holding more than 10% of our shares of
beneficial interest only if:
o the percentage of our dividends that the tax-exempt trust would be
required to treat as unrelated business taxable income is at least 5%;
o we qualify as a REIT by reason of the modification of the rule requiring
that no more than 50% of our shares of beneficial interest be owned by
five or fewer individuals that allows the beneficiaries of the pension
trust to be treated as holding our shares of beneficial interest in
proportion to their actuarial interests in the pension trust (see
"Federal Income Tax Consequences of Our Status as a REIT -- Requirements
for Qualification" in the accompanying prospectus); and
S-24
o either (1) one pension trust owns more than 25% of the value of our
shares of beneficial interest or (2) a group of pension trusts
individually holding more than 10% of the value of our shares of
beneficial interest collectively owns more than 50% of the value of our
shares.
TAXATION OF NON-U.S. SHAREHOLDERS
The rules governing federal income taxation of nonresident alien
individuals, foreign corporations, foreign partnerships, and other foreign
shareholders (collectively, "non-U.S. shareholders") are complex. This section
is only a summary of such rules. WE URGE NON-U.S. SHAREHOLDERS TO CONSULT
THEIR TAX ADVISORS TO DETERMINE THE IMPACT OF FEDERAL, STATE, LOCAL AND
FOREIGN INCOME TAX LAWS ON OWNERSHIP OF OUR COMMON SHARES, INCLUDING ANY
REPORTING REQUIREMENTS.
A non-U.S. shareholder that receives a distribution that is not attributable
to gain from our sale or exchange of a "United States real property interest,"
as defined below, and that we do not designate as a capital gain dividend or
retained capital gain will recognize ordinary income to the extent that we pay
such distribution out of our current or accumulated earnings and profits. A
withholding tax equal to 30% of the gross amount of the distribution
ordinarily will apply to such distribution unless an applicable tax treaty
reduces or eliminates the tax. However, if a distribution is treated as
effectively connected with the non-U.S. shareholder's conduct of a U.S. trade
or business, the non-U.S. shareholder generally will be subject to federal
income tax on the distribution at graduated rates, in the same manner as U.S.
shareholders are taxed with respect to such distribution, and a non-U.S.
shareholder that is a corporation also may be subject to the 30% branch
profits tax with respect to the distribution. We plan to withhold U.S. income
tax at the rate of 30% on the gross amount of any such distribution paid to a
non-U.S. shareholder unless either:
o a lower treaty rate applies and the non-U.S. shareholder files an IRS
Form W-8BEN evidencing eligibility for that reduced rate with us; or
o the non-U.S. shareholder files an IRS Form W-8ECI with us claiming that
the distribution is effectively connected income.
A non-U.S. shareholder will not incur tax on a distribution in excess of our
current and accumulated earnings and profits if the excess portion of such
distribution does not exceed the adjusted basis of its common shares. Instead,
the excess portion of such distribution will reduce the adjusted basis of such
shares. A non-U.S. shareholder will be subject to tax on a distribution that
exceeds both our current and accumulated earnings and profits and the adjusted
basis of its common shares, if the non-U.S. shareholder otherwise would be
subject to tax on gain from the sale or disposition of its common shares, as
described below. Because we generally cannot determine at the time we make a
distribution whether the distribution will exceed our current and accumulated
earnings and profits, we normally will withhold tax on the entire amount of
any distribution at the same rate as we would withhold on a dividend. However,
a non-U.S. shareholder may claim a refund of amounts that we withhold if we
later determine that a distribution in fact exceeded our current and
accumulated earnings and profits.
We may be required to withhold 10% of any distribution that exceeds our
current and accumulated earnings and profits. Consequently, although we intend
to withhold at a rate of 30% on the entire amount of any distribution, to the
extent that we do not do so, we will withhold at a rate of 10% on any portion
of a distribution not subject to withholding at a rate of 30%.
For any year in which we qualify as a REIT, a non-U.S. shareholder will
incur tax on distributions that are attributable to gain from our sale or
exchange of a "United States real property interest" under special provisions
of the federal income tax laws referred to as FIRPTA. The term "United States
real property interest" includes certain interests in real property and stock
in corporations at least 50% of whose assets consist of interests in real
property. Under those rules, a non-U.S. shareholder is taxed on distributions
attributable to gain from sales of United States real property interests as if
such gain were effectively connected with a U.S. business of the non-U.S.
shareholder. A non-U.S. shareholder thus would be taxed on such a distribution
at the normal capital gains rates applicable to U.S. shareholders, subject to
applicable alternative minimum tax and a special alternative minimum tax in
the case of a nonresident alien individual. A non-U.S. corporate shareholder
not entitled to treaty relief or exemption also may be subject to the 30%
S-25
branch profits tax on such a distribution. We must withhold 35% of any
distribution that we could designate as a capital gain dividend. A non-U.S.
shareholder may receive a credit against its tax liability for the amount we
withhold.
Capital gain distributions to the holders of common shares that are
attributable to our sale of real property will be treated as ordinary
dividends rather than as gain from the sale of a United States real property
interest, as long as (1) our common shares continue to treated as being
"regularly traded" on an established securities market in the United States
and (2) the non-U.S. shareholder did not own more than 5% of our common shares
at any time during the taxable year. As a result, non-U.S. shareholders owning
5% or less of our common shares generally will be subject to withholding tax
on such capital gain distributions in the same manner as they are subject to
withholding tax on ordinary dividends. If our common shares cease to be
regularly traded on an established securities market or the non-U.S.
shareholder owned more than 5% of our common shares at any time during the
taxable year, capital gain distributions that are attributable to our sale of
real property would be subject to tax under FIRPTA, as described in the
preceding paragraph. Moreover, if a non-U.S. shareholder disposes of our
common shares during the 30-day period preceding a dividend payment, and such
non-U.S. shareholder (or a person related to such non-U.S. shareholder)
acquires or enters into a contract or option to acquire our common shares
within 61 days of the 1st day of the 30-day period described above, and any
portion of such dividend payment would, but for the disposition, be treated as
a United States real property interest capital gain to such non-U.S.
shareholder, then such non-U.S. shareholder shall be treated as having United
States real property interest capital gain in an amount that, but for the
disposition, would have been treated as United States real property interest
capital gain.
A non-U.S. shareholder generally will not incur tax under FIRPTA with
respect to gain realized upon a disposition of our common shares as long as at
all times non-U.S. persons hold, directly or indirectly, less than 50% in
value of our shares of beneficial interest. We cannot assure you that that
test will be met. However, a non-U.S. shareholder that owned, actually or
constructively, 5% or less of our common shares at all times during a
specified testing period will not incur tax under FIRPTA if the common shares
are "regularly traded" on an established securities market in the United
States. Because our common shares are regularly traded on an established
securities market in the United States, a non-U.S. shareholder will not incur
tax under FIRPTA with respect to any such gain unless it owns, actually or
constructively, more than 5% of our common shares. If the gain on the sale of
the common shares were taxed under FIRPTA, a non-U.S. shareholder would be
taxed in the same manner as U.S. shareholders with respect to such gain,
subject to applicable alternative minimum tax or, a special alternative
minimum tax in the case of nonresident alien individuals. Furthermore, a non-
U.S. shareholder will incur tax on gain not subject to FIRPTA if (1) the gain
is effectively connected with the non-U.S. shareholder's U.S. trade or
business, in which case the non-U.S. shareholder will be subject to the same
treatment as U.S. shareholders with respect to such gain, or (2) the non-U.S.
shareholder is a nonresident alien individual who was present in the United
States for 183 days or more during the taxable year and has a "tax home" in
the United States, in which case the non-U.S. shareholder will incur a 30% tax
on his capital gains.
S-26
UNDERWRITING
We are offering our common shares described in this prospectus supplement
through the underwriters named below. UBS Securities LLC and Wachovia Capital
Markets, LLC are the representatives for the underwriters and the joint book-
running managers. We have entered into an underwriting agreement with the
representatives. Subject to the terms and conditions of the underwriting
agreement, each of the underwriters have severally agreed to purchase the
number of shares listed next to its name in the following table:
UNDERWRITERS NUMBER OF
------------ SHARES
---------
UBS Securities LLC................................ 2,448,000
Wachovia Capital Markets, LLC..................... 2,448,000
Raymond James & Associates, Inc................... 1,080,000
Robert W. Baird & Co. Incorporated................ 720,000
Stifel, Nicolaus & Company, Incorporated.......... 504,000
---------
Total.......................................... 7,200,000
=========
The underwriting agreement provides that the underwriters must buy all of
the shares if they buy any of them. However, the underwriters are not required
to take or pay for the shares covered by the underwriters' over-allotment
option described below.
Our common shares are offered subject to a number of conditions, including:
o receipt and acceptance of our common shares by the underwriters; and
o the underwriters' right to reject orders in whole or in part.
In connection with the offering, certain of the underwriters or securities
dealers may distribute prospectuses electronically.
Sales of shares made outside of the United States may be made by affiliates
of the underwriters. Upon the execution of the underwriting agreement, the
underwriters will be obligated to purchase the shares at the prices and upon
the terms stated therein, and, as a result, will thereafter bear any risk
associated with changing the offering price to the public or other selling
terms.
OVER-ALLOTMENT OPTION
We have granted the underwriters an option to buy up to 1,080,000 additional
common shares. The underwriters may exercise this option solely for the
purpose of covering over-allotments, if any, made in connection with this
offering. The underwriters have 30 days from the date of this prospectus
supplement to exercise this option. If the underwriters exercise this option,
they will each purchase additional shares approximately in proportion to the
amounts specified in the table above.
COMMISSIONS AND DISCOUNTS
Shares sold by the underwriters to the public will initially be offered at
the offering price set forth on the cover of this prospectus supplement. Any
shares sold by the underwriters to securities dealers may be sold at a
discount of up to $0.33 per share from the public offering price. Any of these
securities dealers may resell any shares purchased from the underwriters to
other brokers or dealers at a discount of up to $0.10 per share from the
public offering price. If all of the shares are not sold at the public
offering price, the representatives may change the offering price and the
other selling terms. Upon execution of the underwriting agreement, the
underwriters will be obligated to purchase the shares at the prices and upon
the terms stated therein, and, as a result, will thereafter bear any risk
associated with changing the offering price to the public or other selling
terms. Sales of shares made outside of the United States may be made by
affiliates of the underwriters.
S-27
The following table shows the per share and total underwriting discounts and
commissions we will pay to the underwriters assuming both no exercise and full
exercise of the underwriters' over-allotment option to purchase up to an
additional 1,080,000 shares.
NO EXERCISE FULL EXERCISE
----------- -------------
Per share ......................... $ 0.56 $ 0.56
Total ............................. $4,032,000 $4,636,800
We estimate that the total expenses of this offering payable by us, not
including underwriting discounts and commissions, will be approximately
$150,000.
NO SALES OF SIMILAR SECURITIES
We, our officers and our directors have entered into lock-up agreements with
the underwriters. Under these agreements, subject to certain permitted
exceptions, we and each of these persons may not, without the prior written
consent of UBS Securities LLC and Wachovia Capital Markets, LLC, sell, offer
to sell, contract or agree to sell, hedge or otherwise dispose of, directly or
indirectly, any of our common shares or securities convertible into or
exchangeable or exercisable for common shares during the period from the date
of this prospectus continuing through the date 30 days after the date of this
prospectus. UBS Securities LLC and Wachovia Capital Markets, LLC, in their
sole discretion, may permit early release of our common shares subject to the
restrictions detailed above prior to the expiration of the 30-day lock up
period and without public notice. The 30-day lock up period may be extended
for up to 15 calendar days plus three business days under certain
circumstances where we announce or pre-announce earnings or material news or a
material event within 15 calendar days plus three business days prior to, or
approximately 16 days after, the termination of the 30-day lock up period.
Even under those circumstances, however, the lock-up period will not be
extended if we are actively traded, meaning that we have a public float of at
least $250 million and average trading volume of at least $1 million per day.
AMERICAN STOCK EXCHANGE LISTING
Our common shares are listed on the American Stock Exchange under the symbol
"HT."
PRICE STABILIZATION AND SHORT POSITIONS
In connection with this offering, the underwriters may engage in activities
that stabilize, maintain or otherwise affect the price of our common shares
including:
o stabilizing transactions;
o short sales;
o purchases to cover positions created by short sales;
o imposition of penalty bids; and
o syndicate covering transactions.
Stabilizing transactions consist of bids or purchases made for the purpose
of preventing or retarding a decline in the market price of our common shares
while this offering is in progress. These transactions may also include making
short sales of our common shares, which involves the sale by the underwriters
of a greater number of common shares than they are required to purchase in
this offering, and purchasing common shares on the open market to cover
positions created by short sales. Short sales may be "covered" shorts, which
are short positions in an amount not greater than the underwriters' over-
allotment option referred to above, or may be "naked" shorts, which are short
positions in excess of that amount.
The underwriters may close out any covered short position by either
exercising their over-allotment option, in whole or in part, or by purchasing
common shares in the open market. In making this determination, the
underwriters will consider, among other things, the price of the shares
available for
S-28
purchase in the open market as compared to the price at which they may
purchase shares through the over-allotment option.
Naked short sales are sales in excess of the over-allotment option. The
underwriters must close out any naked short position by purchasing shares in
the open market. A naked short position is more likely to be created if the
underwriters are concerned there may be downward pressure on the price of
shares in the open market after pricing that could adversely affect investors
who purchase in this offering.
The underwriters also may impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the
underwriting discount received by it because the representatives have
repurchased shares sold by or for the account of that underwriter in
stabilizing or short covering transactions.
As a result of these activities, the price of our shares may be higher than
the price that otherwise might exist in the open market. If these activities
are commenced, they may be discontinued by the underwriters at any time. The
underwriters may carry out these transactions on the American Stock Exchange,
in the over-the-counter market or otherwise. Neither we nor any of the
underwriters makes any representation or prediction as to the direction or
magnitude of any effect that the transactions described above may have on the
price of the common shares. In addition, neither we nor any of the
underwriters makes any representation that the underwriters will engage in
these transactions or that these transactions, once commenced, will not be
discontinued without notice.
AFFILIATIONS
In the ordinary course of business, the underwriters and their affiliates
have provided, and may in the future provide, investment banking, commercial
banking, financial advisory and other services to us for which they have
received and may in the future receive, customary fees. In connection with the
acquisition of the McIntosh portfolio, UBS Real Estate Investment, Inc., an
affiliate of UBS Securities LLC, made a $36.3 million mortgage loan to a
number of our subsidiaries, the service on such loan being secured by the
lease fees and rents that the subsidiaries will receive in connection with the
five properties in the McIntosh portfolio. UBS Securities LLC was a lender
under certain of the refinancings of properties that were contributed to our
Mystic Partners joint venture with Waterford. Various subsidiaries of Wachovia
Bank, N.A., an affiliate of Wachovia Capital Markets, LLC, act as servicer
under certain of the mortgage loans secured by properties owned by us. In
connection with the acquisition of the Brookline Courtyard by Marriott in
Brookline, Massachusetts, Wachovia Bank, N.A. made a $38.9 million mortgage
loan to a subsidiary of HHLP (guaranteed by HHLP) secured by the Brookline
property. In connection with the refinancing of a 50% joint venture interest
in the Courtyard by Marriott in Ewing-Hopewell, New Jersey on July 19, 2005,
Wachovia Bank, N.A. made a $13.5 million mortgage loan to the owner of the
hotel, in which we own a 50% interest, secured by the Ewing-Hopewell property.
An affiliate of Raymond James & Associates, Inc. is a lender under our
revolving line of credit, and it will receive a portion of the proceeds of
this offering as repayment of indebtedness incurred thereunder.
INDEMNIFICATION AND CONTRIBUTION
We have agreed to indemnify the underwriters against certain liabilities,
including liabilities under the Securities Act. If we are unable to provide
this indemnification, we will contribute to payments the underwriters may be
required to make with respect to those liabilities.
S-29
NOTICE TO INVESTORS
EUROPEAN ECONOMIC AREA
With respect to each Member State of the European Economic Area which has
implemented Prospectus Directive 2003/71/ EC, including any applicable
implementing measures, from and including the date on which the Prospectus
Directive is implemented in that Member State, the offering of our common
shares in this offering is only being made:
(a) to legal entities which are authorized or regulated to operate in
the financial markets or, if not so authorized or regulated, whose
corporate purpose is solely to invest in securities;
(b) to any legal entity which has two or more of (1) an average of at
least 250 employees during the last financial year; (2) a total
balance sheet of more than (E)43,000,000 and (3) an annual net
turnover of more than (E) 50,000,000, as shown in its last annual or
consolidated accounts; or
(c) in any other circumstances which do not require the publication by
the Issuer of a prospectus pursuant to Article 3 of the Prospectus
Directive.
UNITED KINGDOM
Our common shares may not be offered or sold and will not be offered or sold
to any persons in the United Kingdom other than to persons whose ordinary
activities involve them in acquiring, holding, managing or disposing of
investments (as principal or as agent) for the purposes of their businesses
and in compliance with all applicable provisions of the FSMA with respect to
anything done in relation to our common shares in, from or otherwise involving
the United Kingdom. In addition, any invitation or inducement to engage in
investment activity (within the meaning of Section 21 of the FSMA) in
connection with the issue or sale of our common shares may only be
communicated in circumstances in which Section 21(1) of the FSMA does not
apply to the Company. Without limitation to the other restrictions referred to
herein, this offering circular is directed only at (1) persons outside the
United Kingdom, (2) persons having professional experience in matters relating
to investments who fall within the definition of "investment professionals" in
Article 19(5) of the Financial Services and Markets act 2000 (Financial
Promotion) Order 2005; or (3) high net worth bodies corporate, unincorporated
associations and partnerships and trustees of high value trusts as described
in Article 49(2) of the Financial Services and Markets act 2000 (Financial
Promotion) Order 2005. Without limitation to the other restrictions referred
to herein, any investment or investment activity to which this offering
circular relates is available only to, and will be engaged in only with, such
persons, and persons within the United Kingdom who receive this communication
(other than persons who fall within (2) or (3) above) should not rely or act
upon this communication.
SWITZERLAND
Our common shares may be offered in Switzerland only on the basis of a non-
public offering. This prospectus does not constitute an issuance prospectus
according to articles 652a or 1156 of the Swiss Federal Code of shares may not
be offered or distributed on a professional basis in or from Switzerland and
neither this prospectus nor any other offering material relating to our common
shares may be publicly issued in connection with any such offer or
distribution. The shares have not been and will not be approved by any Swiss
regulatory authority. In particular, the shares are not and will not be
registered with or supervised by the Swiss Federal Banking Commission, and
investors may not claim protection under the Swiss Investment Fund Act.
LEGAL MATTERS
Certain legal matters in connection with this offering will be passed upon
for us by Hunton & Williams LLP. In addition, the summaries of legal matters
contained in the section of the accompanying prospectus under the heading
"Federal Income Tax Consequences of Our Status as a REIT" and in the section
of this prospectus supplement under the heading "Additional Federal Income Tax
Considerations" are based on the
S-30
opinion of Hunton & Williams LLP. Certain legal matters in connection with
this offering will be passed upon for the underwriters by Clifford Chance US
LLP.
EXPERTS
The consolidated financial statements and schedule of Hersha Hospitality
Trust as of December 31, 2005, and 2004, and for each of the years in the two
year period ended December 31, 2005, and management's assessment of the
effectiveness of internal control over financial reporting as of December 31,
2005 have been incorporated by reference herein in reliance upon the reports
of KPMG LLP, independent registered public accounting firm, incorporated by
reference herein, and upon the authority of said firm as experts in accounting
and auditing. KPMG's report on the consolidated financial statements and
schedule as of December 31, 2005, contains an explanatory paragraph that
indicates that we have adopted FASB Interpretation No. 46 (R), Consolidation
of Variable Interest Entities effective March 31, 2004.
KPMG's report on management's assessment of the effectiveness of internal
control over financial reporting and the effectiveness of internal control
over financial reporting as of December 31, 2005, expresses their opinion that
the Company did not maintain effective internal control over financial
reporting as of December 31, 2005 because of the effect of material weaknesses
on the achievement of the objectives of the control over completeness and
accuracy of payroll expense, existence and accuracy of reported revenue and
approval of journal entries and the review and analysis of account
reconciliations and related data did not operate effectively at December 31,
2005. Additionally, an explanatory paragraph stated that Hersha Hospitality
Trust lacked appropriately designed controls to ensure the completeness of
accounts payable and accrued expenses.
Our consolidated balance sheet as of December 31, 2003, and our consolidated
statements of operations, cash flows and shareholders' equity for the year
ended December 31, 2003, incorporated by reference in this prospectus, have
been audited by Reznick Group, P.C. independent registered public accountants,
whose report is incorporated by reference in this prospectus and given upon
their authority as experts in accounting and auditing. The balance sheet of
Hersha Hospitality Management L.P. as of December 31, 2003, and the related
statements of operations, partners' equity (deficit), and cash flows for the
year ended December 31, 2003, incorporated by reference in this prospectus
have been audited by Reznick Group, P.C., independent registered public
accountants, whose report is incorporated by reference in this prospectus and
given upon their authority as experts in accounting and auditing.
The consolidated balance sheet as of December 31, 2005 and consolidated
statements of operations, cash flows and shareholders' equity for the year
ended December 31, 2005 for Affordable Hospitality Associates, L.P.; Metro JFK
Associates, LLC; TCVA Realty, LLC; KW Hotel Group and HT/CNL Metro Hotels, LLC
and Subsidiary incorporated by reference in this prospectus, have been audited
by Reznick Group, P.C. independent registered public accountants, whose
reports are incorporated by reference in this prospectus and given upon their
authority as experts in accounting and auditing.
The audited historical financial statements of Adriaen's Landing Hotel, LLC
as of December 31, 2005 and 2004 and for both of the two years in the period
ended December 31, 2005 incorporated by reference in this prospectus have been
so incorporated in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
S-31
$400,000,000
HERSHA HOSPITALITY TRUST
[HERSHA LOGO]
COMMON SHARES OF BENEFICIAL INTEREST
PREFERRED SHARES OF BENEFICIAL INTEREST
Hersha Hospitality Trust intends to offer and sell from time to time the
equity securities described in this prospectus. The total offering price of
these securities will not exceed $400,000,000 in the aggregate. We will
provide the specific terms of any securities we may offer in a supplement to
this prospectus. You should carefully read this prospectus and any applicable
prospectus supplement before deciding to invest in these securities.
Our common shares are listed on the American Stock Exchange under the symbol
"HT." The last reported sale price of our common shares on November 20, 2006
was $11.10 per share.
The securities may be offered directly, through agents designated by us from
time to time, or through underwriters or dealers.
FOR A DISCUSSION OF CERTAIN RISKS ASSOCIATED WITH AN INVESTMENT IN OUR
SECURITIES, SEE "RISK FACTORS" BEGINNING ON PAGE 3 OF THIS PROSPECTUS AND IN
OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2005 AND OUR
OTHER PERIODIC REPORTS AND OTHER INFORMATION THAT WE FILE FROM TIME TO TIME
WITH THE SECURITIES AND EXCHANGE COMMISSION.
----------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF
THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
----------------
THE DATE OF THIS PROSPECTUS IS NOVEMBER 28, 2006.
TABLE OF CONTENTS
ABOUT THIS PROSPECTUS .................................................... 1
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS ............... 1
CERTAIN DEFINITIONS ...................................................... 1
THE COMPANY .............................................................. 2
RISK FACTORS ............................................................. 3
RATIO OF EARNINGS TO FIXED CHARGES AND OF EARNINGS TO COMBINED FIXED
CHARGES AND PREFERRED SHARE DIVIDENDS................................... 14
USE OF PROCEEDS .......................................................... 14
DESCRIPTION OF SHARES OF BENEFICIAL INTEREST ............................. 15
LEGAL OWNERSHIP OF SECURITIES ............................................ 22
CERTAIN PROVISIONS OF MARYLAND LAW, OUR DECLARATION OF TRUST AND BYLAWS .. 25
PARTNERSHIP AGREEMENT .................................................... 28
FEDERAL INCOME TAX CONSEQUENCES OF OUR STATUS AS A REIT .................. 32
PLAN OF DISTRIBUTION ..................................................... 50
LEGAL MATTERS ............................................................ 52
EXPERTS .................................................................. 52
HOW TO OBTAIN MORE INFORMATION ........................................... 53
INCORPORATION OF INFORMATION FILED WITH THE SEC .......................... 53
----------------
You should rely only on the information contained or incorporated by
reference in this prospectus and any applicable prospectus supplement. We have
not authorized anyone else to provide you with different information. If
anyone provides you with different or inconsistent information, you should not
rely on it. We will not make an offer to sell these securities in any state
where the offer or sale is not permitted. You should assume that the
information appearing in this prospectus, as well as the information we
previously filed with the Securities and Exchange Commission and incorporated
by reference, is accurate only as of the date of the documents containing the
information.
i
ABOUT THIS PROSPECTUS
This prospectus is part of a shelf registration statement. We may sell, from
time to time, in one or more offerings, any combination of the securities
described in this prospectus. This prospectus only provides you with a general
description of the securities we may offer. Each time we offer for sale
securities under this prospectus, we will provide a prospectus supplement that
contains specific information about the terms of the securities we are
offering as well as other information. The prospectus supplement may also add,
update or change information contained in this prospectus. You should read
both this prospectus and any prospectus supplement. You should also read the
additional information described under the heading "How to Obtain More
Information."
The maximum aggregate offering price of the securities sold under this
prospectus will not exceed $400,000,000.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This prospectus and the information incorporated by reference into it
contains certain "forward-looking statements" within the meaning of Section 27A
of the Securities Act of 1933, as amended, or Securities Act, and Section 21E
of the Securities Exchange Act of 1934, as amended, or Exchange Act,
including, without limitation, statements containing the words "believes,"
"anticipates," "expects," "estimates," "intends," "plans," "projects," "will
continue" or other words that describe our expectations of the future. We have
based these forward-looking statements on our current expectations and
projections about future events and trends affecting the financial condition
of our business, which may prove to be incorrect. These forward-looking
statements relate to future events and our future financial performance, and
involve known and unknown risks, uncertainties and other factors which may
cause our actual results, performance, achievements or industry results to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. You should
specifically consider the factors identified under the caption "Risk Factors"
in this prospectus and the various other factors identified in or incorporated
by reference into this prospectus and any other documents filed by us with the
Securities and Exchange Commission (SEC) that could cause actual results to
differ materially from our forward-looking statements.
Except to the extent required by applicable law, we undertake no obligation
to, and do not intend to, update any forward-looking statements or any
statements included in the "Risk Factors" section of this prospectus or to
publicly announce the result of any revisions to any of the forward-looking
statements contained herein to reflect future events or developments. A number
of risk factors are associated with the conduct of our business, and the risks
discussed in the "Risk Factors" section of this prospectus may not be
exhaustive. New risks and uncertainties arise from time to time, and we cannot
predict these events or how they may affect us. All forward-looking statements
should be read with caution.
CERTAIN DEFINITIONS
References to "our company," "we," and "our" in this prospectus mean Hersha
Hospitality Trust, including, unless the context otherwise requires (including
the discussion of the federal income tax treatment of Hersha Hospitality Trust
and its shareholders), our operating partnership and other direct and indirect
subsidiaries. Our "operating partnership" refers to Hersha Hospitality Limited
Partnership, a Virginia limited partnership. "HHMLP" refers to Hersha
Hospitality Management, L.P. and its subsidiaries, which are the entities that
manage all of our wholly owned hotels and many of the hotels owned by our
joint ventures. "Common shares" means our common shares of beneficial
interest, par value $0.01 per share. The term "you" refers to a potential
investor in the securities described in this prospectus.
All brand names, trademarks and service marks appearing in this prospectus
are the property of their respective owners. This prospectus contains
registered trademarks owned or licensed to companies other than us, including
but not limited to Comfort Inn(R), Comfort Suites(R), Courtyard(R) by
Marriott(R), DoubleTree(R), Doubletree Suites(R), Fairfield Inn(R) by
Marriott(R), Hampton Inn(R), Hilton Hotels(R), Hilton Garden Inn(R), Holiday
Inn(R), Holiday Inn Express(R), Homewood Suites by Hilton(R), Mainstay
Suites(R), Marriott Hotels & Resorts(R), Residence Inn(R) by Marriott(R),
Sheraton Four Points(R), Sleep Inn(R), and Springhill Suites by Marriott(R),
none of which, in any way, are participating in or endorsing this offering and
shall not in any way
be deemed an issuer or underwriter of the securities issued under this
prospectus, and shall not have any liability or responsibility for any
financial statements or other financial information contained or incorporated
by reference in this prospectus.
THE COMPANY
Hersha Hospitality Trust is a self-advised Maryland real estate investment
trust that was organized in 1998 as a real estate investment trust ("REIT")
for U.S. federal income tax purposes, and completed its initial public
offering in January of 1999. We focus primarily on owning and operating high
quality, upper-upscale, upscale and mid-scale limited service and extended-
stay hotels in established markets. Our primary strategy is to continue to
acquire high quality, upper-upscale, upscale, mid-scale and extended-stay
hotels in metropolitan markets with high barriers-to-entry. Our common shares
are traded on the American Stock Exchange under the symbol "HT."
As of September 30, 2006, our portfolio consisted of 45 wholly-owned limited
and full service hotels and joint venture investments in 18 hotels with a
total of 7,940 rooms located in New York, New Jersey, Pennsylvania, Maryland,
Delaware, Massachusetts, Connecticut, Rhode Island, Virginia and Georgia. Our
hotels operate under leading brands, such as Marriott Hotels & Resorts(R),
Hilton Hotels(R), Courtyard by Marriott(R), Residence Inn(R), Hilton Garden
Inn(R), Springhill Suites(R), Hampton Inn(R), Holiday Inn(R), Holiday Inn
Express(R), Comfort Inn(R), Comfort Suites(R) and Four Points by Sheraton(R).
We are structured as an umbrella partnership REIT, or UPREIT, and we own all
our hotels through our operating partnership, Hersha Hospitality Limited
Partnership, for which we serve as general partner. All of our wholly-owned
hotels are managed by Hersha Hospitality Management, L.P., or HHMLP, a private
management company owned by certain of our trustees, officers and other third
party investors. Our hotels owned through joint venture interests are managed
by independent third party qualified management companies or HHMLP. We have a
wholly-owned taxable REIT subsidiary, or TRS, to which we lease all of our
wholly-owned hotels. All of the hotels we own through joint ventures are
leased (1) to joint ventures, in which we hold our equity interest through a
TRS, or (2) to a TRS wholly-owned or substantially-owned by the joint venture.
Since our initial public offering in 1999, we have acquired, wholly or
through joint ventures, a total of 64 hotels, including 19 hotels acquired
from entities controlled by our officers or trustees. Of the 19 acquisitions
from these entities, 16 were newly-constructed or newly-renovated by these
entities prior to our acquisition. Because we do not develop properties, we
take advantage of our relationships with these development entities to
identify development and renovation projects that may be attractive to us.
While these entities bear all the construction risks of development, we often
provide secured development loans and bear economic risks through these
development loans. In many instances, we maintain a first right of refusal or
first right of offer to purchase the hotel for which we have provided
development loan financing. We intend to continue to acquire hotels from these
entities if approved by our independent trustees.
In addition to the direct acquisition of hotels, we may make investments in
hotels through joint ventures with strategic partners or through equity
contributions, sales and leasebacks, or secured and mezzanine loans. We seek
to identify acquisition candidates located in markets with economic,
demographic and supply dynamics favorable to hotel owners and operators.
Through our extensive due diligence process, we select those acquisition
targets where we believe selective capital improvements and intensive
management will increase the hotel's ability to attract key demand segments,
enhance hotel operations and increase long-term value.
Our principal executive office is located at 510 Walnut Street, 9th Floor,
Philadelphia, Pennsylvania 19106. Our telephone number is (215) 238-1046.
2
RISK FACTORS
Investment in our securities involves risk. Before acquiring any securities
offered pursuant to this prospectus and any accompanying prospectus
supplement, you should carefully consider the risks described below as well as
the information contained, or incorporated by reference, in this prospectus
and any accompanying prospectus supplement, including, without limitation, the
risks described in our most recent Annual Report on Form 10-K, in our
Quarterly Reports on Form 10-Q, and as described in our other filings with the
SEC. The occurrence of any of these risks might cause you to lose all or a
part of your investment in our securities. Please also refer to the section
above entitled "Cautionary Statement Concerning Forward-Looking Statements."
RISKS RELATING TO OUR BUSINESS AND OPERATIONS
THERE CAN BE NO ASSURANCE THAT WE HAVE SUCCESSFULLY REMEDIED OUR RECENTLY
IDENTIFIED MATERIAL WEAKNESSES IN INTERNAL CONTROL OVER FINANCIAL REPORTING.
As a result of our testing of our internal control over financial reporting
for the year ended December 31, 2005, we identified certain matters involving
our internal control over financial reporting that we and our registered
public accounting firm determined to be material weaknesses under standards
established by the Public Company Accounting Oversight Board. These material
weaknesses related to:
o the accuracy and timeliness of the reconciliations of (i) cash received
in our bank account to the revenue recorded in the financial statements,
and (ii) rooms occupied per the hotel reservation system to the number of
rooms for which revenue was recorded;
o the consistency of the comparison of payroll costs as calculated by our
third-party payroll administrator to payroll expense recorded in the
general ledger;
o the nonperformance of certain controls over journal entries prepared by
HHMLP personnel from account reconciliations, including that the reviews
and assessments by HHMLP personnel were not always performed in time or
by personnel with the appropriate level of experience or knowledge; and
o the lack of controls designed to ensure the completeness of our accounts
payable and accrued expenses administered by HHMLP.
We have described these matters in more detail in Item 9A of our Annual
Report on Form 10-K, as amended, filed with the Securities and Exchange
Commission on March 22, 2006.
Although we have attempted to remedy the material weaknesses in internal
control over financial reporting identified by implementing a number of
actions aimed at strengthening our financial reporting processes, we cannot
assure you that the remedial measures we have taken will adequately address
the identified material weaknesses or that other material weaknesses will not
occur. Moreover, we have only recently implemented processes to address the
material weaknesses identified. We will continue to take further remedial
actions to improve our internal control over financial reporting in order to
continue to meet the requirements for being a public company, including the
rules under Section 404 of the Sarbanes-Oxley Act of 2002, but there can be no
assurance that the improvements we have made or will make will be sufficient
to ensure that we maintain adequate controls over our financial processes and
reporting in the future. Any failure to implement required new or improved
controls, or difficulties encountered in their implementation, could cause us
to fail to meet our reporting obligations or result in misstatements in our
financial statements in amounts that could be material. Inferior internal
controls could also cause investors to lose confidence in our reported
financial information, which could have a negative effect on the value of our
capital shares.
WE MAY BE UNABLE TO INTEGRATE ACQUIRED HOTELS INTO OUR OPERATIONS OR OTHERWISE
MANAGE OUR PLANNED GROWTH, WHICH MAY ADVERSELY AFFECT OUR OPERATING RESULTS.
We have recently acquired a substantial number of hotels. We cannot assure
you that we or HHMLP will be able to adapt our management, administrative,
accounting and operational systems and arrangements, or hire and retain
sufficient operational staff to successfully integrate these investments into
our portfolio and
3
manage any future acquisitions of additional assets without operational
disruptions or unanticipated costs. Acquisition of hotels generates additional
operating expenses that we will be required to pay. As we acquire additional
hotels, we will be subject to the operational risks associated with owning new
lodging properties. Our failure to integrate successfully any future
acquisitions into our portfolio could have a material adverse effect on our
results of operations and financial condition and our ability to pay dividends
to shareholders or make other payments in respect of securities issued by us.
ACQUISITION OF HOTELS WITH LIMITED OPERATING HISTORY MAY NOT ACHIEVE DESIRED
RESULTS.
Many of our recent acquisitions, including some of the hotels in the Mystic
Partners joint venture with Waterford, are newly-developed hotels. Newly-
developed or newly-renovated hotels do not have the operating history that
would allow our management to make pricing decisions in acquiring these hotels
based on historical performance. The purchase prices of these hotels are based
upon management's expectations as to the operating results of such hotels,
subjecting us to risks that such hotels may not achieve anticipated operating
results or may not achieve these results within anticipated time frames. As a
result, we may not be able to generate enough cash flow from these hotels to
make debt payments or pay operating expenses. In addition, room revenues may
be less than that required to provide us with our anticipated return on
investment. In either case, the amounts available for distribution to our
shareholders could be reduced.
OUR ACQUISITIONS MAY NOT ACHIEVE EXPECTED PERFORMANCE, WHICH MAY HARM OUR
FINANCIAL CONDITION AND OPERATING RESULTS.
We anticipate that acquisitions will largely be financed with the net
proceeds of securities offerings and through externally generated funds such
as borrowings under credit facilities and other secured and unsecured debt
financing. Acquisitions entail risks that investments will fail to perform in
accordance with expectations and that estimates of the cost of improvements
necessary to acquire and market properties will prove inaccurate, as well as
general investment risks associated with any new real estate investment.
Because we must distribute annually at least 90% of our taxable income to
maintain our qualification as a REIT, our ability to rely upon income or cash
flow from operations to finance our growth and acquisition activities will be
limited. Accordingly, were we unable to obtain funds from borrowings or the
capital markets to finance our growth and acquisition activities, our ability
to grow could be curtailed, amounts available for distribution to shareholders
could be adversely affected and we could be required to reduce distributions.
WE OWN A LIMITED NUMBER OF HOTELS AND SIGNIFICANT ADVERSE CHANGES AT ONE HOTEL
MAY IMPACT OUR ABILITY TO MAKE DISTRIBUTIONS TO SHAREHOLDERS.
As of September 30, 2006, our portfolio consisted of 45 wholly-owned limited
and full service properties and joint venture investments in 18 hotels with a
total of 7,940 rooms. Significant adverse changes in the operations of any one
hotel could have a material adverse effect on our financial performance and,
accordingly, on our ability to make expected distributions to our
shareholders.
WE FOCUS ON ACQUIRING HOTELS OPERATING UNDER A LIMITED NUMBER OF FRANCHISE
BRANDS, WHICH CREATES GREATER RISK AS THE INVESTMENTS ARE MORE CONCENTRATED.
We place particular emphasis in our acquisition strategy on hotels similar
to our current hotels. We invest in hotels operating under a few select
franchises and therefore will be subject to risks inherent in concentrating
investments in a particular franchise brand, which could have an adverse
effect on amounts available for distribution to shareholders. These risks
include, among others, the risk of a reduction in hotel revenues following any
adverse publicity related to a specific franchise brand.
ALL OUR HOTELS ARE LOCATED IN THE EASTERN UNITED STATES AND MANY ARE LOCATED
IN THE AREA FROM PENNSYLVANIA TO CONNECTICUT, WHICH MAY INCREASE THE EFFECT OF
ANY REGIONAL OR LOCAL ECONOMIC CONDITIONS.
Our hotels are located in the Eastern United States. Twenty-six of our
wholly owned hotels and eleven of our joint venture hotels are located in the
states of Pennsylvania, New Jersey, New York and Connecticut. As a result,
regional or localized adverse events or conditions, such as an economic
recession around these
4
hotels, could have a significant adverse effect on our operations, and
ultimately on the amounts available for distribution to shareholders.
WE FACE RISKS ASSOCIATED WITH THE USE OF DEBT, INCLUDING REFINANCING RISK.
At September 30, 2006, we had long-term debt, excluding capital leases,
outstanding of $449.8 million. We may borrow additional amounts from the same
or other lenders in the future. Some of these additional borrowings may be
secured by our hotels. Our strategy is to maintain target debt levels of
approximately 60% of the total purchase price of our hotels both on an
individual and aggregate basis, and our Board of Trustees' policy is to limit
indebtedness to no more than 67% of the fair market value of the hotels in
which we have invested. However, our declaration of trust (as amended and
restated, our "Declaration of Trust") does not limit the amount of
indebtedness we may incur. We cannot assure you that we will be able to meet
our debt service obligations and, to the extent that we cannot, we risk the
loss of some or all of our hotels to foreclosure. There is also a risk that we
may not be able to refinance existing debt or that the terms of any
refinancing will not be as favorable as the terms of the existing debt. If
principal payments due at maturity cannot be refinanced, extended or repaid
with proceeds from other sources, such as new equity capital or sales of
properties, our cash flow may not be sufficient to repay all maturing debt in
years when significant "balloon" payments come due.
WE DO NOT OPERATE OUR HOTELS AND, AS A RESULT, WE DO NOT HAVE COMPLETE CONTROL
OVER IMPLEMENTATION OF OUR STRATEGIC DECISIONS.
In order for us to satisfy certain REIT qualification rules, we cannot
directly operate any of our hotels. Instead, we must engage an independent
management company to operate our hotels. As of September 30, 2006, our TRS's
and other lessees have engaged an independent management company, HHMLP, as
the property manager for all of our wholly owned hotels and our joint venture
partnerships have retained eligible independent management companies to
operate the respective hotels for the joint ventures, as required by the REIT
qualification rules. HHMLP and the management companies operating the hotels
owned in our joint ventures make and implement strategic business decisions
with respect to these hotels, such as decisions with respect to the
repositioning of a franchise or food and beverage operations and other similar
decisions. Decisions made by HHMLP and the management companies operating the
hotels may not be in the best interests of a particular hotel or of our
company. Accordingly, we cannot assure you that HHMLP or the management
companies operating the hotels owned in our joint ventures will operate our
hotels in a manner that is in our best interests.
WE DEPEND ON KEY PERSONNEL.
We depend on the services of our existing senior management team, including
Jay H. Shah, Neil H. Shah, Ashish R. Parikh and Michael R. Gillespie, to carry
out our business and investment strategies. As we expand, we will continue to
need to attract and retain qualified additional senior management. We have
employment contracts with certain of our senior management; however, the
employment agreements may be terminated under certain circumstances. The
termination of an employment agreement and the loss of the services of any of
our key management personnel, or our inability to recruit and retain qualified
personnel in the future, could have an adverse effect on our business and
financial results.
WE FACE INCREASING COMPETITION FOR THE ACQUISITION OF HOTEL PROPERTIES AND
OTHER ASSETS, WHICH MAY IMPEDE OUR ABILITY TO MAKE FUTURE ACQUISITIONS OR MAY
INCREASE THE COST OF THESE ACQUISITIONS.
We face competition for investment opportunities in high quality, upscale
and mid-scale limited service and extended-stay hotels from entities organized
for purposes substantially similar to our objectives, as well as other
purchasers of hotels. We compete for such investment opportunities with
entities that have substantially greater financial resources than we do,
including access to capital or better relationships with franchisors, sellers
or lenders. Our competitors may generally be able to accept more risk than we
can manage prudently and may be able to borrow the funds needed to acquire
hotels. Competition may generally reduce the number of suitable investment
opportunities offered to us and increase the bargaining power of property
owners seeking to sell.
5
WE MAY ENGAGE IN HEDGING TRANSACTIONS, WHICH CAN LIMIT OUR GAINS AND INCREASE
EXPOSURE TO LOSSES.
We may enter into hedging transactions to protect us from the effects of
interest rate fluctuations on floating rate debt and also to protect our
portfolio of mortgage assets from interest rate and prepayment rate
fluctuations. Our hedging transactions may include entering into interest rate
swaps, caps, and floors, options to purchase such items, and futures and
forward contracts. Hedging activities may not have the desired beneficial
impact on our results of operations or financial condition. No hedging
activity can completely insulate us from the risks associated with changes in
interest rates and prepayment rates. Moreover, interest rate hedging could
fail to protect us or could adversely affect us because, among other things:
o Available interest rate hedging may not correspond directly with the
interest rate risk for which protection is sought.
o The duration of the hedge may not match the duration of the related
liability.
o The party owning money in the hedging transaction may default on its
obligation to pay.
o The credit quality of the party owing money on the hedge may be
downgraded to such an extent that it impairs our ability to sell or
assign our side of the hedging transaction.
o The value of derivatives used for hedging may be adjusted from time to
time in accordance with accounting rules to reflect changes in fair
value.
DOWNWARD ADJUSTMENTS, OR "MARK-TO-MARKET LOSSES," WOULD REDUCE OUR
SHAREHOLDERS' EQUITY.
Hedging involves risk and typically involves costs, including transaction
costs, which may reduce returns on our investments. These costs increase as
the period covered by the hedging increases and during periods of rising and
volatile interest rates. These costs will also limit the amount of cash
available for distribution to shareholders. The REIT qualification rules may
also limit our ability to enter into hedging transactions. We generally intend
to hedge as much of our interest rate risk as our management determines is in
our best interests given the cost of such hedging transactions and the
requirements applicable to REITs. If we are unable to hedge effectively
because of the cost of such hedging transactions or the limitations imposed by
the REIT rules, we will face greater interest risk exposure than may be
commercially prudent.
IF WE CANNOT ACCESS THE CAPITAL MARKETS, WE MAY NOT BE ABLE TO GROW THE
COMPANY AT OUR HISTORICAL GROWTH RATES.
We may not be able to access the capital markets to obtain capital to fund
future acquisitions and investments. If we lack the capital to make future
acquisitions or investments, we may not be able to continue to grow at
historical rates.
RISKS RELATING TO CONFLICTS OF INTEREST
DUE TO CONFLICTS OF INTEREST, MANY OF OUR EXISTING AGREEMENTS MAY NOT HAVE
BEEN NEGOTIATED ON AN ARM'S-LENGTH BASIS AND MAY NOT BE IN OUR BEST INTEREST.
Some of our officers and trustees have ownership interests in HHMLP and in
entities with which we have entered into transactions, including hotel
acquisitions and dispositions and certain financings. Consequently, the terms
of our agreements with those entities, including hotel contribution or
purchase agreements, the Administrative Services Agreement between us and
HHMLP pursuant to which HHMLP provides certain administrative services, the
Option Agreement between the operating partnership and some of the trustees
and officers and our property management agreements with HHMLP may not have
been negotiated on an arm's-length basis and may not be in the best interest
of all our shareholders.
CONFLICTS OF INTEREST WITH OTHER ENTITIES MAY RESULT IN DECISIONS THAT DO NOT
REFLECT OUR BEST INTERESTS.
The following officers and trustees own collectively approximately 96% of
HHMLP: Hasu P. Shah, Jay H. Shah, Neil H. Shah, David L. Desfor, K.D. Patel
and Kiran P. Patel. The following officers and trustees serve as officers of
HHMLP: David L. Desfor, Kiran P. Patel and K.D. Patel. Conflicts of interest
may arise
6
in respect of the ongoing acquisition, disposition and operation of our hotels
including, but not limited to, the enforcement of the contribution and
purchase agreements, the Administrative Services Agreement, the Option
Agreement and our property management agreements with HHMLP. Consequently, the
interests of shareholders may not be fully represented in all decisions made
or actions taken by our officers and trustees.
CONFLICTS OF INTEREST RELATING TO SALES OR REFINANCING OF HOTELS ACQUIRED FROM
SOME OF OUR TRUSTEES AND OFFICERS MAY LEAD TO DECISIONS THAT ARE NOT IN OUR
BEST INTEREST.
Some of our trustees and officers have unrealized gains associated with
their interests in the hotels we have acquired from them and, as a result, any
sale of these hotels or refinancing or prepayment of principal on the
indebtedness assumed by us in purchasing these hotels may cause adverse tax
consequences to such of our trustees and officers. Therefore, our interests
and the interests of these individuals may be different in connection with the
disposition or refinancing of these hotels.
COMPETING HOTELS OWNED OR ACQUIRED BY SOME OF OUR TRUSTEES AND OFFICERS MAY
HINDER THESE INDIVIDUALS FROM SPENDING ADEQUATE TIME ON OUR BUSINESS.
Some of our trustees and officers own hotels and may develop or acquire new
hotels, subject to certain limitations. Such ownership, development or
acquisition activities may materially affect the amount of time these officers
and trustees devote to our affairs. Some of our trustees and officers operate
hotels that are not owned by us, which may materially affect the amount of
time that they devote to managing our hotels. Pursuant to the Option
Agreement, as amended, we have an option to acquire any hotels developed by
our officers and trustees.
NEED FOR CERTAIN CONSENTS FROM THE LIMITED PARTNERS MAY NOT RESULT IN
DECISIONS ADVANTAGEOUS TO SHAREHOLDERS.
Under our operating partnership's amended and restated partnership
agreement, the holders of at least two-thirds of the interests in the
partnership must approve a sale of all or substantially all of the assets of
the partnership or a merger or consolidation of the partnership. Some of our
officers and trustees will own an approximately 8.7% interest in the operating
partnership on a fully-diluted basis. Their large ownership percentage may
make it less likely that a merger or sale of our company that would be in the
best interests of our shareholders will be approved.
RISKS RELATING TO OUR CORPORATE STRUCTURE
OUR OWNERSHIP LIMITATION MAY RESTRICT BUSINESS COMBINATION OPPORTUNITIES.
To qualify as a REIT under the Code, no more than 50% of the value of our
outstanding shares of beneficial interest may be owned, directly or
indirectly, by five or fewer individuals (as defined in the Internal Revenue
Code to include certain entities) during the last half of each taxable year.
To preserve our REIT qualification, our Declaration of Trust generally
prohibits direct or indirect ownership of more than 9.9% of (i) the number of
outstanding common shares of any class or series of common shares or (ii) the
number of outstanding preferred shares of any class or series of preferred
shares. Generally, common shares owned by affiliated owners will be aggregated
for purposes of the ownership limitation. The ownership limitation could have
the effect of delaying, deterring or preventing a change in control or other
transaction in which holders of common shares might receive a premium for
their common shares over the then prevailing market price or which such
holders might believe to be otherwise in their best interests.
THE DECLARATION OF TRUST CONTAINS A PROVISION THAT CREATES STAGGERED TERMS FOR
OUR BOARD OF TRUSTEES.
Our Board of Trustees is divided into two classes. The terms of the first
and second classes expire in 2008 and 2007, respectively. Trustees of each
class are elected for two-year terms upon the expiration of their current
terms and each year one class of trustees will be elected by the shareholders.
The staggered terms of trustees may delay, deter or prevent a tender offer, a
change in control of us or other transaction, even though such a transaction
might be in the best interest of the shareholders.
7
MARYLAND BUSINESS COMBINATION LAW MAY DISCOURAGE A THIRD PARTY FROM ACQUIRING
US.
Under the Maryland General Corporation Law, as amended (MGCL), as applicable
to REITs, certain "business combinations" (including certain issuances of
equity securities) between a Maryland REIT and any person who beneficially
owns ten percent or more of the voting power of the trust's shares, or an
affiliate thereof, are prohibited for five years after the most recent date on
which this shareholder acquired at least ten percent of the voting power of
the trust's shares. Thereafter, any such business combination must be approved
by two super-majority shareholder votes unless, among other conditions, the
trust's common shareholders receive a minimum price (as defined in the MGCL)
for their shares and the consideration is received in cash or in the same form
as previously paid by the interested shareholder for its common shares. These
provisions could delay, deter or prevent a change of control or other
transaction in which holders of our equity securities might receive a premium
for their shares above then-current market prices or which such shareholders
otherwise might believe to be in their best interests.
OUR BOARD OF TRUSTEES MAY CHANGE OUR INVESTMENT AND OPERATIONAL POLICIES
WITHOUT A VOTE OF THE COMMON SHAREHOLDERS.
Our major policies, including our policies with respect to acquisitions,
financing, growth, operations, debt limitation and distributions, are
determined by our Board of Trustees. The Trustees may amend or revise these
and other policies from time to time without a vote of the holders of the
common shares.
OUR BOARD OF TRUSTEES AND MANAGEMENT MAKE DECISIONS ON OUR BEHALF, AND
SHAREHOLDERS HAVE LIMITED MANAGEMENT RIGHTS.
Our shareholders have no right or power to take part in our management
except through the exercise of voting rights on certain specified matters. The
board of trustees is responsible for our management and strategic business
direction, and our management is responsible for our day-to-day operations.
Certain policies of our board of trustees may not be consistent with the
immediate best interests of our securityholders.
HOLDERS OF OUR OUTSTANDING SERIES A PREFERRED SHARES HAVE DIVIDEND,
LIQUIDATION, AND OTHER RIGHTS THAT ARE SENIOR TO THE RIGHTS OF THE HOLDERS OF
OUR COMMON SHARES.
Our Board of Trustees has the authority to designate and issue preferred
shares with liquidation, dividend and other rights that are senior to those of
our common shares. As of September 30, 2006, 2,400,000 shares of our Series A
preferred shares were issued and outstanding. The aggregate liquidation
preference with respect to the outstanding preferred shares is approximately
$60.0 million, and annual dividends on our outstanding preferred shares are
approximately $4.8 million. Holders of our Series A preferred shares are
entitled to cumulative dividends before any dividends may be declared or set
aside on our common shares. Upon our voluntary or involuntary liquidation,
dissolution or winding up, before any payment is made to holders of our common
shares, holders of our Series A preferred shares are entitled to receive a
liquidation preference of $25.00 per share plus any accrued and unpaid
distributions. This will reduce the remaining amount of our assets, if any,
available to distribute to holders of our common shares. In addition, holders
of our Series A preferred shares have the right to elect two additional
trustees to our Board of Trustees whenever dividends are in arrears in an
aggregate amount equivalent to six or more quarterly dividends, whether or not
consecutive.
OUR BOARD OF TRUSTEES MAY ISSUE ADDITIONAL SHARES THAT MAY CAUSE DILUTION OR
PREVENT A TRANSACTION THAT IS IN THE BEST INTERESTS OF OUR SHAREHOLDERS.
Our Declaration of Trust authorizes the Board of Trustees, without
shareholder approval, to:
o amend the Declaration of Trust to increase or decrease the aggregate
number of shares of beneficial interest or the number of shares of
beneficial interest of any class or series that we have the authority to
issue;
o cause us to issue additional authorized but unissued common shares or
preferred shares; and
8
o classify or reclassify any unissued common or preferred shares and to set
the preferences, rights and other terms of such classified or
reclassified shares, including the issuance of additional common shares
or preferred shares that have preference rights over the common shares
with respect to dividends, liquidation, voting and other matters.
Any one of these events could cause dilution to our common shareholders,
delay, deter or prevent a transaction or a change in control that might
involve a premium price for the common shares or otherwise not be in the best
interest of holders of common shares.
FUTURE OFFERINGS OF EQUITY SECURITIES, WHICH WOULD DILUTE OUR EXISTING
SHAREHOLDERS AND MAY BE SENIOR TO OUR COMMON SHARES FOR THE PURPOSES OF
DIVIDEND DISTRIBUTIONS, MAY ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON
SHARES.
In the future, we may attempt to increase our capital resources by making
additional offerings of equity securities, including classes of preferred or
common shares. Upon liquidation, holders of our preferred shares and lenders
with respect to other borrowings will receive a distribution of our available
assets prior to the holders of our common shares. Additional equity offerings
may dilute the holdings of our existing shareholders or reduce the market
price of our common shares, or both. Our preferred shares, if issued, could
have a preference on liquidating distributions or a preference on dividend
payments that could limit our ability to make a dividend distribution to the
holders of our common shares. Because our decision to issue securities in any
future offering will depend on market conditions and other factors beyond our
control, we cannot predict or estimate the amount, timing or nature of our
future offerings. Thus, our shareholders bear the risk of our future offerings
reducing the market price of our common shares and diluting their share
holdings in us.
THERE ARE NO ASSURANCES OF OUR ABILITY TO MAKE DISTRIBUTIONS IN THE FUTURE.
We intend to pay quarterly dividends and to make distributions to our
shareholders in amounts such that all or substantially all of our taxable
income in each year, subject to certain adjustments, is distributed. However,
our ability to pay dividends may be adversely affected by the risk factors
described in this prospectus. All distributions will be made at the discretion
of our Board of Trustees and will depend upon our earnings, our financial
condition, maintenance of our REIT status and such other factors as our board
may deem relevant from time to time. There are no assurances of our ability to
pay dividends in the future. In addition, some of our distributions may
include a return of capital.
AN INCREASE IN MARKET INTEREST RATES MAY HAVE AN ADVERSE EFFECT ON THE MARKET
PRICE OF OUR SECURITIES.
One of the factors that investors may consider in deciding whether to buy or
sell our securities is our dividend rate as a percentage of our share or unit
price, relative to market interest rates. If market interest rates increase,
prospective investors may desire a higher dividend or interest rate on our
securities or seek securities paying higher dividends or interest. The market
price of our common shares likely will be based primarily on the earnings and
return that we derive from our investments and income with respect to our
properties and our related distributions to shareholders, and not from the
market value or underlying appraised value of the properties or investments
themselves. As a result, interest rate fluctuations and capital market
conditions can affect the market price of our common shares. For instance, if
interest rates rise without an increase in our dividend rate, the market price
of our common shares could decrease because potential investors may require a
higher dividend yield on our common shares as market rates on interest-bearing
securities, such as bonds, rise. In addition, rising interest rates would
result in increased interest expense on our variable rate debt, thereby
adversely affecting cash flow and our ability to service our indebtedness and
pay dividends.
9
RISKS RELATED TO OUR TAX STATUS
IF WE FAIL TO QUALIFY AS A REIT, OUR DIVIDENDS WILL NOT BE DEDUCTIBLE TO US,
AND OUR INCOME WILL BE SUBJECT TO TAXATION.
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,
among other things, the ownership of our outstanding shares of beneficial
interest, the nature of our assets, the sources of our income, and the amount
of our distributions to our shareholders. If we were to fail to qualify as a
REIT in any taxable year and do not qualify for certain statutory relief
provisions, we would not be allowed a deduction for distributions to our
shareholders in computing our taxable income and would be subject to federal
income tax (including any applicable alternative minimum tax) on our taxable
income at regular corporate rates. Unless entitled to relief under certain
Internal Revenue Code provisions, we also would be disqualified from treatment
as a REIT for the four taxable years following the year during which
qualification was lost. As a result, amounts available for distribution to
shareholders would be reduced for each of the years involved. Although we
currently intend 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 the trustees, with the consent of holders of two-thirds of the
outstanding shares, to revoke the REIT election.
FAILURE TO MAKE REQUIRED DISTRIBUTIONS WOULD SUBJECT US TO TAX.
In order to qualify as a REIT, each year we must distribute to our
shareholders at least 90% of our REIT taxable income, other than any net
capital gain. To the extent that we satisfy the distribution requirement, but
distribute less than 100% of our taxable income, we will be subject to federal
corporate income tax on our undistributed income. In addition, we will incur a
4% nondeductible excise tax on the amount, if any, by which our distributions
in any year are less than the sum of:
o 85% of our net ordinary income for that year;
o 95% of our net capital gain net income for that year; and
o 100% of our undistributed taxable income from prior years.
We have paid out, and intend to continue to pay out, our income to our
shareholders in a manner intended to satisfy the distribution requirement and
to avoid corporate income tax and the 4% nondeductible excise tax. Differences
in timing between the recognition of income and the related cash receipts or
the effect of required debt amortization payments could require us to borrow
money or sell assets to pay out enough of our taxable income to satisfy the
distribution requirement and to avoid corporate income tax and the 4%
nondeductible excise tax in a particular year. In the past we have borrowed,
and in the future we may borrow, to pay distributions to our shareholders and
the limited partners of our operating partnership. Such borrowings subject us
to risks from borrowing as described herein.
THE TAXATION OF CORPORATE DIVIDENDS MAY ADVERSELY AFFECT THE VALUE OF OUR
COMMON SHARES.
Legislation enacted in 2003 and 2006, among other things, generally reduced
to 15% the maximum marginal rate of tax payable by domestic noncorporate
taxpayers on dividends received from a regular C corporation through 2010.
This reduced tax rate, however, does not apply to dividends paid to domestic
noncorporate taxpayers by a REIT on its shares, except for certain limited
amounts. Although the earnings of a REIT that are distributed to its
shareholders are still generally subject to less federal income taxation than
earnings of a non-REIT C corporation that are distributed to its shareholders
net of corporate-level income tax, this legislation could cause domestic
noncorporate investors to view the shares of regular C corporations as more
attractive relative to the shares of a REIT than was the case prior to the
enactment of the legislation, because the dividends from regular C
corporations are generally taxed at a lower rate while dividends from REITs
are generally taxed at the same rate as the individual's other ordinary
income. We cannot predict what effect, if any, the enactment of this
legislation may have on the value of the shares of REITs in general or on our
shares in particular, either in terms of price or relative to other
investments.
10
RISKS RELATED TO THE HOTEL INDUSTRY
THE VALUE OF OUR HOTELS DEPENDS ON CONDITIONS BEYOND OUR CONTROL.
Our hotels are subject to varying degrees of risk generally incident to the
ownership of hotels. The underlying value of our hotels, our income and
ability to make distributions to our shareholders are dependent upon the
operation of the hotels in a manner sufficient to maintain or increase
revenues in excess of operating expenses. Hotel revenues may be adversely
affected by adverse changes in national economic conditions, adverse changes
in local market conditions due to changes in general or local economic
conditions and neighborhood characteristics, competition from other hotels,
changes in interest rates and in the availability, cost and terms of mortgage
funds, the impact of present or future environmental legislation and
compliance with environmental laws, the ongoing need for capital improvements,
particularly in older structures, changes in real estate tax rates and other
operating expenses, adverse changes in governmental rules and fiscal policies,
civil unrest, acts of terrorism, acts of God, including earthquakes,
hurricanes and other natural disasters, acts of war, adverse changes in zoning
laws, and other factors that are beyond our control. In particular, general
and local economic conditions may be adversely affected by the recent
terrorist incidents in New York and Washington, D.C. Our management is unable
to determine the long-term impact, if any, of these incidents or of any acts
of war or terrorism in the United States or worldwide, on the U.S. economy, on
us or our hotels or on the market price of our common shares.
OUR HOTELS ARE SUBJECT TO GENERAL HOTEL INDUSTRY OPERATING RISKS, WHICH MAY
IMPACT OUR ABILITY TO MAKE DISTRIBUTIONS TO SHAREHOLDERS.
Our hotels are subject to all operating risks common to the hotel industry.
The hotel industry has experienced volatility in the past, as have our hotels,
and there can be no assurance that such volatility will not occur in the
future. These risks include, among other things, competition from other
hotels; over-building in the hotel industry that could adversely affect hotel
revenues; increases in operating costs due to inflation and other factors,
which may not be offset by increased room rates; reduction in business and
commercial travel and tourism; strikes and other labor disturbances of hotel
employees; increases in energy costs and other expenses of travel; adverse
effects of general and local economic conditions; and adverse political
conditions. These factors could reduce revenues of the hotels and adversely
affect our ability to make distributions to our shareholders.
COMPETITION FOR GUESTS IS HIGHLY COMPETITIVE.
The hotel industry is highly competitive. Our hotels compete with other
existing and new hotels in their geographic markets. Many of our competitors
have substantially greater marketing and financial resources than we do. If
their marketing strategies are effective, we may be unable to make
distributions to our shareholders.
OUR INVESTMENTS ARE CONCENTRATED IN A SINGLE SEGMENT OF THE HOTEL INDUSTRY.
Our current business strategy is to own and acquire hotels primarily in the
high quality, upscale and mid-scale limited service and extended-stay segment
of the hotel industry. We are subject to risks inherent in concentrating
investments in a single industry and in a specific market segment within that
industry. The adverse effect on amounts available for distribution to
shareholders resulting from a downturn in the hotel industry in general or the
mid-scale segment in particular could be more pronounced than if we had
diversified our investments outside of the hotel industry or in additional
hotel market segments.
THE HOTEL INDUSTRY IS SEASONAL IN NATURE.
The hotel industry is seasonal in nature. Generally, hotel revenues are
greater in the second and third quarters than in the first and fourth
quarters. Our hotels' operations historically reflect this trend. We believe
that we will be able to make distributions necessary to maintain REIT status
through cash flow from operations; but if we are unable to do so, we may not
be able to make the necessary distributions or we may have to generate cash by
a sale of assets, increasing indebtedness or sales of securities to make the
11
distributions. Risks of operating hotels under franchise licenses, which may
be terminated or not renewed, may impact our ability to make distributions to
shareholders.
RISKS OF OPERATING HOTELS UNDER FRANCHISE LICENSES, WHICH MAY BE TERMINATED OR
NOT RENEWED, MAY IMPACT OUR ABILITY TO MAKE DISTRIBUTIONS TO SHAREHOLDERS.
The continuation of the franchise licenses is subject to specified operating
standards and other terms and conditions. All of the franchisors of our hotels
periodically inspect our hotels to confirm adherence to their operating
standards. The failure of our partnership or HHMLP to maintain such standards
or to adhere to such other terms and conditions could result in the loss or
cancellation of the applicable franchise license. It is possible that a
franchisor could condition the continuation of a franchise license on the
completion of capital improvements that the trustees determine are too
expensive or otherwise not economically feasible in light of general economic
conditions, the operating results or prospects of the affected hotel. In that
event, the trustees may elect to allow the franchise license to lapse or be
terminated.
There can be no assurance that a franchisor will renew a franchise license
at each option period. If a franchisor terminates a franchise license, we, our
partnership, and HHMLP may be unable to obtain a suitable replacement
franchise, or to successfully operate the hotel independent of a franchise
license. The loss of a franchise license could have a material adverse effect
upon the operations or the underlying value of the related hotel because of
the loss of associated name recognition, marketing support and centralized
reservation systems provided by the franchisor. Our loss of a franchise
license for one or more of the hotels could have a material adverse effect on
our partnership's revenues and our amounts available for distribution to
shareholders.
OPERATING COSTS AND CAPITAL EXPENDITURES FOR HOTEL RENOVATION MAY BE GREATER
THAN ANTICIPATED AND MAY ADVERSELY IMPACT DISTRIBUTIONS TO SHAREHOLDERS.
Hotels generally have an ongoing need for renovations and other capital
improvements, particularly in older structures, including periodic replacement
of furniture, fixtures and equipment. Under the terms of our management
agreements with HHMLP, we are obligated to pay the cost of expenditures for
items that are classified as capital items under GAAP that are necessary for
the continued operation of our hotels. If these expenses exceed our estimate,
the additional cost could have an adverse effect on amounts available for
distribution to shareholders. In addition, we may acquire hotels in the future
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 and the emergence of
unanticipated competition from hotels.
RISKS RELATED TO REAL ESTATE INVESTMENT GENERALLY
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.
Real estate investments are relatively illiquid. Our ability to vary our
portfolio in response to changes in operating, economic and other conditions
will be limited. No assurances can be given that the fair market value of any
of our hotels will not decrease in the future.
IF WE SUFFER LOSSES THAT ARE NOT COVERED BY INSURANCE OR THAT ARE IN EXCESS OF
OUR INSURANCE COVERAGE LIMITS, WE COULD LOSE INVESTMENT CAPITAL AND
ANTICIPATED PROFITS.
We require comprehensive insurance to be maintained on each of the our
hotels, including liability and fire and extended coverage in amounts
sufficient to permit the replacement of the hotel in the event of a total
loss, subject to applicable deductibles. However, there are certain types of
losses, generally of a catastrophic nature, such as earthquakes, floods,
hurricanes and acts of terrorism, that may be uninsurable or not economically
insurable. Inflation, changes in building codes and ordinances, environmental
considerations and other factors also might make it impracticable to use
insurance proceeds to replace the applicable hotel after such applicable hotel
has been damaged or destroyed. Under such circumstances, the insurance
proceeds received by us might not be adequate to restore our economic position
with respect to the applicable hotel. If
12
any of these or similar events occur, it may reduce the return from the
attached property and the value of our investment.
REITS ARE SUBJECT TO PROPERTY TAXES.
Each hotel is subject to real and personal property taxes. The real and
personal property taxes on hotel properties in which we invest may increase as
property tax rates change and as the properties are assessed or reassessed by
taxing authorities. Many state and local governments are facing budget
deficits which has led many of them, and may in the future lead others to,
increase assessments and/or taxes. If property taxes increase, our ability to
make expected distributions to our shareholders could be adversely affected.
ENVIRONMENTAL MATTERS COULD ADVERSELY AFFECT OUR RESULTS.
Operating costs may be affected by the obligation to pay for the cost of
complying with existing environmental laws, ordinances and regulations, as
well as the cost of future legislation. 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 removal or
remediation of hazardous or toxic substances on, under or in such property.
Such laws often impose liability whether or not the owner or operator knew of,
or was responsible for, the presence of such hazardous or toxic substances.
The cost of complying with environmental laws could materially adversely
affect amounts available for distribution to shareholders. Phase I
environmental assessments have been obtained on all of our hotels.
Nevertheless, it is possible that these reports do not reveal all
environmental liabilities or that there are material environmental liabilities
of which we are unaware.
COSTS ASSOCIATED WITH COMPLYING WITH THE AMERICANS WITH DISABILITIES ACT MAY
ADVERSELY AFFECT OUR FINANCIAL CONDITION AND OPERATING RESULTS.
Under the Americans with Disabilities Act of 1993 (ADA), all public
accommodations are required to meet certain federal requirements related to
access and use by disabled persons. While we believe that our hotels are
substantially in compliance with these requirements, 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, changes in governmental
rules and regulations or enforcement policies affecting the use and operation
of the hotels, including changes to building codes and fire and life-safety
codes, may occur. If we were required to make substantial modifications at the
hotels to comply with the ADA or other changes in governmental rules and
regulations, our ability to make expected distributions to our shareholders
could be adversely affected.
13
RATIO OF EARNINGS TO FIXED CHARGES AND OF EARNINGS TO COMBINED
FIXED CHARGES AND PREFERRED SHARE DIVIDENDS
The following table sets forth the Company's consolidated ratios of earnings
to fixed charges and of earnings to combined fixed charges and preferred share
dividends for the nine months ended September 30, 2006, and for each of the
last five fiscal years.
NINE MONTHS YEAR ENDED
ENDED DECEMBER 31,
SEPTEMBER 30, ----------------------------------
2006 2005 2004 2003 2002 2001
------------- ---- ---- ---- ---- ----
Ratio of earnings to fixed charges .......................................... 1.30 1.22 1.33 1.46 1.73 1.59
Ratio of earnings to combined fixed charges and preferred share dividends ... 1.09 1.06 1.21 1.08 1.73 1.59
The ratio of earnings to fixed charges is based on our earnings from
continuing operations and fixed charges incurred in continuing operations. The
ratio of earnings to fixed charges was computed by dividing earnings by fixed
charges. The ratio of earnings to combined fixed charges and preferred share
dividends was computed by dividing earnings by the sum of fixed charges and
dividends on preferred shares. "Fixed charges" consist of interest costs,
whether expensed or capitalized, amortization of line of credit fees and
amortization of interest rate caps and swap agreements. "Preferred Share
Dividends" consist of the amount of pre-tax earnings that is required to pay
the dividends on our outstanding preferred shares.
USE OF PROCEEDS
Unless indicated otherwise in a prospectus supplement, we expect to use the
net proceeds from the sale of these securities for general corporate purposes.
14
DESCRIPTION OF SHARES OF BENEFICIAL INTEREST
The following summary of the terms of our shares of beneficial interest does
not purport to be complete and is subject to and qualified in its entirety by
reference to our Declaration of Trust and Bylaws, copies of which are exhibits
to the Registration Statement of which this Prospectus is a part. See "How to
Obtain More Information."
GENERAL
Our Declaration of Trust provides that we may issue up to 50,000,000 Class A
common shares of beneficial interest, $0.01 par value per share, up to
50,000,000 Class B common shares of beneficial interest, $0.01 par value per
share, and up to 10,000,000 preferred shares of beneficial interest, $0.01 par
value per share. As of September 30, 2006, 32,391,287 Class A common shares
were issued and outstanding, 2,400,000 Series A preferred shares of beneficial
interest were issued and outstanding, and no Class B common shares were issued
and outstanding. As permitted by the Maryland REIT Law, our Declaration of
Trust contains a provision permitting our Board of Trustees, without any
action by our shareholders, to amend the Declaration of Trust to increase or
decrease the aggregate number of shares of beneficial interest or the number
of shares of any class of shares of beneficial interest that we have authority
to issue.
Our Declaration of Trust provides that none of our shareholders is
personally liable for any of our obligations solely as a result of his status
as a shareholder. Our Bylaws further provide that we shall indemnify each
shareholder against any claim or liability to which the shareholder, subject
to certain limitations, may become subject by reason of his being or having
been a shareholder or former shareholder and that we shall pay or reimburse
each shareholder or former shareholder for all legal and other expenses
reasonably incurred by him in connection with any claim or liability.
COMMON SHARES
All common shares offered through this prospectus will be duly authorized,
fully paid and nonassessable. As a shareholder, you will be entitled to
receive distributions, or dividends, on the shares you own if the Board of
Trustees authorizes a dividend out of our legally available assets. Your right
to receive those dividends may be affected, however, by the preferential
rights of any other class or series of shares of beneficial interest and the
provisions of our Declaration of Trust regarding restrictions on the transfer
of shares of beneficial interest. For example, you may not receive dividends
if no funds are available for distribution after we pay dividends to holders
of preferred shares. You will also be entitled to receive dividends based on
our assets available for distribution to common shareholders if we liquidate,
dissolve or wind-up our operations. The amount you, as a shareholder, would
receive in the distribution would be determined by the amount of your
beneficial ownership of us in comparison with other beneficial owners. Assets
will be available for distribution to shareholders only after we have paid all
of our known debts and liabilities and paid the holders of any preferred
shares we may issue which are outstanding at that time.
VOTING RIGHTS OF COMMON SHARES
Subject to the provisions of the Declaration of Trust regarding the
restrictions on the transfer and ownership of shares of beneficial interest,
each outstanding common share entitles the holder to one vote on all matters
submitted to a vote of shareholders, including the election of trustees.
Except as may be provided with respect to any other class or series of our
shares of beneficial interest, including our Series A preferred shares, only
holders of our common shares possess voting rights. There is no cumulative
voting in the election of trustees, which means that, subject to certain
voting rights of our Series A preferred shares set forth in our Declaration of
Trust, the holders of a majority of the outstanding common shares, voting as a
single class, can elect all of the trustees then standing for election and the
holders of the remaining shares are not able to elect any trustees.
Under the Maryland REIT Law, a Maryland REIT generally cannot amend its
declaration of trust or merge unless approved by the affirmative vote of
shareholders holding at least two-thirds of the shares entitled to vote on the
matter unless a lesser percentage (but not less than a majority of all the
votes entitled to be cast on the matter) is set forth in the REIT's
declaration of trust subject to the terms of any other
15
class or series of shares of beneficial interest. Our Declaration of Trust
provides for approval by a majority of all the votes entitled to be cast on
the matter in all situations permitting or requiring action by the
shareholders except with respect to: (a) our intentional disqualification as a
REIT or revocation of our election to be taxed as a REIT (which requires the
affirmative vote of two-thirds of the number of common shares entitled to vote
on such matter at a meeting of our shareholders); (b) the election of trustees
(which requires a plurality of all the votes cast at a meeting of our
shareholders at which a quorum is present); (c) the removal of trustees (which
requires the affirmative vote of the holders of two-thirds of our outstanding
voting shares); (d) the amendment or repeal of certain designated sections of
the Declaration of Trust (which require the affirmative vote of two-thirds of
the outstanding shares entitled to vote on such matters); (e) the amendment of
the Declaration of Trust by shareholders (which requires the affirmative vote
of a majority of votes entitled to be cast on the matter, except under certain
circumstances specified in the Declaration of Trust that require the
affirmative vote of two-thirds of all the votes entitled to be cast on the
matter); and (f) our termination (which requires the affirmative vote of two-
thirds of all the votes entitled to be cast on the matter). Under the Maryland
REIT Law, a declaration of trust may permit the trustees by a two-thirds vote
to amend the declaration of trust from time to time to qualify as a REIT under
the Code or the Maryland REIT Law without the affirmative vote or written
consent of the shareholders. Our Declaration of Trust permits such action by a
majority vote of the trustees. As permitted by the Maryland REIT Law, our
Declaration of Trust contains a provision permitting our trustees, without any
action by our shareholders, to amend the Declaration of Trust to increase or
decrease the aggregate number of shares of beneficial interest or the number
of shares of any class of shares of beneficial interest that we have authority
to issue.
PREFERRED SHARES
Preferred shares may be offered and sold from time to time, in one or more
series, as authorized by the Board of Trustees. The Declaration of Trust
authorizes our Board of Trustees to classify any unissued preferred shares and
to reclassify any previously classified but unissued preferred shares of any
series from time to time in one or more series, as authorized by the Board of
Trustees. Prior to issuance of shares of each series, the Board of Trustees is
required by the Maryland REIT Law and our Declaration of Trust to set for each
such series, subject to the provisions of our Declaration of Trust regarding
the restriction on transfer of shares of beneficial interest, the terms, the
preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends or other distributions, qualifications and terms
or conditions of redemption for each such series. Thus, our Board of Trustees
could authorize the issuance of preferred shares with terms and conditions
which could have the effect of delaying, deterring or preventing a transaction
or a change in control in us that might involve a premium price for holders of
common shares or otherwise be in their best interest.
You should refer to the prospectus supplement relating to the offering of
any preferred shares for specific terms, including the following terms:
o the title and stated value of those preferred shares;
o the number of preferred shares offered and the offering price of those
preferred shares;
o the dividend rate(s), period(s) and/or payment date(s) or method(s) of
calculation of any of those terms that apply to those preferred shares;
o the date from which dividends on those preferred shares will accumulate,
if applicable;
o the terms and amount of a sinking fund, if any, for the purchase or
redemption of those preferred shares;
o the redemption rights, including conditions and the redemption price(s),
if applicable, of those preferred shares;
o any listing of those preferred shares on any securities exchange;
o the terms and conditions, if applicable, upon which those preferred
shares will be convertible into common shares or any of our other
securities, including the conversion price or rate (or manner of
calculation thereof);
16
o the relative ranking and preference of those preferred shares as to
dividend rights and rights upon liquidation, dissolution or the winding
up of our affairs;
o any limitations on issuance of any series of preferred shares ranking
senior to or on a parity with that series of preferred shares as to
dividend rights and rights upon liquidation, dissolution or the winding
up of our affairs;
o the procedures for any auction and remarketing, if any, for those
preferred shares;
o any other specific terms, preferences, rights, limitations or
restrictions of those preferred shares;
o a discussion of federal income tax consequences applicable to those
preferred shares; and
o any limitations on direct or beneficial ownership and restrictions on
transfer in addition to those described in "-- Restrictions on Ownership
and Transfer," in each case as may be appropriate to preserve our status
as a real estate investment trust.
The terms of any preferred shares we issue through this prospectus will be
set forth in an articles supplementary or amendment to our Declaration of
Trust. We will file the articles supplementary or amendment as an exhibit to
the registration statement that includes this prospectus, or as an exhibit to
a filing with the SEC that is incorporated by reference into this prospectus.
The description of preferred shares in any prospectus supplement will not
describe all of the terms of the preferred shares in detail. You should read
the applicable articles supplementary or amendment to our declaration of trust
for a complete description of all of the terms.
RANK
o Unless we say otherwise in a prospectus supplement, the preferred shares
offered through that supplement will, with respect to dividend rights and
rights upon our liquidation, dissolution or winding up, rank:
o senior to all classes or series of our common shares, and to all other
equity securities ranking junior to those preferred shares;
o on a parity with all of our equity securities ranking on a parity with
the preferred shares; and junior to all of our equity securities ranking
senior to the preferred shares.
The term "equity securities" does not include convertible debt securities.
DIVIDENDS
Subject to any preferential rights of any outstanding shares or series of
shares, including the Series A Preferred Shares, and to the provisions of our
Declaration of Trust regarding ownership of shares in excess of the ownership
limitation described below under "-- Restrictions on Ownership and Transfer,"
our preferred shareholders are entitled to receive dividends, when and as
authorized by our Board of Trustees, out of legally available funds.
REDEMPTION
If we provide for a redemption right in a prospectus supplement, the
preferred shares offered through that supplement will be subject to mandatory
redemption or redemption at our option, in whole or in part, in each case upon
the terms, at the times and at the redemption prices set forth in that
supplement.
LIQUIDATION PREFERENCE
As to any preferred shares offered through this prospectus, the applicable
supplement shall provide that, upon the voluntary or involuntary liquidation,
dissolution or winding up of our affairs, the holders of those preferred
shares shall receive, before any distribution or payment shall be made to the
holders of any other class or series of shares ranking junior to those
preferred shares in our distribution of assets upon any liquidation,
dissolution or winding up, and after payment or provision for payment of our
debts and other
17
liabilities, out of our assets legally available for distribution to
shareholders, liquidating distributions in the amount of any liquidation
preference per share (set forth in the applicable supplement), plus an amount,
if applicable, equal to all distributions accrued and unpaid thereon (not
including any accumulation in respect of unpaid distributions for prior
distribution periods if those preferred shares do not have a cumulative
distribution). After payment of the full amount of the liquidating
distributions to which they are entitled, the holders of those preferred
shares will have no right or claim to any of our remaining assets. In the
event that, upon our voluntary or involuntary liquidation, dissolution or
winding up, the legally available assets are insufficient to pay the amount of
the liquidating distributions on all of those outstanding preferred shares and
the corresponding amounts payable on all of our shares of other classes or
series of equity security ranking on a parity with those preferred shares in
the distribution of assets upon liquidation, dissolution or winding up, then
the holders of those preferred shares and all other such classes or series of
equity security shall share ratably in any such distribution of assets in
proportion to the full liquidating distributions to which they would otherwise
be respectively entitled.
If the liquidating distributions are made in full to all holders of
preferred shares entitled to receive those distributions prior to any other
classes or series of equity security ranking junior to the preferred shares
upon our liquidation, dissolution or winding up, then our remaining assets
shall be distributed among the holders of those junior classes or series of
equity shares, in each case according to their respective rights and
preferences and their respective number of shares.
VOTING RIGHTS
Unless otherwise indicated in the applicable supplement, holders of our
preferred shares will not have any voting rights, except as may be required by
applicable law or any applicable rules and regulations of the American Stock
Exchange.
CONVERSION RIGHTS
The terms and conditions, if any, upon which any series of preferred shares
is convertible into common shares will be set forth in the prospectus
supplement relating to the offering of those preferred shares. These terms
typically will include:
o the number of common shares into which the preferred shares are
convertible;
o the conversion price (or manner of calculation thereof);
o the conversion period;
o provisions as to whether conversion will be at the option of the holders
of the preferred shares or at our option;
o the events requiring an adjustment of the conversion price; and
o provisions affecting conversion in the event of the redemption of that
series of preferred shares.
THE SERIES A PREFERRED SHARES
The Company has issued and outstanding 2,400,000 of Series A Preferred
Shares. The Series A Preferred Shares generally provide for the following
rights, preferences and obligations.
Dividend Rights. The Series A Preferred Shares accrue a cumulative cash
dividend at an annual rate of 8.00% on the $25.00 per share liquidation
preference, equivalent to a fixed annual amount of $2.00 per share.
Liquidation Rights. Upon any voluntary or involuntary liquidation,
dissolution or winding up of our company, the holders of Series A Preferred
Shares will be entitled to receive a liquidation preference of $25.00 per
share, plus an amount equal to all accrued and unpaid dividends to the date of
payment, before any payment or distribution will be made or set aside for
holders of any junior shares.
Redemption Provisions. The Series A Preferred Shares are not redeemable
prior to August 5, 2010, except in certain limited circumstances relating to
our ability to qualify as a REIT. On and after August 5,
18
2010, the Series A Preferred Shares may be redeemed for cash at our option, in
whole or in part, at any time and from time to time, at a redemption price
equal to $25.00 per share plus an amount equal to all accrued and unpaid
dividends to and including the date fixed for redemption. The Series A
Preferred Shares have no stated maturity and are not subject to any sinking
fund or mandatory redemption provisions.
Voting Rights. Holders of Series A Preferred Shares generally have no
voting rights, except as required by law. However, if we fail to pay dividends
on any Series A Preferred Shares for six or more quarterly periods, whether or
not consecutive, the holders of the Series A Preferred Shares will be entitled
to elect two directors to serve on our Board of Trustees until all dividends
accumulated on the Series A Preferred Shares have been fully paid or declared
and a sum sufficient for the payment thereof set aside for payment. In
addition, the issuance of senior shares or certain changes to the terms of the
Series A Preferred Shares that would be materially adverse to the rights of
holders of Series A Preferred Shares cannot be made without the affirmative
vote of holders of at least 66 2/3% of the outstanding Series A Preferred
Shares and shares of any class or series of shares ranking on a parity with
the Series A Preferred Shares which are entitled to similar voting rights, if
any, voting as a single class.
Conversion and Preemptive Rights. The Series A Preferred Shares are not
convertible or exchangeable for any of our other securities or property, and
holders of our Series A Preferred Shares have no preemptive rights to
subscribe for any securities of our company.
CLASSIFICATION OR RECLASSIFICATION OF COMMON SHARES OR PREFERRED SHARES
Our Declaration of Trust authorizes the Board of Trustees to classify or
reclassify any unissued common shares or preferred shares into one or more
classes or series of shares of beneficial interest by setting or changing the
preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends or distributions, qualifications or terms or
conditions of redemption of such new class or series of shares of beneficial
interest.
RESTRICTIONS ON OWNERSHIP AND TRANSFER
Our Declaration of Trust, subject to certain exceptions described below,
provides that no person may own, or be deemed to own by virtue of the
attribution provisions of the Internal Revenue Code, more than 9.9% of (i) the
number of outstanding common shares of any class or series of common shares or
(ii) the number of outstanding preferred shares of any class or series of
preferred shares. For this purpose, a person includes a "group" and a
"beneficial owner" as those terms are used for purposes of Section 13(d)(3) of
the Exchange Act. Any transfer of common or preferred shares that would (i)
result in any person owning, directly or indirectly, common or preferred
shares in excess of the ownership limitation, (ii) result in the common and
preferred shares being owned by fewer than 100 persons (determined without
reference to any rules of attribution), (iii) result in our being "closely
held" within the meaning of Section 856(h) of the Internal Revenue Code, or
(iv) cause us to own, actually or constructively, 10% or more of the ownership
interests in a tenant of our or our partnership's real property (other than a
TRS), within the meaning of Section 856(d)(2)(B) of the Internal Revenue Code,
will be null and void, and the intended transferee will acquire no rights in
such common or preferred shares.
Subject to certain exceptions described below, any common shares or
preferred shares the purported transfer of which would (i) result in any
person owning, directly or indirectly, common shares or preferred shares in
excess of the ownership limitation, (ii) result in the common shares and
preferred shares being owned by fewer than 100 persons (determined without
reference to any rules of attribution), (iii) result in our being "closely
held" within the meaning of Section 856(h) of the Internal Revenue Code, or
(iv) cause us to own, actually or constructively, 10% or more of the ownership
interests in a tenant of our or our partnership's real property (other than a
TRS), within the meaning of Section 856(d)(2)(B) of the Internal Revenue Code,
will be designated as "shares-in-trust" and transferred automatically to a
trust effective on the day before the purported transfer of such common shares
or preferred shares. The record holder of the common or preferred shares that
are designated as shares-in-trust will be required to submit such number of
common shares or preferred shares to us for registration in the name of the
trust. The trustee will be designated by us, but will
19
not be affiliated with us. The beneficiary of a trust will be one or more
charitable organizations that are named by us.
Shares-in-trust will remain issued and outstanding common shares or
preferred shares and will be entitled to the same rights and privileges as all
other shares of the same class or series. The trust will receive all dividends
and distributions on the shares-in-trust and will hold such dividends or
distributions in trust for the benefit of the beneficiary. The trust will vote
all shares-in-trust. The trust will designate a permitted transferee of the
shares-in-trust, provided that the permitted transferee (i) purchases such
shares-in-trust for valuable consideration and (ii) acquires such shares-in-
trust without such acquisition resulting in a transfer to another trust.
The prohibited owner with respect to shares-in-trust will be required to
repay to the record holder the amount of any dividends or distributions
received by the prohibited owner (i) that are attributable to any shares-in-
trust and (ii) the record date of which was on or after the date that such
shares became shares-in-trust. The prohibited owner generally will receive
from the record holder the lesser of (i) the price per share such prohibited
owner paid for the common shares or preferred shares that were designated as
shares-in-trust (or, in the case of a gift or devise, the market price (as
defined below) per share on the date of such transfer) or (ii) the price per
share received by the record holder from the sale of such shares- in-trust.
Any amounts received by the record holder in excess of the amounts to be paid
to the prohibited owner will be distributed to the beneficiary.
The shares-in-trust will be deemed to have been offered for sale to us, or
its designee, at a price per share equal to the lesser of (i) the price per
share in the transaction that created such shares-in-trust (or, in the case of
a gift or devise, the market price per share on the date of such transfer) or
(ii) the market price per share on the date that we, or our designee, accepts
such offer. We will have the right to accept such offer for a period of 90
days after the later of (i) the date of the purported transfer which resulted
in such shares-in-trust or (ii) the date we determine in good faith that a
transfer resulting in such shares-in-trust occurred.
"Market price" on any date shall mean the average of the last quoted sale
price as reported by the American Stock Exchange for the five consecutive
trading days (as defined below) ending on such date.
Any person who acquires or attempts to acquire common or preferred shares in
violation of the foregoing restrictions, or any person who owned common or
preferred shares that were transferred to a trust, will be required (i) to
give immediately written notice to us of such event and (ii) to provide to us
such other information as we may request in order to determine the effect, if
any, of such transfer on our status as a REIT.
All persons who own, directly or indirectly, more than 5% (or such lower
percentages as required pursuant to regulations under the Internal Revenue
Code) of the outstanding common and preferred shares must, within 30 days
after December 31 of each year, provide to us a written statement or affidavit
stating the name and address of such direct or indirect owner, the number of
common and preferred shares owned directly or indirectly, and a description of
how such shares are held. In addition, each direct or indirect shareholder
shall provide to us such additional information as we may request in order to
determine the effect, if any, of such ownership on our status as a REIT and to
ensure compliance with the ownership limitation.
The ownership limitation generally does not apply to the acquisition of
common or preferred shares by an underwriter that participates in a public
offering of such shares. In addition, the trustees, upon receipt of advice of
counsel or other evidence satisfactory to the trustees, in their sole and
absolute discretion, may, in their sole and absolute discretion, exempt a
person from the ownership limitation under certain circumstances. The
foregoing restrictions continue to apply until (i) the trustees determine that
it is no longer in our best interests to attempt to qualify, or to continue to
qualify, as a REIT and (ii) there is an affirmative vote of two-thirds of the
number of common and preferred shares entitled to vote on such matter at a
regular or special meeting of our shareholders.
All certificates representing common or preferred shares bear a legend
referring to the restrictions described above.
20
This ownership limitation could have the effect of delaying, deterring or
preventing a change in control or other transaction in which holders of some,
or a majority, of shares of common shares might receive a premium for their
shares of common shares over the then prevailing market price or which such
holders might believe to be otherwise in their best interest.
OTHER MATTERS
Our transfer agent and registrar for our common shares is American Stock
Transfer and Trust Company, Charlotte, North Carolina.
21
LEGAL OWNERSHIP OF SECURITIES
We can issue securities in registered form or in the form of one or more
global securities. We describe global securities in greater detail below. We
refer to those persons who have securities registered in their own names on
the books that we or any applicable trustee maintain for this purpose as the
"holders" of those securities. These persons are the legal holders of the
securities. We refer to those persons who, indirectly through others, own
beneficial interests in securities that are not registered in their own names,
as "indirect holders" of those securities. As we discuss below, indirect
holders are not legal holders, and investors in securities issued in book-
entry form or in street name will be indirect holders.
BOOK-ENTRY HOLDERS
We may issue securities in book-entry form only, as we will specify in the
applicable prospectus supplement. This means securities may be represented by
one or more global securities registered in the name of a financial
institution that holds them as depositary on behalf of other financial
institutions that participate in the depositary's book-entry system. These
participating institutions, which are referred to as participants, in turn,
hold beneficial interests in the securities on behalf of themselves or their
customers.
Only the person in whose name a security is registered is recognized as the
holder of that security. Securities issued in global form will be registered
in the name of the depositary or its participants. Consequently, for
securities issued in global form, we will recognize only the depositary as the
holder of the securities, and we will make all payments on the securities to
the depositary. The depositary passes along the payments it receives to its
participants, which in turn pass the payments along to their customers who are
the beneficial owners. The depositary and its participants do so under
agreements they have made with one another or with their customers; they are
not obligated to do so under the terms of the securities.
As a result, investors in a book-entry security will not own securities
directly. Instead, they will own beneficial interests in a global security,
through a bank, broker or other financial institution that participates in the
depositary's book-entry system or holds an interest through a participant. As
long as the securities are issued in global form, investors will be indirect
holders, and not holders, of the securities.
STREET NAME HOLDERS
We may terminate a global security or issue securities in non-global form.
In these cases, investors may choose to hold their securities in their own
names or in "street name." Securities held by an investor in street name would
be registered in the name of a bank, broker or other financial institution
that the investor chooses, and the investor would hold only a beneficial
interest in those securities through an account he or she maintains at that
institution.
For securities held in street name, we will recognize only the intermediary
banks, brokers and other financial institutions in whose names the securities
are registered as the holders of those securities, and we will make all
payments on those securities to them. These institutions pass along the
payments they receive to their customers who are the beneficial owners, but
only because they agree to do so in their customer agreements or because they
are legally required to do so. Investors who hold securities in street name
will be indirect holders, not holders, of those securities.
LEGAL HOLDERS
Our obligations, as well as the obligations of any applicable trustee and of
any third parties employed by us or a trustee, run only to the legal holders
of the securities. We do not have obligations to investors who hold beneficial
interests in global securities, in street name or by any other indirect means.
This will be the case whether an investor chooses to be an indirect holder of
a security or has no choice because we are issuing the securities only in
global form.
For example, once we make a payment or give a notice to the holder, we have
no further responsibility for the payment or notice even if that holder is
required, under agreements with depositary participants or customers or by
law, to pass it along to the indirect holders but does not do so. Similarly,
we may want to obtain the approval of the holders to amend an indenture, to
relieve us of the consequences of a default or of
22
our obligation to comply with a particular provision of the indenture or for
other purposes. In such an event, we would seek approval only from the
holders, and not the indirect holders, of the securities. Whether and how the
holders contact the indirect holders is up to the holders.
SPECIAL CONSIDERATIONS FOR INDIRECT HOLDERS
If you hold securities through a bank, broker or other financial
institution, either in book-entry form or in street name, you should check
with your own institution to find out:
o how it handles securities payments and notices;
o whether it imposes fees or charges;
o how it would handle a request for the holders' consent, if ever required;
o whether and how you can instruct it to send you securities registered in
your own name so you can be a holder, if that is permitted in the future;
o how it would exercise rights under the securities if there were a default
or other event triggering the need for holders to act to protect their
interests; and
o if the securities are in book-entry form, how the depositary's rules and
procedures will affect these matters.
GLOBAL SECURITIES
A global security is a security held by a depositary which represents one or
any other number of individual securities. Generally, all securities
represented by the same global securities will have the same terms.
Each security issued in book-entry form will be represented by a global
security that we deposit with and register in the name of a financial
institution or its nominee that we select. The financial institution that we
select for this purpose is called the depositary. Unless we specify otherwise
in the applicable prospectus supplement, The Depository Trust Company, New
York, New York, known as DTC, will be the depositary for all securities issued
in book-entry form.
A global security may not be transferred to or registered in the name of
anyone other than the depositary, its nominee or a successor depositary,
unless special termination situations arise. We describe those situations
below under "-- Special Situations When a Global Security Will Be Terminated."
As a result of these arrangements, the depositary, or its nominee, will be the
sole registered owner and holder of all securities represented by a global
security, and investors will be permitted to own only beneficial interests in
a global security. Beneficial interests must be held by means of an account
with a broker, bank or other financial institution that in turn has an account
with the depositary or with another institution that does. Thus, an investor
whose security is represented by a global security will not be a holder of the
security, but only an indirect holder of a beneficial interest in the global
security.
If the prospectus supplement for a particular security indicates that the
security will be issued in global form only, then the security will be
represented by a global security at all times unless and until the global
security is terminated. If termination occurs, we may issue the securities
through another book-entry clearing system or decide that the securities may
no longer be held through any book-entry clearing system.
SPECIAL CONSIDERATIONS FOR GLOBAL SECURITIES
As an indirect holder, an investor's rights relating to a global security
will be governed by the account rules of the investor's financial institution
and of the depositary, as well as general laws relating to securities
transfers. We do not recognize an indirect holder as a holder of securities
and instead deal only with the depositary that holds the global security.
If securities are issued only in the form of a global security, an investor
should be aware of the following:
23
o An investor cannot cause the securities to be registered in his or her
name, and cannot obtain non-global certificates for his or her interest
in the securities, except in the special situations we describe below;
o An investor will be an indirect holder and must look to his or her own
bank or broker for payments on the securities and protection of his or
her legal rights relating to the securities, as we describe under "--
Ownership of Securities" above;
o An investor may not be able to sell interests in the securities to some
insurance companies and to other institutions that are required by law to
own their securities in non-book-entry form;
o An investor may not be able to pledge his or her interest in a global
security in circumstances where certificates representing the securities
must be delivered to the lender or other beneficiary of the pledge in
order for the pledge to be effective;
o The depositary's policies, which may change from time to time, will
govern payments, transfers, exchanges and other matters relating to an
investor's interest in a global security. We and any applicable trustee
have no responsibility for any aspect of the depositary's actions or for
its records of ownership interests in a global security. We and the
trustee also do not supervise the depositary in any way;
o The depositary may, and we understand that DTC will, require that those
who purchase and sell interests in a global security within its book-
entry system use immediately available funds, and your broker or bank may
require you to do so as well; and
o Financial institutions that participate in the depositary's book-entry
system, and through which an investor holds its interest in a global
security, may also have their own policies affecting payments, notices
and other matters relating to the securities. There may be more than one
financial intermediary in the chain of ownership for an investor. We do
not monitor and are not responsible for the actions of any of those
intermediaries.
SPECIAL SITUATIONS WHEN A GLOBAL SECURITY WILL BE TERMINATED
In a few special situations described below, the global security will
terminate and interests in it will be exchanged for physical certificates
representing those interests. After that exchange, the choice of whether to
hold securities directly or in street name will be up to the investor.
Investors must consult their own banks or brokers to find out how to have
their interests in securities transferred to their own name, so that they will
be direct holders. We have described the rights of holders and street name
investors above.
The global security will terminate when the following special situations
occur:
o if the depositary notifies us that it is unwilling, unable or no longer
qualified to continue as depositary for that global security and we do
not appoint another institution to act as depositary within 90 days;
o if we notify any applicable trustee that we wish to terminate that global
security; or
o if an event of default has occurred with regard to securities represented
by that global security and has not been cured or waived.
The prospectus supplement may also list additional situations for
terminating a global security that would apply only to the particular series
of securities covered by the prospectus supplement. When a global security
terminates, the depositary, and not we or any applicable trustee, is
responsible for deciding the names of the institutions that will be the
initial direct holders.
24
CERTAIN PROVISIONS OF MARYLAND LAW, OUR DECLARATION OF TRUST
AND BYLAWS
CLASSIFICATION OF THE BOARD OF TRUSTEES
Our Bylaws provide that the number of our trustees may be established by the
Board of Trustees but may not be fewer than three nor more than nine. As of
September 30, 2006, we have seven trustees. The trustees may increase or
decrease the number of trustees by a vote of at least 80% of the members of
the Board of Trustees, provided that the number of trustees shall never be
less than the number required by Maryland law and that the tenure of office of
a trustee shall not be affected by any decrease in the number of trustees. Any
vacancy will be filled, including a vacancy created by an increase in the
number of trustees, at any regular meeting or at any special meeting called
for that purpose, by a majority of the remaining trustees or, if no trustees
remain, by a majority of our shareholders.
Pursuant to our Declaration of Trust, the Board of Trustees is divided into
two classes of trustees. Trustees of each class are chosen for two-year terms
and each year one class of trustees will be elected by the shareholders. We
believe that classification of the Board of Trustees helps to assure the
continuity and stability of our business strategies and policies as determined
by the trustees. Holders of common shares have no right to cumulative voting
in the election of trustees. Consequently, at each annual meeting of
shareholders, the holders of a majority of the common shares are able to elect
all of the successors of the class of trustees whose terms expire at that
meeting.
The classified board provision could have the effect of making the
replacement of incumbent trustees more time consuming and difficult. The
staggered terms of trustees may delay, defer or prevent a tender offer or an
attempt to change control in us or other transaction that might involve a
premium price for holders of common shares that might be in the best interest
of the shareholders.
REMOVAL OF TRUSTEES
The Declaration of Trust provides that a trustee may be removed with or
without cause upon the affirmative vote of at least two-thirds of the votes
entitled to be cast in the election of trustees. This provision, when coupled
with the provision in the Bylaws authorizing the Board of Trustees to fill
vacant trusteeships, precludes shareholders from removing incumbent trustees,
except upon a substantial affirmative vote, and filling the vacancies created
by such removal with their own nominees.
BUSINESS COMBINATIONS
Maryland law prohibits "business combinations" between us and an interested
shareholder or an affiliate of an interested shareholder for five years after
the most recent date on which the interested shareholder becomes an interested
shareholder. These business combinations include a merger, consolidation,
share exchange, or, in circumstances specified in the statute, an asset
transfer or issuance or reclassification of equity securities. Maryland law
defines an interested shareholder as:
o any person who beneficially owns 10% or more of the voting power of our
shares; or
o an affiliate or associate of ours who, at any time within the two-year
period prior to the date in question, was the beneficial owner of 10% or
more of the voting power of our then outstanding voting shares.
A person is not an interested shareholder if our Board of Trustees approved
in advance the transaction by which the person otherwise would have become an
interested shareholder.
After the five-year prohibition, any business combination between us and an
interested shareholder generally must be recommended by our board of trustees
and approved by the affirmative vote of at least:
o 80% of the votes entitled to be cast by holders of our then outstanding
shares of beneficial interest; and
25
o two-thirds of the votes entitled to be cast by holders of our voting
shares other than shares held by the interested shareholder with whom or
with whose affiliate the business combination is to be effected or shares
held by an affiliate or associate of the interested shareholder.
These super-majority vote requirements do not apply if our common
shareholders receive a minimum price, as defined under Maryland law, for their
shares in the form of cash or other consideration in the same form as
previously paid by the interested shareholder for its shares.
The statute permits various exemptions from its provisions, including
business combinations that are approved or exempted by the Board of Trustees
before the time that the interested shareholder becomes an interested
shareholder.
CONTROL SHARE ACQUISITIONS
Maryland law provides that "control shares" of a Maryland REIT acquired in a
"control share acquisition" have no voting rights unless approved by a vote of
two-thirds of the votes entitled to be cast on the matter. Shares owned by the
acquiror, or by officers or by trustees who are employees of the REIT are
excluded from shares entitled to vote on the matter. "Control shares" are
voting shares which, if aggregated with all other shares previously acquired
by the acquiring person, or in respect of which the acquiring person is able
to exercise or direct the exercise of voting power (except solely by virtue of
a revocable proxy), would entitle the acquiring person to exercise voting
power in electing trustees within one of the following ranges of voting power:
o one-tenth or more but less than one-third;
o one-third or more but less than a majority; or
o a majority or more of all voting power.
Control shares do not include shares the acquiring person is then entitled
to vote as a result of having previously obtained shareholder approval. A
"control share acquisition" means the acquisition of control shares, subject
to certain exceptions.
A person who has made or proposes to make a control share acquisition may
compel the board of trustees of a Maryland REIT to call a special meeting of
shareholders to be held within 50 days of demand to consider the voting rights
of the shares. The right to compel the calling of a special meeting is subject
to the satisfaction of certain conditions, including an undertaking to pay the
expenses of the meeting. If no request for a meeting is made, REIT may present
the question at any shareholders' meeting.
If voting rights are not approved at the shareholders' meeting or if the
acquiring person does not deliver the statement required by Maryland law,
then, subject to certain conditions and limitations, the REIT may redeem any
or all of the control shares, except those for which voting rights have
previously been approved, for fair value. Fair value is determined without
regard to the absence of voting rights for the control shares and as of the
date of the last control share acquisition or of any meeting of shareholders
at which the voting rights of the shares were considered and not approved. If
voting rights for control shares are approved at a shareholders' meeting and
the acquiror may then vote a majority of the shares entitled to vote, then all
other shareholders may exercise appraisal rights. The fair value of the shares
for purposes of these appraisal rights may not be less than the highest price
per share paid by the acquiror in the control share acquisition. The control
share acquisition statute does not apply to shares acquired in a merger,
consolidation or share exchange if we are a party to the transaction, nor does
it apply to acquisitions approved or exempted by our Declaration of Trust or
Bylaws.
Our Bylaws contain a provision exempting from the control share acquisition
act any and all acquisitions by any person of our shares. There can be no
assurance that this provision will not be amended or eliminated at any time in
the future.
26
AMENDMENT
Our Declaration of Trust provides that it may be amended with the approval
of at least a majority of all of the votes entitled to be cast on the matter,
but that certain provisions of the Declaration of Trust regarding (i) our
Board of Trustees, including the provisions regarding independent trustee
requirements, (ii) the restrictions on transfer of the common shares and the
preferred shares, (iii) amendments to the Declaration of Trust by the trustees
and our shareholders and (iv) our termination may not be amended, altered,
changed or repealed without the approval of two-thirds of all of the votes
entitled to be cast on these matters. In addition, the Declaration of Trust
provides that it may be amended by the Board of Trustees, without shareholder
approval to (a) increase or decrease the aggregate number of shares of
beneficial interest or the number of shares of any class of beneficial
interest that the Trust has authority to issue or (b) qualify as a REIT under
the Code or under the Maryland REIT law. Our Bylaws may be amended or altered
exclusively by the Board of Trustees.
LIMITATION OF LIABILITY AND INDEMNIFICATION
Our Declaration of Trust limits the liability of our trustees and officers
for money damages, except for liability resulting from:
o actual receipt of an improper benefit or profit in money, property or
services; or
o a final judgment based upon a finding of active and deliberate dishonesty
by the trustees or others that was material to the cause of action
adjudicated.
Our Declaration of Trust authorizes us, to the maximum extent permitted by
Maryland law, to indemnify, and to pay or reimburse reasonable expenses to,
any of our present or former trustees or officers or any individual who, while
a trustee or officer and at our request, serves or has served another entity,
employee benefit plan or any other enterprise as a trustee, director, officer,
partner or otherwise. The indemnification covers any claim or liability
against the person. Our Bylaws and Maryland law require us to indemnify each
trustee or officer who has been successful, on the merits or otherwise, in the
defense of any proceeding to which he or she is made a party by reason of his
or her service to us.
Maryland law permits a Maryland REIT to indemnify its present and former
trustees and officers against liabilities and reasonable expenses actually
incurred by them in any proceeding unless:
o the act or omission of the trustee or officer was material to the matter
giving rise to the proceeding; and
o was committed in bad faith; or
o was the result of active and deliberate dishonesty; or
o the trustee or officer actually received an improper personal benefit in
money, property or services; or
o in a criminal proceeding, the trustee or officer had reasonable cause to
believe that the act or omission was unlawful.
However, Maryland law prohibits us from indemnifying our present and former
trustees and officers for an adverse judgment in a derivative action or for a
judgment of liability on the basis that personal benefit was improperly
received, unless in either case a court orders indemnification and then only
for expenses. Our Bylaws and Maryland law require us, as a condition to
advancing expenses in certain circumstances, to obtain:
o a written affirmation by the trustee or officer of his or her good faith
belief that he or she has met the standard of conduct necessary for
indemnification; and
o a written undertaking to repay the amount reimbursed if the standard of
conduct is not met.
27
POSSIBLE ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF OUR
DECLARATION OF TRUST
AND BYLAWS
The business combination provisions and, if the applicable exemption in the
Bylaws is rescinded, the control share acquisition provisions of the MGCL, the
provisions of our Declaration of Trust on classification of the Board of
Trustees, the removal of trustees and the restrictions on the transfer of
shares of beneficial interest and the advance notice provisions of the Bylaws
could have the effect of delaying, deferring or preventing a transaction or a
change in control that might involve a premium price for holders of the common
shares or otherwise be in their best interest.
PARTNERSHIP AGREEMENT
MANAGEMENT
Hersha Hospitality Limited Partnership, our operating partnership, has been
organized as a Virginia limited partnership. Pursuant to the partnership
agreement, we, as the sole general partner of the operating partnership, have,
subject to certain protective rights of limited partners described below,
full, exclusive and complete responsibility and discretion in the management
and control of the partnership, including the ability to cause the operating
partnership to enter into certain major transactions including acquisitions,
dispositions, refinancings and selection of lessees and to cause changes in
the partnership's line of business and distribution policies. However, any
amendment to the partnership agreement that would affect the redemption rights
requires the consent of limited partners holding more than 50% of the
operating partnership units held by such partners.
The affirmative vote of more than fifty percent of the limited partnership
units (other than limited partnership units owned by the general partner or
owned by a subsidiary of the general partner) in our operating partnership, is
required for a sale of all or substantially all of the assets of the
partnership, or to approve a merger or consolidation of the partnership;
provided, however, that the affirmative vote of at least two-thirds of the
limited partnership units in our operating partnership is required if we fail
to pay a distribution of $0.72 per share to the holders of the Class A common
shares for any 12-month period. As of September 30, 2006, we own a 89.3%
interest and other limited partners own a 10.7% interest in the operating
partnership.
TRANSFERABILITY OF INTERESTS
We may not voluntarily withdraw from the partnership or transfer or assign
our interest in the partnership unless the transaction in which such
withdrawal or transfer occurs results in the limited partners receiving
property in an amount equal to the amount they would have received had they
exercised their redemption rights immediately prior to such transaction, or
unless our successor contributes substantially all of its assets to the
partnership in return for a general partnership interest in the partnership.
With certain limited exceptions, the limited partners may not transfer their
interests in the partnership, in whole or in part, without our written
consent, which consent we may withhold in our sole discretion. We may not
consent to any transfer that would cause the partnership to be treated as a
corporation for federal income tax purposes.
CAPITAL CONTRIBUTIONS
The partnership agreement provides that if the partnership requires
additional funds at any time in excess of funds available to the partnership
from borrowing or capital contributions, we may borrow such funds from a
financial institution or other lender and lend such funds to the partnership
on the same terms and conditions as are applicable to our borrowing of such
funds. Under the partnership agreement, we are obligated to contribute the
proceeds of any offering of shares of beneficial interest as additional
capital to the partnership. We are authorized to cause the partnership to
issue partnership interests for less than fair market value if we have
concluded in good faith that such issuance is in both the partnership's and
our best interests. If we contribute additional capital to the partnership, we
will receive additional limited partnership units and our percentage interest
will be increased on a proportionate basis based upon the amount of such
additional capital contributions and the value of the partnership at the time
of such contributions. Conversely, the percentage interests of the limited
partners will be decreased on a proportionate basis in the event of
28
additional capital contributions by us. In addition, if we contribute
additional capital to the partnership, we will revalue the property of the
partnership to its fair market value (as determined by us) and the capital
accounts of the partners will be adjusted to reflect the manner in which the
unrealized gain or loss inherent in such property (that has not been reflected
in the capital accounts previously) would be allocated among the partners
under the terms of the partnership agreement if there were a taxable
disposition of such property for such fair market value on the date of the
revaluation.
REDEMPTION RIGHTS
Pursuant to the partnership agreement, the limited partners receive
redemption rights, which enables them to cause the partnership to redeem their
interests therein in exchange for cash or, at our option, Class B common
shares on a one-for-one basis. In the event that the Class B common shares are
converted into Class A common shares prior to redemption of the limited
partnership units, such outstanding units will be redeemable for Class A
common shares. If we do not exercise our option to redeem such interests for
Class B common shares, then the limited partner may make a written demand that
we redeem such interests for Class B common shares. Notwithstanding the
foregoing, a limited partner shall not be entitled to exercise its redemption
rights to the extent that the issuance of common shares to the redeeming
limited partner would
o result in any person owning, directly or indirectly, common shares in
excess of the ownership limitation as per our Declaration of Trust,
o result in the shares of our beneficial interest being owned by fewer than
100 persons (determined without reference to any rules of attribution),
o result in our being "closely held" within the meaning of Section 856(h)
of the Internal Revenue Code,
o cause any person who operates Property on behalf of a "taxable REIT
subsidiary" of the Company, as defined in Section 856(l) of the Internal
Revenue Code, which Property is a "qualified lodging facility" within the
meaning of Section 856(d)(9)(D) of the Internal Revenue Code that is
leased to such taxable REIT subsidiary, to fail to qualify as an
"eligible independent contractor" within the meaning of
Section 856(d)(9)(A) of the Internal Revenue Code with respect to such
taxable REIT subsidiary,
o cause us to own, actually or constructively, 10% or more of the ownership
interests in a tenant of ours or the partnership's real property (other
than a TRS), within the meaning of Section 856(d)(2)(B) of the Internal
Revenue Code, or
o cause the acquisition of common shares by such redeeming limited partner
to be "integrated" with any other distribution of common shares for
purposes of complying with the Securities Act.
With respect to the limited partnership units that were issued in connection
with the acquisition of our hotels, the redemption rights may be exercised by
the limited partners at any time after one year following the issuance of such
units. In this case, however,
o each limited partner may not exercise the redemption right for fewer than
1,000 units or, if such limited partner holds fewer than 1,000 limited
partnership units, all of the units held by such limited partner,
o each limited partner may not exercise the redemption right for more than
the number of limited partnership units that would, upon redemption,
result in such limited partner or any other person owning, directly or
indirectly, common shares in excess of the ownership limitation and
o each limited partner may not exercise the redemption right more than two
times annually.
The aggregate number of common shares currently issuable upon exercise of
the redemption rights is approximately 3,835,586. The number of common shares
issuable upon exercise of the redemption rights will be adjusted on account of
share splits, mergers, consolidations or similar pro rata share transactions.
The partnership agreement requires that the partnership be operated in a
manner that enables us to satisfy the requirements for being classified as a
REIT, to avoid any federal income or excise tax liability imposed
29
by the Internal Revenue Code (other than any federal income tax liability
associated with our retained capital gains) and to ensure that the partnership
will not be classified as a "publicly traded partnership" for purposes of
Section 7704 of the Internal Revenue Code.
In addition to the administrative and operating costs and expenses incurred
by the partnership, the partnership will pay all of our administrative costs
and expenses and these expenses will be treated as expenses of the
partnership. Our expenses generally include
o all expenses relating to our continuity of existence,
o all expenses relating to offerings and registration of securities,
o all expenses associated with the preparation and filing of any of our
periodic reports under federal, state or local laws or regulations,
o all expenses associated with our compliance with laws, rules and
regulations promulgated by any regulatory body and
o all of our other operating or administrative costs incurred in the
ordinary course of its business on behalf of the partnership.
The company expenses, however, do not include any of our administrative and
operating costs and expenses incurred that are attributable to hotel
properties that are owned by us directly.
DISTRIBUTIONS
The partnership agreement provides that the partnership will distribute cash
from operations (including net sale or refinancing proceeds, but excluding net
proceeds from the sale of the partnership's property in connection with the
liquidation of the partnership) on a quarterly (or, at our election, more
frequent) basis, in amounts determined by us in our sole discretion, to us and
the limited partners in accordance with their respective percentage interests
in the partnership.
The partnership agreement provides that upon a liquidation of the
partnership after payment of, or adequate provision for, debts and obligations
of the partnership, including any partner loans, any remaining assets of the
partnership will be distributed to us and the limited partners with positive
capital accounts in accordance with their respective positive capital account
balances.
ALLOCATIONS
Net profits of the partnership for each fiscal year are allocated in the
following order of priority:
(a) first, to us in respect of our Series A Preferred Partnership Units to
the extent that net loss previously allocated to us pursuant to clause (iii)
below for all prior fiscal years or other applicable periods exceeds net
profit previously allocated to us pursuant to this clause (a) for all prior
fiscal years or other applicable periods,
(b) second, to us and the holders of operating partnership units in
proportion to their respective percentage interests to the extent that net
loss previously allocated to such holders pursuant to clause (ii) below for
all prior fiscal years or other applicable periods exceeds net profit
previously allocated to such holders pursuant to this clause (b) for all prior
fiscal years or other applicable periods,
(c) third, to us in respect of our Series A Preferred Partnership Units
until we have been allocated net profit equal to the excess of (x) the
cumulative amount of distributions we have received for all fiscal years or
other applicable period to the date of redemption, to the extent such Series A
Preferred Units are redeemed during such period, over (y) the cumulative net
profit allocated to us pursuant to this clause (c) for all prior fiscal years
or other applicable periods, and
(d) thereafter, to the holders of operating partnership units in accordance
with their respective percentage interests.
30
Net losses of the partnership for each fiscal year are allocated to us and
the limited partners in accordance with the following order of priority:
(i) first, to the holders of operating partnership units in accordance with
their respective percentage interests to the extent of net profit previously
allocated to such holders pursuant to (d) above for all prior fiscal years or
other applicable period exceeds net loss previously allocated to such holders
pursuant to this clause (i) for all prior fiscal years or other applicable
periods,
(ii) second, to us and the holders of operating partnership units in
proportion to their respective percentage interests until the adjusted capital
account of each holder with respect to such operating partnership units is
reduced to zero; and
(iii) thereafter, to us in respect of our Series A Preferred Partnership
Units, until our adjusted capital account with respect to the Series A
Preferred Partnership Units is reduced to zero.
All of the foregoing allocations are subject to compliance with the
provisions of Sections 704(b) and 704(c) of the Internal Revenue Code and
Treasury Regulations promulgated thereunder.
TERM
The partnership will continue until December 31, 2050, or until sooner
dissolved upon:
o our bankruptcy, dissolution or withdrawal (unless the limited partners
elect to continue the partnership),
o the sale or other disposition of all or substantially all the assets of
the partnership,
o the redemption of all operating partnership units (other than those held
by us, if any) or
o an election by us as the General Partner.
TAX MATTERS
Pursuant to the partnership agreement, we are the tax matters partner of the
partnership and, as such, have authority to handle tax audits and to make tax
elections under the Internal Revenue Code on behalf of the partnership.
31
FEDERAL INCOME TAX CONSEQUENCES OF OUR STATUS AS A REIT
This section summarizes the federal income tax issues that you, as a holder
of our capital stock, may consider relevant. Hunton & Williams LLP has acted
as our counsel, has reviewed this summary and is of the opinion that the
discussion contained herein fairly summarizes the federal income tax
consequences that are likely to be material to a holder of our capital stock.
Because this section is a summary, it does not address all of the tax issues
that may be important to you. In addition, this section does not address the
tax issues that may be important to certain types of holders of our capital
stock that are subject to special treatment under the federal income tax laws,
such as insurance companies, tax-exempt organizations, financial institutions
or broker-dealers, and non-U.S. individuals and foreign corporations.
The statements in this section and the opinion of Hunton & Williams LLP are
based on the current federal income tax laws governing qualification as a
REIT. We cannot assure you that new laws, interpretations of law or court
decisions, any of which may take effect retroactively, will not cause any
statement in this section to be inaccurate.
WE URGE YOU TO CONSULT YOUR OWN TAX ADVISOR REGARDING THE SPECIFIC TAX
CONSEQUENCES TO YOU OF INVESTING IN OUR CAPITAL STOCK AND OF OUR ELECTION TO
BE TAXED AS A REIT. SPECIFICALLY, YOU SHOULD CONSULT YOUR OWN TAX ADVISOR
REGARDING THE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES OF
SUCH INVESTMENT AND ELECTION, AND REGARDING POTENTIAL CHANGES IN APPLICABLE
TAX LAWS.
TAXATION OF OUR COMPANY
We elected to be taxed as a REIT under the federal income tax laws beginning
with our taxable year ended December 31, 1999. We believe that we have
operated in a manner qualifying us as a REIT since our election and intend to
continue to so operate. This section discusses the laws governing the federal
income tax treatment of a REIT and its shareholders. These laws are highly
technical and complex.
In the opinion of Hunton & Williams LLP, we qualified to be taxed as a REIT
under the federal income tax laws for our taxable years ended December 31,
2003 through December 31, 2005, and our organization and current and proposed
method of operation will enable us to continue to qualify as a REIT for our
taxable year ending December 31, 2006 and in the future. You should be aware
that the opinion is based on current law and is not binding on the Internal
Revenue Service or any court. In addition, the opinion is based on customary
assumptions and on our representations as to factual matters, all of which are
described in the opinion. Our qualification as a REIT depends on our ability
to meet, on a continuing basis, qualification tests in the federal tax laws.
Those qualification tests involve the percentage of our income that we earn
from specified sources, the percentages of our assets that fall within
specified categories, the diversity of our share ownership and the percentage
of our earnings that we distribute. Hunton & Williams LLP will not review our
compliance with those tests on a continuing basis. Accordingly, no assurance
can be given that the actual results of our operation for any particular
taxable year will satisfy such requirements. For a discussion of the tax
consequences of our failure to qualify as a REIT, see "--Failure to Qualify."
If we qualify as a REIT, we generally will not be subject to federal income
tax on the taxable income that we distribute to our shareholders. The benefit
of that tax treatment is that it avoids the "double taxation," or taxation at
both the corporate and shareholder levels, that generally results from owning
shares in a corporation. However, we will be subject to federal tax in the
following circumstances:
o We will pay federal income tax on taxable income, including net capital
gain, that we do not distribute to shareholders during, or within a
specified time period after, the calendar year in which the income is
earned.
o We may be subject to the "alternative minimum tax" on any items of tax
preference that we do not distribute or allocate to shareholders.
o We will pay income tax at the highest corporate rate on:
32
o net income from the sale or other disposition of property acquired
through foreclosure ("foreclosure property") that we hold primarily for
sale to customers in the ordinary course of business, and
o other non-qualifying income from foreclosure property.
o We will pay a 100% tax on net income from sales or other dispositions of
property, other than foreclosure property, that we hold primarily for
sale to customers in the ordinary course of business.
o If we fail to satisfy the 75% gross income test or the 95% gross income
test, as described below under "Requirements for Qualification--Income
Tests," and nonetheless continue to qualify as a REIT because we meet
other requirements, we will pay a 100% tax on:
o the gross income attributable to the greater of (1) the amount by which
we fail the 75% gross income test, and (2) the amount by which 95% (or
90% for our 2004 and prior taxable years) of our gross income exceeds
the amount of income qualifying under the 95% gross income test, in
each case, multiplied by
o a fraction intended to reflect our profitability.
o If we fail to distribute during a calendar year at least the sum of (1)
85% of our REIT ordinary income for the year, (2) 95% of our REIT capital
gain net income for the year, and (3) any undistributed taxable income
from earlier periods, we will pay a 4% nondeductible excise tax on the
excess of the required distribution over the amount we actually
distributed.
o We may elect to retain and pay income tax on our net long-term capital
gain. In that case, a U.S. shareholder would be taxed on its
proportionate share of our undistributed long-term capital gain (to the
extent that we made a timely designation of such gain to the
shareholders) and would receive a credit or refund for its proportionate
share of the tax we paid.
o We will be subject to a 100% excise tax on transactions with a taxable
REIT subsidiary that are not conducted on an arm's-length basis.
o In the event of a failure of any of the asset tests occurring during our
2005 and subsequent taxable years, other than a de minimis failure of the
5% asset test or the 10% vote or value test, as described below under "--
Requirements for Qualification-Asset Tests," as long as the failure was
due to reasonable cause and not to willful neglect, we file a description
of each asset that caused such failure with the Internal Revenue Service,
and we dispose of the assets or otherwise comply with the asset tests
within six months after the last day of the quarter in which we identify
such failure, we will pay a tax equal to the greater of $50,000 or 35% of
the net income from the nonqualifying assets during the period in which
we failed to satisfy the asset tests.
o In the event we fail to satisfy one or more requirements for REIT
qualification during our 2005 and subsequent taxable years, other than
the gross income tests and the asset tests, and such failure is due to
reasonable cause and not to willful neglect, we will be required to pay a
penalty of $50,000 for each such failure.
o If we acquire any asset from a C corporation, or a corporation that
generally is subject to full corporate-level tax, in a merger or other
transaction in which we acquire a basis in the asset that is determined
by reference either to the C corporation's basis in the asset or to
another asset, we will pay tax at the highest regular corporate rate
applicable if we recognize gain on the sale or disposition of the asset
during the 10-year period after we acquire the asset provided no election
is made for the transaction to be taxable on a current basis. The amount
of gain on which we will pay tax is the lesser of:
o the amount of gain that we recognize at the time of the sale or
disposition, and
o the amount of gain that we would have recognized if we had sold the
asset at the time we acquired it.
33
REQUIREMENTS FOR QUALIFICATION
A REIT is a corporation, trust, or association that meets each of the
following requirements:
1. It is managed by one or more trustees or directors.
2. Its beneficial ownership is evidenced by transferable shares, or by
transferable certificates of beneficial interest.
3. It would be taxable as a domestic corporation, but for the REIT
provisions of the federal income tax laws.
4. It is neither a financial institution nor an insurance company subject to
special provisions of the federal income tax laws.
5. At least 100 persons are beneficial owners of its shares or ownership
certificates.
6. Not more than 50% in value of its outstanding shares or ownership
certificates is owned, directly or indirectly, by five or fewer
individuals, which the federal income tax laws define to include certain
entities, during the last half of any taxable year.
7. It elects to be a REIT, or has made such election for a previous taxable
year, and satisfies all relevant filing and other administrative
requirements established by the Internal Revenue Service that must be met
to elect and maintain REIT status.
8. It meets certain other qualification tests, described below, regarding
the nature of its income and assets and the amount of its distributions
to shareholders.
9. It uses a calendar year for federal income tax purposes and complies with
the recordkeeping requirements of the federal income tax laws.
We must meet requirements 1 through 4 during our entire taxable year and
must meet requirement 5 during at least 335 days of a taxable year of 12
months, or during a proportionate part of a taxable year of less than 12
months. If we comply with all the requirements for ascertaining the ownership
of our outstanding shares in a taxable year and have no reason to know that we
violated requirement 6, we will be deemed to have satisfied requirement 6 for
that taxable year. For purposes of determining share ownership under
requirement 6, an "individual" generally includes a supplemental unemployment
compensation benefits plan, a private foundation, or a portion of a trust
permanently set aside or used exclusively for charitable purposes. An
"individual," however, generally does not include a trust that is a qualified
employee pension or profit sharing trust under the federal income tax laws,
and beneficiaries of such a trust will be treated as holding our shares in
proportion to their actuarial interests in the trust for purposes of
requirement 6. We have issued sufficient common shares with sufficient
diversity of ownership to satisfy requirements 5 and 6. In addition, our
Declaration of Trust restricts the ownership and transfer of our shares of
beneficial interest so that we should continue to satisfy these requirements.
A corporation that is a "qualified REIT subsidiary" (i.e., a corporation
that is 100% owned by a REIT with respect to which no TRS election has been
made) is not treated as a corporation separate from its parent REIT. All
assets, liabilities, and items of income, deduction, and credit of a
"qualified REIT subsidiary" are treated as assets, liabilities, and items of
income, deduction, and credit of the REIT. Thus, in applying the requirements
described herein, any "qualified REIT subsidiary" that we own will be ignored,
and all assets, liabilities, and items of income, deduction, and credit of
such subsidiary will be treated as our assets, liabilities, and items of
income, deduction, and credit.
An unincorporated domestic entity, such as a limited liability company, that
has a single owner, generally is not treated as an entity separate from its
parent for federal income tax purposes. An unincorporated domestic entity with
two or more owners is generally treated as a partnership for federal income
tax purposes. In the case of a REIT that is a partner in a partnership that
has other partners, the REIT is treated as owning its proportionate share of
the assets of the partnership and as earning its allocable share of the gross
income of the partnership for purposes of the applicable REIT qualification
tests. Thus, our proportionate share of the assets, liabilities and items of
income of our operating partnership and any other
34
partnership, joint venture, or limited liability company that is treated as a
partnership for federal income tax purposes in which we have acquired or will
acquire an interest, directly or indirectly (a "subsidiary partnership"), will
be treated as our assets and gross income for purposes of applying the various
REIT qualification requirements.
A REIT may own up to 100% of the shares of one or more "taxable REIT
subsidiaries," or TRSs. A TRS is a fully taxable corporation that may earn
income that would not be qualifying income if earned directly by the parent
REIT. However, a TRS may not directly or indirectly operate or manage any
hotels or health care facilities or provide rights to any brand name under
which any hotel or health care facility is operated. The subsidiary and the
REIT must jointly elect to treat the subsidiary as a TRS. A TRS will pay
income tax at regular corporate rates on any income that it earns. In
addition, the TRS rules limit the deductibility of interest paid or accrued by
a TRS to its parent REIT to assure that the TRS is subject to an appropriate
level of corporate taxation. Further, the rules impose a 100% excise tax on
transactions between a TRS and its parent REIT or the REIT's tenants that are
not conducted on an arm's-length basis. We lease all of our hotels to TRSs. We
lease all of our wholly owned hotels to 44 New England Management Company, a
TRS owned by our operating partnership. All of our hotels owned by joint
ventures are leased (1) to joint ventures, in which we hold equity interests
through a TRS, or (2) to a TRS wholly owned or substantially owned by the
joint venture. We have formed seven TRSs in connection with the financing of
certain of our hotels. Those TRSs own a 1% general partnership interest in the
partnerships that own those hotels. See
"--Taxable REIT Subsidiaries."
INCOME TESTS
We must satisfy two gross income tests annually to maintain our
qualification as a REIT. First, at least 75% of our gross income for each
taxable year must consist of defined types of income that we derive, directly
or indirectly, from investments relating to real property or mortgages on real
property or qualified temporary investment income. Qualifying income for
purposes of that 75% gross income test generally includes:
o rents from real property;
o interest on debt secured by mortgages on real property, or on interests
in real property;
o dividends or other distributions on, and gain from the sale of, shares in
other REITs;
o gain from the sale of real estate assets; and
o income derived from the temporary investment of new capital that is
attributable to the issuance of our shares or a public offering of our
debt with a maturity date of at least five years and that we receive
during the one-year period beginning on the date on which we received
such new capital.
Second, in general, at least 95% of our gross income for each taxable year
must consist of income that is qualifying income for purposes of the 75% gross
income test, other types of interest and dividends, gain from the sale or
disposition of shares or securities, income from hedging instruments or any
combination of these. Gross income from our sale of property that we hold
primarily for sale to customers in the ordinary course of business is excluded
from both the numerator and the denominator in both income tests. In addition,
commencing with our 2005 taxable year, income and gain from "hedging
transactions," as defined in
"--Hedging Transactions," that are clearly and timely identified as such are
excluded from both the numerator and the denominator for purposes of the 95%
gross income test, but not the 75% gross income test. The following paragraphs
discuss the specific application of the gross income tests to us.
Rents from Real Property. Rent that we receive from our real property will
qualify as "rents from real property," which is qualifying income for purposes
of the 75% and 95% gross income tests, only if the following conditions are
met:
o First, the rent must not be based, in whole or in part, on the income or
profits of any person, but may be based on a fixed percentage or
percentages of receipts or sales.
35
o Second, neither we nor a direct or indirect owner of 10% or more of our
shares may own, actually or constructively, 10% or more of a tenant from
whom we receive rent other than a TRS. If the tenant is a TRS, such TRS
may not directly or indirectly operate or manage the related property.
Instead, the property must be operated on behalf of the TRS by a person
who qualifies as an "independent contractor" and who is, or is related to
a person who is, actively engaged in the trade or business of operating
lodging facilities for any person unrelated to us and the TRS. See "--
Taxable REIT Subsidiaries."
o Third, if the rent attributable to personal property leased in connection
with a lease of real property is 15% or less of the total rent received
under the lease, then the rent attributable to personal property will
qualify as rents from real property. However, if the 15% threshold is
exceeded, the rent attributable to personal property will not qualify as
rents from real property.
o Fourth, we generally must not operate or manage our real property or
furnish or render services to our tenants, other than through an
"independent contractor" who is adequately compensated and from whom we
do not derive revenue. However, we need not provide services through an
"independent contractor," but instead may provide services directly to
our tenants, if the services are "usually or customarily rendered" in
connection with the rental of space for occupancy only and are not
considered to be provided for the tenants' convenience. In addition, we
may provide a minimal amount of "noncustomary" services to the tenants of
a property, other than through an independent contractor, as long as our
income from the services (valued at not less than 150% of our direct cost
of performing such services) does not exceed 1% of our income from the
related property. Furthermore, we may own up to 100% of the stock of a
TRS which may provide customary and noncustomary services to our tenants
without tainting our rental income for the related properties. See "--
Taxable REIT Subsidiaries."
Pursuant to percentage leases, our lessees lease the land, buildings,
improvements, furnishings and equipment comprising our hotels, for terms
ranging from 5 years to 20 years, with options to renew for terms of five
years at the expiration of the initial lease term. The percentage leases
provide that the lessees are obligated to pay (1) the greater of a minimum
base rent or percentage rent and (2) "additional charges" or other expenses,
as defined in the leases. Percentage rent is calculated by multiplying fixed
percentages by gross room revenues and gross food and beverage revenues for
each of the hotels. Both base rent and the thresholds in the percentage rent
formulas are adjusted for inflation. Base rent and percentage rent accrue and
are due monthly or quarterly.
In order for the base rent, percentage rent and additional charges to
constitute "rents from real property," the percentage leases must be respected
as true leases for federal income tax purposes and not treated as service
contracts, joint ventures or some other type of arrangement. The determination
of whether the percentage leases are true leases depends on an analysis of all
the surrounding facts and circumstances. In making such a determination,
courts have considered a variety of factors, including the following:
o the intent of the parties;
o the form of the agreement;
o the degree of control over the property that is retained by the property
owner, or whether the lessee has substantial control over the operation
of the property or is required simply to use its best efforts to perform
its obligations under the agreement; and
o the extent to which the property owner retains the risk of loss with
respect to the property, or whether the lessee bears the risk of
increases in operating expenses or the risk of damage to the property or
the potential for economic gain or appreciation with respect to the
property.
In addition, federal income tax law provides that a contract that purports to
be a service contract or a partnership agreement will be treated instead as a
lease of property if the contract is properly treated as such, taking into
account all relevant factors, including whether or not:
o the service recipient is in physical possession of the property;
36
o the service recipient controls the property;
o the service recipient has a significant economic or possessory interest
in the property, or whether the property's use is likely to be dedicated
to the service recipient for a substantial portion of the useful life of
the property, the recipient shares the risk that the property will
decline in value, the recipient shares in any appreciation in the value
of the property, the recipient shares in savings in the property's
operating costs or the recipient bears the risk of damage to or loss of
the property;
o the service provider bears the risk of substantially diminished receipts
or substantially increased expenditures if there is nonperformance under
the contract;
o the service provider uses the property concurrently to provide
significant services to entities unrelated to the service recipient; and
o the total contract price substantially exceeds the rental value of the
property for the contract period.
Since the determination whether a service contract should be treated as a
lease is inherently factual, the presence or absence of any single factor will
not be dispositive in every case.
Hunton & Williams LLP is of the opinion that the percentage leases will be
treated as true leases for federal income tax purposes. Such opinion is based,
in part, on the following facts:
o we and the lessees intend for our relationship to be that of a lessor and
lessee and such relationship is documented by lease agreements;
o the lessees have the right to the exclusive possession, use and quiet
enjoyment of the hotels during the term of the percentage leases;
o the lessees bear the cost of, and are responsible for, day-to-day
maintenance and repair of the hotels, other than the cost of maintaining
underground utilities, structural elements and capital improvements, and
generally dictate how the hotels are operated, maintained and improved;
o the lessees generally bear the costs and expenses of operating the
hotels, including the cost of any inventory used in their operation,
during the term of the percentage leases;
o the lessees benefit from any savings in the cost of operating the hotels
during the term of the percentage leases;
o the lessees generally have indemnified us against all liabilities imposed
on us during the term of the percentage leases by reason of (1) injury to
persons or damage to property occurring at the hotels, (2) the lessees'
use, management, maintenance or repair of the hotels, (3) any
environmental liability caused by acts or grossly negligent failures to
act of the lessees, (4) taxes and assessments in respect of the hotels
that are the obligations of the lessees or (5) any breach of the
percentage leases or of any sublease of a hotel by the lessees;
o the lessees are obligated to pay substantial fixed rent for the period of
use of the hotels;
o the lessees stand to incur substantial losses or reap substantial gains
depending on how successfully they operate the hotels;
o we cannot use the hotels concurrently to provide significant services to
entities unrelated to the lessees; and
o the total contract price under the percentage leases does not
substantially exceed the rental value of the hotels for the term of the
percentage leases.
Investors should be aware that there are no controlling Treasury
regulations, published rulings or judicial decisions involving leases with
terms substantially the same as the percentage leases that discuss whether
such leases constitute true leases for federal income tax purposes. If the
percentage leases are characterized as service contracts or partnership
agreements, rather than as true leases, part or all of the payments that our
operating partnership and its subsidiaries receive from the lessees may not be
considered rent or may not otherwise satisfy the various requirements for
qualification as "rents from real property." In that case, we
37
likely would not be able to satisfy either the 75% or 95% gross income test
and, as a result, would lose our REIT status unless we qualify for relief, as
described below under "--Failure to Satisfy Gross Income Tests".
As described above, in order for the rent that we receive to constitute
"rents from real property," several other requirements must be satisfied. One
requirement is that the percentage rent must not be based in whole or in part
on the income or profits of any person. The percentage rent, however, will
qualify as "rents from real property" if it is based on percentages of
receipts or sales and the percentages:
o are fixed at the time the percentage leases are entered into;
o are not renegotiated during the term of the percentage leases in a manner
that has the effect of basing percentage rent on income or profits; and
o conform with normal business practice.
More generally, the percentage rent will not qualify as "rents from real
property" if, considering the percentage leases and all the surrounding
circumstances, the arrangement does not conform with normal business practice,
but is in reality used as a means of basing the percentage rent on income or
profits. Since the percentage rent is based on fixed percentages of the gross
revenue from the hotels that are established in the percentage leases, and we
have represented that the percentages (1) will not be renegotiated during the
terms of the percentage leases in a manner that has the effect of basing the
percentage rent on income or profits and (2) conform with normal business
practice, the percentage rent should not be considered based in whole or in
part on the income or profits of any person. Furthermore, we have represented
that, with respect to other hotel properties that we acquire in the future, we
will not charge rent for any property that is based in whole or in part on the
income or profits of any person, except by reason of being based on a fixed
percentage of gross revenues, as described above.
Second, we must not own, actually or constructively, 10% or more of the
shares or the assets or net profits of any lessee (a "related party tenant")
other than a TRS. The constructive ownership rules generally provide that, if
10% or more in value of our shares is owned, directly or indirectly, by or for
any person, we are considered as owning the shares owned, directly or
indirectly, by or for such person. We do not own any shares or any assets or
net profits of any lessee directly or indirectly, other than our indirect
ownership of our TRS lessees. We currently lease all of our hotels to TRS
lessees, and intend to lease any hotels we acquire in the future to a TRS.
Even if we were to lease a hotel to a non-TRS lessee, our Declaration of Trust
prohibits transfers of our shares that would cause us to own actually or
constructively, 10% or more of the ownership interests in a non-TRS lessee.
Based on the foregoing, we should never own, actually or constructively, 10%
or more of any lessee other than a TRS. Furthermore, we have represented that,
with respect to other hotel properties that we acquire in the future, we will
not rent any property to a related party tenant (other than a TRS). However,
because the constructive ownership rules are broad and it is not possible to
monitor continually direct and indirect transfers of our shares, no absolute
assurance can be given that such transfers or other events of which we have no
knowledge will not cause us to own constructively 10% or more of a lessee
other than a TRS at some future date.
As described above, we may own up to 100% of the shares of one or more TRSs.
A TRS is a fully taxable corporation that is permitted to lease hotels from
the related REIT as long as it does not directly or indirectly operate or
manage any hotels or health care facilities or provide rights to any brand
name under which any hotel or health care facility is operated. However, rent
that we receive from a TRS will qualify as "rents from real property" as long
as the property is operated on behalf of the TRS by an "independent
contractor" who is adequately compensated, who does not, directly or through
its shareholders, own more than 35% of our shares, taking into account certain
ownership attribution rules, and who is, or is related to a person who is,
actively engaged in the trade or business of operating "qualified lodging
facilities" for any person unrelated to us and the TRS lessee (an "eligible
independent contractor"). A "qualified lodging facility" is a hotel, motel, or
other establishment more than one-half of the dwelling units in which are used
on a transient basis, unless wagering activities are conducted at or in
connection with such facility by any person who is engaged in the business of
accepting wagers and who is legally authorized to engage in such business at
or in connection with such facility. A "qualified lodging facility" includes
customary amenities and facilities operated as part of, or associated with,
the lodging facility as long as such amenities and
38
facilities are customary for other properties of a comparable size and
class owned by other unrelated owners. See "--Taxable REIT Subsidiaries."
We have formed several TRSs to lease our hotels. We lease all of our wholly
owned hotels to 44 New England Management Company, a TRS owned by our
operating partnership, and HHMLP, an "eligible independent contractor,"
manages those hotels. All of our hotels owned by joint ventures are leased (1)
to joint venture, in which we hold our equity interest through a TRS, or (2)
to a TRS wholly owned or substantially owned by the joint venture. Those
hotels are operated and managed by HHMLP or other hotel managers that qualify
as "eligible independent contractors." We have represented that, with respect
to properties that we lease to our TRSs in the future, each such TRS will
engage an "eligible independent contractor" to manage and operate the hotels
leased by such TRS.
Third, the rent attributable to the personal property leased in connection
with the lease of a hotel must not be greater than 15% of the total rent
received under the lease. The rent attributable to the personal property
contained in a hotel is the amount that bears the same ratio to total rent for
the taxable year as the average of the fair market values of the personal
property at the beginning and at the end of the taxable year bears to the
average of the aggregate fair market values of both the real and personal
property contained in the hotel at the beginning and at the end of such
taxable year (the "personal property ratio"). With respect to each hotel, we
believe either that the personal property ratio is less than 15% or that any
rent attributable to excess personal property will not jeopardize our ability
to qualify as a REIT. There can be no assurance, however, that the Internal
Revenue Service would not challenge our calculation of a personal property
ratio, or that a court would not uphold such assertion. If such a challenge
were successfully asserted, we could fail to satisfy the 75% or 95% gross
income test and thus potentially lose our REIT status.
Fourth, we cannot furnish or render noncustomary services to the tenants of
our hotels, or manage or operate our hotels, other than through an independent
contractor who is adequately compensated and from whom we do not derive or
receive any income. However, we need not provide services through an
"independent contractor," but instead may provide services directly to our
tenants, if the services are "usually or customarily rendered" in connection
with the rental of space for occupancy only and are not considered to be
provided for the tenants' convenience. Provided that the percentage leases are
respected as true leases, we should satisfy that requirement, because we do
not perform any services other than customary ones for the lessees. In
addition, we may provide a minimal amount of "noncustomary" services to the
tenants of a property, other than through an independent contractor, as long
as our income from the services does not exceed 1% of our income from the
related property. Finally, we may own up to 100% of the shares of one or more
TRSs, which may provide noncustomary services to our tenants without tainting
our rents from the related hotels. We will not perform any services other than
customary ones for our lessees, unless such services are provided through
independent contractors or TRSs. Furthermore, we have represented that, with
respect to other hotel properties that we acquire in the future, we will not
perform noncustomary services for the lessee of the property to the extent
that the provision of such services would jeopardize our REIT status.
If a portion of the rent that we receive from a hotel does not qualify as
"rents from real property" because the rent attributable to personal property
exceeds 15% of the total rent for a taxable year, the portion of the rent that
is attributable to personal property will not be qualifying income for
purposes of either the 75% or 95% gross income test. Thus, if such rent
attributable to personal property, plus any other income that is nonqualifying
income for purposes of the 95% gross income test, during a taxable year
exceeds 5% of our gross income during the year, we would lose our REIT
qualification. If, however, the rent from a particular hotel does not qualify
as "rents from real property" because either (1) the percentage rent is
considered based on the income or profits of the related lessee, (2) the
lessee either is a related party tenant or fails to qualify for the exception
to the related party tenant rule for qualifying TRSs or (3) we furnish
noncustomary services to the tenants of the hotel, or manage or operate the
hotel, other than through a qualifying independent contractor or a TRS, none
of the rent from that hotel would qualify as "rents from real property." In
that case, we might lose our REIT qualification because we would be unable to
satisfy either the 75% or 95% gross income test. In addition to the rent, the
lessees are required to pay certain additional charges. To the extent that
such additional charges represent either (1) reimbursements of amounts that we
are obligated to pay to third parties, such as a lessee's proportionate share
of a property's operational or capital expenses, or (2) penalties for
nonpayment or late payment of such amounts, such charges should qualify as
"rents from
39
real property." However, to the extent that such charges do not qualify as
"rents from real property," they instead will be treated as interest that
qualifies for the 95% gross income test.
Interest. The term "interest" generally does not include any amount
received or accrued, directly or indirectly, if the determination of such
amount depends in whole or in part on the income or profits of any person.
However, interest generally includes the following:
o an amount that is based on a fixed percentage or percentages of receipts
or sales; and
o an amount that is based on the income or profits of a debtor, as long as
the debtor derives substantially all of its income from the real property
securing the debt from leasing substantially all of its interest in the
property, and only to the extent that the amounts received by the debtor
would be qualifying "rents from real property" if received directly by a
REIT.
If a loan contains a provision that entitles a REIT to a percentage of the
borrower's gain upon the sale of the real property securing the loan or a
percentage of the appreciation in the property's value as of a specific date,
income attributable to that loan provision will be treated as gain from the
sale of the property securing the loan, which generally is qualifying income
for purposes of both gross income tests.
From time to time, we have made mortgage loans in connection with the
development of hotel properties. Our loans are directly secured by an interest
in real property, and we believe that the income from those mortgage loans is
qualifying income for purposes of both gross income tests.
In the future, we may make mezzanine loans that are not secured by a direct
interest in real property. Rather, those mezzanine loans likely will be
secured by ownership interests in an entity owning real property. In Revenue
Procedure 2003-65, the Internal Revenue Service established a safe harbor
under which interest from loans secured by a first priority security interest
in an ownership interest in a partnership or limited liability company owning
real property will be treated as qualifying income for both the 75% and 95%
gross income tests, provided several requirement are satisfied. Although we
intend to structure any future mezzanine loan in a manner that satisfies the
requirements of the safe harbor, it is possible that we may make some
mezzanine loans that do not qualify for that safe harbor. In those cases, the
interest income from the loan will be qualifying income for purposes of the
95% gross income test, but potentially will not be qualifying income for
purpose of the 75% gross income test. We will make mezzanine loans that do not
qualify for the safe harbor in Revenue Procedure 2003-65 only to the extent
that interest from those loans, combined with our other nonqualifying income,
will not cause us to fail to satisfy the 75% gross income test. Any loan fees
that we receive in making a loan, other than commitment fees for a mortgage
loan, will not be qualifying income for purposes of the 75% and the 95% gross
income tests.
Prohibited Transactions. A REIT will incur a 100% tax on the net income
derived from any sale or other disposition of property, other than foreclosure
property, that the REIT holds primarily for sale to customers in the ordinary
course of a trade or business. We believe that none of our assets are held
primarily for sale to customers and that a sale of any of our assets will not
be in the ordinary course of our business. Whether a REIT holds an asset
"primarily for sale to customers in the ordinary course of a trade or
business" depends, however, on the facts and circumstances in effect from time
to time, including those related to a particular asset. Nevertheless, we will
attempt to comply with the terms of safe-harbor provisions in the federal
income tax laws prescribing when an asset sale will not be characterized as a
prohibited transaction. We cannot assure you, however, that we can comply with
the safe-harbor provisions or that we will avoid owning property that may be
characterized as property that we hold "primarily for sale to customers in the
ordinary course of a trade or business."
Foreclosure Property. We will be subject to tax at the maximum corporate
rate on any income from foreclosure property, other than income that otherwise
would be qualifying income for purposes of the 75% gross income test, less
expenses directly connected with the production of that income. However, gross
income from foreclosure property will qualify under the 75% and 95% gross
income tests. Foreclosure property is any real property, including interests
in real property, and any personal property incident to such real property:
40
o that is acquired by a REIT as the result of the REIT having bid on such
property at foreclosure, or having otherwise reduced such property to
ownership or possession by agreement or process of law, after there was a
default or default was imminent on a lease of such property or on
indebtedness that such property secured;
o for which the related loan was acquired by the REIT at a time when the
default was not imminent or anticipated; and
o for which the REIT makes a proper election to treat the property as
foreclosure property.
We have no foreclosure property as of the date of this prospectus. Property
generally ceases to be foreclosure property at the end of the third taxable
year following the taxable year in which the REIT acquired the property, or
longer if an extension is granted by the Secretary of the Treasury. However,
this grace period terminates and foreclosure property ceases to be foreclosure
property on the first day:
o on which a lease is entered into for the property that, by its terms,
will give rise to income that does not qualify for purposes of the 75%
gross income test, or any amount is received or accrued, directly or
indirectly, pursuant to a lease entered into on or after such day that
will give rise to income that does not qualify for purposes of the 75%
gross income test;
o on which any construction takes place on the property, other than
completion of a building or any other improvement, where more than 10% of
the construction was completed before default became imminent; or
o which is more than 90 days after the day on which the REIT acquired the
property and the property is used in a trade or business which is
conducted by the REIT, other than through an independent contractor from
whom the REIT itself does not derive or receive any income.
Hedging Transactions. From time to time, we or our operating partnership
may enter into hedging transactions with respect to one or more of our assets
or liabilities. Our hedging activities may include entering into interest rate
swaps, caps, and floors, options to purchase such items, and futures and
forward contracts. Prior to our 2005 taxable year, any periodic income or gain
from the disposition of any financial instrument for those or similar
transactions to hedge indebtedness we or our operating partnership incurred to
acquire or carry "real estate assets" was qualifying income for purposes of
the 95% gross income test, but not the 75% gross income test. To the extent
that we or our operating partnership hedged with other types of financial
instruments, or in other situations, it is not entirely clear how the income
from those transactions should have been treated for the gross income tests.
Commencing with our 2005 taxable year, income and gain from "hedging
transactions" is excluded from gross income for purposes of the 95% gross
income test, but not the 75% gross income test. For those taxable years, a
"hedging transaction" means any transaction entered into in the normal course
of our or our operating partnership's trade or business primarily to manage
the risk of interest rate, price changes, or currency fluctuations with
respect to borrowings made or to be made, or ordinary obligations incurred or
to be incurred, to acquire or carry real estate assets. We are required to
clearly identify any such hedging transaction before the close of the day on
which it was acquired, originated, or entered into and to satisfy other
identification requirements. We intend to structure any hedging transactions
in a manner that does not jeopardize our qualification as a REIT.
Failure to Satisfy Gross Income Tests. If we fail to satisfy one or both of
the gross income tests for any taxable year, we nevertheless may qualify as a
REIT for that year if we qualify for relief under certain provisions of the
federal income tax laws. Prior to our 2005 taxable year, those relief
provisions generally were available if:
o our failure to meet such tests was due to reasonable cause and not due to
willful neglect;
o we attached a schedule of the sources of our income to our tax return;
and
o any incorrect information on the schedule was not due to fraud with
intent to evade tax.
Commencing with our 2005 taxable year, those relief provisions are available
if:
o our failure to meet those tests is due to reasonable cause and not to
willful neglect; and
41
o following such failure for any taxable year, we file a schedule of the
sources of our income with the Internal Revenue Service.
We cannot predict, however, whether in all circumstances we would qualify
for the relief provisions. In addition, as discussed above in "--Taxation of
Our Company," even if the relief provisions apply, we would incur a 100% tax
on the gross income attributable to the greater of (1) the amount by which we
fail the 75% gross income test and (2) the amount by which 95% (or 90% for our
2004 and prior taxable years) of our income exceeds the amount of income
qualifying under the 95% gross income test, in each case, multiplied by a
fraction intended to reflect our profitability.
ASSET TESTS
To maintain our qualification as a REIT, we also must satisfy the following
asset tests at the end of each quarter of each taxable year. First, at least
75% of the value of our total assets must consist of:
o cash or cash items, including certain receivables;
o government securities;
o interests in real property, including leaseholds and options to acquire
real property and leaseholds;
o interests in mortgages on real property;
o shares in other REITs; and
o investments in shares or debt instruments during the one-year period
following our receipt of new capital that we raise through equity
offerings or public offerings of debt with at least a five-year term.
Second, of our investments not included in the 75% asset class, the value of
our interest in any one issuer's securities may not exceed 5% of the value of
our total assets (the "5% asset test").
Third, of our investments not included in the 75% asset class, we may not
own more than 10% of the voting power or value of any one issuer's outstanding
securities (the "10% vote or value test").
Fourth, no more than 20% of the value of our total assets may consist of the
securities of one or more TRSs.
Fifth, no more than 25% of the value of our total assets may consist of the
securities of TRSs and other non-TRS taxable subsidiaries and other assets
that are not qualifying assets for purposes of the 75% asset test.
For purposes of the 5% asset test and the 10% vote or value test, the term
"securities" does not include shares in another REIT, equity or debt
securities of a qualified REIT subsidiary or TRS, mortgage loans that
constitute real estate assets, or equity interests in a partnership. For
purposes of the 10% value test, the term "securities" does not include:
o "Straight debt" securities, which is defined as a written unconditional
promise to pay on demand or on a specified date a sum certain in money if
(i) the debt is not convertible, directly or indirectly, into shares, and
(ii) the interest rate and interest payment dates are not contingent on
profits, the borrower's discretion, or similar factors. "Straight debt"
securities do not include any securities issued by a partnership or a
corporation in which we or any TRS in which we own more than 50% of the
voting power or value of the shares hold non-"straight debt" securities
that have an aggregate value of more than 1% of the issuer's outstanding
securities. However, "straight debt" securities include debt subject to
the following contingencies:
o a contingency relating to the time of payment of interest or principal,
as long as either (i) there is no change to the effective yield of the
debt obligation, other than a change to the annual yield that does not
exceed the greater of 0.25% or 5% of the annual yield, or (ii) neither
the aggregate issue price nor the aggregate face amount of the issuer's
debt obligations held by us exceeds $1 million and no more than 12
months of unaccrued interest on the debt obligations can be required to
be prepaid; and
42
o a contingency relating to the time or amount of payment upon a default
or prepayment of a debt obligation, as long as the contingency is
consistent with customary commercial practice.
o Any loan to an individual or an estate.
o Any "section 467 rental agreement," other than an agreement with a
related party tenant.
o Any obligation to pay "rents from real property."
o Certain securities issued by governmental entities.
o Any security issued by a REIT.
o Any debt instrument issued by an entity treated as a partnership for
federal income tax purposes to the extent of our interest as a partner in
the partnership.
o Any debt instrument issued by an entity treated as a partnership for
federal income tax purposes not described in the preceding bullet points
if at least 75% of the partnership's gross income, excluding income from
prohibited transactions, is qualifying income for purposes of the 75%
gross income test described above in "--Income Tests."
We believe that our existing hotels and mortgage loans are qualifying assets
for purposes of the 75% asset test. We also believe that any additional real
property that we acquire and temporary investments that we make generally will
be qualifying assets for purposes of the 75% asset test. We intend to
structure any mezzanine loans we make in the future in a manner that satisfies
the requirements of the safe harbor in Revenue Procedure 2003-65 pursuant to
which certain loans secured by a first priority security interest in ownership
interests in a partnership or limited liability company will be treated as
qualifying assets for purposes of the 75% asset test, the 5% asset test, and
the 10% vote or value test. "--Income Tests." However, it is possible that we
make some mezzanine loans that do not qualify for that safe harbor, and we may
make mezzanine loans and other non-mortgage loans that do not qualify
"straight debt" safe harbor or one of the other exceptions to the definition
of "securities" described above. We will make mezzanine loans and non-mortgage
loans only to the extent such loans will not cause us to fail the asset tests
described above.
We intend to continue monitoring the status of our acquired assets for
purposes of the various asset tests and will manage our portfolio in order to
comply at all times with such tests. If we fail to satisfy the asset tests at
the end of a calendar quarter, we will not lose our REIT qualification if:
o we satisfied the asset tests at the end of the preceding calendar
quarter; and
o the discrepancy between the value of our assets and the asset test
requirements arose from changes in the market values of our assets and
was not wholly or partly caused by the acquisition of one or more non-
qualifying assets.
If we did not satisfy the condition described in the second item, above, we
still could avoid disqualification by eliminating any discrepancy within 30
days after the close of the calendar quarter in which it arose.
In the event that, at the end of any calendar quarter commencing with our
2005 taxable year, we violate the 5% asset test or the 10% vote or value test
described above, we will not lose our REIT qualification if (1) the failure is
de minimis (up to the lesser of 1% of our assets or $10 million) and (2) we
dispose of assets or otherwise comply with the asset tests within six months
after the last day of the quarter in which we identify such failure. In the
event of a failure of any of the asset tests (other than de minimis failures
described in the preceding sentence), as long as the failure was due to
reasonable cause and not to willful neglect, we will not lose our REIT status
if we (1) dispose of assets or otherwise comply with the asset tests within
six months after the last day of the quarter in which we identify the failure,
(2) we file a description of each asset causing the failure with the Internal
Revenue Service and (3) pay a tax equal to the greater of $50,000 or 35% of
the net income from the nonqualifying assets during the period in which we
failed to satisfy the asset tests.
43
DISTRIBUTION REQUIREMENTS
Each taxable year, we must distribute dividends, other than capital gain
dividends and deemed distributions of retained capital gain, to our
shareholders in an aggregate amount at least equal to:
o the sum of
o 90% of our "REIT taxable income," computed without regard to the
dividends paid deduction and our net capital gain or loss, and
o 90% of our after-tax net income, if any, from foreclosure property,
minus
o the sum of certain items of non-cash income.
We must pay such distributions in the taxable year to which they relate, or
in the following taxable year if we declare the distribution before we timely
file our federal income tax return for the year and pay the distribution on or
before the first regular dividend payment date after such declaration.
We will pay federal income tax on taxable income, including net capital
gain, that we do not distribute to shareholders. Furthermore, if we fail to
distribute during a calendar year, or by the end of January following the
calendar year in the case of distributions with declaration and record dates
falling in the last three months of the calendar year, at least the sum of:
o 85% of our REIT ordinary income for such year,
o 95% of our REIT capital gain income for such year, and
o any undistributed taxable income from prior periods,
we will incur a 4% nondeductible excise tax on the excess of such required
distribution over the amounts we actually distribute. We may elect to retain
and pay income tax on the net long-term capital gain we receive in a taxable
year. If we so elect, we will be treated as having distributed any such
retained amount for purposes of the 4% nondeductible excise tax described
above. We have made, and we intend to continue to make, timely distributions
sufficient to satisfy the annual distribution requirements and to avoid
corporate income tax and the 4% nondeductible excise tax.
It is possible that, from time to time, we may experience timing differences
between the actual receipt of income and actual payment of deductible expenses
and the inclusion of that income and deduction of such expenses in arriving at
our REIT taxable income. For example, we may not deduct recognized capital
losses from our "REIT taxable income." Further, it is possible that, from time
to time, we may be allocated a share of net capital gain attributable to the
sale of depreciated property that exceeds our allocable share of cash
attributable to that sale. As a result of the foregoing, we may have less cash
than is necessary to distribute taxable income sufficient to avoid corporate
income tax and the excise tax imposed on certain undistributed income or even
to meet the 90% distribution requirement. In such a situation, we may need to
borrow funds or issue additional common or preferred shares.
Under certain circumstances, we may be able to correct a failure to meet the
distribution requirement for a year by paying "deficiency dividends" to our
shareholders in a later year. We may include such deficiency dividends in our
deduction for dividends paid for the earlier year. Although we may be able to
avoid income tax on amounts distributed as deficiency dividends, we will be
required to pay interest to the Internal Revenue Service based upon the amount
of any deduction we take for deficiency dividends.
TAXABLE REIT SUBSIDIARIES
As described above, we may own up to 100% of the shares of one or more TRSs.
A TRS is a fully taxable corporation that may earn income that would not be
qualifying income if earned directly by us. A TRS may provide services to our
lessees and perform activities unrelated to our lessees, such as third-party
management, development, and other independent business activities. However, a
taxable REIT subsidiary may not directly or indirectly operate or manage any
hotels or health care facilities or provide rights to any brand name under
which any hotel or health care facility is operated.
44
We and our corporate subsidiary must elect for the subsidiary to be treated
as a TRS. A corporation of which a qualifying TRS directly or indirectly owns
more than 35% of the voting power or value of the shares will automatically be
treated as a TRS. Overall, no more than 20% of the value of our assets may
consist of securities of one or more TRSs, and no more than 25% of the value
of our assets may consist of the securities of TRSs and other taxable
subsidiaries and other assets that are not qualifying assets for purposes of
the 75% asset test.
Rent that we receive from our TRSs will qualify as "rents from real
property" as long as the property is operated on behalf of the TRS by a person
who qualifies as an "independent contractor" and who is, or is related to a
person who is, actively engaged in the trade or business of operating
"qualified lodging facilities" for any person unrelated to us and the TRS
lessee (an "eligible independent contractor"). A "qualified lodging facility"
is a hotel, motel, or other establishment more than one-half of the dwelling
units in which are used on a transient basis, unless wagering activities are
conducted at or in connection with such facility by any person who is engaged
in the business of accepting wagers and who is legally authorized to engage in
such business at or in connection with such facility. A "qualified lodging
facility" includes customary amenities and facilities operated as part of, or
associated with, the lodging facility as long as such amenities and facilities
are customary for other properties of a comparable size and class owned by
other unrelated owners.
We lease all of our hotels to TRSs, and all of those TRSs have engaged
"eligible independent contractors" to operate and manage those hotels. We
lease all of our wholly owned hotels to 44 New England Management Company, a
TRS owned by our operating partnership, and HHMLP, an "eligible independent
contractor," operates and manages those hotels. All of our hotels owned by
joint ventures are leased (1) to joint ventures, in which we hold equity
interests through a TRS, or (2) to a TRS wholly owned or substantially owned
by the joint venture and those hotels are operated and managed by HHMLP or
other hotel managers that qualify as "eligible independent contractors." We
have formed seven TRSs in connection with the financing of certain of our
hotels. Those TRSs own a 1% general partnership interest in the partnerships
that own those hotels. We may form new TRSs in the future, and we have
represented that, with respect to properties that we lease to our TRSs in the
future, each such TRS will engage an "eligible independent contractor" to
manage and operate the hotels leased by such TRS.
The TRS rules limit the deductibility of interest paid or accrued by a TRS
to us to assure that the TRS is subject to an appropriate level of corporate
taxation. Further, the rules impose a 100% excise tax on certain transactions
between a TRS and us or our tenants that are not conducted on an arm's-length
basis. We believe that all transactions between us and each of our existing
TRSs have been and will be conducted on an arm's-length basis.
RECORDKEEPING REQUIREMENTS
We must maintain certain records in order to qualify as a REIT. In addition,
to avoid a monetary penalty, we must request on an annual basis information
from our shareholders designed to disclose the actual ownership of our
outstanding shares of beneficial interest. We have complied, and we intend to
continue to comply, with these requirements.
FAILURE TO QUALIFY
Commencing with our 2005 taxable year, if we fail to satisfy one or more
requirements for REIT qualification, other than the gross income tests and the
asset tests, we could avoid disqualification if our failure is due to
reasonable cause and not to willful neglect and we pay a penalty of $50,000
for each such failure. In addition, there are relief provisions for a failure
of the gross income tests and asset tests, as described in "Requirements for
Qualification-Income Tests" and "--Asset Tests."
If we fail to qualify as a REIT in any taxable year, and no relief provision
applies, we would be subject to federal income tax and any applicable
alternative minimum tax on our taxable income at regular corporate rates. In
calculating our taxable income in a year in which we fail to qualify as a
REIT, we would not be able to deduct amounts paid out to shareholders. In
fact, we would not be required to distribute any amounts to shareholders in
that year. In such event, to the extent of our current and accumulated
earnings and profits,
45
distributions to most domestic non-corporate shareholders would generally be
taxable at capital gains tax rates. Subject to certain limitations of the
federal income tax laws, corporate shareholders might be eligible for the
dividends received deduction. Unless we qualified for relief under specific
statutory provisions, we also would be disqualified from taxation as a REIT
for the four taxable years following the year during which we ceased to
qualify as a REIT. We cannot predict whether in all circumstances we would
qualify for such statutory relief.
TAX ASPECTS OF OUR INVESTMENTS IN OUR OPERATING PARTNERSHIP AND THE SUBSIDIARY
PARTNERSHIPS
The following discussion summarizes certain federal income tax
considerations applicable to our direct or indirect investments in our
operating partnership and any subsidiary partnerships or limited liability
companies that we form or acquire (each individually a "Partnership" and,
collectively, the "Partnerships"). The discussion does not cover state or
local tax laws or any federal tax laws other than income tax laws.
Classification as Partnerships. We are entitled to include in our income
our distributive share of each Partnership's income and to deduct our
distributive share of each Partnership's losses only if such Partnership is
classified for federal income tax purposes as a partnership (or an entity that
is disregarded for federal income tax purposes if the entity has only one
owner or member) rather than as a corporation or an association taxable as a
corporation. An unincorporated entity with at least two owners or members will
be classified as a partnership, rather than as a corporation, for federal
income tax purposes if it:
o is treated as a partnership under the Treasury regulations relating to
entity classification (the "check-the-box regulations"); and
o is not a "publicly traded" partnership.
Under the check-the-box regulations, an unincorporated entity with at least
two owners or members may elect to be classified either as an association
taxable as a corporation or as a partnership. If such an entity fails to make
an election, it generally will be treated as a partnership (or an entity that
is disregarded for federal income tax purposes if the entity has only one
owner or member) for federal income tax purposes. Each Partnership intends to
be classified as a partnership for federal income tax purposes and no
Partnership will elect to be treated as an association taxable as a
corporation under the check-the-box regulations.
A publicly traded partnership is a partnership whose interests are traded on
an established securities market or are readily tradable on a secondary market
or the substantial equivalent thereof. A publicly traded partnership will not,
however, be treated as a corporation for any taxable year if, for each taxable
year beginning after December 31, 1987 in which it was classified as a
publicly traded partnership, 90% or more of the partnership's gross income for
such year consists of certain passive-type income, including real property
rents, gains from the sale or other disposition of real property, interest,
and dividends (the "90% passive income exception"). Treasury regulations (the
"PTP regulations") provide limited safe harbors from the definition of a
publicly traded partnership. Pursuant to one of those safe harbors (the
"private placement exclusion"), interests in a partnership will not be treated
as readily tradable on a secondary market or the substantial equivalent
thereof if (1) all interests in the partnership were issued in a transaction
or transactions that were not required to be registered under the Securities
Act of 1933, as amended, and (2) the partnership does not have more than 100
partners at any time during the partnership's taxable year. In determining the
number of partners in a partnership, a person owning an interest in a
partnership, grantor trust, or S corporation that owns an interest in the
partnership is treated as a partner in such partnership only if (1)
substantially all of the value of the owner's interest in the entity is
attributable to the entity's direct or indirect interest in the partnership
and (2) a principal purpose of the use of the entity is to permit the
partnership to satisfy the 100-partner limitation. Each Partnership qualifies
for the private placement exclusion. We have not requested, and do not intend
to request, a ruling from the Internal Revenue Service that the Partnerships
will be classified as partnerships for federal income tax purposes.
If for any reason a Partnership were taxable as a corporation, rather than
as a partnership, for federal income tax purposes, we likely would not be able
to qualify as a REIT. See "--Requirements for Qualification--Income Tests" and
"--Requirements for Qualification--Asset Tests." In addition, any change in a
Partnership's status for tax purposes might be treated as a taxable event, in
which case we might incur
46
tax liability without any related cash distribution. See "--Requirements for
Qualification--Distribution Requirements." Further, items of income and
deduction of such Partnership would not pass through to its partners, and its
partners would be treated as shareholders for tax purposes. Consequently, such
Partnership would be required to pay income tax at corporate rates on its net
income, and distributions to its partners would constitute dividends that
would not be deductible in computing such Partnership's taxable income.
INCOME TAXATION OF THE PARTNERSHIPS AND THEIR PARTNERS
Partners, Not the Partnerships, Subject to Tax. A partnership is not a
taxable entity for federal income tax purposes. Rather, we are required to
take into account our allocable share of each Partnership's income, gains,
losses, deductions, and credits for any taxable year of such Partnership
ending within or with our taxable year, without regard to whether we have
received or will receive any distribution from such Partnership.
Partnership Allocations. Although a partnership agreement generally will
determine the allocation of income and losses among partners, such allocations
will be disregarded for tax purposes if they do not comply with the provisions
of the federal income tax laws governing partnership allocations. If an
allocation is not recognized for federal income tax purposes, the item subject
to the allocation will be reallocated in accordance with the partners'
interests in the partnership, which will be determined by taking into account
all of the facts and circumstances relating to the economic arrangement of the
partners with respect to such item. Each Partnership's allocations of taxable
income, gain, and loss are intended to comply with the requirements of the
federal income tax laws governing partnership allocations.
Tax Allocations With Respect to Contributed Properties. Income, gain, loss,
and deduction attributable to appreciated or depreciated property that is
contributed to a partnership in exchange for an interest in the partnership
must be allocated in a manner such that the contributing partner is charged
with, or benefits from, respectively, the unrealized gain or unrealized loss
associated with the property at the time of the contribution. The amount of
such unrealized gain or unrealized loss ("built-in gain" or "built-in loss")
is generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution (a "book-tax difference"). Such
allocations are solely for federal income tax purposes and do not affect the
book capital accounts or other economic or legal arrangements among the
partners. The U.S. Treasury Department has issued regulations requiring
partnerships to use a "reasonable method" for allocating items with respect to
which there is a book-tax difference and outlining several reasonable
allocation methods.
Under our operating partnership's partnership agreement, depreciation or
amortization deductions of our operating partnership generally will be
allocated among the partners in accordance with their respective interests in
our operating partnership, except to the extent that our operating partnership
is required under the federal income tax laws governing partnership
allocations to use a method for allocating tax depreciation deductions
attributable to contributed properties that results in our receiving a
disproportionate share of such deductions. In addition, gain or loss on the
sale of a property that has been contributed, in whole or in part, to our
operating partnership will be specially allocated to the contributing partners
to the extent of any built-in gain or loss with respect to such property for
federal income tax purposes.
Basis in Partnership Interest. Our adjusted tax basis in our partnership
interest in our operating partnership generally is equal to:
o the amount of cash and the basis of any other property contributed by us
to our operating partnership;
o increased by our allocable share of our operating partnership's income
and our allocable share of indebtedness of our operating partnership; and
o reduced, but not below zero, by our allocable share of our operating
partnership's loss and the amount of cash distributed to us, and by
constructive distributions resulting from a reduction in our share of
indebtedness of our operating partnership.
If the allocation of our distributive share of our operating partnership's
loss would reduce the adjusted tax basis of our partnership interest below
zero, the recognition of such loss will be deferred until such time as
47
the recognition of such loss would not reduce our adjusted tax basis below
zero. To the extent that our operating partnership's distributions, or any
decrease in our share of the indebtedness of our operating partnership, which
is considered a constructive cash distribution to the partners, reduce our
adjusted tax basis below zero, such distributions will constitute taxable
income to us. Such distributions and constructive distributions normally will
be characterized as long-term capital gain.
Depreciation Deductions Available to Our Operating Partnership. To the
extent that our operating partnership acquired its hotels in exchange for
cash, its initial basis in such hotels for federal income tax purposes
generally was or will be equal to the purchase price paid by our operating
partnership. Our operating partnership depreciates such depreciable hotel
property for federal income tax purposes under the modified accelerated cost
recovery system of depreciation ("MACRS"). Under MACRS, our operating
partnership generally depreciates furnishings and equipment over a seven-year
recovery period using a 200% declining balance method and a half-year
convention. If, however, our operating partnership places more than 40% of its
furnishings and equipment in service during the last three months of a taxable
year, a mid-quarter depreciation convention must be used for the furnishings
and equipment placed in service during that year. A first-year "bonus"
depreciation deduction equal to 50% of the adjusted basis of qualified
property is available for qualified property placed in service after May 5,
2003. "Qualified Property" includes qualified leasehold improvement property
and property with a recovery period of less than 20 years, such as furnishings
and equipment at our hotels. "Qualified leasehold improvement property"
generally includes improvements made to the interior of nonresidential real
property that are placed in service more than three years after the date the
building was placed in service. In addition, certain qualified leasehold
improvement property placed in service before January 1, 2006 will be
depreciated over a 15-year recovery period using a straight method and a half-
year convention. Under MACRS, our operating partnership generally depreciates
buildings and improvements over a 39-year recovery period using a straight
line method and a mid-month convention. Our operating partnership's initial
basis in hotels acquired in exchange for units in our operating partnership
should be the same as the transferor's basis in such hotels on the date of
acquisition by our operating partnership. Although the law is not entirely
clear, our operating partnership generally depreciates such depreciable hotel
property for federal income tax purposes over the same remaining useful lives
and under the same methods used by the transferors. Our operating
partnership's tax depreciation deductions are allocated among the partners in
accordance with their respective interests in our operating partnership,
except to the extent that our operating partnership is required under the
federal income tax laws governing partnership allocations to use a method for
allocating tax depreciation deductions attributable to contributed properties
that results in our receiving a disproportionate share of such deductions.
SALE OF A PARTNERSHIP'S PROPERTY
Generally, any gain realized by a Partnership on the sale of property held
by the Partnership for more than one year will be long-term capital gain,
except for any portion of such gain that is treated as depreciation or cost
recovery recapture. Any gain or loss recognized by a Partnership on the
disposition of contributed properties will be allocated first to the partners
of the Partnership who contributed such properties to the extent of their
built-in gain or loss on those properties for federal income tax purposes. The
partners' built-in gain or loss on such contributed properties will equal the
difference between the partners' proportionate share of the book value of
those properties and the partners' tax basis allocable to those properties at
the time of the contribution. Any remaining gain or loss recognized by the
Partnership on the disposition of the contributed properties, and any gain or
loss recognized by the Partnership on the disposition of the other properties,
will be allocated among the partners in accordance with their respective
percentage interests in the Partnership.
Our share of any gain realized by a Partnership on the sale of any property
held by the Partnership as inventory or other property held primarily for sale
to customers in the ordinary course of the Partnership's trade or business
will be treated as income from a prohibited transaction that is subject to a
100% penalty tax. Such prohibited transaction income also may have an adverse
effect upon our ability to satisfy the income tests for REIT status. See "--
Requirements for Qualification--Income Tests." We, however, do not presently
intend to acquire or hold or to allow any Partnership to acquire or hold any
property that represents
48
inventory or other property held primarily for sale to customers in the
ordinary course of our or such Partnership's trade or business.
STATE AND LOCAL TAXES
We and/or you may be subject to taxation by various states and localities,
including those in which we or a shareholder transacts business, owns property
or resides. The state and local tax treatment may differ from the federal
income tax treatment described above. Consequently, you should consult your
own tax advisors regarding the effect of state and local tax laws upon an
investment in our capital stock.
49
PLAN OF DISTRIBUTION
We may sell the securities being offered hereby in one or more of the
following ways from time to time:
o through agents to the public or to investors;
o to underwriters for resale to the public or to investors;
o directly to agents;
o directly to investors; or
o through a combination of any of these methods of sale.
We will set forth in a prospectus supplement the terms of the offering of
securities, including:
o the name or names of any agents or underwriters;
o the purchase price of the securities being offered and the proceeds we
will receive from the sale;
o the terms of the securities offered;
o any over-allotment options under which underwriters or agents may
purchase or place additional securities;
o any agency fees or underwriting discounts and other items constituting
agents' or underwriters' compensation;
o any public offering price;
o any discounts or concessions allowed or reallowed or paid to dealers; and
o any securities exchanges on which such securities may be listed.
AGENTS
We may designate agents who agree to use their reasonable efforts to solicit
purchases for the period of their appointment or to sell the securities being
offered hereby on a continuing basis, unless otherwise provided in a
prospectus supplement.
We may from time to time engage a company to act as our offering agent for
one or more offerings of our securities. If we reach agreement with an
offering agent with respect to a specific offering, including the number of
securities and any minimum price below which sales may not be made, then the
offering agent will try to sell such common shares on the agreed terms. The
offering agent could make sales in privately negotiated transactions and/or
any other method permitted by law, including sales deemed to be an "at-the-
market" offering as defined in Rule 415 promulgated under the Securities Act
of 1933, including sales made directly on the American Stock Exchange, or
sales made to or through a market maker other than on an exchange. The
offering agent will be deemed to be an "underwriter" within the meaning of the
Securities Act of 1933, with respect to any sales effected through an "at-the-
market" offering.
UNDERWRITERS
If we use underwriters for a sale of securities, the underwriters will
acquire the securities, and may resell the securities in one or more
transactions, including negotiated transactions, at a fixed public offering
price or at varying prices determined at the time of sale. The obligations of
the underwriters to purchase the securities will be subject to the conditions
set forth in the applicable underwriting agreement. We may change from time to
time any public offering price and any discounts or concessions the
underwriters allow or reallow or pay to dealers. We may use underwriters with
whom we have a material relationship. We will describe in the prospectus
supplement naming the underwriter the nature of any such relationship.
50
DIRECT SALES
We may also sell securities directly to one or more purchasers without using
underwriters or agents. Underwriters, dealers and agents that participate in
the distribution of the securities may be underwriters as defined in the
Securities Act of 1933 and any discounts or commissions they receive from us
and any profit on their resale of the securities may be treated as
underwriting discounts and commissions under the Securities Act. We will
identify in the applicable prospectus supplement any underwriters, dealers or
agents and will describe their compensation. We may have agreements with the
underwriters, dealers and agents to indemnify them against specified civil
liabilities, including liabilities under the Securities Act of 1933.
Underwriters, dealers and agents may engage in transactions with or perform
services for us in the ordinary course of their businesses from time to time.
TRADING MARKETS AND LISTING OF SECURITIES
Unless otherwise specified in the applicable prospectus supplement, each
class or series of securities will be a new issue with no established trading
market, other than our common shares or our 8.00% Series A cumulative
redeemable preferred shares, each of which is listed on the American Stock
Exchange. We may elect to list any other class or series of securities on any
exchange, but we are not obligated to do so. It is possible that one or more
underwriters may make a market in a class or series of securities, but the
underwriters will not be obligated to do so and may discontinue any market
making at any time without notice. We cannot give any assurance as to the
liquidity of the trading market for any of the securities.
STABILIZATION ACTIVITIES
In accordance with Regulation M under the Exchange Act, underwriters may
engage in over-allotment, stabilizing or short covering transactions or
penalty bids in connection with an offering of our securities. Over-allotment
transactions involves sales in excess of the offering size, which create a
short position. Stabilizing transactions permit bids to purchase the
underlying security so long as the stabilizing bids do not exceed a specified
maximum price. Short covering transactions involve purchases of the securities
in the open market after the distribution is completed to cover short
positions. Penalty bids permit the underwriters to reclaim a selling
concession from a dealer when the securities originally sold by the dealer are
purchased in a covering transaction to cover short positions. Those activities
may cause the price of the securities to be higher than they would otherwise
be. If commenced, the underwriters may discontinue any of the activities at
any time.
51
LEGAL MATTERS
Certain legal matters in connection with this offering will be passed upon
for us by Hunton & Williams LLP. In addition, the summary of legal matters
contained in the section of this Prospectus under the heading "Federal Income
Tax Consequences of Our Status as a REIT" is based on the opinion of Hunton &
Williams LLP.
EXPERTS
The consolidated financial statements and schedule of Hersha Hospitality
Trust as of December 31, 2005, and 2004, and for each of the years in the two
year period ended December 31, 2005, and management's assessment of the
effectiveness of internal control over financial reporting as of December 31,
2005 have been incorporated by reference herein in reliance upon the reports
of KPMG LLP, independent registered public accounting firm, incorporated by
reference herein, and upon the authority of said firm as experts in accounting
and auditing. KPMG's report on the consolidated financial statements and
schedule as of December 31, 2005, contains an explanatory paragraph that
indicates that we have adopted FASB Interpretation No. 46 (R), Consolidation
of Variable Interest Entities effective March 31, 2004.
KPMG's report on management's assessment of the effectiveness of internal
control over financial reporting and the effectiveness of internal control
over financial reporting as of December 31, 2005, expresses their opinion that
the Company did not maintain effective internal control over financial
reporting as of December 31, 2005 because of the effect of material weaknesses
on the achievement of the objectives of the control over completeness and
accuracy of payroll expense, existence and accuracy of reported revenue and
approval of journal entries and the review and analysis of account
reconciliations and related data did not operate effectively at December 31,
2005. Additionally, an explanatory paragraph stated that Hersha Hospitality
Trust lacked appropriately designed controls to ensure the completeness of
accounts payable and accrued expenses.
Our consolidated balance sheet as of December 31, 2003, and our consolidated
statements of operations, cash flows and shareholders' equity for the year
ended December 31, 2003, incorporated by reference in this prospectus, have
been audited by Reznick Group, P.C. independent registered public accountants,
whose report is incorporated by reference in this prospectus and given upon
their authority as experts in accounting and auditing. The balance sheet of
Hersha Hospitality Management L.P. as of December 31, 2003, and the related
statements of operations, partners' equity (deficit), and cash flows for the
year ended December 31, 2003, incorporated by reference in this prospectus
have been audited by Reznick Group, P.C., independent registered public
accountants, whose report is incorporated by reference in this prospectus and
given upon their authority as experts in accounting and auditing.
The consolidated balance sheet as of December 31, 2005 and consolidated
statements of operations, cash flows and shareholders' equity for the year
ended December 31, 2005 for Affordable Hospitality Associates, L.P.; Metro JFK
Associates, LLC; TCVA Realty, LLC; KW Hotel Group and HT/CNL Metro Hotels, LLC
and Subsidiary incorporated by reference in this prospectus, have been audited
by Reznick Group, P.C. independent registered public accountants, whose
reports are incorporated by reference in this prospectus and given upon their
authority as experts in accounting and auditing.
The audited historical financial statements of Adriaen's Landing Hotel, LLC
as of December 31, 2005 and 2004 and for both of the two years in the period
ended December 31, 2005 incorporated by reference in this prospectus have been
so incorporated in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
52
HOW TO OBTAIN MORE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the SEC. You may read and copy any reports, statements, or
other information we file with the SEC at its public reference room in
Washington, D.C. (100 F Street, N.E., 20549). Please call the SEC at 1-800-
SEC-0330 for further information on the public reference room. Our filings are
also available to the public on the internet, through a database maintained by
the SEC at http://www.sec.gov. In addition, you can inspect and copy reports,
proxy statements and other information concerning Hersha Hospitality Trust at
the offices of the American Stock Exchange, Inc., 86 Trinity Place, New York,
New York 10006, on which our common shares (symbol: "HT") are listed.
We also make available through out internet website (www.hersha.com) our
Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after such
documents are electronically filed with, or furnished to, the SEC. The
information of our website is not, and shall not be deemed to be, a part of this
report or incorporated into any other filings we make with the SEC.
INCORPORATION OF INFORMATION FILED WITH THE SEC
The SEC allows us to "incorporate by reference" into this prospectus the
information we file with the SEC, which means that we can disclose important
business, financial and other information to you by referring you to other
documents separately filed with the SEC. All information incorporated by
reference is part of this prospectus, unless and until that information is
updated and superseded by the information contained in this prospectus or any
information incorporated later. We incorporate by reference the documents
listed below and any future filings we make with the SEC under Sections 13(a),
13(c), 14 or 15(d) of the Exchange Act prior to completion of this offering.
o Annual Report on Form 10-K for the year ended December 31, 2005, filed
March 22, 2006, as amended by Amendment No. 1 thereto filed on March 31,
2006;
o Quarterly Reports on Form 10-Q for the quarter ended March 31, 2006,
filed May 10, 2006; and for the quarter ended June 30, 2006, filed
August 9, 2006; and for the quarter ended September 30, 2006, filed
November 9, 2006; and
o Current Reports on Form 8-K filed January 9, 2006, January 23, 2006,
January 25, 2006, February 14, 2006, February 21, 2006, April 6, 2006,
April 10, 2006, April 27, 2006, May 8, 2006, May 30, 2006, July 17, 2006,
September 13, 2006, September 19, 2006, October 4, 2006 and November 21,
2006 in each case as amended; and
o Our Proxy Statement relating to our 2006 annual meeting of shareholders
filed on April 24, 2006.
We also incorporate by reference all future filings we make with the SEC
between the date of this prospectus and the date upon which we sell all of the
securities we offer with this prospectus and any applicable supplement.
You may obtain copies of these documents at no cost by requesting them from
us in writing at the following address: Hersha Hospitality Trust, 510 Walnut
Street, 9th Floor, Philadelphia, PA 19106, telephone (215) 238-1046.
53
[HERSHA LOGO]