As filed with the Securities and Exchange Commission on July 20, 2010

Registration No. 333-168078

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Amendment No. 1

to

Form S-11

FOR REGISTRATION
UNDER
THE SECURITIES ACT OF 1933
OF SECURITIES
OF CERTAIN REAL ESTATE COMPANIES

 

 

 

 

PEBBLEBROOK HOTEL TRUST

(Exact name of registrant as specified in governing instruments)

 

 

 

 

2 Bethesda Metro Center, Suite 1530
Bethesda, MD 20814
(240) 507-1300
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

Jon E. Bortz
Chairman, President and Chief Executive Officer
2 Bethesda Metro Center, Suite 1530
Bethesda, MD 20814
(240) 507-1300
(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

 

 

Copies to:

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

 

If any of the Securities registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box:  o

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

 

 

 

CALCULATION OF REGISTRATION FEE

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

Subject to Completion

Preliminary Prospectus dated July 20, 2010

 

PROSPECTUS

 

17,000,000 Shares

 

 

Common Shares

 

 

 

Pebblebrook Hotel Trust is an internally managed hotel investment company recently organized to opportunistically acquire and invest in hotel properties.

 

We are offering 17,000,000 common shares of beneficial interest, $0.01 par value per share, or common shares. Our common shares are listed on the New York Stock Exchange, or NYSE, under the symbol “PEB.” The last reported sale price of our common shares on the NYSE on July 19, 2010 was $18.02 per share.

 

We are organized and conduct our operations to qualify as a real estate investment trust, or REIT, for federal income tax purposes. To assist us in qualifying as a REIT, among other reasons, ownership of our outstanding common shares by any person is limited to 9.8%, subject to certain exceptions. In addition, our declaration of trust contains various other restrictions on the ownership and transfer of our common shares. See “Description of Shares of Beneficial Interest — Restrictions on Ownership and Transfer.”

 

Investing in our common shares involves risks. You should read the section entitled “Risk Factors” beginning on page 19 of this prospectus for a discussion of these risks.

 

 

 

The underwriters may also purchase up to an additional 2,550,000 common shares from us, at the public offering price, less the underwriting discount, within 30 days from the date of this prospectus to cover overallotments, if any.

 

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 common shares will be ready for delivery on or about July   , 2010.

 

 

 

 

 

The date of this prospectus is July   , 2010.

 

TABLE OF CONTENTS

 

 

 

You should rely only on the information contained in this prospectus, any free writing prospectus prepared by us or information to which we have referred you. We have not, and the underwriters have not, authorized any other person to provide you with different or additional information. If anyone provides you with different or additional information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus or another date specified herein. Our business, financial condition and prospects may have changed since such dates.

 

PROSPECTUS SUMMARY

																				For the Year Ended												For the Quarter Ended
						Year														December 31, 2009												March 31, 2010
				Date of		Opened/		Number				Purchase				Assumed				Occupancy(1)				ADR(2)				RevPAR(3)				Occupancy(1)				ADR(2)				RevPAR(3)
Property		Location		Acquisition		Renovated		of Rooms				Price				Debt				(%)				($)				($)				(%)				($)				($)
Doubletree Bethesda Hotel and Executive Meeting Center		Bethesda, Maryland		June 4, 2010		1971/2007			269				$67.1 million				—				70.7				160.20				113.24				57.8				157.13				90.78
Sir Francis Drake Hotel		San Francisco, California		June 22, 2010		1928/2009			416				90.0 million				—				76.4				138.51				105.80				66.3				135.13				89.57
InterContinental Buckhead Hotel		Atlanta, Georgia		July 1, 2010		2004			422				105.0 million				—				67.6				155.58				105.10				79.0				143.38				113.29

(1)		Occupancy is the average daily occupancy for the period presented.
(2)		ADR is average daily rate.
(3)		RevPAR is room revenue per available room.

																		For the Year Ended												For the Quarter Ended
				Year														December 31, 2009												March 31, 2010
				Opened/		Number				Purchase				Assumed				Occupancy				ADR				RevPAR				Occupancy				ADR				RevPAR
Property		Location		Renovated		of Rooms				Price				Debt				(%)				($)				($)				(%)				($)				($)
Hotel Monaco Washington DC		Washington, D.C.		1839/2002			183			$	74.0 million				$35.0 million				79.6				256.76				204.47				75.2				233.75				175.87
The Grand Hotel Minneapolis		Minneapolis, Minnesota		1915/2000			140				36.0 million				—				61.0				175.78				107.19				54.0				157.07				84.77

		Facility
Lenders		Amount		Interest Rate		Term		Security
Bank of America, N.A.; Wells Fargo Bank, N.A.; US Bank N.A.; Credit Agricole Corporate and Investment Bank; Royal Bank of Canada; Raymond James Bank, FSB; Chevy Chase Bank		$150,000,000(1)		Our choice of (i) LIBOR(2) (minimum of 1.5%) + a margin between 3.0% and 4.0%, depending on our leverage ratio(3); or (ii) Base Rate(4) + 2.0% to 3.0%, depending on our leverage ratio		3 years (July 7, 2013) with a one-year extension at our option		All borrowing base properties,(5) including any related personal property, and the equity interests of certain of our subsidiaries

(1)		At our option and subject to the consent of the lenders, we may increase the facility amount by an additional $50,000,000 up to an aggregate balance of $200,000,000.
(2)		LIBOR means London Interbank Offered Rate.
(3)		Leverage ratio is the ratio of our total net debt to our EBITDA for the four fiscal quarters most recently ended at the time of calculation.
(4)		Base Rate means for any day a fluctuating annual rate equal to the highest of (a) the Federal Funds Rate plus 0.50%, (b) the administrative agent bank’s then-current “prime rate” and (c) LIBOR (minimum 1.5%) plus 1.00%.
(5)		Borrowing base properties are subject to lender approval as set forth in the senior secured revolving credit facility agreements.

		Three Months Ended
		June 30, 2010
General and administrative expenses:
Cash corporate general and administrative expenses(1)			$1,600,000 – $2,000,000
Non-cash corporate general and administrative expenses(2)			$500,000
Acquisition costs(3)			$3,100,000 – $3,500,000
Total general and administrative expenses			$5,200,000 – $6,000,000
Net loss attributable to shareholders			($3,800,000) – ($4,600,000)

(1)		Includes approximately $350,000 of expenses related to moving and other relocation expenses of senior management.

(2)		Non-cash compensation expense of equity awards made to our trustees and executive officers.

(3)		Acquisition costs incurred in connection with our acquisition of hotel properties and recognized as expenses as incurred pursuant to FASB Accounting Standards Codification Topic 805.

	•	Significant debt defaults. Cash flow at many hotel properties has declined to levels that are inadequate to support required debt service payments or that violate applicable covenants. Real Capital Analytics estimates that, as of May 31, 2010, there were over 1,600 hotel properties in distress (which includes default, deed-in-lieu of foreclosure, forced sales, foreclosure or bankruptcy), having an aggregate value of approximately $35 billion. We believe many of these hotel properties will be sold by lenders after foreclosure, while in receivership or in cooperation with the borrower.
	•	Maturity defaults and lack of available financing. According to Standard & Poor’s, or S&P, hotel-related commercial mortgage-backed securities, or CMBS, with an aggregate

		principal amount of approximately $21 billion are scheduled to mature in the years 2010 through 2012. In the current economic environment, traditional lending sources, such as banks, insurance companies and pension funds have adopted more conservative lending policies and have materially decreased new lending commitments to hotel properties. We believe the current and projected cash flows at many hotel properties, when coupled with more conservative lending policies, will only support mortgage financing that is significantly less than the amounts currently borrowed against such properties. As a result, we expect many owners of hotel properties will be unable to refinance maturing debt without significant additional equity investment, which may result in sales or foreclosures.

	•	Under-capitalized owners. Maintaining a hotel’s physical condition at the levels required by major hotel brands often requires significant capital investment. This is particularly true for hotels in urban markets and in the upper upscale segment of the lodging industry, where we focus our investment activity. We believe cash flow after debt service at many hotel properties may be insufficient to fund necessary capital expenditures and their owners may face capital investment demands that could require additional equity investments. We believe some hotel owners will be unable or unwilling to make the required equity investments and may choose or be compelled to sell their hotels.

	•	Experienced leadership. Our senior executive management team is led by our Chairman, President and Chief Executive Officer, Mr. Bortz, who has a proven track record and substantial experience in the hotel industry. Mr. Bortz has over 29 years of lodging and real estate experience, including expertise in hotel and resort property acquisitions, divestitures, repositioning, redevelopment, asset management, branding and financing. Our company represents Mr. Bortz’s third lodging investment vehicle and his second publicly-listed venture. He most recently founded and served as Chief Executive Officer of LaSalle Hotel Properties, an internally managed, NYSE-listed hotel REIT, from its inception in April 1998 and as the Chairman of its Board of Trustees from January 2001 until his retirement in September 2009. Prior to LaSalle Hotel Properties, Mr. Bortz founded and led Jones Lang LaSalle’s Hotel Investment Group, which acquired 15 hotels over his four-year tenure as its President. Through his past professional experiences, Mr. Bortz has developed strong relationships with hotel owners, management companies, brand companies, brokers, lenders and institutional investors. Our Executive Vice President and Chief Financial Officer, Raymond D. Martz, has over 15 years of experience in the hotel and real estate industries, including having served as Chief Financial Officer in his last two positions and in senior finance positions at two NYSE-listed hotel REITs, including LaSalle Hotel Properties. Our Executive Vice President and Chief Investment Officer, Thomas C. Fisher, also has over 15 years of experience in the hotel and real estate industries, including having served as Managing Director in his last position with Jones Lang LaSalle Hotels, leading its national full-service hotel brokerage platform.

	•	Proven acquirer with strong track record of growth. Throughout his career, Mr. Bortz has demonstrated the ability to acquire, redevelop and reposition hotel properties. During Mr. Bortz’s tenure as Chief Executive Officer of LaSalle Hotel Properties, he led transactions totaling $2.5 billion in asset value. During this period, LaSalle Hotel Properties’ portfolio increased from 10 hotel properties at the time of its initial public offering in April 1998 to 31 properties with over 8,400 rooms at the time of Mr. Bortz’s retirement in September 2009. In aggregate, Mr. Bortz oversaw the acquisition of 42 hotel

		and resort properties during his leadership tenure at LaSalle Hotel Properties and Jones Lang LaSalle’s Hotel Investment Group. Since the completion of our initial public offering on December 14, 2009, Mr. Bortz has overseen our acquisition of three hotels for purchase prices aggregating approximately $262.1 million. Mr. Bortz also established a strong capital sourcing network while at LaSalle Hotel Properties, overseeing that company’s raising of more than $3.0 billion of debt and equity capital to finance its significant growth over 11 years. During Mr. Bortz’s tenure at LaSalle Hotel Properties, that company experienced significant challenges resulting from severe industry downturns, such as the periods following September 11, 2001 and the global recession beginning in August 2008, during which LaSalle Hotel Properties reduced dividend distributions and capital investments due to substantial declines in revenues and earnings.

	•	Focused property investment strategy. According to Smith Travel Research, U.S. hotel RevPAR grew in March 2010, after 19 months of declines, and industry analysts project that RevPAR growth will continue throughout 2010 and into 2011, thereby improving profitability. We believe that as the U.S. economy continues to recover and generate positive growth in U.S. gross domestic product, or GDP, transient and group travel is likely to rebound, allowing hotel owners to grow occupancy as demand growth exceeds diminishing supply growth, leading to increasing ADRs. We invest primarily in upper upscale, full-service, branded and independent hotels in major U.S. cities, with an emphasis on the major coastal markets, where we believe there are significant barriers to entry for new hotel supply and meeting and room-night demand will experience the most robust recovery as the U.S. economy improves. In addition, we expect to acquire resort properties located near our primary urban target markets as well as in select, unique destination markets. We also may invest in branded, upscale, select-service hotels in premium urban locations in these major cities. Within these markets, we intend to establish a diversified customer base by investing in urban, resort and convention hotels, each of which typically has a different mix of business transient, leisure transient and group and convention customers, all of which follow different demand trends.

	•	Flexible and diversified operating strategy. Upon completion of this offering we will have approximately $408.8 million of cash, together with a $150 million senior secured revolving credit facility, to invest in additional hotel properties. All of our owned properties were recently acquired. We do not have the burden and distraction of legacy operating or legacy leverage issues that have adversely affected many existing hotel companies during the recent industry downturn, such as properties suffering from significant declines in cash flows or mortgage loan defaults. Since we are not affiliated with any hotel management company, we retain and plan to retain multiple branded and independent third-party hotel management companies to operate our hotels, based on our assessment of the operator most beneficial for each property. We believe this strategy of retaining multiple hotel managers assists us in identifying best practices that we implement across our portfolio, as appropriate.

	•	Intensive asset management. We intend to employ a dedicated and experienced asset management team to proactively manage our third-party hotel management companies in order to improve operational performance and maximize our return on investment. Although we do not operate our hotel properties, both our asset management team and our executive management team actively participate with our hotel managers in all aspects of our hotels’ operations, including property positioning and repositioning, operations analysis, physical design, renovation and capital improvements, guest experience and overall strategic direction. Through these initiatives, we seek to improve property efficiencies, lower costs, maximize revenues, and enhance property operating

		margins. We also anticipate implementing certain value-added strategies, such as changing operators, re-branding and de-flagging, when appropriate.

	•	Prudent capital structure. We expect to maintain a low-leverage capital structure and intend to limit the sum of the outstanding principal amount of our consolidated net indebtedness and the liquidation preference of any outstanding preferred shares to not more than 4.5x our earnings before interest, taxes, depreciation and amortization, or EBITDA, for the 12-month period preceding the incurrence of such debt or the issuance of such preferred shares. Our board of trustees may modify or eliminate this limitation at any time without the approval of our shareholders.

	•	premier locations, facilities and other competitive advantages not easily replicated;
	•	significant barriers to entry in the market, such as scarcity of development sites, regulatory hurdles, high per room development costs and long lead times for new development;
	•	acquisition price at a significant discount to replacement cost;
	•	properties not subject to long-term management contracts with hotel management companies;
	•	potential return on investment initiatives, including redevelopment, rebranding, redesign, expansion and change of management;
	•	opportunities to implement value-added operational improvements; and
	•	strong demand growth characteristics supported by favorable demographic indicators.

	•	more than $2.5 billion in hotel investments, including acquisitions, dispositions, mergers and joint ventures;
	•	more than $3.0 billion in financings, including mortgage financings, common and preferred equity financings and secured and unsecured credit facilities;
	•	the establishment of strong relationships within the lodging industry, including with hotel owners, management companies, brand companies and brokers; and
	•	the development of strong relationships within the financial community, including with leading institutional investors, investment banks, professional service firms and lenders.

	•	We were organized in October 2009 and have limited operating history. We may be unable to successfully implement our business strategy or generate sufficient operating cash flows to make or sustain distributions to our shareholders.
	•	The purchase of the properties we have under contract may not be consummated.
	•	Our success will depend upon the efforts and expertise of our existing and future management team. The loss of their services, and our inability to find suitable replacements, could delay the implementation of our investment strategy.
	•	A substantial part of our business strategy is based on our expectation that lodging industry fundamentals will improve as forecast by industry analysts, such as Smith Travel Research and Jones Lang LaSalle Hotels, or JLLH. If lodging industry fundamentals do not

		improve when or as we expect, or deteriorate, the operating results of our hotels and our ability to execute our business strategy may be impaired.

	•	The performance of the lodging industry has historically been linked to the performance of the general economy and U.S. GDP. Declines in corporate travel budgets and consumer demand due to adverse general economic conditions such as declines in U.S. GDP can lower the revenues and profitability of our hotel properties.
	•	We rely on third-party hotel management companies to operate our hotel properties under the terms of hotel management contracts. Even if we believe our hotel properties are being operated inefficiently or in a manner that does not result in satisfactory RevPAR or profits we may not be able to force the hotel management company to change its method of operating our hotels.
	•	Our hotel management contracts require us, through the wholly owned subsidiaries of our taxable REIT subsidiary, or TRS, Pebblebrook Hotel Lessee, Inc., to bear the risks of decreased revenues or increased expenses at our hotel properties. We refer to our TRS and its wholly owned subsidiaries as our TRS lessees. Any increases in operating expenses, such as wages and benefits, repair and maintenance, energy, taxes and insurance, or decreases in revenues resulting from decreased demand or competition from new supply, are borne entirely by us and may have a significant adverse impact on our earnings and cash flow.
	•	To qualify for taxation as a REIT, we generally are required to distribute at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gain, each year to our shareholders. As a result, our ability to fund capital expenditures, acquisitions, hotel redevelopment and development through retained earnings will be very limited. We may not be able to fund capital improvements or acquisitions solely from cash provided from our operating activities. Consequently, after investing the net proceeds of this offering, we will rely upon the availability of debt or equity capital to fund investments in hotel properties and capital improvements. There can be no assurance that we will be able to obtain such financing on favorable terms or at all. We also may not generate sufficient cash flow to fund distributions required to maintain our qualification as a REIT.

	•	If we fail to qualify, or to remain qualified, as a REIT, or if a state and/or local jurisdiction were to change its laws related to the taxation of REIT taxable income or the deductibility of dividends paid, we will be subject to federal and or state and local income tax on our taxable income at regular corporate rates.

	•	Our hotel properties leased by our TRS lessees must be operated by “eligible independent contractors,” as defined in the Internal Revenue Code of 1986, as amended, or the Code, in order for our TRS lessees to qualify as such and for the rental income from our TRS leases to qualify as rents from real property under the applicable REIT gross income tests. Complex constructive ownership rules under the Code apply in determining whether a person qualifies as an eligible independent contractor.
	•	We will incur a 100% excise tax on transactions with TRSs, including our TRS lessees, that are not conducted on an arm’s-length basis.
	•	Subject to certain exceptions, our declaration of trust provides that no person may beneficially own more than 9.8% in value or in number of shares, whichever is more restrictive, of the outstanding shares of any class or series of our shares of beneficial

		interest. In addition, our declaration of trust and bylaws contain other provisions that may delay, defer or prevent an acquisition of control of our company by a third party without our board of trustees’ approval, even if our shareholders believe the change of control is in their best interests.

	•	Because real estate investments are relatively illiquid, our ability to promptly sell one or more hotel properties for reasonable prices in response to changing economic, financial and investment conditions will be limited. In addition, because some of our hotel management contracts may be long-term and may not terminate in the event of a sale, our ability to sell hotel properties may be further limited.

(1)		Does not reflect 929,099 common shares underlying an aggregate of 929,099 long-term incentive partnership units, or LTIP units, that were granted to Messrs. Bortz, Martz and Andrew H. Dittamo, our Vice President and Controller, upon completion of our initial public offering, and to Mr. Fisher upon his joining our company, pursuant to our 2009 Equity Incentive Plan.

(2)		We have issued an aggregate of 929,099 LTIP units to certain of our officers. See “Our Management — Compensation Discussion and Analysis — Components and Criteria of Executive Compensation — Long-Term Equity Incentive Awards.”

Common shares offered		17,000,000 common shares (plus up to an additional 2,550,000 common shares that we may issue and sell upon the exercise of the underwriters’ overallotment option).

Common shares to be outstanding upon completion of this offering		37,344,337 common shares(1)

Use of proceeds		We will contribute the net proceeds of this offering to our operating partnership. Our operating partnership will invest these net proceeds in hotel properties in accordance with our investment strategy described in this prospectus and for general business purposes. Prior to the full investment of the net offering proceeds in hotel properties, we intend to invest the net proceeds in certificates of deposit, interest-bearing short-term investment grade securities or money-market accounts which are consistent with our intention to qualify as a REIT. These initial investments are expected to provide a lower net return than we will seek to achieve from investments in hotel properties. See “Use of Proceeds.”

New York Stock Exchange symbol		“PEB”
Ownership and transfer restrictions		Our declaration of trust, subject to certain exceptions, prohibits any person from directly or indirectly owning more than 9.8% by value or number of shares, whichever is more restrictive, of the outstanding shares of any class or series of our shares of beneficial interest. See “Description of Shares of Beneficial Interest — Restrictions on Ownership and Transfer.”
Risk factors		Investing in our common shares involves risks. You should carefully read and consider the information set forth under “Risk Factors” and all other information in this prospectus before investing in our common shares.

(1)		Does not include (i) 929,099 common shares underlying an aggregate of 929,099 LTIP units that were granted to our officers pursuant to our 2009 Equity Incentive Plan, (ii) 311,689 common shares reserved for issuance under our 2009 Equity Incentive Plan and (iii) up to 2,550,000 common shares issuable upon exercise of the underwriters’ overallotment option.

		Historical								Pro Forma
		Period ended				Three Months				Year ended				Three Months
		December 31,				ended				December 31,				ended
		2009				March 31, 2010				2009				March 31, 2010
		(In thousands, except share and per share data)
						(Unaudited)				(Unaudited)				(Unaudited)
Statement of Operations Data:
Total revenues		$	—			$	—			$	99,772			$	22,605
Hotel operating expenses			—				—				74,152				17,840
General and administrative			262				1,576				7,625				1,576
Ground rent			—				—				383				45
Acquisition transaction costs			—				—				4,700				—
Real estate taxes, personal property taxes and insurance			—				—				4,059				1,100
Depreciation and amortization			—				—				9,541				2,384
Total operating expenses			262				1,576				100,460				22,945
Operating loss			(262	)			(1,576	)			(688	)			(340	)
Interest income			115				977				115				209
Interest expense			—				—				(2,095	)			(515	)
Other income			—				—				8				—
Income tax expense			—				—				(399	)			(90	)
Net loss and net loss attributable to common shareholders		$	(147	)		$	(599	)		$	(3,059	)		$	(736	)
Loss per common share, basic and diluted		$	(0.04	)		$	(0.03	)		$	(0.08	)		$	(0.02	)
Weighted average number of common shares, basic and diluted			4,011,198				20,260,046				37,260,046				37,260,046

		Historical								Pro Forma
		As of December 31,				As of March 31,				As of March 31,
		2009				2010				2010
		(In thousands)								(In thousands)
						(Unaudited)				(Unaudited)
Balance Sheet Data:
Investment in hotel properties, net		$	—			$	—			$	336,100
Cash and cash equivalents and investments			389,119				387,898				376,183
Accounts receivable, net, prepaid expenses and other assets			284				409				1,490
Total assets		$	389,403			$	388,307			$	713,773
Accounts payable, accrued expenses and other liabilities		$	9,977			$	9,417			$	12,062
Mortgage loans			—				—				35,000
Total liabilities			9,977				9,417				47,062
Total shareholders’ equity			379,426				378,890				666,711
Total liabilities and shareholders’ equity		$	389,403			$	388,307			$	713,773

 

An investment in our common shares involves risks. In addition to other information in this prospectus, you should carefully consider the following risks before investing in our common shares offered by this prospectus. The occurrence of any of the following risks could materially and adversely affect our business, prospects, financial condition, results of operations and our ability to make cash distributions to our shareholders, which could cause you to lose all or a significant portion of your investment in our common shares. Some statements in this prospectus, including statements in the following risk factors, constitute forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements.”

 

Risks Related to Our Business and Properties

 

We have a limited operating history and may not be able to successfully operate our business or generate sufficient operating cash flows to make or sustain distributions to our shareholders.

 

We were organized in October 2009 and commenced operations following our initial public offering in December 2009. We therefore have a limited operating history. Our ability to make or sustain distributions to our shareholders will depend on many factors, including our ability to identify attractive acquisition opportunities that satisfy our investment strategy, our success in consummating acquisitions on favorable terms, the level and volatility of interest rates, readily accessible short-term and long-term financing on favorable terms, and conditions in the financial markets, the real estate market and the economy. We face competition in acquiring attractive hotel properties. The value of the hotel properties we own or will acquire may decline substantially. We may not be able to successfully operate our business or implement our operating policies and investment strategy successfully. Furthermore, we may not be able to generate sufficient operating cash flow to pay our operating expenses and make distributions to our shareholders.

 

As a recently formed company, we are subject to the risks of any recently established business enterprise, including risks that we will be unable to attract and retain qualified personnel, create effective operating and financial controls and systems or effectively manage our anticipated growth, any of which could have a material adverse effect on our business and our operating results.

 

The purchase of the properties we have under contract may not be consummated.

 

We have entered into agreements to purchase The Grand Hotel Minneapolis in Minneapolis, Minnesota and the Hotel Monaco Washington DC in Washington, D.C. The closing of the acquisition of the Hotel Monaco Washington DC is subject to obtaining lender and ground lessor consents and the satisfaction of other customary closing requirements and conditions, and there is no assurance that this acquisition will be consummated. Moreover, on June 29, 2010, we agreed with the seller of The Grand Hotel Minneapolis to extend our due diligence period with respect to that hotel for an additional 30 days until July 30, 2010. Pending further due diligence with respect to this hotel, we can provide no assurance that we will elect to move forward with our purchase of the hotel or that if we do elect to move forward, that the acquisition will close or the specific terms of the acquisition.

 

These transactions, whether or not they are successful, require substantial time and attention from management. Furthermore, these potential acquisitions require significant expense, including expenses for due diligence, legal fees and related overhead. To the extent we do not acquire these hotels, these expenses will not be offset by revenues from these properties.

Therefore, if we do not realize a return on these acquisitions in a timely manner in order to offset these costs and expenses, we could be adversely affected.

 

We depend on the efforts and expertise of our key executive officers and would be adversely affected by the loss of their services.

 

We depend on the efforts and expertise of our President and Chief Executive Officer, as well as our other executive officers, to execute our business strategy. The loss of their services, and our inability to find suitable replacements, would have an adverse effect on our business.

 

Failure of the lodging industry to exhibit improvement may adversely affect the operating results of our hotels and our ability to execute our business strategy.

 

A substantial part of our business strategy is based on our expectation that lodging industry fundamentals will improve as forecast by industry analysts, such as JLLH and Smith Travel Research, which project that industry RevPAR, which grew in March 2010 after 19 months of declines, will continue to grow throughout 2010 and into 2011, thereby improving profitability. There can be no assurance as to whether, or when, lodging industry fundamentals will in fact improve or to what extent they will improve. In the event conditions in the lodging industry do not improve when and as we expect, or deteriorate, the operating results of our hotels and our ability to execute our business strategy may be impaired.

 

We invest in the upper upscale segment of the lodging market which is highly competitive and generally subject to greater volatility than most other market segments and could negatively affect our profitability.

 

The upper upscale segment of the hotel business is highly competitive. Our hotel properties compete on the basis of location, room rates, quality, service levels, reputation and reservations systems, among many factors. There are many competitors in the upper upscale segment, and many of these competitors may have substantially greater marketing and financial resources than we have. This competition could reduce occupancy levels and room revenue at our hotels. Over-building in the lodging industry may increase the number of rooms available and may decrease occupancy and room rates. In addition, in periods of weak demand, as may occur during a general economic recession, profitability is negatively affected by the relatively high fixed costs of operating upper upscale hotels.

 

Our returns could be negatively impacted if the third-party management companies that operate our hotels do not manage our hotel properties effectively.

 

Since the federal income tax laws restrict REITs and their subsidiaries from operating or managing a hotel, we do not operate or manage any of our hotel properties. Instead, we lease our hotel properties to subsidiaries that qualify as TRSs, under applicable REIT laws, and our TRS lessees retain third-party managers to operate our hotels pursuant to management contracts. Our cash flow from the hotels may be adversely affected if our managers fail to provide quality services and amenities or if they or their affiliates fail to maintain a quality brand name. In addition, our managers or their affiliates may manage, and in some cases may own, invest in or provide credit support or operating guarantees to hotels that compete with our hotel properties, which may result in conflicts of interest and decisions regarding the operation of our hotels that are not in our best interests.

 

We do not have the authority to require any hotel property to be operated in a particular manner or to govern any particular aspect of the daily operations of any hotel property (for example, setting room rates). Thus, even if we believe our hotels are being operated inefficiently

or in a manner that does not result in satisfactory occupancy rates, RevPAR and ADR, we may not be able to force the management company to change its method of operating our hotels. We generally will attempt to resolve issues with our managers through discussions and negotiations. However, if we are unable to reach satisfactory results through discussions and negotiations, we may choose to litigate the dispute or submit the matter to third-party dispute resolution. We can only seek redress if a management company violates the terms of the applicable management contract with a TRS lessee, and then only to the extent of the remedies provided for under the terms of the management contract. Additionally, in the event that we need to replace any management company, we may be required by the terms of the management contract to pay substantial termination fees and may experience significant disruptions at the affected hotels.

 

Because our senior executive officers have broad discretion to invest the net proceeds of this offering, they may make investments where the returns are substantially below expectations or which result in net operating losses.

 

Our senior executive officers have broad discretion, within the general investment criteria established by our board of trustees, to invest the net proceeds of this offering and to determine the timing of such investments. In addition, our investment policies may be revised from time to time at the discretion of our board of trustees, without a vote of our shareholders. Such discretion could result in investments that may not yield returns consistent with expectations.

 

Restrictive covenants in our management contracts could preclude us from taking actions with respect to the sale or refinancing of a hotel property that would otherwise be in our best interest.

 

We may enter into management contracts that contain some restrictive covenants or acquire properties subject to existing management contracts that do not allow the flexibility we seek, including management contracts that restrict our ability to terminate the contract or require us to pay large termination fees. For example, the terms of some management contracts, such as our management contract in connection with the InterContinental Buckhead Hotel, may restrict our ability to sell a property unless the purchaser is not a competitor of the manager and assumes the related management contract and meets specified other conditions. Any such management contract may preclude us from taking actions that would otherwise be in our best interest or could cause us to incur substantial expense.

 

Our TRS lessee structure subjects us to the risk of increased hotel operating expenses.

 

Our leases with our TRS lessees will require our TRS lessees to pay us rent based in part on revenues from our hotels. Our operating risks include decreases in hotel revenues and increases in hotel operating expenses, which would adversely affect our TRS lessees’ ability to pay us rent due under the leases, including but not limited to the increases in:

 

 

Increases in these operating expenses can have a significant adverse impact on our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

 

Our hotels operated under franchise agreements are subject to risks arising from adverse developments with respect to the franchise brand and to costs associated with maintaining the franchise license.

 

Certain of our hotel properties operate under franchise agreements and we anticipate that some of the hotels we acquire in the future will operate under franchise agreements. We are therefore subject to the risks associated with concentrating hotel investments in several franchise brands, including reductions in business following negative publicity related to one of the brands or the general decline of a brand.

 

The maintenance of the franchise licenses for branded hotel properties are subject to the franchisors’ operating standards and other terms and conditions. Franchisors periodically inspect hotel properties to ensure that we and our lessees and management companies follow their standards. Failure by us, one of our TRS lessees or one of our third-party management companies to maintain these standards or other terms and conditions could result in a franchise license being canceled. If a franchise license is cancelled due to our failure to make required improvements or to otherwise comply with its terms, we also may be liable to the franchisor for a termination payment, which varies by franchisor and by hotel property. As a condition of maintaining a franchise license, a franchisor could require us to make capital expenditures, even if we do not believe the capital improvements are necessary or desirable or will result in an acceptable return on our investment. We may risk losing a franchise license if we do not make franchisor-required capital expenditures.

 

If a franchisor terminates the franchise license or the license expires, we may try either to obtain a suitable replacement franchise or to operate the hotel without a franchise license. The loss of a franchise license could materially and adversely affect the operations and the underlying value of the hotel property because of the loss of associated name recognition, marketing support and centralized reservation system provided by the franchisor and adversely affect our revenues. This loss of revenue could in turn adversely affect our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

 

Our ability to make distributions to our shareholders is subject to fluctuations in our financial performance, operating results and capital improvements requirements.

 

To qualify for taxation as a REIT, we are required to distribute at least 90 percent of our REIT taxable income (determined before the deduction for dividends paid and excluding any net capital gains) each year to our shareholders and we generally expect to make distributions in excess of such amount. In the event of downturns in our operating results, unanticipated capital improvements to our hotel properties or other factors, we may be unable to declare or pay distributions to our shareholders. The timing and amount of distributions are in the sole discretion of our board of trustees which will consider, among other factors, our financial performance, any debt service obligations, any debt covenants, our taxable income and capital expenditure requirements. Our ability to make distributions to our shareholders is also limited by the terms of our senior secured revolving credit facility and we cannot assure you that we will generate sufficient cash in order to fund distributions.

We may use a portion of the net proceeds from this offering to make distributions to our shareholders, which would, among other things, reduce our cash available to invest in hotel properties and may reduce the returns on your investment in our common shares.

 

Prior to the time we have fully invested the net proceeds of this offering, we may fund distributions to our shareholders out of the net proceeds of this offering, which would reduce the amount of cash we have available to invest in hotel properties and may reduce the returns on your investment in our common shares. The use of the net proceeds for distributions to shareholders could adversely affect our financial results. In addition, funding distributions from the net proceeds of this offering may constitute a return of capital to our shareholders, which would have the effect of reducing each shareholder’s tax basis in our common shares.

 

If we cannot obtain financing, our growth will be limited.

 

To qualify for taxation as a REIT, we are required to distribute at least 90 percent of our REIT taxable income (determined before the deduction for dividends paid and excluding any net capital gains) each year to our shareholders and we generally expect to make distributions in excess of such amount. As a result, our ability to retain earnings to fund acquisitions, redevelopment and development or other capital expenditures will be limited. After investing the net proceeds of this offering, we do not expect to have a significant amount of debt, including debt that may be assumed in connection with hotel acquisitions. Although our business strategy contemplates access to debt financing (in addition to our senior secured revolving credit facility) to fund acquisitions, redevelopment, development, return on investment initiatives and working capital requirements, there can be no assurance that we will be able to obtain such other financing on favorable terms or at all. Recent events in the financial markets have had an adverse impact on the credit markets and, as a result, credit has become significantly more expensive and difficult to obtain, if available at all. Some lenders are imposing more stringent credit terms, there has been and may continue to be a general reduction in the amount of credit available, and many banks are either unable or unwilling to provide new asset based lending. Tightening credit markets may have an adverse effect on our ability to obtain financing on favorable terms, if at all, thereby increasing financing costs and/or requiring us to accept financing with increasing restrictions. If adverse conditions in the credit markets — in particular with respect to real estate or lodging industry finance — materially deteriorate, our business could be materially and adversely affected. Our long-term ability to grow through investments in hotel properties will be limited if we cannot obtain additional financing. Market conditions may make it difficult to obtain financing, and we cannot assure you that we will be able to obtain additional debt or equity financing or that we will be able to obtain it on favorable terms.

 

There are material limitations in estimating our results for prior periods before the completion of our and our auditors’ normal review procedures for such periods.

 

The estimated results contained in “Prospectus Summary — Recent Developments” are not a comprehensive statement of our financial results for the three months ended June 30, 2010 and have not been reviewed or audited by our independent registered public accounting firm. Our consolidated financial statements for the three months ended June 30, 2010 will not be available until after this offering is completed, and, consequently, will not be available to you prior to investing in this offering. The final financial results for the three months ended June 30, 2010 may vary from our expectations and may be materially different from the preliminary financial estimates we have provided due to completion of quarterly closing procedures, reviewing adjustments and other developments that may arise between now and the time the financial results for the quarter are finalized. Accordingly, investors should not place undue reliance on such financial information.

Debt service obligations could adversely affect our overall operating results, may require us to sell hotel properties, may jeopardize our qualification as a REIT and could adversely affect our ability to make distributions to our shareholders and the market price of our common shares.

 

Our business strategy contemplates the use of both secured and unsecured debt to finance long-term growth. Although we intend to limit the sum of the outstanding principal amount of our consolidated net indebtedness and the liquidation preference of any outstanding preferred shares to not more than 4.5x our EBITDA for the 12-month period preceding the incurrence of new debt or the issuance of preferred shares, our board of trustees may modify or eliminate this limitation at any time without the approval of our shareholders. As a result, we may be able to incur substantial additional debt, including secured debt, in the future. Incurring debt could subject us to many risks, including the risks that:

 

 

If we violate covenants in our agreements relating to indebtedness, we could be required to repay all or a portion of our indebtedness before maturity at a time when we might be unable to arrange financing for such repayment on attractive terms, if at all. In addition, our agreements relating to our indebtedness may require that we meet certain covenant tests in order to make distributions to our shareholders.

 

If we do not have sufficient funds to repay our debt at maturity, it may be necessary to refinance the debt through additional debt or additional equity financings. If, at the time of any refinancing, prevailing interest rates or other factors result in higher interest rates on refinancings, increases in interest expense could adversely affect our cash flow, and, consequently, cash available for distribution to our shareholders. If we are unable to refinance our debt on acceptable terms, we may be forced to dispose of hotel properties on disadvantageous terms, potentially resulting in losses. We will assume a mortgage in connection with our anticipated acquisition of the Hotel Monaco Washington DC and we will place mortgages on certain of our hotel properties to secure our senior secured revolving credit facility and may do so in the future to secure other debt. To the extent we cannot meet any of our debt service obligations, we will risk losing to foreclosure some or all of our pledged hotel properties. Also, covenants applicable to any future debt could impair our planned investment strategy and, if violated, result in a default.

 

Higher interest rates could increase debt service requirements on any of our floating rate debt, including our senior secured revolving credit facility, and could reduce the amounts available for distribution to our shareholders, as well as reduce funds available for our operations, future business opportunities, or other purposes. We may obtain one or more forms of interest

rate protection — in the form of swap agreements, interest rate cap contracts or similar agreements — to “hedge” against the possible negative effects of interest rate fluctuations. However, such hedging implies costs and we cannot assure you that any hedging will adequately relieve the adverse effects of interest rate increases or that counterparties under these agreement will honor their obligations thereunder. Adverse economic conditions could also cause the terms on which we borrow to be unfavorable. We could be required to liquidate one or more of our hotel properties in order to meet our debt service obligations at times which may not permit us to receive an attractive return on our investments.

 

Our cash and cash equivalents and short term investments are maintained in a limited number of financial institutions and the funds in those institutions may not be fully or federally insured.

 

We maintain cash balances in a limited number of financial institutions. However, our cash balances are generally in excess of federally insured limits. The failure or collapse of one or more of these financial institutions may materially adversely affect our ability to recover our cash balances.

 

Any joint venture investments that we make could be adversely affected by our lack of sole decision-making authority, our reliance on co-venturers’ financial condition and disputes between us and our co-venturers.

 

We may co-invest in hotels in the future with third parties through partnerships, joint ventures or other entities, acquiring non-controlling interests in or sharing responsibility for a property, partnership, joint venture or other entity. In this event, we would not be in a position to exercise sole decision-making authority regarding the property, partnership, joint venture or other entity. Investments through partnerships, joint ventures, or other entities may, under certain circumstances, involve risks not present were a third party not involved, including the possibility that partners or co-venturers might become bankrupt, fail to fund their share of required capital contributions, make dubious business decisions or block or delay necessary decisions. Partners or co-venturers may have economic or other business interests or goals which are inconsistent with our business interests or goals, and may be in a position to take actions contrary to our policies or objectives. Such investments may also have the potential risk of impasses on decisions, such as a sale, because neither we nor the partner or co-venturer would have full control over the partnership or joint venture. Disputes between us and partners or co-venturers may result in litigation or arbitration that would increase our expenses and prevent our officers and/or trustees from focusing their time and effort on our business. Consequently, action by, or disputes with, partners or co-venturers might result in subjecting properties owned by the partnership or joint venture to additional risk. In addition, we may in certain circumstances be liable for the actions of our third-party partners or co-venturers.

 

Due to our concentration in hotel investments, a downturn in the lodging industry would adversely affect our operations and financial condition.

 

Our primary business is hotel-related. Therefore, a downturn in the lodging industry, in general, and the segments and markets in which we operate, in particular, would have a material adverse effect on our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

Unanticipated expenses and insufficient demand for hotels in new geographic markets could adversely affect our profitability and our ability to make distributions to our shareholders.

 

As part of our business strategy, we may acquire or develop hotel properties in geographic areas in which our management may have little or no operating experience and in which potential customers may not be familiar with the brand of that particular hotel. As a result, we may have to incur costs relating to the opening, operation and promotion of such hotel properties that are substantially greater than those incurred in other areas. These hotels may attract fewer customers than other hotel properties we may acquire, while at the same time, we may incur substantial additional costs with such hotel properties. Unanticipated expenses and insufficient demand at a new hotel property, therefore, could adversely affect our financial condition and results of operations.

 

Our conflicts of interest policy may not adequately address all of the conflicts of interest that may arise with respect to our activities.

 

In order to avoid any actual or perceived conflicts of interest with our trustees, officers or employees, we have adopted a conflicts of interest policy to specifically address some of the conflicts relating to our activities. Although under this policy the approval of a majority of our disinterested trustees is required to approve any transaction, agreement or relationship in which any of our trustees, officers or employees has an interest, there is no assurance that this policy will be adequate to address all of the conflicts that may arise or will address such conflicts in a manner that is favorable to us.

 

Risks Related to Investments in Mortgage Loans

 

Acquiring outstanding debt secured by a hotel or resort property may expose us to risks of costs and delays in acquiring the underlying property.

 

We may acquire outstanding debt secured by a hotel or resort property from lenders and investors if we believe we can ultimately foreclose or otherwise acquire ownership of the underlying property in the near-term through foreclosure, deed-in-lieu of foreclosure or other means. However, if we do acquire such debt, borrowers may seek to assert various defenses to our foreclosure or other actions and we may not be successful in acquiring the underlying property on a timely basis, or at all, in which event we could incur significant costs and experience significant delays in acquiring such properties, all of which could adversely affect our financial performance and reduce our expected returns from such investments. In addition, we may not earn a current return on such investments particularly if the loan that we acquire is in default.

 

Risks Related to the Lodging Industry

 

Current economic conditions may reduce demand for hotel properties and adversely affect hotel profitability.

 

The performance of the lodging industry has historically been closely linked to the performance of the general economy and, specifically, growth in U.S. GDP. It is also sensitive to business and personal discretionary spending levels. Declines in corporate travel budgets and consumer demand due to adverse general economic conditions, such as declines in U.S. GDP, risks affecting or reducing travel patterns, lower consumer confidence or adverse political conditions can lower the revenues and profitability of hotel properties and therefore the net operating profits of our TRS lessees to whom we lease our hotel properties. The current global

economic downturn has led to a significant decline in demand for products and services provided by the lodging industry, lower occupancy levels and significantly reduced room rates.

 

We anticipate that recovery of demand for products and services provided by the lodging industry will lag improvement in economic conditions. We cannot predict how severe or prolonged the global economic downturn will be or how severe or prolonged the lodging industry downturn will be. A further extended period of economic weakness would likely have an adverse impact on our revenues and negatively affect our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

 

Our operating results and ability to make distributions to our shareholders may be adversely affected by various operating risks common to the lodging industry.

 

Our hotel properties have different economic characteristics than many other real estate assets and a hotel REIT is structured differently than many other types of REITs. A typical office property owner, for example, has long-term leases with third-party tenants, which provides a relatively stable long-term stream of revenue. Our TRS lessees, on the other hand, will not enter into a lease with a hotel manager. Instead, our TRS lessees will engage the hotel manager pursuant to a management contract and will pay the manager a fee for managing the hotel. The TRS lessees will receive all the operating profit or losses at the hotel. Moreover, virtually all hotel guests stay at the hotel for only a few nights, so the rate and occupancy at each of our hotels changes every day. As a result, we may have highly volatile earnings.

 

In addition, our hotel properties will be subject to various operating risks common to the lodging industry, many of which are beyond our control, including the following:

 

 

 

These factors could reduce the net operating profits of our TRS lessees, which in turn could adversely affect our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

 

Competition for acquisitions may reduce the number of properties we can acquire.

 

We compete for investment opportunities with entities that may have substantially greater financial resources than we have. These entities generally may be able to accept more risk than we can prudently manage. This competition may generally limit the number of suitable investment opportunities offered to us or the number of properties that we are able to acquire. This competition may also increase the bargaining power of property owners seeking to sell to us, making it more difficult for us to acquire new properties on attractive terms.

 

The seasonality of the lodging industry may cause fluctuations in our quarterly revenues that cause us to borrow money to fund distributions to our shareholders.

 

The lodging industry is seasonal in nature. This seasonality can be expected to cause quarterly fluctuations in our revenues. Our quarterly earnings may be adversely affected by factors outside our control, including weather conditions and poor economic factors. As a result, we may have to enter into short-term borrowings in certain quarters in order to offset these fluctuations in revenues and to make distributions to our shareholders.

 

The cyclical nature of the lodging industry may cause the returns from our investments to be less than we expect.

 

The lodging industry is highly cyclical in nature. Fluctuations in lodging demand and, therefore, hotel operating performance, are caused largely by general economic and local market conditions, which subsequently affect levels of business and leisure travel. In addition to general economic conditions, new hotel room supply is an important factor that can affect lodging industry fundamentals, and overbuilding has the potential to further exacerbate the negative impact of an economic recession. Room rates and occupancy, and thus RevPAR, tend to increase when demand growth exceeds supply growth. Although we believe that cyclical supply growth peaked in late 2008 to early 2009, and that lodging demand will continue to rebound in 2010 and into 2011, no assurances can be given that this will prove to be the case. A decline in lodging demand, or a continued growth in lodging supply, could result in continued deterioration in lodging industry fundamentals and returns that are substantially below expectations, or result in losses, which could adversely affect our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

 

Capital expenditure requirements at our properties may be costly and require us to incur debt, postpone improvements, reduce distributions or otherwise adversely affect the results of our operations and the market price of our common shares.

 

Some of the hotel properties we acquire may have a need for renovations and capital improvements at the time of acquisition and all of our hotel properties will have an ongoing need for renovations and other capital improvements, including replacement, from time to time, of furniture, fixtures and equipment. The franchisors of our hotel properties will also require periodic capital improvements as a condition to our maintaining the franchise licenses. In

addition, if we incur additional indebtedness, as we intend to do in the future, our lenders will likely require that we set aside annual amounts for capital improvements to our hotel properties. These capital improvements may give rise to the following risks:

 

 

The costs of renovations and capital improvements could adversely affect our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

 

Hotel and resort development and redevelopment is subject to timing, budgeting and other risks that may adversely affect our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

 

Though not currently intended to be a primary focus of our investment strategy, we may engage in hotel development and redevelopment if suitable opportunities arise. Hotel development and redevelopment involves a number of risks, including risks associated with:

 

 

We cannot assure you that any development or redevelopment project will be completed on time or within budget. Our inability to complete a project on time or within budget could adversely affect our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

The increasing use of Internet travel intermediaries by consumers may reduce our revenues.

 

Some of our hotel rooms are booked through Internet travel intermediaries, such as Travelocity.com, Expedia.com, Priceline.com and Hotels.com. As these Internet bookings increase, these intermediaries may be able to obtain higher commissions, reduced room rates or other significant contract concessions from the management companies that operate our hotels. Moreover, some of these Internet travel intermediaries are attempting to offer hotel rooms as a commodity, by increasing the importance of price and general indicators of quality (such as “three-star downtown hotel”), at the expense of brand identification or quality of product or service. These intermediaries hope that consumers will eventually develop brand loyalties to their reservations system rather than to lodging brands or properties. If the amount of bookings made through Internet travel intermediaries proves to be more significant than we expect, room revenues may be lower than expected, and our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders may be adversely affected.

 

We may be adversely affected by increased use of business related technology which may reduce the need for business related travel.

 

The increased use of teleconference and video-conference technology by businesses could result in decreased business travel as companies increase the use of technologies that allow multiple parties from different locations to participate at meetings without traveling to a centralized meeting location. To the extent that such technologies play an increased role in day-to-day business and the necessity for business related travel decreases, hotel room demand may decrease and our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders may be adversely affected.

 

Future terrorist attacks or changes in terror alert levels could adversely affect travel and hotel demand.

 

Previous terrorist attacks and subsequent terrorist alerts have adversely affected the U.S. travel and hospitality industries over the past several years, often disproportionately to the effect on the overall economy. The impact that terrorist attacks in the U.S. or elsewhere could have on domestic and international travel and our business in particular cannot be determined but any such attacks or the threat of such attacks could have a material adverse effect on our business, our ability to finance our business, our ability to insure our properties and our results of operations and financial condition.

 

The outbreak of influenza or other widespread contagious disease could reduce travel and adversely affect hotel demand.

 

The widespread outbreak of infectious or contagious disease in the U.S., such as the H1N1 virus, could reduce travel and adversely affect the hotel industry generally and our business in particular.

 

Uninsured and underinsured losses could result in a loss of capital.

 

We intend to maintain comprehensive insurance on each of our hotel properties, including liability, fire and extended coverage, of the type and amount we believe are customarily obtained for or by hotel owners. There are no assurances that coverage will be available at reasonable rates. Various types of catastrophic losses, such as losses caused by earthquakes, floods and terrorist activities may not be insurable or may not be economically insurable.

In the event of a substantial loss, our insurance coverage may not be sufficient to cover the full current market value or replacement cost of our lost investment. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a hotel property, as well as the anticipated future revenue from the property. In that event, we might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property. Inflation, changes in building codes and ordinances, environmental considerations and other factors might also keep us from using insurance proceeds to replace or renovate a hotel after it has been damaged or destroyed. Under those circumstances, the insurance proceeds we receive might be inadequate to restore our economic position on the damaged or destroyed property.

 

Our hotels may be subject to unknown or contingent liabilities which could cause us to incur substantial costs.

 

Our hotel properties may be subject to unknown or contingent liabilities for which we may have no recourse, or only limited recourse, against the sellers. In general, the representations and warranties provided under the transaction agreements related to the sales of the hotel properties may not survive the closing of the transactions. While we will likely seek to require the sellers to indemnify us with respect to breaches of representations and warranties that survive, such indemnification may be limited and subject to various materiality thresholds, a significant deductible or an aggregate cap on losses. As a result, there is no guarantee that we will recover any amounts with respect to losses due to breaches by the sellers of their representations and warranties. In addition, the total amount of costs and expenses that may be incurred with respect to liabilities associated with these hotels may exceed our expectations, and we may experience other unanticipated adverse effects, all of which may adversely affect our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

 

Noncompliance with environmental laws and regulations could subject us to fines and liabilities which could adversely affect our operating results.

 

Our hotel properties are subject to various federal, state and local environmental laws. Under these laws, courts and government agencies have the authority to require us, as owner of a contaminated property, to clean up the property, even if we did not know of or were not responsible for the contamination. These laws also apply to persons who owned a property at the time it became contaminated, and therefore it is possible we could incur cleanup costs even after we sell some of our hotel properties. In addition to the costs of cleanup, environmental contamination can affect the value of a property and, therefore, an owner’s ability to borrow funds using the property as collateral or to sell the property. Under the environmental laws, courts and government agencies also have the authority to require that a person who sent waste to a waste disposal facility, such as a landfill or an incinerator, pay for the clean-up of that facility if it becomes contaminated and threatens human health or the environment. A person that arranges for the disposal or transports for disposal or treatment of a hazardous substance at a property owned by another may be liable for the costs of removal or remediation of hazardous substances released into the environment at that property.

 

Furthermore, various court decisions have established that third parties may recover damages for injury caused by property contamination. For instance, a person exposed to asbestos while staying in a hotel may seek to recover damages if he or she suffers injury from the asbestos. Lastly, some of these environmental laws restrict the use of a property or place conditions on various activities. An example would be laws that require a business using chemicals (such as swimming pool chemicals at a hotel property) to manage them carefully and to notify local officials that the chemicals are being used.

We could be responsible for any of the costs discussed above. The costs to clean up a contaminated property, to defend against a claim, or to comply with environmental laws could be material and could adversely affect our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

 

As a result, we may become subject to material environmental liabilities. We can make no assurances that future laws or regulations will not impose material environmental liabilities or that the current environmental condition of our hotel properties will not be affected by the condition of the properties in the vicinity of our hotel properties (such as the presence of leaking underground storage tanks) or by third parties unrelated to us.

 

Compliance with the Americans with Disabilities Act could require us to incur substantial costs.

 

Under the Americans with Disabilities Act of 1990, or the ADA, all public accommodations must meet various federal requirements related to access and use by disabled persons. Compliance with the ADA’s requirements could require removal of access barriers, and non-compliance could result in the U.S. government imposing fines or in private litigants winning damages.

 

In June 2008, the Department of Justice proposed a substantial number of changes to the Accessibility Guidelines under the ADA. In January 2009, President Obama suspended final publication and implementation of these regulations, pending a comprehensive review by his administration. If implemented as proposed, the new guidelines could cause some of our hotel properties to incur costly measures to become fully compliant.

 

If we are required to make substantial modifications to our hotel properties, whether to comply with the ADA or other changes in governmental rules and regulations, our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders could be adversely affected.

 

General Risks Related to the Real Estate Industry

 

Illiquidity of real estate investments could significantly impede our ability to sell hotels or otherwise respond to adverse changes in the performance of our hotel properties.

 

Because real estate investments are relatively illiquid, our ability to promptly sell one or more hotel properties for reasonable prices in response to changing economic, financial and investment conditions will be limited. The real estate market is affected by many factors beyond our control, including:

 

 

 

Additionally, our assumption of the ground lease with respect to the Hotel Monaco Washington DC, which we currently have under contract to purchase, requires the consent of the U.S. government, as ground lessor, and any sale of that hotel would require the consent of the U.S. government. This consent requirement may make it more difficult or expensive to sell or finance the Hotel Monaco Washington DC.

 

We may decide to sell hotel properties in the future. We cannot predict whether we will be able to sell any hotel property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a hotel property.

 

We may be required to expend funds to correct defects or to make improvements before a hotel property can be sold. We cannot assure you that we will have funds available to correct those defects or to make those improvements. In acquiring a hotel property, we may agree to lock-out provisions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. These factors and any others that would impede our ability to respond to adverse changes in the performance of the hotel properties or a need for liquidity could adversely affect our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

 

Increases in property taxes would increase our operating costs, reduce our income and adversely affect our ability to make distributions to our shareholders.

 

Each of our hotel properties is subject to real and personal property taxes. These taxes may increase as tax rates change and as the properties are assessed or reassessed by taxing authorities. If property taxes increase, our financial condition, results of operations and our ability to make distributions to our shareholders could be materially and adversely affected and the market price of our common shares could decline.

 

The costs of compliance with or liabilities under environmental laws could significantly reduce our profitability.

 

Operating expenses at our hotels could be higher than anticipated due to the cost of complying with existing or future environmental laws and regulations. In addition, an owner of real property can face liability for environmental contamination created by the presence or discharge of hazardous substances on the property. We may face liability regardless of:

 

 

Environmental laws also impose ongoing compliance requirements on owners and operators of real property. Environmental laws potentially affecting us address a wide variety of matters, including, but not limited to, asbestos-containing building materials, storage tanks, storm water and wastewater discharges, lead-based paint, mold/mildew and hazardous wastes. Failure to

comply with these laws could result in fines and penalties and/or expose us to third-party liability. Some of our properties may have conditions that are subject to these requirements, and we could be liable for such fines or penalties and/or liable to third parties, as described below in “Our Business — Environmental Matters.”

 

Certain of our hotel properties may contain, or may have contained, asbestos-containing building materials, or ACBMs. Environmental laws require that ACBMs be properly managed and maintained, and may impose fines and penalties on building owners and operators for failure to comply with these requirements. Also, certain properties may be adjacent or near other properties that have contained or currently contain storage tanks for the storage of petroleum products or other hazardous or toxic substances. These operations create a potential for the release of petroleum products or other hazardous or toxic substances. Third parties may be permitted by law to seek recovery from owners or operators for property damage and/or personal injury associated with exposure to contaminants, including, but not limited to, petroleum products, hazardous or toxic substances and asbestos fibers.

 

We have obtained Phase I environmental site assessments, or ESAs, on our hotel properties and expect to do so for all of the hotel properties we acquire in the future. ESAs are intended to evaluate information regarding the environmental condition of the surveyed property and surrounding properties based generally on visual observations, interviews and certain publicly available databases. These assessments do not typically take into account all environmental issues including, but not limited to, testing of soil or groundwater or the possible presence of asbestos, lead-based paint, radon, wetlands or mold. As a result, these assessments may fail to reveal all environmental conditions, liabilities or compliance concerns. Material environmental conditions, liabilities or compliance concerns may arise after the ESAs; and future laws, ordinances or regulations may impose material additional environmental liability. We cannot assure you that costs of future environmental compliance will not affect our ability to make distributions to our shareholders or that such costs or other remedial measures will not be material to us.

 

The presence of hazardous substances on a property may limit our ability to sell the property on favorable terms or at all, and we may incur substantial remediation costs. The discovery of material environmental liabilities at our properties could subject us to unanticipated significant costs, which could significantly reduce our profitability and the cash available for distribution to our shareholders.

 

Our properties may contain or develop harmful mold, which could lead to liability for adverse health effects and costs of remediating the problem.

 

When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Concern about indoor exposure to mold has been increasing as exposure to mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions. Some of our properties may contain microbial matter such as mold and mildew. The presence of significant mold at any of our properties could require us to undertake a costly remediation program to contain or remove the mold from the affected property. The presence of significant mold could expose us to liability from hotel guests, hotel employees and others if property damage or health concerns arise.

Any mortgage debt obligations we incur will expose us to increased risk of property losses to foreclosure, which could adversely affect our financial condition, cash flow and ability to satisfy our other debt obligations and make distributions to our shareholders.

 

Incurring mortgage debt increases our risk of property losses, because any defaults on indebtedness secured by properties may result in foreclosure actions initiated by lenders and ultimately our loss of the property securing the loan for which we are in default. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure but would not receive any cash proceeds. As a result, we may be required to identify and utilize other sources of cash for distributions to our shareholders of that income.

 

In addition, any default under our mortgage debt obligations may increase the risk of our default on other indebtedness. If this occurs, our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders may be adversely affected.

 

Risks Related to Our Organization and Structure

 

Provisions of our declaration of trust may limit the ability of a third party to acquire control of us by authorizing our board of trustees to authorize issuances of additional securities.

 

Our declaration of trust authorizes our board of trustees to cause us to issue up to 500,000,000 common shares and up to 100,000,000 preferred shares. In addition, our board of trustees may, without shareholder approval, amend our declaration of trust to increase the aggregate number of shares or the number of shares of any class or series that we have the authority to issue and to classify or reclassify any unissued common shares or preferred shares and to set the preferences, rights and other terms of the classified or reclassified shares. As a result, our board of trustees may authorize the issuance of additional shares or establish a series of common or preferred shares that may have the effect of delaying or preventing a change in control of our company, including transactions at a premium over the market price of our shares, even if shareholders believe that a change of control is in their interest.

 

Provisions of Maryland law may limit the ability of a third party to acquire control of us by requiring our board of trustees or shareholders to approve proposals to acquire our company or effect a change of control.

 

Certain provisions of the Maryland General Corporation Law, or the MGCL, applicable to Maryland real estate investment trusts may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could provide our common shareholders with the opportunity to realize a premium over the then-prevailing market price of such shares, including:

 

 

 

By resolution of our board of trustees, we have opted out of the business combination provisions of the MGCL and provided that any business combination between us and any other person is exempt from the business combination provisions of the MGCL, provided that the business combination is first approved by our board of trustees (including a majority of trustees who are not affiliates or associates of such persons). Pursuant to a provision in our bylaws, we have opted out of the control share provisions of the MGCL. However, our board of trustees may by resolution elect to opt in to the business combination provisions of the MGCL and we may, by amendment to our bylaws, opt in to the control share provisions of the MGCL in the future.

 

Additionally, Title 8, Subtitle 3 of the MGCL permits our board of trustees, without shareholder approval and regardless of what is currently provided in our declaration of trust or bylaws, to implement certain takeover defenses, such as a classified board, some of which we do not yet have. These provisions may have the effect of inhibiting a third party from making an acquisition proposal for us or of delaying, deferring or preventing a change in control of us under the circumstances that otherwise could provide our common shareholders with the opportunity to realize a premium over the then current market price.

 

The ownership limitations in our declaration of trust may restrict or prevent you from engaging in certain transfers of our common shares.

 

In order for us to qualify and remain qualified as a REIT, no more than 50 percent in value of our outstanding shares of beneficial interest may be owned, directly or indirectly, by five or fewer individuals (as defined in the federal income tax laws to include various kinds of entities) during the last half of any taxable year. To assist us in qualifying as a REIT, our declaration of trust contains a share ownership limit. Generally, any of our shares owned by affiliated owners will be added together for purposes of the share ownership limit.

 

If anyone transfers shares in a way that would violate the share ownership limit or prevent us from qualifying as a REIT under the federal income tax laws, those shares instead will be transferred to a trust for the benefit of a charitable beneficiary and will be either redeemed by us or sold to a person whose ownership of the shares will not violate the share ownership limit or we will consider the transfer to be null and void from the outset, and the intended transferee of those shares will be deemed never to have owned the shares. Anyone who acquires shares in violation of the share ownership limit or the other restrictions on transfer in our declaration of trust bears the risk of suffering a financial loss when the shares are redeemed or sold if the market price of our shares falls between the date of purchase and the date of redemption or sale.

 

In addition, these ownership limitations may prevent an acquisition of control of us by a third party without our board of trustees’ approval, even if our shareholders believe the change of control is in their interest.

Our rights and the rights of our shareholders to take action against our trustees and officers are limited, which could limit your recourse in the event of actions not in your best interests.

 

Under Maryland law, generally, a trustee’s actions will be upheld if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. In addition, our declaration of trust limits the liability of our trustees and officers to us and our shareholders for money damages, except for liability resulting from:

 

 

Our declaration of trust authorizes us to indemnify our trustees and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. Our bylaws require us to indemnify each trustee or officer, to the maximum extent permitted by Maryland law, in the defense of any proceeding to which he or she is made, or threatened to be made, a party by reason of his or her service to us. In addition, we may be obligated to fund the defense costs incurred by our trustees and officers. As a result, we and our shareholders may have more limited rights against our trustees and officers than might otherwise exist absent the current provisions in our declaration of trust and bylaws or that might exist with other companies.

 

Our declaration of trust contains provisions that make removal of our trustees difficult, which could make it difficult for our shareholders to effect changes to our management.

 

Our declaration of trust provides that a trustee may be removed only for cause (as defined in our declaration of trust) and then only by the affirmative vote of at least two-thirds of the votes entitled to be cast generally in the election of trustees. Our declaration of trust also provides that vacancies on our board of trustees may be filled only by a majority of the remaining trustees in office, even if less than a quorum. These requirements prevent shareholders from removing trustees except for cause and with a substantial affirmative vote and from replacing trustees with their own nominees and may prevent a change in control of our company that is in the best interests of our shareholders.

 

The ability of our board of trustees to change our major policies without the consent of shareholders may not be in your interest.

 

Our board of trustees determines our major policies, including policies and guidelines relating to our acquisitions, leverage, financing, growth, operations and distributions to shareholders. Our board may amend or revise these and other policies and guidelines from time to time without the vote or consent of our shareholders. Accordingly, our shareholders will have limited control over changes in our policies and those changes could adversely affect our financial condition, results of operations, the market price of our common shares and our ability to make distributions to our shareholders.

 

We have entered into an agreement with each of our executive officers that requires us to make payments in the event the officer’s employment is terminated by us without cause, by the officer for good reason or under certain circumstances following a change of control of our company.

 

The agreements that we have entered into with our executive officers provide benefits under certain circumstances that could make it more difficult for us to terminate these officers and may

prevent or deter a change of control of our company that would otherwise be in the interest of our shareholders. See “Change in Control Severance Agreements, Equity Award Vesting and Other Termination Policies.”

 

If we fail to implement and maintain an effective system of internal controls, we may not be able to accurately determine our financial results or prevent fraud. As a result, our shareholders could lose confidence in our financial results, which could harm our business and the value of our common shares.

 

Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. We are a recently formed company that is developing financial and operational reporting and control systems. We may in the future discover areas of our internal controls that need improvement. Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal controls over financial reporting, and have our independent auditors annually issue their own opinion on our internal controls over financial reporting. While we intend to undertake substantial work to prepare for compliance with Section 404, we cannot be certain that we will be successful in implementing or maintaining adequate internal controls over our financial reporting and financial processes. Furthermore, as we grow our business, our internal controls will become more complex, and we will require significantly more resources to ensure our internal controls remain effective. If we or our independent auditors discover a material weakness, the disclosure of that fact, even if quickly remedied, could reduce the market value of our common shares. Additionally, the existence of any material weakness or significant deficiency would require management to devote significant time and incur significant expense to remediate any such material weaknesses or significant deficiencies and management may not be able to remediate any such material weaknesses or significant deficiencies in a timely manner.

 

Risks Related to This Offering

 

We have not established a minimum distribution payment level and we may be unable to generate sufficient cash flows from our operations to make distributions to our shareholders at any time in the future.

 

We are required to distribute to our shareholders at least 90 percent of our REIT taxable income each year for us to qualify as a REIT under the Code. To the extent we satisfy the 90 percent distribution requirement but distribute less than 100 percent of our REIT taxable income, we will be subject to a U.S. federal corporate income tax and potentially a U.S. federal excise tax on our undistributed taxable income. We have not established a minimum distribution payment level, and our ability to make distributions to our shareholders may be adversely affected by the risk factors described in this prospectus. Since completion of our initial public offering in December 2009, we have not made any distributions to our shareholders. We may not generate sufficient income to make distributions to our shareholders and cannot predict when distributions will commence. We currently do not expect to use the net proceeds from this offering to make distributions to our shareholders. However, to the extent we do so, the amount of cash we have available to invest in hotel properties or for other purposes would be reduced. Our board of trustees has the sole discretion to determine the timing, form and amount of any distributions to our shareholders. The amount of such distributions may be limited until we have a larger portfolio of income-generating hotel properties. Our board of trustees will make determinations regarding distributions based upon, among other factors, our financial performance, any debt service obligations, any debt covenants, and capital expenditure

requirements. Among the factors that could impair our ability to make distributions to our shareholders are:

 

 

As a result, no assurance can be given that we will be able to make distributions to our shareholders at any time in the future or that the level of any distributions we do make to our shareholders will increase or even be maintained over time, any of which could materially and adversely affect the market price of our common shares.

 

In addition, distributions that we make to our shareholders generally will be taxable to our shareholders as ordinary income. However, a portion of our distributions may be designated by us as long-term capital gains to the extent that they are attributable to capital gain income recognized by us or may constitute a return of capital to the extent that they exceed our accumulated earnings and profits as determined for tax purposes. A return of capital is not taxable, but has the effect of reducing the tax basis of a shareholder’s investment in our common shares.

 

The common shares issued in this offering and any common shares eligible for future sale may adversely affect the prevailing market prices for our common shares.

 

Our shares have only traded on the NYSE since December 9, 2009. Assuming the underwriters do not exercise their overallotment option, we are selling 17,000,000 of our common shares in this offering, an amount equal to 83.6% of our common shares outstanding prior to the offering. Excluding the common shares owned by our management that are subject to the lock up agreement with our underwriters, the 17,000,000 common shares being offered will represent approximately 45.8% of the common shares available to trade after this offering. Also, the three month average trading volume in our common shares as reported by the NYSE as of July 19, 2010 was only 213,961 shares per day. We cannot predict the effect, if any, of this offering or of future sales of common shares, or the availability of common shares for future sale, on the market price of our common shares. Sales of substantial amounts of common shares (including shares issued to our trustees and officers), or the perception that these sales could occur, may adversely affect the liquidity of the market for our common shares or prevailing market prices for our common shares. Large price changes or low volume may preclude you from buying or selling our common shares at all, or at any particular price or during a time frame that satisfies your investment objectives.

 

Each of our trustees and officers has entered into lock-up agreements with respect to their common shares, restricting the sale of their shares, for 120 days. The representatives, at any time, may release all or a portion of the common shares subject to the foregoing lock-up provisions. If the restrictions under such agreements are waived, the affected common shares may be available for sale into the market, which could reduce the market price for our common shares.

 

We also may issue from time to time additional common shares or limited partnership interests in our operating partnership in connection with the acquisition of properties and we may grant demand or piggyback registration rights in connection with these issuances. Sales of

substantial amounts of our common shares or the perception that these sales could occur may adversely affect the prevailing market price for our common shares or may impair our ability to raise capital through a sale of additional equity securities.

 

This offering may be dilutive.

 

Giving effect to the issuance of common shares in this offering, which may include shares issued pursuant to a full or partial exercise by the underwriters of their overallotment option, the receipt of the expected net proceeds and the use of those proceeds, this offering may have a dilutive effect on our expected earnings per share. The actual amount of any dilution cannot be determined at this time and will be based on numerous factors.

 

Future offerings of debt or equity securities ranking senior to our common shares may limit our operating and financial flexibility and may adversely affect the market price of our common shares.

 

If we decide to issue debt or equity securities in the future ranking senior to our common shares or otherwise incur indebtedness, it is possible that these securities or indebtedness will be governed by an indenture or other instrument containing covenants restricting our operating flexibility and limiting our ability to make distributions to our shareholders. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges, including with respect to distributions, more favorable than those of our common shares and may result in dilution to owners of our common shares. Because our decision to issue debt or equity securities in any future offering or otherwise incur indebtedness 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 or financings, any of which could reduce the market price of our common shares and dilute the value of our common shares.

 

The market price of our common shares may be volatile due to numerous circumstances beyond our control.

 

The trading prices of equity securities issued by REITs historically have been affected by changes in market interest rates. One of the factors that may influence the price of our common shares is the annual yield from distributions on our common shares as compared to yields on other financial instruments. An increase in market interest rates, or a decrease in our distributions to shareholders, may lead prospective purchasers of our common shares to demand a higher annual yield, which could reduce the market price of our common shares.

 

Other factors that could affect the market price of our common shares include the following:

 

 

 

Federal Income Tax Risk Factors

 

Our failure to qualify, or to remain qualified, as a REIT would result in higher taxes and reduced cash available for distribution to our shareholders.

 

We intend to elect to be taxed as a REIT for federal income tax purposes commencing with our short taxable year ended December 31, 2009 upon the filing of our federal income tax return for that year. However, qualification as a REIT involves the application of highly technical and complex provisions of the Code, for which only a limited number of judicial and administrative interpretations exist. Even an inadvertent or technical mistake could jeopardize our REIT qualification. Our qualification as a REIT depends on our satisfaction of certain asset, income, organizational, distribution, shareholder ownership and other requirements on a continuing basis.

 

Moreover, new tax legislation, administrative guidance or court decisions, in each instance potentially applicable with retroactive effect, could make it more difficult or impossible for us to qualify as a REIT. If we were to fail to qualify as a REIT in any taxable year, we would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and distributions to shareholders would not be deductible by us in computing our taxable income. Any such corporate tax liability could be substantial and would reduce the amount of cash available for distribution to our shareholders, which in turn could have an adverse impact on the value of our shares. If, for any reason, we failed to qualify as a REIT and we were not entitled to relief under certain Code provisions, we would be unable to elect REIT status for the four taxable years following the year during which we ceased to so qualify which would negatively impact the value of our common shares.

 

Failure to make required distributions would subject us to tax, which would reduce the cash available for distribution to our shareholders.

 

To qualify and maintain our qualification as a REIT, we must distribute to our shareholders each calendar year at least 90 percent of our REIT taxable income (including certain items of non-cash income), determined before the deduction for dividends paid and excluding any net capital gain. To the extent that we satisfy the 90 percent distribution requirement, but distribute less than 100 percent of our REIT taxable income, we will be subject to federal corporate income tax on our undistributed income. In addition, we will incur a 4 percent nondeductible excise tax on the amount, if any, by which our distributions in any calendar year are less than the sum of:

 

 

We intend to distribute our REIT taxable income to our shareholders in a manner intended to satisfy the 90 percent distribution requirement and to avoid both corporate income tax and the 4 percent nondeductible excise tax. However, there is no requirement that TRSs distribute their after tax net income to their parent REIT or their shareholders.

 

Our REIT taxable income may substantially exceed our net income as determined based on U.S. generally accepted accounting principles, or GAAP, because, for example, realized capital losses will be deducted in determining our GAAP net income, but may not be deductible in computing our REIT taxable income. 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 properties at prices or at times that we regard as unfavorable in order to pay out enough of our REIT taxable income to satisfy the distribution requirement and to avoid corporate income tax and the 4 percent nondeductible excise tax in a particular year.

 

Under recently issued Internal Revenue Service, or IRS, guidance, we may pay taxable dividends of our common shares and cash, in which case shareholders may sell our common shares to pay tax on such dividends, placing downward pressure on the market price of our common shares.

 

Under recently issued IRS guidance, we may distribute taxable dividends that are payable in cash and common shares at the election of each shareholder. Under Revenue Procedure 2010-12, up to 90 percent of any such taxable dividend paid with respect to our 2010 and 2011 taxable years could be payable in our common shares. Taxable shareholders receiving such dividends will be required to include the full amount of the dividend as ordinary income to the extent of our current and accumulated earnings and profits, as determined for federal income tax purposes. As a result, shareholders may be required to pay income tax with respect to such dividends in excess of the cash dividends received. If a U.S. shareholder sells the common shares that it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our common shares at the time of the sale. Furthermore, with respect to certain non-U.S. shareholders, we may be required to withhold U.S. federal income tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in common shares. If we utilize Revenue Procedure 2010-12 and a significant number of our shareholders determine to sell our common shares in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our common shares.

 

Our TRS lessees increase our overall tax liability.

 

Our TRS lessees are subject to federal and state income tax on their taxable income, which will consist of the revenues from the hotel properties leased by our TRS lessees, net of the operating expenses (including management fees) for such hotel properties and rent payments to us. Accordingly, although our ownership of our TRS lessees will allow us to participate in the operating income from our hotel properties in addition to receiving rent, that operating income will be fully subject to income tax. The after-tax net income of our TRS lessees is available for distribution to us.

 

Our ownership of TRSs is limited and our transactions with TRSs will cause us to be subject to a 100 percent penalty tax on certain income or deductions if those transactions are not conducted on arm’s-length terms.

 

A REIT may own up to 100 percent of the stock of one or more TRSs. A TRS may hold assets and earn income that would not be qualifying assets or income if held or earned directly by a REIT, including gross operating income from hotel operations pursuant to hotel management

contracts. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35 percent of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 25 percent of the value of a REIT’s assets may consist of stock or securities of one or more TRSs. 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. The rules also impose a 100 percent excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis.

 

Our TRSs are subject to applicable federal, foreign, state and local income tax on their taxable income, and their after-tax net income will be available for distribution to us but is not required to be distributed to us. We believe that the aggregate value of the stock and securities of our TRSs is and will continue to be less than 25 percent of the value of our total assets (including our TRS stock and securities). Furthermore, we will monitor the value of our respective investments in our TRSs for the purpose of ensuring compliance with TRS ownership limitations. In addition, we will scrutinize all of our transactions with our TRSs to ensure that they are entered into on arm’s-length terms to avoid incurring the 100 percent excise tax described above. There can be no assurance, however, that we will be able to comply with the 25 percent limitation discussed above or to avoid application of the 100 percent excise tax discussed above.

 

If the leases of our hotel properties to our TRS lessees are not respected as true leases for federal income tax purposes, we would fail to qualify as a REIT and would be subject to higher taxes and have less cash available for distribution to our shareholders.

 

To qualify as a REIT, we must satisfy two gross income tests, under which specified percentages of our gross income must be derived from certain sources, such as “rents from real property.” Rents paid to our operating partnership by our TRS lessees pursuant to the lease of our hotel properties will constitute substantially all of our gross income. In order for such rent to qualify as “rents from real property” for purposes of the gross income tests, the leases must be respected as true leases for federal income tax purposes and not be treated as service contracts, joint ventures or some other type of arrangement. If our leases are not respected as true leases for federal income tax purposes, we would fail to qualify as a REIT.

 

If our operating partnership failed to qualify as a partnership for federal income tax purposes, we would cease to qualify as a REIT and would be subject to higher taxes and have less cash available for distribution to our shareholders and suffer other adverse consequences.

 

We believe that our operating partnership qualifies to be treated as a partnership for federal income tax purposes. As a partnership, our operating partnership is not subject to federal income tax on its income. Instead, each of its partners, including us, is required to pay tax on its allocable share of the operating partnership’s income. No assurance can be provided, however, that the IRS, will not challenge its status as a partnership for federal income tax purposes, or that a court would not sustain such a challenge. If the IRS were successful in treating our operating partnership as a corporation for tax purposes, we would fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, cease to qualify as a REIT. Also, the failure of our operating partnership to qualify as a partnership would cause it to become subject to federal and state corporate income tax, which would reduce significantly the amount of cash available for debt service and for distribution to its partners, including us.

If our hotel managers do not qualify as “eligible independent contractors,” we would fail to qualify as a REIT and would be subject to higher taxes and have less cash available for distribution to our shareholders.

 

Rent paid by a lessee that is a “related party tenant” of ours will not be qualifying income for purposes of the two gross income tests applicable to REITs. We lease all of our hotels to our TRS lessees. A TRS lessee will not be treated as a “related party tenant” with respect to our properties that are managed by an independent hotel management company that qualifies as an “eligible independent contractor.” We believe that our TRSs will qualify to be treated as TRSs for federal income tax purposes, but there can be no assurance that the IRS will not challenge the status of a TRS for federal income tax purposes or that a court would not sustain such a challenge. If the IRS were successful in disqualifying any of our TRSs lessees from treatment as a TRS, it is possible that we would fail to meet the asset tests applicable to REITs and substantially all of our income would fail to qualify for the gross income tests. If we failed to meet either the asset or gross income tests, we would likely lose our REIT qualification for federal income tax purposes.

 

Additionally, if our hotel managers do not qualify as “eligible independent contractors,” we would fail to qualify as a REIT. Each of the hotel management companies that enter into a management contract with our TRS lessees must qualify as an “eligible independent contractor” under the REIT rules in order for the rent paid to us by our TRS lessees to be qualifying income for purposes of the REIT gross income tests. Among other requirements, in order to qualify as an eligible independent contractor a manager must not own, directly or through its shareholders, more than 35 percent of our outstanding shares, taking into account certain ownership attribution rules. The ownership attribution rules that apply for purposes of these 35 percent thresholds are complex. Although we intend to monitor ownership of our shares by our hotel managers and their owners, there can be no assurance that these ownership levels will not be exceeded.

 

Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.

 

The maximum tax rate applicable to income from “qualified dividends” payable to U.S. shareholders that are individuals, trusts and estates has been reduced by legislation to 15 percent (through the end of 2010). Dividends payable by REITs, however, generally are not eligible for the reduced rates. Although this legislation does not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our common shares.

 

Complying with REIT requirements may limit our ability to hedge our liabilities effectively and may cause us to incur tax liabilities.

 

The REIT provisions of the Code substantially limit our ability to hedge our liabilities. Any income from a hedging transaction we enter into to manage risk of interest rate changes, price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets does not constitute “gross income” for purposes of the 75 percent or 95 percent gross income tests. To the extent that we enter into other types of hedging transactions, the income from those transactions is likely to be treated as non-qualifying income for purposes of both of the gross income tests. See “Material Federal Income Tax Considerations — Gross Income Tests — Hedging Transactions.” As a result of these rules, we may need to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities because our TRS would be subject to

tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in our TRSs will generally not provide any tax benefit, except for being carried forward against future taxable income in the TRSs.

 

Complying with REIT requirements may cause us to forego otherwise attractive business opportunities or liquidate otherwise attractive investments.

 

To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our shareholders and the ownership of our shares of beneficial interest. In order to meet these tests, we may be required to forego investments we might otherwise make. Thus, compliance with the REIT requirements may hinder our performance.

 

In particular, we must ensure that at the end of each calendar quarter, at least 75 percent of the value of our assets consists of cash, cash items, government securities and qualified real estate assets. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10 percent of the outstanding voting securities of any one issuer or more than 10 percent of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5 percent of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 25 percent of the value of our total assets can be represented by the securities of one or more TRSs. The Code provides that temporary investments of new capital in stock or debt instruments for the period of one year beginning on the date on which we receive the new capital will be considered qualified real estate assets for purposes of the above requirements. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our shareholders.

 

The ability of our board of trustees to revoke our REIT qualification without shareholder approval may subject us to federal and state income tax and reduce distributions to our shareholders.

 

Our declaration of trust provides that our board of trustees may revoke or otherwise terminate our REIT election, without the approval of our shareholders, if it determines that it is no longer in our best interest to continue to qualify as a REIT. If we cease to be a REIT, we would become subject to federal income tax on our taxable income and would no longer be required to distribute most of our taxable income to our shareholders, which may have adverse consequences on our total return to our shareholders and on the market price of our common shares.

 

We may be subject to adverse legislative or regulatory tax changes that could increase our tax liability, reduce our operating flexibility and reduce the market price of our common shares.

 

At any time, the federal income tax laws governing REITs or the administrative and judicial interpretations of those laws may be amended. We cannot predict when or if any new federal income tax law, regulation, or administrative and judicial interpretation, or any amendment to any existing federal income tax law, regulation or administrative or judicial interpretation, will be adopted, promulgated or become effective and any such law, regulation, or interpretation may

take effect retroactively. We and our shareholders could be adversely affected by any such change in, or any new, federal income tax law, regulation or administrative and judicial interpretation.

 

The share ownership restrictions of the Code for REITs and the 9.8 percent share ownership limit in our declaration of trust may inhibit market activity in our shares of beneficial interest and restrict our business combination opportunities.

 

In order to qualify as a REIT for each taxable year after 2009, five or fewer individuals, as defined in the Code, may not own, actually or constructively, more than 50 percent in value of our issued and outstanding shares at any time during the last half of a taxable year. Attribution rules in the Code determine if any individual or entity actually or constructively owns our shares under this requirement. Additionally, at least 100 persons must beneficially own our shares during at least 335 days of a taxable year for each taxable year after 2009. To help insure that we meet these tests, our declaration of trust restricts the acquisition and ownership of our shares.

 

Our declaration of trust, with certain exceptions, authorizes our trustees to take such actions as are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our board of trustees, our declaration of trust prohibits any person from beneficially or constructively owning more than 9.8 percent (measured by value or number of shares, whichever is more restrictive) of any class or series of our shares. Our board of trustees may not grant an exemption from these restrictions to any proposed transferee whose ownership in excess of 9.8 percent of the value of our outstanding shares would result in the termination of our qualification as a REIT. These restrictions on transferability and ownership will not apply, however, if our board of trustees determines that it is no longer in our best interest to continue to qualify as a REIT.

 

These ownership limits could delay or prevent a transaction or a change in control that might involve a premium price for our common shares or otherwise be in the best interest of the shareholders.

 

If states and localities in which we own material amounts of property or conduct material amounts of business raise their income and property tax rates or amend their tax regimes in a manner that increases our state and local tax liabilities, we would have less cash available for distribution to our shareholders and the market price of our common shares could be adversely affected.

 

We and our subsidiaries may be subject to income tax by states and localities in which we conduct business. Additionally, we will be subject to property taxes in states and localities in which we own property, and our TRS lessees will be subject to state and local corporate income tax. Many states and localities are currently financially distressed as a result of the recent recession. As these states and localities seek additional sources of revenue to reduce budget deficits and otherwise improve their financial condition, they may, among other steps, raise income and property tax rates and/or amend their tax regimes to eliminate for state income tax purposes the favorable tax treatment REITs enjoy for federal income tax purposes. We cannot predict when or if any states or localities would make any such changes, or what form those changes would take. If states and localities in which we own material amounts of property or conduct material amounts of business make changes to their tax rates or tax regimes that increase our state and local tax liabilities, such increases would reduce the amount of cash available for distribution to our shareholders and could adversely affect the market price of our common shares.

 

We make forward-looking statements in this prospectus that are subject to risks and uncertainties. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. Statements regarding the following subjects are forward-looking by their nature.

 

 

The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, prospects, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. You should carefully consider this risk when you make an investment decision concerning our common shares. Additionally, the following factors could cause actual results to vary from our forward-looking statements:

 

 

 

When we use the words “will,” “will likely result,” “may,” “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend” or similar expressions, we intend to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. We are not obligated to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

We obtained certain data provided in this prospectus from publicly available materials published by JLLH, STR, Real Capital Analytics and S&P. The data was not prepared in connection with this offering.

 

We estimate that the net proceeds of this offering will be approximately $292.5 million after deducting the underwriting discount and other estimated offering expenses. If the underwriters’ overallotment option is exercised in full, our net proceeds will be approximately $336.5 million.

 

We will contribute the net proceeds of this offering to our operating partnership. Our operating partnership will invest these net proceeds in hotel properties in accordance with our investment strategy described in this prospectus and for general business purposes. Prior to the full investment of the net proceeds in hotel properties, we intend to invest the net proceeds in certificates of deposit, interest-bearing short-term investment grade securities or money-market accounts which are consistent with our intention to qualify as a REIT. Such investments may include, for example, government and government agency certificates, certificates of deposit, money-market deposit accounts, interest-bearing bank deposits and mortgage loan participations. These initial investments are expected to provide a lower net return than we will seek to achieve from investments in hotel properties.

 

Our common stock is traded on the NYSE under the symbol “PEB.” As of July 19, 2010, there were 20,344,337 shares of common stock outstanding and eight stockholders of record. On July 19, 2010, the closing price of our common shares as reported on the NYSE, was $18.02. The following table sets forth, for the periods indicated, the high and low sale prices of our common shares as reported on the NYSE. We have not declared or paid any dividends on our common shares.

 

 

 

The following table sets forth:

 

 

 

This table should be read in conjunction with the section captioned “Management’s Discussion and Analysis of Results of Operations and Financial Condition” and our historical and pro forma financial statements included elsewhere in this prospectus.

 

 

 

 

We intend to distribute at least 90% of our REIT taxable income each year (subject to certain adjustments as described below) to our shareholders in order to qualify as a REIT under the Code. We intend to make regular quarterly distributions to our common shareholders beginning at such time as our board of trustees determines that we have acquired hotels generating sufficient cash flow to do so. Since completion of our initial public offering in December 2009, we have not made any distributions to our shareholders. We cannot predict the timing of our additional hotel investments or when we will commence paying quarterly distributions.

 

In order to qualify for taxation as a REIT, we intend to make annual distributions to our shareholders of an amount at least equal to:

 

 

 

 

Generally, we expect to distribute 100% of our REIT taxable income so as to avoid the income and excise tax on undistributed REIT taxable income. However, we cannot assure you as to when we will begin to generate sufficient cash flow to make distributions to our shareholders or our ability to sustain those distributions. See “Material Federal Income Tax Considerations.” Also, the terms of our senior secured revolving credit facility may restrict our ability to make distributions to our shareholders and may prevent us from distributing 100% of our REIT taxable income.

 

Distributions will be authorized by our board of trustees and declared by us based upon a variety of factors, including:

 

 

To the extent that, in respect of any calendar year, cash available for distribution is less than our REIT taxable income, we could be required to sell assets or borrow funds to make cash distributions or make a portion of the required distribution in the form of a taxable share distribution or distribution of debt securities. In addition, prior to the time we have fully invested the net proceeds of this offering we may fund our quarterly distributions out of such net proceeds. The use of our net proceeds for distributions could adversely impact our financial results. In addition, funding our distributions from our net proceeds may constitute a return of

capital to our investors, which would have the effect of reducing each shareholder’s basis in its common shares. Income as computed for purposes of the tax rules described above will not necessarily correspond to our income as determined for financial reporting purposes.

 

The following table presents selected historical financial information as of and for the quarter ended March 31, 2010 and as of and for the year ended December 31, 2009 (since inception). The selected historical financial information as of and for the period from inception through December 31, 2009 has been derived from our historical financial statements audited by KPMG LLP, independent registered public accounting firm, whose report with respect to such financial information is included elsewhere in this prospectus. The selected historical financial information as of and for the quarter ended March 31, 2010 has been derived from our interim unaudited financial statements. These interim unaudited financial statements have been prepared on substantially the same basis as our audited consolidated financial statements and reflect all adjustments which are, in the opinion of management, necessary to provide a fair statement of our financial position as of March 31, 2010 and the results of our operations and cash flow for the interim period ended March 31, 2010. All such adjustments are of a normal recurring nature. These results are not necessarily indicative of our results for the full fiscal year. The selected historical financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements.

 

The following table presents selected pro forma consolidated balance sheet data as of March 31, 2010, which has been prepared to reflect adjustments to our historical consolidated balance sheet to illustrate the estimated effect of the following transactions as if they had occurred on March 31, 2010:

 

(i) the acquisition of the three hotel properties we currently own for approximately $262.1 million in cash and the payment of approximately $3.3 million of closing costs;

 

(ii) the acquisition of the Hotel Monaco Washington DC, which we currently have under contract, for approximately $39.0 million in cash, the assumption of approximately $35.0 million of long-term indebtedness and the payment of approximately $1.4 million of closing costs; and

 

(iii) the sale of 17,000,000 common shares in this offering at an assumed public offering price of $18.02 per share, net of the underwriting discount and offering costs.

 

The unaudited selected pro forma consolidated operating data in the table below for the quarter ended March 31, 2010, and the year ended December 31, 2009, has been prepared to illustrate the estimated effect of the transactions described in items (i) through (iii) above, assuming such transactions and our initial public offering were completed on January 1, 2009.

 

Due to the significant uncertainty regarding whether our acquisition of The Grand Hotel Minneapolis will be completed and the terms of the acquisition should it be consummated, we are not including the effects of the acquisition of that property in our pro forma financial information. See “Prospectus Summary — Recent Developments.”

 

The following selected historical and pro forma financial data should be read in conjunction with (i) our historical audited financial statements as of and for the period ended December 31, 2009 and the notes thereto appearing elsewhere in this prospectus, (ii) our historical unaudited financial statements as of and for the period ended March 31, 2010 and the notes thereto appearing elsewhere in this prospectus (iii) our unaudited pro forma financial statements and the notes thereto appearing elsewhere in this prospectus, (iv) the historical audited consolidated financial statements of the Doubletree Bethesda Hotel and Executive Meeting Center and the notes thereto appearing elsewhere in this prospectus, (v) the historical audited consolidated financial statements of the Sir Francis Drake Hotel and the notes thereto appearing elsewhere in

this prospectus, (vi) the historical audited consolidated financial statements of the InterContinental Buckhead Hotel and the notes thereto appearing elsewhere in this prospectus, (vii) the historical audited consolidated financial statements of the Hotel Monaco Washington DC and the notes thereto appearing elsewhere in this prospectus and (viii) the “Risk Factors,” “Cautionary Note Regarding Forward-Looking Statements,” and “Management’s Discussion and Analysis of Results of Operations and Financial Condition” sections in this prospectus. We have based our unaudited pro forma adjustments on available information and assumptions that we believe are reasonable. The following selected pro forma financial data is presented for information purposes only and does not purport to be indicative of our future results of operations or financial condition and should not be viewed as indicative of our future results of operations or financial condition.

 

 

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this prospectus.

 

Overview

 

On December 14, 2009, we completed our initial public offering and a concurrent private placement of our common shares, resulting in net proceeds of approximately $379.6 million, after underwriting discounts and offering costs. We owned two properties at June 30, 2010 and had three properties under contract for purchase. On July 1, 2010, we completed the acquisition of the InterContinental Buckhead Hotel. We expect to acquire the Hotel Monaco Washington DC (one of the hotel properties we have under contract for purchase), subject to obtaining lender and ground lessor consents and the satisfaction of other customary closing requirements and conditions. On June 29, 2010, we agreed with the seller of The Grand Hotel Minneapolis (one of the hotel properties we have under contract for purchase) to extend our due diligence period with respect to that hotel for an additional 30 days until July 30, 2010. Pending further due diligence with respect to this hotel, we can provide no assurance that we will elect to move forward with our purchase of this hotel or that if we do elect to move forward, that the acquisition will close or the specific terms of the acquisition. There can be no assurance that we will complete the acquisition of either The Grand Hotel Minneapolis or the Hotel Monaco Washington DC. In July 2010, we entered into a senior secured revolving credit facility to fund future acquisitions, as well as for property redevelopments, return on investment initiatives and working capital requirements. Currently, we have no outstanding borrowings under this credit facility.

 

We believe the economy has begun to recover from the recent recession with improvements in corporate profits and increases in business travel. In 2010, we expect industry demand for rooms in the U.S. to increase while supply rises to a lesser extent, resulting in an increase in occupancy. However, we also expect a decline in ADR for the U.S. hotel industry due to the weakened economic environment.

 

While we are encouraged by improvements in economic fundamentals, the unprecedented declines in operating performance experienced by the hotel industry since the recession began will continue to make it a challenging environment for hotel owners and lenders. We believe we are well-positioned to take advantage of opportunities created by this difficult operating environment by acquiring hotels in the early stages of an economic and lodging industry recovery at attractive historical valuations.

 

Results of Operations

 

Results for the initial period of our operations are not indicative of the results we expect when our investment strategy has been fully implemented. Our net loss attributable to common shareholders for the three months ended March 31, 2010 was ($599,000). We earned $977,000 in interest income on cash and short term investment balances and incurred $1,576,000 in general and administrative expenses. The general and administrative expenses primarily consist of employee compensation costs (including non-cash share-based compensation cost of $444,000), professional fees, insurance and acquisition costs.

 

Critical Accounting Policies

 

Our consolidated financial statements have been prepared in conformity with GAAP, which requires management to make estimates and assumptions that affect the reported amount of assets

and liabilities at the date of our financial statements and the reported amounts of revenues and expenses during the reporting period. While we do not believe the reported amounts would be materially different from actual amounts, application of these policies involves the exercise of judgment and the use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. We evaluate our estimates and judgments on an ongoing basis. We base our estimates on experience and on various other assumptions that are believed to be reasonable under the circumstances. The following represent certain critical accounting policies that require us to exercise our business judgment or make significant estimates:

 

Investment in Hotel Properties

 

Upon acquisition of a property, our company allocates the purchase price based on the fair value of the acquired land, building, furniture, fixtures and equipment, identifiable intangible assets, other assets and assumed liabilities. Identifiable intangible assets typically arise from contractual arrangements. Acquisition-date fair values of assets and assumed liabilities are determined based on replacement costs, appraised values, and estimated fair values using methods similar to those used by independent appraisers (e.g., discounted cash flow analysis) and that use appropriate discount and/or capitalization rates and available market information. Estimates of future cash flows are based on a number of factors, including historical operating results, known and anticipated trends, and market and economic conditions. Acquisition costs are expensed as incurred.

 

Hotel renovations and replacements of assets that improve or extend the life of the asset are recorded at cost and depreciated over their estimated useful lives. Furniture, fixtures and equipment under capital leases are carried at the present value of the minimum lease payments. Repair and maintenance costs are charged to expense as incurred.

 

Hotel properties are carried at cost and depreciated using the straight-line method over an estimated useful life of 25 to 40 years for buildings and one to 10 years for furniture, fixtures and equipment. Intangible assets arising from contractual arrangements are typically amortized over the life of the contract. Our company is required to make subjective assessments as to the useful lives and classification of properties for purposes of determining the amount of depreciation expense to reflect each year with respect to the assets. These assessments may impact our company’s results of operations.

 

Our company monitors events and changes in circumstances for indicators that the carrying value of each hotel and related assets may be impaired. If facts and circumstances support the possibility of impairment, our company will prepare an estimate of the undiscounted future cash flows, without interest charges, of the specific hotel and determine if the investment in such hotel is recoverable based on the undiscounted future cash flows. If impairment is indicated, an adjustment is made to the carrying value of the hotel to reflect the hotel at fair value. These assessments may impact the results of operations.

 

A hotel is considered held for sale when a contract for sale is entered into, a substantial, non-refundable deposit has been committed by the purchaser, and sale is expected to close.

 

Income Taxes

 

Our company elected to be taxed as a pass-through entity under subchapter S of the Code from the period of October 6, 2009 to December 11, 2009. Our company’s loss for that period was passed through to its sole shareholder. Our company revoked its subchapter S election on December 11, 2009, and intends to elect to be taxed as a REIT for federal income tax purposes

commencing with a short taxable year that began on December 12, 2009 and ended on December 31, 2009.

 

To qualify as a REIT, our company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our company’s annual REIT taxable income to our company’s shareholders and a requirement that our company cannot operate the hotels it acquires. As a REIT, our company generally will not be subject to federal income tax to the extent it distributes its taxable income to its shareholders. Our company has not recognized any deferred taxes on any temporary differences, as our company intends to be a treated as a REIT commencing on December 12, 2009.

 

Our company has formed a TRS whose wholly owned subsidiaries lease our hotels from our operating partnership. The TRS lessees have engaged independent hotel managers to operate the properties. The TRS generally is subject to federal and state income taxes and will account for such taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in earnings in the period when the new rate is enacted.

 

As of December 31, 2009, our company did not have any unrecognized tax positions and had not incurred any interest or penalties on such positions during the period presented. Interest and penalties related to unrecognized tax benefits, if any, in the future will be recognized as operating expenses.

 

Share-based Compensation

 

Our company has adopted an equity incentive plan that provides for the grant of common share options, share awards, share appreciation rights, performance units and other equity-based awards. Equity-based compensation is recognized as an expense in the financial statements and measured at the fair value of the award on the date of grant. The determination of fair value of these awards is subjective and involves significant estimates. The LTIP units were valued using a Monte Carlo simulation method model, which requires a number of assumptions including expected volatility of our company’s stock, expected dividend yield, expected term, and assumptions of whether these awards will achieve parity with other operating partnership units.

 

Fair Value of Financial Instruments

 

Fair value is determined by using available market information and appropriate valuation methodologies. The carrying amounts of our company’s financial instruments, which consist of cash and cash equivalents, investments, and accounts payable approximate fair value because of the relatively short maturities of these instruments.

 

Recent Accounting Standards

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2009-17, Consolidations (Topic 810) — Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities that requires enterprises to perform a more qualitative approach to determining whether or not a variable interest entity will need to be consolidated. This evaluation will be based on an enterprise’s ability to direct and influence the activities of a variable interest entity that most significantly impact its economic performance. It requires

ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. This accounting standard is effective for fiscal years beginning after November 15, 2009. Early adoption is not permitted. The adoption of this accounting standard did not have impact on the Company’s financial statements.

 

In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This update provides amendments to Topic 820 that will provide more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009 with early adoption permitted, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of Level 3 activity. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years with early adoption permitted. The adoption of this standard did not have impact on the Company’s financial statements.

 

Liquidity and Capital Resources

 

On December 14, 2009, we raised approximately $379.6 million, net of underwriting discounts and offering costs, in an initial public offering and concurrent private placement of our common shares. To date, we have invested approximately $262.1 million of the net proceeds from our initial public offering and concurrent private placement in hotel properties. We currently have two additional hotel properties under contract to purchase for prices aggregating approximately $110 million.

 

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 senior secured revolving credit facility. Our existing cash balances will fund our operating costs in the near term. As we acquire hotel properties, we believe that our net cash provided by operations will be adequate to fund operating requirements, pay interest on any borrowings and fund dividends in accordance with the REIT requirements of the federal income tax laws.

 

We expect to meet our long-term liquidity requirements, such as hotel property acquisitions and property redevelopment, through the net proceeds from additional issuances of common shares, issuances of preferred shares, issuances of units of limited partnership interest in our operating partnership, secured and unsecured borrowings, and cash provided by operations. The success of our business strategy may depend, in part, on our ability to access additional capital through issuances of debt and equity securities, which is dependent on favorable market conditions.

 

We intend to limit the sum of the outstanding principal amount of our consolidated net indebtedness and the liquidation preference of any outstanding preferred shares to not more than 4.5x our EBITDA for the 12-month period preceding the incurrence of such debt or the issuance of such preferred shares. Net indebtedness consists of total debt less cash and cash equivalents and investments. Compliance with this limitation will be measured at the time debt is incurred, and a subsequent decrease in EBITDA will not require us to repay debt. In addition, if we assume or incur debt in connection with our hotel acquisitions, our debt level could exceed the general limitation described above.

 

In July 2010, we entered into a senior secured revolving credit facility to fund future acquisitions, as well as for property redevelopments, return on investment initiatives and working capital requirements. Currently, we have no outstanding borrowings under this credit

facility. We intend to repay indebtedness incurred under our senior secured revolving credit facility from time to time out of cash flows from operations and from the net proceeds of issuances of additional equity and debt securities, as market conditions permit.

 

The following chart summarizes certain terms of our senior secured revolving credit facility.

 

 

 

 

In addition, the terms of our senior secured revolving credit facility may restrict our ability to make distributions to our shareholders and may prevent us from distributing 100% of our REIT taxable income.

 

Sources and Uses of Cash

 

On December 14, 2009, we raised approximately $379.6 million, net of underwriting discounts and offering costs, in an initial public offering and concurrent private placement of our common shares. At March 31, 2010, we had $302.9 million of cash and cash equivalents and $85.0 million in short-term investments. Short term investments consist of certificates of deposits which matured between June 24, 2010 and July 12, 2010. We held these funds following their maturity in our money market accounts and includes the funds in cash and cash equivalents. Since March 31, 2010, we have invested approximately $262.1 million in hotel properties and have two properties under contract to purchase at prices aggregating approximately $110 million. As of July 19, 2010, we had approximately $116.3 million of cash and cash equivalents. We accrued underwriters’ commissions of $8.1 million in connection with our initial public offering that, in accordance with the underwriting agreement relating to our initial public offering, will be payable at the time our company invests all of the net proceeds from that offering. For the three months ended March 31, 2010, we earned interest income of approximately $1.0 million and had cash flow from operations of approximately $0.4 million.

Contractual Obligations and Off-Balance Sheet Arrangements

 

As of March 31, 2010, we were under no contractual obligations and had no off-balance sheet arrangements.

 

Tax and Depreciation

 

The following table reflects certain real estate tax information for our hotel properties and the hotel properties we have under contract to purchase.

 

 

 

 

Quantitative and Qualitative Disclosures about Market Risk

 

Interest Rate Sensitivity

 

We earn interest income from cash and cash equivalents and investments. At March 31, 2010, we had $387.9 million in cash and cash equivalents and short term investments. If interest rates on our cash and cash equivalents and short term investments increase or decrease by 0.1 percent, our interest income will increase or decrease by approximately $0.4 million, respectively.

 

Our Company

 

We are an internally managed hotel investment company organized by our Chairman, President and Chief Executive Officer, Jon E. Bortz, in late 2009 to opportunistically acquire and invest in hotel properties located primarily in major United States cities, with an emphasis on the major coastal markets. As a result of construction costs and density, we believe these markets have significant barriers to entry and, as shown in historical industry data, we believe these markets will experience the most robust recovery in meeting and room-night demand as the U.S. economy improves. In addition, we may invest in resort properties located near our primary urban target markets, as well as in select destination markets such as Hawaii, south Florida and southern California. We seek geographic diversity in our investments, although attractive opportunities are more important than geographic mix in our investment activity. We focus on full-service hotel properties in the “upper upscale” segment of the lodging industry as defined by Smith Travel Research, Inc., or Smith Travel Research. In addition, we seek to acquire branded, upscale, select-service properties in our primary urban target markets. We believe that these investments can produce attractive risk-adjusted returns because we believe (i) there is an opportunity to acquire properties at cyclically low prices in the current economic and financing environment and (ii) our properties will benefit from increasing business and leisure travel as the economy improves. On December 14, 2009, we completed our initial public offering of common shares and a concurrent private placement of our common shares, resulting in net proceeds of approximately $379.6 million, after underwriting discounts and offering costs. Since the completion of our initial public offering, we have acquired three hotels for purchase prices aggregating approximately $262.1 million, and we have two hotels under contract for purchase prices aggregating approximately $110 million. We are organized and conduct our operations to qualify as a REIT for federal income tax purposes.

 

We believe that the current market environment presents a significant number of attractive investment opportunities and that our management team has the experience and expertise necessary to acquire a high-quality portfolio of hotel properties. Our management team is led by Mr. Bortz, the founder and former Chairman of the Board of Trustees and Chief Executive Officer of LaSalle Hotel Properties, a NYSE-listed hotel REIT. Prior to that, he founded and led Jones Lang LaSalle’s Hotel Investment Group. Mr. Bortz has over 29 years of lodging and real estate experience, having overseen more than $2.7 billion of lodging-related transactions. Similarly, each of our Executive Vice President and Chief Financial Officer, Raymond D. Martz, and our Executive Vice President and Chief Investment Officer, Mr. Fisher, has over 15 years of experience in the hotel and real estate industries. Mr. Martz served as Chief Financial Officer in his last two positions and in senior finance positions at two NYSE-listed hotel REITs, while Mr. Fisher served as Managing Director in his last position with Jones Lang LaSalle Hotels, leading its national full-service hotel brokerage platform.

 

Upon completion of this offering we will have approximately $408.8 million of cash, together with a $150 million senior secured revolving credit facility, to invest in additional hotel properties. Accordingly, we believe we will be well-positioned to take advantage of attractive investment opportunities that we expect will be available in the lodging industry.

Our Hotels

 

The following table sets forth certain operating information for each of our owned hotels. This information relates to periods prior to our acquisition of these hotels.

 

 

 

 

Doubletree Bethesda Hotel and Executive Meeting Center, Bethesda, Maryland

 

We acquired the Doubletree Bethesda Hotel and Executive Meeting Center on June 4, 2010 for $67.1 million. The Doubletree Bethesda Hotel and Executive Meeting Center is located at 8120 Wisconsin Avenue, Bethesda, Maryland, and we own a fee simple interest in the hotel. The hotel, which was built in 1971, includes 269 guestrooms. The hotel was most recently renovated from 2006 to 2007. During the next 12 to 24 months, we expect to invest approximately $2.5 million for structural repairs to the underground garage and approximately $2.5 million for guestroom refurbishments, along with property improvements required by the franchisor in connection with our acquisition of the hotel. Upon acquisition of the hotel, we retained Thayer Lodging Group, Inc., or Thayer, to manage the hotel.

 

Demand for the hotel is generated primarily by federal government complexes, the National Institutes of Health, Nuclear Regulatory Commission, U.S. Food and Drug Administration and the National Naval Medical Center, as well as people conducting business, visiting or attending conventions in the Washington, D.C. metro area. Primary competitor hotels include Hyatt Regency Bethesda, Bethesda Marriott, Residence Inn Bethesda Downtown, Bethesda North Marriott Hotel and Conference Center and the Hilton Rockville.

 

The hotel contains 10 conference rooms and one grand ballroom, for a total of over 13,000 square feet of meeting space. The hotel also includes: The O.Z. (a three meal-a-day restaurant), Umi Sushi (a sushi bar), The Wine Bar, The Cup (a coffee and breakfast shop), on-site valet parking, a fitness center and a 24-hour business center.

 

Sir Francis Drake Hotel, San Francisco, California

 

We acquired the Sir Francis Drake Hotel on June 22, 2010 for $90.0 million. The Sir Francis Drake Hotel is located at 450 Powell Street, San Francisco, California, and we own a fee simple interest in the hotel. The hotel, which was built in 1928, includes 416 guestrooms. The hotel was most recently renovated from 2006 to 2009. We expect to invest approximately $7.0 million for guestroom improvements, public area improvements and other general refurbishments during the next two years. Upon acquisition of the hotel, we retained Kimpton Hotels & Restaurant Group, LLC, or Kimpton, to manage the hotel.

 

Demand for the hotel is generated primarily by leisure, corporate and convention business relating to Union Square, the Moscone Convention Center and the city of San Francisco. Primary competitor hotels include San Francisco Marriott Union Square, Grand Hyatt San Francisco, Parc 55 Wyndham San Francisco — Union Square, Westin San Francisco Market Street and The Westin St. Francis.

 

The hotel contains 12 conference rooms, for a total of approximately 15,000 square feet of meeting space. The hotel also includes: Scala’s Bistro (a three meal-a-day restaurant), Harry Denton’s Starlight Room, Starbucks, off-site valet parking, a 24-hour fitness center and a business center.