Item 1.
Business
OVERVIEW
Hersha Hospitality Trust is a self-advised Maryland real estate investment trust that was organized in 1998 and completed its initial public offering in January of 1999. Our common shares are traded on the American Stock Exchange under the symbol “HT”. We focus primarily on owning and operating high quality, upscale and mid-scale limited service and extended-stay hotels in established markets in the Eastern United States. Our primary strategy is to continue to acquire high quality, upscale, mid-scale and extended-stay hotels in metropolitan markets with high barriers to entry in the Northeastern United States. As of December 31, 2005, our portfolio consisted of 31 wholly owned limited and full service properties and joint venture investments in 16 hotels with a total of 5,513 rooms located in Pennsylvania, New York, New Jersey, Maryland, Delaware, Massachusetts, Connecticut, Rhode Island, Virginia and Georgia which operate under leading brands, such as Courtyard by Marriott ® , Residence Inn ®, Hilton Garden Inn ®, Springhill Suites ®, Hampton Inn ® , Holiday Inn ® , Holiday Inn Express ® , Comfort Inn ® , Comfort Suites ® , Mainstay Suites ® , Sleep Inn ® and Four Points by Sheraton ® .
We are structured as an umbrella partnership REIT, or UPREIT, and we own our hotels through our operating partnership, Hersha Hospitality Limited Partnership, for which we serve as general partner. All of our wholly-owned hotels are managed by Hersha Hospitality Management, L.P., or HHMLP, a private management company owned by certain of our trustees, officers and other third party investors. Our hotels owned through joint venture interests are managed by HHMLP or other qualified independent management companies. In response to tax law changes, we have formed a wholly-owned taxable REIT subsidiary, or TRS, to which we lease all of our wholly-owned hotels as of December 31, 2005. In addition, all of the hotels we own through joint ventures are leased to TRSs owned by the respective venture. We believe that transitioning to this TRS structure positions us to participate more directly in the operating efficiencies and revenue gains at our hotels.
Our address is 148 Sheraton Drive, Box A, New Cumberland, Pennsylvania 17070. Our telephone number is (717) 770-2405.
As of December 31, 2005, we owned interests in the following 47 hotels:
Since our initial public offering in 1999, we have acquired, wholly or through joint ventures, a total of 49 hotels, including 16 hotels acquired from entities controlled by our officers or trustees. Of the 16 acquisitions from these entities, 15 were newly-constructed or newly-renovated by these entities prior to our acquisition. Because we do not develop properties, we take advantage of our relationships with these development entities to identify development and renovation projects that may be attractive to us. While these entities bear all the construction risks of development, we often provide secured development loans and bear economic risks through these development loans. In many instances, we maintain a first right of refusal or first right of offer to purchase the hotel for which we have provided development loan financing. We intend to continue to acquire hotels from these entities if approved by our independent trustees.
In addition to the direct acquisition of hotels, we may make investments in hotels through joint ventures with strategic partners or through equity contributions, sales and leasebacks, or secured loans. We seek to identify acquisition candidates located in markets with economic, demographic and supply dynamics favorable to hotel owners and operators. Through our extensive due diligence process, we select those acquisition targets where we believe selective capital improvements and intensive management will increase the hotel’s ability to attract key demand segments, enhance hotel operations and increase long-term value.
Recent Acquisitions
Since December, 31, 2005, we have acquired, disposed or modified our interests in the following hotels:
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Fairfield Inn & Suites, Mt. Laurel, NJ; Fairfield Inn & Suites, Bethlehem, PA; Courtyard, Langhorne, PA. On January 3, 2006, we acquired the 118 room Fairfield Inn & Suites in Mt. Laurel, NJ, the 103 room Fairfield Inn & Suites in Bethlehem, NJ, and the 118 room Langhorne Courtyard in Langhorne, PA for approximately $40.5 million.
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Courtyard, Scranton, PA. On February 1, 2006, we acquired the 120 room Courtyard in Scranton, PA for approximately $8.7 million.
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Residence Inn, Tyson’s Corner, VA. On February 2, 2006, we acquired the 96 room Residence Inn in Tyson’s Corner, VA for approximately $19.8 million.
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Marriott, Hartford, CT. On February 8, 2006, we acquired through our Mystic Partners joint venture a 15% interest in the 409 room Hartford Marriott for approximately $6.7 million.
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Hilton, Hartford, CT. On February 8, 2006, the Mystic Hotel Investors, our partner in the Mystic Partners joint venture and an affiliate of the Waterford Hotel Group, purchased approximately $5.4 million of our interest in the 392 room Hartford Hilton. As a result, our ownership interest in the Hartford Hilton was reduced from 50% to 10% of Mystic Partners interest in the hotel.
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Hampton Inn, Philadelphia. On February 15, 2006, we acquired an 80% interest of the limited partnership interests in Affordable Hospitality Associates, LP, the owner of the land, improvements and certain personal property of the 250 room Hampton Inn (Center City) in Philadelphia for approximately $6.9 million.
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Hilton Garden Inn, JFK Airport, NY. On February 16, 2006, we acquired 100% of the outstanding interests in Metro JFK Associates, LLC, the owner of a leasehold interest in the land, improvements and certain personal property of the Hilton Garden Inn - JFK, located in Jamaica, NY for approximately $29.0 million.
Joint Ventures
As of December 31, 2005, we maintain ownership stakes in the following sixteen hotels through joint ventures with third parties:
(1) - Preferred return tier of 8.0% and 10.0% during years 1 and 2, respectively, and then a 12% preferred return thereafter.
Hersha Inn America TRS Inc; Hersha/CNL TRS Inc.; Hersha PRA TRS, Inc; South Bay Sandeep, LLC; and Revere Hotel Group, LLC, are each a TRS wholly-owned by their respective joint ventures. Mystic Partners, LLC owns an interest in eight hotel properties. Each of the eight properties owned by Mystic Partners, LLC is leased to a separate entity that is consolidated in Mystic Partners Leaseco, LLC which is owned by 44 New England and the Company’s joint venture partner in Mystic Partners, LLC. South Bay Boston, LLC; HT LTD Williamsburg LLC; and HT LTD Williamsburg Two LTD LLC lease properties from each respective joint venture and are owned by 44 New England and the Company’s joint venture partner in each venture.
New England and the joint venture TRS lessees lease the hotel properties pursuant to separate percentage lease agreements (the “Percentage Leases”) that provide for percentage rents based on the revenues of the hotels. HHMLP serves as the manager for all of the owned assets and joint venture assets, except for the properties owned by Mystic Partners, LLC; Hiren Boston, LLC; SB Partners, LLC; LTD Associates One, LLC; and LTD Associates Two, LLC. These properties are managed by parties related to our partners in those joint ventures. HHMLP is owned in part by four of the Company’s executive officers, two of its trustees and other third party investors.
Financing
We may finance additional investments in hotels, in whole or in part, with undistributed cash, issuances of common shares, preferred stock, operating partnership units, cash received from the disposition of hotels or borrowings. Our debt policy is to limit consolidated indebtedness to less than 67% of the fair market values for the hotels in which we invest. Our Board of Trustees, however, may change the debt policy without the approval of our shareholders.
Prior to January 2006, we maintained a credit line with Sovereign Bank for $35.0 million. Outstanding borrowings under the line of credit bear interest at the bank’s prime rate. The line of credit is collateralized by a first mortgage on three of our hotels. The interest rate on borrowings under the line of credit at December 31, 2005, was 7.25%. As of December 31, 2005, there was no balance on our Line of Credit.
Prior to January 2006, we maintained an unsecured revolving line of credit from Commerce Bank (the “Unsecured Line of Credit”) in the maximum amount of $5.0 million. Outstanding borrowings under the Unsecured Line of Credit bear interest at the bank’s prime rate (which at December 31, 2005, was 7.25%). The Unsecured Line of Credit is scheduled to expire on March 24, 2007. The Company had no outstanding borrowings under the Unsecured Line of Credit at December 31, 2005.
On January 17, 2006, we entered into a revolving credit loan and security agreement with Commerce Bank, N.A. with a maximum amount of $60.0 million, which replaced the Sovereign Bank Line of Credit and the Unsecured Line of Credit. Outstanding borrowings under the line of credit bear annual interest at the Company’s option of either (i) the Wall Street Journal variable prime rate of interest minus 0.50% or (ii) LIBOR available for the periods of 1, 2, 3, or 6 months plus 2.25%. The line of credit is collateralized by (i) a first lien-security interest in certain existing and future assets of HHLP, (ii) title-insured, first-line mortgages on the Holiday Inn Express, Harrisburg, PA, the Mainstay Suites and Sleep Inn, King of Prussia, PA, the Fairfield Inn, Laurel, MD, and a hotel property to be determined, and (iii) collateral assignment of all hotel management contracts from which HHLP or its affiliates derive revenues.
Dispositions
Since our initial public offering in 1999, we have sold a total of twelve hotels, including four hotels sold back to entities controlled by our officers or trustees at the same purchase price we acquired the hotels from those entities. All sales to these entities were in situations where we believed an independent buyer would demand seller financing, which we were not willing to provide. We do not intend to sell hotels to such entities in the future.
We will evaluate our hotels on a periodic basis to determine if these hotels continue to satisfy our investment criteria. We may sell hotels opportunistically based upon management’s forecast and review of the cash flow potential for the hotel and re-deploy the proceeds into debt reduction or acquisitions of hotels. We utilize several criteria to determine the long-term potential of our hotels. Hotels are identified for sale based upon management’s forecast of the strength of the hotel’s cash flows and its ability to remain accretive to our portfolio. Our decision to sell an asset is often predicated upon the size of the hotel, strength of the franchise, property condition and related costs to renovate the property, strength of market demand generators, projected supply of hotel rooms in the market, probability of increased valuation and geographic profile of the hotel. All asset sales are comprehensively reviewed by our Board of Trustees, including our independent trustees. A majority of the independent trustees must approve the terms of all asset sales.
Property Management
As of December 31, 2005, our TRS’s have engaged HHMLP as the property manager for all of our wholly owned hotels pursuant to substantially similar management agreements. Each management agreement provides for a five year term and is subject to early termination upon the occurrence of defaults and certain other events described therein. As required under the REIT qualification rules, HHMLP must qualify as an “eligible independent contractor” during the term of the management agreements.
Under the management agreements, HHMLP generally pays the operating expenses of our hotels. All operating expenses or other expenses incurred by HHMLP in performing its authorized duties are reimbursed or borne by our TRS to the extent the operating expenses or other expenses are incurred within the limits of the applicable approved hotel operating budget. HHMLP is not obligated to advance any of its own funds for operating expenses of a hotel or to incur any liability in connection with operating a hotel.
For its services, HHMLP receives a base management fee, and if a hotel meets and exceeds certain thresholds, an additional incentive management fee. The base management fee for a hotel is due monthly and is equal to 3% of the gross revenues associated with that hotel for the related month. There were no incentive management fees payable in 2004 or 2005. The incentive management fee, if any, for all of the hotels is due annually in arrears on the ninetieth day following the end of each fiscal year and is generally based upon the financial performance of all of the hotels under a predetermined formula.
HHMLP must from time to time make expenditures for repairs and maintenance as are necessary to keep a hotel in good operating condition. Our TRS or we may elect to, from time to time at its or our expense, make alterations, additions, or improvements (including structural changes or repairs) in or to our hotels.
Under the management agreements, our TRSs retain the right to sell, lease, transfer or otherwise dispose of our hotels. HHMLP may not transfer or assign any of its rights and obligations under a management agreement without the prior written consent of our TRS. On the other hand, our TRSs may transfer or assign their rights and obligations under a management agreement without the consent of HHMLP. However, HHMLP will have the right to terminate the management agreement after receiving notice of such transfer or assignment and could be entitled to certain termination fees.
As of December 31, 2005, our joint venture partnerships have retained the following management companies to operate the respective hotels for the joint ventures:
We do not operate our own hotels because we are not permitted to do so by the REIT qualification rules. Furthermore, under the REIT qualification rules in effect prior to 2001, we were generally required to lease our hotels to a third party and as a result, we originally leased substantially all of our hotels to HHMLP. However, the REIT rules that prompted this structure were modified in 2001 and the new rules permit a REIT to lease its hotels to a taxable REIT subsidiary, or TRS, provided that the TRS engages an eligible independent contractor to manage the hotels. Accordingly, since the time of the rule modification we have leased all of our hotels to a wholly-owned TRS which pays us qualifying rents.
Distributions
We have made twenty eight consecutive quarterly distributions to the holders of our common shares since our initial public offering in January 1999 and intend to continue to make regular quarterly distributions to our shareholders.
Our Board of Trustees will determine the amount of our future distributions and its decision will depend on a number of factors, including the amount of funds from operations, our partnership’s financial condition, debt service requirements, capital expenditure requirements for our hotels, the annual distribution requirements under the REIT provisions of the Code and such other factors as the trustees deem relevant. Our ability to make distributions will depend on the profitability and cash flow available from our hotels.
The Class A common shares enjoyed a priority period that expired on January 26, 2004. During the priority period, holders of the Class A common shares were entitled to receive, prior to any distributions either to the holders of the operating partnership units or to the holders of the Class B common shares, cumulative dividends in an amount per priority common share equal to $0.18 per quarter. After holders of the Class A common shares received the $0.18 quarterly distribution, holders of the operating partnership units and the Class B common shares were entitled to receive an amount per operating partnership unit or Class B common share equal to the distribution paid to the holders of the common shares. Holders of Class A common shares and the holders of the operating partnership units and the Class B common shares were entitled to receive future distributions on a pro rata basis. As of January 26, 2004, no Class B common shares were outstanding. Thus, the Class A common shares had priority distribution rights only with respect to the outstanding operating partnership units. All distinctions between these two classes of common shares expired as of January 26, 2004. All references herein to common shares refer to the Class A common shares.
The hotel business is seasonal in nature and, therefore, revenues from the hotels in the first and fourth quarters are traditionally lower than those in the second and third quarters and profitability and cash flows may be lower in these quarters. We expect to use excess cash flow from the second and third quarters to fund distribution shortfalls in the first and fourth quarters. There are no assurances we will be able to continue to make quarterly distributions at the current rate.
Operating Practices
HHMLP utilizes a centralized accounting and data processing system, which facilitates financial statement and budget preparation, payroll management, quality control and other support functions for the on-site hotel management team. HHMLP provides centralized control over purchasing and project management (which can create economies of scale in purchasing) while emphasizing local discretion within specific guidelines.
Prior to July 1, 2005, under the terms of an administrative service agreement, HHMLP provided accounting and securities reporting services for the Company. The terms of the agreement provided for us to pay HHMLP an annual fee of $10,000 per property (prorated from the time of acquisition) for each hotel in our portfolio. On July 1, 2005, the administrative service fee was replaced by monthly accounting and information technology fees for each of our wholly owned hotels. Monthly fees for accounting services are $2,000 per property and monthly information technology fees are $500 per property.
Seasonality
Our hotels’ operations historically have been seasonal in nature, reflecting higher occupancy rates during the second and third quarters. This seasonality can be expected to cause fluctuations in our quarterly operating revenues and profitability.
The hotel business is seasonal, with hotel revenue generally greater in the second and third quarters than in the first and fourth quarters. To the extent that cash flow from operating activities is insufficient to provide all of the estimated quarterly distributions, we anticipate that we will be able to fund any such deficit from future working capital.
Competition
The upscale and mid-scale, limited service segment of the hotel business is highly competitive. Our hotels compete on the basis of location, room rates and quality, service levels, reputation, and reservation systems, among many other factors. There are many competitors in our market segments, and many of them have substantially greater marketing and financial resources than our operators or us. New hotels are always being constructed, and these additions to supply create new competitors, in some cases without corresponding increases in demand for hotel rooms. The result in some cases may be lower revenue, which would result in lower cash available for distribution to shareholders.
We also compete for hotel acquisitions with entities that have investment objectives similar to ours but have substantially greater financial resources or lower investment return requirements than we have. These entities generally may be able to accept higher levels of debt, or otherwise may tolerate more risk than we think is prudent for us. They may also have better relations with franchisors, sellers or lenders. This competition could limit the number of suitable investment opportunities offered to us. It 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.
Employees
As of December 31, 2005, we had thirteen employees who were principally engaged in managing the affairs of the company unrelated to property management. HHMLP had approximately 1,350 employees at that date. Our relations with our employees are satisfactory. HHMLP has advised us that its relationship with its employees is satisfactory.
Capital Improvements, Renovation and Refurbishment
We have established capital reserves for each of our hotels to maintain the hotels in a condition that complies with their respective franchise licenses among other requirements. In addition, we may upgrade the hotels in order to capitalize on opportunities to increase revenue, and as deemed necessary by our management to seek to meet competitive conditions and preserve asset quality. We will also renovate hotels when we believe the investment in renovations will provide an attractive return to us through increased revenues and profitability and is in the best interests of our shareholders. We maintain a capital expenditures policy by which replacements and renovations are monitored to determine whether they qualify as capital improvements. All items that are deemed to be repairs and maintenance costs are expensed and recorded in Hotel Operating Expenses.
Business Risks
The hotels are subject to all operating risks common to the hotel industry. These risks include, among other things, competition from other hotels, which can adversely affect occupancy and room rates; increases in operating costs due to inflation and other factors, which increases have not in recent years been, and may not necessarily in the future be, offset by increased room rates; significant dependence on business and commercial travelers and tourism; increases in energy costs and other expenses of travel; and adverse effects of general and local economic conditions. These factors could adversely affect the profitability and cash flows of our hotels and our ability to make expected distributions to shareholders.
Environmental Risks
Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or remediation of hazardous or toxic substances, on, under or in such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. In addition, the presence of hazardous or toxic substances, or the failure to remediate such property properly, may adversely affect the owner’s ability to borrow using such real property as collateral. Persons who arrange for the disposal or treatment of hazardous or toxic substances may also be liable for the costs of removal or remediation of such substances at the disposal or treatment facility, whether or not such facility is or ever was owned or operated by such person. Certain environmental laws and common law principles could be used to impose liability for release of asbestos-containing materials (“ACMs”) into the air and third parties may seek recovery from owners or operators of real properties for personal injury associated with exposure to released ACMs. In connection with the ownership of the hotels, we, our partnership or the subsidiary partnerships may be potentially liable for any such costs.
Phase I environmental site assessments were obtained on all of the hotels prior to their acquisition by us. Phase I environmental assessments were intended to identify potential environmental contamination for which the hotels may be responsible. The Phase I environmental assessments included historical reviews of the hotels, reviews of certain public records, preliminary investigations of the sites and surrounding properties, screening for the presence of hazardous substances, toxic substances and underground storage tanks, and the preparation and issuance of a written report. The Phase I environmental assessments did not include invasive procedures, such as soil sampling or ground water analysis.
The Phase I site assessments have not revealed any environmental liability that we believe would have a material adverse effect on our business, assets, results of operations or liquidity, nor are we aware of any such liability. Nevertheless, it is possible that the Phase I site assessments do not reveal environmental liabilities or that there are material environmental liabilities of which we are unaware. Moreover, no assurance can be given that (i) future laws, ordinances or regulations will not impose any material environmental liability, or (ii) the current environmental condition of the hotels will not be affected by the condition of other properties in the vicinity of the hotels (such as the presence of leaking underground storage tanks) or by third parties unrelated to us, our partnership, the subsidiary partnerships or HHMLP.
Franchise Agreements
All of our hotels operate under franchise licenses from national hotel franchisors, including Marriott International, Starwood Hotels, Intercontinental Hotel Group, Hilton Hotels Corporation and Choice Hotels International. Residence Inn, SpringHill Suites and Courtyards are registered trademarks of Marriott International, Four Points by Sheraton is a registered trademark of Starwood Hotels, Holiday Inn Express and Holiday Inn are registered trademarks of Intercontinental Hotel Group; Hilton Garden Inn, Hampton Inn and Doubletree Club are registered trademarks of Hilton Hotels Corporation, and Comfort Inn, Comfort Suites, Mainstay Suites and Sleep Inn are registered trademarks of Choice Hotels International.
New England, our TRS, and our JV TRS’ hold the franchise licenses for properties that they lease. HHMLP holds some of the franchise licenses for some of the hotels that it manages for our TRS. We do not anticipate any difficulty in maintaining the franchise licenses for hotel properties managed by third party management companies. It is anticipated that franchise licenses for hotel properties managed by other lessees will be maintained by the respective TRS or operating entity.
We anticipate that most of the additional hotels in which we invest will be operated under franchise licenses. We believe that the public’s perception of quality associated with a franchisor is an important feature in the operation of a hotel. Franchisors provide a variety of benefits for franchisees, which include national advertising, publicity and other marketing programs designed to increase brand awareness, training of personnel, continuous review of quality standards and centralized reservation systems.
The franchise licenses generally specify certain management, operational, record-keeping, accounting, reporting and marketing standards and procedures with which the franchisee must comply. The franchise licenses obligate our lessees to comply with the franchisors’ standards and requirements with respect to training of operational personnel, safety, maintaining specified insurance, the types of services and products ancillary to guest room services that may be provided by our lessees, display of signage, and the type, quality and age of furniture, fixtures and equipment included in guest rooms, lobbies and other common areas.
The following table sets forth certain information in connection with the franchise licenses purchased by the Company for hotels wholly owned or owned through a joint venture acquisition as of December 31, 2005:
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(1)
Franchise fee agreement on a month to month basis at December 31, 2005. Interim extension filed until March 2006, when the Company expects a new five year contract will be executed.
(2)
Franchise fees are structured to increase on a yearly basis during the first five years of operations.
(3)
Hotel owned through a joint venture with third party.
Tax Status
We have elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code, commencing with our taxable year ending December 31, 1999. As long as we qualify for taxation as a REIT, we generally will not be subject to Federal income tax on the portion of our income that is distributed to shareholders. If we fail to qualify as a REIT in any taxable year, we will be subject to Federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate tax rates. Even if we qualify for taxation as a REIT, we may be subject to certain state and local taxes on our income and property and to Federal income and excise taxes on our undistributed income.
Under the REIT Modernization Act (“RMA”), which became effective January 1, 2001, we may now own up to 100% of one or more taxable REIT subsidiaries (“TRS”). A TRS is a taxable corporation that may lease hotels under certain circumstances, provide services to us, and perform activities such as third party management, development, and other independent business activities. Overall, no more than 20% of the value of our consolidated assets may consist of securities of one or more TRSs. In addition, no more than 25% of our consolidated revenue for any year, excluding all TRS revenues, but including any dividends received from TRSs, may consist of dividends from one or more TRSs.
Under the RMA, a TRS is permitted to lease hotels from us as long as the hotels are operated on behalf of the TRS by a third party manager who satisfies the following requirements:
1.
such manager is, or is related to a person who is, actively engaged in the trade or business of operating “qualified lodging facilities” for any person unrelated to us and the TRS;
2.
such manager does not own, directly or indirectly, more than 35% of our common shares;
3.
no more than 35% of such manager is owned, directly or indirectly, by one or more persons owning 35% or more of our common shares; and
4.
we do not directly or indirectly derive any income from such manager.
The RMA limits the deductibility of interest paid or accrued by a TRS to us to assure that the TRS is subject to an appropriate level of corporate taxation. The RMA also imposes a 100% excise tax on transactions between a TRS and us or our tenants that are not on an arm’s length basis.
Earnings and profits, which will determine the taxability of dividends to shareholders, will differ from net income reported for financial reporting purposes due to the differences for federal tax purposes in the estimated useful lives and methods used to compute depreciation. The following table sets forth certain per share information regarding the Company’s common and preferred share distributions for the years ended December 31, 2005, 2004 and 2003.
Available Information
Our Internet website address is: www.hersha.com. We make available free of charge through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such documents are electronically filed with, or furnished to, the SEC. The information of our website is not, and shall not be deemed to be, a part of this report or incorporated into any other filings we make with the SEC.
Item 1A.
Item 1A.
Risk Factors
You should carefully consider the following risks, together with the other information included in this Annual Report on Form 10-K. If any of the following risks actually occur, our business, financial condition or results of operations may suffer. As a result, the trading price of our securities could decline, and you may lose all or part of any investment you have in our securities.
Risks Relating to Our Business and Operations
We may be unable to integrate acquired hotels into our operations or otherwise manage our planned growth, which may adversely affect our operating results.
We have recently acquired a substantial number of hotels. We cannot assure you that we or HHMLP will be able to adapt our management, administrative, accounting and operational systems and arrangements, or hire and retain sufficient operational staff to successfully integrate these investments into our portfolio and manage any future acquisitions of additional assets without operational disruptions or unanticipated costs. Acquisition of hotels generates additional operating expenses that we will be required to pay. As we acquire additional hotels, we will be subject to the operational risks associated with owning new lodging properties. Our failure to integrate successfully any future acquisitions into our portfolio could have a material adverse effect on our results of operations and financial condition and our ability to pay dividends to shareholders or make other payments in respect of securities issued by us.
Acquisition of hotels with limited operating history may not achieve desired results.
Many of our recent acquisitions, including some of the hotels in the Mystic Partners joint venture with Waterford, are newly developed hotels. Newly−developed or newly−renovated hotels do not have the operating history that would allow our management to make pricing decisions in acquiring these hotels based on historical performance. The purchase prices of these hotels are based upon management’s expectations as to the operating results of such hotels, subjecting us to risks that such hotels may not achieve anticipated operating results or may not achieve these results within anticipated time frames. As a result, we may not be able to generate enough cash flow from these hotels to make debt payments or pay operating expenses. In addition, room revenues may be less than that required to provide us with our anticipated return on investment. In either case, the amounts available for distribution to our shareholders could be reduced.
Our acquisitions may not achieve expected performance, which may harm our financial condition and operating results.
We anticipate that acquisitions will largely be financed with the net proceeds of securities offerings and through externally generated funds such as borrowings under credit facilities and other secured and unsecured debt financing. Acquisitions entail risks that investments will fail to perform in accordance with expectations and that estimates of the cost of improvements necessary to acquire and market properties will prove inaccurate, as well as general investment risks associated with any new real estate investment. Because we must distribute annually at least 90% of our taxable income to maintain our qualification as a REIT, our ability to rely upon income or cash flow from operations to finance our growth and acquisition activities will be limited. Accordingly, were we unable to obtain funds from borrowings or the capital markets to finance our growth and acquisition activities, our ability to grow could be curtailed, amounts available for distribution to shareholders could be adversely affected and we could be required to reduce distributions.
We own a limited number of hotels and significant adverse changes at one hotel may impact our ability to make distributions to shareholders.
As of December 31, 2005, our portfolio consisted of 31 wholly owned limited and full service properties and joint venture investments in 16 hotels with a total of 5,513 rooms. Significant adverse changes in the operations of any one hotel could have a material adverse effect on our financial performance and, accordingly, on our ability to make expected distributions to our shareholders.
We focus on acquiring hotels operating under a limited number of franchise brands, which creates greater risk as the investments are more concentrated.
We place particular emphasis in our acquisition strategy on hotels similar to our current hotels. We invest in hotels operating under a few select franchises and therefore will be subject to risks inherent in concentrating investments in a particular franchise brand, which could have an adverse effect on amounts available for distribution to shareholders. These risks include, among others, the risk of a reduction in hotel revenues following any adverse publicity related to a specific franchise brand.
All our hotels are located in the Eastern United States and many are located in the area from Pennsylvania to Connecticut, which may increase the effect of any regional or local economic conditions.
Our hotels are located in the Eastern United States. Twenty of our wholly owned hotels and ten of our joint venture hotels are located in the states of Pennsylvania, New Jersey, New York and Connecticut. As a result, regional or localized adverse events or conditions, such as an economic recession around these hotels, could have a significant adverse effect on our operations, and ultimately on the amounts available for distribution to shareholders.
We face risks associated with the use of debt, including refinancing risk.
At December 31, 2005, we had debt outstanding of $256 million. We may borrow additional amounts from the same or other lenders in the future, or may issue corporate debt securities in public or private offerings. Some of these additional borrowings may be secured by our hotels. Our strategy is to maintain target debt levels of approximately 60% of the total purchase price of our hotels both on an individual and aggregate basis, and our Board of Trustees’ policy is to limit indebtedness to no more than 67% of the fair market value of the hotels in which we have invested. However our declaration of trust (as amended and restated, our “Declaration of Trust”) does not limit the amount of indebtedness we may incur. We cannot assure you that we will be able to meet our debt service obligations and, to the extent that we cannot, we risk the loss of some or all of our hotels to foreclosure. There is also a risk that we may not be able to refinance existing debt or that the terms of any refinancing will not be as favorable as the terms of the existing debt. If principal payments due at maturity cannot be refinanced, extended or repaid with proceeds from other sources, such as new equity capital or sales of properties, our cash flow may not be sufficient to repay all maturing debt in years when significant “balloon” payments come due.
We do not operate our hotels and, as a result, we do not have complete control over implementation of our strategic decisions.
In order for us to satisfy certain REIT qualification rules, we cannot directly operate any of our hotels. Instead, we must engage an independent management company to operate our hotels. As of December 31, 2005, our TRS’s have engaged an independent management company, HHMLP, as the property manager for all of our wholly owned hotels and our joint venture partnerships have retained eligible independent management companies to operate the respective hotels for the joint ventures, as required by the REIT qualification rules. HHMLP and the management companies operating the hotels owned in our joint ventures make and implement strategic business decisions with respect to these hotels, such as decisions with respect to the repositioning of a franchise or food and beverage operations and other similar decisions. Decisions made by HHMLP and the management companies operating the hotels may not be in the best interests of a particular hotel or of our company. Accordingly, we cannot assure you that HHMLP or the management companies operating the hotels owned in our joint ventures will operate our hotels in a manner that is in our best interests.
We depend on key personnel.
We depend on the services of our existing senior management to carry out our business and investment strategies. As we expand, we will continue to need to attract and retain qualified additional senior management. We have employment contracts with certain of our senior management; however, the employment agreements may be terminated under certain circumstances. The termination of an employment agreement and the loss of the services of any of our key management personnel, or our inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business and financial results.
We face increasing competition for the acquisition of hotel properties and other assets, which may impede our ability to make future acquisitions or may increase the cost of these acquisitions.
We face competition for investment opportunities in high quality, upscale and mid-scale limited service and extended-stay hotels from entities organized for purposes substantially similar to our objectives, as well as other purchasers of hotels. We compete for such investment opportunities with entities that have substantially greater financial resources than we do, including access to capital or better relationships with franchisors, sellers or lenders. Our competitors may generally be able to accept more risk than we can manage prudently and may be able to borrow the funds needed to acquire hotels. Competition may generally reduce the number of suitable investment opportunities offered to us and increase the bargaining power of property owners seeking to sell.
There can be no assurance that we have successfully remedied our recently identified material weaknesses in internal control over financing reporting.
In connection with the closing of our 2005 fiscal year, we identified certain matters involving our internal control over financial reporting that we and our independent auditors determined to be material weaknesses under standards established by the American Institute of Certified Public Accountants. We have identified these matters in Item 9A, herein. Although we have attempted to remedy the material weaknesses in internal control over financial reporting identified in 2005, by implementing a number of actions aimed at strengthening our financial reporting processes, we cannot assure you that the remedial measures we have taken will adequately address the identified material weaknesses. Moreover, we have only recently implemented processes to address the material weaknesses identified. We will continue to take further remedial actions to improve our internal control over financial reporting in order to continue to meet the requirements for being a public company, including the rules under Section 404 of the Sarbanes−Oxley Act of 2002, but there can be no assurance that the improvements we have made or will make will be sufficient to ensure that we maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could cause us to fail to meet our reporting obligations or result in misstatements in our financial statements in amounts that could be material. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the value of our capital stock.
We may engage in hedging transactions, which can limit our gains and increase exposure to losses.
We may enter into hedging transactions to protect us from the effects of interest rate fluctuations on floating rate debt and also to protect our portfolio of mortgage assets from interest rate and prepayment rate fluctuations. Our hedging transactions may include entering into interest rate swaps, caps, and floors, options to purchase such items, and futures and forward contracts. Hedging activities may not have the desired beneficial impact on our results of operations or financial condition. No hedging activity can completely insulate us from the risks associated with changes in interest rates and prepayment rates. Moreover, interest rate hedging could fail to protect us or could adversely affect us because, among other things:
•
Available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought.
•
The duration of the hedge may not match the duration of the related liability.
•
The party owing money in the hedging transaction may default on its obligation to pay.
•
The credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction.
•
The value of derivatives used for hedging may be adjusted from time to time in accordance with accounting rules to reflect changes in fair value.
Downward adjustments, or “mark−to−market losses,” would reduce our stockholders’ equity.
Hedging involves risk and typically involves costs, including transaction costs, which may reduce returns on our investments. These costs increase as the period covered by the hedging increases and during periods of rising and volatile interest rates. These costs will also limit the amount of cash available for distribution to stockholders. The REIT qualification rules may also limit our ability to enter into hedging transactions. We generally intend to hedge as much of our interest rate risk as our management determines is in our best interests given the cost of such hedging transactions and the requirements applicable to REITs. If we are unable to hedge effectively because of the cost of such hedging transactions or the limitations imposed by the REIT rules, we will face greater interest risk exposure than may be commercially prudent.
If we cannot access the capital markets, we may not be able to grow the Company at our historical growth rates.
We may not be able to access the capital markets to obtain capital to fund future acquisitions and investments. If we lack the capital to make future acquisitions or investments, we may not be able to continue to grow at historical rates.
Risks Relating to Conflicts of Interest
Due to conflicts of interest, many of our existing agreements may not have been negotiated on an arm’s-length basis and may not be in our best interest.
Some of our officers and trustees have ownership interests in HHMLP and in entities with which we have entered into transactions, including hotel acquisitions and dispositions and certain financings. Consequently, the terms of our agreements with those entities, including hotel contribution or purchase agreements, the Administrative Services Agreement between us and HHMLP pursuant to which HHMLP provides certain administrative services, the Option Agreement between the operating partnership and some of the trustees and officers and our property management agreements with HHMLP may not have been negotiated on an arm’s-length basis and may not be in the best interest of all our shareholders.
Conflicts of interest with other entities may result in decisions that do not reflect our best interests.
The following officers and trustees own collectively approximately 96% of HHMLP: Hasu P. Shah, Jay H. Shah, Neil H. Shah, David L. Desfor, K.D. Patel and Kiran P. Patel. The following officers and trustees serve as officers of HHMLP: David L. Desfor, Kiran P. Patel and K.D. Patel. Conflicts of interest may arise in respect of the ongoing acquisition, disposition and operation of our hotels including, but not limited to, the enforcement of the contribution and purchase agreements, the Administrative Services Agreement, the Option Agreement and our property management agreements with HHMLP. Consequently, the interests of shareholders may not be fully represented in all decisions made or actions taken by our officers and trustees.
Conflicts of interest relating to sales or refinancing of hotels acquired from some of our trustees and officers may lead to decisions that are not in our best interest.
Some of our trustees and officers have unrealized gains associated with their interests in the hotels we have acquired from them and, as a result, any sale of the these hotels or refinancing or prepayment of principal on the indebtedness assumed by us in purchasing these hotels may cause adverse tax consequences to such of our trustees and officers. Therefore, our interests and the interests of these individuals may be different in connection with the disposition or refinancing of these hotels.
Competing hotels owned or acquired by some of our trustees and officers may hinder these individuals from spending adequate time on our business.
Some of our trustees and officers own hotels and may develop or acquire new hotels, subject to certain limitations. Such ownership, development or acquisition activities may materially affect the amount of time these officers and trustees devote to our affairs. Some of our trustees and officers operate hotels that are not owned by us, which may materially affect the amount of time that they devote to managing our hotels. Pursuant to the Option Agreement, as amended, we have an option to acquire any hotels developed by our officers and trustees.
Need for certain consents from the limited partners may not result in decisions advantageous to shareholders.
Under our operating partnership’s amended and restated partnership agreement, the holders of at least two- thirds of the interests in the partnership must approve a sale of all or substantially all of the assets of the partnership or a merger or consolidation of the partnership. Some of our officers and trustees will own an approximately 11.5% interest in the operating partnership on a fully-diluted basis. Their large ownership percentage may make it less likely that a merger or sale of our company that would be in the best interests of our shareholders will be approved.
Risks Relating to Our Corporate Structure
Our ownership limitation may restrict business combination opportunities.
To qualify as a REIT under the Code, no more than 50% of the value of our outstanding shares of beneficial interest may be owned, directly or indirectly, by five or fewer individuals during the last half of each taxable year. To preserve our REIT qualification, our Declaration of Trust generally prohibits direct or indirect ownership of more than 9.9% of the number of outstanding shares of any class of our securities, including the common shares, by any person. Generally, common shares owned by affiliated owners will be aggregated for purposes of the ownership limitation. The ownership limitation could have the effect of delaying, deferring or preventing a change in control or other transaction in which holders of common shares might receive a premium for their common shares over the then prevailing market price or which such holders might believe to be otherwise in their best interests.
The Declaration of Trust contains a provision that creates staggered terms for our Board of Trustees.
Our Board of Trustees is divided into two classes. The terms of the first and second classes expire in 2006 and 2007, respectively. Trustees of each class are elected for two-year terms upon the expiration of their current terms and each year one class of trustees will be elected by the shareholders. The staggered terms of trustees may delay, defer or prevent a tender offer, a change in control of us or other transaction, even though such a transaction might be in the best interest of the shareholders.
Maryland Business Combination Law may discourage a third party from acquiring us.
Under the Maryland General Corporation Law, as amended (MGCL), as applicable to real estate investment trusts, certain “business combinations” (including certain issuances of equity securities) between a Maryland real estate investment trust and any person who beneficially owns ten percent or more of the voting power of the trust’s shares or an affiliate thereof or any person who is an affiliate or associate of the trust and was the beneficial owner of ten percent or more of the voting shares of the trust within the two year period immediately prior to the date in question, are prohibited for five years after the most recent date on which this shareholder acquired at least ten percent of the voting power of the trust’s shares. Thereafter, any such business combination must be approved by two super-majority shareholder votes unless, among other conditions, the trust’s common shareholders receive a minimum price (as defined in the MGCL) for their shares and the consideration is received in cash or in the same form as previously paid by the interested shareholder for its common shares. These provisions could delay, defer or prevent a transaction or change of control of our company in which our shareholders might otherwise receive a premium for their shares above then-current market prices or might otherwise deem to be in their best interests.
The Board of Trustees may change our investment and operational policies without a vote of the common shareholders.
Our major policies, including our policies with respect to acquisitions, financing, growth, operations, debt limitation and distributions, are determined by our Board of Trustees. The Trustees may amend or revise these and other policies from time to time without a vote of the holders of the common shares.
Our Board of Trustees may issue additional shares that may cause dilution or prevent a transaction that is in the best interests of our shareholders.
Our Declaration of Trust authorizes the Board of Trustees, without shareholder approval, to:
•
amend the Declaration of Trust to increase or decrease the aggregate number of shares of beneficial interest or the number of shares of beneficial interest of any class that we have the authority to issue,
•
cause us to issue additional authorized but unissued common shares or preferred shares and
•
classify or reclassify any unissued common or preferred shares and to set the preferences, rights and other terms of such classified or reclassified shares, including the issuance of additional common shares or preferred shares that have preference rights over the common shares with respect to dividends, liquidation, voting and other matters.
Any one of these events could cause dilution to our common shareholders, delay, defer or prevent a transaction or a change in control that might involve a premium price for the common shares or otherwise not be in the best interest of holders of common shares.
Future offerings of debt securities, which would be senior to our common shares upon liquidation, or equity securities, which would dilute our existing shareholders and may be senior to our common shares for the purposes of dividend distributions, may adversely affect the market price of our common shares.
In the future, we may attempt to increase our capital resources by making additional offerings of debt or equity securities, including medium-term notes, senior or subordinated notes and classes of preferred or common shares. Upon liquidation, holders of our debt securities and shares of preferred shares and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common shares. Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common shares, or both. Our preferred shares, if issued, could have a preference on liquidating distributions or a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common shares. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our shareholders bear the risk of our future offerings reducing the market price of our common shares and diluting their stock holdings in us.
There are no assurances of our ability to make distributions in the future.
We intend to pay quarterly dividends and to make distributions to our shareholders in amounts such that all or substantially all of our taxable income in each year, subject to certain adjustments, is distributed. However, our ability to pay dividends may be adversely affected by the risk factors described in this prospectus. All distributions will be made at the discretion of our Board of Trustees and will depend upon our earnings, our financial condition, maintenance of our REIT status and such other factors as our board may deem relevant from time to time. There are no assurances of our ability to pay dividends in the future. In addition, some of our distributions may include a return of capital.
An increase in market interest rates may have an adverse effect on the market price of our securities.
One of the factors that investors may consider in deciding whether to buy or sell our securities is our dividend rate as a percentage of our share or unit price, relative to market interest rates. If market interest rates increase, prospective investors may desire a higher dividend or interest rate on our securities or seek securities paying higher dividends or interest. The market price of our common shares likely will be based primarily on the earnings and return that we derive from our investments and income with respect to our properties and our related distributions to shareholders, and not from the market value or underlying appraised value of the properties or investments themselves. As a result, interest rate fluctuations and capital market conditions can affect the market price of our common shares. For instance, if interest rates rise without an increase in our dividend rate, the market price of our common shares could decrease because potential investors may require a higher dividend yield on our common shares as market rates on interest-bearing securities, such as bonds, rise. In addition, rising interest rates would result in increased interest expense on our variable rate debt, thereby adversely affecting cash flow and our ability to service our indebtedness and pay dividends.
Our transition to a TRS structure may result in a decrease in revenue.
During the years ended December 31, 2003, 2002 and 2001, certain hotels owned by us were under fixed lease agreements with HHMLP. The payments received from some of these fixed leases exceeded the payments that we estimate would have been received had the hotels been leased directly to our TRS. Each of these leases has now expired, and these hotels were released to our TRS. The revenue generated by these hotels under the leases to our TRS may be less than the rent we received when they were leased to HHMLP.
Risks Related to Our Tax Status
If we fail to qualify as a REIT, our dividends will not be deductible to us, and our income will be subject to taxation.
We have operated and intend to continue to operate so as to qualify as a REIT for federal income tax purposes. Our continued qualification as a REIT will depend on our continuing ability to meet various requirements concerning, among other things, the ownership of our outstanding shares of beneficial interest, the nature of our assets, the sources of our income, and the amount of our distributions to our shareholders. If we were to fail to qualify as a REIT in any taxable year, we would not be allowed a deduction for distributions to our shareholders in computing our taxable income and would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates. Unless entitled to relief under certain Code provisions, we also would be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost. As a result, amounts available for distribution to shareholders would be reduced for each of the years involved. Although we currently intend to operate in a manner designed to qualify as a REIT, it is possible that future economic, market, legal, tax or other considerations may cause the trustees, with the consent of holders of two-thirds of the outstanding shares, to revoke the REIT election.
Failure to make required distributions would subject us to tax.
In order to qualify as a REIT, each year we must distribute to our shareholders at least 90% of our REIT taxable income, other than any net capital gain. To the extent that we satisfy the distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any year are less than the sum of:
•
85% of our REIT ordinary income for that year;
•
95% of our REIT capital gain net income for that year; and
•
100% of our undistributed taxable income from prior years.
We have paid out, and intend to continue to pay out, our income to our shareholders in a manner intended to satisfy the distribution requirement and to avoid corporate income tax and the 4% nondeductible excise tax. Differences in timing between the recognition of income and the related cash receipts or the effect of required debt amortization payments could require us to borrow money or sell assets to pay out enough of our taxable income to satisfy the distribution requirement and to avoid corporate income tax and the 4% nondeductible excise tax in a particular year. In the past we have borrowed, and in the future we may borrow, to pay distributions to our shareholders and the limited partners of our operating partnership. Such borrowings subject us to risks from borrowing as described herein.
The taxation of corporate dividends may adversely affect the value of our common shares.
The Jobs and Growth Tax Relief Reconciliation Act of 2003, which was enacted into law on May 28, 2003, among other things, generally reduced to 15% the maximum marginal rate of tax payable by domestic noncorporate taxpayers on dividends received from a regular C corporation. This reduced tax rate, however, does not apply to dividends paid to domestic noncorporate taxpayers by a REIT on its stock, except for certain limited amounts. Although the earnings of a REIT that are distributed to its shareholders are still generally subject to less federal income taxation than earnings of a non-REIT C corporation that are distributed to its shareholders net of corporate-level income tax, this legislation could cause domestic noncorporate investors to view the stock of regular C corporations as more attractive relative to the stock of a REIT than was the case prior to the enactment of the legislation, because the dividends from regular C corporations are generally taxed at a lower rate while dividends from REITs are generally taxed at the same rate as the individual’s other ordinary income. We cannot predict what effect, if any, the enactment of this legislation may have on the value of the stock of REITs in general or on our shares in particular, either in terms of price or relative to other investments.
Risks Related to the Hotel Industry
The value of our hotels depends on conditions beyond our control.
Our hotels are subject to varying degrees of risk generally incident to the ownership of hotels. The underlying value of our hotels, our income and ability to make distributions to our shareholders are dependent upon the operation of the hotels in a manner sufficient to maintain or increase revenues in excess of operating expenses. Hotel revenues may be adversely affected by adverse changes in national economic conditions, adverse changes in local market conditions due to changes in general or local economic conditions and neighborhood characteristics, competition from other hotels, changes in interest rates and in the availability, cost and terms of mortgage funds, the impact of present or future environmental legislation and compliance with environmental laws, the ongoing need for capital improvements, particularly in older structures, changes in real estate tax rates and other operating expenses, adverse changes in governmental rules and fiscal policies, civil unrest, acts of terrorism, acts of God, including earthquakes, hurricanes and other natural disasters, acts of war, adverse changes in zoning laws, and other factors that are beyond our control. In particular, general and local economic conditions may be adversely affected by the recent terrorist incidents in New York and Washington, D.C. Our management is unable to determine the long-term impact, if any, of these incidents or of any acts of war or terrorism in the United States or worldwide, on the U.S. economy, on us or our hotels or on the market price of our common shares.
Our hotels are subject to general hotel industry operating risks, which may impact our ability to make distributions to shareholders.
Our hotels are subject to all operating risks common to the hotel industry. The hotel industry has experienced volatility in the past, as have our hotels, and there can be no assurance that such volatility will not occur in the future. These risks include, among other things, competition from other hotels; over-building in the hotel industry that could adversely affect hotel revenues; increases in operating costs due to inflation and other factors, which may not be offset by increased room rates; reduction in business and commercial travel and tourism; strikes and other labor disturbances of hotel employees; increases in energy costs and other expenses of travel; adverse effects of general and local economic conditions; and adverse political conditions. These factors could reduce revenues of the hotels and adversely affect our ability to make distributions to our shareholders.
Competition for guests is highly competitive.
The hotel industry is highly competitive. Our hotels compete with other existing and new hotels in their geographic markets. Many of our competitors have substantially greater marketing and financial resources than we do. If their marketing strategies are effective, we may be unable to make distributions to our shareholders.
Our investments are concentrated in a single segment of the hotel industry.
Our current business strategy is to own and acquire hotels primarily in the high quality, upscale and mid-scale limited service and extended-stay segment of the hotel industry. We are subject to risks inherent in concentrating investments in a single industry and in a specific market segment within that industry. The adverse effect on amounts available for distribution to shareholders resulting from a downturn in the hotel industry in general or the mid-scale segment in particular could be more pronounced than if we had diversified our investments outside of the hotel industry or in additional hotel market segments.
The hotel industry is seasonal in nature.
The hotel industry is seasonal in nature. Generally, hotel revenues are greater in the second and third quarters than in the first and fourth quarters. Our hotels’ operations historically reflect this trend. We believe that we will be able to make distributions necessary to maintain REIT status through cash flow from operations; but if we are unable to do so, we may not be able to make the necessary distributions or we may have to generate cash by a sale of assets, increasing indebtedness or sales of securities to make the distributions. Risks of operating hotels under franchise licenses, which may be terminated or not renewed, may impact our ability to make distributions to shareholders.
Risks of operating hotels under franchise licenses, which may be terminated or not renewed, may impact our ability to make distributions to shareholders.
The continuation of the franchise licenses is subject to specified operating standards and other terms and conditions. All of the franchisors of our hotels periodically inspect our hotels to confirm adherence to their operating standards. The failure of our partnership or HHMLP to maintain such standards or to adhere to such other terms and conditions could result in the loss or cancellation of the applicable franchise license. It is possible that a franchisor could condition the continuation of a franchise license on the completion of capital improvements that the trustees determine are too expensive or otherwise not economically feasible in light of general economic conditions, the operating results or prospects of the affected hotel. In that event, the trustees may elect to allow the franchise license to lapse or be terminated.
There can be no assurance that a franchisor will renew a franchise license at each option period. If a franchisor terminates a franchise license, we, our partnership, and HHMLP may be unable to obtain a suitable replacement franchise, or to successfully operate the hotel independent of a franchise license. The loss of a franchise license could have a material adverse effect upon the operations or the underlying value of the related hotel because of the loss of associated name recognition, marketing support and centralized reservation systems provided by the franchisor. Our loss of a franchise license for one or more of the hotels could have a material adverse effect on our partnership’s revenues and our amounts available for distribution to shareholders.
Operating costs and capital expenditures for hotel renovation may be greater than anticipated and may adversely impact distributions to shareholders.
Hotels generally have an ongoing need for renovations and other capital improvements, particularly in older structures, including periodic replacement of furniture, fixtures and equipment. Under the terms of our management agreements with HHMLP, we are obligated to pay the cost of expenditures for items that are classified as capital items under GAAP that are necessary for the continued operation of our hotels. If these expenses exceed our estimate, the additional cost could have an adverse effect on amounts available for distribution to shareholders. In addition, we may acquire hotels in the future that require significant renovation. Renovation of hotels involves certain risks, including the possibility of environmental problems, construction cost overruns and delays, uncertainties as to market demand or deterioration in market demand after commencement of renovation and the emergence of unanticipated competition from hotels.
Risks Related to Real Estate Investment Generally
Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition.
Real estate investments are relatively illiquid. Our ability to vary our portfolio in response to changes in operating, economic and other conditions will be limited. No assurances can be given that the fair market value of any of our hotels will not decrease in the future.
If we suffer losses that are not covered by insurance or that are in excess of our insurance coverage limits, we could lose investment capital and anticipated profits.
We require comprehensive insurance to be maintained on each of the our hotels, including liability and fire and extended coverage in amounts sufficient to permit the replacement of the hotel in the event of a total loss, subject to applicable deductibles. However, there are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes and acts of terrorism, that may be uninsurable or not economically insurable. Inflation, changes in building codes and ordinances, environmental considerations and other factors also might make it impracticable to use insurance proceeds to replace the applicable hotel after such applicable hotel has been damaged or destroyed. Under such circumstances, the insurance proceeds received by us might not be adequate to restore our economic position with respect to the applicable hotel. If any of these or similar events occur, it may reduce the return from the attached property and the value of our investment.
REITs are subject to property taxes.
Each hotel is subject to real and personal property taxes. The real and personal property taxes on hotel properties in which we invest may increase as property tax rates change and as the properties are assessed or reassessed by taxing authorities. Many state and local governments are facing budget deficits which has led many of them, and may in the future lead others to, increase assessments and/or taxes. If property taxes increase, our ability to make expected distributions to our shareholders could be adversely affected.
Environmental matters could adversely affect our results.
Operating costs may be affected by the obligation to pay for the cost of complying with existing environmental laws, ordinances and regulations, as well as the cost of future legislation. Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or remediation of hazardous or toxic substances on, under or in such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. The cost of complying with environmental laws could materially adversely affect amounts available for distribution to shareholders. Phase I environmental assessments have been obtained on all of our hotels. Nevertheless, it is possible that these reports do not reveal all environmental liabilities or that there are material environmental liabilities of which we are unaware.
Costs associated with complying with the Americans with Disabilities Act may adversely affect our financial condition and operating results.
Under the Americans with Disabilities Act of 1993 (ADA), all public accommodations are required to meet certain federal requirements related to access and use by disabled persons. While we believe that our hotels are substantially in compliance with these requirements, a determination that we are not in compliance with the ADA could result in imposition of fines or an award of damages to private litigants. In addition, changes in governmental rules and regulations or enforcement policies affecting the use and operation of the hotels, including changes to building codes and fire and life-safety codes, may occur. If we were required to make substantial modifications at the hotels to comply with the ADA or other changes in governmental rules and regulations, our ability to make expected distributions to our shareholders could be adversely affected.
Item 1B.
Item 1B.
Unresolved Staff Comments
None.
Item 2.
Item 2.
Properties
The following table sets forth certain information with respect to the hotels we wholly owned as of December 31, 2005.
_________________________
(1)
Represents restaurant revenue, telephone revenue and other revenue.
(2)
REVPAR is determined by dividing room revenue by available rooms for the applicable period.
(3)
A portion of the land adjacent to this hotel, which is not currently used for hotel operations, is leased to an affiliate for $1 per year for years.
(4)
We assumed operations of this hotel in January 2005.
(5)
We assumed operations of this hotel in April 2005.
(6)
We assumed operations of these hotels in May 2005.
(7)
We assumed operations of these hotels in June 2005.
The following table sets forth certain information with respect to the hotels we owned through joint ventures with third parties as of December 31, 2005.
_________________________
(1)
Represents restaurant revenue, telephone revenue and other revenue.
(2)
REVPAR is determined by dividing room revenue by available rooms for the applicable period.
(3)
Hotel opened in July 2004. We own 50% of the joint venture. Inn America, LLC owns 50% of joint venture.
(4)
We own 55% of the joint venture. Logan Hospitality Associates, LLC owns 45% of joint venture.
(5)
Hotel opened in August 2003. We own 33.3% of the joint venture. CNL Hospitality Partners, L.P. owns 66.7% of joint venture.
(6)
Hotel opened in November 2003. We own 40% of the joint venture. Joseph Pacitti and PRA Glastonbury Management own 59% and 1% of the joint venture, respectively.
(7)
We assumed operations of these hotels in August 2005. We own 66.7% of the joint venture. Mystic Hotel Investors owns 33.3% of the joint venture.
(8)
We assumed operations of this hotel in September 2005. We own 66.7% of the joint venture. Mystic Hotel Investors owns 33.3% of the joint venture.
(9)
We assumed operations of this hotel in October 2005. We own 44% of the joint venture. Mystic Hotel Investors and a minority interest holder owns 44% and 12% of the joint venture, respectively.
(10)
We assumed operations of this hotel in July 2005. We own 50% of the joint venture. Hiren Boston, LLC owns 50% of the joint venture.
(11)
We assumed operations of this hotel in November 2005. We own 75% of the joint venture. LTD Associates Two, LLC owns 25% of the joint venture.
(12)
We assumed operations of this hotel in October 2005. We own 50% of the joint venture. SB Partners owns 50% of the joint venture.
(13)
We assumed operations of this hotel in November 2005. We own 75% of the joint venture. LTD Associates One, LLC owns 25% of the joint venture.
(14)
We assumed operations of this hotel in August 2005. We own 44.7% of the joint venture. Mystic Hotel Investors and a minority interest holder own 22.3% and 33.0% of the joint venture, respectively.
The following table sets forth certain information with respect to each of our hotels:
______________
(1)
This hotel opened in May 2004 and, thus, the data shown for 2004 represents approximately seven months of operations.
(2)
This hotel was acquired in July 2004 and, thus, the data shown for 2004 represents approximately six months of operations. The hotel is owned by a joint venture with Inn America, LLC
(3)
This hotel opened in January 2002.
(4)
We assumed operations of this hotel in March 2004 and, thus, the data shown for 2004 represents approximately ten months of operations. The hotel is owned by a joint venture with Logan Hospitality Associates, LLC
(5)
This hotel opened in August 2003 and, thus, the data shown for 2003 represents approximately five months of operations. The hotel is owned by a joint venture with CNL Hospitality Partners, L.P.
(6)
We assumed operations of this hotel in October 2003 and, thus, the data shown for 2003 represents approximately three months of operations.
(7)
This hotel opened in October 2003 and, thus, the data shown for 2003 represents approximately three months of operations.
(8)
This hotel opened in November 2003 and, thus, the data shown for 2003 represents approximately two months of operations. The hotel is owned by a joint venture with Joseph Pacitti and PRA Glastonbury Management.
(9)
This hotel opened in July 2004 and, thus, the data shown for 2004 represents approximately five months of operations.
(10)
This hotel opened in May 2001 and, thus, the data shown for 2001 represents approximately eight months of operations.
(11)
This hotel opened in January 2004 and, thus, the data shown for 2004 represents approximately eleven months of operations.
(12)
This hotel opened in April 2000 and, thus, the data shown for 2000 represents approximately nine months of operations.
(13)
This hotel opened in September 2000 thus the data shown for 2000 represents four months of operations.
(14)
We assumed operations of this hotel in March 2004 and, thus, the data shown for 2004 represents approximately nine months of operations.
(15)
We assumed operations of this hotel in July 2004 and, thus, the data shown for 2004 represents approximately six months of operations.
(16)
We assumed operations of this hotel in January 2005 and, thus, the data shown for 2005 represents approximately eleven months of operations.
(17)
We assumed operations of this hotel in April 2005 and, thus, the data shown for 2005 represents approximately eight months of operations.
(18)
We assumed operations of these hotels in May 2005 and, thus, the data shown for 2005 represents approximately seven months of operations.
(19)
We assumed operations of these hotels in June 2005 and, thus, the data shown for 2005 represents approximately six months of operations.
(20)
We assumed operations of these hotels in August 2005 and, thus, the data shown for 2005 represents approximately four months of operations. We own 66.7% of the joint venture. Mystic Hotel Investors owns 33.3% of the joint venture.
(21)
We assumed operations of this hotel in September 2005 and, thus, the data shown for 2005 represents approximately three months of operations. We own 66.7% of the joint venture. Mystic Hotel Investors owns 33.3% of the joint venture.
(22)
We assumed operations of this hotel in October 2005 and, thus, the data shown for 2005 represents approximately two months of operations. We own 44% of the joint venture. Mystic Hotel Investors and a minority interest holder owns 44% and 12% of the joint venture, respectively.
(23)
We assumed operations of this hotel in July 2005 and, thus, the data shown for 2005 represents approximately five months of operations. We own 50% of the joint venture. Hiren Boston, LLC owns 50% of the joint venture.
(24)
We assumed operations of this hotel in November 2005 and, thus, the data shown for 2005 represents approximately one month of operation. We own 75% of the joint venture. LTD Associates Two, LLC owns 25% of the joint venture.
(25)
We assumed operations of this hotel in October 2005 and, thus, the data shown for 2005 represents approximately two months of operations. We own 50% of the joint venture. SB Partners owns 50% of the joint venture.
(26)
We assumed operations of this hotel in November 2005 and, thus, the data shown for 2005 represents approximately one month of operation. We own 75% of the joint venture. LTD Associates One, LLC owns 25% of the joint venture.
(27)
We assumed operations of this hotel in August 2005 and, thus, the data shown for 2005 represents approximately four months of operation. We own 44.7% of the joint venture. Mystic Hotel Investors and a minority interest holder own 22.3% and 33.0% of the joint venture, respectively.
Taxable REIT Subsidiaries
In January 2003, the operating partnership formed a wholly owned taxable REIT subsidiary (“TRS”), 44 New England Management Company (“44 New England”), to lease certain of the company’s hotels.
We entered into an agreement with HHMLP, our affiliated lessor, effective April 1, 2004, to terminate the eight remaining affiliated leases, which related to the following properties:
·
Holiday Inn Express, Long Island City, New York
·
Doubletree Club, Jamaica, JFK Airport - New York
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Mainstay Suites, Frederick, Maryland
·
Hampton Inn & Suites, Hershey, Pennsylvania
·
Hampton Inn, Danville, Pennsylvania
·
Holiday Inn Express & Suites, Harrisburg, Pennsylvania
·
Sleep Inn and Mainstay Suites, King of Prussia, Pennsylvania
Hersha Inn America TRS Inc; Hersha/CNL TRS Inc.; Hersha PRA TRS, Inc; South Bay Sandeep, LLC; and Revere Hotel Group, LLC, are each a TRS wholly-owned by their respective joint ventures. Mystic Partners, LLC owns an interest in eight hotel properties. Each of the eight properties owned by Mystic Partners, LLC is leased to a separate entity that is consolidated in Mystic Partners Leaseco, LLC that is owned by 44 New England and the Company’s joint venture partner in Mystic Partners, LLC. South Bay Boston, LLC; HT LTD Williamsburg LLC; and HT LTD Williamsburg Two LTD LLC lease properties from each respective joint venture and are owned by 44 New England and the Company’s joint venture partner in each venture.
New England and the joint venture TRS lessees lease the hotel properties pursuant to separate percentage lease agreements (the “Percentage Leases”) that provide for percentage rents based on the revenues of the hotels. The hotels are located principally in the Mid-Atlantic region of the United States. HHMLP serves as the manager for all of the owned assets and joint venture assets, except for the properties owned by Mystic Partners, LLC; Hiren Boston, LLC; SB Partners, LLC; LTD Associates One, LLC; and LTD Associates Two, LLC. These properties are managed by parties related to our partners in those joint ventures. HHMLP is owned in part by four of the Company’s executive officers, two of its trustees and other third party investors.
Management Agreements
Our TRSs have engaged HHMLP as the property manager for our hotels pursuant to substantially similar management agreements. Each management agreement provides for a five year term and is subject to early termination upon the occurrence of defaults and certain other events described therein. As required under the REIT qualification rules, HHMLP must qualify as an “eligible independent contractor” during the term of the management agreements.
Under the management agreements, HHMLP generally pays the operating expenses of our hotels. All operating expenses or other expenses incurred by HHMLP in performing its authorized duties are reimbursed or borne by our TRS to the extent the operating expenses or other expenses are incurred within the limits of the applicable approved hotel operating budget. HHMLP is not obligated to advance any of its own funds for operating expenses of a hotel or to incur any liability in connection with operating a hotel.
For its services, HHMLP receives a base management fee, and if a hotel meets and exceeds certain thresholds, an additional incentive management fee. The base management fee for a hotel is due monthly and is equal to 3% of the gross revenues associated with that hotel for the related month. There were no incentive management fees payable in 2004 or 2005. The incentive management fee, if any, for a hotel is due annually in arrears on the ninetieth day following the end of each fiscal year and is equal to an amount determined based upon the financial performance of the hotel according to a pre-determined formula.
HHMLP must from time to time make expenditures on our behalf for repairs and maintenance as are necessary to keep a hotel in good operating condition. Our TRS or we may elect to, from time to time at its or our expense, make alterations, additions, or improvements (including structural changes or repairs) in or to our hotels.
Under the management agreements, our TRSs retain the right to sell, lease, transfer or otherwise dispose of our hotels. HHMLP may not transfer or assign any of its rights and obligations under a management agreement without the prior written consent of our TRS. On the other hand, our TRSs may transfer or assign their rights and obligations under a management agreement without the consent of HHMLP. However, HHMLP will have the right to terminate the management agreement after receiving notice of such transfer or assignment and could be entitled to termination fees.
Item 3.
Item 3.
Legal Proceedings
We are not presently subject to any material litigation nor, to our knowledge, is any other litigation threatened against us, other than routine actions for negligence or other claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance and all of which collectively are not expected to have a material adverse effect on our liquidity, results of operations or business or financial condition.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of our security holders during the fourth quarter of 2005, through the solicitation of proxies or otherwise.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common shares began trading on the American Stock Exchange on January 20, 1999 under the symbol “HT.” As of March 15, 2006, the last reported closing price per common share on the American Stock Exchange was $9.14. The following table sets forth the high and low sales price per common share reported on the American Stock Exchange as traded and the dividends paid on the common shares for each of the quarters indicated.
* Dividend for the quarter ending March 31, 2006 was declared on March 17, 2006. We declared a dividend of $0.18 per Class A common share and distribution of $0.18 per limited partnership unit to shareholders and unitholders on record at March 31, 2006. The dividend and distribution payment date is April 21, 2006.
Shareholder Information
At March 15, 2006 we had approximately 137 holders of record and 5,075 beneficial owners of our common shares. Units of limited partnership interest in our operating partnership (which are redeemable for common shares subject to certain limitations) were held by 14 entities and persons.
Our organizational documents limit the number of equity securities of any series that may be owned by any single person or affiliated group to 9.9% of the outstanding shares. We granted limited waivers of these ownership limitations as follows:
·
a limited waiver to RREEF America L.L.C., Deutche Asset Management, Inc., and their related mutual funds and accounts, specifically including Scudder RREEF Real Estate Fund Inc., Scudder RREEF Real Estate Fund II Inc. and Scudder RREEF Securities Trust (collectively, the “Scudder RREEF Group”) to own up to 16% of the outstanding common shares, subject to their compliance with certain representations and warranties, including that no single person will own more than 9.9% of the outstanding common shares; and
·
a limited waiver to K.G. Redding & Associates, and its managed accounts to own up to 15% of the outstanding common shares, subject to their compliance with certain representations and warranties including that no single person will own more than 9.9% of the outstanding common shares.
Distribution Information
While it is the current policy of our Board to maintain our dividends at least at historical levels, future distributions, if any, will be at the discretion of our Board of Trustees and will depend on our actual cash flow, financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code and such other factors as we may deem relevant. Our ability to make distributions will depend on our receipt of distributions from our operating partnership and lease payments from our lessees with respect to the hotels. We rely on the profitability and cashflows of our hotels to generate sufficient cash flow for distributions.
Common Shares Issuable Pursuant to Options
As of December 31, 2005, no options or warrants to acquire our securities were outstanding. The following table summarizes information with respect to equity compensation as of December 31, 2005:
Equity Compensation Plan Information
(1) In March 2005, we issued 419 common shares to each of our Independent Trustees pursuant to our 2004 Equity Incentive Plan. In June 2005, we issued 71,000 restricted common shares of beneficial interest to executives of the Company. In January 2006, we issued 5,000 common shares to each of our Independent Trustees pursuant to our 2004 Equity Incentive Plan.
Item 6.
Item 6.
Selected Financial Data
The following sets forth selected financial and operating data on a historical consolidated basis. The following data should be read in conjunction with the financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K.
HERSHA HOSPITALITY TRUST
SELECTED FINANCIAL DATA
(In thousands, except per share data)
_________________________
(1)
Represents initial fixed rent plus aggregate percentage rent paid by HHMLP to the Partnership pursuant to percentage leases, which payments are calculated by applying the rent provisions in the respective percentage leases to the historical room revenues.
(2)
Represents initial fixed rent paid by the lessee to the Partnership pursuant to percentage leases, which payments are calculated by applying the rent provisions in the respective percentage leases to the historical room revenues.
(3)
Represents basic earnings per share computed in accordance with FAS No. 128.
(4)
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Funds From Operations” for an explanation of FFO, why we believe Adjusted FFO is a meaningful measure of our operating performance and a reconciliation of Adjusted FFO to net income calculated in accordance with GAAP.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
All statements contained in this section that are not historical facts are based on current expectations. Words such as “believes”, “expects”, “anticipate”, “intends”, “plans” and “estimates” and variations of such words and similar words also identify forward-looking statements. Our actual results may differ materially. We caution you not to place undue reliance on any such forward-looking statements. We assume no obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances.
General
As of December 31, 2005, we owned interests in 47 hotels in the eastern United States including 16 hotels owned through joint ventures. For purposes of the REIT qualification rules, we cannot directly operate any of our hotels. Instead, we must lease our hotels. In 2001, the REIT rules were modified, allowing a hotel REIT to lease its hotels to a taxable REIT subsidiary, or TRS, provided that the TRS engages an eligible independent contractor to manage the hotels. Accordingly, as of December 31, 2005, we have leased all 47 of our hotels to a wholly-owned TRS, a joint venture owned TRS, or a corporate entity owned by our wholly-owned TRS. Each of these TRS entities will pay qualifying rent, and the TRS entities have entered into management contracts with qualified independent managers, including HHMLP, with respect to our hotels. We intend to lease all newly acquired hotels to a TRS. As of December 31, 2005, we also owned interests in sixteen hotels through joint ventures, and those hotels are leased to TRSs that are wholly owned by those joint ventures. The hotels owned by the joint ventures are managed by various management companies pursuant to the terms of certain management agreements.
As all of our hotels have been leased to our TRS or a joint venture TRS, which enables us to participate more directly in the operating performance of our hotels. Rather than receiving base and percentage lease payments from HHMLP, which funded its own hotel operating expenses, the TRS directly receives all revenue from, and funds all expenses relating to, hotel operations. The TRS is also be subject to income tax on its earnings.
The following table outlines operating results for the Company's full portfolio, including all wholly owned hotels and those owned through a joint venture interest, for the years ended December 31, 2005, 2004 and 2003.
The increase in revenue per available room (“RevPAR”) during the years ended December 31, 2005, and 2004, was due primarily to a rebounding economy; the Company’s broadened strategic portfolio focus on stronger central business districts and primary suburban office parks; the size of the recent acquisitions as a percentage of the portfolio; franchise affiliations with stronger brands, such as Hilton Garden Inn, Residence Inn and Four Points by Sheraton; and a strong focus on improving the average daily rate (“ADR”). The increase in both rooms and total revenue can be attributed primarily to the hotels acquired during the respective periods.
Comparison of the year ended December 31, 2005 to December 31, 2004 (in thousands, except per share data)
Revenue
Our total revenues for the year ended December 31, 2005, consisted substantially of hotel operating revenues for hotels leased to our wholly owned TRS, 44 New England. Our total revenues were approximately $80,899, an increase of $32,368 or 66.70% compared to total revenues of $48,531 for the year ended December 31, 2004. The increase in revenue is primarily attributable to the acquisition of new hotels since the period ended December 31, 2004, an increase in same store revenues and the direct recording of hotel operating revenues for hotels leased to our TRS. Under the TRS structure, we recognize gross hotel operating revenues and gross hotel operating expenses for hotels leased to 44 New England. Under the percentage lease structure, we recorded only lease revenues pursuant to the terms of the percentage leases that were calculated as a percentage of a hotel’s revenues per the lease agreements.
Hotel operating revenues increased by approximately $33,560 as hotels previously leased to HHMLP through percentage leases were converted to a TRS structure and were subsequently leased to our TRS, 44 New England. During the first three months ended March 31, 2004, eight of our hotels were leased to HHMLP through percentage leases and 14 hotels were leased to our TRS. As of April 1, 2004, all of our owned hotels were leased to our TRS, and all of our hotels owned in a joint venture were leased to a TRS owned by the joint venture. Accordingly there was no lease revenue from the percentage leases in 2005. Lease revenues from the percentage leases were $1,192 in 2004. Additionally, since December 31, 2004, the Company has acquired eight hotels and a joint venture interest in twelve additional hotels. Revenue for all eight purchases and two consolidated joint ventures was recorded from the date of acquisition as Hotel Operating Revenues. The other joint ventures were accounted for utilizing the equity method of accounting and our portion of the net income from our joint ventures using the equity method is recorded as “Income from Unconsolidated Joint Venture Investments” in our Statement of Operations.
Interest income and other revenue increased to approximately $5,062 in 2005, from $2,608 in 2004. The Company recorded interest revenue of $4,183 on its secured development lines for five hotels in 2005 compared to $2,191 in 2004. Additionally, the Company earned interest on short term investments and escrow accounts of $359 in 2005. Other revenue totaling $520 primarily related to asset management fees received from Mystic Partners, LLC and the Hampton Inn, (Manhattan) Chelsea, NY, as well as, loan commitment fees on our secured lending.
Expenses
Total expenses increased $26,016, or 58.96%, to approximately $70,141 for the year ended December 31, 2005, from $44,125 for the year ended December 31, 2004.
Hotel operating expenses increased to approximately $49,783 in 2005, from $30,335 in 2004, due to the direct recognition of hotel operating expenses for hotels leased to 44 New England. Under the TRS structure we recognize gross hotel operating revenues and gross hotel operating expenses for hotels leased to New England. In addition, we recorded expenses for the eight acquisitions and two consolidated joint ventures in 2005 from the dates of acquisition.
Depreciation and amortization increased from approximately $6,930 in 2004, to $10,600 in 2005, an increase of $3,670, due to additional depreciation expense incurred related to property acquisitions.
Interest expense increased approximately $7,927 from $6,167 in 2004, to $14,094 in 2005. The increase is related to an increase of $158,385 in mortgages and notes payable from $97,761 as of December 31, 2004 to $256,146 as December 31, 2005. These additional financings related to the property acquisitions.
Real estate and personal property taxes and insurance increased by approximately $1,242 from $3,104 in 2004, to $4,346 in 2005. The increase is primarily related to additional property taxes incurred at our hotels acquired since December 31, 2004.
General and administrative expense increased by approximately $1,802 from $3,190 in 2004, to $4,992 in 2005. General and administrative expenses increased due to an increase in employee head count and increased audit and legal expenses incurred during the period and costs associated with compliance work related to the Sarbanes-Oxley Act.
Net Income
Net income available to common shareholders for the year ended December 31, 2005, was approximately $1,377, compared to 2004 net income of $2,049. As mentioned above, we converted a majority of our hotels to a TRS structure, in which we recognize both gross hotel operating revenues and gross hotel operating expenses. Excluding unconsolidated joint ventures, we own or have a consolidated joint venture interest in 34 hotels that are leased to a wholly-owned TRS.
In August of 2005, the Company issued 2.4 million 8% Series A cumulative preferred shares. As a result, net income available to common shareholders was decreased by $1,920 due to dividend payments to preferred shareholders. On April 16, 2004, CNL converted all of its Series A Preferred Units into common stock and sold these shares in a secondary offering. Net income available for common shareholders was positively impacted in 2005 due to the fact that there were no distributions paid on the Series A Preferred Units after this conversion.
Net income was negatively impacted by a decrease in income from unconsolidated joint venture investments of $24 from $481 in 2004 to $457 in 2005. Income allocated to minority interest during the period decreased as a result of the losses from consolidated joint ventures allocated to our joint venture partners. Income allocated to minority interest during the period also decreased due to the September 2004 common share offerings and contribution of the proceeds to our operating partnership. Net income was positively impacted in 2005 by a gain of $1,161 on the sale of two hotel properties. However, income from discontinued operations decreased from $1,325 in 2004 to a loss of $47. Net income was negatively impacted by start up costs at hotels that were recently acquired and are still in the ramp up or stabilization phase.
Comparison of year ended December 31, 2004 to year ended December 31, 2003 (in thousands, except per share data)
Revenue
Our total revenues for the year ended December 31, 2004, consisted substantially of hotel operating revenues for hotels leased to our wholly owned TRS, 44 New England, and percentage lease revenue recognized pursuant to percentage leases with HHMLP. Our total revenues were approximately $48,531, an increase of $32,696 or 206.48% compared to total revenues of $15,835 for the year ended December 31, 2003. The increase in revenue is primarily attributable to the acquisition of new hotels since the period ended December 31, 2003, and the direct recording of hotel operating revenues for hotels leased to our TRS. Under the TRS structure, we recognize gross hotel operating revenues and gross hotel operating expenses for hotels leased to 44 New England. Under the percentage lease structure, we recorded only lease revenues pursuant to the terms of the percentage leases that were calculated as a percentage of a hotel’s revenues per the lease agreements.
Hotel operating revenues increased by approximately $42,608 as hotels previously leased to HHMLP through percentage leases were converted to a TRS structure and were subsequently leased to our TRS, 44 New England. During the first three months ended March 31, 2004, eight of our hotels were leased to HHMLP through percentage leases and 14 hotels were leased to our TRS. As of April 1, 2004, all of our owned hotels were leased to our TRS, and all of our hotels owned in a joint venture were leased to a TRS owned by the joint venture.
Additionally, during 2004, the Company has acquired five hotels and a joint venture interest in two additional hotels. Revenue for all five purchases and one consolidated joint venture was recorded from the date of acquisition as Hotel Operating Revenues. The other joint venture was accounted for utilizing the equity method of accounting and our portion of the net income from three of our joint ventures using the equity method is recorded as “Income from Unconsolidated Joint Venture Investments” in our Statement of Operations.
Lease revenues from the percentage leases decreased from approximately $10,144 in 2003, to $1,192 in 2004. This decrease is due to the expiration of six percentage leases on January 31, 2004, and the transfer of all of our leases to a TRS structure as of April 1, 2004, as mentioned above.
Interest income and other revenue increased to approximately $2,608 in 2004, from $809 in 2003. The Company recorded interest revenue of $2,191 on its secured and unsecured development lines for six hotels and a loan to HT/CNL Metro Hotels, LP during the year ended December 31, 2004. The loan to HT/CNL Metro Hotels, LP was fully repaid in July 2004. Additionally, the Company earned interest on short term investments and escrow accounts of $241 in 2004. Other revenue primarily related to asset management fees received for the Hampton Inn, (Manhattan) Chelsea, NY and loan commitment fees on our secured lending totaling $176.
Expenses
Total expenses increased 304.37%, to approximately $44,125 for the year ended December 31, 2004, from $10,912 for the year ended December 31, 2003.
Hotel operating expenses increased to approximately $30,335 in 2004, from $3,323 in 2003, due to the direct recognition of hotel operating expenses for hotels leased to 44 New England. Under the TRS structure we recognize gross hotel operating revenues and gross hotel operating expenses for hotels leased to New England. In addition, we recorded expenses for five acquisitions and one joint venture from the dates of acquisition.
Depreciation and amortization increased from approximately $4,136 in 2003, to $6,930 in 2004, an increase of $2,794, due to additional depreciation expense incurred related to property acquisitions.
Interest expense increased approximately $1,917 from $4,250 in 2003, to $6,167 in 2004. The increase is related to additional financings related to the property acquisitions.
Real estate and personal property taxes and insurance increased by approximately $1,795 from $1,309 in 2003, to $3,104 in 2004. The increase is primarily related to additional property taxes incurred at our hotels acquired in 2004.
General and administrative expense increased by approximately $2,519 from $671 in 2003, to $3,190 in 2004. The increase is related to the establishment of a formal management compensation plan in 2004. In prior periods, HHMLP was responsible for a majority of the compensation expense related to our employees. General and administrative expenses also increased due to increased audit and legal expenses incurred during the period and costs associated with compliance work related to the Sarbanes-Oxley Act.
The Company assumed land leases on the Hilton Garden Inn, Edison, NJ in conjunction with the acquisition of these assets and has realized an increase of land lease expense by approximately $454 during the year ended December 31, 2004.
Net Income
Net income for the year ended December 31, 2004, was approximately $2,049, compared to 2003 net income of $785. As mentioned above, we converted a majority of our hotels to a TRS structure, in which we recognize both gross hotel operating revenues and gross hotel operating expenses. Excluding unconsolidated joint ventures, we own or have a consolidated joint venture interest in 26 hotels that are leased to a wholly-owned TRS.
On April 16, 2004, CNL converted all of its Series A Preferred Units into common stock and sold these shares in a secondary offering. Net income was positively impacted due to the fact that there were no distributions paid on the Series A Preferred Units after this conversion.
Net income was positively impacted by income from unconsolidated joint venture investments of $481 and the reduction in income allocated to minority interest during the period as a result of the October 2003 and September 2004 common share offerings and contribution of the proceeds to our operating partnership. Net income was negatively impacted by start up costs at hotels that were recently acquired and are still in the ramp up or stabilization phase.
Liquidity and Capital Resources (in thousands, except per share data)
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 lines of credit. We believe that the net cash provided by operations will be adequate to fund the Company’s operating requirements, debt service and the payment of dividends in accordance with REIT requirements of the federal income tax laws. We expect to meet our long-term liquidity requirements, such as scheduled debt maturities and property acquisitions, through long-term secured and unsecured borrowings, the issuance of additional equity securities or, in connection with acquisitions of hotel properties, the issuance of units of operating partnership interest in our operating partnership subsidiary.
Our cash and cash equivalents balance of $8,780 at December 31, 2005, was primarily due to the proceeds from repayment of development loan receivables and net cash provided by operations.
On August 5, 2005, the Company completed a public offering of 2,400,000 of its 8.00% Series A Cumulative Redeemable Preferred Shares of Beneficial Interest, liquidation preference $25.00 per share. Net proceeds of the offering, less expenses and underwriters commissions, were approximately $57,750. Proceeds from the offering were used to finance the acquisition of the Company’s interests in Mystic Partners, LLC and SB Partners, LLC. The remaining net proceeds have been principally allocated to fund secured development loans and for general corporate purposes.
In the second quarter of 2005, the Company issued two junior subordinated notes payable in the aggregate amount of $51,548 to statutory trusts entities pursuant to indenture agreements. The $25,774 note issued to Hersha Statutory Trust I will mature on June 30, 2035, but may be redeemed at our option, in whole or in part, beginning on June 30, 2010 in accordance with the provisions of the indenture agreement. The $25,774 note issued to Hersha Statutory Trust II will mature on July 30, 2035, but may be redeemed at our option, in whole or in part, beginning on July 30, 2010 in accordance with the provisions of the indenture agreement. The note issued to Hersha Statutory Trust I bears interest at a fixed rate of 7.34% per annum through June 30, 2010, and the note issued to Hersha Statutory Trust II bears interest at a fixed rate of 7.173% per annum through July 30, 2010. Subsequent to June 30, 2010 for notes issued to Hersha Statutory Trust I and July 30, 2010 for notes issued to Hersha Statutory Trust II, holders the notes bear interest at a variable rate of LIBOR plus 3.0% pre annum. Interest expense on trust notes in amount of $2,313 was recorded during the year ended December 31, 2005.
On September 24, 2004, we completed a public offering of 3,500,000 common shares at $9.37 per share. On September 30, 2004, the underwriter exercised its over-allotment option on these shares, and we issued an additional 400,000 common shares at $9.37 per share. Proceeds to the Company, net of underwriting discounts and commissions and expenses, were approximately $36,317. Immediately upon closing the offering, the Company contributed all of the net proceeds of the offering to the Partnership in exchange for additional Partnership interests. Of the net offering proceeds, approximately $5,000 was used to repay indebtedness. The remaining net proceeds have been principally allocated to fund secured development loans, acquisitions and for general corporate purposes.
As of December 31, 2005, we had a $35,000 line of credit with Sovereign Bank. We may use the line of credit to fund future acquisitions and for working capital. Outstanding borrowings under the line of credit bear interest at the bank’s prime rate and are collateralized by certain of our properties. In the future, we may seek to increase the amount of the line of credit, negotiate additional credit facilities or issue corporate debt instruments. Any debt incurred or issued by us may be secured or unsecured, long-term or short-term, fixed or variable interest rate and may be subject to such other terms as we deem prudent. As of December 31, 2005, the interest rate on the line of credit was 7.25% and there were no amounts outstanding.
On January 17, 2006, we entered into a Revolving Credit Loan and Security Agreement (the “Credit Agreement”) with Commerce Bank, N.A. (the “Bank”), replacing the $35,000 line of credit with Sovereign Bank. The Credit Agreement provides for a revolving line of credit (the “Line of Credit”) in the principal amount of $60,000, including a sub-limit of $15,000 for irrevocable stand-by letters of credit. The Credit Agreement provides that $10,000 of the Line of Credit shall be made available for a period of not greater than ninety days on an unsecured basis and $50,000 of the Line of Credit shall be made available for a period of not greater than eighteen months on a secured basis, provided that the aggregate principal balance of the line of credit shall not exceed at any time the lesser of (i) 67% of the appraised value of certain hotel properties pledged to the Bank as collateral or (ii) an amount that would cause us to exceed a minimum debt service coverage ratio of 1.35 to 1.00 as set forth in the Credit Agreement.
The Credit Agreement includes certain financial covenants and requires that Hersha maintain (1) a minimum tangible net worth of $110,000; (2) a maximum of accounts and other receivables from affiliates of $75,000; and (3) certain financial ratios, including:
·
a debt service coverage ratio of 1.35 to 1.00;
·
a total funded liabilities to gross asset value ratio of .67 to 1.00; and
·
a EBITDA to debt service ratio of 1.40 to 1.00;
The Line of Credit expires on December 31, 2008, and, provided no event of default occurs, and remains uncured, the Bank may renew the line of credit for an additional period of one year. At our option, the interest rate on the line of credit is either (1) the Wall Street Journal variable prime rate minus one-half of one percent (0.50%) per annum or (2) LIBOR available for the periods of 1, 2, 3, or 6 months plus two and one quarter percent (2.25%) per annum. The Line of Credit is collateralized by (i) a first lien-security interest in certain existing and future assets of HHLP, (ii) title-insured, first-line mortgages on the Holiday Inn Express, Harrisburg, PA, the Mainstay Suites and Sleep Inn, King of Prussia, PA, the Fairfield Inn, Laurel, MD, and a hotel property to be determined, and (iii) collateral assignment of all hotel management contracts from which HHLP or its affiliates derive revenues.
The proceeds of the Line of Credit shall be used for working capital and general corporate purposes, including payment of distributions or dividends and the future purchase of additional hotels.
We have a debt policy that limits our consolidated indebtedness to less than 67% of the fair market value for the hotels in which we have invested. However, our organizational documents do not limit the amount of indebtedness that we may incur and our Board of Trustees may modify our debt policy at any time without shareholder approval. We intend to repay indebtedness incurred under the line of credit from time to time, for acquisitions or otherwise, out of cash flow and from the proceeds of issuances of additional common shares and other securities.
We intend to invest in additional hotels only as suitable opportunities arise and adequate sources of financing are available. Our bylaws require the approval of a majority of our Board of Trustees, including a majority of the independent trustees, to acquire any additional hotel in which one of our trustees or officers, or any of their affiliates, has an interest (other than solely as a result of his status as our trustee, officer or shareholder). We expect that future investments in hotels will depend on and will be financed by, in whole or in part, our existing cash, the proceeds from additional issuances of common shares, issuances of operating partnership units or other securities or borrowings. We currently have no agreement or understanding to acquire any hotel, and there can be no assurance that we will acquire any additional hotels that meet our investment criteria.
We make available to the TRS of our hotels 4% (6% for full service properties) of gross revenues per quarter, on a cumulative basis, for periodic replacement or refurbishment of furniture, fixtures and equipment at each of our hotels. We believe that a 4% (6% for full service hotels) reserve is a prudent estimate for future capital expenditure requirements. We intend to spend amounts in excess of the obligated amounts if necessary to comply with the reasonable requirements of any franchise license under which any of our hotels operate and otherwise to the extent we deem such expenditures to be in our best interests. We are also obligated to fund the cost of certain capital improvements to our hotels. We may use undistributed cash or borrowings under credit facilities to pay for the cost of capital improvements and any furniture, fixture and equipment requirements in excess of the set aside referenced above.
Cash Flow Analysis
Comparison of year ended December 31, 2005 to year ended December 31,
Net cash provided by operating activities for the year ended December 31, 2005, and 2004, was $15,413 and $12,148, respectively. The increase in net cash provided by operating activities was primarily the result of an increase in income before depreciation and amortization, distributions from unconsolidated joint ventures, and increases in due to related parties and accounts payable and accrued expenses. This was offset by an increase in escrow and lease deposits and other assets.
Net cash used in investing activities for the year ended December 31, 2005 and 2004 increased $112,858, from $78,378 in the year ended December 31, 2004 compared to $191,236 for the year ended December 31, 2005. Net cash used for the purchase of hotel properties increased $83,543 in 2005 over 2004 and advances and capital contributions for unconsolidated joint ventures increased $42,692 in 2005 over 2004. Also in 2005, $8,250 was on deposit for hotel properties that were acquired in the first quarter of 2006. We increased our capital expenditures from $2,494 in 2004 to $2,958 in 2005. The increases in these expenditures in 2005 were offset by a decrease in cash used to invest in development loans to related parties, net of repayments of $30,725 in 2005 as certain loans funded in the prior year were repaid. The uses of cash in 2005 were also offset by cash provided by the disposition of hotel assets held for sale of $6,288 received during 2005.
Net cash provided by financing activities for the year ended December 31, 2005 was $163,989 compared to cash provided by financing activities of $46,137 for the year ended December 31, 2005. This was, in part, the result of cash proceeds of $51,548 from the issuance of junior subordinated notes and cash proceeds of $57,750 from the issuance of 8.0% Series A Preferred Shares were received during the year ended December 31, 2005. Dividends of $947 were paid on the preferred shares. During the same period in 2004, proceeds of $38,279 were received from the sale of common stock and the Company used $8,951 in cash to redeem common partnership units.
Comparison of year ended December 31, 2004 to year ended December 31,
Net cash provided by operating activities for the year ended December 31, 2004, and 2003, was $12,148 and $5,193, respectively. The increase in net cash provided by operating activities was primarily the result of an increase in net income, a decrease in income allocated to minority interest, a decrease in lease payments receivable - related party and an increase in accounts payable and accrued expenses.
Net cash used in investing activities for the year ended December 31, 2004, and 2003 was $78,378 and $58,370, respectively. The increase in net cash used in investing activities was primarily the result of (a) $51,516 related to the purchase of the Residence Inn, Framingham, MA; Comfort Inn, Frederick, MD; Residence Inn, Greenbelt, MD; Hilton Garden Inn, Gettysburg, PA, (b) $2,494 to fund capital improvements in our hotels, (c) $5,012 utilized for joint venture investments in the Four Points by Sheraton, Revere, MA and the Courtyard by Marriott, Ewing, NJ and certain capital improvements at our existing joint venture properties, (d) $13,939 utilized to fund a development loan to Metro Ten Hotels, LLC, and (e) $20,550 of development loans to related parties. This was partially offset by $15,133 received from HT/CNL Metro Hotels, LP related to the repayment of indebtedness.
Net cash provided by financing activities for the year ended December 31, 2004 and 2003 was $46,137 and $93,744, respectively. The increase in net cash provided by financing activities for the years ended December 31, 2004 and 2003 was primarily the result of $38,279 and $77,262 respectively, of proceeds related to the issuance of common shares and $37,375 and $29,907, respectively, of proceeds from mortgages payable.
Funds From Operations
The National Association of Real Estate Investment Trusts (“NAREIT”) developed Funds from Operations (“FFO”) as a non-GAAP financial measure of performance and liquidity of an equity REIT in order to recognize that income-producing real estate historically has not depreciated on the basis determined under GAAP. FFO as defined by NAREIT is net income (loss) (computed in accordance with GAAP) excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated assets, plus certain non-cash items, such as depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.
FFO does not represent cash flows from operating activities in accordance with GAAP and should not be considered an alternative to net income as an indication of Hersha’s performance or to cash flow as a measure of liquidity or ability to make distributions. We consider FFO to be a meaningful, additional measure of operating performance because it excludes the effects of the assumption that the value of real estate assets diminishes predictably over time, and because it is widely used by industry analysts as a performance measure. Comparison of our presentation of FFO to similarly titled measures for other REITs is not necessarily meaningful due to the differences in the calculations used by us and other REITs.
The following table reconciles FFO for the periods presented to the most directly comparable GAAP measure, net income, for the same periods.
(in thousands, except per share data)
FFO was $13,452 for the year ended December 31, 2005, which was an increase of $3,638, or 37%, over FFO in the comparable period in 2004, which was $9,814. The increase in FFO was due to improved operating results as a consequence of a strengthened economy; the benefits of asset acquisitions and investments in joint ventures since December 31, 2004; continued stabilization and maturation of the existing portfolio; an increase in business travel and aggressive attention to the average daily rate. Under the REIT Modernization Act (“RMA”), which became effective January 1, 2001, the Company is permitted to lease hotels to a wholly owned taxable REIT subsidiary (“TRS”) and may continue to qualify as a REIT provided the TRS enters into management agreements with an “eligible independent contractor” who will manage the hotels leased by the TRS.
FFO was negatively impacted by start up costs at hotels that were recently acquired and are still in the ramp up or stabilization phase. FFO was also negatively impacted by increases in our general and administrative expenses during the year ended December 31, 2005 reflecting the addition of management personnel and additional expenses incurred enhancing internal controls during the periods.
FFO was $9,814 for the year ended December 31, 2004, which was an increase of $4,756, or 94% over FFO in the comparable period in 2003, which was $5,058. The increase in FFO was due to improved operating results as a consequence of a strengthened economy; the benefits of asset acquisitions since December 31, 2003; the conversion of fixed and percentage leases with HHMLP to leases with our TRS since April 1, 2004; continued stabilization and maturation of the existing portfolio; an increase in business travel and aggressive attention to the average daily rate. The Company formed the TRS Lessee in 2003. As of December 31, 2004, the TRS leased 25 properties from the Partnership, and is subject to taxation as a c-corporation. During 2004, all of our fixed and percentage leases have either expired or been terminated, and the Company now records the hotel operating revenues and expenses directly on its books.
Critical Accounting Policies and Estimates (in thousands, except per share data)
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.
On an on-going basis, estimates are evaluated by us, including those related to carrying value of investments in hotel properties. Our estimates are based upon historical experience and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:
Revenue Recognition
We directly recognize revenue and expense for all hotels leased through 44 New England as “Hotel Operating Revenue” and “Hotel Operating Expense” when earned and incurred.
Stock Compensation
We apply Statement of Financial Accounting Standards No. 123R, “Share-Based Payments” (SFAS 123R) whereby we measure the cost of employee service received in exchange for an award of equity instruments based on the grant -date fair value of the award. The cost is recognized over the period during which an employee is required to provide service in exchange for the award. We granted 71,000 shares of Stock Awards in the second quarter of 2005, at fair value of $9.60 per share vesting over four years. This resulted in $99 in compensation expense for the year ended December 31, 2005. There were no options issued during the year ended December 31, 2005. There were no shares or options issued in 2004 and 2003.
Allowance for Doubtful Accounts
Accounts receivable are charged to bad debt expense when they are determined to be uncollectible based upon a periodic review of the accounts by management. Accounting principles generally accepted in the United States of America require that the allowance method be used to recognize bad debts.
Derivatives
The Company’s objective in using derivatives is to add stability to interest expense and to manage its exposure to interest rate movements or other identified risks. To accomplish this objective, the Company primarily uses interest rate swaps as part of its cash flow hedging strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amount. Interest rate caps designated as cash flow hedges limit the Company's exposure to increased cash payments due to increases in variable interest rates. During 2005, these derivatives were used to hedge the variable cash flows associated with existing variable-rate debt.
As of December 31, 2005, no derivatives were designated as fair value hedges or hedges of net investments in foreign operations. Additionally, the Company does not use derivatives for trading or speculative purposes and currently does not have any derivatives that are not designated as hedges.
Investment in Unconsolidated Joint Ventures
The equity method of accounting is used for joint ventures in which we have the ability to exercise significant influence. Under this method, the investment, originally recorded at cost, is adjusted to recognize our share of net earnings or losses of the affiliates as they occur rather then as dividends or other distributions are received, limited to the extent of our investment in, advances to and commitments for the investee.
Impairment of Long-Lived Assets
We review the carrying value of each hotel property in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144 to determine if circumstances exist indicating an impairment in the carrying value of the investment in the hotel property or if depreciation periods should be modified. Long-lived assets are reviewed for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. We perform undiscounted cash flow analyses to determine if an impairment exists. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Hotel properties held for sale are presented at the lower of carrying amount or fair value less cost to sell.
We would record an impairment charge if we believe an investment in hotel property has been impaired such that future undiscounted cash flows would not recover the book basis of the investment in the hotel property. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s carrying value, thereby possibly requiring an impairment charge in the future. We have reviewed each of our hotel properties at December 31, 2005 for impairment and, based on our estimate of each hotel’s future undiscounted cash flows, determined that no impairment existed at any of our hotels.
REIT Qualification Tests
We are subject to numerous operational and organizational requirements to maintain our REIT status. Based on tests performed by management for the years ended December 31, 1999 through December 31, 2005, we believe that we satisfied the requirements needed to maintain our REIT status. However, we are subject to audit and if the Internal Revenue Service determined that we failed one or more of these tests, we could lose our REIT status. If we did not qualify as a REIT, our income would become subject to federal and state income taxes, which would be substantial, and the resulting adverse effects on our results of operations, liquidity and amounts distributable to shareholders would be material.
Equity Offerings
In October, 2003, we completed an equity offering of 9,775,000 common shares. Net proceeds from the offering were $77,300 after deducting underwriting discounts, commissions, and offering expenses paid by us. Net proceeds were used to reduce debt; redeem limited partnership units; pay dividends and operating expenses; and fund acquisitions.
On September 24, 2004, we completed a public offering of 3,500,000 common shares at $9.37 per share. On September 30, 2004, the underwriter exercised its over-allotment option on these shares, and we issued an additional 400,000 common shares at $9.37 per share. Proceeds to the Company, net of underwriting discounts and commissions and expenses, were approximately $36,300. Immediately upon closing the offering, the Company contributed all of the net proceeds of the offering to the Partnership in exchange for additional Partnership interests. Of the net offering proceeds, approximately $5,000 was used to repay indebtedness. The remaining net proceeds have been principally allocated to fund secured development loans, acquisitions and for general corporate purposes.
On August 5, 2005, the Company completed a public offering of 2,400,000 of its 8.00% Series A Cumulative Redeemable Preferred Shares of Beneficial Interest, liquidation preference $25.00 per share. Net proceeds of the offering, less expenses and underwriters commissions, were approximately $57,750. Proceeds from the offering were used to finance the acquisition of the Company’s interests in Mystic Partners, LLC and SB Partners, LLC. The remaining net proceeds have been principally allocated to fund secured development loans and for general corporate purposes.
Distributions/Dividends
We have paid regular distributions on our common shares, and each of the 2005 and 2004 quarterly distributions was $0.18 per share. In addition, the operating partnership has paid regular distributions to the holders of units of limited partnership interest in the partnership in an amount of $0.18 per unit. There currently are no accruals for distributions not yet paid to the unitholders.
We have paid quarterly distributions of 8% on our Series A preferred shares each quarter since the issuance of the preferred shares on August 5, 2005.
Related Party Transactions
We have entered into a number of transactions and arrangements that involve related parties. For a description of the transactions and arrangements, please see Notes 3, 4, 5 and 6 to the financial statements.
Contractual Obligations and Commercial Commitments
The following table summarizes our contractual obligations and commitments to make future payments under contracts, such as debt and lease agreements, as of December 31, 2005.
(1)
This capital lease relates to an equipment lease for the Holiday Inn Express, Hartford, CT which is currently held for sale. The capital lease obligation is classified in Debt and Capital Lease Payable Related to Hotel Assets Held for Sale on the consolidated balance sheet, and in discontinued operations on the consolidated income statement.
The carrying value of the mortgages and notes payable and the line of credit approximates fair value since the interest rates approximate the interest rates currently offered for similar debt with similar maturities.
Inflation
Operators of hotels in general possess the ability to adjust room rates. However, competitive pressures may limit the hotel operator’s ability to raise room rates in the face of inflation.
Seasonality
Our hotels’ operations historically have been seasonal in nature, reflecting higher occupancy rates during the second and third quarters. This seasonality can be expected to cause fluctuations in our quarterly lease revenue to the extent that we receive percentage rent.
Recently Issued Accounting Standards
Investor’s Accounting for an Investment in a Limited Partnership When the Investor Is the Sole General Partner and the Limited Partners Have Certain Rights
In July of 2005, the Emerging Issues task Force (EITF) agreed on a framework for evaluating whether a general partner or a group of general partners controls a limited partnership and therefore should consolidate it. EITF Issue 04-5, “Investor’s Accounting for an Investment in a Limited Partnership When the Investor Is the Sole General Partner and the Limited Partners Have Certain Rights” (EITF 04-5), amends the guidance in AICPA Statement of Position No. 78-9, “Accounting for Investments in Real Estate Ventures” (SOP 78-9) and states that the presumption of general-partner control would be overcome only when the limited partners have either of two types of rights. The first type-referred to as “kick-out rights”-is the right to dissolve or liquidate the partnership or otherwise remove the general partner “without cause.” The second type-referred to as “participating rights”-is the right to effectively participate in significant decisions made in the ordinary course of the partnership’s business. The kick-out rights and the participating rights must be substantive in order to overcome the presumption of general-partner control. EITF 04-5’s guidance is effective immediately for all newly formed limited partnerships and for existing limited partnership agreements that are modified. The guidance will be effective for existing limited-partnership agreements that are modified no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005. The Company has adopted EITF 04-5 immediately for newly formed or modified partnerships on June 29, 2005 and adopted EITF 04-05 on January 1, 2006 for all existing partnerships. The Company does not expect the adoption of EITF 04-5 to have a material effect on its consolidated financial statements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk (in thousands, except per share data)
Our primary market risk exposure is to changes in interest rates on our variable rate Line of Credit and other floating rate debt. At December 31, 2005, we did not maintain any amounts outstanding on our Line of Credit. The total floating rate mortgages payable of $59,758 had a current weighted average interest rate of 7.46%. The total fixed rate mortgages payable of $196,388 had a current weighted average interest rate of 6.84%. The carrying value of all of our fixed rate debt approximates fair value.
Our interest rate risk objectives are to limit the impact of interest rate fluctuations on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, we manage our exposure to fluctuations in market interest rates for a portion of our borrowings through the use of fixed rate debt instruments to the extent that reasonably favorable rates are obtainable with such arrangements. We may enter into derivative financial instruments such as interest rate swaps or caps and treasury options or locks to mitigate our interest rate risk on a related financial instrument or to effectively lock the interest rate on a portion of our variable rate debt. Currently, we have one interest rate swap related to debt on the Four Points by Sheraton, Revere and one interest rate cap related to debt on a portfolio of hotels acquired in May and June of 2005. We do not intend to enter into derivative or interest rate transactions for speculative purposes.
Approximately 76.7% of our outstanding mortgages payable are subject to fixed rates, including the debt whose rate is fixed through a derivative instrument, while approximately 23.3% of our outstanding mortgages payable are subject to floating rates. The total weighted average interest rate on our debt and Line of Credit as of December 31, 2005 was approximately 6.98%. If the interest rate for our Line of Credit and other variable rate debt was 100 basis points higher or lower during the year ended December 31, 2005, our interest expense for the year ended December 31, 2005 would have been increased or decreased by approximately $604.
We regularly review interest rate exposure on our outstanding borrowings in an effort to minimize the risk of interest rate fluctuations. For debt obligations outstanding at December 31, 2005, the following table presents expected principal repayments and related weighted average interest rates by expected maturity dates (in thousands):
The table incorporates only those exposures that existed as of December 31, 2005 and does not consider exposure or positions that could arise after that date. As a result, our ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the future period, prevailing interest rates, and our hedging strategies at that time. The carrying value of the mortgages payable and the line of credit approximates fair value since the interest rates approximate the interest rate currently offered for similar debt with similar maturities.
At December 31, 2005, the fair value of the interest rate cap was $23 included in assets and the fair value of the interest rate swap was $0 included in liabilities. The net unrealized gains/losses of $327 at December 31, 2005 for derivatives designated as cash flow hedges is separately disclosed on our Balance Sheet as Accumulated Other Comprehensive Income. Hedge ineffectiveness of $13 on cash flow hedges was recognized in unrealized gain/loss on derivatives during 2005.
Item 8.
Item 8.
Financial Statements and Supplementary Data
Hersha Hospitality Trust
Report of Independent Registered Public Accounting Firm
The Shareholders and Board of Trustees of
Hersha Hospitality Trust:
We have audited the accompanying consolidated balance sheets of Hersha Hospitality Trust and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity and comprehensive income and cash flows for each of the years in the two-year period ended December 31, 2005. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hersha Hospitality Trust and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements for 2005 and 2004 taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, the Company adopted the provision of FASB Interpretation No. 46(R) Consolidation of Variable Interest Entities effective March 31, 2004.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Hersha Hospitality Trust and subsidiaries’ internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2006, expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Harrisburg, Pennsylvania
March 17,
Report of Independent Auditors
To the Shareholders and Board of Trustees of
Hersha Hospitality Trust
New Cumberland, Pennsylvania
We have audited the accompanying consolidated balance sheet of Hersha Hospitality Trust and subsidiaries as of December 31, 2003, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the year then ended. These consolidated financial statements schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hersha Hospitality Trust and subsidiaries as of December 31, 2003, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
REZNICK GROUP, P.C.
Baltimore, Maryland
March 5, 2004, except for the effect
on 2003 amounts as described in
Note 12 as to which the date is
March 21, 2006
Part I. Financial Information
Item 1. Financial Statements
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2005 AND 2004
[IN THOUSANDS, EXCEPT SHARE AMOUNTS]
The Accompanying Notes Are an Integral Part of These Consolidated Financial Statements.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2005 AND 2004
[IN THOUSANDS, EXCEPT SHARE AMOUNTS]
The Accompanying Notes Are an Integral Part of These Consolidated Financial Statements.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
[IN THOUSANDS, EXCEPT SHARES]
The Accompanying Notes Are an Integral Part of These Consolidated Financial Statements.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
The Accompanying Notes Are an Integral Part of These Consolidated Financial Statements.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
The Accompanying Notes Are an Integral Part of These Consolidated Financial Statements.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Hersha Hospitality Trust (“we” or the “Company”) was formed in May 1998 as a self-administered, Maryland real estate investment trust (“REIT”) for Federal income tax purposes.
The Company owns a controlling general partnership interest in Hersha Hospitality Limited Partnership (the “Partnership”), which owns a 99% limited partnership interest in various subsidiary partnerships. Hersha Hospitality, LLC (“HHLLC”), a Virginia limited liability company, owns a 1% general partnership interest in the subsidiary partnerships and the Partnership is the sole member of HHLLC.
On January 16, 2003, the Partnership formed a wholly owned taxable REIT subsidiary, 44 New England Management Company (“44 New England” or “TRS Lessee”), to lease certain of the Company’s hotels.
On April 21, 2003, May 21, 2003 and August 29, 2003, CNL Hospitality Partnership, LP (“CNL”) purchased $10,000, $5,000 and $4,027, respectively, of convertible preferred units of limited partnership interest in the Partnership (the “Series A Preferred Units”). Net of offering expenses, the Partnership received proceeds of $17,023. On April 16, 2004, CNL exercised its conversion right and redeemed all of its convertible preferred units in exchange for 2,816,460 shares of common stock.
On October 21, 2003, we completed a public offering of 9,775,000 common shares at $8.50 per share. Proceeds to the Company, net of underwriting discounts and commissions, structuring fees and expenses, were approximately $77,262. Immediately upon closing the offering, the Company contributed all of the net proceeds of the offering to the Partnership. Of the net offering proceeds, approximately $10,400 was used to fund limited partner redemptions and approximately $24,000 was used to repay indebtedness. The remaining net proceeds were used principally to fund acquisitions and for general corporate purposes.
On September 24, 2004, we completed a public offering of 3,500,000 common shares at $9.37 per share. On September 30, 2004, the underwriter exercised its over-allotment option on these shares, and we issued an additional 400,000 common shares at $9.37 per share. Proceeds to the Company, net of underwriting discounts and commissions and expenses, were approximately $36,317. Immediately upon closing the offering, the Company contributed all of the net proceeds of the offering to the Partnership in exchange for additional Partnership interests. Of the net offering proceeds, approximately $5,000 was used to repay indebtedness. The remaining net proceeds have been principally allocated to fund secured development loans, acquisitions and for general corporate purposes.
On August 5, 2005, the Company completed a public offering of 2,400,000 of its 8.00% Series A Cumulative Redeemable Preferred Shares of Beneficial Interest, liquidation preference $25.00 per share. Net proceeds of the offering, less expenses and underwriters commissions, were approximately $57,750. Proceeds from the offering were used to finance the acquisition of the Company’s interests in Mystic Partners, LLC and SB Partners, LLC. The remaining net proceeds have been principally allocated to fund secured development loans and for general corporate purposes.
As of December 31, 2005, the Company, through the Partnership and subsidiary partnerships, owned thirty-one limited and full service hotels. All of the owned hotel facilities are leased to the Company’s taxable REIT subsidiary (“TRS”), 44 New England. Prior to April 1, 2004, eight owned hotels were leased to Hersha Hospitality Management, LP (“HHMLP”), a Pennsylvania limited partnership. As of April 1, 2004, the Company terminated these eight leases with HHMLP and leased the hotels to 44 New England.
In addition to the wholly owned hotel properties, as of December 31, 2005, the Company owned joint venture interests in sixteen properties. The properties owned by the joint ventures are leased to a TRS owned by the joint venture or to an entity owned by the joint venture partners and 44 New England. The following table lists the properties owned by these joint ventures:
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Hersha Inn America TRS Inc; Hersha/CNL TRS Inc.; Hersha PRA TRS, Inc; South Bay Sandeep, LLC; and Revere Hotel Group, LLC, are each a TRS wholly-owned by their respective joint ventures. Mystic Partners, LLC owns an interest in eight hotel properties. Each of the eight properties owned by Mystic Partners, LLC is leased to a separate entity that is consolidated in Mystic Partners Leaseco, LLC which is owned by 44 New England and the Company’s joint venture partner in Mystic Partners, LLC. South Bay Boston, LLC; HT LTD Williamsburg LLC; and HT LTD Williamsburg Two LTD LLC lease properties from each respective joint venture and are owned by 44 New England and the Company’s joint venture partner in each venture.
New England and the joint venture TRS lessees lease the hotel properties pursuant to separate percentage lease agreements (the “Percentage Leases”) that provide for percentage rents based on the revenues of the hotels. HHMLP serves as the manager for all of the owned assets and joint venture assets, except for the properties owned by Mystic Partners, LLC; Hiren Boston, LLC; SB Partners, LLC; LTD Associates One, LLC; and LTD Associates Two, LLC. These properties are managed by parties related to our partners in those joint ventures. HHMLP is owned in part by four of the Company’s executive officers, two of its trustees and other third party investors.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Principles of Consolidation and Presentation
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include all of our accounts as well as accounts of the Partnership, subsidiary partnerships and our wholly owned TRS Lessee. All significant inter-company amounts have been eliminated.
Consolidated properties are either wholly owned or owned less than 100% by the Partnership and are controlled by the Company as general partner of the Partnership. Properties owned in joint ventures are also consolidated if the determination is made that we are the primary beneficiary in a variable interest entity or we maintain control of the asset through our voting interest in the entity. Control is demonstrated by the ability of the general partner to manage day-to-day operations, refinance debt and sell the assets of the partnerships without the consent of the limited partners and the inability of the limited partners to replace the general partner.
The Financial Accounting Standards Board issued FASB Interpretation No. 46, (“FIN 46”) “Consolidation of Variable Interest Entities (VIE’s), an interpretation of Accounting Research Bulletin No. 51 (ARB No. 51),” in January 2003 and a further interpretation of FIN 46 in December 2003 (“FIN 46-R” and FIN 46, collectively “FIN 46”). FIN 46 addresses how a business enterprise should evaluate whether it has a controlling financial interest in any variable interest entity (“VIE”) through means other than voting rights, and accordingly, should include the VIE in its consolidated financial statements. We have adopted FIN 46 effective as of March 31, 2004.
Our investments and contractual relationships with the following entities have been evaluated to determine whether they meet the guidelines of consolidation in accordance with FIN 46: HHMLP; Logan Hospitality Associates, LLC; HT CNL Metro Hotels, LP; PRA Glastonbury, LLC; Inn America Hospitality at Ewing, LLC; Mystic Partners, LLC; Mystic Partners Leaseco, LLC; Hiren Boston, LLC; South Bay Boston, LLC, SB Partners, LLC; LTD Associates One, LLC; HT LTD Williamsburg LLC; LTD Associates Two, LLC; HT LTD Williamsburg Two LLC; Hersha Statutory Trust I; Hersha Statutory Trust II; HPS Seaport LLC & BCM, LLC; 44 Fifth Avenue, LLC; 5444 Associates, LP; Metro Ten Hotels, LLC; and PRA Suites at Glastonbury, LLC.
Our examination consisted of reviewing the sufficiency of equity at risk, controlling financial interests, voting rights, and the obligation to absorb expected losses and expected gains, including residual returns. Based on our examination, each of the following entities were determined to be a VIE, except Mystic Partners, LLC; Mystic Partners Leaseco, LLC; South Bay Boston, LLC; HT LTD Williamsburg LLC; HT LTD Williamsburg Two LTD LLC; Hersha Statutory Trust I; and Hersha Statutory Trust II.
We have terminated all of the existing leases with HHMLP, effective April 1, 2004. Due to the termination of the leases and the funding of sufficient equity by the partners of HHMLP, we have determined that HHMLP is a voting interest entity and we have no ownership interest in that entity. Therefore we have not consolidated the financial statements of HHMLP with ours effective as of April 1, 2004.
We have consolidated the operations of the Logan Hospitality Associates, LLC; LTD Associates One, LLC; and LTD Associates Two, LLC joint ventures because each entity is a voting interest entity and the Company owns a majority voting interest in the venture.
Our investments in HT/CNL Metro Hotels, LP; PRA Glastonbury, LLC; Inn America Hospitality at Ewing, LLC; Hiren Boston, LLC; and SB Partners, LLC represent non-controlling ownership interests in the ventures. All of these entities are voting interest entities. These investments are accounted for using the equity method of accounting. These investments are recorded initially at cost and subsequently adjusted for net equity in income (loss), which is allocated in accordance with the provisions of the applicable partnership or joint venture agreements.
We hold an investment in development loan receivables with HPS Seaport LLC & BCM, LLC; 44 Fifth Avenue, LLC; 5444 Associates, LP; Metro Ten Hotels, LLC; and PRA Suites at Glastonbury, LLC. We have determined that each borrower has sufficient equity at risk, a controlling financial interest and an obligation to absorb expected losses and expected gains, including residual returns of the entity. These entities are voting interest entities and because we have no voting interest they are not consolidated.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Mystic Partners, LLC is a VIE entity, however because we are not the primary beneficiary it is not consolidated by the Company. Also, Mystic Partners Leaseco, LLC; South Bay Boston, LLC; HT LTD Williamsburg LLC; and HT LTD Williamsburg Two LTD LLC lease hotel properties from our joint venture interests and are variable interest entities. These entities are consolidated by the lessors, the primary beneficiaries of each entity.
During the second quarter of 2005, we formed Hersha Statutory Trust I and Hersha Statutory Trust II, Delaware statutory trusts (collectively, the “Hersha Statutory Trusts”), to collectively issue $50,000 of trust preferred securities in private placements. We acquired, for $1,548, residual interests (common securities) in the Hersha Statutory Trusts. Preferred equity securities of $25,000 issued by Hersha Statutory Trust I will mature on June 30, 2035, and the remaining $25,000 preferred equity securities issued by Hersha Statutory Trust II will mature on July 30, 2035, at par. The preferred equity securities issued by Hersha Statutory Trust I and Hersha Statutory Trust II may be redeemed by the trusts beginning on June 30, 2010 and July 30, 2010, respectively. The holders of both the preferred equity and common securities will receive quarterly distributions from the Hersha Statutory Trusts, at a fixed rate of 7.34% per annum through June 30, 2010 for Hersha Statutory Trust I and 7.173% per annum through July 30, 2010 for Hersha Statutory Trust II. Subsequent to June 30, 2010, for Hersha Statutory Trust I and July 30, 2010 for Hersha Statutory Trust II, holders of the trusts preferred equity and common securities will receive quarterly distributions at a variable rate of LIBOR plus 3.0% per annum. The Hersha Statutory Trusts used the proceeds from the issuance of the preferred and common securities to acquire $51,548 of junior subordinated notes from HHLP pursuant to indenture agreements. The note acquired by Hersha Statutory Trust I will mature on June 30, 2035, but may be redeemed at our option, in whole or in part, beginning on June 30, 2010 in accordance with the provisions of the indenture agreement. The note acquired by Hersha Statutory Trust II will mature on July 30, 2035, but may be redeemed at our option, in whole or in part, beginning on July 30, 2010 in accordance with the provisions of the indenture agreement. The note acquired by Hersha Statutory Trust I bears interest at a fixed rate of 7.34% per annum through June 30, 2010 and the note acquired by Hersha Statutory Trust II bears interest at a fixed rate of 7.173% per annum through July 30, 2010. Subsequent to June 30, 2010 for Hersha Statutory Trust I and July 30, 2010 for Hersha Statutory Trust II, holders the notes bear interest at a variable rate of LIBOR plus 3.0% per annum.
The Hersha Statutory Trusts are VIEs under FIN 46, because the equity holders at risk hold no substantial decision-making rights. Because HHLP is not the primary beneficiary in the Hersha Statutory Trusts, the accounts of the trusts are not consolidated with and into HHLP. HHLP’s investment in the Hersha Statutory Trusts is accounted for using the equity method of accounting and is presented on our consolidated balance sheet in other assets.
The proceeds received by HHLP in exchange for the notes were used to fund acquisitions of hotel properties, pay down outstanding borrowings under our revolving credit facility and for general corporate purposes. The notes are presented on our consolidated balance sheet in Mortgages and Notes Payable.
We will continue to evaluate each of our investments and contractual relationships to determine if consolidation is required based upon the provisions of FIN 46.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Investment in Hotel Properties
Investment in hotel properties is stated at cost. Depreciation for financial reporting purposes is principally based upon the straight-line method.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The estimated lives used to depreciate the hotel properties are as follows:
Revenue Recognition
We directly recognize revenue and expense for all hotels leased through 44 New England as “Hotel Operating Revenue” and “Hotel Operating Expense” when earned and incurred.
Stock Compensation
We apply Statement of Financial Accounting Standards No. 123R, “Share-Based Payments” (SFAS 123R) where by we measure the cost of employee service received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost is recognized over the period during which an employee is required to provide service in exchange for the award.
Earnings Per Common Share
We compute earnings per share in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share.”
Minority Interest
Minority Interest in the Partnership represents the limited partner’s proportionate share of the equity of the Partnership. Income (Loss) is allocated to minority interest in accordance with the weighted average percentage ownership of the Partnership during the period. At the end of each reporting period the appropriate adjustments to the income (loss) are made based upon the weighted average percentage ownership of the Partnership during the period. Our ownership interest in the Partnership as of December 31, 2005, 2004 and 2003 was 87.8%, 87.7% and 65.1%, respectively.
We also maintain minority interests for the equity interest owned by third parties in Logan Hospitality Associates, LLC; LTD Associates One, LLC; and LTD Associates Two, LLC. Third parties own a 45% interest in Logan Hospitality Associates, LLC and a 25% interest in each of LTD Associates One LLC and LTD Associates Two, LLC. We allocate these joint venture’s income (loss) to the minority interest in consolidated joint venture account based upon the ownership of the entities.
Impairment of Long-Lived Assets
We review the carrying value of each hotel property in accordance with SFAS No. 144 to determine if circumstances exist indicating an impairment in the carrying value of the investment in the hotel property or if depreciation periods should be modified. Long-lived assets are reviewed for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. We perform undiscounted cash flow analyses to determine if impairment exists. If impairment is determined to exist, any related impairment loss is calculated based on fair value. Hotel properties held for sale are presented at the lower of carrying amount or fair value less cost to sell.
Investment in Unconsolidated Joint Ventures
The equity method of accounting is used for joint ventures in which we have the ability to exercise significant influence. Under this method, the investment, originally recorded at cost, is adjusted to recognize our share of net earnings or losses of the affiliates as they occur rather then as dividends or other distributions are received, limited to the extent of our investment in, advances to and commitments for the investee.
Income Taxes
The Company qualifies as a REIT under applicable provisions of the Internal Revenue Code, as amended, and intends to continue to qualify as a REIT. In general, under such provisions, a trust which has made the required election and, in the taxable year, meets certain requirements and distributes to its shareholders at least 90% of its REIT taxable income will not be subject to Federal income tax to the extent of the income which it distributes. Earnings and profits, which determine the taxability of dividends to shareholders, differ from net income reported for financial reporting purposes due primarily to differences in depreciation of hotel properties for Federal income tax purposes.
Deferred income taxes relate primarily to the TRS Lessee and are accounted for using the asset and liability method. Under this method, deferred income taxes are recognized for temporary differences between the financial reporting bases of assets and liabilities of the TRS Lessee and their respective tax bases and for their operating loss and tax credit carry forwards based on enacted tax rates expected to be in effect when such amounts are realized or settled. However, deferred tax assets are recognized only to the extent that it is more likely than not that they will be realized based on consideration of available evidence, including tax planning strategies and other factors. There were no income taxes recorded in the Statement of Operations.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Under the REIT Modernization Act (“RMA”), which became effective January 1, 2001, the Company is permitted to lease hotels to a wholly owned taxable REIT subsidiary (“TRS”) and may continue to qualify as a REIT provided the TRS enters into management agreements with an “eligible independent contractor” who will manage the hotels leased by the TRS. The Company formed the TRS Lessee in 2003. The TRS Lessee currently leases 31 properties from the Partnership. The TRS Lessee is subject to taxation as a C-Corporation. The TRS Lessee had an operating loss for financial reporting purposes for the period ended December 31, 2005. Although the TRS Lessee is expected to operate at a profit for Federal income tax purposes in future periods, the value of the deferred tax asset is not able to be quantified with certainty. Therefore, no deferred tax assets have been recorded as we have not concluded that it is more likely than not that these deferred tax assets will be realizable.
Cash Equivalents
The Company considers highly liquid investments with an original maturity of three months or less to be cash equivalents.
Escrow Deposits
We are obligated to maintain reserve funds for items such as capital expenditures at hotels (including the periodic replacement or refurbishment of furniture, fixtures and equipment), property taxes and insurance pursuant to mortgage agreements with participating lenders.
Accounts Receivable
Accounts receivable are charged to bad debt expense when they are determined to be uncollectible based upon a periodic review of the accounts by management. Accounting principles generally accepted in the United States of America require that the allowance method be used to recognize bad debts.
Development Loan Receivables and Notes Receivable
The Company has invested in development loan receivables and notes receivable in connection with hotel property transactions. Interest income is recognized on the notes receivable when earned based upon the terms of the related notes. Fees and costs incurred are amortized over the term of the related notes. The ultimate repayment of the notes is subject to a number of variables, including the performance and value of the underlying real property. The carrying amount of the notes receivable approximates its fair value in consideration of interest rates, market conditions and other qualitative factors.
Deferred Costs and Intangibles
Deferred Costs consist of loan acquisition fees. Intangibles consist of franchise fees, goodwill and an intangible asset related to the acquisition of leases at rates below market value. Deferred costs and intangibles are carried at cost net of accumulated amortization. Amortization of loan acquisition fees is computed using the straight-line method over the term of the related debt. Amortization of franchise fees and the lease related intangible asset is computed using the straight-line method over the term of the related agreement.
Goodwill of $412, net of accumulated amortization of $353, resulted from the acquisition of the Holiday Inn Hotel and Conference Center, Harrisburg, Pennsylvania. We have not recognized amortization expense on goodwill subsequent to December 31, 2001. We test goodwill for impairment at least annually and have not recognized any impairment during the three years ended December 31, 2005.
Advertising and Marketing
Advertising and marketing costs are expensed as incurred and totaled $1,459, $1,034 and $143 for the years ended December 31, 2005, 2004 and December 31, 2003, respectively, related to the hotels consolidated in these financial statements. In connection with our franchise agreements, a portion of the franchise fees paid is for marketing services.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Distributions
We intend to pay distributions that, at a minimum, will be sufficient for us to maintain our REIT status.
Concentration of Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk include cash and cash equivalents, rent receivable and note receivable arising from our normal business activities. We place our cash and cash equivalents with high credit quality financial institutions. We require collateral to support our financial instruments. We perform periodic evaluations of the relative credit standing of these financial institutions and limit the amount of credit exposure with any one institution. At December 31, 2005, we maintained funds at financial institutions that exceeded federally insured amounts.
Fair Value of Financial Instruments
At December 31, 2005 and 2004, financial instruments include cash and cash equivalents, development loans receivable, notes receivable, accounts payable, accrued expenses, loans to and from related parties, notes payable, a line of credit and mortgages payable. The fair values of cash and cash equivalents, development loans receivable, notes receivable and accounts payable and accrued expenses approximate carrying value because of the short-term nature of these instruments. The carrying value of loans with related parties approximates fair value. The carrying value of the mortgages payable and the line of credit approximates fair value since the interest rates approximate the interest rates currently offered for similar debt with similar maturities.
Derivatives
The Company’s objective in using derivatives is to add stability to interest expense and to manage its exposure to interest rate movements or other identified risks. To accomplish this objective, the Company primarily uses interest rate swaps and caps as part of its cash flow hedging strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amount. Interest rate caps limit the Company’s exposure to increasing interest payments when interest rates increase. During 2005 and 2004, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt. As of December 31, 2005 and 2004, no derivatives were designated as fair value hedges or hedges of net investments in foreign operations.
The Company does not use derivatives for trading or speculative purposes and currently does not have any derivatives that are not designated as hedges.
Reclassification
Certain amounts in the prior year financial statements have been reclassified to conform to the current year presentation.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 2 - INVESTMENT IN HOTEL PROPERTIES
Investment in hotel properties consist of the following at December 31, 2005 and 2004:
Depreciation expense was $10,540, $7,356 and $4,681 for the years ended December 31, 2005, 2004 and 2003, respectively.
No hotels were sold in 2004 and 2003. In 2005, we sold the following hotels for the approximate amounts indicated.
The following summarizes the number of hotels owned excluding those owned in joint ventures for the periods presented:
During the years ended December 31, 2005, 2004 and 2003, we acquired the following hotel properties, including closing costs:
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 2 - INVESTMENTS IN HOTEL PROPERTIES (Continued)
The above acquisitions were accounted for as purchases, and the results of such acquisitions are included in the Company’s consolidated statements of operations from the dates of acquisition. No goodwill arose in the transactions. A $10,500 note receivable with the sellers was applied for the purchase of the Hampton Inn, New York, NY.
On February 23, 2004, we purchased a 55% joint venture interest in Logan Hospitality Associates, LLC, the owner of the Sheraton Four Point, Revere, MA. We have determined that we have a majority voting interest in this joint venture and that it qualifies for consolidation as it is a voting interest entity.
On November 22, 2005, we purchased a 75% joint venture interest in LTD Associates One, LLC (LTD One) and LTD Associates Two, LLC (LTD Two), the owners of the Springhill Suites and Residence Inn, Williamsburg, VA, respectively. We have determined that we have a majority voting interest in these joint ventures and that they qualify for consolidation as they are voting interest entities.
The consolidated assets of these properties included in our balance sheet as of December 31, 2005 and 2004 are as follows:
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 2 - INVESTMENTS IN HOTEL PROPERTIES (Continued)
Pro Forma Operating Results (Unaudited)
The following condensed pro forma financial information is presented as if the acquisitions of the Residence Inn, Greenbelt, MD; the Fairfield Inn, Laurel, MD; the McIntosh Porfolio; the Courtyard by Marriott, Brookline, MA; LTD One and LTD Two had been consummated as of January 1, 2004. All of the other acquisitions listed above were either purchased without any operating history or did not have a full year's operating history in 2005 or 2004. The condensed pro forma information is not necessarily indicative of what actual results of operations of the Company would have been assuming the acquisitions had been consummated at the beginning of the respective periods presented, nor does it purport to represent the results of operations for future periods.
Assets Held for Sale consisted of the following at December 31, 2005 and December 31, 2004:
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 3 - NOTES RECEIVABLE
On September 26, 2002, in connection with the sale of the Clarion Suites, Philadelphia, PA, we provided financing in the amount of $200, of which $25 and $103 was outstanding as of December 31, 2005 and 2004. The terms of the note called for accrued interest at 10% per annum through maturity on December 31, 2003, when the outstanding balance and accrued interest were due. The note is unsecured. During 2004, we extended the due date of the note through June 30, 2005. The note modification also increased our interest rate to 12% from July 1, 2004 until maturity. We had not been accruing interest in prior periods due to the uncertainty of collection of this interest. Based upon current interest and principal payments made during 2004 and our ongoing negotiations, we have determined that the interest and principal is fully collectible. We have recognized accrued interest income from September 2002 until December 31, 2003 during the year ended December 31, 2004. This note has been extended to mature on June 30, 2006 with all other terms remaining unchanged. For the years ended December 31, 2005 and December 31, 2004, we recorded interest income of $6 and $44 which is included in “Other Revenue” on the statement of operations.
On May 13, 2005, in connection with the sale of the Doubletree Club, Jamaica, NY, we provided financing in the amount of $1,700 to the buyer. The note receivable bears interest at a rate of 12% per annum and is due on April 30, 2006. Interest payments are due quarterly with repayment of the principal due upon maturity. The balance as of December 31, 2005 was $1,861. For the year ended December 31, 2005, we recorded interest income of $137, which is included in “Interest Income-Secured Loans” on the statement of operations.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 4 - INVESTMENT IN JOINT VENTURES
On August 29, 2003, HT/CNL Metro Hotels, LP purchased the Hampton Inn, (Manhattan) Chelsea, NY. We own a one-third equity interest in this joint venture partnership while CNL Hospitality Partners LP owns the remaining equity interests. HT/CNL Metro Hotels purchased this asset for $28,000 plus settlement costs of approximately $480 and leased it to Hersha CNL TRS, Inc., a TRS wholly owned by HT/CNL Metro Hotels. In conjunction with this transaction, HT/CNL Metro Hotels executed mortgage indebtedness of approximately $15,400 payable to the Partnership and paid cash of approximately $14,080. HT/CNL Metro Hotels repaid the entire amount of the indebtedness to the Partnership in July 2004.
On November 13, 2003, we purchased a 40% joint venture interest in PRA Glastonbury, LLC. The only asset owned by PRA Glastonbury, LLC is the Hilton Garden Inn, Glastonbury, CT. We purchased our joint venture interest in this asset for $2,680 including settlement costs of approximately $250 and leased the hotel assets to Hersha PRA TRS, Inc., a TRS wholly owned by PRA Glastonbury, LLC. In conjunction with this transaction, PRA Glastonbury, LLC assumed mortgage indebtedness of approximately $9,900.
On July 1, 2004, we purchased a 50% joint venture interest in Inn America Hospitality at Ewing, LLC. The only asset owned by this entity is the Courtyard by Marriott, Ewing-Hopewell, NJ. We purchased our joint venture interest in this asset for $1,025 including closing costs of approximately $55 and leased the hotel assets to Hersha Inn America TRS, Inc., a TRS wholly-owned by Inn America Hospitality at Ewing, LLC.
On July 1, 2005, we acquired a 49.9% interest in Hiren Boston. LLC (“Hiren”), the owner of a 164 room Courtyard by Marriott in South Boston, Massachusetts, for approximately $5,031, including settlement costs of approximately $331. This hotel is leased to South Bay Boston, LLC, a joint venture owned by 44 New England and our joint venture partner, and managed by an affiliate of our joint venture partner. Our joint venture partner and the manager of the property are unaffiliated with the Company. The Hiren joint venture agreement provides for a 10% preferred return during the first two years of the venture based on the equity interest in Hiren. Cash distributions will be made from cash available for distribution, first, to us to provide a 10% annual non-compounded return on our capital contributions and then to our joint venture partner to provide a 10% annual non-compounded return of their contributions. The 10% returns are not cumulative. Any remaining cash available for distribution will be distributed 50% to us. Subsequent to this initial two year period, cash distributions will be made 50% to us and 50% to our joint venture partners in Hiren. In accordance with AICPA Statement of Position 78-9 “Accounting for Investments in Real Estate Ventures” (SOP 78-9), Hiren will allocate income to HHLP and our joint venture partner consistent with the allocation of cash distributions and liquidating distributions.
On October 7, 2005, we acquired a 49.9% interest in SB Partners, LLC (“SB Partners”), the owner of a 118 room Holiday Inn Express in South Boston, Massachusetts, for approximately $2,250. This hotel will be leased to South Bay Sandeep, LLC, a TRS wholly owned by SB Partners, and managed by an affiliate of our joint venture partner. Our joint venture partner and the manager of the property are owned by certain members that have an interest in Hiren and are unaffiliated with the Company. The SB Partners joint venture agreement provides for a 10% preferred return during the first two years of the venture based on the equity interest in SB Partners. Cash distributions will be made from cash available for distribution, first, to us to provide a 10% annual non-compounded return on our capital contributions and then to our joint venture partner to provide a 10% annual non-compounded return of their contributions. The 10% returns are not cumulative. Any remaining cash available for distribution will be distributed 50% to us. Subsequent to this initial two year period, cash distributions will be made 50% to us and 50% to our joint venture partners in SB Partners. In accordance with SOP 78-9, SB Partners allocates income to us and our joint venture partner consistent with the allocation of cash distributions and liquidating distributions.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 4 - INVESTMENT IN UNCONSOLIDATED JOINT VENTURES (Continued)
We entered into a joint venture with Waterford Hospitality and Mystic Hotel Investors, LLC (“MHI,” and together with Waterford, the “Waterford Parties”), pursuant to which the parties agreed to establish Mystic Partners, LLC (“Mystic”). The Waterford Parties agreed to contribute to Mystic Partners its membership interests (the “Membership Interests”) in a portfolio of nine entities, each of which was either wholly-owned or majority-owned by the Waterford Parties (the “Owners”). These entities own nine Marriott- or Hilton-branded hotels in Connecticut and Rhode Island with an aggregate fair value of approximately $250,000. Hersha agreed to contribute to Mystic Partners approximately $52,000 in cash, subject to adjustment, in exchange for a 66.7% preferred equity interest in the seven stabilized hotel properties in the portfolio and a 50% preferred equity interest in the two newly-developed hotel properties in the portfolio, subject to minority interest participations in certain hotels. The Mystic Partners joint venture agreement provides for an 8.5% preferred return based on our preferred equity interest in the stabilized and newly-developed hotel properties. Cash distributions will be made from cash available for distribution, first, to us to provide an 8.5% annual non-compounded return on our unreturned capital contributions and then to the Waterford Parties to provide an 8.5% annual non-compounded return of their unreturned contributions. The 8.5% returns are not cumulative. Any remaining cash available for distribution will be distributed to us 56.7%, with respect to the net cash flow from the stabilized properties, and 35%, with respect to the net cash flow from the newly-developed properties. In accordance with SOP 78-9, Mystic Partners will allocate income to us and the Waterford Parties consistent with the allocation of cash distributions and liquidating distributions.
On August 9, 2005, the Company and the Waterford Parties completed the formation of Mystic, and the joint venture acquired the first six stabilized hotels. The Company contributed an aggregate of $32,011 to Mystic Partners and the Waterford Parties contributed its Membership Interests in the Owners of the six hotels. Mystic issued membership interests to us equivalent to a 66.7 % interest in the six hotels and issued membership interests to the Waterford Parties equivalent to a 33.3 % interest in the six hotels, subject to a minority partner that owns 33% of the interests in Southington Suites, LLC, the Owner of Southington Residence Inn. Aggregate debt secured by the six hotels of approximately $66,500 was assumed or incurred. The debt secured by Mystic Marriott Hotel and Spa assumed by the joint venture matures in 2010 and accrues interest at the rate of 6.98 % per annum, and the debt secured by the remainder of the five properties matures in 2015 and accrues interest at the rate of 5.56 %.
On September 15, 2005, the Company contributed $7,139 to Mystic, in connection with the acquisition of the seventh stabilized property by Mystic. The Waterford Parties contributed their Membership Interests in the Owner of the hotel. In connection with this closing, Mystic issued membership interests to us equivalent to a 66.7% interest in the Owner and issued membership interests to the Waterford Partners equivalent to a 33.3% interest in the Owner. Debt of $8,200 secured by the property was assumed.
On September 18, 2005, Mystic closed on approximately $9,000 of mezzanine financing related to the Mystic Marriott Hotel & Spa, one of the six hotels acquired by the joint venture in the first closing. Net proceeds of the mezzanine financing were distributed to the Company and the Waterford Parties according to their ownership interests.
On October 6, 2005, the Company contributed $6,765 to Mystic, in connection with Mystic’s acquisition of the first newly-developed property. The Waterford Parties contributed its Membership Interests in the Owner of the Hartford Hilton. The acquisition included the hotel, improvements, certain personal property and pre-paid air rights leases relating to airspace situated on Chapel, Church and Trumbull streets in Hartford, Connecticut. The air leases do not contain options or rights of extensions, renewals or the option to purchase and expire at various times through June 14, 2023 and March 12, 2072. In connection with this third closing, Mystic issued membership interests to HHLP equivalent to a 44.0% interest in the Owner of the property and issued membership interests to the Waterford Partners equivalent to a 44.0% interest in Owner of the property. A minority partner owns approximately 12.0% of the interests in Owner of the property. In connection with the closing, The Owner incurred approximately $22,000 of aggregate debt secured by the property, which matures in 2009 and accrues interest at a daily floating rate of one-month LIBOR plus 2.75%.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 4 - INVESTMENT IN UNCONSOLIDATED JOINT VENTURES (Continued)
The eight hotels acquired by Mystic through December 31, 2005 are:
Each of the Mystic Partners hotel properties is under an Asset Management Agreement with 44 New England to provide asset management services. Fees for these services are paid monthly to 44 New England in the amount 1% of operating revenues, except for the Hartford Hilton which is 0.25% of operating revenues. Each property owned by the joint venture is managed by Waterford Hotel Group, Inc., an affiliate of Waterford. The property manager will receive a base fee of 3% or 4% of gross revenues of the property, depending on the property, and an incentive fee of 10% of net operating income less debt service after each of HHLP and the Waterford Parties receive a 12.0% annual non-compounded return on its unreturned capital contributions.
On February 8, 2006, the Mystic Partners agreed to adjust each party’s equity ownership interest in each of the Hartford Hilton and the Hartford Marriott as follows:
Additionally, the amendment provides us with the option to purchase up to a 50.0% equity ownership interest in Mystic Partners’ equity interest in the Hartford Hilton and the Hartford Marriott, respectively, at a price determined in accordance with Amendment. Also, the Company entered into an agreement whereby we and MHI jointly and severally guarantee the performance of the terms of a loan to Adriaen’s Landing Hotel, LLC, owner of the Hartford Marriott, in the amount of $50,000, and 315 Trumbull Street Associates, LLC, in the amount of $27,000 if at any time during the term of the note and during such time as the net worth of Mystic falls below the amount of the guarantee.
On February 8, 2006, Mystic closed on the acquisition of the 409 room Hartford Marriott in Hartford, Connecticut, the final hotel in the Waterford portfolio to be acquired by Mystic. The acquisition included the hotel, improvements, certain personal property and a pre-paid airspace sublease relating to airspace comprising a portion of the Hartford Convention Center. The Company contributed approximately $6,700 to Mystic, and the Waterford Parties contributed its Membership Interests in the Owner of the Hartford Marriott. In connection with this closing, Mystic issued membership interests to HHLP equivalent to a 15.0% interest in Mystic Partners’ interest in Adriaen’s Landing Hotel, LLC. In connection with the closing, Adriaen’s Landing Hotel, LLC incurred approximately $45,000 of aggregate debt secured by the Hartford Marriott. This debt matures in 2010 and accrues interest at one-month LIBOR plus 2.9%.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 4 - INVESTMENT IN UNCONSOLIDATED JOINT VENTURES (Continued)
We account for our investment in the above mentioned unconsolidated joint ventures using the equity method of accounting.
As of December 31, 2005 and December 31, 2004 our investment in unconsolidated joint ventures consists of the following:
The following tables set forth the total assets, liabilities, equity and components of net income, including the Company’s share, related to the unconsolidated joint ventures discussed above as of December 31, 2005, and 2004 and for the years ended December 31, 2005, 2004 and 2003.
Balance Sheet
Statement of Operations
Equity income (loss) recognized during the twelve months ended December 31, 2005, 2004, and 2003 for our Equity Investments in Unconsolidated Joint Ventures:
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 5 - DEBT
Mortgages and Notes Payable
The total mortgages payable balance at December 31, 2005, and December 31, 2004, was $256,146 and $110,819, respectively, and consisted of mortgages with fixed and variable interest rates ranging from 4.0% to 9.43%. We had mortgages on our held for sale properties of $ -0- and $13,058 as of December 31, 2005 and December 31, 2004, respectively, which is classified in Debt and Capital Lease Payable Related to Hotel Assets Held for Sale on the consolidated balance sheets. The maturities for the outstanding mortgages ranged from August 2007, to January 2032. Aggregate interest expense incurred under the mortgages payable totaled $10,936, $6,780 and $4,894 during 2005, 2004 and 2003, respectively. The mortgages are secured by first deeds of trust various hotel properties with a combined net book value of $297,138 and $164,517 as of December 31, 2005, and 2004, respectively.
Aggregate annual principal payments for the Company’s mortgages payable for the five years following December 31, 2005 and thereafter are as follows:
In the second quarter of 2005, HHLP issued two junior subordinated notes payable in the aggregate amount of $51,548 to the Hersha Statutory Trusts pursuant to indenture agreements. The $25,774 note issued to Hersha Statutory Trust I will mature on June 30, 2035, but may be redeemed at HHLP’s option, in whole or in part, beginning on June 30, 2010 in accordance with the provisions of the indenture agreement. The $25,774 note issued to Hersha Statutory Trust II will mature on July 30, 2035, but may be redeemed at our option, in whole or in part, beginning on July 30, 2010 in accordance with the provisions of the indenture agreement. The note issued to Hersha Statutory Trust I bears interest at a fixed rate of 7.34% per annum through June 30, 2010, and the note issued to Hersha Statutory Trust II bears interest at a fixed rate of 7.173% per annum through July 30, 2010. Subsequent to June 30, 2010 for notes issued to Hersha Statutory Trust I and July 30, 2010 for notes issued to Hersha Statutory Trust II, holders the notes bear interest at a variable rate of LIBOR plus 3.0% pre annum. Interest expense in amount of $2,313 was recorded during the year ended December 31, 2005.
Revolving Line of Credit
The Company had a revolving line of credit from Sovereign Bank (the “Line of Credit”) in the maximum amount of $35,000. Outstanding borrowings under the Line of Credit bear interest at the bank’s prime rate and the Line of Credit is collateralized by the Holiday Inn Express and Suites, Harrisburg, PA and the Mainstay Suites and Sleep Inn, King of Prussia, PA. On August 31, 2004, the Company extended the term of the Line of Credit from its scheduled expiration in December 2004 to its current expiration in August 31, 2007. The Company maintained a Line of Credit balance of $-0- at December 31, 2005, and $1,027 at December 31, 2004. The Company recorded interest expense of $186, $163, and $66 for the years ended December 31, 2005, 2004, and 2003, respectively. The weighted average interest rate on our Line of Credit during the years ended December 31, 2005 and 2004 was approximately 6.10% and 4.30%.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 5 - DEBT (Continued)
Unsecured Line of Credit
As of March 24, 2005, we have obtained an unsecured revolving line of credit from Commerce Bank (the “Unsecured Line of Credit”) in the maximum amount of $5,000. Outstanding borrowings under the Unsecured Line of Credit bear interest at the bank’s prime rate (which at December 31, 2005, was 7.25%). The Unsecured Line of Credit is scheduled to expire on March 24, 2007. The Company had no outstanding borrowings under the Unsecured Line of Credit at December 31, 2005.
New Line of Credit
On January 17, 2006, we entered into a revolving credit loan and security agreement with Commerce Bank, N.A. with a maximum amount of $60,000. Outstanding borrowings under the line of credit bear interest at the Company’s option of either the bank’s prime rate of interest minus .50% or LIBOR available for the periods of 1, 2, 3, or 6 months plus 2.25%. The line of credit is collateralized by a first lien-security interest in all existing and futurer assets of HHLP, and title-insured, first-lien mortgages on the Holiday Inn Express, Harrisburg, PA, the Mainstay Suites and Sleep Inn, King of Prussia, PA, the Fairfield Inn, Laurel, MD, and a hotel property to be determined, and collateral assignment of all hotel management contracts from which HHLP or its affiliates derive revenues. The line of credit expires on December 31, 2008 and replaces the Sovereign Bank Line of Credit. This revolving credit loan replaced both the Sovereign $35,000 line of credit and the $5,000 unsecured line of credit described above.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 6 - COMMITMENTS AND CONTINGENCIES AND RELATED PARTY TRANSACTIONS
We are the sole general partner in the Partnership, which is indirectly the sole general partner of the subsidiary partnerships. The Company does not anticipate any losses as a result of our obligations as general partner.
Percentage Leases
In June 2004, we entered into an agreement effective April 1, 2004, with HHMLP to terminate the eight remaining leases for the following properties:
Holiday Inn Express, Long Island City, NY
Doubletree Club, Jamaica, JFK Airport - NY
Mainstay Suites, Frederick, MD
Hampton Inn & Suites, Hershey, PA
Hampton Inn, Danville, PA
Holiday Inn Express & Suites, Harrisburg, PA
Sleep Inn and Mainstay Suites, King of Prussia, PA
All of these properties have entered into leases with 44 New England (our TRS) effective as of April 1, 2004, and will continue to be managed by HHMLP. As part of the lease termination, the original sellers of the properties, HHLP and HHMLP have agreed to waive any and all purchase price adjustment in the original purchase agreements for each of the properties. There is no potential liability for any future repricings with any of our owned properties as of December 31, 2005. We entered into management agreements with HHMLP for each of these hotels, but did not pay any consideration in connection with the lease terminations.
We did not earn any fixed or percentage rents for the year ended December 31, 2005. For the year ended December 31, 2004, we earned fixed rents of $1,222 and earned percentage rents of $662. For the year ended December 31, 2003, we earned fixed rents of $4,889 and earned percentage rents of $8,021.
The Company had previously entered into leases with Noble Investment Group Ltd. (“Noble”), an independent third party management company, to lease and manage four hotels in the metropolitan Atlanta, Georgia market. Noble elected not to renew these leases upon expiration of the initial terms of the leases. The leases for the Hampton Inn, Newman, GA and Hampton Inn, Peachtree City, GA expired on April 20, 2003 and the leases for the Comfort Suites, Duluth, GA and Holiday Inn Express, Duluth, GA expired on May 20, 2003. On the respective lease termination dates, the Company leased the four properties to 44 New England and engaged HHMLP to operate the hotels under management contracts.
The consolidated financial statements include the operating results of these four hotels under the TRS structure from the termination dates. Previously, revenues in the consolidated financial statements were derived primarily from lease payments which were made out of the net operating income of the properties pursuant to the Percentage Leases. Under the TRS structure, total revenues from the hotel properties and the related operating expenses are reported in the consolidated statements of operations.
Management Agreements
Beginning in April 2003, 44 New England, our TRS, engaged HHMLP as the property manager for hotels it leased from us pursuant to management agreements. Each management agreement provides for a five-year term and is subject to early termination upon the occurrence of defaults and certain other events described therein. As required under the REIT qualification rules, HHMLP must qualify as an “eligible independent contractor” during the term of the management agreements. Under the management agreements, HHMLP generally pays the operating expenses of our hotels. All operating expenses or other expenses incurred by HHMLP in performing its authorized duties are reimbursed or borne by our TRS to the extent the operating expenses or other expenses are incurred within the limits of the applicable approved hotel operating budget. HHMLP is not obligated to advance any of its own funds for operating expenses of a hotel or to incur any liability in connection with operating a hotel.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 6 - COMMITMENTS AND CONTINGENCIES AND RELATED PARTY TRANSACTIONS (Continued)
As of December 31, 2005, HHMLP managed all 31 hotels leased to our TRS, and we consolidated the financial statements of these 31 hotels in these financial statements. HHMLP also managed one consolidated joint venture hotel property and three unconsolidated joint venture hotel properties in which we maintain an investment. For its services, HHMLP receives a base management fee, and if a hotel exceeds certain thresholds, an additional incentive management fee. The base management fee for a hotel is due monthly and is equal to 3% of gross revenues associated with each hotel managed for the related month. The incentive management fee, if any, for a hotel is due annually in arrears on the ninetieth day following the end of each fiscal year and is based upon the financial performance of the hotel. There were no incentive management fees for the years ended December 31, 2005, 2004 and 2003. For the years ended December 31, 2005, 2004 and 2003, management fees incurred totaled $2,887, $1,454 and $142, respectively, and are recorded as Hotel Operating Expenses. In addition the Company incurred $104 for the early termination of management contracts related to the sale of two hotels in the second quarter in 2005. These fees are included in discontinued operations.
Administrative Services Agreement
Prior to July 1, 2005, under the terms of an administrative service agreement, HHMLP provided accounting and securities reporting services for the Company. The terms of the agreement provided for us to pay HHMLP an annual fee of $10 per property (prorated from the time of acquisition) for each hotel in our portfolio. On July 1, 2005, the administrative service fee was replaced by monthly accounting and information technology fees for each of our wholly owned hotels. Monthly fees for accounting services are $2 per property and monthly information technology fees are $0.5 per property. For the years ended December 31, 2005, 2004 and 2003, the Company incurred administrative services fees of $140, $253 and $178, respectively. For the year ended December 31, 2005, the Company incurred accounting fees of $386 and information technology fees of $95. Administrative services fees, accounting fees, and information technology fees are included in General and Administrative expenses.
Franchise Agreements
The hotel properties are operated under franchise agreements assumed by the hotel property lessee. The franchise agreements have 10 to 20 year terms but may be terminated by either the franchisee or franchisor on certain anniversary dates specified in the agreements. The franchise agreements require annual payments for franchise royalties, reservation, and advertising services, and such payments are based upon percentages of gross room revenue. These payments are paid by the lessees and charged to expenses as incurred. The initial fees incurred to enter into the franchise agreements are amortized over the life of the franchise agreements.
Acquisitions from Affiliates
We have acquired from entities owned or controlled by certain of our executive officers and our related party trustees, newly-developed or newly-renovated hotels that do not have an operating history that would allow us to make purchase price decisions based on historical performance. In buying these hotels, we previously utilized, a “re-pricing” methodology that, in effect, adjusted the initial purchase price for the hotel, one or two years after we initially purchased the hotel, based on the actual operating performance of the hotel during the twelve months prior to the repricing. As part of our lease termination agreement with HHMLP, the original sellers of all of these properties, HHMLP and the Company have waived their respective rights to any and all purchase price adjustments for all properties. In the future, we do not intend to use any re-pricing methodology in acquisitions from entities controlled by our officers and trustees.
We have entered into an option agreement with each of our officers and trustees such that we obtain a first right of refusal to purchase any hotel owned or developed in the future by these individuals or entities controlled by them. This right of first refusal would apply to each party until one year after such party ceases to be an officer or trustee of our Company. Since our initial public offering in 1999, we have acquired, wholly or through joint ventures, a total of 49 hotels, including 16 hotels acquired from entities controlled by our officers or trustees. Of the 16 acquisitions from these entities, 15 were newly-constructed or newly-renovated by these entities prior to our acquisition. Our Acquisition Committee of the Board of Trustees is comprised solely of independent trustees, and the purchase prices and all material terms of the purchase of hotels from related parties are negotiated with the Acquisition Committee. In addition, we have hired an independent accounting firm to provide our Board of Trustees with an “Agreed Upon Procedures” report for all acquisitions and dispositions to related parties.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 6 - COMMITMENTS AND CONTINGENCIES AND RELATED PARTY TRANSACTIONS (Continued)
Hotel Supplies
For the years ended December 31, 2005, 2004 and 2003, we incurred expenses of $969, $804 and $73, respectively, for hotel supplies from Hersha Hotel Supply, an unconsolidated related party, which are expenses included in Hotel Operating Expenses. Approximately $52 and $4 is included in accounts payable at December 31, 2005 and 2004.
Due From Related Parties
The Due from Related Party balance as of December 31, 2005 and December 31, 2004 was approximately $2,779 and $4,482, respectively. The majority of the balance as of December 31, 2005 was accrued interest due on our development loans, and the remaining due from related party balance are receivables owed from our unconsolidated joint ventures. As of December 31, 2004, we also maintained interest bearing deposits of $3,500 related to a letters of intent for the acquisition of the Hampton Inn Herald Square, which we purchased on April 1, 2005.
Due to Related Parties
The due to related party balance as of December 31, 2005, and 2004, totaled $4,655 and $129, respectively. The due to related party balances at December 31, 2005 and 2004 consists of monies payable to HHMLP for administrative, management, and benefit related fees.
Land Leases
During 2003, in conjunction with the acquisition of the Hilton Garden Inn, Edison, NJ, we assumed a land lease from a third party with an original term of 75 years. Monthly payments as determined by the lease agreement are due through the expiration in August 2074. The land lease for the Hilton Garden Inn, Edison, NJ provides rent increases at scheduled intervals. We record rent expense on a straight-line basis over the life of the lease from the beginning of the lease term. For the years ended December 31, 2005, 2004 and 2003, we incurred $433, $504, and $50 respectively, in lease expense under the agreement.
Future minimum lease payments (without reflecting future applicable Consumer Price Index increases) under this agreement is as follows:
On January 6, 2005, we purchased land in Carlisle, PA for $700 plus closing costs from a related party entity and leased the land to 44 Carlisle Associates, L.P., a related party. In July 2005, 44 Carlisle Associates, L.P. exercised their option to purchase the land from us. The purchase price consisted of $700 for the land plus all fees and expenses.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 6 - COMMITMENTS AND CONTINGENCIES AND RELATED PARTY TRANSACTIONS (Continued)
On February 18, 2005, we purchased land at the Bradley International Airport, Windsor Locks, CT for $1,000 plus closing costs and leased the land to 44 Windsor Locks Associates, LLC, a related party. In addition to the purchase price, the terms of the lease required 44 Windsor Locks Associates, LLC to post a $350 deposit. In July 2005, 44 Windsor Locks Associates, LLC exercised their option to purchase the land from us. The purchase price consisted of $1,000 for the land plus all fees and expenses, and the $350 deposit was returned.
Litigation
We are not presently subject to any material litigation nor, to our knowledge, is any other litigation threatened against us, other than routine actions for negligence or other claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance and all of which collectively are not expected to have a material adverse effect on our liquidity, results of operations or business or financial condition.
Legal Fees
We have paid to the law firm of Shah & Byler, LLP and its predecessor, Shah Ray & Byler, LLP, whose former senior partner, Jay H. Shah is now our Chief Executive Officer and is the son of Hasu P. Shah, legal fees aggregating $806, $679 and $212 during 2005, 2004 and 2003, respectively. Mr. Shah had resigned from the law firm and relinquished all ownership and control of the firmas of September 2003. Mr. Shah will continue as counsel to the law firm and may receive compensation from the firm for prior client origination. We intend to continue to use the services of Shah & Byler, LLP. Approximately $101 and $15 is included in accounts payable at December 31, 2005 and 2004, respectively. In addition, we have paid Shah & Byler, LLP approximately $73, $59, and $ -0- in office rent expenses for the years ended December 31, 2005, 2004, and 2003, respectively, for the use of our corporate office space.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 7 - DEVELOPMENT LOANS RECEIVABLE
We have approved mortgage lending to entities in which our executive officers and affiliated trustees own an interest to enable such entities to construct hotels and conduct related improvements on specific hotel projects at interest rates ranging from 9.0% to 10.0% (“Development Line Funding”). As of December 31, 2005 and 2004, we had Development Loans Receivable from Related Parties of $32,470 and $36,550, respectively. The December 31, 2005 and 2004 balances include a development loan to Metro Ten Hotels, LLC in the amounts of $850 and $13,800, respectively. During 2005, Hasu P. Shah, our Chief Executive Officer, purchased a 50% interest in Metro Ten Hotels, LLC, and as a result, this loan is classified in Development Loans Receivable from Related Parties as of December 31, 2005 and 2004. Interest income from these advances included in “Interest - Secured Loans Related Party,” was $3,581, $1,498 and $715 for the years ended December 31, 2005, 2004, and 2003.
As of December 31, 2005, our development loans to related parties consist of the following:
* As of March 16, 2006, loans receivable from the 5444 Associates, LP and Metro Ten Hotels, LLC were paid in full. 44 Fifth Avenue, LLC paid $9,000 as of March 16, 2005, resulting in an outstanding balance of $100.
As of December 31, 2004 our development loans to related parties consisted of the following:
(*) - Loan has been paid off as of March 4, 2005
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 8 - DERIVATIVE INSTRUMENTS
The Company’s objective in using derivatives is to add stability to interest expense and to manage its exposure to interest rate movements or other identified risks. To accomplish this objective, the Company primarily uses interest rate swaps and interest rate caps as part of its cash flow hedging strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amount. Interest rate caps designated as cash flow hedges limit the Company’s exposure to increased cash payments due to increases in variable interest rates.
On July 1, 2005, the Company acquired an interest rate cap with a notional amount of $34,230 to hedge against the variability in cash flows on a variable interest rate debt instrument. The principal of the variable interest rate debt being hedged equals the notional amount of the interest rate cap. The interest rate cap effectively fixes interest payments when LIBOR exceeds 5.0%. The interest rate cap matures on January 11, 2007.
During 2005, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt.
As of December 31, 2005, no derivatives were designated as fair value hedges or hedges of net investments in foreign operations. The Company does not use derivatives for trading or speculative purposes and currently does not have any derivatives that are not designated as hedges.
At December 31, 2005, the fair value of the interest rate cap was $23 and is included in assets and the fair value of the interest rate swap was $.07 and also is included in assets. At December 31, 2004, the fair value of the interest rate swap was $306 and is included in liabilities. The change in net unrealized gains/losses of $327 and $33 for the years ended December 31, 2005 and 2004, respectively, for derivatives designated as cash flow hedges is separately disclosed on our Balance Sheet as Accumulated Other Comprehensive Income. Hedge ineffectiveness of $13 and $62 on cash flow hedges was recognized in unrealized gain/loss on derivatives during 2005 and 2004, respectively.
Amounts reported in Accumulated Other Comprehensive Income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. The change in net unrealized gains/losses on cash flow hedges reflects a reclassification of $119 of net unrealized gains/losses from Accumulated Other Comprehensive Income to interest expense during 2005. During 2006, the Company estimates that an additional $22 will be reclassified.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 9 - SHARE-BASED PAYMENTS
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123R”) which is a revision of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”). SFAS No. 123R supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB Opinion No. 25”) and its related implementation guidance. SFAS No. 123R requires companies to record compensation expense for share-based payments to employees, including grants of employee stock options and stock awards, at fair value. Effective April 1, 2005, the Company has adopted SFAS 123R. No stock-based payments were outstanding at the time SFAS 123R was adopted. In 2004, the Company established the Hersha Hospitality Trust 2004 Equity Incentive Plan which provides for the grant of stock options, stock appreciation rights, stock awards, performance shares and incentive awards. The maximum number of shares of common stock that can be issued under this plan is 1.5 million shares. No share-based payments were granted under this plan during the year ended December 31, 2004.
On June 1, 2005, the Compensation Committee of the Board of Directors granted 71,000 restricted share awards to executives. The restricted share awards vest 25% each year over four years and compensation expense is recognized ratably over the four year vesting period based on the fair value of the shares on the date of grant. The fair value of the restricted share awards on the grant date was $9.60 per share. Compensation expense of $99 was incurred during the year ended December 31, 2005 related to the restricted share awards and is recorded in general and administrative expense on the statement of operations. Unearned compensation as of December 31, 2005 was $582.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 10 - EARNINGS PER SHARE
The following is a reconciliation of the income (numerator) and weighted average shares (denominator) used in the calculation of basic earnings per common share and diluted earnings per common share in accordance with SFAS No. 128, Earnings Per Share:
The Common Partnership Units (which may be converted to common shares of beneficial interest) have been excluded from the diluted earnings per share calculation as there would be no effect on the amounts since the income attributed to the Common Partnership Units would also be added back to net income. The computation of basic and diluted earnings per common share is presented below:
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 11 - CASH FLOW DISCLOSURES AND NON-CASH INVESTING AND FINANCING ACTIVITIES
Interest paid in 2005, 2004 and 2003 totaled $10,550, $6,706 and $4,927, respectively. The following non-cash investing and financing activities occurred during 2005, 2004 and 2003:
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 12 - DISCONTINUED OPERATIONS
The Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” effective January 1, 2002 which requires, among other things, that the operating results of certain real estate assets which have been sold subsequent to January 1, 2002, or otherwise qualify as held for disposition (as defined by SFAS No. 144), be included in discontinued operations in the statements of operations for all periods presented.
On May 13, 2005, we completed the disposition of the Doubletree Club, Jamaica, NY and the Holiday Inn Express, Long Island City, NY in a sale of the land, improvements and certain personal property to unaffiliated buyers for $20,500, plus transaction costs. Assets sold had a net book value of $18,806 and were classified as assets held for sale on the balance sheet. Debt related to assets held for sale of $12,952 was assumed by the buyers. A note receivable for $1,700 was received as part of the proceeds from the sale of the Doubletree Club. The notes receivable bears interest at a rate of 12% per annum and is due on April 30, 2006. Interest payments are due quarterly with repayment of the principal due upon maturity. Gain on the sale of the two properties was $1,323, of which $162 was allocated to minority interest in HHLP.
In September of 2005, our Board of Trustees authorized management of the Company to sell the Holiday Inn Express, Hartford, CT and this asset is classified as “held for sale” on the Company’s Consolidated Balance Sheet as of December 31, 2005. The operating results for this hotel have been reclassified to discontinued operations in the statements of operations for the years ended December 31, and 2004. The hotel was acquired by the Company in January 2004.
As of December 31, 2005, Debt and Capital Lease Payable related to the assets Held for Sale was $375 and consisted of capital lease obligations for the Holiday Inn Express, Hartford, CT. This capital lease obligation is from a third party assumed during the acquisition of the Holiday Inn Express, Hartford, CT. The six year lease is secured by furniture, fixtures and equipment and the hotel property and is amortized over a six year period from the acquisition at a fixed rate of 8.3%.
Aggregate annual payments for the Company’s capital leases payable for the five years following December 31, 2005 and thereafter are as follows:
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 12 - DISCONTINUED OPERATIONS (continued)
In addition, during 2004, in conjunction with the acquisition of the Holiday Inn Express, Hartford, CT we assumed a land lease from a third party with an original term of 99 years. Monthly payments as determined by the lease agreement are due through the expiration in September 2101. For the years ended December 31, 2005 and 2004, we incurred $300 and $275 in lease expense under this agreement, which have been reclassified to discontinued operations in the statement of operations.
Future minimum lease payments (without reflecting future applicable Consumer Price Index increases) under this agreement is as follows:
The balance as of December 31, 2004 was $13,058 related to mortgage debt obligations for the Doubletree Club, Jamaica, NY and the Holiday Inn Express, Long Island City, NY.
We allocate interest and capital lease expense to discontinued operations for debt that is to be assumed or that is required to be repaid as a result of the disposal transaction. We allocated $323, $676 and $644 of interest and capital lease expense to discontinued operations for the years ended December 31, 2005, 2004 and 2003, respectively.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 12 - DISCONTINUED OPERATIONS (continued)
The following table sets forth the components of discontinued operations for the years ended December 31, 2005, 2004 and 2003:
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 13 - SHAREHOLDERS’ EQUITY AND MINORITY INTEREST IN PARTNERSHIP
As of December 31, 2003, the Priority Class A Common Shares had priority as to the payment of dividends until dividends declared equal $0.18 per share on a quarterly basis ($.72 per year) and participated equally in additional dividends after the Class B Common Shares received $.18 per share in each quarterly period. The Priority Class A Common Shares carried a liquidation preference of $6.00 per share plus unpaid dividends and voted with the Class B Common Shares on a one vote per share basis. The priority period of the Class A Shares commenced on the date of the closing of the initial public offering and ended on January 26, 2004.
There have never been any Class B Common Shares outstanding since our initial public offering on January 26, 1999. The conversion features of the Class B Common Shares into Priority Class A Common Shares are exactly the same as the conversion features of the Hersha Hospitality Limited Partnership (HHLP) Units into Priority Class A Common Shares. The Limited Partnership Units and Class B Common Shares were convertible into Priority Class A Common Shares as of January 26, 2004. During 2005 and 2004, 8,155 and 957,286 common units were converted to Class A Common Shares. respectively.
The Company’s common shares are duly authorized, fully paid and non-assessable. Common shareholders are entitled to receive dividends if and when authorized and declared by the Board of Trustees of the Company out of assets legally available and to share ratably in the assets of the Company legally available for distribution to its shareholders in the event of its liquidation, dissolution or winding up after payment of, or adequate provision for, all known debts and liabilities of the Company.
Preferred Shares
On August 5, 2005, the Company completed a public offering of 2,400,000 of its 8.00% Series A Cumulative Redeemable Preferred Shares of Beneficial Interest, liquidation preference $25.00 per share. Net proceeds of the offering, less expenses and underwriters commissions, were approximately $57,750. Proceeds from the offering were used to finance the acquisition of the Company’s interests in Mystic Partners, LLC and SB Partners, LLC. The remaining net proceeds have been principally allocated to fund secured development loans and for general corporate purposes.
The Declaration of Trust authorizes our Board of Trustees to classify any unissued preferred shares and to reclassify any previously classified but unissued preferred shares of any series from time to time in one or more series, as authorized by the Board of Trustees. Prior to issuance of shares of each series, the Board of Trustees is required by Maryland REIT Law and our Declaration of Trust to set for each such series, subject to the provisions of our Declaration of Trust regarding the restriction on transfer of shares of beneficial interest, the terms, the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each such series. Thus, our Board of Trustees could authorize the issuance of additional preferred shares with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or a change in control in us that might involve a premium price for holders of common shares or otherwise be in their best interest.
Preferred Units of Limited Partnership Interests
During 2003, CNL purchased a total of 190,266 of convertible preferred limited partnership units (the “Series A Convertible Preferred Units”) at a per unit price of $100.00. The Series A Preferred Units had priority over all Common Shares and Partnership Units, as to the payment of dividends at a rate of 10.5% per annum of the original issue price. In addition, the Series A Preferred Units had a liquidation preference of $100 per unit plus accrued and unpaid distributions. CNL converted all of their preferred limited partnership units during 2004.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 13 - SHAREHOLDERS’ EQUITY AND MINORITY INTEREST IN PARTNERSHIP (Continued)
Common Partnership Units
Since the completion of the initial public offering we have issued an additional 173,539 units of limited partnership interest in connection with the acquisition of the Hampton Inn, Danville, PA and 76,555 units in connection with the acquisition of the Holiday Inn Express, Long Island City. We have also issued an additional 1,275,663 units of limited partnership interest in connection with final settlement of the purchase prices of several hotels and have redeemed 458,465 units of limited partnership interest in connection with the sale of certain hotels. On October 21, 2003, we redeemed 1,300,000 limited partnership units at a price of $8.00 per unit, or $10,400 in the aggregate. The redemption price was funded with the proceeds of our public equity offering in October 2003. During 2005, 8,155 units of limited partnership interest were converted to Class A Common Shares.
The total number of units of limited partnership interest outstanding as of December 31, 2005, 2004 and 2003 was 2,834,282; 2,842,437; and 3,799,723, respectively.
At December 31, 2005 and 2004, the aggregate number of common shares issuable to the limited partners upon exercise of the redemption rights is 2,834,282 and 2,842,437, respectively. The number of shares issuable upon exercise of the redemption rights will be adjusted upon the occurrence of stock splits, mergers, consolidation or similar pro rata share transactions, that otherwise would have the effect of diluting the ownership interest of the limited partners or our shareholders.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 14 - INCOME TAXES
The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Code commencing with its taxable year ended December 31, 1999. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including a requirement that it currently distribute at least 90% of its adjusted taxable income to its shareholders. It is the Company’s current intention to adhere to these requirements and maintain the Company’s qualification for taxation as a REIT. As a REIT, the Company generally will not be subject to federal corporate income tax on that portion of its net income that is currently distributed to shareholders. If the Company fails to qualify for taxation as a REIT in any taxable year, it will be subject to federal income taxes at regular corporate rates (including any applicable alternative minimum tax) and may not be able to qualify as a REIT for four subsequent taxable years. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and property, and to federal income and excise taxes on its undistributed taxable income.
In addition, taxable income from non-REIT activities managed through taxable REIT subsidiaries is subject to federal, state and local income taxes. 44 New England Company, a 100% owned taxable REIT subsidiary, and Revere Hotel Group LLC, a 55% owned taxable REIT subsidiary, (collectively “Consolidated TRS”) are both entities subject to income taxes at the applicable federal, state and local tax rates.
In 2005, 2004 and 2003, 44 New England Management Company generated net operating losses of $20, $1,279 and $351, respectively. In 2005 and 2004, Revere Hotel Group LLC generated net operating losses of $670 and $201, respectively. The Company did not record a tax benefit for the net operating losses generated in either 2005 or 2004.
There was no income tax expense (benefit) recognized by the Consolidated TRS for 2005, 2004 and 2003.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 14 - INCOME TAXES (continued)
The provision for income taxes differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate to pretax income as a result of the following differences:
The components of consolidated TRS’s deferred tax assets as of December 31, 2005 were as follows:
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Based on the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Consolidated TRS will not realize the benefits of these Net Operating Losses at December 31, 2005.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 15 - RECENT ACCOUNTING PRONOUNCEMENTS
In July of 2005, the Emerging Issues task Force (EITF) agreed on a framework for evaluating whether a general partner or a group of general partners controls a limited partnership and therefore should consolidate it. EITF Issue 04-5, “Investor’s Accounting for an Investment in a Limited Partnership When the Investor Is the Sole General Partner and the Limited Partners Have Certain Rights” (EITF 04-5), amends the guidance in AICPA Statement of Position No. 78-9, “Accounting for Investments in Real Estate Ventures” (SOP 78-9) and states that the presumption of general-partner control would be overcome only when the limited partners have either of two types of rights. The first type-referred to as “kick-out rights”-is the right to dissolve or liquidate the partnership or otherwise remove the general partner “without cause.” The second type-referred to as “participating rights”-is the right to effectively participate in significant decisions made in the ordinary course of the partnership’s business. The kick-out rights and the participating rights must be substantive in order to overcome the presumption of general-partner control. EITF 04-5’s guidance is effective immediately for all newly formed limited partnerships and for existing limited partnership agreements that are modified. The guidance will be effective for existing limited-partnership agreements no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005. The Company has adopted EITF 04-5 immediately for newly formed or modified partnerships and will adopt EITF 04-05 on January 1, 2006 for all existing partnerships. The Company does not expect the adoption of EITF 04-5 to have a material effect on its consolidated financial statements.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 16 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
[IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS]
NOTE 17 - SUBSEQUENT EVENTS
On January 3, 2006, we acquired the 118 room Fairfield Inn & Suites in Mt. Laurel, NJ, the 103 room Fairfield Inn & Suites in Bethlehem, NJ, and the Langhorne Courtyard in Langhorne, PA for approximately $40,500.
On February 1, 2006, we acquired the 120 room Courtyard in Scranton, PA for approximately $8,700.
On February 2, 2006, we acquired the 96 room Residence Inn in Tyson’s Corner, VA for approximately $19,800.
On February 8, 2006, we acquired through our Mystic Partners joint venture a 15% interest in the 409 room Hartford Marriott for approximately $6,700.
On February 15, 2006, we acquired an 80% interest of the limited partnership interests in Affordable Hospitality Associates, LP, the owner of the land, improvements and certain personal property of the Hampton Inn (Center City) in Philadelphia for approximately $6,900.
On February 16, 2006, we acquired 100% of the outstanding interests in Metro JFK Associates, LLC, the owner of a leasehold interest in the land, improvements and certain personal property of the Hilton Garden Inn - JFK, located in Jamaica, NY for approximately $29,000. Consideration was given in the form of cash, assumption of debt, and issuance of 657,895 limited partnership units.
On December 8, 2005, we declared a $0.18 per common share dividend and distribution of $0.18 per limited partnership unit that was paid on January 16, 2006. The quarterly dividend pertaining to the Series A Preferred Shares for the fourth quarter was declared on December 8, 2005 and paid on January 16, 2006 at a rate of $0.50 per share.
On March 17, 2006, we declared a $0.18 per common share dividend and distribution of $0.18 per limited partnership unit to shareholders and unitholders on record at March 31, 2006. The dividend and distribution payment date is April 21, 2006. The quarterly dividend pertaining to the Series A Preferred Shares for the first quarter of 2006 was declared on March 17, 2006 to shareholders of record on April 1, 2006 at a rate of $0.50 per share. The dividend payment date is April 17, 2006.
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION AS OF DECEMBER 31,
[IN THOUSANDS]
HERSHA HOSPITALITY TRUST AND SUBSIDIARIES
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION AS OF DECEMBER 31, 2005 (continued)
[IN THOUSANDS]
The aggregate cost of land, buildings and improvements for Federal income tax purposes is approximately $252,444.
The aggregate cost of land, buildings and improvements for Federal income tax purposes is approximately $128,518.
Depreciation is computed based upon the following useful lives:
Buildings and Improvements
to 40 years
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Please refer to our Current Report on Form 8-K filed on April 22, 2004.
Item 9A.
Item 9A.
Controls and Procedures
(a)
Evaluation of Disclosure Controls and Procedures
The Company’s management, under the supervision of and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of December 31, 2005. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are not effective and reasonably designed to ensure that all material information relating to the Company required to be included in the Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission due to the Company’s material weaknesses in internal control over financial reporting that existed as of December 31, 2005, as described below.
(b)
Management’s Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as that term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting refers to the processes designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes policies and procedures that:
·
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
·
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
·
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness in internal control over financial reporting is a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
Management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting based on the criteria contained in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on that evaluation, management has concluded that, as of December 31, 2005, the Company did not maintain effective internal control over financial reporting because of the following material weaknesses in internal control over financial reporting.
·
Inadequate controls at HHMLP related to the existence and accuracy of revenue. Specifically, the following two reconciliation controls were designed to ensure the existence and accuracy of revenue, (i) a reconciliation of cash received in the Company’s bank account to the revenue recorded in the financial statements and (ii) a reconciliation of rooms occupied per the hotel reservation system to the number of rooms for which revenue was recorded in the financial statements. These revenue reconciliations were not operating effectively. These deficiencies resulted in more than a remote likelihood that a material misstatement of the Company’s annual or interim financial statements would not be prevented or detected.
·
Inadequate controls at HHMLP related to completeness and accuracy of payroll expense. Specifically, a control was designed to compare the payroll costs as calculated by the third party who administers the Company’s payroll to payroll expense recorded in the general ledger. This control was not consistently performed. This deficiency resulted in more than a remote likelihood that a material misstatement of the Company’s annual or interim financial statements would not be prevented or detected.
·
Inadequate controls related to the approval of journal entries and the review and analysis of account reconciliations and related data. Specifically, controls over the approval of the Company’s journal entries prepared by HHMLP personnel from account reconciliations and related data were not being performed. Additionally, controls related to the review and analysis of the Company’s account reconciliations and related data were not always performed timely or by personnel with the appropriate level of experience or knowledge. The failure of these controls resulted in material errors in hotel accounts receivable, due from related parties, accounts payable and accrued expenses, minority interest, hotel operating expenses, general and administrative expenses, other revenue, (loss) income in joint venture investments, income allocated to minority interest and the classification of proceeds from mortgages and notes payable in connection with the purchase of hotel property assets in the consolidated statement of cash flows. These errors were corrected prior to the issuance of the consolidated financial statements.
·
Inadequate controls designed to ensure the completeness of accounts payable and accrued expenses. Specifically, the Company lacks controls designed to ensure the completeness of the Company’s accounts payable and accrued expenses administered by HHMLP. The failure of these controls resulted in material errors in accounts payable and accrued expenses, hotel operating expenses and general and administrative expenses. These errors were corrected prior to the issuance of the consolidated financial statements.
We acquired Fairfield Inn, Laurel, MD, McIntosh Portfolio, Courtyard by Marriott, Brookline, MA, LTD Associates One, LLC and LTD Associates Two, LLC during the year ended December 31, 2005 and excluded from our assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2005, their internal control over financial reporting associated with total assets of $141.7 million and total revenues of $14.4 million included in the consolidated financial statements for the year ended December 31, 2005.
Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their attestation report which appears herein in Item 9A.
(c)
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting during the quarter ended December 31, 2005, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
In response to the material weaknesses described above, subsequent to December 31, 2005, the Company is closely monitoring HHMLP’s progress to ensure that HHMLP has taken, and intends to take further, remedial measures in response to these identified material weaknesses. To date, those remedial measures include the following:
·
HHMLP has hired a Corporate Controller and is seeking to hire additional senior accounting professionals. The Company intends to continue its oversight of the internal control improvements being implemented by HHMLP and other third party service providers.
·
The Company is working with HHMLP to establish additional and more rigorous procedures to be performed by HHMLP to prepare and review financial information prior to release to the Company for inclusion in the consolidated financial statements.
·
HHMLP, in cooperation with the Company, is taking steps to better inform and train hotel level accounting employees regarding controls over revenue accounting, account reconciliations and account analysis.
Report of Independent Registered Public Accounting Firm
The Shareholders and Board of Trustees of
Hersha Hospitality Trust:
We have audited management's assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A(b)), that Hersha Hospitality Trust (the Company) did not maintain effective internal control over financial reporting as of December 31, 2005, because of the effect of material weaknesses identified in management's assessment, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management's assessment as of December 31, 2005:
·
Inadequate controls at Hersha Hospitality Management, LP (HHMLP) related to the existence and accuracy of revenue. Specifically, the following two reconciliation controls were designed to ensure the existence and accuracy of revenue: (i) a reconciliation of cash received in the Company’s bank account to the revenue recorded in the financial statements and (ii) a reconciliation of rooms occupied per the hotel reservation system to the number of rooms for which revenue was recorded in the financial statements. These revenue reconciliations were not operating effectively. These deficiencies resulted in more than a remote likelihood that a material misstatement of the Company’s annual or interim financial statements would not be prevented or detected.
·
Inadequate controls at HHMLP related to completeness and accuracy of payroll expense. Specifically, a control was designed to compare the payroll costs as calculated by the third party who administers the Company’s payroll to payroll expense recorded in the general ledger. This control was not consistently performed. This deficiency resulted in more than a remote likelihood that a material misstatement of the Company’s annual or interim financial statements would not be prevented or detected.
·
Inadequate controls related to the approval of journal entries and the review and analysis of account reconciliations and related data. Specifically, controls over the approval of the Company’s journal entries prepared by HHMLP personnel from account reconciliations and related data were not being performed. Additionally, controls related to the review and analysis of the Company’s account reconciliations and related data were not always performed timely or by personnel with the appropriate level of experience or knowledge. The failure of these controls resulted in material errors in hotel accounts receivable, due from related parties, accounts payable and accrued expenses, minority interest, hotel operating expenses, general and administrative expenses, other revenue, (loss) income in joint venture investments, income allocated to minority interest and the classification of proceeds from mortgages and notes payable in connection with the purchase of hotel property assets in the consolidated statement of cash flows. These errors were corrected prior to the issuance of the consolidated financial statements.
·
Inadequate controls designed to ensure the completeness of accounts payable and accrued expenses. Specifically, the Company lacks controls designed to ensure the completeness of the Company’s accounts payable and accrued expenses administered by HHMLP. The failure of these controls resulted in material errors in accounts payable and accrued expenses, hotel operating expenses and general and administrative expenses. These errors were corrected prior to the issuance of the consolidated financial statements.
The Company acquired Fairfield Inn, Laurel, MD., McIntosh Portfolio, Courtyard by Marriott, Brookline MA, LTD Associates One, LLC and LTD Associated Two, LLC ( the Acquisitions) during the year ended December 31, 2005, and management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, the Acquisitions’ internal control over financial reporting associated with total assets of $141.7 million and total revenues of $14.4 million included in the consolidated financial statements of the Company as of and for the year ended December 31, 2005. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of the Acquisitions.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity and comprehensive income and cash flows for the year then ended. These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the consolidated financial statements, and this report does not affect our report dated March 15, 2006, which expressed an unqualified opinion on those consolidated financial statements.
In our opinion, management's assessment that the Company did not maintain effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by COSO. Also, in our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by COSO.
/s/ KPMG LLP
Harrisburg, Pennsylvania
March 17,
Item 9B.
Item 9B.
Other Information
None.
PART III
Item 10.
Item 10.
Trustees and Executive Officers of the Registrant
Incorporated herein by reference from our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to our 2006 Annual Meeting of Shareholders.
Item 11.
Item 11.
Executive Compensation
Incorporated herein by reference from our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to our 2006 Annual Meeting of Shareholders.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Incorporated herein by reference from our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to our 2006 Annual Meeting of Shareholders.
Item 13.
Item 13.
Certain Relationships and Related Transactions
Incorporated herein by reference from our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to our 2006 Annual Meeting of Shareholders.
Item 14.
Item 14.
Principal Accountant Fees and Services
Incorporated herein by reference from our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to our 2006 Annual Meeting of Shareholders.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(a)
Documents filed as part of this report.
1.
Financial Reports:
Reports of Independent Auditors
Consolidated Balance Sheets as of December 31, 2005 and 2004
Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and
Notes to Consolidated Financial Statements
2.
Financial Statement Schedules:
Schedule III - Real Estate and Accumulated Depreciation for the year ended December 31,
(b)
Exhibits
The Exhibits listed in the accompanying “Index of Exhibits” on pages 103 through 105 hereof are filed and incorporated by reference as a part of this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HERSHA HOSPITALITY TRUST
March 21, 2006
/s/ Jay H. Shah
Jay H. Shah
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE
TITLE
DATE
_______
_______
/s/ Hasu P. Shah
Chairman of the Board
March 21, 2006
Hasu P. Shah
/s/ Jay H. Shah
Trustee and Chief Executive Officer (Principal Executive Officer)
March 21, 2006
Jay H. Shah
/s/ Thomas S. Capello
Trustee
March 21, 2006
Thomas S. Capello
/s/ John M. Sabin
Trustee
March 21, 2006
John M. Sabin
/s/ Donald J. Landry
Trustee
March 21,
Donald J. Landry
/s/ William Lehr, Jr.
Trustee
March 21, 2006
William Lehr, Jr.
/s/ Michael A. Leven
Trustee
March 21, 2006
Michael A. Leven
/s/ K.D. Patel
Trustee
March 21, 2006
K.D. Patel
/s/ Ashish R. Parikh
Chief Financial Officer (Principal Financial Officer)
March 21, 2006
Ashish R. Parikh
/s/ Michael R. Gillespie
Chief Accounting Officer (Principal Accounting Officer)
March 21, 2006
Michael R. Gillespie
INDEX OF EXHIBITS
_____________________
*
Filed as an exhibit to Hersha Hospitality Trust’s Registration Statement on Form S-11, as amended, filed June 5, 1998 (SEC File No. 333-56087) and incorporated by reference herein.
**
Filed as an exhibit to Hersha Hospitality Trust’s Registration Statement on Form S-2, filed on September 25, 2003 (SEC File No. 333-109100) and incorporated by reference herein.
***
Filed herewith.
+ Indicates management contract or compensatory plan or arrangement.