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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1999 Commission File No. 001-14625
HOST MARRIOTT CORPORATION
Maryland 53-0085950
(State of Incorporation) (I.R.S. Employer Identification
Number)
10400 Fernwood Road
Bethesda, Maryland 20817
(301) 380-9000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
----------------------------------------- ---------------------------
Common Stock, $.01 par value (221,193,529
shares New York Stock Exchange
outstanding as of March 1, 2000) Chicago Stock Exchange
Purchase Share rights for Series A Junior
Participating Pacific Stock Exchange
Preferred Stock, .01 par value Philadelphia Stock Exchange
Class A Preferred Stock, $.01 par value
(4,160,000 million
shares outstanding as of March 1, 2000)
Class B Preferred Stock, $.01 par value
(4,000,000 million
shares outstanding as of March 1, 2000)
The aggregate market value of shares of common stock held by non-affiliates
at March 1, 2000 was $1,618,000,000.
Indicate by check mark whether the registrant (i) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (ii) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Document Incorporated by Reference
Notice of 2000 Annual Meeting and Proxy Statement
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FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K and the information incorporated by
reference into this annual report include forward-looking statements. We have
based these forward-looking statements on our current expectations and
projections about future events. We intend to identify forward-looking
statements in this prospectus and the information incorporated by reference
into this prospectus by using words or phrases such as "anticipate",
"believe", "estimate", "expect", "intend", "may be", "objective", "plan",
"predict", "project" and "will be" and similar words or phrases, or the
negative thereof.
These forward-looking statements are subject to numerous assumptions, risks
and uncertainties. Factors which may cause our actual results, performance or
achievements to be materially different from any future results, performance
or achievements expressed or implied by us in those statements include, among
others, the following:
. national and local economic and business conditions that will affect,
among other things, demand for products and services at our hotels and
other properties, the level of room rates and occupancy that can be
achieved by such properties and the availability and terms of financing;
. our ability to maintain the properties in a first-class manner,
including meeting capital expenditure requirements;
. our ability to compete effectively in areas such as access, location,
quality of accommodations and room rate structures;
. our ability to acquire or develop additional properties and the risk
that potential acquisitions or developments may not perform in
accordance with expectations;
. our degree of leverage which may affect our ability to obtain financing
in the future or compliance with current debt covenants;
. changes in travel patterns, taxes and government regulations which
influence or determine wages, prices, construction procedures and costs;
. government approvals, actions and initiatives including the need for
compliance with environmental and safety requirements, and change in
laws and regulations or the interpretation thereof;
. the effects of tax legislative action, including specified provisions of
the Work Incentives Improvement Act of 1999 as enacted on December 17,
1999 (we refer to this as the "REIT Modernization Act");
. our ability to satisfy complex rules in order to qualify as a REIT for
federal income tax purposes and in order for the operating partnership
to qualify as a partnership for federal income tax purposes, and our
ability to operate effectively within the limitations imposed by these
rules; and
. other factors discussed below under the heading "Risk Factors" and in
other filings with the Securities and Exchange Commission.
Although we believe the expectations reflected in our forward-looking
statements are based upon reasonable assumptions, we can give no assurance
that we will attain these expectations or that any deviations will not be
material. We disclaim any obligations or undertaking to publicly release any
updates or revisions to any forward-looking statement contained in this annual
report on Form 10-K and the information incorporated by reference herein to
reflect any change in our expectations with regard thereto or any change in
events, conditions or circumstances on which any such statement is based.
Items 1 & 2. Business and Properties
We are a self-managed and self-administered real estate investment trust, or
"REIT," owning full service hotel properties. We were formed as a Maryland
corporation in 1998, under the name HMC Merger Corporation, as a wholly owned
subsidiary of Host Marriott Corporation, a Delaware corporation, in connection
with its efforts to reorganize its business operations to qualify as a REIT
for federal income tax purposes. As part of this
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reorganization, which we refer to as the REIT conversion, and which is
described below in more detail on December 29, 1998, we merged with Host
Marriott and changed our name to Host Marriott Corporation. As a result, we
have succeeded to the hotel ownership business formerly conducted by Host
Marriott. We conduct our business as an umbrella partnership REIT, or UPREIT,
through Host Marriott, L.P., or the "operating partnership", a Delaware
limited partnership, of which we are the sole general partner and in which we
hold approximately 78% of the outstanding partnership interests.
Together with the operating partnership we were formed primarily to
continue, in an UPREIT structure, the full service hotel ownership business
formerly conducted by Host Marriott and its subsidiaries. We use the name Host
Marriott to refer to Host Marriott Corporation, the Delaware corporation,
prior to the REIT conversion and to ourselves on and after the REIT
conversion. Our primary business objective is to provide superior total
returns to our shareholders through a combination of dividends and
appreciation in share price. In addition, we endeavor to:
. achieve long-term sustainable growth in "Funds from Operations" per
share, as defined by the National Association of Real Estate Investment
Trusts (i.e., net income computed in accordance with generally accepted
accounting principles, excluding gains or losses from debt
restructuring, sales of properties and other non-recurring items, plus
real estate-related depreciation and amortization, and after adjustments
for unconsolidated partnerships and joint ventures), and cash flow;
. increase asset values by selectively improving and expanding our hotels;
. acquire additional existing and newly developed upscale and luxury full
service hotels in targeted markets primarily focusing on downtown hotels
in core business districts in major metropolitan markets and select
airport and resort/convention locations;
. develop and construct upscale and luxury full service hotels; and
. opportunistically pursue other real estate investments.
Our operations are conducted solely through the operating partnership and
its subsidiaries. As of March 1, 2000, we own 122 hotels, containing
approximately 58,000 rooms, located throughout the United States and Canada.
The hotels are generally operated under the Marriott, Ritz-Carlton, Four
Seasons, Swissotel and Hyatt brand names. These brand names are among the most
respected and widely recognized brand names in the lodging industry. The
hotels are leased by the operating partnership and its subsidiaries to
lessees, including Crestline and its subsidiaries, and are managed on behalf
of the lessees by subsidiaries of Marriott International and other companies.
We are the sole general partner of the operating partnership and manage all
aspects of the business of the operating partnership. This includes decisions
with respect to:
. sales and purchases of hotels;
. the financing of the hotels;
. the leasing of the hotels; and
. capital expenditures for the hotels subject to the terms of the leases
and the management agreements.
We are managed by our Board of Directors and have no employees who are not
also employees of the operating partnership.
Under current federal income tax law, REITs are restricted in their ability
to derive revenues directly from the operations of hotels. Therefore we,
through the operating partnership and its subsidiaries lease virtually all of
our hotels to the Lessees. See "--The Leases" below. The Lessees pay rent to
the operating partnership and its subsidiaries generally equal to a specified
minimum rent plus percentage rent based on specified percentages of different
categories of aggregate sales at the relevant hotels to the extent such
"percentage rent" would exceed the minimum rent. The Lessees operate the
hotels pursuant to management agreements with the managers. Each of the
management agreements provides for certain base and incentive management fees,
plus reimbursement of specific costs, as further described below. See "--The
Management Agreements." Such fees and cost
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reimbursements are the obligation of the Lessees and not the operating
partnership or its subsidiaries (although the obligation to pay such fees
could adversely affect the ability of the Lessees to pay the required rent to
the operating partnership or its subsidiaries).
The leases, through the sales percentage rent provisions, are designed to
allow us to participate in any growth above specified levels in room sales at
the hotels, which management expects can be achieved through increases in room
rates and occupancy levels. Although the economic trends affecting the hotel
industry will be the major factor in generating growth in lease revenues, the
abilities of the lessees and the managers will also have a material impact on
future sales growth.
In addition to external growth generated by new acquisitions, we intend to
carefully and periodically review our portfolio to identify opportunities to
selectively enhance existing assets to improve operating performance through
major capital improvements. The leases of the operating partnership and its
subsidiaries do provide the operating partnership and its subsidiaries with
the right to approve and finance major capital improvements.
Our primary focus is on the acquisition of upscale and luxury full service
hotel lodging properties. Since the beginning of 1994 through the date hereof,
we have acquired, directly and through our respective subsidiaries, 106 full
service hotels representing more than 48,000 rooms for an aggregate purchase
price of approximately $6.2 billion. Based upon data provided by Smith Travel
Research, we believe that our full service hotels outperform the industry's
average occupancy rate by a significant margin and averaged 77.7% occupancy
for both fiscal years 1999 and 1998 compared to a 69.1% and 69.4% average
occupancy for our competitive set for 1999 and 1998, respectively. "Our
competitive set" refers to hotels in the upscale and luxury full service
segment of the lodging industry, the segment which is most representative of
our full service hotels, and consists of Crowne Plaza; Doubletree; Hyatt;
Hilton; Radisson; Renaissance; Sheraton; Swissotel; Westin and Wyndham.
The relatively high occupancy rates of our hotels, along with increased
demand for full-service hotel rooms, have allowed the managers of our hotels
to increase average daily room rates by selectively raising room rates and by
minimizing, in specified cases, discounted group business, replacing it with
higher-rate group and transient business. As a result, on a comparable basis,
room revenue per available room ("REVPAR") for our full-service properties
increased approximately 4.1% in 1999.
Business Strategy
Our primary business objective is to provide superior total returns to our
shareholders through a combination of dividends and appreciation in share
price. In order to achieve this objective and, therefore, enhance our equity
value, we employ the following strategies:
. Acquire existing upscale and luxury full-service hotels as market
conditions permit, including Marriott and Ritz-Carlton hotels and other
hotels operated by leading management companies such as Four Seasons and
Hyatt which satisfy our investment criteria, which acquisitions may be
completed through various means including by entering into joint
ventures when we believe our return on investment will be maximized by
doing so;
. Develop selected new upscale and luxury full-service hotels, including
Marriott and Ritz-Carlton hotels and other hotels operated by leading
management companies such as Four Seasons and Hyatt which satisfy our
investment criteria and employ transaction structures which mitigate our
risk;
. Participate in the sales growth for each of our hotels through leases
which provide for the payment of rent based upon the lessees' gross
hotel sales in excess of specified thresholds; and
. Enhance existing hotel operations by completing selective capital
improvements which are designed to increase gross hotel sales or improve
operations.
Although competition for acquisitions has remained steady and the
availability of suitable acquisition candidates has been limited recently due
to market conditions, we believe that the upscale and luxury full-service
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segments of the market will continue to offer opportunities over time to
acquire assets at attractive multiples of cash flow and at discounts to
replacement value, including underperforming hotels which can be improved by
conversion to the Marriott, Ritz-Carlton, or other high quality brands. Since
the beginning of fiscal year 1994, we have acquired 14 hotels which we have
converted to the Marriott brand. The vast majority of our hotel properties are
operated under the Marriott and Ritz-Carlton brands. In general, based upon
data provided by Smith Travel Research, we believe that the Marriott brand has
consistently outperformed the industry. Demonstrating the strength of the
Marriott brand name, our comparable properties, consisting of 84 hotels, owned
directly or indirectly by us for the entire 1999 and 1998 fiscal years,
respectively, excluding two properties where significant expansion at the
hotels substantially affected operations during the two fiscal years,
generated a 31% and 29% REVPAR premium over our competitive set for fiscal
years 1999 and 1998, respectively. Accordingly, management anticipates that
any additional full service properties acquired in the future and converted
from other brands to the Marriott brand should achieve higher occupancy rates
and average room rates than has previously been the case for those properties
as the properties begin to benefit from Marriott's brand name recognition,
reservation system and group sales organization.
We have increased our pool of potential acquisition candidates by
considering acquisitions of select non-Marriott and non-Ritz-Carlton hotels
that offer long-term growth potential and are consistent with the overall
quality of our current portfolio. We will focus on upscale and luxury full
service properties in difficult to duplicate locations with high costs to
prospective competitors, such as hotels located in downtown, airport and
resort/convention locations, which are operated by quality managers. For
example, in December 1998, we consummated the Blackstone acquisition for
approximately $1.55 billion in a combination of cash, operating partnership
units, assumed debt and other consideration. The Blackstone acquisition
consisted of two Ritz-Carlton, two Four Seasons, one Grand Hyatt, three Hyatt
Regency and four Swissotel properties. In the future, we may also consider
opportunities to improve property operations by converting certain existing or
acquired hotels to these and other quality national brands. For example, we
are currently converting the resort property in Singer Island, Florida to the
Hilton brand, which is expected to be completed April 1, 2000.
We believe we are well qualified to pursue our acquisition and development
strategy. Management has extensive experience in acquiring and financing
lodging properties and believes its industry knowledge, relationships and
access to market information provide a competitive advantage with respect to
identifying, evaluating and acquiring hotel assets.
In September 1999, our board of directors approved the repurchase, from time
to time on the open market and/or in privately negotiated transactions, of up
to 22 million of the outstanding shares of our common stock, operating
partnership units, or Convertible Preferred Securities convertible into a like
number of shares of common stock. Based on current market conditions, we
believe that the stock repurchase program reflects the best return on
investment for our shareholders. However, we will continue to look at
strategic acquisitions as well as evaluate our stock repurchase program based
on changes in market conditions and our stock price. The stock repurchases may
be financed through cash from operations, assets sales, and other financing
activities, such as the issuances of the Class A and Class B Preferred Stock
made during 1999. Such repurchases will be made at management's discretion,
subject to market conditions and may be suspended at any time at our
discretion. Through March 8, 2000, we spent, in the aggregate, approximately
$149 million to repurchase 10.5 million shares of our common stock, and 1.5
million shares of the Convertible Preferred Securities and 0.6 million
operating partnership units for a total reduction of 16.0 million equivalent
shares on a fully diluted basis.
The REIT Conversion
During 1998, Host Marriott and its subsidiaries and affiliates consummated a
series of transactions intended to enable us to qualify as a REIT for federal
income tax purposes. As a result of these transactions, the hotels formerly
owned by Host Marriott and its subsidiaries and other affiliates are now owned
by the operating partnership and its subsidiaries; the operating partnership
and its subsidiaries lease substantially all of these hotels to Crestline
Capital Corporation, and Marriott International and other hotel operators
conduct the day to day
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management of the hotels pursuant to management agreements with Crestline. We
have elected to be treated as a REIT for federal income tax purposes effective
January 1, 1999. The important transactions comprising the REIT conversion are
summarized below.
During 1998, Host Marriott reorganized its hotels and certain other assets so
that they were owned by the operating partnership and its subsidiaries. Host
Marriott and its subsidiaries received a number of OP Units equal to the number
of then outstanding shares of Host Marriott common stock, and the operating
partnership and its subsidiaries assumed substantially all of the liabilities
of Host Marriott and its subsidiaries. As a result of this reorganization and
the related transactions described below, we are the sole general partner in
the operating partnership and as of December 31, 1999 held approximately 78% of
the outstanding OP Units. The operating partnership and its subsidiaries
conduct our hotel ownership business. OP Units owned by holders other than us
are redeemable at the option of the holder, generally commencing one year after
the issuance of their OP Units. Upon redemption of an OP Unit, the holder would
receive from the operating partnership cash in an amount equal to the market
value of one share of our common stock. However, in lieu of a cash redemption
by the operating partnership, we have the right to acquire any OP Unit offered
for redemption directly from the holder thereof in exchange for either one
share of our common stock or cash in an amount equal to the market value of one
share of our common stock.
In connection with the REIT conversion, two taxable corporations were formed
in which the operating partnership owns approximately 95% of the economic
interest but none of the voting interest. We refer to these two subsidiaries as
the non-controlled subsidiaries. The non-controlled subsidiaries hold various
assets and related liabilities which were originally contributed by Host
Marriott and its subsidiaries to the operating partnership, but whose direct
ownership by the operating partnership or its other subsidiaries generally
would jeopardize our status as a REIT and the operating partnership's status as
a partnership for federal income tax purposes. These assets primarily consist
of interests in partnerships or other interests in three hotels which are not
leased, and specified furniture, fixtures and equipment--also known as FF&E--
used in the hotels. The operating partnership has no control over the operation
or management of the hotels or other assets owned by the non-controlled
subsidiaries. The Host Marriott Statutory Employee/Charitable Trust acquired
all of the voting common stock of each non-controlled subsidiary, representing,
in each case, the remaining approximately 5% of the total economic interests in
each non-controlled subsidiary. The beneficiaries of the Employee/Charitable
Trust are a trust formed for the benefit of specified employees of the
operating partnership and the J. Willard and Alice S. Marriott Foundation.
Under current federal income tax law, REITs are restricted in their ability
to derive revenues from the operation of hotels. However, they can derive
rental income by leasing hotels. Therefore, the operating partnership and its
subsidiaries lease virtually all of their hotel properties to subsidiaries of
Crestline. The lessees pay rent to the operating partnership and its
subsidiaries generally equal to the greater of (1) a specified minimum rent or
(2) rent based on specified percentages of different categories of aggregate
sales at the relevant hotels. Generally, there is a separate lessee for each
hotel property or there is a separate lessee for each group of hotel properties
that has separate mortgage financing or has owners in addition to the operating
partnership and its wholly owned subsidiaries. The lessees for all but four of
our hotels are wholly owned subsidiaries of Crestline, formed as limited
liability companies, each of whose purpose is limited to acting as lessee under
an applicable lease. The limited liability company agreement for each Crestline
lessee provides that Crestline will have full control over the management of
the business of the lessee, except with respect to certain decisions for which
the consent of other members or the hotel manager will be required. In
addition, although the Crestline lessees are wholly owned subsidiaries of
Crestline, Marriott International or its appropriate subsidiary has a non-
economic voting interest on specific matters pertaining to hotels which are
managed by Marriott International or its subsidiaries.
The leases, through the sales percentage rent provisions, are designed to
allow us and our subsidiaries to participate in any growth above specified
levels in room sales at the hotels, which management expects can be achieved
through increases in room rates and occupancy levels. Although the economic
trends affecting the hotel
5
industry will be the major factor in generating growth in lease revenues, the
abilities of the lessees and the managers will also have a material impact on
future sales growth. Our leases have remaining terms ranging from two to ten
years, subject to earlier termination upon the occurrence of contingencies
that are specified in the leases. We may elect to purchase each of the leases
either upon a sale of a hotel to a third party or upon the occurrence of
certain changes in tax law such as those changes included in the REIT
Modernization Act (discussed below), for a purchase price equal to the fair
rental value of the lessee's interest in the lease over the remaining term of
such lease. Effective November 15, 1999, we amended substantially all of our
leases with Crestline to give Crestline the right to renew each of these
leases for up to four additional terms of seven years each at a fair rental
value, to be determined either by agreement between us and Crestline or
through arbitration at the time the renewal option is exercised. Crestline is
under no obligation to exercise these renewal options, and we have the right
to terminate the renewal options during time periods specified in the
amendments. In addition, the amendments provide that the fair rental value
payable by us to Crestline in connection with the purchase of a lease as
described above does not include any amounts relating to any renewal period.
Therefore, the fair rental value of a lease after expiration of the initial
term for such lease would be zero. We have received notices of termination
from Crestline on five leases, with effective dates ranging from March through
June 2000. We are currently negotiating for replacement leases on those five.
We expect to be able to obtain replacement leases for these leases without
material impact to our future operations.
In December 1999, the REIT Modernization Act was passed, with most
provisions effective for taxable years beginning after December 31, 2000,
which significantly amends the REIT laws applicable to us. Among the changes,
the REIT Modernization Act allows a REIT to own up to 100% of the voting stock
of one or more taxable REIT subsidiaries subject to limitations on the value
of those subsidiaries. The rents received from such subsidiaries would not be
disqualified from being "rents from real property" by reason of the operating
partnership's ownership interest in the subsidiary so long as the property is
operated on behalf of the taxable REIT subsidiary by an "eligible independent
contractor." This would enable the operating partnership to lease its hotels
to wholly owned taxable subsidiaries if the hotels are operated and managed on
behalf of such subsidiaries by an independent third party. Under the REIT
Modernization Act, taxable REIT subsidiaries will be subject to federal income
tax. Under the law that is currently in effect, a REIT must satisfy three
tests relating to the nature of its assets:
. First, at least 75% of its total assets must be represented by real
estate assets.
. Second, no more than 25% of total assets may be represented by
securities other than those in the 75% asset class.
. Third, within the 25% assets class, the value of any one issuer's
securities may not exceed 5% of its total assets and a REIT may not own
more than 10% of any one issuer's outstanding voting securities.
The third test will be modified in two respects by the REIT Modernization
Act:
. The 10% voting securities test will be expanded so that we will be
prohibited from owning more than 10% of the value of the outstanding
securities of any one issuer.
. We will be permitted to own securities of a subsidiary that exceed the
5% value test and the new 10% vote or value test if the subsidiary
elects to be a taxable REIT subsidiary.
Under the REIT Modernization Act, beginning January 1, 2001, we could lease
our hotels to a subsidiary of the operating partnership that is a taxable
corporation and that elects to be treated as a "taxable REIT subsidiary". In
addition, as a result of passage of the REIT Modernization Act, we have the
right to purchase the leases from Crestline on or after January 1, 2001, for a
price equal to their fair market value, the amount of which could be
significant. We intend to evaluate our options regarding the Crestline leases
and have not yet made a decision whether or not to purchase those leases.
Finally, under the REIT Modernization Act, beginning January 1, 2001, the
aggregate fair market values of real and personal property will be used for
purposes of determining rents from real property. Currently, the aggregate tax
bases of both real and personal property are used for this purpose.
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Recent Acquisitions, Developments and Dispositions
The pace of acquisitions changed significantly in 1999 from the previous
years. After three years of acquisitions numbering 36, 17, and 24 full service
hotels for 1998, 1997 and 1996, respectively, our 1999 acquisitions were
limited to completing the acquisition of minority interests in two hotels
where we had previously acquired the controlling interests for a total
consideration of approximately $14 million.
During the year we focused our energies on increasing the value of our
current portfolio with selective investments and expansions and new
developments. We plan to selectively develop new upscale and luxury full-
service hotels in major urban markets and convention/resort locations with
strong growth prospects, unique or difficult to duplicate sites, high costs
for prospective competitors for other new hotels and limited new supply. We
intend to target only development projects that show promise of providing
financial returns that represent a premium to acquisitions. The largest of
these projects was the construction of a 717-room full service hotel adjacent
to the convention center in downtown Tampa, Florida. The hotel, which was
completed and opened for business on February 19, 2000, includes 45,000 square
feet of meeting space, three restaurants and a 30 slip marina as well as many
other amenities. The total development cost of the property was approximately
$104 million, not including a $16 million tax subsidy provided by the City of
Tampa.
In April 1999 we completed a 210-room expansion of the Philadelphia
Marriott, through a renovation of the historic railroad headhouse building
adjacent to the property. The project was completed for approximately $37
million including a $7 million tax financing provided by the City of
Philadelphia.
Two other development projects, the Orlando World Center Marriott expansion
and the Ritz-Carlton Naples, Florida spa addition are currently under
construction. At the Orlando Marriott, the addition of a 500-room tower and
15,000 square feet of meeting space will make it the single largest hotel in
the Marriott system at 2000 rooms. We also have renovated the golf course,
added a multi-level parking deck, and upgraded and expanded several
restaurants. The Orlando World Center Marriott construction is expected to be
completed by mid-year 2000. Also under development is a 50,000 square-foot
world-class spa at the Ritz-Carlton, Naples. This project is anticipated to be
completed late in 2000. The combined approximate development cost for these
expansions is estimated to be $107 million.
Two longer-term development projects are currently active with anticipated
completion in 2001. These are the construction of a 295-room Ritz-Carlton,
Naples, Golf Lodge and the 200-room expansion of the Memphis Marriott. The
construction of the Naples Golf Lodge near the 463-room Ritz-Carlton, Naples,
as well as the construction of the new spa facility, will offer travelers an
unmatched resort experience. The Memphis Marriott, which is located adjacent
to a newly-renovated convention center, was converted to the Marriott brand
upon acquisition in 1998 to capitalize on Marriott's brand name recognition.
The combined development cost for these projects is estimated to be
approximately $90 million.
In addition to investments in partnerships in which we already held minority
interests, we have been successful in adding properties to our portfolio
through partnership arrangements with either the seller of the property or the
incoming managers (typically Marriott International or a Marriott franchisee).
We have the financial flexibility and, due to our existing private partnership
investment portfolio, the administrative infrastructure in place to
accommodate such arrangements. We view this ability as a competitive advantage
and expect to enter into similar arrangements to acquire additional properties
in the future.
Through subsidiaries we currently own four Canadian properties, with 1,636
rooms. We intend to continue to evaluate other attractive acquisition
opportunities in Canada. In addition, the overbuilding and economic stress
experienced in some European and Pacific Rim countries may eventually lead to
additional international acquisition opportunities. We will acquire
international properties only when we believe such acquisitions achieve
satisfactory returns after adjustments for currency and country risks.
We will also consider from time to time selling hotels that do not fit our
long-term strategy, or otherwise meet our ongoing investment criteria,
including for example, hotels in some suburban locations, hotels that
7
require significant capital improvement and other underperforming assets. The
net proceeds from these sales will be reinvested in upscale and luxury hotels
more consistent with our strategy or otherwise applied in a manner consistent
with our investment strategy (which may include the purchase of securities) at
the time of sale. The following table summarizes our 1999 dispositions (in
millions):
Pre-tax
Total Gain (Loss)
Property Location Rooms Consideration on Disposal
-------- ---------------- ----- ------------- -----------
Minneapolis/Bloomington
Marriott.................... Bloomington, MN 479 $ 35 $10
Saddle Brook Marriott........ Saddle Brook, NJ 221 15 3
Marriott's Grand Hotel Resort
and Golf Club............... Point Clear, AL 306 28 (2)
The Ritz-Carlton, Boston..... Boston, MA 275 119 15
El Paso Marriott............. El Paso, TX 296 1 (2)
Hotel Lodging Industry
The lodging industry posted moderate gains in 1999 as higher average daily
rates drove strong increases in REVPAR, which measures daily room revenues
generated on a per room basis. This does not include food and beverage or
other ancillary revenues generated by the property. REVPAR represents the
product of the average daily room rate charged and the average daily occupancy
achieved. Previously, the lodging industry benefited from a favorable
supply/demand imbalance, driven in part by low construction levels combined
with high gross domestic product, or GDP, growth. However, during 1999 and
1998 supply moderately outpaced demand, causing slight declines in occupancy
rates in the upscale and luxury full-service segments in which we operate.
According to Smith Travel Research, supply in our brands' competitive set
consisting of Crowne Plaza; Doubletree; Hyatt; Hilton; Radisson; Renaissance;
Sheraton; Westin; Swissotel and Wyndham increased 1.6% for the year ended
December 31, 1999, while demand in our competitive set increased 1.1%. At the
same time, occupancy declined 0.4% in our competitive set for the year ended
December 31, 1999.
These declines in occupancy, however, were more than offset by increases in
average daily rates which generated higher REVPAR. According to Smith Travel
Research, for the year ended December 31, 1999, average daily rate and REVPAR
for our competitive set increased 3.0% and 2.5%, respectively, versus the same
period one year ago. The current amount of excess supply in the upper-upscale
and luxury portions of the full-service segment of the lodging industry is
relatively moderate and much less severe than that experienced in the lodging
industry in other occupancy downturns, in part because of the greater
financial discipline and lending practices imposed by financial institutions
and public markets today relative to those during the late 1980's.
Our hotels have outperformed both the industry as a whole and the upper-
upscale and luxury full service segment. The attractive locations of our
hotels, the limited availability of new building sites for new construction of
competing full service hotels, and the lack of availability of financing for
new full service hotels has allowed us to maintain REVPAR and average daily
rate premiums over our competitors in these service segments. For our
comparable hotels, average daily rates increased 3.8% in 1999. The increase in
average daily rate helped generate a strong increase in comparable hotel
REVPAR of 4.1% for the same period. Furthermore, because our lodging
operations have a high fixed-cost component, increases in REVPAR generally
yield greater percentage increases in our consolidated earnings before
interest expense, income taxes, depreciation, amortization and other non-cash
items or EBITDA. While we do not benefit directly from increases in EBITDA
levels at our properties due to the structure of our leases, we should benefit
from such increases due to expected higher market valuations of our properties
based on such elevated EBITDA levels.
We believe that the current environment of excess new supply will most
likely continue over the next twelve to twenty-four months. However, the
relative balance between supply and demand growth may be influenced by a
number of factors including growth of the economy, interest rates, unique
local considerations and the relatively long lead time to develop urban,
convention and resort hotels. We believe that growth in room supply in upscale
and luxury full-service sub-markets in which we operate will continue to
exceed room demand
8
growth through the year 2001. There can be no assurance that growth in supply
will moderate or that REVPAR and EBITDA will continue to improve.
Hotel Lodging Properties
Our lodging portfolio, as of March 1, 2000, consists of 122 upscale and
luxury full service hotels containing approximately 58,000 rooms. Our hotel
lodging properties represent quality upscale and luxury assets in the full
service. All but thirteen of our hotel properties are currently operated under
the Marriott or Ritz-Carlton brand names.
Our hotels average approximately 474 rooms. Thirteen of our hotels have more
than 750 rooms. Hotel facilities typically include meeting and banquet
facilities, a variety of restaurants and lounges, swimming pools, gift shops
and parking facilities. Our hotels primarily serve business and pleasure
travelers and group meetings at locations in downtown, airport, resort
convention and suburban locations throughout the United States. The properties
are generally well situated in locations where there are significant barriers
to entry by competitors including downtown areas of major metropolitan cities
at airports and resort/convention locations where there are limited or no
development sites. The average age of the properties is 16 years, although
many of the properties have had more recent substantial renovations or major
additions.
To maintain the overall quality of our lodging properties, each property
undergoes refurbishments and capital improvements on a regularly scheduled
basis. Typically, refurbishing has been provided at intervals of five years,
based on an annual review of the condition of each property. For fiscal years
1999, 1998 and 1997 we spent $197 million, $165 million and $129 million,
respectively, on capital improvements to existing properties. As a result of
these expenditures, we expect to maintain high quality rooms at our
properties.
We continue to benefit from our strategic alliance with Marriott
International. Marriott International serves as the manager for 99 of our 122
hotels and all but 13 are part of Marriott International's full-service hotel
system. The Marriott brand name has consistently delivered occupancy and
REVPAR premiums over other brands. Our properties have reported annual
increases in REVPAR since 1993. Based upon data provided by Smith Travel
Research, our comparable properties have more than a 9 percentage point
occupancy premium and approximately 31% REVPAR premium over the competitive
set for 1999.
Comparable properties refer to properties that we owned for the same period
of time in each of the periods covered as adjusted to exclude properties where
significant disruptions to operations occurred due to expansions to the
properties.
The chart below sets forth performance information for our comparable
properties:
1999 1998
------- -------
Comparable Full-Service Hotels(1)
Number of properties.......................................... 84 84
Number of rooms............................................... 40,868 40,868
Average daily rate............................................ $146.74 $141.41
Occupancy percentage.......................................... 78.5% 78.2%
REVPAR........................................................ $115.13 $110.57
REVPAR % change............................................... 4.1% --
- --------
(1) Consists of 84 properties owned, directly or indirectly, by us for the
entire 1999 and 1998 fiscal years, respectively, after giving effect to
adjustments to remove two properties where significant expansion at the
hotels affected operations for the 1999 and 1998 fiscal years. These
properties, for the respective periods, represent the "comparable
properties."
9
The chart below presents some performance information for our hotels:
1999(1) 1998 1997
------- -------- -------
Number of properties................................ 121 126(2) 95
Number of rooms..................................... 57,086 58,445(2) 45,718
Average daily rate.................................. $149.51 $ 140.36 $133.74
Occupancy percentage................................ 77.7% 77.7% 78.4%
REVPAR.............................................. $116.13 $ 109.06 $104.84
- --------
(1) The property statistics and operating results include operations for the
Minneapolis/Bloomington Marriott, the Saddle Brook Marriott, Marriott's
Grand Hotel Resort and Golf Club, the Ritz-Carlton, Boston, and the El
Paso Marriott, which were sold at various times throughout 1999, through
the date of sale.
(2) Number of properties and rooms is as of December 31, 1998 and includes 25
properties (9,965 rooms) acquired in that month.
The following table presents full service hotel information by geographic
region for 1999:
Year Ended December 31,
As of December 31, 1999 1999(1)
------------------------ ---------------------------
Average
Number Average Number Average Daily
Geographic Region of Hotels of Guest Rooms Occupancy Rate REVPAR
- ----------------- --------- -------------- --------- -------- --------
Atlanta.................... 11 486 74.7% $ 148.78 $ 111.12
Florida.................... 12 531 77.1 149.75 115.51
Mid-Atlantic............... 17 364 75.8 132.80 100.69
Midwest.................... 14 358 76.6 132.19 101.24
New York................... 10 716 84.0 203.16 170.70
Northeast.................. 11 390 77.4 140.99 109.07
South Central.............. 19 497 76.2 123.25 93.89
Western.................... 27 491 78.2 154.26 120.60
---
Average--All regions....... 121 472 77.7 149.51 116.13
===
- --------
(1) The property statistics and operating results include operations for the
Minneapolis/Bloomington Marriott, the Saddle Brook Marriott, Marriott's
Grand Hotel Resort and Golf Club, the Ritz-Carlton, Boston, and the El
Paso Marriott, all sold at various times throughout 1999, through the date
of applicable sale.
Prior to 1997, we divested virtually all of our limited-service hotel
properties through the sale and leaseback of 53 Courtyard properties and 18
Residence Inn properties. The Courtyard and Residence Inn properties are
subleased to subsidiaries of Crestline under sublease agreements and are
managed by Marriott International under long-term management agreements.
During 1999, limited-service properties represented less than 1% of our EBITDA
from hotel properties. Lease revenues for the 71 properties that we sub-lease
are reflected in our revenues in 1999, while gross property-level sales were
reflected previous to that.
10
The following table sets forth as of March 1, 2000, the location and number
of rooms relating to each of our 122 hotels. All of the properties are leased
to a subsidiary of Crestline and operated under Marriott brands by Marriott
International, unless otherwise indicated.
Location Rooms
- -------- -----
Arizona
Mountain Shadows Resort.......... 337
Scottsdale Suites................ 251
The Ritz-Carlton, Phoenix........ 281
California
Coronado Island Resort(1)(2)..... 300
Costa Mesa Suites................ 253
Desert Springs Resort and Spa.... 884
Fullerton(2)..................... 224
Hyatt Regency, Burlingame(3)..... 793
Manhattan Beach(1)(2)(4)(6)...... 380
Marina Beach(1)(2)............... 368
Newport Beach.................... 570
Newport Beach Suites............. 250
Ontario Airport(4)(6)............ 299
Sacramento Airport(2)(3)(7)...... 85
San Diego Marriott Hotel and
Marina(2)(6).................... 1,355
San Diego Mission Valley(6)(7)... 350
San Francisco Airport............ 684
San Francisco Fisherman's
Wharf(4)........................ 285
San Francisco Moscone Center(2).. 1,498
San Ramon(2)..................... 368
Santa Clara(2)................... 754
The Ritz-Carlton, Marina del
Rey(2).......................... 306
The Ritz-Carlton, San Francisco.. 336
Torrance......................... 487
Colorado
Denver Southeast(2).............. 595
Denver Tech Center(1)............ 625
Denver West(2)................... 307
Marriott's Mountain Resort at
Vail(1)......................... 349
Connecticut
Hartford/Farmington.............. 380
Hartford/Rocky Hill(2)........... 251
Florida
Fort Lauderdale Marina(2)........ 580
Harbor Beach Resort(2)(5)(6)..... 624
Jacksonville(2)(4)............... 256
Miami Airport(2)................. 782
Miami Biscayne Bay(2)............ 605
Orlando World Center............. 1,503
Palm Beach Gardens(4)............ 279
Singer Island Holiday Inn(3)..... 222
Tampa Airport(2)................. 295
Tampa Waterside.................. 717
Tampa Westshore(2)............... 309
The Ritz-Carlton, Amelia Island.. 449
The Ritz-Carlton, Naples......... 463
Georgia
Atlanta Marriott Marquis(6)...... 1,671
Atlanta Midtown Suites(2)........ 254
Atlanta Norcross................. 222
Atlanta Northwest................ 400
Atlanta Perimeter(2)............. 400
Four Seasons, Atlanta(3)......... 246
Location Rooms
- -------- -----
Georgia (Continued)
Grand Hyatt, Atlanta(3)........... 439
JW Marriott Hotel at Lenox(2)..... 371
Swissotel, Atlanta(3)............. 348
The Ritz-Carlton, Atlanta(2)...... 447
The Ritz-Carlton, Buckhead........ 553
Illinois
Chicago/Deerfield Suites.......... 248
Chicago/Downers Grove Suites...... 254
Chicago/Downtown Courtyard........ 334
Chicago O'Hare(2)................. 681
Chicago O'Hare Suites(2).......... 256
Swissotel, Chicago(3)............. 630
Indiana
South Bend(2)..................... 300
Louisiana
New Orleans....................... 1,290
Maryland
Bethesda(2)....................... 407
Gaithersburg/Washingtonian
Center........................... 284
Massachusetts
Boston/Newton..................... 430
Hyatt Regency, Cambridge(3)....... 469
Swissotel, Boston(3).............. 498
Michigan
The Ritz-Carlton, Dearborn........ 308
Detroit Livonia................... 224
Detroit Romulus................... 245
Detroit Southfield................ 226
Minnesota
Minneapolis City Center(2)........ 583
Minneapolis Southwest(6)(7)....... 320
Missouri
Kansas City Airport(2)............ 382
New Hampshire
Nashua............................ 251
New Jersey
Hanover........................... 353
Newark Airport(2)................. 590
Park Ridge(2)..................... 289
New Mexico
Albuquerque(2).................... 411
New York
Albany(6)(7)...................... 359
New York Marriott Financial
Center........................... 504
New York Marriott Marquis(2)...... 1,919
Marriott World Trade Center
(1)(2)........................... 820
Swissotel, The Drake(3)........... 494
North Carolina
Charlotte Executive Park(4)....... 298
Greensboro/Highpoint(2)........... 299
Raleigh Crabtree Valley........... 375
Research Triangle Park............ 224
Ohio
Dayton............................ 399
Oklahoma
Oklahoma City..................... 354
Oklahoma City Waterford(1)(4)(6).. 197
11
Location Rooms
- -------- -----
Oregon
Portland....................... 503
Pennsylvania
Four Seasons, Philadelphia(3).. 365
Philadelphia Convention
Center(2)(6).................. 1,410
Philadelphia Airport(2)........ 419
Pittsburgh City
Center(1)(2)(4)(6)............ 400
Tennessee
Memphis(1)(2).................. 403
Texas
Dallas/Fort Worth Airport...... 492
Dallas Quorum(2)............... 547
Houston Airport(2)............. 566
Houston Medical Center(2)...... 386
JW Marriott Houston............ 503
Plaza San Antonio(1)(2)(4)..... 252
San Antonio Rivercenter(2)..... 999
San Antonio Riverwalk(2)....... 500
Utah
Salt Lake City(2).............. 510
Location Rooms
- -------- ------
Virginia
Dulles Airport(2)............ 370
Fairview Park(2)............. 395
Hyatt Regency, Reston(3)..... 514
Key Bridge(2)................ 588
Norfolk Waterside(2)(4)...... 404
Pentagon City Residence Inn.. 300
The Ritz-Carlton, Tysons
Corner(2)................... 397
Washington Dulles Suites..... 254
Westfields(1)................ 335
Williamsburg(1).............. 295
Washington
Seattle SeaTac Airport....... 459
Washington, DC
Washington Metro Center(1)... 456
Canada
Calgary(1)................... 380
Toronto Airport(6)........... 423
Toronto Eaton Center(2)...... 459
Toronto Delta Meadowvale(3).. 374
------
TOTAL......................... 57,803
======
- --------
(1) This property was converted to the Marriott brand after acquisition.
(2) The land on which this hotel is built is leased under one or more long-
term lease agreements.
(3) This property is not operated under the Marriott brand and is not managed
by Marriott International.
(4) This property is operated as a Marriott franchised property.
(5) This property is leased to Marriott International.
(6) This property is not wholly owned by the operating partnership.
(7) This property is not leased to Crestline.
Investments in Affiliated Partnerships
The operating partnership and certain of its subsidiaries also manage our
partnership investments and conduct the partnership services business. As
previously discussed, in connection with the REIT conversion, the non-
controlled subsidiaries were formed to hold various assets. The direct
ownership of those assets by us or the operating partnership could jeopardize
our status as a REIT or the operating partnership's treatment as a partnership
for federal income tax purposes. Substantially all our general and limited
partner interests in partnerships owning 209 limited-service hotels were held
by the non-controlled subsidiaries at year end. Additionally, of the 20 full-
service hotels in which we had general and limited partner interests 13 were
acquired by the operating partnership, two were sold, four were transferred to
the non-controlled subsidiary and one was retained. We executed a definitive
agreement regarding litigation for seven of these limited pantherships
subsequent to year end. See "--Legal Proceedings" below.
The managing general partner of the partnership is responsible for the day-
to-day management of the partnership operations, which generally includes
payment of partnership obligations from partnership funds, preparation of
financial reports and tax returns and communications with lenders, limited
partners and regulatory bodies. As the general partner, we are reimbursed for
the cost of providing these services subject to limitations in certain cases.
The partnership hotels are currently operated under management agreements
with Marriott International or its subsidiaries. As the general partner, we
oversee and monitor Marriott International and its subsidiaries' performance
pursuant to these agreements.
Cash distributions provided from these partnerships including distributions
related to partnerships sold, transferred or acquired in 1998 are tied to the
overall performance of the underlying properties and the overall level of
debt. There were no distributions in 1999. Distributions from these
partnerships to us were $2 million in 1998 and $5 million in 1997. All debt of
these partnerships is nonrecourse to us and our subsidiaries, except that we
are contingently liable under various guarantees of debt obligations of
certain of the limited-service partnerships.
12
Marketing
As of March 1, 2000, 99 of our 122 hotel properties were managed by
subsidiaries of Marriott International as Marriott or Ritz-Carlton brand
hotels. Ten of the 23 remaining hotels are operated as Marriott brand hotels
under franchise agreements with Marriott International. The remaining hotels
are managed primarily by Hyatt, Four Seasons, and Swissotel. In addition, we
are currently converting the resort property in Singer Island, Florida to the
Hilton brand, which is expected to be completed April 1, 2000.
We believe that our properties will continue to enjoy competitive advantages
arising from their participation in the Marriott, Ritz-Carlton, Hyatt, Four
Seasons, Swissotel, and Hilton hotel systems. The national marketing programs
and reservation systems of each of these managers, as well as the advantages of
strong customer preference for these upper-upscale and luxury brands should
also help these properties to maintain or increase their premium over
competitors in both occupancy and room rates. Repeat guest business is enhanced
by guest rewards programs offered by Marriott, Hyatt, Swissotel, and Hilton.
For example, the Marriott Rewards program membership includes more than 7.5
million members.
Each of the managers maintain national reservation systems that provide
reservation agents with complete descriptions of the rooms available and up-to-
date rate information from the properties. Marriott's reservation system also
features connectivity to airline reservation systems, providing travel agents
with access to available rooms inventory for all Marriott and Ritz-Carlton
lodging properties. In addition, software at Marriott's centralized
reservations centers enables agents to immediately identify the nearest
Marriott or Ritz-Carlton brand property with available rooms when a caller's
first choice is fully occupied. Our website (www.hostmarriott.com) currently
permits users to connect to the Marriott, Ritz-Carlton, Hyatt, Four Seasons,
and Swissotel reservation systems to reserve rooms in our hotels.
Competition
Our hotels compete with several other major lodging brands in each segment in
which they operate. Competition in the industry is based primarily on the level
of service, quality of accommodations, convenience of locations and room rates.
Although the competitive position of each of our hotel properties differs from
market to market, we believe that our properties compare favorably to their
competitive set in the markets in which they operate on the basis of these
factors. The following table presents key participants in segments of the
lodging industry in which we compete:
Segment Representative Participants
- ------- ---------------------------
Luxury Full-Service Ritz-Carlton; Four Seasons
Upscale Full-Service Crown Plaza; Doubletree; Hyatt; Hilton; Marriott Hotels, Resort and Suites; Radisson;
Renaissance; Sheraton; Swissotel; Westin; Wyndham
Seasonality
Our hotel revenues have traditionally experienced significant seasonality.
Additionally, hotel revenues in the fourth quarter reflect sixteen weeks of
results compared to twelve weeks for the first three quarters of the fiscal
year. Average hotel sales by quarter over the three years 1997 through 1999 for
our lodging properties are as follows:
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
22% 23% 22% 33%
Other Real Estate Investments
We have lease and sublease activity relating primarily to Host Marriott's
former restaurant operations. Additionally, we have lease activity related to
certain office space that we own in Atlanta, Chicago, and San Francisco which
is included in other revenues in our statements of operations. Prior to the
REIT conversion, we
13
owned 12 undeveloped parcels of vacant land, totaling approximately 83 acres,
originally purchased primarily for the development of hotels or senior living
communities. These parcels are now owned by one of the non-controlled
subsidiaries.
Employees
We are managed by our Board of Directors and we have no employees who are not
employees of the operating partnership.
Currently, the operating partnership has approximately 188 management
employees, and approximately 15 other employees which are covered by a
collective bargaining agreement that is subject to review and renewal on a
regular basis. We believe that we and our managers have good relations with
labor unions and have not experienced any material business interruptions as a
result of labor disputes.
Environmental and Regulatory Matters
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 may 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, certain environmental laws and
common law principles could be used to impose liability for release of
asbestos-containing materials, and third parties may seek recovery from owners
or operators of real properties for personal injury associated with exposure to
released asbestos-containing materials. Environmental laws also may impose
restrictions on the manner in which property may be used or business may be
operated, and these restrictions may require expenditures. In connection with
our current or prior ownership or operation of hotels, we may be potentially
liable for any such costs or liabilities. Although we are currently not aware
of any material environmental claims pending or threatened against us, we can
offer no assurance that a material environmental claim will not be asserted
against us.
The Leases
In order for us to qualify as a REIT for federal income tax purposes we may
not operate the hotels or related properties. Accordingly, we lease the hotels
to lessees, which are primarily wholly owned indirect subsidiaries of
Crestline. The following is a brief summary of the general terms of the leases
a form of which has been filed with the Commission.
. Lessees. There generally is a separate lessee for each hotel or group of
hotels that is owned by a separate subsidiary of the operating
partnership. Each lessee is a Delaware limited liability company, whose
purpose is limited to acting as lessee under the applicable lease(s).
For those hotels where it is the manager, Marriott International or a
subsidiary has a noneconomic membership interest in the lessee entitling
it to certain voting rights but no economic rights. The operating
agreements for such lessees provide that the Crestline member of the
lessee has full control over the management of the business of the
lessee, except with respect to specific decisions for which the consent
of both members are required. Upon any termination of the applicable
management agreement, these special voting rights of Marriott
International or its subsidiary will cease.
. Lease Terms. Each lease has a fixed term ranging generally from seven to
ten years (depending upon the lease), subject to earlier termination
upon the occurrence of specified contingencies described in the lease.
Effective November 15, 1999, we amended substantially all of our leases
with Crestline to give Crestline the right to renew each of these leases
for up to four additional terms of seven years each at a fair rental
value, to be determined either by agreement between us and Crestline or
through arbitration at the time the renewal option is exercised.
Crestline is under no obligation to exercise these renewal options, and
we have the right to terminate the renewal options during time periods
specified
14
in the amendments. In addition, the amendments provide that the fair
rental value payable by us to Crestline in connection with the purchase
of a lease as described above does not include any amounts relating to
any renewal period. Therefore, the fair rental value of a lease after
expiration of the initial term for such lease would be zero.
. Termination of the Leases upon Changes in Tax Laws. In the event that
changes in the federal income tax laws such as those included in the
REIT Modernization Act allow the lessors, or subsidiaries or affiliates
of the lessors, to directly operate the hotels without jeopardizing our
status as a REIT, the lessors have the right to terminate all, but not
less than all, of the leases (excluding leases of hotels that must still
be leased following the tax law change) in return for paying the lessees
the fair market value of the remaining terms of the leases.
. Minimum Rent; Percentage Rent. Each lease requires the lessee to pay
minimum rent in a fixed dollar amount specified in each lease per annum
plus to the extent it exceeds minimum rent, percentage rent based upon
specified percentages of aggregate sales from the applicable hotel,
including room sales, food and beverage sales and other income in excess
of specified thresholds. The amount of minimum rent and the percentage
rent thresholds are to be adjusted each year. The annual adjustment with
respect to minimum rent equals a percentage of any increase in the
Consumer Price Index during the previous twelve months. Neither minimum
rent nor percentage rent thresholds will be decreased because of the
annual adjustment.
. Lessee Expenses. Each lessee is responsible for paying all of the
expenses of operating the applicable hotel(s), including all personnel
costs, utility costs and general repair and maintenance of the hotel(s).
The lessee also is responsible for all fees payable to the applicable
manager, including base and incentive management fees, chain services
payments and franchise or system fees, with respect to periods covered
by the term of the lease. The lessee is not obligated to bear the cost
of any capital improvements or capital repairs to the hotels or the
other expenses borne by the lessor, as described below.
. Lessor Expenses. The lessor is responsible for the following expenses:
real estate taxes, personal property taxes, casualty insurance on the
structures, ground lease rent payments, required expenditures for
furniture, fixtures and equipment ("FF&E") and capital expenditures. The
consent of the lessor is required for any capital expenditures or a
change in the amount of the FF&E reserve payment.
. Crestline Guarantee. Crestline and some of its subsidiaries have entered
into a limited guarantee of the lease and management agreement
obligations of each lessee. For each of four identified "pools" of
hotels, the cumulative limit of the guarantee at any time is 10% of the
aggregate rents under all leases in such pool paid with respect to the
preceding thirteen full accounting periods (with an annualized amount
based upon the minimum rent for those leases that have not been in
effect for thirteen full accounting periods). In the event of a payment
default under any lease or failure of Crestline to maintain specified
minimum net worth or debt service coverage ratios, the obligations under
the guarantees of leases in each pool are secured by excess cash flow of
each lessee in such pool. Such excess cash flow will be collected, held
in a cash collateral account, and disbursed in accordance with agreed
cash management procedures.
. Working Capital. Each lessor sold the existing working capital
(including Inventory and Fixed Asset Supplies (as defined in the Uniform
System of Accounts for Hotels) and receivables due from the manager, net
of accounts payable and accrued expenses) to the applicable lessee upon
the commencement of the lease at a price equal to the fair market value
of such assets. The purchase price was represented by a note evidencing
a loan that bears interest at a rate per year equal to the "long-term
applicable federal rate" in effect on the commencement of the lease.
Interest owed on the working capital loan is due simultaneously with
each periodic rent payment and the amount of each payment of interest
will be credited against such rent payment. The principal amount of the
working capital loan will be payable upon termination of the lease.
15
. Termination of Leases upon Disposition of Full Service Hotels. In the
event the applicable lessor enters into an agreement to sell or
otherwise transfer any full-service hotel free and clear of the
applicable lease, the lessor must pay the lessee a termination fee equal
to the fair market value of the lessee's leasehold interest in the
remaining term of the lease. Alternatively, the lessor would be entitled
to substitute a comparable hotel or hotels for any hotel that is sold or
sell the hotel subject to the lease subject to the lessee's reasonable
approval. In addition, the lessors collectively and the lessees
collectively each have the right to terminate up to 12 leases without
being required to pay any fee or other compensation as a result of such
termination, but the lessors are permitted to exercise such right only
in connection with sales of hotels to an unrelated third party or the
transfer of a hotel to a joint venture in which the operating
partnership does not have a two-thirds or greater interest. We have
received notices of termination from Crestline on five leases, with
effective dates ranging from March through June 2000, which we are
currently negotiating. We expect to be able to obtain replacement leases
for these leases without material impact to our future operations.
. Assignment of Lease. A lessee is permitted to sublet all or part of the
hotel or assign its interest under its lease, without the consent of the
lessor, to any wholly owned and controlled single purpose subsidiary of
Crestline, provided that Crestline continues to meet the minimum net
worth test and all other requirements of the lease. Transfers to other
parties are permitted if approved by the lessor.
. Subordination to Qualifying Mortgage Debt. The rights of each lessee are
expressly subordinate to qualifying mortgage debt and any refinancing
thereof.
. Personal Property Limitation. If a lessor reasonably anticipates that
the average tax basis of the items of the lessor's FF&E and other
personal property that are leased to the applicable lessee will exceed
15% of the aggregate average tax basis of the real and personal property
subject to the applicable lease the lessor would acquire any replacement
FF&E that would cause the applicable limits to be exceeded, and
immediately thereafter the lessee would be obligated either to acquire
such excess FF&E from the lessor or to cause a third party to purchase
such FF&E. The annual rent under the applicable lease would then be
reduced in accordance with a formula based on market leasing rates for
the excess FF&E. Beginning January 1, 2001, the average aggregate fair
market values of both real and personal property will be used for
purposes of determining rents from real property as opposed to the
aggregate tax bases.
. Change in Manager. A lessee is permitted to change the manager or the
brand affiliation of a hotel only with the approval of the applicable
lessor, which approval may not be unreasonably withheld.
The Management Agreements
All of our hotels are subject to management agreements for the operation of
the properties. The original terms of the management agreements are generally
15 to 20 years in length with multiple optional renewal terms. The following is
a brief summary of the general terms of the management agreements a form of
which has been filed with the Commission. The lessees lease the hotels from the
operating partnership or its subsidiaries. Upon leasing the hotels, the lessees
assumed substantially all of the obligations of such subsidiaries under the
management agreements between those entities and the subsidiaries of Marriott
International and other companies that currently manage the hotels. As a result
of their assumptions of obligations under the management agreements, the
lessees have substantially all of the rights and obligations of the "owners" of
the hotels under the management agreements for the period during which the
leases are in effect (including the obligation to pay the management and other
fees thereunder) and hold the operating partnership harmless with respect
thereto. The subsidiaries of the operating partnership remain liable for all
obligations under the management agreements.
. General. Under each management agreement related to a Marriott
International-managed hotel, the manager provides complete management
services to the applicable lessees in connection with its management of
such lessee's hotels.
16
. Operational services. The managers have sole responsibility and
exclusive authority for all activities necessary for the day-to-day
operation of the hotels, including establishment of all room rates, the
processing of reservations, procurement of inventories, supplies and
services, periodic inspection and consultation visits to the hotels by
the managers' technical and operational experts and promotion and
publicity of the hotels. The manager receives compensation from the
lessee in the form of a base management fee and an incentive management
fee, which are normally calculated as percentages of gross revenues and
operating profits, respectively.
. Executive supervision and management services. The managers provide all
managerial and other employees for the hotels; review the operation and
maintenance of the hotels; prepare reports, budgets and projections;
provide other administrative and accounting support services, such as
planning and policy services, financial planning, divisional financial
services, risk planning services, product planning and development,
employee planning, corporate executive management, legislative and
governmental representation and certain in-house legal services; and
protect the "Marriott" trademark and other tradenames and service marks.
The manager also provides a national reservations system.
. Chain services. The management agreements require the manager to furnish
chain services that are furnished generally on a central or regional
basis to hotels in the Marriott hotel system. Such services include: (1)
the development and operation of computer systems and reservation
services, (2) regional management and administrative services, regional
marketing and sales services, regional training services, manpower
development and relocation costs of regional personnel and (3) such
additional central or regional services as may from time to time be more
efficiently performed on a regional or group level. Costs and expenses
incurred in providing such services are allocated among all hotels in
the Marriott hotel system managed by the manager or its affiliates and
each applicable lessee is required to reimburse the manager for its
allocable share of such costs and expenses.
. Working capital and fixed asset supplies. The lessee is required to
maintain working capital for each hotel and fund the cost of fixed asset
supplies, which principally consist of linen and similar items. The
applicable lessee also is responsible for providing funds to meet the
cash needs for the operations of the hotels if at any time the funds
available from operations are insufficient to meet the financial
requirements of the hotels.
. Use of affiliates. The manager employs the services of its affiliates to
provide certain services under the management agreements. Certain of the
management agreements provide that the terms of any such employment must
be no less favorable to the applicable lessee, in the reasonable
judgment of the manager, than those that would be available from the
manager.
FF&E replacements. The management agreements generally provide that once each
year the manager will prepare a list of FF&E to be acquired and certain routine
repairs that are normally capitalized to be performed in the next year and an
estimate of the funds necessary therefor. Under the terms of the leases, the
lessor is required to provide to the applicable lessee all necessary FF&E for
the operation of the hotels (including funding any required FF&E replacements).
For purposes of funding the FF&E replacements, a specified percentage
(generally 5%) of the gross revenues of the hotel is deposited by the manager
into a book entry account. These amounts are treated under the leases as paid
by the lessees to the lessor and will be credited against their rental
obligations.
Under each lease, the lessor is responsible for the costs of FF&E
replacements and for decisions with respect thereto (subject to its obligations
to the lessee under the lease).
. Building alterations, improvements and renewals. The management
agreements require the manager to prepare an annual estimate of the
expenditures necessary for major repairs, alterations, improvements,
renewals and replacements to the structural, mechanical, electrical,
heating, ventilating, air conditioning, plumbing and vertical
transportation elements of each hotel. Such estimate must be submitted
to the lessor and the lessee for their approval. In addition to the
foregoing, the management
17
agreements generally provide that the manager may propose such changes,
alterations and improvements to the hotel as are required, in the
manager's reasonable judgment, to keep the hotel in a competitive,
efficient and economical operating condition or in accordance with
Marriott standards. The cost of the foregoing is paid from the FF&E
reserve account; to the extent that there are insufficient funds in such
account, the operating partnership is required to pay any shortfall.
. Service marks. During the term of the management agreements, the service
mark, such as "Marriott" and other symbols, logos and service marks
currently used by the manager and its affiliates, may be used in the
operation of the hotels. Marriott International (or its applicable
affiliates), Hyatt, Swissotel, and Four Seasons intend to retain their
legal ownership of these marks. Any right to use the service marks, logo
and symbols and related trademarks at a hotel will terminate with
respect to that hotel upon termination of the management agreement with
respect to such hotel.
. Termination fee. Certain of the management agreements provide that if
the management agreement is terminated prior to its full term due to
casualty, condemnation or the sale of the hotel, the manager would
receive a termination fee as specified in the specific management
agreement. Under the leases, the responsibility for the payment of any
such termination fee as between the lessee and the lessor depends upon
the cause for such termination.
. Termination for failure to perform. Most of the management agreements
may be terminated based upon a failure to meet certain financial
performance criteria, subject to the manager's right to prevent such
termination by making specified payments to the lessee based upon the
shortfall in such criteria.
Assignment of management agreements. The management agreements applicable to
each hotel have been assigned to the applicable lessee for the term of the
lease of such hotel. The lessee is obligated to perform all of the obligations
of the lessor under the management agreement during the term of its lease,
other than specified retained obligations including, without limitation,
payment of real property taxes, property casualty insurance and ground rent,
and maintaining a reserve fund for FF&E replacements and capital expenditures,
for which the lessor retains responsibility. Although the lessee has assumed
obligations of the lessor under the management agreement, the lessor is not
released from its obligations and, if the lessee fails to perform any
obligations, the manager will be entitled to seek performance by or damages
from the lessor. If the lease is terminated for any reason, any new or
successor lessee must meet certain requirements for an approved lessee or
otherwise be acceptable to Marriott International.
Non-competition agreements
Pursuant to a non-competition agreement entered into in connection with the
leases, Crestline has agreed, among other things, that until the earlier of
December 31, 2008 and the date on which it is no longer a lessee for more than
25% of the number of the hotels owned by us on December 29, 1998, it will not
(1) own, operate or otherwise control (as owner or franchisor) any full-service
hotel brand or franchise, or purchase, finance or otherwise invest in full-
service hotels, or act as an agent or consultant with respect to any of the
foregoing activities, or lease or manage full-service hotels (other than hotels
owned by the operating partnership) if its economic return therefrom would be
more similar to returns derived from ownership interests in such hotels except
for acquisitions of property used in hotels as to which a subsidiary of
Crestline is the lessee, investments in full-service hotels which represent an
immaterial portion of a merger or similar transaction or a minimal portfolio
investment in another entity, limited investments (whether debt or equity) in
full-service hotels as to which a subsidiary of Crestline is the lessee or
activities undertaken with respect to its business of providing asset
management services to hotel owners, or (2) without our consent, manage any of
the hotels owned by the operating partnership, other than to provide asset
management services.
We have agreed with Crestline, among other things, that, (1) until December
31, 2003, we will not purchase, finance or otherwise invest in senior living
communities, or act as an agent or consultant with respect to any of the
foregoing activities (except for acquisitions of communities which represent an
immaterial portion of a
18
merger or similar transaction or for minimal portfolio investments in other
entities) and (2) until the earlier of December 31, 2008 and the date on which
subsidiaries of Crestline are no longer lessees for more than 25% of the
number of the hotels owned by Host Marriott on December 29, 1998, we will not
lease, as tenant or subtenant, limited- or full-service hotel properties from
any "real estate investment trust" within the meaning of Sections 856 through
859 of the Internal Revenue Code where it will not be the operator or manager
of the hotel (other than through a contractual arrangement with a non-
affiliated party) and where its rental payments qualify as "rents from real
property" within the meaning of Section 856(d) of the Internal Revenue Code,
or purchase, finance or otherwise invest in persons or entities which engage
in any of the foregoing activities, or act as an agent or consultant with
respect to any of the foregoing activities (except for acquisitions of
entities which engage in any of the foregoing activities where the prohibited
activities represent an immaterial portion of a merger or similar transaction,
or minimal portfolio investments in other entities which engage in any of the
foregoing activities, or certain leasing arrangements existing on December 29,
1998 or entered into in the future between us and certain other related
parties, or by our management of any hotels in which it has an equity
interest). In addition, both Crestline and we have agreed not to hire or
attempt to hire any of the other company's senior employees at any time prior
to December 31, 2000.
We entered into a noncompetition agreement with Marriott International that
defines our rights and obligations with respect to certain businesses operated
by each of us. Crestline became an additional party to this agreement at the
time its shares were distributed to our stockholders. At that time, we also
entered into an agreement with Crestline under which we agreed with Crestline
about the allocation between us of the rights to engage in certain activities
permitted under the agreement with Marriott International. In general, until
October 8, 2000, we and our subsidiaries are prohibited from entering into or
acquiring any business that competes with the hotel management business (i.e.,
managing, operating or franchising full-service or limited-service hotels) as
conducted by Marriott International. Pursuant to this agreement, we cannot (1)
operate any hotel under a common name with any other hotel we operate or with
any hotel operated by Crestline, (2) have a manager (other than Marriott
International or one of its affiliates) manage any limited-service hotel for
us under a common name with any other limited-service hotel managed by such
manager for use or for Crestline, (3) have a manager (other than Marriott
International or one of affiliates manage more than the greater (a) 10 full-
service hotels under a common name which is a brand other than "Delta," "Four
Seasons," "Holiday Inn," "Hyatt" and Swissotel" (the "Existing Brands") or (b)
25% of any system operated by such manager under a common name which is not an
Existing Brand, (4) have a manager (other than Marriott International or one
of its affiliates) manage more than the greater of (a) 5 full-service hotels
under a common name which is an Existing Brand or (b) 12.5% of any system
operated by such manager under a common name which is an Existing Brand, (5)
franchise as franchisor any limited-service hotel under a common name with any
other limited-service hotel for which we or Crestline is a franchisor or (6)
franchise as franchisor more than 10 full-service hotels under a common name.
Risk Factors
The following risk factors should be considered by prospective investors who
should carefully consider the material described below.
Risks of ownership of our common stock
There are limitations on the acquisition of our common stock and changes in
control. Our charter and bylaws, the partnership agreement of the operating
partnership, our shareholder rights plan and the Maryland General Corporation
Law contain a number of provisions that could delay, defer or prevent a
transaction or a change in control of us that might involve a premium price
for our shareholders or otherwise be in their best interests, including the
following:
Ownership limit. The 9.8% ownership limit described under "--Possible
adverse consequences of limits on ownership of our common stock" below may
have the effect of precluding a change in control of us by a third party
without the consent of our Board of Directors, even if such change in
control would be in the interest of our shareholders, and even if such
change in control would not reasonably jeopardize our REIT status.
19
Staggered board. Our charter provides that our Board of Directors will
consist of eight members and can be increased or decreased after that
according to our bylaws, provided that the total number of directors is not
less than three nor more than 13. Pursuant to our bylaws, the number of
directors will be fixed by our Board of Directors within the limits in our
charter. Our Board of Directors is divided into three classes of directors.
Directors for each class are chosen for a three-year term when the term of
the current class expires. The staggered terms for directors may affect
shareholders' ability to effect a change in control of us, even if a change
in control would be in the interest of our shareholders.
Removal of board of directors. Our charter provides that, except for any
directors who may be elected by holders of a class or series of shares of
capital stock other than our common stock, directors may be removed only
for cause and only by the affirmative vote of shareholders holding at least
two-thirds of our outstanding shares entitled to be cast for the election
of directors. Vacancies on the Board of Directors may be filled by the
concurring vote of a majority of the remaining directors and, in the case
of a vacancy resulting from the removal of a director by the shareholders,
by at least two-thirds of all the votes entitled to be cast in the election
of directors.
Preferred shares; classification or reclassification of unissued shares
of capital stock without shareholder approval. Our charter provides that
the total number of shares of stock of all classes which we have authority
to issue is 800,000,000, initially consisting of 750,000,000 shares of
common stock and 50,000,000 shares of preferred stock, of which 8,160,000
have been issued. Our Board of Directors has the authority, without a vote
of shareholders, to classify or reclassify any unissued shares of stock,
including common stock into preferred stock or vice versa, and to establish
the preferences and rights of any preferred or other class or series of
shares to be issued. The issuance of preferred shares or other shares
having special preferences or rights could delay or prevent a change in
control even if a change in control would be in the interests of our
shareholders. Because our Board of Directors has the power to establish the
preferences and rights of additional classes or series of shares without a
shareholder vote, our Board of Directors may give the holders of any class
or series preferences, powers and rights, including voting rights, senior
to the rights of holders of our common stock.
Consent rights of the limited partners. Under the partnership agreement
of the operating partnership, we generally will be able to merge or
consolidate with another entity with the consent of partners holding
percentage interests that are more than 50% of the aggregate percentage
interests of the outstanding limited partnership interests entitled to vote
on the merger or consolidation, including any limited partnership interests
held by us, as long as the holders of limited partnership interests either
receive or have the right to receive the same consideration as our
shareholders. We, as holder of a majority of the limited partnership
interests, would be able to control the vote. Under our charter, holders of
at least two-thirds of our outstanding shares of common stock generally
must approve the merger or consolidation.
Maryland business combination law. Under the Maryland General Corporation
Law, specified "business combinations," including specified issuances of
equity securities, between a Maryland corporation and any person who owns
10% or more of the voting power of the corporation's then outstanding
shares, or an "interested shareholder," or an affiliate of the interested
shareholder are prohibited for five years after the most recent date in
which the interested shareholder becomes an interested shareholder.
Thereafter, any such business combination must be approved by 80% of
outstanding voting shares, and by two-thirds of voting shares other than
voting shares held by an interested shareholder unless, among other
conditions, the corporation's common shareholders receive a minimum price,
as defined in the Maryland General Corporation Law, for their shares and
the consideration is received in cash or in the same form as previously
paid by the Interested Shareholder. We are subject to the Maryland business
combination statute.
Maryland control share acquisition law. Under the Maryland General
Corporation Law, "control shares" acquired in a "control share acquisition"
have no voting rights except to the extent approved by a vote of two-thirds
of the votes entitled to be cast on the matter, excluding shares owned by
the acquiror and by officers or directors who are employees of the
corporation. "Control shares" are voting shares which, if aggregated with
all other such shares previously acquired by the acquiror or in respect of
which the acquiror
20
is able to exercise or direct the exercise of voting power (except solely
by virtue of a revocable proxy), would entitle the acquiror to exercise
voting power in electing directors within one of the following ranges of
voting power: (1) one-fifth or more but less than one-third, (2) one-third
or more but less than a majority or (3) a majority or more of the voting
power. Control shares do not include shares the acquiring person is then
entitled to vote as a result of having previously obtained shareholder
approval. A "control share acquisition" means the acquisition of control
shares, subject to specified exceptions. We are subject to these control
share provisions of Maryland law, subject to an exemption for Marriott
International pursuant to its purchase right. See "Risks of Ownership of
Our Common Stock--Marriott International purchase right."
Merger, consolidation, share exchange and transfer of our
assets. Pursuant to our charter, subject to the terms of any outstanding
class or series of capital stock, we can merge with or into another entity,
consolidate with one or more other entities, participate in a share
exchange or transfer our assets within the meaning of the Maryland General
Corporation Law if approved (1) by our Board of Directors in the manner
provided in the Maryland General Corporation Law and (2) by our
shareholders holding two-thirds of all the votes entitled to be cast on the
matter, except that any merger of us with or into a trust organized for the
purpose of changing our form of organization from a corporation to a trust
requires only the approval of our shareholders holding a majority of all
votes entitled to be cast on the merger. Under the Maryland General
Corporation Law, specific mergers without a vote of shareholders and a
share exchange is only required to be approved by a Maryland successor by
its Board of Directors. Our voluntary dissolution also would require
approval of shareholders holding two-thirds of all the votes entitled to be
cast on the matter.
Amendments to our charter and bylaws. Our charter contains provisions
relating to restrictions on transferability of our common stock, the
classified Board of Directors, fixing the size of our Board of Directors
within the range set forth in Host Marriott's charter, removal of directors
and the filling of vacancies, all of which may be amended only by a
resolution adopted by the Board of Directors and approved by our
shareholders holding two-thirds of the votes entitled to be cast on the
matter. As permitted under the Maryland General Corporation Law, our
charter and bylaws provide that directors have the exclusive right to amend
our bylaws. Amendments of this provision of our charter also would require
action of our Board of Directors and approval by shareholders holding two-
thirds of all the votes entitled to be cast on the matter.
Marriott International purchase right. As a result of our spin-off of
Marriott International in 1993, Marriott International has the right to
purchase up to 20% of each class of our outstanding voting shares at the
then fair market value when specific change of control events involving us
occur, subject to specified limitations to protect our REIT status. The
Marriott International purchase right may have the effect of discouraging a
takeover of us, because any person considering acquiring a substantial or
controlling block of our common stock will face the possibility that its
ability to obtain or exercise control would be impaired or made more
expensive by the exercise of the Marriott International purchase right.
Shareholder rights plan. We adopted a shareholder rights plan which
provides, among other things, that when specified events occur, our
shareholders will be entitled to purchase from us a newly created series of
junior preferred shares, subject to our Ownership Limit. The preferred
share purchase rights are triggered by the earlier to occur of (1) ten days
after the date of a public announcement that a person or group acting in
concert has acquired, or obtained the right to acquire, beneficial
ownership of 20% or more of our outstanding shares of common stock or (2)
ten business days after the commencement of or announcement of an intention
to make a tender offer or exchange offer, the consummation of which would
result in the acquiring person becoming the beneficial owner of 20% or more
of our outstanding common stock. The preferred share purchase rights would
cause substantial dilution to a person or group that attempts to acquire us
on terms not approved by our Board of Directors.
There are possible adverse consequences of limits on ownership of our common
stock. To maintain our qualification as a REIT for federal income tax
purposes, not more than 50% in value of our outstanding shares of capital
stock may be owned, directly or indirectly, by five or fewer individuals, as
defined in the Internal Revenue Code to include some entities. In addition, a
person who owns, directly or by attribution, 10%
21
or more of an interest in a tenant of ours, or a tenant of any partnership in
which we are a partner, cannot own, directly or by attribution, 10% or more of
our shares without jeopardizing our qualification as a REIT. Primarily to
facilitate maintenance of its qualification as a REIT for federal income tax
purposes, the ownership limit under Host Marriott's charter will prohibit
ownership, directly or by virtue of the attribution provisions of the Internal
Revenue Code, by any person or persons acting as a group of more than 9.8% of
the issued and outstanding shares of our common stock, subject to an exception
for shares of our common stock held prior to the REIT conversion so long as
the holder would not own more than 9.9% in value of our outstanding shares,
and will prohibit ownership, directly or by virtue of the attribution
provisions of the Internal Revenue Code, by any person, or persons acting as a
group, of more than 9.8% of the issued and outstanding shares of any class or
series of Host Marriott's preferred shares. Together, these limitations are
referred to as the "ownership limit." The Board of Directors, in its sole and
absolute discretion, may waive or modify the ownership limit with respect to
one or more persons who would not be treated as "individuals" for purposes of
the Internal Revenue Code if it is satisfied, based upon information required
to be provided by the party seeking the waiver and upon an opinion of counsel
satisfactory to the Board of Directors, that ownership in excess of this limit
will not cause a person who is an individual to be treated as owning shares in
excess of the ownership limit, applying the applicable constructive ownership
rules, and will not otherwise jeopardize our status as a REIT for federal
income tax purposes for example, by causing any of our tenants or any of the
partnerships, including Crestline and the lessees, to be considered a "related
party tenant" for purposes of the REIT qualification rules. Common stock
acquired or held in violation of the ownership limit will be transferred
automatically to a trust for the benefit of a designated charitable
beneficiary, and the person who acquired such common stock in violation of the
ownership limit will not be entitled to any distributions thereon, to vote
such shares of common stock or to receive any proceeds from the subsequent
sale thereof in excess of the lesser of the price paid therefor or the amount
realized from such sale. A transfer of shares of our common stock to a person
who, as a result of the transfer, violates the ownership limit may be void
under certain circumstances, and, in any event, would deny that person any of
the economic benefits of owning shares of our common stock in excess of the
ownership limit. The ownership limit may have the effect of delaying,
deferring or preventing a change in control and, therefore, could adversely
affect the shareholders' ability to realize a premium over the then-prevailing
market price for our common stock in connection with such transaction.
We depend on external sources of capital for future growth. As with other
REITs, but unlike corporations generally, our ability to reduce our debt and
finance our growth largely must be funded by external sources of capital
because we generally will have to distribute to our shareholders 95% of our
taxable income in order to qualify as a REIT, including taxable income which
does not generate corresponding cash. This distribution requirement will be
reduced to 90% for taxable years after December 31, 2000. Our access to
external capital will depend upon a number of factors, including general
market conditions, the market's perception of our growth potential, our
current and potential future earnings, cash distributions and the market price
of our common stock. Currently, our access to external capital has been
limited to the extent that our common stock is trading at what we believe is a
significant discount to our estimated net asset value.
Shares of our common stock that are or become available for sale could
affect the price for our shares of common stock. Sales of a substantial number
of our shares of common stock, or the perception that sales could occur, could
adversely affect prevailing market prices for our common stock. In addition,
holders of OP Units who redeem their OP Units and receive our common stock
will be able to sell their shares freely after they are received, unless the
person is our affiliate. There are currently approximately 64.0 million OP
Units outstanding, substantially all of which are currently redeemable.
Further, a substantial number of shares of our common stock have been and will
be issued or reserved for issuance from time to time under our employee
benefit plans, including shares of our common stock reserved for options, and
these shares of common stock would be available for sale in the public markets
from time to time pursuant to exemptions from registration or upon
registration. Moreover, the issuance of additional shares of our common stock
by us in the future would be available for sale in the public markets. We can
make no prediction about the effect that future sales of our common stock
would have on the market price of our common stock.
22
Our earnings and cash distributions will affect the market price of shares
of our common stock. We believe that the market value of a REIT's equity
securities is based primarily upon the market's perception of the REIT's
growth potential and its current and potential future cash distributions,
whether from operations, sales, acquisitions, development or refinancings, and
is secondarily based upon the value of the underlying assets. For that reason,
shares of our common stock may trade at prices that are higher or lower than
the net asset value per share. To the extent we retain operating cash flow for
investment purposes, working capital reserves or other purposes rather than
distributing such cash flow to shareholders, these retained funds, while
increasing the value of our underlying assets, may not correspondingly
increase the market price of our common stock. Our failure to meet the
market's expectation with regard to future earnings and cash distributions
would likely adversely affect the market price of our common stock.
Market interest rates may affect the price of shares of our common
stock. One of the factors that investors consider important in deciding
whether to buy or sell shares of a REIT is the distribution rate on such
shares, considered as a percentage of the price of such shares, relative to
market interest rates. If market interest rates increase, prospective
purchasers of REIT shares may expect a higher distribution rate. Thus, higher
market interest rates could cause the market price of our shares to go down.
Risks of operation
We do not control our hotel operations, and we are dependent on the managers
and lessees of our hotels. Because federal income tax laws currently restrict
REITs and "publicly traded" partnerships from deriving revenues directly from
operating a hotel, we operate none of our hotels. Instead, we lease virtually
all of our hotels to subsidiaries of Crestline which, in turn, retain managers
to manage our hotels pursuant to management agreements. Thus, we are dependent
on the lessees but, under the hotel leases, we have little influence over how
the lessees operate our hotels. Similarly, we are dependent on the managers,
principally Marriott International, but we have little influence over how the
managers manage our hotels. We have very limited recourse if we believe that
the hotel managers do not maximize the revenues from our hotels, which in turn
will maximize the rental payments we receive under the leases. We may seek
redress under most leases only if the lessee violates the terms of the lease
and then only to the extent of the remedies set forth in the lease.
Each lessee's ability to pay rent accrued under its lease depends to a large
extent on the ability of the hotel manager to operate the hotel effectively
and to generate gross sales in excess of its operating expenses. Our rental
income from the hotels may therefore be adversely affected if the managers
fail to provide quality services and amenities and competitive room rates at
our hotels or fail to maintain the quality of the hotel brand names. Although
the lessees have primary liability under the management agreements while the
leases are in effect, we remain liable under the management agreements for all
obligations that the lessees do not perform. We may terminate a lease if the
lessee defaults under a management agreement, but terminating the lease could,
unless another suitable lessee is found, impair our ability to qualify as a
REIT for federal income tax purposes and the operating partnership's ability
to qualify as a partnership for federal income tax purposes if it is a
"publicly traded partnership" unless another suitable lessee is found. As
described below, our inability to qualify as a REIT or the operating
partnership's inability to qualify as a partnership for federal income tax
purposes would have a material adverse effect on us.
We do not control the assets held by the non-controlled subsidiaries. The
operating partnership owns economic interests in several taxable corporations,
which we refer to as "non-controlled subsidiaries," that hold various assets
which, under our credit facility may not exceed, in the aggregate, 15% of the
value of our assets. The assets held by the non-controlled subsidiaries
consist primarily of interests in partnerships that own hotels that are not
leased to third parties, hotels that are not leased to third parties, some
FF&E used in our hotels and some international hotels. If the operating
partnership owned these assets, it could jeopardize our REIT status and/or the
status of the operating partnership as a partnership for federal income tax
purposes. Although the operating partnership owns approximately 95% of the
total economic interests of the non-controlled subsidiaries, it owns none of
the voting stock of the non-controlled subsidiaries. The Host Marriott
Statutory
23
Employee/Charitable Trust, the beneficiaries of which are (1) a trust formed
for the benefit of a number of our employees and (2) the J. Willard and Alice
S. Marriott Foundation, owns all of the voting common stock, representing
approximately 5% of the total economic interests in such the controlled
subsidiaries. The Host Marriott Statutory Employee/Charitable Trust elects the
directors who are responsible for overseeing the operations of the non-
controlled subsidiaries. The directors are currently our employees, although
this is not required. As a result, we have no control over the operation or
management of the hotels or other assets owned by the non-controlled
subsidiaries, even though we depend upon the non-controlled subsidiaries for a
portion of our revenues. Also, the activities of the non-controlled
subsidiaries could cause us to be in default under our principal credit
facilities.
We are dependent upon the ability of Crestline and the lessees to meet their
rent obligations. The lessees' rent payments are the primary source of our
revenues. Crestline guarantees the obligations of its subsidiaries under the
hotel leases, but Crestline's liability is limited to a relatively small
portion of the aggregate rent obligation of its subsidiaries. The ability of
Crestline and each of its subsidiaries to meet its obligations under the
leases will determine the amount of our revenue and our ability to meet our
obligations. We have no control over Crestline or any of its subsidiaries and
cannot assure you that Crestline or any of its subsidiaries will have
sufficient assets, income and access to financing to enable them to satisfy
their obligations under the leases or to make payments of fees under the
management agreements. Although the lessees have primary liability under the
management agreements while the leases are in effect, we and our subsidiaries
remain liable under the management agreements for all obligations that the
lessees do not perform. Because of our dependence on Crestline, our credit
rating will be affected by its creditworthiness.
Our relationships with Marriott International and Crestline may result in
conflicts of interest.
Marriott International, a public hotel management company, manages a
significant number of our hotels. In addition, Marriott International manages
hotels that compete with our hotels. As a result, Marriott International may
make decisions regarding competing lodging facilities which it manages that
would not necessarily be in our best interests. J.W. Marriott, Jr. is a member
of our Board of Directors and his brother, Richard E. Marriott, is our
Chairman of the Board. Both J.W. Marriott, Jr. and Richard E. Marriott serve
as directors, and J.W. Marriott, Jr. also serves as an officer, of Marriott
International. J.W. Marriott, Jr. and Richard E. Marriott also beneficially
own, as determined for securities law purposes, as of January 31, 2000,
approximately 10.8% and 10.6%, respectively, of the outstanding shares of
common stock of Marriott International. In addition, J.W. Marriott, Jr. and
Richard E. Marriott own, as of January 31, 2000, approximately 5.1% and 4.8% ,
respectively, of the outstanding shares of common stock of Crestline. Neither
J.W. Marriott, Jr. or Richard E. Marriott serves as an officer or director of
Crestline. As a result, J.W. Marriott, Jr. and Richard E. Marriott have
potential conflicts of interest as our directors when making decisions
regarding Marriott International, including decisions relating to the
management agreements involving the hotels, Marriott International's
management of competing lodging properties and Crestline's leasing and other
businesses.
Both our Board of Directors and the Board of Directors of Marriott
International follow appropriate policies and procedures to limit the
involvement of Messrs. J.W. Marriott, Jr. and Richard E. Marriott in conflict
situations, including requiring them to abstain from voting as directors of
either us or Marriott International or our or their subsidiaries on matters
which present a conflict between the companies. If appropriate, these policies
and procedures will apply to other directors and officers.
When the leases expire or terminate, we might not be able to find other
lessees. Our current hotel leases have terms generally ranging from seven to
ten years. We cannot assure that when our leases expire, our hotels will be
re-leased to the current lessees, or if re-leased, will be re-leased on terms
favorable to us. If our hotels are not re-leased, we will be required to find
other lessees who meet the requirements of the management agreements and of
the federal income tax rules that govern REITs. We have received notices of
termination from Crestline on five leases, with effective dates ranging from
March through June 2000. We are in the process of finding new lessees for
these hotels, and we expect to be able to obtain replacement leases for these
leases
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without material impact to our future operations. We cannot assure you that we
will be able to find satisfactory lessees or that the terms of any new leases
would be favorable. If we fail to find satisfactory lessees:
. we could lose our REIT status;
. the operating partnership would be taxed as a "C" corporation if it is a
"publicly traded partnership," which would require us and the operating
partnership to pay substantial federal income taxes;
. the operating partnership would be required to distribute more cash to
us and other equity holders to enable us to meet our tax burden; and
. it could adversely affect our and the operating partnership's ability to
raise additional capital.
Failure to enter leases on satisfactory terms could also result in reduced
cash available for debt service and distributions to shareholders.
We have substantial indebtedness. Our degree of leverage could affect our
ability to:
. obtain financing in the future for working capital, capital
expenditures, acquisitions, development or other general business
purposes;
. undertake financings on terms and conditions acceptable to us;
. pursue our acquisition strategy; or
. compete effectively or operate successfully under adverse economic
conditions.
We have a policy of incurring debt only if, immediately following the
incurrence, our debt-to-total market capitalization ratio on a pro forma basis
would be 60% or less. Our debt-to-total market capitalization ratio was
approximately 69% as of December 31, 1999. If our total market capitalization
does not change, we would have to waive or change our debt policy to incur
additional indebtedness. Our debt-to-total market capitalization ratio has
increased primarily because of a general decline in the market valuation of
the stock of lodging companies, including our stock. As a result of this
decline, our Board of Directors may reconsider whether our debt incurrence
policy should be linked to another measure of value instead of total market
capitalization.
If our cash flow and working capital is not sufficient to fund our
expenditures or service our indebtedness, we would have to raise additional
funds through:
. the sale of equity;
. the refinancing of all or part of our indebtedness;
. the incurrence of additional permitted indebtedness; or
. the sale of assets.
We cannot assure you that any of these sources of funds would be available
in amounts sufficient for us to meet our obligations or fulfill our business
plans. Additionally, our debt contains certain performance related covenants
which, if not achieved, could require immediate repayment of the debt or
significantly increase the rate of interest on the debt.
There is no limitation on the amount of debt we may incur. There are no
limitations in our or the operating partnership's organizational documents
that limit the amount of indebtedness that we may incur. However, our existing
debt instruments contain restrictions on the amount of indebtedness that we
may incur. Accordingly, our Board of Directors could alter or eliminate our
60% policy without shareholder approval to the extent permitted by our debt
agreements. If this policy were changed, we could become more highly
leveraged, which would increase our debt service payments and adversely affect
our cash flow and our ability to service our debt and make distributions to
our shareholders.
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Our leases and management agreements could impair the sale or other
disposition of our hotels. Under each lease with a subsidiary of Crestline, we
generally must purchase a lease if we want to terminate the lease prior to the
expiration of its term. We must purchase the lease even if we are terminating
the lease because of a change in the federal income tax laws that either would
make continuation of the lease jeopardize our status as a REIT or would enable
us to operate our hotels directly ourselves. The REIT Modernization Act will
allow us to lease the hotels to a "taxable REIT subsidiary" after December 31,
2000. See "--REIT Modernization Act Changes to REIT asset tests" below. At the
present time, no decision has been made regarding whether a taxable REIT
subsidiary would be formed and, if so, whether it would purchase any of the
leases from a Crestline subsidiary. The purchase price generally will be equal
to the fair market value of the lessee's leasehold interest in the remaining
term of the lease, which could be a significant amount. In addition, if we
decide to sell a hotel, we may be required to terminate its lease, and the
payment of the purchase price under such c