8-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 8-K

CURRENT REPORT

PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

Date of report (Date of earliest event reported): November 9, 2010

MHI HOSPITALITY CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Maryland	333-118873	20-1531029
(State or Other Jurisdiction of Incorporation)	(Commission File Number)	(IRS Employer Identification No.)

410 W. Francis Street

Williamsburg, Virginia 23185

(757) 229-5648

(Address, including Zip Code and Telephone Number, including

Area Code, of Principal Executive Offices)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

¨ Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

¨ Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

¨ Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

¨ Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

Item 2.02 Results of Operations and Financial Condition.

On November 9, 2010, MHI Hospitality Corporation issued a press release (the “Press Release”) announcing the results of operations and financial condition of the Company for the quarter ended September 30, 2010. A copy of the Press Release is furnished as Exhibit 99.1 to this report and is incorporated by reference herein.

The Press Release contains “non-GAAP financial measures” as defined in Item 10 of Regulation S-K of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In the Press Release, the Company has provided reconciliations of the non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with generally accepted accounting principles in the United States.

The information contained in this Form 8-K is furnished under “Item 2.02 Results of Operations and Financial Condition” in accordance with SEC Release 33-8216. The information in this Form 8-K and the Exhibit attached hereto shall not be deemed “filed” for the purposes of Section 18 of the Exchange Act, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, except as shall be expressly set forth by specific reference in such filing.

Item 9.01 Financial Statements and Exhibits

(a) Exhibits

99.1 Press Release of MHI Hospitality Corporation dated November 9, 2010, reporting financial results for the quarter ended September 30, 2010.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

Date: November 9, 2010

MHI HOSPITALITY CORPORATION
By:	/s/ ANDREW M. SIMS
	Andrew M. Sims President and Chief Executive Officer

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Exhibit List

99.1 Press Release of MHI Hospitality Corporation dated November 9, 2010, reporting financial results for the quarter ended September 30, 2010.

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EX-99.1

Exhibit 99.1

                

	RE:	MHI Hospitality Corporation 410 West Francis Street Williamsburg, VA 23185 (757) 229-5648 TRADED: NASDAQ: MDH
FOR YOUR INFORMATION:
AT THE COMPANY:		AT FINANCIAL RELATIONS BOARD:
Bill Zaiser		Vicki Baker
Chief Financial Officer		General Information
(301) 220-5400		(703) 796-1798

MHI HOSPITALITY CORPORATION REPORTS FINANCIAL RESULTS FOR

THIRD QUARTER 2010

Williamsburg, VA – November 9, 2010 – MHI Hospitality Corporation (NASDAQ: MDH) (the “Company”), a self-managed and self-administered lodging real estate investment trust (“REIT”), today reported consolidated results for the third quarter ended September 30, 2010.

HIGHLIGHTS:

• Net operating income (“NOI”) increased 76.2%, or approximately $0.7 million over third quarter 2009, to approximately $1.5 million and increased 40.7%, or approximately $1.5 million over the nine months ended September 30, 2009, to approximately $5.1 million;

• Occupancy increased to 69.2% in the third quarter 2010, an increase of 9.0% over the same period for the prior year, and increased to 68.1% for the nine months ended September 30, 2010, an increase of 10.3% over the nine months ended September 30, 2009;

• Total room revenue increased approximately $1.0 million, or 7.5% over third quarter 2009, to approximately $13.7 million and increased approximately $3.4 million, or 9.0% over the nine months ended September 30, 2009, to approximately $40.8 million;

• Net loss before taxes improved 12.7%, or approximately $0.2 million over third quarter 2009, to approximately $1.4 million, compared to a net loss before taxes for the comparable 2009 period of approximately $1.6 million, and improved

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39.0%, or approximately $1.1 million over the nine months ended September 30, 2009, to approximately $1.7 million, compared to a net loss before taxes for the comparable 2009 period of approximately $2.8 million;

• Adjusted operating income increased approximately $0.6 million, or 15.4% over the third quarter 2009, to approximately $4.2 million and increased approximately $1.9 million, or 16.1% over the nine months ended September 30, 2009, to approximately $13.6 million; and

• Funds from Operations (“FFO”) decreased 23.6%, or approximately $0.3 million over third quarter 2009, to approximately $1.0 million and decreased 0.2% over the nine months ended September 30, 2009 to remain level at approximately $4.8 million.

Andrew M. Sims, President and CEO of MHI Hospitality Corporation, commented, “For the sixth consecutive quarter as compared with the same quarters in prior years, we delivered top-line growth as our hotels continued to take share from competitors within an improving environment. We also delivered net operating income growth for the third consecutive quarter as compared with the same quarter in prior year. The quality of our earnings is improving as a result of this meaningful growth at the portfolio level.”

Operating Results

The Company reported consolidated total revenue of approximately $19.5 million for the three-month period ended September 30, 2010, an increase of 8.7% over the three-month period ended September 30, 2009. The Company reported net operating income of approximately $1.5 million for the three-month period ended September 30, 2010, an increase of approximately $0.7 million or 76.2% over the comparable 2009 period. The Company incurred increased interest expense of approximately $0.4 million related to the recent amendment to the Company’s credit agreement, such additional interest expense equating to a $0.03 reduction of FFO per share in the third quarter 2010. The Company reported an income tax provision of approximately $0.0 million for the three-month period ended September 30, 2010 compared to an income tax benefit of approximately $0.5 million for the three-month period ended September 30, 2009, due to increased profitability in its TRS Lessee. For the third quarter 2010, the Company also reported a consolidated net loss attributable to the Company of approximately $1.0 million, or $0.11 per share, as compared to a consolidated net loss attributable to the Company of approximately $0.7 million, or $0.10 per share, for the comparable 2009 period. During the third quarter, FFO was approximately $1.0 million, or $0.08 per share, compared to approximately $1.3 million, or $0.12 per share, for the third quarter of 2009. FFO for the nine months ended September 30, 2010 remained constant at approximately $4.8 million or $0.37 per share compared to $0.45 per share for the comparable 2009 period.

Adjusted operating income and FFO are non-GAAP financial measures within the meaning of the rules of the Securities and Exchange Commission. The Company defines adjusted operating income as net operating income excluding depreciation and amortization, corporate general and administrative expenses, lease revenue and related expenses as well as other fee income not related to the Company’s wholly-owned hotel properties. The Company defines FFO as net income excluding extraordinary items,

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depreciation and minority interest. Management believes FFO is a key measure of a REIT’s performance and should be considered along with, but not as an alternative to, net income and cash flow as a measure of the Company’s operating performance. Reconciliations of these non-GAAP financial measures are included in the accompanying financial tables.

Portfolio Operating Performance

The following tables illustrate the key operating metrics for the three months and nine months ended September 30, 2010 and 2009 for the Company’s wholly-owned properties during each respective reporting period (“consolidated” properties) as well as the eight wholly-owned properties in the portfolio that were not under development and under the Company’s control during all of 2009 and the nine months ended September 30, 2010 (“same-store” properties). Accordingly, the same store data does not reflect the Crowne Plaza Tampa Westshore, which opened in March 2009. The tables also exclude performance data for the Crowne Plaza Hollywood Beach Resort, which was acquired through a joint venture in August 2007 and in which the Company has a 25.0% indirect interest.

Consolidated (All Hotels)	Quarter ended September  30, 2010			Quarter ended September  30, 2009			Variance
Occupancy		69.2	%		63.5	%		9.0	%
Average Daily Rate (“ADR”)	$	102.19		$	103.63			-1.4	%
Revenue per Available Room (“RevPAR”)	$	70.62		$	65.85			7.5	%

For the quarter ended September 30, 2010, the Company’s consolidated properties realized a 7.5% increase in RevPAR versus the same period in 2009. The RevPAR increase was the result of a 9.0% increase in occupancy offset by a 1.4% decrease in ADR.

Consolidated (All Hotels)	Nine months ended September 30, 2010			Nine months ended September 30, 2009			Variance
Occupancy		68.1	%		61.7	%		10.3	%
ADR	$	104.03		$	107.90			-3.6	%
RevPAR	$	70.80		$	66.58			6.3	%
Same Store (8 Hotels)	Nine months ended September 30, 2010			Nine months ended September 30, 2009			Variance
Occupancy		68.7	%		63.8	%		7.7	%
ADR	$	105.73		$	109.46			-3.4	%
RevPAR	$	72.67		$	69.87			4.0	%

For the nine months ended September 30, 2010, the Company’s consolidated properties realized a 6.3% increase in RevPAR over the same period in 2009. The RevPAR increase

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was the result of a 10.3% increase in occupancy offset by a 3.6% decrease in ADR. For the first nine months of 2010, the same-store portfolio generated a 4.0% increase in RevPAR over the comparable period in 2009.

Portfolio Update

As of September 30, 2010, total assets were approximately $212.5 million, including approximately $184.7 million of net investment in hotel properties, plus approximately $9.6 million for the Company’s joint venture investment in the Crowne Plaza Hollywood Beach Resort.

On July 26, 2010, the Company executed a Doubletree Franchise License Agreement (the “License Agreement”) with Hilton Worldwide for its Raleigh, North Carolina, property in order to upbrand the hotel from its current Holiday Inn affiliation. In conjunction with the License Agreement, the Company is executing a Product Improvement Plan and expects to rebrand the hotel no later than November 30, 2011. The License Agreement will remain in effect for a period of 10 years from the conversion date.

Balance Sheet/Liquidity

At September 30, 2010, the Company had approximately $5.9 million of available cash and cash equivalents, of which approximately $2.2 million was reserved for real estate taxes, insurance, capital improvements and certain other expenses. The Company has approximately $75.2 million outstanding on its line of credit, which had been deployed primarily to fund the acquisitions and renovations of the Sheraton Louisville Riverside Hotel and the Crowne Plaza Tampa Westshore, the Company’s equity contribution to its joint venture with The Carlyle Group for the purchase of the Crowne Plaza Hollywood Beach Resort, as well as the acquisition of the Hampton, Virginia hotel property.

On June 7, 2010, the Company announced that it had entered into a fifth amendment to its credit agreement. As of September 30, 2010, the Company was in compliance with all credit agreement covenants.

On July 7, 2010, the Company announced that during the second quarter 2010 it had exercised the option to extend the scheduled maturity date of the $18.0 million mortgage on the Crowne Plaza Jacksonville Riverfront Hotel. The new maturity date is July 22, 2011.

The Company has no debt maturing before May 2011.

Dividend

As previously announced, the fifth amendment to the credit agreement entered into in June 2010 permits the Company to pay in any given fiscal year a dividend in an amount minimally necessary in order to maintain its status as a REIT, provided that no default or event of default exists at the time of, or after giving effect to, the distribution and the Company does not incur indebtedness to make the distribution. The Company anticipates

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the amount of such a dividend will remain at 90% of taxable income excluding net capital gains, which does not necessarily equal net income as calculated in accordance with GAAP. The credit agreement also provides that the Company may make additional dividend distributions so long as no event of default exists at the time, or after giving effect to, such additional distributions if the Company maintains a minimum liquidity position of $10 million and satisfies a debt yield ratio of EBITDA to total liabilities of at least 10% before and after giving effect to such distribution, provided the aggregate amount of such distributions in a given year cannot exceed 90% of FFO for the prior fiscal year. Any future changes to the Company’s current dividend policy will need to be in compliance with restrictions on the payment of cash dividends as set forth in the referenced amendment to the credit agreement.

Outlook and Market Trends

Set forth below is guidance for 2010, which is predicated on continued strengthening of the economy and expected improvements in hotel lodging industry fundamentals. These projections are based on occupancy and rate estimates that are consistent with calendar year 2010 trend forecasts by Smith Travel Research for the market segments in which the Company operates. The FFO forecast reflects management’s expectation that recently renovated and opened properties, including the Hilton Savannah DeSoto and the Crowne Plaza Tampa Westshore, will continue to experience increased demand and improved operations and that there will be continued, albeit slowed, expansion in the lodging industry through 2010.

The table below reconciles projected 2010 net loss to projected FFO and provides projected key operating metrics and supplemental information:

	Low Range Y/E Dec 31, 2010			High Range Y/E Dec 31, 2010
Net loss	$	(1,915,000	)	$	(1,430,000	)
Noncontrolling interest		(695,000	)		(530,000	)
Depreciation and amortization		8,510,000			8,510,000
Equity in depreciation and amortization of joint venture		550,000			550,000
FFO	$	6,450,000		$	7,100,000
Weighted average shares and units		12,894,691			12,894,691
FFO per share and unit	$	0.50		$	0.55

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Earnings Call/Webcast

The Company will conduct its third quarter 2010 conference call for investors and other interested parties at 10:00 a.m. Eastern Time (ET) on Tuesday, November 9, 2010. The conference call will be accessible by telephone and through the Internet. Interested individuals are invited to listen to the call by telephone at 877-317-6789 (United States) or 866-605-3852 (Canada). To participate on the webcast, log on to www.mhihospitality.com at least 15 minutes before the call to download the necessary software. For those unable to listen to the call live, a taped rebroadcast will be available beginning one hour after completion of the live call on November 9, 2010 through December 31, 2010 at 5:00 p.m. ET. To access the rebroadcast, dial 877-344-7529 and enter passcode number 445139. A replay of the call also will be available on the Internet at www.mhihospitality.com until November 9, 2011.

About MHI Hospitality Corporation

MHI Hospitality Corporation is a self-managed and self-administered lodging REIT focused on the acquisition, renovation, upbranding and repositioning of upscale to upper upscale full-service hotels in the Mid-Atlantic and Southern United States. Currently, the Company’s portfolio consists of investments in ten hotel properties, nine of which are wholly-owned and comprise 2,110 rooms. All of the Company’s wholly-owned properties operate under the Hilton Worldwide, InterContinental Hotels Group and Starwood Hotels and Resorts brands. The Company has a 25.0% interest in the Crowne Plaza Hollywood Beach Resort. The Company also has a leasehold interest in the common area of Shell Island Resort, a resort condominium property. MHI Hospitality Corporation was organized in 2004 and is headquartered in Williamsburg, Virginia. For more information please visit www.mhihospitality.com.

Forward-Looking Statements

This news release includes “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. Although the Company believes that the expectations and assumptions reflected in the forward-looking statements are reasonable, these statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict and many of which are beyond the Company’s control. Therefore, actual outcomes and results may differ materially from what is expressed, forecasted or implied in such forward-looking statements. Factors which could have a material adverse effect on the Company’s future results, performance and achievements, include, but are not limited to: national and local economic and business conditions, including the current economic downturn, that will affect occupancy rates at the Company’s hotels and the demand for hotel products and services; risks associated with the hotel industry, including competition, increases in wages, energy costs and other operating costs; the magnitude, sustainability and timing of an anticipated recovery in the hospitality industry and in the markets in which the Company operates; the availability and terms of financing and capital and the general volatility of the securities markets, specifically, the impact of the current credit crisis which has severely constrained the availability of debt financing; risks associated with the level of the Company’s indebtedness and its ability to meet covenants

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in its debt agreements and, if necessary, to refinance or seek an extension of the maturity of such indebtedness; management and performance of the Company’s hotels; risks associated with the conflicts of interest of the Company’s officers and directors; risks associated with redevelopment and repositioning projects, including delays and cost overruns; supply and demand for hotel rooms in the Company’s current and proposed market areas; the Company’s ability to acquire additional properties and the risk that potential acquisitions may not perform in accordance with expectations; the Company’s ability to successfully expand into new markets; legislative/regulatory changes, including changes to laws governing taxation of real estate investment trusts; the Company’s ability to maintain its qualification as a REIT; and the Company’s ability to maintain adequate insurance coverage. These risks and uncertainties are described in greater detail under “Risk Factors” in the Company’s Annual Report on Form 10-K and subsequent reports filed with the Securities and Exchange Commission. The Company undertakes no obligation and does not intend to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Although the Company believes its current expectations to be based upon reasonable assumptions, it can give no assurance that its expectations will be attained or that actual results will not differ materially.

Financial Tables Follow…

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MHI HOSPITALITY CORPORATION

CONSOLIDATED BALANCE SHEETS

	September 30, 2010 (unaudited)			December 31, 2009 (audited)
ASSETS
Investment in hotel properties, net	$	184,666,214		$	188,587,507
Investment in joint venture		9,552,547			9,685,844
Cash and cash equivalents		3,746,472			3,490,487
Restricted cash		2,155,506			701,730
Accounts receivable		2,829,419			1,625,161
Accounts receivable-affiliate		5,783			32,444
Prepaid expenses, inventory and other assets		2,550,520			2,046,082
Notes receivable, net		100,000			100,000
Shell Island lease purchase, net		1,170,956			1,441,176
Deferred income taxes		4,593,054			4,920,973
Deferred financing costs, net		1,108,975			1,328,351
TOTAL ASSETS	$	212,479,446		$	213,959,755
LIABILITIES
Line of credit	$	75,197,858		$	75,522,858
Mortgage loans		72,430,567			72,738,250
Loans payable		4,543,970			4,613,163
Accounts payable and accrued liabilities		7,493,592			6,696,605
Advance deposits		856,767			547,653
TOTAL LIABILITIES	$	160,522,754		$	160,118,529
Commitments and contingencies
EQUITY
MHI Hospitality Corporation stockholders’ equity
Preferred stock , par value $0.01, 1,000,000 shares authorized, 0 shares issued and outstanding		—			—
Common stock, par value $0.01; 49,000,000 shares authorized; 9,541,286 shares and 9,096,943 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively		95,413			90,969
Additional paid in capital		55,654,475			52,543,562
Distributions in excess of retained earnings		(15,982,863	)		(14,454,238	)
Total MHI Hospitality Corporation stockholders’ equity		39,767,025			38,180,293
Noncontrolling interest		12,189,667			15,660,933
TOTAL EQUITY		51,956,692			53,841,226
TOTAL LIABILITIES AND EQUITY	$	212,479,446		$	213,959,755

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MHI HOSPITALITY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	Three months ended September 30, 2010			Three months ended September 30, 2009			Nine months ended September 30, 2010			Nine months ended September 30, 2009
REVENUE
Rooms department	$	13,736,101		$	12,781,958		$	40,784,193		$	37,404,739
Food and beverage department		4,657,257			4,124,670			14,395,240			13,187,953
Other operating departments		1,144,373			1,073,404			3,383,410			3,419,049
Total revenue		19,537,731			17,980,032			58,562,843			54,011,741
EXPENSES
Hotel operating expenses
Rooms department		3,972,346			3,765,650			11,495,313			10,498,088
Food and beverage department		3,227,304			2,957,662			9,756,741			8,990,305
Other operating departments		196,410			206,865			540,248			581,202
Indirect		7,770,926			7,290,182			22,610,861			21,677,157
Total hotel operating expenses		15,166,986			14,220,359			44,403,163			41,746,752
Depreciation and amortization		2,123,761			2,152,350			6,381,378			6,148,408
Corporate general and administrative		725,909			744,171			2,687,719			2,497,275
Total operating expenses		18,016,656			17,116,880			53,472,260			50,392,435
NET OPERATING INCOME		1,521,075			863,152			5,090,583			3,619,306
Other income (expense)
Interest expense		(2,608,276	)		(2,546,971	)		(7,385,350	)		(7,131,677	)
Interest income		4,843			9,861			15,779			37,689
Equity income (loss) in joint venture		(184,237	)		(157,942	)		5,089			(169,966	)
Unrealized gain (loss) on hedging activities		(16,566	)		316,914			630,828			854,171
Loss on disposal of assets		(84,128	)		(51,740	)		(84,128	)		(42,870	)
Net loss before taxes		(1,367,289	)		(1,566,726	)		(1,727,199	)		(2,833,347	)
Income tax benefit (provision)		(3,461	)		502,019			(365,861	)		1,026,874
Net loss		(1,370,750	)		(1,064,707	)		(2,093,060	)		(1,806,473	)
Add: Net loss attributable to the noncontrolling interest		366,400			371,894			564,435			631,031
Net loss attributable to the Company	$	(1,004,350	)	$	(692,813	)	$	(1,528,625	)	$	(1,175,442	)
Net loss per share attributable to the Company
Basic	$	(0.11	)	$	(0.10	)	$	(0.16	)	$	(0.17	)
Diluted	$	(0.11	)	$	(0.10	)	$	(0.16	)	$	(0.17	)
Weighted average number of shares outstanding
Basic		9,541,286			6,964,263			9,415,593			6,962,170
Diluted		9,557,286			6,990,263			9,431,593			6,988,170

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MHI HOSPITALITY CORPORATION

RECONCILIATION OF NET LOSS TO FUNDS FROM OPERATIONS (FFO)

(unaudited)

	Three months ended September 30, 2010			Three months ended September 30, 2009			Nine months ended September 30, 2010			Nine months ended September 30, 2009
Net loss attributable to the Company	$	(1,004,350	)	$	(692,813	)	$	(1,528,625	)	$	(1,175,442	)
Adjust noncontrolling interest		(366,400	)		(371,894	)		(564,435	)		(631,031	)
Add depreciation and amortization		2,123,761			2,152,350			6,381,378			6,148,408
Add equity in depreciation and amortization of joint venture		136,695			135,935			409,660			407,814
Add loss on disposal of assets		84,128			51,740			84,128			42,870
FFO	$	973,834		$	1,275,318		$	4,782,106		$	4,792,619
Weighted average shares outstanding		9,541,286			6,964,263			9,415,593			6,962,170
Weighted average units outstanding		3,366,656			3,737,607			3,476,389			3,737,607
Weighted average shares and units		12,907,942			10,701,870			12,891,982			10,699,777
FFO per share and unit	$	0.08		$	0.12		$	0.37		$	0.45

Industry analysts and investors use Funds from Operations, FFO, as a supplemental operating performance measure of an equity REIT. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of the National Association of Real Estate Investment Trusts, NAREIT. FFO, as defined by NAREIT, represents net income or loss determined in accordance with GAAP, excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated operating real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after adjustment for any noncontrolling interest from unconsolidated partnerships and joint ventures. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by itself. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from GAAP net income. Management believes that the use of FFO, combined with the required GAAP presentations, has improved the understanding of the operating results of REITs among the investing public and made comparisons of REIT operating results more meaningful. Management considers FFO to be a useful measure of adjusted net income (loss) for reviewing comparative operating and financial performance. Management believes FFO is most directly comparable to net income (loss), which remains the primary measure of performance, because by excluding gains or losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization, FFO assists in comparing the operating performance of a company’s real estate between periods or as compared to different companies. Although FFO is intended to be a REIT industry standard, other companies may not calculate FFO in the same manner as we do, and investors should not assume that FFO as reported by us is comparable to FFO as reported by other REITs.

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MHI HOSPITALITY CORPORATION

RECONCILIATION OF NET OPERATING INCOME TO

ADJUSTED OPERATING INCOME

(unaudited)

	Three months ended September 30, 2010			Three months ended September 30, 2009			Nine months ended September 30, 2010			Nine months ended September 30, 2009
Net operating income	$	1,521,075		$	863,152		$	5,090,583		$	3,619,306
Add corporate general and administrative		725,909			744,171			2,687,719			2,497,275
Add depreciation and amortization		2,123,761			2,152,350			6,381,378			6,148,408
Subtract net lease rental income		(111,250	)		(95,750	)		(333,750	)		(318,250	)
Subtract other fee income		(39,051	)		(5,283	)		(186,554	)		(196,420	)
Adjusted operating income	$	4,220,444		$	3,658,640		$	13,639,376		$	11,750,319

We provide adjusted operating income as supplemental information for investors. We eliminate corporate-level costs and expenses to arrive at property-level results because we believe property-level results provide investors with supplemental information into the ongoing operating performance of our hotels. We eliminate depreciation and amortization because, even though depreciation and amortization are property-level expenses, these non-cash expenses, which are based on historical cost accounting for real estate assets, implicitly assume that the value of real estate assets diminishes predictably over time. As noted earlier, because real estate values have historically risen or fallen with market conditions, many industry investors have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves.

As a result of the elimination of corporate-level costs and expenses, depreciation and amortization, net lease income as well as other fee income not related to our wholly-owned hotel properties, the adjusted operating income we present should not be used to evaluate our performance as a whole. Management compensates for these limitations by separately considering the impact of these excluded items to the extent they are material to operating decisions or assessments or our operating performance. Our consolidated statements of operations include such amounts, all of which should be considered by investors when evaluating our performance.

We also believe that providing adjusted operating income provides investors and management with useful information for evaluating the period-to-period performance of our hotels and facilitates comparisons with other hotels REITs and hotel owners.