Hotel Management Agreements and Leases

6 Months Ended

Jun. 30, 2012

Hotel Management Agreements and Leases

Hotel Management Agreements and Leases

Note 12. Hotel Management Agreements and Leases

Marriott No. 234 agreement.  During the three and six months ended June 30, 2012, the payments we received under our Marriott No. 234 agreement which requires annual minimum returns to us of $102,472 were $2,389 and $4,670 less than the minimum amounts contractually required, respectively.  During the three months ended June 30, 2012, after giving effect to the retroactive adjustment to the capital expenditure, or FF&E, reserve funding requirements discussed below, the amount available under Marriott’s guaranty was replenished by $6,523 and during the six months ended June 30, 2012 the amount available under Marriott’s guaranty was reduced by the $400 of net guaranty payments to us.  Also, during the period from June 30, 2012 to August 7, 2012, the minimum return payments we received for these hotels were $765 less than the contractual minimum returns due to us and the amount available under Marriott’s guaranty was replenished by $1,294.  The balance of this guaranty was $31,766 as of August 7, 2012.

We and Marriott previously identified 21 Marriott hotels included in our Marriott No. 234 agreement for potential sale.  In May 2012, we announced we had entered agreements with Marriott to retain ownership of and renovate 18 of the 21 hotels.  We currently expect to fund approximately $43,000 for certain improvements to the 18 hotels.  As we fund these amounts, our annual minimum returns due under the Marriott No. 234 agreement will be increased by 9% of the amounts funded.  As discussed in Note 7, in July 2012 we sold one of these 21 hotels, a full service Marriott hotel in St. Louis, MO.  We received net proceeds of $28,850 from the sale and our annual minimum returns under the Marriott No. 234 agreement were decreased by $2,597 when this hotel was sold.  In June 2012, we provided notice to Marriott that we plan to remove the remaining two of the 21 hotels from the Marriott No. 234 agreement during the third quarter of 2012.  We currently expect to convert these two hotels to Sonesta brands and management.  Our annual minimum returns under the Marriott No. 234 agreement will be reduced by $990 when these two hotels are removed from the Marriott No. 234 agreement.

The May 2012 agreements with Marriott provide that the FF&E reserve funding requirements for all hotels included in the Marriott No. 234 agreement are eliminated during 2012 (effective May 30, 2012 and retroactive to January 1, 2012), reduced in 2013 and 2014, and then increased in 2015 through the remaining agreement term.  This change in FF&E reserve funding requirements had the impact of reducing our reported net income and normalized FFO for the three months ended June 30, 2012, by $7,422, or $0.06 per share, but had no impact on our cash flows from operating activities.  The May 2012 agreements with Marriott also provide that Marriott’s limited guarantee of the minimum return amounts due to us under the Marriott No. 234 agreement will be extended through 2019.

InterContinental agreement. During the three months ended June 30, 2012, the payments we received under our agreement with InterContinental covering 126 hotels and requiring minimum returns to us of $153,352 were $1,501 more than the minimum amounts contractually required.  We replenished the available security deposit by the $1,501 of excess payments received.  During the six months ended June 30, 2012, the payments we received under our agreement with InterContinental were $14,750 less than the minimum amounts contractually required.  We applied the available security deposit to cover these shortfalls.  Also, during the period from June 30, 2012 to August 7, 2012, the minimum return payments we received under our InterContinental agreement were $800 more than the minimum amounts due to us.  We replenished the available security deposit by the additional amounts received.  The remaining balance of the security deposit was $41,871 as of August 7, 2012.

When we reduce the amounts of the security deposits we hold for these agreements or any other operating agreements for payment deficiencies, we record income equal to the amounts by which these deposits are reduced up to the minimum return or minimum rent due to us. However, reducing the security deposits does not result in additional cash flow to us of the deficiency amounts, but reducing amounts of security deposits may reduce the refunds due to the respective lessees or managers who have provided us with these deposits upon expiration of the respective lease or management agreement.  The security deposits are non-interest bearing and are not held in escrow.  Under all of our hotel contracts that include a security deposit, any amount of the security deposits which are applied to payment deficits may be replenished from future cash flows from the applicable hotel operations pursuant to the terms of the respective contracts.

Under the InterContinental agreement, we have the option to sell or rebrand up to 42 hotels included in the agreement.  In April 2012, we and InterContinental agreed to retain three of the 42 hotels in the InterContinental agreement.  During the period February 2012 to June 2012, we provided notices to InterContinental that we plan to remove the remaining 39 of the 42 hotels from the InterContinental agreement.  As of June 30, 2012, we had removed four of the 39 hotels from the InterContinental agreement and our annual minimum returns due under the agreement were reduced by $9,923.  We entered into management agreements with Sonesta for these hotels, which were converted to Sonesta brands and management during the second quarter of 2012.  Since June 30, 2012, we have converted an additional seven hotels to Sonesta brands and management and we currently expect to convert an additional six of the 39 hotels to Sonesta brands and management in the third quarter of 2012.  Our annual minimum returns due under the InterContinental agreement will decrease by $15,583 when these 13 hotels are removed.  As described below, in May 2012, we entered into an agreement with Wyndham Hotel Group, or Wyndham, a member of the Wyndham Worldwide Corporation for 20 of these 39 hotels.  We converted these 20 hotels to the Wyndham brands and management on August 1, 2012.  Our annual minimum returns under the InterContinental agreement decreased by $9,038 when these hotels were removed.  In August 2012, we entered into agreements to sell the remaining two of the 39 hotels for a combined purchase price of $5,570, excluding closing costs.  We will retain the net proceeds from the sales and our annual minimum returns due under the InterContinental agreement will decrease by $446 when these hotels are sold.  We currently expect to complete these sales in the third quarter of 2012; these pending sales are subject to closing conditions; accordingly, we cannot provide any assurance that we will sell these hotels.

Sonesta agreements.  As described in Note 11, on January 31, 2012, we entered into two management agreements with Sonesta to manage our Cambridge Hotel and New Orleans Hotel.  The management agreement for our Cambridge Hotel, which is included in our Sonesta No. 1 agreement, provides that we are paid a fixed minimum return equal to 8% of our invested capital, as defined, if gross revenues of the hotels, after payment of hotel operating expenses and base fees to Sonesta, are sufficient to do so.  Under the terms of this agreement, we may earn additional returns of 80% of cash flow after payment of our minimum returns and reimbursement of operating losses or working capital advances, if any.  We are required to fund operating losses or working capital shortfalls, but may recover these amounts from future cash flows, if any.  As described above, we have notified InterContinental that we plan to remove and rebrand a total of 17 hotels to Sonesta brands and management.  During the second quarter of 2012, we entered into hotel management agreements with Sonesta for four of these hotels and added them to our Sonesta No. 1 agreement.  Since June 30, 2012, we have entered into an additional 13 hotel management agreements with Sonesta for the conversion of 13 hotels to Sonesta brands and management.  Seven of these hotels have already been converted to Sonesta brands and management and added to our Sonesta No. 1 agreement.  The terms of these management agreements are substantially the same as our Cambridge Hotel management agreement, except that in the case of limited service hotels where the base management fee payable to Sonesta is 5% of gross revenues (compared to 3% of gross revenues for other Sonesta branded hotels) and our working capital advance per room requirements are less.  In addition, in April 2012, we entered into a pooling agreement with Sonesta as further described in Note 11.  Under the terms of the pooling agreement, results from the hotels included in our Sonesta No. 1 agreement are combined for purposes of calculating gross revenues, payment of hotel operating expenses, payment of fees and distributions and the calculation of minimum returns due to us.  Our annual minimum return under the Sonesta No. 1 agreement, which includes five hotels as of June 30, 2012, was $19,523.  Also as described above, we have notified Marriott that we plan to remove and rebrand two hotels to the Sonesta brand and management.  We currently expect the conversion of the remaining six InterContinental hotels and two Marriott hotels to be completed during the third quarter of 2012 and expect to add these hotels to our Sonesta No. 1 agreement.  The annual minimum returns for these 15 hotels (13 InterContinental and two Marriott) to be, or already rebranded as Sonesta brands are expected to approximate the reductions in the annual minimum returns due under the InterContinental and Marriott No. 234 agreements when they are removed.  We currently expect to fund between $130,000 and $150,000 for rebranding, renovations and other improvements to the 19 hotels we have or expect to rebrand as Sonesta hotels.  As these amounts are funded, the annual minimum returns due to us under the Sonesta No. 1 agreement will increase.

The New Orleans Hotel is subject to a lease with a third party.  The annual rent payable by us under the lease is calculated as 75% of the sum of the net profit of the hotel (hotel operating revenues less hotel operating expenses, including a 3% management fee to Sonesta), less capital expenditures made during the lease year.  The management agreement for our New Orleans Hotel, which we refer to as our Sonesta No. 2 agreement, provides that we are paid all cash flow of the hotel after the payment of operating expenses, including a management fee to Sonesta and rent expense.

We do not have any security deposits or guarantees for our hotels managed by Sonesta.  Sonesta’s incentive management fees, but not its base fees, are only earned after we receive our minimum returns, and we may cancel these management agreements if approximately 75% of our minimum returns are not paid for certain periods.  Accordingly, the returns we receive from hotels managed by Sonesta will depend exclusively upon the performance of those hotels.

Wyndham agreement.  On May 21, 2012, we entered an agreement to rebrand 20 of our hotels which were managed by InterContinental to brands owned by Wyndham, which conversion occurred on August 1, 2012.  All 20 hotels are being managed by Wyndham under a long term management contract with an initial term of 25 years and two renewal terms of 15 years each.  Wyndham has agreed to pay us an annual minimum return from the operating results of these hotels of $9,240, and such payment is partially guaranteed by Wyndham.  We have agreed to provide up to $75,000 for refurbishment and rebranding of these hotels to “Wyndham Hotels and Resorts” (four hotels) and “Hawthorn Suites by Wyndham” (16 hotels) brand standards.  As these amounts are funded, our annual minimum returns due to us under the management agreement will increase by 8% of the amounts funded.

Other management agreement and lease matters. As of August 7, 2012, all payments due to us from our managers and tenants under our other operating agreements were current.  Certain amounts of minimum return and minimum rent payments due to us under some of our other hotel management agreements and leases are supported by guarantees. The guaranty provided by Hyatt Hotels Corporation, or Hyatt, with respect to the 22 hotels managed by Hyatt is limited to $50,000 ($19,265 remaining at June 30, 2012). The guaranty provided by Carlson Hotels Worldwide, or Carlson, with respect to the 11 hotels managed by Carlson is limited to $40,000 ($24,204 remaining at June 30, 2012).  The guaranty provided by Marriott with respect to the one hotel leased by Marriott (our Marriott No. 5 agreement) is unlimited and continues throughout the lease term.

Certain of our managed hotel portfolios had net operating results that were, in the aggregate, $535 and $6,165, less than the minimum returns due to us in the three months ended June 30, 2012 and 2011, respectively, and $26,396 and $31,222 less than the minimum returns due to us in the six months ended June 30, 2012 and 2011, respectively.  When the shortfalls are funded by the managers of these hotels under the terms of our operating agreements, we reflect such fundings (including security deposit applications) in our Condensed Consolidated Statements of Income and Comprehensive Income as a reduction of hotel operating expenses. The reduction to operating expenses was $535 and $6,165 in the three months ended June 30, 2012 and 2011, respectively, and $20,027 and $31,222 in the six months ended June 30, 2012 and 2011, respectively.  We had $6,369 of shortfalls not funded by managers during the six months ended June 30, 2012, which represents the unguaranteed portion of our minimum returns from Marriott and from Sonesta.

In November 2010, Host Hotels & Resorts, Inc., or Host, notified us that it will not exercise its renewal option at the end of the current lease term for 53 hotels which we have historically referred to as our Marriott No. 1 agreement.  In the absence of any default by Host, upon expiration of the agreement on December 31, 2012, we expect to return the $50,540 security deposit to Host, to lease these hotels to one of our TRSs and to continue the existing hotel brand and management agreements with Marriott with respect to these hotels; this management agreement with Marriott expires in 2024.