Hotel Management Agreements and Leases

9 Months Ended

Sep. 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 nine months ended September 30, 2012, the payments we received under our Marriott No. 234 agreement, which requires annual minimum returns to us of $100,622, were $2,318 and $6,989 less than the minimum amounts contractually required, respectively.  Pursuant to our Marriott No. 234 agreement, Marriott provided us with a limited guarantee for shortfalls up to 90% of our minimum returns.  During the three and nine months ended September 30, 2012, Marriott was not required to make any guaranty payments to us because the payments received by us were in excess of the guaranty threshold amount (90% of the minimum returns due to us). During the three months ended September 30, 2012, the amount available under Marriott’s guaranty was replenished by the $400 of hotel cash flows in excess of the guaranty threshold amount.  Also, during the period from September 30, 2012 to November 6, 2012, the payments we received for these hotels were $1,555 less than the contractual minimum returns due to us.  Marriott was not required to make any guaranty payments to us because the minimum return payments received were in excess of the guaranty threshold.  The balance of this guaranty was $30,873 as of November 6, 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 these 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 August 2012, we removed the remaining two of the 21 hotels from the Marriott No. 234 agreement and converted them to the Sonesta ES Suites brand and Sonesta management.  Our annual minimum returns under the Marriott No. 234 agreement were reduced by $990 when these two hotels were 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 29, 2012 and retroactive to January 1, 2012), reduced in 2013 and 2014, and then increased in 2015 through the remaining agreement term of 2025.  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 and nine months ended September 30, 2012, the payments we received under our agreement with InterContinental covering 91 hotels and requiring minimum returns to us of $131,654 were $2,743 and $17,493 less than the minimum amounts contractually required, respectively.  We applied the available security deposit to cover these shortfalls.  Also, during the period from September 30, 2012 to November 6, 2012, the minimum return payments we received under our InterContinental agreement were $5,061 less than the minimum amounts due to us.  We applied the available security deposit to cover these shortfalls.  The remaining balance of the security deposit was $33,266 as of November 6, 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 had 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.  We provided notices to InterContinental during the period from February 2012 to June 2012 that we planned to remove the remaining 39 of the 42 hotels from the InterContinental agreement.  We entered into management agreements with Sonesta for 17 of these hotels, which were converted to Sonesta brands and management during the second and third quarters of 2012.  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 Wyndham brands and management on August 1, 2012.  In August 2012, we sold the remaining two of the 39 hotels for combined net proceeds of $5,354.  Our annual minimum returns due under the InterContinental agreement were reduced by an aggregate of $34,990 when these 39 hotels were removed.

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 our 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 in the management agreement for our Cambridge Hotel, 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, during the second and third quarters of 2012, we removed 17 hotels from our InterContinental agreement and two hotels from our Marriott No. 234 agreement and converted them to Sonesta brands and management.  We entered into hotel management agreements with Sonesta for these hotels and added them 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 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 required advance per room is less ($750 per key compared to $1,500 per key for the full service Sonesta hotels).  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 returns as of September 30, 2012 for the 20 hotels included in the Sonesta No. 1 agreement were $36,476.  We currently expect to fund between $130,000 and $150,000 for rebranding, renovations and other improvements to the 19 hotels we rebranded as Sonesta hotels.  The annual minimum returns due to us under the Sonesta No. 1 agreement will increase to the extent amounts funded for these improvements exceed threshold amounts, as defined.

We lease the New Orleans Hotel from 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 other 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.  As described above, on May 21, 2012, we entered an agreement to rebrand 20 of our hotels which were managed by InterContinental to Wyndham brands, 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.  Our annual minimum return under our Wyndham agreement for these 20 hotels was $9,681 as of September 30, 2012, and such payment was subject to a $20,000 limited guarantee by Wyndham (and an annual payment limit of $10,000).  The cash flows generated by our Wyndham hotels were $3,547 less than the minimum returns due for the period August 1, 2012 through September 30, 2012 and Wyndham provided guaranty payments to cover these shortfalls.  There was $16,453 remaining at September 30, 2012 under our Wyndham guarantee.  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, the annual minimum returns due to us under the management agreement will increase by 8% of the amounts funded.

On November 1, 2012, we acquired the Hotel 71, a full service hotel in Chicago, IL for $85,000, excluding closing costs, and added it to our Wyndham agreement.  Upon completion of a planned renovation, the property will consist of 348 hotel rooms managed by Wyndham and 48 vacation units leased to Wyndham Vacation Resorts, Inc., a subsidiary of Wyndham Worldwide Corporation.  Our annual minimum returns under the Wyndham agreement increased by $5,800 and the limited guaranty provided by Wyndham increased by $9,000 upon closing of this hotel acquisition (and increased the annual payment limit to $14,500).  The lease with Wyndham Vacation Resorts, Inc. provides for annual initial rent to us of $1,000 increasing 3% per annum.  We plan to convert this hotel to the “Wyndham Grand Chicago Riverfront” hotel and have agreed to provide up to $18,000 for the rebranding and renovation of this hotel.  As these rebranding and renovation amounts are funded, the annual minimum return due to us under the Wyndham agreement will increase by 8% of the amounts funded.

Other management agreement and lease matters.  As of November 6, 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 ($18,141 remaining at September 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 ($24,130 remaining at September 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, $20,300 and $6,653, less than the minimum returns due to us in the three months ended September 30, 2012 and 2011, respectively, and $46,697 and $37,875 less than the minimum returns due to us in the nine months ended September 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 $12,791 and $6,653 in the three months ended September 30, 2012 and 2011, respectively, and $30,483 and $37,875 in the nine months ended September 30, 2012 and 2011, respectively.  We had $9,840 and $16,210 of shortfalls not funded by managers during the three and nine months ended September 30, 2012, respectively, 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.