Table of Contents
UNITED STATESSECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2024
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-32319
Sunstone Hotel Investors, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Maryland
20-1296886
(State or Other Jurisdiction ofIncorporation or Organization)
(I.R.S. EmployerIdentification Number)
15 Enterprise, Suite 200Aliso Viejo, California
92656
(Address of Principal Executive Offices)
(Zip Code)
Registrant’s telephone number, including area code: (949) 330-4000
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on Which Registered
Common Stock, $0.01 par value
SHO
New York Stock Exchange
Series H Cumulative Redeemable Preferred Stock, $0.01 par value
SHO.PRH
Series I Cumulative Redeemable Preferred Stock, $0.01 par value
SHO.PRI
Indicate by check mark whether the registrant: (1) 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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☒
Accelerated filer ☐
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of November 6, 2024, there were 200,901,248 shares of Sunstone Hotel Investors, Inc.’s common stock, $0.01 par value per share, outstanding.
SUNSTONE HOTEL INVESTORS, INC.
QUARTERLY REPORT ON
For the Quarterly Period Ended September 30, 2024
TABLE OF CONTENTS
Page
PART I—FINANCIAL INFORMATION
Item 1.
Financial Statements
2
Consolidated Balance Sheets as of September 30, 2024 (unaudited) and December 31, 2023
Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2024 and 2023
3
Unaudited Consolidated Statements of Equity for the Three and Nine Months Ended September 30, 2024 and 2023
4
Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2024 and 2023
6
Notes to Unaudited Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
23
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
39
Item 4.
Controls and Procedures
PART II—OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
40
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
41
SIGNATURES
42
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
September 30,
December 31,
2024
2023
(unaudited)
ASSETS
Investment in hotel properties, net
$
2,849,875
2,585,279
Operating lease right-of-use assets, net
9,330
12,755
Cash and cash equivalents
115,542
426,403
Restricted cash
77,018
67,295
Accounts receivable, net
34,110
31,206
Prepaid expenses and other assets, net
30,666
26,383
Total assets
3,116,541
3,149,321
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Debt, net of unamortized deferred financing costs
814,112
814,559
Operating lease obligations
13,039
16,735
Accounts payable and accrued expenses
63,644
48,410
Dividends and distributions payable
22,619
29,965
Other liabilities
78,332
73,014
Total liabilities
991,746
982,683
Commitments and contingencies (Note 11)
Stockholders’ equity:
Preferred stock, $0.01 par value, 100,000,000 shares authorized:
Series G Cumulative Redeemable Preferred Stock, 2,650,000 shares issued and outstanding at both September 30, 2024 and December 31, 2023, stated at liquidation preference of $25.00 per share
66,250
6.125% Series H Cumulative Redeemable Preferred Stock, 4,600,000 shares issued and outstanding at both September 30, 2024 and December 31, 2023, stated at liquidation preference of $25.00 per share
115,000
5.70% Series I Cumulative Redeemable Preferred Stock, 4,000,000 shares issued and outstanding at both September 30, 2024 and December 31, 2023, stated at liquidation preference of $25.00 per share
100,000
Common stock, $0.01 par value, 500,000,000 shares authorized, 200,919,457 shares issued and outstanding at September 30, 2024 and 203,479,585 shares issued and outstanding at December 31, 2023
2,009
2,035
Additional paid in capital
2,394,525
2,416,417
Distributions in excess of retained earnings
(552,989)
(533,064)
Total stockholders’ equity
2,124,795
2,166,638
Total liabilities and stockholders' equity
See accompanying notes to unaudited consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended September 30,
Nine Months Ended September 30,
REVENUES
Room
138,759
158,467
425,870
484,304
Food and beverage
63,866
64,007
196,572
213,634
Other operating
23,767
25,226
68,597
69,317
Total revenues
226,392
247,700
691,039
767,255
OPERATING EXPENSES
37,453
41,034
110,349
122,756
46,286
47,777
138,343
148,309
5,815
6,129
18,153
18,031
Advertising and promotion
13,220
12,767
38,326
39,686
Repairs and maintenance
9,094
10,060
26,783
29,112
Utilities
7,670
7,784
19,909
21,644
Franchise costs
4,711
4,278
13,735
12,756
Property tax, ground lease and insurance
19,777
21,709
58,686
60,320
Other property-level expenses
26,702
29,020
82,445
92,654
Corporate overhead
7,577
7,127
23,263
23,991
Depreciation and amortization
31,689
33,188
91,841
97,927
Total operating expenses
209,994
220,873
621,833
667,186
Interest and other income
2,350
1,218
11,306
6,398
Interest expense
(15,982)
(11,894)
(39,685)
(34,911)
Gain on sale of assets, net
—
457
Gain on extinguishment of debt
9
59
9,930
Income before income taxes
2,766
16,160
41,343
81,486
Income tax benefit (provision), net
483
(602)
1,083
(1,763)
NET INCOME
3,249
15,558
42,426
79,723
Preferred stock dividends
(3,931)
(3,226)
(11,297)
(10,762)
(LOSS) INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS
(682)
12,332
31,129
68,961
Basic and diluted per share amounts:
Basic (loss) income attributable to common stockholders per common share
0.00
0.06
0.15
0.33
Diluted (loss) income attributable to common stockholders per common share
Basic weighted average common shares outstanding
201,402
205,570
202,261
206,257
Diluted weighted average common shares outstanding
205,782
202,857
206,553
UNAUDITED CONSOLIDATED STATEMENTS OF EQUITY
Distributions
Preferred Stock
Common Stock
in Excess of
Number of
Additional
Retained
Shares
Amount
Paid in Capital
Earnings
Total
Balance at December 31, 2023 (audited)
11,250,000
281,250
203,479,585
Amortization of deferred stock compensation
2,887
Issuance of restricted common stock, net
194,813
(3,219)
(3,217)
Common stock distributions declared at $0.07 per share
(14,364)
Series G preferred stock dividends declared at $0.187500 per share
(497)
Series H preferred stock dividends declared at $0.382813 per share
(1,761)
Series I preferred stock dividends declared at $0.356250 per share
(1,425)
Net income
13,035
Balance at March 31, 2024
203,674,398
2,037
2,416,085
(538,076)
2,161,296
3,298
Issuance of restricted common stock
75,002
Common stock distributions declared at $0.09 per share
(18,504)
Repurchases of outstanding common stock
(359,008)
(3)
(3,619)
(3,622)
26,142
Balance at June 30, 2024
203,390,392
2,034
2,415,764
(534,121)
2,164,927
2,351
Repurchases of common stock for employee tax obligations
(91,439)
(1)
(942)
(943)
Forfeiture of restricted common stock
(68,131)
1
(18,186)
Series G preferred stock dividends declared at $0.281250 per share
(745)
(2,311,365)
(23)
(22,649)
(22,672)
Balance at September 30, 2024
200,919,457
Balance at December 31, 2022 (audited)
209,320,447
2,093
2,465,595
(663,977)
2,084,961
2,545
55,970
(3,349)
(3,348)
(1,435)
Common stock distributions declared at $0.05 per share
(10,449)
Series G preferred stock dividends declared at $0.219536 per share
(582)
(1,964,923)
(20)
(18,606)
(18,626)
21,087
Balance at March 31, 2023
207,410,059
2,074
2,446,185
(657,107)
2,072,402
3,442
82,552
(429)
(428)
(6,459)
(10,448)
(301,461)
(2,852)
(2,855)
Acquisition of noncontrolling interest, net
(299)
43,078
Balance at June 30, 2023
207,184,691
2,072
2,446,047
(628,245)
2,101,124
2,628
(14,357)
Series G preferred stock dividends declared at $0.015182 per share
(40)
(1,561,375)
(16)
(14,026)
(14,042)
Balance at September 30, 2023
205,623,316
2,056
2,434,649
(630,270)
2,087,685
5
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by operating activities:
Bad debt expense
319
184
(457)
(59)
(9,930)
Noncash interest on derivatives, net
1,095
Depreciation
90,862
97,540
Amortization of franchise fees and other intangibles
979
332
Amortization of deferred financing costs
2,219
1,960
8,381
8,263
Gain on insurance recoveries
(314)
(3,722)
Changes in operating assets and liabilities:
(17)
7,477
Prepaid expenses and other assets
(5,555)
(5,804)
Accounts payable and other liabilities
275
(3,851)
Operating lease right-of-use assets and obligations
(271)
(82)
Net cash provided by operating activities
139,883
168,742
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of hotel property
(229,330)
Disposition deposit
10,000
Proceeds from property insurance
314
3,722
Renovations and additions to hotel properties and other assets
(110,241)
(73,944)
Net cash used in investing activities
(339,257)
(60,222)
CASH FLOWS FROM FINANCING ACTIVITIES
Acquisition of noncontrolling interest, including transaction costs
Payment of common stock offering costs
(26,294)
(35,523)
(4,160)
Proceeds from note payable
225,000
Payments on notes payable
(1,613)
(221,554)
Payments of deferred financing costs
(2,332)
Dividends and distributions paid
(69,697)
(42,246)
Net cash used in financing activities
(101,764)
(80,730)
Net (decrease) increase in cash and cash equivalents and restricted cash
(301,138)
27,790
Cash and cash equivalents and restricted cash, beginning of period
493,698
157,206
Cash and cash equivalents and restricted cash, end of period
192,560
184,996
Supplemental Disclosure of Cash Flow Information
113,768
71,228
Total cash and cash equivalents and restricted cash shown on the consolidated statements of cash flows
Cash paid for interest, net of capitalized interest
39,734
39,013
Cash paid for income taxes, net
3,476
1,272
Operating cash flows used for operating leases
4,288
4,150
Changes in operating lease right-of-use assets
3,425
3,304
Changes in operating lease obligations
(3,696)
(3,386)
Changes in operating lease right-of-use assets and lease obligations, net
Supplemental Disclosure of Noncash Investing and Financing Activities
Accrued renovations and additions to hotel properties and other assets
25,247
12,029
Operating lease right-of-use asset obtained in exchange for operating lease obligation
2,163
Amortization of deferred stock compensation — construction activities
155
352
17,765
7
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Description of Business
Sunstone Hotel Investors, Inc. (the “Company”) was incorporated in Maryland on June 28, 2004 in anticipation of an initial public offering of common stock, which was consummated on October 26, 2004. The Company elected to be taxed as a real estate investment trust (“REIT”) for federal income tax purposes, commencing with its taxable year ended on December 31, 2004. The Company, through its 100% controlling interest in Sunstone Hotel Partnership, LLC (the “Operating Partnership”), of which the Company is the sole managing member, and the subsidiaries of the Operating Partnership, including Sunstone Hotel TRS Lessee, Inc. (the “TRS Lessee”) and its subsidiaries, invests in hotels where it can add value through capital investment, hotel repositioning and asset management. In addition, the Company seeks to capitalize on its portfolio’s embedded value and balance sheet strength to actively recycle past investments into new growth and value creation opportunities in order to deliver strong stockholder returns and superior per share net asset value growth.
As a REIT, certain tax laws limit the amount of “non-qualifying” income the Company can earn, including income derived directly from the operation of hotels. The Company leases all of its hotels to its TRS Lessee, which in turn enters into long-term management agreements with third parties to manage the operations of the Company’s hotels, in transactions that are intended to generate qualifying income.
As of both September 30, 2024 and 2023, the Company owned 15 hotels.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements as of September 30, 2024 and December 31, 2023, and for the three and nine months ended September 30, 2024 and 2023, include the accounts of the Company, the Operating Partnership, the TRS Lessee and their controlled subsidiaries. All significant intercompany balances and transactions have been eliminated. If the Company determines that it has an interest in a variable interest entity, the Company will consolidate the entity when it is determined to be the primary beneficiary of the entity.
The accompanying interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and in conformity with the rules and regulations of the Securities and Exchange Commission. In the Company’s opinion, the interim financial statements presented herein reflect all adjustments, consisting solely of normal and recurring adjustments, which are necessary to fairly present the interim financial statements. These financial statements should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023, filed with the Securities and Exchange Commission on February 23, 2024. Operating results for the three and nine months ended September 30, 2024 are not necessarily indicative of the results that may be expected for the year ending December 31, 2024.
The Company does not have any comprehensive income other than what is included in net income. If the Company has any comprehensive income in the future such that a statement of comprehensive income would be necessary, the Company will include such statement in one continuous consolidated statement of operations.
The Company has evaluated subsequent events through the date of issuance of these financial statements.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.
Earnings Per Share
The Company applies the two-class method when computing its earnings per share. Net income per share for each class of stock is calculated assuming all of the Company’s net income is distributed as dividends to each class of stock based on their contractual rights.
Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid), which include the Company’s time-based restricted stock awards, are considered participating securities and are included in the computation of earnings per share.
Basic earnings attributable to common stockholders per common share is computed based on the weighted average number of shares of common stock outstanding during each period, including shares of the Company’s performance-based restricted stock units for which all necessary conditions have been satisfied except for the passage of time. Diluted earnings attributable to common stockholders per common share is computed based on the weighted average number of shares of common stock outstanding during each period, plus potential common shares considered outstanding during the period, as long as the inclusion of such awards is not anti-dilutive. Potential common shares consist of time-based unvested restricted stock awards and performance-based restricted stock units, using the more dilutive of either the two-class method or the treasury stock method. The Company’s performance-based restricted stock units are considered for computing diluted net income per common share as of the beginning of the period in which all necessary conditions have been satisfied and the only remaining vesting condition is a service vesting condition.
The following table sets forth the computation of basic and diluted earnings per common share (unaudited and in thousands, except per share data):
Numerator:
Distributions paid to participating securities
(62)
(72)
(211)
(176)
Undistributed income allocated to participating securities
(178)
Numerator for basic and diluted (loss) income attributable to common stockholders
(744)
12,260
30,918
68,607
Denominator:
Weighted average basic common shares outstanding
Unvested restricted stock units
212
596
296
Weighted average diluted common shares outstanding
In its calculation of diluted earnings per share, the Company excluded 688,288 anti-dilutive unvested time-based restricted stock awards for the three and nine months ended September 30, 2024, and 1,032,564 anti-dilutive unvested time-based restricted stock awards for the three and nine months ended September 30, 2023, respectively (see Note 10).
The Company also had 1,382,074 and 1,076,160 unvested performance-based restricted stock units as of September 30, 2024 and 2023, respectively, that are not considered participating securities as the awards contain forfeitable rights to dividends or dividend equivalents. The performance-based restricted stock units were granted based on either target market condition thresholds or pre-determined stock price targets (see Note 10). Based on the Company’s third quarter 2024 loss attributable to common stockholders, the Company excluded all 1,382,074 anti-dilutive performance based restricted stock units from its calculation of diluted earnings per share for the three months ended September 30, 2024. Based on the Company’s common stock performance, the Company excluded 188,004 anti-dilutive performance-based restricted stock units from its calculations of diluted earnings per share for the three months ended September 30, 2023 and for both the nine months ended September 30, 2024 and 2023.
Restricted Cash
Restricted cash primarily includes reserves for operating expenses and capital expenditures required by certain of the Company’s management, franchise, and debt agreements. At times, restricted cash also includes hotel acquisition or disposition-related earnest money held in escrow reserves pending completion of the associated transaction. In addition, restricted cash as of December 31, 2023 included $0.2 million held in escrow related to certain current and potential employee-related obligations at one of the Company’s former hotels. In the second quarter of 2024, the escrow agreement was terminated and the remaining $0.1 million of restricted cash held in escrow was returned to the Company (see Note 11). As of both September 30, 2024 and December 31, 2023, restricted cash included $0.2 million held as collateral for certain letters of credit (see Note 11).
Investments in Hotel Properties
Investments in hotel properties, including land, buildings, furniture, fixtures and equipment (“FF&E”) and identifiable intangible assets are recorded at their respective relative fair values for an asset acquisition or at their estimated fair values for a business acquisition. Property and equipment purchased after the hotel acquisition date is recorded at cost. Replacements and improvements are capitalized, while repairs and maintenance are expensed as incurred. Interest imputed during construction or renovation projects is capitalized, using the Company’s weighted average interest rate on its variable rate debt, including the effects of interest rate swap derivatives, until construction is substantially complete or the assets are placed in service. Upon the sale or retirement of a fixed asset, the cost and related accumulated depreciation is removed from the Company’s accounts and any resulting gain or loss is included in the consolidated statements of operations.
Depreciation expense is based on the estimated life of the Company’s assets. The life of the assets is based on a number of assumptions, including the cost and timing of capital expenditures to maintain and refurbish the Company’s hotels, as well as specific market and economic conditions. Hotel properties are depreciated using the straight-line method over estimated useful lives primarily ranging from five years to forty years for buildings and improvements and three years to twelve years for FF&E. Intangible assets are amortized using the straight-line method over the shorter of their estimated useful life or over the length of the related agreement.
The Company’s investment in hotel properties, net also includes initial franchise fees which are recorded at cost and amortized using the straight-line method over the terms of the franchise agreements ranging from fifteen years to twenty years. All other franchise fees that are based on the Company’s results of operations are expensed as incurred.
While the Company believes its estimates are reasonable, a change in the estimated lives could affect depreciation expense and net income or the gain or loss on the sale of any of the Company’s hotels. The Company has not changed the useful lives of any of its assets during the periods discussed.
Impairment losses are recorded on investments in hotel properties to be held and used by the Company whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Factors the Company considers when assessing whether impairment indicators exist include, but are not limited to, hotel disposition strategy and hold period, a significant decline in operating results not related to renovations or repositionings, significant changes in the manner in which the Company uses the asset, physical damage to the property due to unforeseen events such as natural disasters, and other market and economic conditions.
Recoverability of assets that will continue to be used is measured by comparing the carrying amount of the asset to the related total future undiscounted net cash flows. If an asset’s carrying value is not recoverable through those cash flows, the asset is considered to be impaired. The impairment is measured by the difference between the asset’s carrying amount and its fair value. The Company performs a fair value assessment using valuation techniques such as discounted cash flows and comparable sale transactions in the market to estimate the fair value of the hotel and, if appropriate and available, current estimated net sales proceeds from pending offers. The Company’s judgment is required in determining the discount rate, terminal capitalization rate, the estimated growth of revenues and expenses, revenue per available room and margins, as well as specific market and economic conditions. Based on the Company’s review, no hotels were impaired during either the three or nine months ended September 30, 2024 and 2023.
Fair value represents the amount at which an asset could be bought or sold in a current transaction between willing parties, that is, other than a forced or liquidation sale. The estimation process involved in determining if assets have been impaired and in the determination of fair value is inherently uncertain because it requires estimates of current market yields as well as future events and conditions. Such future events and conditions include economic and market conditions, as well as the availability of suitable financing. The realization of the Company’s investment in hotel properties is dependent upon future uncertain events and conditions and, accordingly, the actual timing and amounts realized by the Company may be materially different from their estimated fair values.
10
Leases
The Company determines if a contract is a lease at inception. Leases with an initial term of twelve months or less are not recorded on the balance sheet. Expense for these short-term leases is recognized on a straight-line basis over the lease term. For leases with an initial term greater than twelve months, the Company records a right-of-use (“ROU”) asset and a corresponding lease obligation. ROU assets represent the Company’s right to use an underlying asset for the lease term, and lease obligations represent the Company’s obligation to make fixed lease payments as stipulated by the lease. The Company has elected to not separate lease components from nonlease components, resulting in the Company accounting for lease and nonlease components as one single lease component.
Leases are accounted for using a dual approach, classifying leases as either operating or financing based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the Company. This classification determines whether the lease expense is recognized on a straight-line basis over the term of the lease for operating leases or based on an effective interest method for finance leases.
Lease ROU assets are recognized at the lease commencement date and include the amount of the initial operating lease obligation, any lease payments made at or before the commencement date, excluding any lease incentives received, and any initial direct costs incurred. For leases that have extension options that the Company can exercise at its discretion, management uses judgment to determine if it is reasonably certain that the Company will in fact exercise such option. If the extension option is reasonably certain to occur, the Company includes the extended term’s lease payments in the calculation of the respective lease liability. None of the Company’s leases contain any material residual value guarantees or material restrictive covenants.
Lease obligations are recognized at the lease commencement date based on the present value of lease payments over the lease term. As the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate (“IBR”) based on information available at the commencement date in determining the present value of lease payments over the lease term. The IBR is the rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. In order to estimate the Company’s IBR, the Company first looks to its own unsecured debt offerings, and adjusts the rate for both length of term and secured borrowing using available market data as well as consultations with leading national financial institutions that are active in the issuance of both secured and unsecured notes.
The Company reviews its right-of-use assets for indicators of impairment. If such assets are considered to be impaired, the related assets are adjusted to their estimated fair value and an impairment loss is recognized. The impairment loss recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. Based on the Company’s review, no ROU assets were impaired during either the three or nine months ended September 30, 2024 and 2023.
Revenue Recognition
Revenues are recognized when control of the promised goods or services is transferred to hotel guests, which is generally defined as the date upon which a guest occupies a room and/or utilizes the hotel’s services. Room revenue and other occupancy based fees are recognized over a guest’s stay at the previously agreed upon daily rate. Some of the Company’s hotel rooms are booked through independent internet travel intermediaries. If the guest pays the independent internet travel intermediary directly, revenue for the room is recognized by the Company at the price the Company sold the room to the independent internet travel intermediary, less any discount or commission paid. If the guest pays the Company directly, revenue for the room is recognized by the Company on a gross basis, with the related discount or commission recognized in room expense. A majority of the Company’s hotels participate in frequent guest programs sponsored by the hotel brand owners whereby the hotel allows guests to earn loyalty points during their hotel stay. The Company expenses charges associated with these programs as incurred, and recognizes revenue at the amount it will receive from the brand when a guest redeems their loyalty points by staying at one of the Company’s hotels. In addition, some contracts for rooms or food and beverage services require an advance deposit, which the Company records as deferred revenue (or a contract liability) and recognizes once the performance obligations are satisfied. Cancellation fees and attrition fees, which are charged to groups when they do not fulfill their contracted minimum number of room nights or minimum food and beverage spending requirements, are typically recognized as revenue in the period the Company determines it is probable that a significant reversal in the amount of revenue recognized will not occur, which is generally the period in which these fees are collected.
Food and beverage revenue and other ancillary services revenue are generated when a customer chooses to purchase goods or services. The revenue is recognized when the goods or services are provided to the customer at the amount the Company expects to be entitled to in exchange for those goods or services. For ancillary services provided by third parties, the Company assesses whether it is the principal or the agent. If the Company is the principal, revenue is recognized based upon the gross sales price. If the Company is the agent, revenue is recognized based upon the commission earned from the third party.
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Additionally, the Company collects sales, use, occupancy and other similar taxes from customers at its hotels at the time of purchase, which are not included in revenue. The Company records a liability upon collection of such taxes from the customer, and relieves the liability when payments are remitted to the applicable governmental agency.
Trade receivables and contract liabilities consisted of the following (in thousands):
Trade receivables, net (1)
13,306
14,431
Contract liabilities (2)
50,562
45,432
During the three months ended September 30, 2024 and 2023, the Company recognized approximately $4.6 million and $3.0 million, respectively, in revenue related to its outstanding contract liabilities. During the nine months ended September 30, 2024 and 2023, the Company recognized approximately $38.3 million and $41.9 million, respectively, in revenue related to its outstanding contract liabilities.
Segment Reporting
The Company considers each of its hotels to be an operating segment and allocates resources and assesses the operating performance for each hotel. Because all of the Company’s hotels have similar economic characteristics, facilities and services, the hotels have been aggregated into one single reportable segment, hotel ownership.
New Accounting Standards and Accounting Changes
In November 2023, the FASB issued Accounting Standards Update No. 2023-07, “Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures” (“ASU 2023-07”), which amended the guidance in Accounting Standards Codification (ASC) 280, Segment Reporting, to require a public entity to disclose significant segment expenses and other segment items on an annual and interim basis and to provide in interim periods all disclosures about a reportable segment’s profit or loss and assets that are currently required annually. Public entities with a single reportable segment, such as the Company, are required to provide the new disclosures and all the disclosures required under ASC 280. ASU 2023-07 is applied retrospectively to all periods presented in the financial statements, unless it is impracticable. The guidance will be effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024, with early adoption permitted. The Company is currently evaluating ASU 2023-07’s additional disclosure requirements and expects to adopt the additional disclosure requirements beginning with its fiscal year ending December 31, 2024.
In December 2023, the FASB issued Accounting Standards Update No. 2023-09, “Income Taxes (Topic 740): Improvements to Income Tax Disclosures” (“ASU 2023-09”), to enhance the transparency and decision-usefulness of income tax disclosures, particularly in the rate reconciliation table and disclosures about income taxes paid. All entities should apply the guidance prospectively but have the option to apply it retrospectively. ASU 2023-09 will be effective for fiscal years beginning after December 15, 2024, with early adoption permitted. The Company is currently evaluating ASU 2023-09’s additional disclosure requirements.
In November 2024, the FASB issued Accounting Standards Update No. 2024-03, “Income Statement-Reporting Comprehensive Income-Expense Disaggregation Disclosures (Subtopic 220-40): Disaggregation of Income Statement Expenses” (“ASU 2024-03”), to improve the disclosures about a public business entity’s expenses and address requests from investors for more detailed information about the types of expenses (including purchases of inventory, employee compensation, depreciation, and amortization) in each income statement line item that contains those expenses. All entities are required to apply the guidance prospectively and may apply it retrospectively. ASU 2024-03 is effective for fiscal years beginning after December 15, 2026, and interim periods within fiscal years beginning after December 15, 2027, with early adoption permitted. The Company is currently evaluating ASU 2024-03’s additional disclosure requirements.
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3. Investment in Hotel Properties
Investment in hotel properties, net consisted of the following (in thousands):
Land
645,884
614,112
Buildings and improvements
2,818,307
2,587,278
Furniture, fixtures and equipment
442,872
407,861
Intangible assets
44,063
42,187
Construction in progress
117,513
61,247
Investment in hotel properties, gross
4,068,639
3,712,685
Accumulated depreciation and amortization
(1,218,764)
(1,127,406)
In April 2024, the Company purchased the fee-simple interest in the 630-room Hyatt Regency San Antonio Riverwalk, located in San Antonio Texas, for a contractual purchase price of $230.0 million. In addition to the fee-simple interest in the hotel, an affiliate of the seller will reimburse the Company for the first $8.0 million of capital invested into the hotel pursuant to the hotel’s management agreement. The acquisition was accounted for as an asset acquisition and was funded from available cash.
4. Fair Value Measurements and Interest Rate Derivatives
Fair Value Measurements
As of September 30, 2024 and December 31, 2023, the carrying amount of certain financial instruments, including cash and cash equivalents, restricted cash, accounts receivable and accounts payable and accrued expenses were representative of their fair values due to the short-term maturity of these instruments.
A fair value measurement is based on the assumptions that market participants would use in pricing an asset or liability in an orderly transaction. The hierarchy for inputs used in measuring fair value is as follows:
Level 1
Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2
Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the asset or the liability; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3
Unobservable inputs reflecting the Company’s own assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.
As of both September 30, 2024 and December 31, 2023, the Company measured its interest rate derivatives at fair value on a recurring basis. The Company estimated the fair value of its interest rate derivatives using Level 2 measurements based on quotes obtained from the counterparties, which are based upon the consideration that would be required to terminate the agreements.
Fair Value of Debt
As of September 30, 2024 and December 31, 2023, 51.1% and 51.2%, respectively, of the Company’s outstanding debt had fixed interest rates, including the effects of interest rate swap derivatives. The Company uses Level 3 measurements to estimate the fair value of its debt by discounting the future cash flows of each instrument at estimated market rates.
The Company’s principal balances and fair market values of its consolidated debt as of September 30, 2024 (unaudited) and December 31, 2023 were as follows (in thousands):
September 30, 2024
December 31, 2023
Carrying Amount (1)
Fair Value (2)
Debt
817,437
817,252
819,050
805,212
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Interest Rate Derivatives
The Company’s interest rate derivatives, which are not designated as effective cash flow hedges, consisted of the following at September 30, 2024 (unaudited) and December 31, 2023 (in thousands):
Estimated Fair Value of Assets (Liabilities) (1)
Strike / Capped
Effective
Maturity
Notional
Hedged Debt
Type
Rate
Index
Date
Term Loan 1
Swap
3.675
%
CME Term SOFR
March 17, 2023
March 17, 2026
75,000
(966)
417
3.931
September 14, 2023
September 14, 2026
(113)
(401)
(1,079)
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Noncash changes in the fair values of the Company’s interest rate derivatives resulted in increases (decreases) to interest expense for the three and nine months ended September 30, 2024 and 2023 as follows (unaudited and in thousands):
3,326
(1,469)
5. Prepaid Expenses and Other Assets
Prepaid expenses and other assets, net consisted of the following (in thousands):
Prepaid expenses
13,300
8,123
Inventory
10,474
9,185
Deferred financing costs
2,574
3,627
Property and equipment, net
2,515
3,120
Interest rate derivatives
Deferred rent on straight-lined third-party tenant leases
437
552
Liquor licenses
930
Other
436
429
Total prepaid expenses and other assets, net
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6. Notes Payable
Notes payable consisted of the following (in thousands):
Balance Outstanding as of
Rate Type
Interest Rate
Maturity Date
Mortgage Loans
JW Marriott New Orleans
Fixed
4.15
December 11, 2024
72,437
74,050
Unsecured Corporate Credit Facilities
5.27
July 25, 2027
175,000
Term Loan 2
Variable
(2)
6.70
January 25, 2028
Term Loan 3
6.55
May 1, 2025
Total unsecured corporate credit facilities
575,000
Unsecured Senior Notes
Series A
4.69
January 10, 2026
65,000
Series B
4.79
January 10, 2028
105,000
Total unsecured senior notes
170,000
Total debt
Unamortized deferred financing costs
(3,325)
(4,491)
As of September 30, 2024, the Company had no amount outstanding on its credit facility, with $500.0 million of capacity available for borrowing under the facility. The Company’s ability to draw on the credit facility is subject to the Company’s compliance with various covenants.
Interest Expense
Total interest incurred and expensed on the Company’s debt was as follows (unaudited and in thousands):
Interest expense on debt
12,395
12,623
37,012
36,299
741
740
Capitalized interest
(480)
(641)
Total interest expense
15,982
11,894
39,685
34,911
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7. Other Liabilities
Other Liabilities
Other liabilities consisted of the following (in thousands):
Advance deposits
Property, sales and use taxes payable
15,254
6,903
Accrued interest
2,984
6,346
Deferred rent
1,752
2,711
Income taxes payable
2,860
Interest rate derivative
1,079
401
Management fees payable
1,321
6,517
7,040
Total other liabilities
8. Leases
As of both September 30, 2024 and December 31, 2023, the Company had operating leases for ground, office, equipment and airspace leases with maturity dates ranging from 2025 through 2097, excluding renewal options. Including renewal options available to the Company, the lease maturity date extends to 2147.
Operating leases were included on the Company’s consolidated balance sheets as follows (in thousands):
Right-of-use assets, net
Lease obligations
Weighted average remaining lease term
25 years
Weighted average discount rate
5.4
The components of lease expense were as follows (unaudited and in thousands):
Operating lease cost
1,334
1,360
4,024
4,068
Variable lease cost (1)
2,015
2,481
6,521
6,764
Sublease income (2)
(296)
(890)
Total lease cost
3,053
3,545
9,655
9,942
9. Stockholders’ Equity
Series G Cumulative Redeemable Preferred Stock
Contemporaneous with the Company’s April 2021 purchase of the Montage Healdsburg, the Company issued 2,650,000 shares of its Series G Cumulative Redeemable Preferred Stock (“Series G preferred stock”) to the hotel’s seller as partial payment of the hotel. The Series G preferred stock, which is callable at its $25.00 redemption price plus accrued and unpaid dividends by the Company at any time, initially accrued dividends at a rate equal to the Montage Healdsburg’s annual net operating income yield on the
Company’s total investment in the resort. In January 2024, the annual dividend rate increased to the greater of 3.0% or the rate equal to the Montage Healdsburg’s annual net operating income yield on the Company’s total investment in the resort. Beginning with the third quarter of 2024, the annual dividend rate increased to the greater of 4.5% or the rate equal to the Montage Healdsburg’s annual net operating income yield on the Company’s total investment in the resort. The Series G preferred stock is not convertible into any other security.
Series H Cumulative Redeemable Preferred Stock
In May 2021, the Company issued 4,600,000 shares of its 6.125% Series H Cumulative Redeemable Preferred Stock (“Series H preferred stock”) with a liquidation preference of $25.00. On or after May 24, 2026, the Series H preferred stock will be redeemable at the Company’s option, in whole or in part, at any time or from time to time, for cash at a redemption price of $25.00 per share, plus accrued and unpaid dividends up to, but not including, the redemption date. Upon the occurrence of a change of control, as defined by the Articles Supplementary for Series H preferred stock, the Company may at its option redeem the Series H preferred stock for cash at a redemption price of $25.00 per share, plus accrued and unpaid dividends up to, but not including, the redemption date. If the Company chooses not to redeem the Series H preferred stock upon the occurrence of a change of control, holders of the Series H preferred stock may convert their preferred shares into shares of the Company’s common stock.
Series I Cumulative Redeemable Preferred Stock
In July 2021, the Company issued 4,000,000 shares of its 5.70% Series I Cumulative Redeemable Preferred Stock (“Series I preferred stock”) with a liquidation preference of $25.00. On or after July 16, 2026, the Series I preferred stock will be redeemable at the Company’s option, in whole or in part, at any time or from time to time, for cash at a redemption price of $25.00 per share, plus accrued and unpaid dividends up to, but not including, the redemption date. Upon the occurrence of a change of control, as defined by the Articles Supplementary for Series I preferred stock, the Company may at its option redeem the Series I preferred stock for cash at a redemption price of $25.00 per share, plus accrued and unpaid dividends up to, but not including, the redemption date. If the Company chooses not to redeem the Series I preferred stock upon the occurrence of a change of control, holders of the Series I preferred stock may convert their preferred shares into shares of the Company’s common stock.
Stock Repurchase Program. In February 2023, the Company’s board of directors reauthorized the Company’s existing stock repurchase program, allowing the Company to acquire up to an aggregate of $500.0 million of its common and preferred stock. The stock repurchase program has no stated expiration date.
Details of the Company’s repurchases were as follows (dollars in thousands):
Number of common shares repurchased
2,311,365
1,561,375
2,670,373
3,827,759
Cost, including fees and commissions
22,672
14,042
26,294
35,523
Number of preferred shares repurchased
As of September 30, 2024, $428.5 million remains available for repurchase under the stock repurchase program. Future repurchases will depend on various factors, including the Company’s capital needs and restrictions under its various financing agreements, as well as the price of the Company’s common and preferred stock.
ATM Agreements. In March 2023, the Company entered into separate “At the Market” Agreements (the “ATM Agreements”) with several financial institutions. In accordance with the terms of the ATM Agreements, the Company may from time to time offer and sell shares of its common stock having an aggregate offering price of up to $300.0 million. No common stock was issued under the ATM Agreements during either the three or nine months ended September 30, 2024 and 2023, leaving $300.0 million available for sale.
10. Incentive Award Plan
The Company’s Incentive Award Plan (the “Plan”) provides for granting discretionary awards to employees, consultants and non-employee directors. The awards may be made in the form of options, restricted stock awards, dividend equivalents, stock payments, restricted stock units, other incentive awards, LTIP units or share appreciation rights.
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Should a stock grant be forfeited prior to its vesting, the shares covered by the stock grant are added back to the Plan and remain available for future issuance. Shares of common stock tendered or withheld to satisfy the grant or exercise price or tax withholding obligations upon the vesting of a stock grant are not added back to the Plan.
Restricted shares and units are measured at fair value on the date of grant and amortized as compensation expense over the relevant requisite service period or derived service period. The Company has elected to account for forfeitures as they occur.
As of both September 30, 2024 and 2023, the Company’s issued and outstanding awards consisted of both time-based and performance-based restricted stock grants. The Company’s amortization expense, including forfeitures related to restricted shares was as follows (unaudited and in thousands):
Amortization expense, including forfeitures
2,430
2,511
Capitalized compensation cost (1)
(79)
117
Restricted Stock Awards
The Company’s restricted stock awards are time-based restricted shares that generally vest over periods ranging from three years to five years from the date of grant. The following is a summary of non-vested restricted stock award activity for the nine months ended September 30, 2024:
Weighted-Average
Grant Date
Number of Shares
Fair Value
Unvested at January 1, 2024
1,032,266
11.11
Granted
444,077
10.66
Vested
(719,924)
11.25
Forfeited
10.89
Unvested at September 30, 2024
688,288
10.70
Restricted Stock Units
The Company’s restricted stock units are performance-based restricted shares that generally vest based on the Company’s total relative shareholder return or the achievement of pre-determined stock price targets during performance periods ranging from three years to five years. The following is a summary of non-vested restricted stock unit activity, at target performance, for the nine months ended September 30, 2024:
Target Number
of Shares
1,076,160
10.69
475,746
11.50
(119,732)
11.21
(50,100)
1,382,074
10.90
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The restricted stock units granted during the first nine months of 2024 vest based on the Company’s total relative shareholder return following a three-year performance period. The number of shares that may become vested ranges from zero to 200% of the amount granted. The grant date fair values of the restricted stock units were determined using a Monte Carlo simulation model with the following assumptions:
Expected volatility
31.0
Dividend yield (1)
Risk-free rate
4.34
Expected term
3 years
11. Commitments and Contingencies
Management Agreements
Management agreements with the Company’s third-party hotel managers currently require the Company to pay between 2.0% and 3.0% of total revenue of the managed hotels to the third-party managers each month as a basic management fee. In addition to basic management fees, provided that certain operating thresholds are met, the Company may also be required to pay incentive management fees to certain of its third-party managers.
Total basic management and incentive management fees were included in other property-level expenses on the Company’s consolidated statements of operations as follows (unaudited and in thousands):
Basic management fees
6,022
6,774
18,635
21,101
Incentive management fees
604
2,603
6,546
Total basic and incentive management fees
5,278
7,378
21,238
27,647
License and Franchise Agreements
The Company has entered into license and franchise agreements related to certain of its hotels. The license and franchise agreements require the Company to, among other things, pay monthly fees that are calculated based on specified percentages of certain revenues. The license and franchise agreements generally contain specific standards for, and restrictions and limitations on, the operation and maintenance of the hotels which are established by the franchisors to maintain uniformity in the system created by each such franchisor. Such standards generally regulate the appearance of the hotel, quality and type of goods and services offered, signage and protection of trademarks. Compliance with such standards may from time to time require the Company to make significant expenditures for capital improvements.
Total license and franchise fees were included in franchise costs on the Company’s consolidated statements of operations as follows (unaudited and in thousands):
Franchise assessments (1)
4,411
4,025
12,781
11,842
Franchise royalties
300
253
954
914
Total franchise costs
Renovation and Construction Commitments
At September 30, 2024, the Company had various contracts outstanding with third parties in connection with the ongoing renovations of certain of its hotels. The remaining commitments under these contracts at September 30, 2024 totaled $79.3 million.
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Concentration of Risk
The concentration of the Company’s hotels in California, Florida, Hawaii and Washington DC exposes the Company’s business to economic and severe weather conditions, competition and real and personal property tax rates unique to these locales.
As of September 30, 2024, our hotels were geographically concentrated as follows (unaudited):
Trailing 12-Month
Percentage of
Total Consolidated
Number of Hotels
Total Rooms
Revenue
Northern California
21
Southern California
22
Florida
Hawaii
Washington DC
In accordance with the assignment-in-lieu agreement executed in December 2020 between the Company and the mortgage holder of a hotel disposed of in a prior year, the Company was required to retain reserves for certain current and potential employee-related obligations (the “potential obligation”). There was $0.2 million included in accounts payable and accrued expenses for the potential obligation on the accompanying consolidated balance sheet as of December 31, 2023. The potential obligation was reassessed at the end of the first and second quarters of 2024, resulting in a total gain on extinguishment of debt of $0.1 million, which was included on the accompanying consolidated statement of operations for the nine months ended September 30, 2024. In the second quarter of 2024, the escrow agreement was terminated and the remaining $0.1 million of restricted cash held in escrow was returned to the Company.
The Company has provided customary unsecured indemnities to certain lenders, including in particular, environmental indemnities. The Company has performed due diligence on the potential environmental risks, including obtaining an independent environmental review from outside environmental consultants. These indemnities obligate the Company to reimburse the indemnified parties for damages related to certain environmental matters. There is no term or damage limitation on these indemnities; however, if an environmental matter arises, the Company could have recourse against other previous owners or a claim against its environmental insurance policies.
At September 30, 2024, the Company had $0.2 million of outstanding irrevocable letters of credit to guarantee the Company’s financial obligations related to workers’ compensation insurance programs from prior policy years. The beneficiaries of these letters of credit may draw upon the letters of credit in the event of a contractual default by the Company relating to each respective obligation. No draws have been made through September 30, 2024. The letters of credit are collateralized with $0.2 million held in a restricted bank account owned by the Company, which is included in restricted cash on the accompanying consolidated balance sheets as of both September 30, 2024 and December 31, 2023.
The Company is subject to various claims, lawsuits and legal proceedings, including routine litigation arising in the ordinary course of business, regarding the operation of its hotels, its managers and other Company matters. While it is not possible to ascertain the ultimate outcome of such matters, the Company believes that the aggregate identifiable amount of such liabilities, if any, in excess of amounts covered by insurance will not have a material adverse impact on its financial condition or results of operations. The outcome of claims, lawsuits and legal proceedings brought against the Company, however, is subject to significant uncertainties.
12. Subsequent Event
On November 7, 2024, the Company entered into a new delayed draw $100.0 million term loan agreement with several financial institutions. The new term loan will bear interest pursuant to a leverage-based pricing grid ranging from 1.35% to 2.20% over the applicable adjusted term SOFR and the Company may elect to swap some or all of the loan balance to fixed rates. The new term loan has an initial term of one year with two six-month extension options at the Company’s election, resulting in an extended maturity of November 7, 2026. The Company expects to fully draw the new term loan in early December and use most of the proceeds to repay the loan secured by the JW Marriott New Orleans, which matures December 11, 2024 and is projected to have a balance of $72.1 million.
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Cautionary Statement
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. The Company intends such forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and includes this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe the Company’s future plans, strategies and expectations, are generally identifiable by use of the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “project,” or similar expressions. You should not rely on forward-looking statements because they involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond the Company’s control, and which could materially affect actual results, performances or achievements. Accordingly, there is no assurance that the Company’s expectations will be realized. In evaluating these statements, you should specifically consider the risks outlined in detail in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on February 23, 2024, under the caption “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q, including but not limited to the following factors:
These factors may cause our actual events to differ materially from the expectations expressed or implied by any forward-looking statement. Except as otherwise required by federal securities laws, the Company disclaims any obligations or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in the
Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Sunstone Hotel Investors, Inc. (the “Company,” “we,” “our” or “us”) is a Maryland corporation. We operate as a self-managed and self-administered real estate investment trust (“REIT”). A REIT is a corporation that directly or indirectly owns real estate assets and has elected to be taxable as a real estate investment trust for federal income tax purposes. To qualify for taxation as a REIT, the REIT must meet certain requirements, including regarding the composition of its assets and the sources of its income. REITs generally are not subject to federal income taxes at the corporate level as long as they pay stockholder dividends equivalent to 100% of their taxable income. REITs are required to distribute to stockholders at least 90% of their REIT taxable income. We own, directly or indirectly, 100% of the interests of Sunstone Hotel Partnership, LLC (the “Operating Partnership”), which is the entity that directly or indirectly owns our hotels. We also own 100% of the interests of our taxable REIT subsidiary, Sunstone Hotel TRS Lessee, Inc. (the “TRS Lessee”), which, directly or indirectly, leases all of our hotels from the Operating Partnership, and engages independent third-parties to manage our hotels.
We own hotels in urban and resort destinations that benefit from significant barriers to entry by competitors and diverse economic drivers. As of September 30, 2024, we owned 15 hotels (the “15 Hotels”), which average 484 rooms in size. All of our hotels are operated under nationally recognized brands, except the Oceans Edge Resort & Marina, which has established itself in a resort destination market.
Operating Activities
Revenues. Substantially all of our revenues are derived from the operation of our hotels. Specifically, our revenues consist of the following:
Expenses. Our expenses consist of the following:
Other Revenue and Expense. Other revenue and expense consists of the following:
Operating Performance Indicators. The following performance indicators are commonly used in the hotel industry:
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Factors Affecting Our Operating Results. The primary factors affecting our operating results include overall demand for hotel rooms, the pace of new hotel development, or supply, and the relative performance of our operators in increasing revenue and controlling hotel operating expenses.
25
Operating Results. The following table presents our unaudited operating results for the three months ended September 30, 2024 and 2023, including the amount and percentage change in the results between the two periods.
Change $
Change %
(in thousands, except statistical data)
(19,708)
(12.4)
(141)
(0.2)
(1,459)
(5.8)
(21,308)
(8.6)
Hotel operating
144,026
151,538
(7,512)
(5.0)
(2,318)
(8.0)
450
6.3
(1,499)
(4.5)
(10,879)
(4.9)
1,132
92.9
(4,088)
(34.4)
(9)
(100.0)
(13,394)
(82.9)
1,085
180.2
(12,309)
(79.1)
(705)
(21.9)
(13,014)
(105.5)
The following table presents our unaudited operating results for the nine months ended September 30, 2024 and 2023, including the amount and percentage change in the results between the two periods.
(58,434)
(12.1)
(17,062)
(720)
(1.0)
(76,216)
(9.9)
424,284
452,614
(28,330)
(6.3)
(10,209)
(11.0)
(728)
(3.0)
(6,086)
(6.2)
(45,353)
(6.8)
4,908
76.7
(4,774)
(13.7)
100.0
(9,871)
(99.4)
(40,143)
(49.3)
2,846
161.4
(37,297)
(46.8)
(535)
INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS
(37,832)
(54.9)
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Summary of Operating Results. The following items significantly impact the year-over-year comparability of our operations:
Room revenue. Room revenue decreased $19.7 million, or 12.4%, in the third quarter of 2024 as compared to the third quarter of 2023 as follows:
Change
Occ%
ADR
RevPAR
Two Renovation Hotels
39.6
219.50
86.92
63.9
204.71
130.81
(2,430)
bps
7.2
(33.6)
Comparable Portfolio
72.3
318.79
230.49
69.8
327.94
228.90
250
(2.8)
0.7
For the nine months ended September 30, 2024, room revenue decreased $58.4 million, or 12.1%, as compared to the nine months ended September 30, 2023 as follows:
34.8
234.41
81.57
71.4
253.66
181.11
(3,660)
(7.6)
(55.0)
27
73.7
329.22
242.64
71.5
335.02
239.54
220
(1.7)
1.3
Food and beverage revenue. Food and beverage revenue decreased $0.1 million, or 0.2%, in the third quarter of 2024 as compared to the third quarter of 2023, as follows:
For the first nine months of 2024, food and beverage revenue decreased $17.1 million, or 8.0%, as compared to the first nine months of 2023, as follows:
Other operating revenue. Other operating revenue decreased $1.5 million, or 5.8%, in the third quarter of 2024 as compared to the third quarter of 2023 as follows:
For the first nine months of 2024, other operating revenue decreased $0.7 million, or 1.0%, as compared to the first nine months of 2023 as follows:
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Hotel operating expenses. Hotel operating expenses, which are comprised of room, food and beverage, advertising and promotion, repairs and maintenance, utilities, franchise costs, property tax, ground lease and insurance, and other hotel operating expenses decreased $7.5 million, or 5.0%, in the third quarter of 2024 as compared to the third quarter of 2023 as follows:
For the first nine months of 2024, hotel operating expenses decreased $28.3 million, or 6.3%, as compared to the first nine months of 2023 as follows:
Other property-level expenses. Other property-level expenses decreased $2.3 million, or 8.0%, in the third quarter of 2024 as compared to the third quarter of 2023 as follows:
For the first nine months of 2024, other property-level expenses decreased $10.2 million, or 11.0%, as compared to the first nine months of 2023 as follows:
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Corporate overhead expense. Corporate overhead expense increased $0.5 million, or 6.3%, in the third quarter of 2024 as compared to the third quarter of 2023, primarily due to increased due diligence fees, professional fees, and entity-level state franchise and minimum taxes. These increased expenses were partially offset by decreased payroll and related expenses and deferred stock amortization expense.
For the first nine months of 2024, corporate overhead expense decreased $0.7 million, or 3.0%, as compared to the first nine months of 2023, primarily due to decreased entity-level state franchise and minimum taxes, payroll and related expenses, and board of director expenses. These decreased expenses were partially offset by increased professional fees, deferred stock amortization expense, and due diligence expenses.
Depreciation and amortization expense. Depreciation and amortization expense decreased $1.5 million, or 4.5%, in the third quarter of 2024 as compared to the third quarter of 2023 as follows:
For the first nine months of 2024, depreciation and amortization expense decreased $6.1 million, or 6.2%, as compared to the first nine months of 2023 as follows:
Interest and other income. Interest and other income totaled $2.4 million and $1.2 million in the third quarters of 2024 and 2023, respectively, and $11.3 million and $6.4 million in the first nine months of 2024 and 2023, respectively.
During the third quarters of 2024 and 2023, we recognized interest income of $2.3 million and $1.2 million, respectively. Interest income increased in the third quarter of 2024 as compared to the third quarter of 2023 due to increases in our cash balances as well as increased interest rates. In addition, during the third quarter of 2024, we recognized other miscellaneous income of $0.1 million.
During the first nine months of 2024 and 2023, we recognized interest income of $10.9 and $2.7 million, respectively. Interest income increased in the first nine months of 2024 as compared to the first nine months of 2023 due to increases in our cash balances as well as increased interest rates. In addition, during the first nine months of 2024 and 2023, we recognized property insurance recoveries of $0.3 million and $3.7 million related to fire damage at the Hilton San Diego Bayfront and Hurricane Ida-related property damage at the Hilton New Orleans St. Charles, respectively. During the first nine months of 2024, we also recognized other miscellaneous income of $0.1 million.
We expect our interest income will decrease in the fourth quarter of 2024 and into 2025 in accordance with the Federal Reserve Board’s interest rates reductions and our lower cash balances.
Interest expense. We incurred interest expense as follows (in thousands):
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Interest expense increased $4.1 million, or 34.4%, and $4.8 million, or 13.7%, in the third quarter and first nine months of 2024, respectively, as compared to the same periods in 2023.
The increase in interest expense during the third quarter of 2024 was primarily due to a $4.8 million noncash change in the fair market value of our derivatives. This increase to expense was partially offset by $0.5 million in capitalized interest and a $0.2 million decrease in interest expense on our debt. During the third quarter of 2024, we capitalized $0.5 million of interest expense related to the extensive renovation work at The Confidante Miami Beach as it transitions to Andaz Miami Beach. Interest expense on our debt decreased $0.2 million primarily due to decreased interest on our variable rate debt.
The increase in interest expense during the first nine months of 2024 was primarily due to a $4.4 million noncash change in the fair market value of our derivatives. In addition, interest expense on our debt increased $0.7 million primarily due to increased interest on our variable rate debt and our draw of the $225.0 million available under our third term loan in May 2023, which was partially offset due to our repayment of the $220.0 million loan secured by the Hilton San Diego Bayfront in May 2023. The amortization of deferred financing costs caused interest expense to increase $0.3 million in the first nine months of 2024 as compared to the same period in 2023 due to costs incurred on our third term loan. These increases were partially offset by $0.6 million of interest capitalized related to the extensive renovation work at The Confidante Miami Beach as it transitions to Andaz Miami Beach.
Our weighted average interest rate per annum, including our variable rate debt obligations and excluding capitalized interest, was approximately 5.7% and 5.8% at September 30, 2024 and 2023, respectively. Approximately 51.1% and 51.2% of our outstanding notes payable had fixed interest rates or had been swapped to fixed interest rates at September 30, 2024 and 2023, respectively.
Gain on sale of assets, net. Gain on sale of assets, net totaled zero and $0.5 million for the third quarter and first nine months of 2024, respectively, and zero for both the third quarter and first nine months of 2023. In the first quarter of 2024, we recognized an additional $0.5 million net gain related to a contingency resolution at a hotel sold in a prior year.
Gain on extinguishment of debt. Gain on extinguishment of debt totaled zero and a nominal amount for the third quarters of 2024 and 2023, respectively. In the third quarter of 2023, we recorded a nominal gain associated with reassessments of the remaining potential employee-related obligations held in escrow associated with our assignment of a hotel to the hotel’s mortgage holder in 2020.
For the first nine months of 2024 and 2023, gain on extinguishment of debt totaled $0.1 million and $9.9 million, respectively, both of which were related to the remaining potential employee-related obligations noted above in the discussion regarding the third quarter of 2023. During the first nine months of 2024, we recognized $21,000 due to reassessments of the remaining potential employee-related obligations held in escrow, and $38,000 due to the release of the remaining potential employee-related obligations in conjunction with the termination of the escrow agreement during the second quarter of 2024. During the first nine months of 2023 we recognized a gain of $9.9 million, comprised of $9.8 million from the relief of the majority of the potential employee-related obligations, with the funds released to us from escrow, and $0.1 million due to reassessments of the remaining potential employee-related obligations held in escrow.
Income tax benefit (provision), net. We lease our hotels to the TRS Lessee and its subsidiaries, which are subject to federal and state income taxes. In addition, we and the Operating Partnership may also be subject to various state and local income taxes.
In the third quarter and first nine months of 2024, we recognized net current income tax benefits of $0.5 million and $1.1 million, respectively, resulting from current state and federal income tax expenses, net of any refunds.
In the third quarter and first nine months of 2023, we recognized current income tax provisions of $0.6 million and $1.8 million, respectively, resulting from current state and federal income tax expenses.
Preferred stock dividends. Preferred stock dividends were incurred as follows (in thousands):
Series G preferred stock
745
1,739
1,204
Series H preferred stock
1,761
5,283
Series I preferred stock
1,425
4,275
Total preferred stock dividends
3,931
3,226
11,297
10,762
The Series G preferred stock initially accrued dividends at a rate equal to the Montage Healdsburg’s annual net operating income yield on our total investment in the resort. In the first and third quarters of 2024, the annual dividend rate increased to the
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greater of 3.0% and 4.5%, respectively, or the rate equal to the Montage Healdsburg’s annual net operating income yield on our total investment in the resort.
Non-GAAP Financial Measures. We use the following “non-GAAP financial measures” that we believe are useful to investors as key supplemental measures of our operating performance: EBITDAre; Adjusted EBITDAre; FFO attributable to common stockholders; and Adjusted FFO attributable to common stockholders. These measures should not be considered in isolation or as a substitute for measures of performance in accordance with accounting principles generally accepted in the United States (“GAAP”). In addition, our calculation of these measures may not be comparable to other companies that do not define such terms exactly the same as the Company. These non-GAAP measures are used in addition to and in conjunction with results presented in accordance with GAAP. They should not be considered as alternatives to net income (loss), cash flow from operations, or any other operating performance measure prescribed by GAAP. These non-GAAP financial measures reflect additional ways of viewing our operations that we believe, when viewed with our GAAP results and the reconciliations to the corresponding GAAP financial measures, provide a more complete understanding of factors and trends affecting our business than could be obtained absent this disclosure. We strongly encourage investors to review our financial information in its entirety and not to rely on a single financial measure.
We present EBITDAre in accordance with guidelines established by the National Association of Real Estate Investment Trusts (“Nareit”), as defined in its September 2017 white paper “Earnings Before Interest, Taxes, Depreciation and Amortization for Real Estate.” We believe EBITDAre is a useful performance measure to help investors evaluate and compare the results of our operations from period to period in comparison to our peers. Nareit defines EBITDAre as net income (calculated in accordance with GAAP) plus interest expense, income tax expense, depreciation and amortization, gains or losses on the disposition of depreciated property (including gains or losses on change in control), impairment write-downs of depreciated property and of investments in unconsolidated affiliates caused by a decrease in the value of depreciated property in the affiliate, and adjustments to reflect the entity’s share of EBITDAre of unconsolidated affiliates.
We make additional adjustments to EBITDAre when evaluating our performance because we believe that the exclusion of certain additional items described below provides useful information to investors regarding our operating performance, and that the presentation of Adjusted EBITDAre, when combined with the primary GAAP presentation of net income, is beneficial to an investor’s complete understanding of our operating performance. In addition, we use both EBITDAre and Adjusted EBITDAre as measures in determining the value of hotel acquisitions and dispositions.
We adjust EBITDAre for the following items, which may occur in any period, and refer to this measure as Adjusted EBITDAre:
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The following table reconciles our unaudited net income to EBITDAre and Adjusted EBITDAre for the three and nine months ended September 30, 2024 and 2023 (in thousands):
Income tax (benefit) provision, net
(483)
602
(1,083)
1,763
EBITDAre
50,437
61,242
172,412
214,324
Amortization of right-of-use assets and obligations
(153)
(13)
Amortization of contract intangibles, net
(19)
(55)
Pre-opening costs
853
1,452
Adjustments to EBITDAre, net
3,130
2,470
9,189
(5,526)
Adjusted EBITDAre
53,567
63,712
181,601
208,798
Adjusted EBITDAre decreased $10.1 million, or 15.9%, in the third quarter of 2024 as compared to the third quarter of 2023, and $27.2 million, or 13.0%, in the first nine months of 2024 as compared to the first nine months of 2023 primarily due to the following:
We believe that the presentation of FFO attributable to common stockholders provides useful information to investors regarding our operating performance because it is a measure of our operations without regard to specified noncash items such as real estate depreciation and amortization, any real estate impairment loss and any gain or loss on sale of real estate assets, all of which are based on historical cost accounting and may be of lesser significance in evaluating our current performance. Our presentation of FFO attributable to common stockholders conforms to the Nareit definition of “FFO applicable to common shares.” Our presentation may not be comparable to FFO reported by other REITs that do not define the terms in accordance with the current Nareit definition, or that interpret the current Nareit definition differently than we do.
We also present Adjusted FFO attributable to common stockholders when evaluating our operating performance because we believe that the exclusion of certain additional items described below provides useful supplemental information to investors regarding our ongoing operating performance and may facilitate comparisons of operating performance between periods and our peer companies.
We adjust FFO attributable to common stockholders for the following items, which may occur in any period, and refer to this measure as Adjusted FFO attributable to common stockholders:
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The following table reconciles our unaudited net income to FFO attributable to common stockholders and Adjusted FFO attributable to common stockholders for the three and nine months ended September 30, 2024 and 2023 (in thousands):
Real estate depreciation and amortization
31,320
33,025
90,846
97,456
FFO attributable to common stockholders
30,638
45,357
121,518
166,417
Real estate amortization of right-of-use assets and obligations
(129)
(124)
(381)
(371)
315
84
833
252
Prior year income tax benefit, net
(1,530)
Adjustments to FFO attributable to common stockholders, net
6,213
993
9,477
(8,856)
Adjusted FFO attributable to common stockholders
36,851
46,350
130,995
157,561
Adjusted FFO attributable to common stockholders decreased $9.5 million, or 20.5%, and $26.6 million, or 16.9%, in the third quarter and first nine months of 2024, respectively, as compared to the same periods in 2023 primarily due to the same reasons noted in the discussion above regarding Adjusted EBITDAre.
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Liquidity and Capital Resources
During the periods presented, our sources of cash included our operating activities and working capital, as well as proceeds from our term loan, property insurance, and a hotel disposition deposit. Our primary uses of cash were for capital expenditures for hotels and other assets, an acquisition of a hotel, operating expenses, repurchases of our common stock, repayments of notes payable and dividends and distributions on our preferred and common stock. We cannot be certain that traditional sources of funds will be available in the future.
Operating activities. Our net cash provided by or used in operating activities fluctuates primarily as a result of changes in the net cash generated by our hotels, offset by the cash paid for corporate expenses. Our net cash provided by or used in operating activities may also be affected by changes in our portfolio resulting from hotel acquisitions, dispositions or renovations. Net cash provided by operating activities was $139.9 million in the first nine months of 2024 as compared to $168.7 million in the first nine months of 2023. The net decrease in cash provided by operating activities during the first nine months of 2024 as compared to the same period in 2023 was primarily due to decreases in operating cash at the Two Renovation Hotels, as well as decreases caused by our sale of the Boston Park Plaza and higher interest payments on our variable rate debt, partially offset by the acquisition of the Hyatt Regency San Antonio Riverwalk as well as additional operating cash provided by the increase in travel demand benefiting our hotels.
Investing activities. Our net cash provided by or used in investing activities fluctuates primarily as a result of acquisitions, dispositions and renovations of hotels and other assets. Net cash used in investing activities during the first nine months of 2024 as compared to the first nine months of 2023 was as follows (in thousands):
During the first nine months of 2024, we paid $229.3 million to acquire the Hyatt Regency San Antonio Riverwalk, including closing costs and prorations and we invested $110.2 million for renovations and additions to our portfolio and other assets. These cash outflows were slightly offset by $0.3 million in property insurance proceeds received related to fire damage at the Hilton San Diego Bayfront.
During the first nine months of 2023, we received a disposition deposit of $10.0 million from the buyer of the Boston Park Plaza, which we sold in October 2023, and we received insurance proceeds of $3.7 million for hurricane-related property damage at the Hilton New Orleans St. Charles. These cash inflows were offset by $73.9 million invested for renovations and additions to our portfolio and other assets.
Financing activities. Our net cash provided by or used in financing activities fluctuates primarily as a result of our dividends and distributions paid, issuance and repurchase of common stock, issuance and repayment of notes payable and our credit facility, and issuance and redemption of other forms of capital, including preferred equity. Net cash used in financing activities during the first nine months of 2024 as compared to the first nine months of 2023 was as follows (in thousands):
During the first nine months of 2024, we paid $26.3 million to repurchase 2,670,373 shares of our outstanding common stock, $4.2 million to repurchase common stock to satisfy the tax obligations in connection with the vesting of restricted common stock issued to employees, $1.6 million in scheduled principal payments on our loan secured by the JW Marriott New Orleans and $69.7 million in dividends and distributions to our preferred and common stockholders.
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During the first nine months of 2023, we paid an additional $0.3 million to true-up the total acquisition cost of the outside 25.0% equity interest in the entity that owns the Hilton San Diego Bayfront and $0.4 million in common stock offering costs related to our shelf registration statement. In addition, we paid $35.5 million to repurchase 3,827,759 shares of our outstanding common stock, $3.3 million to repurchase common stock to satisfy the tax obligations in connection with the vesting of restricted common stock issued to employees, and $42.2 million in dividends and distributions to our preferred and common stockholders. We also entered into a term loan agreement, receiving $225.0 million in proceeds and paying $2.3 million in related deferred financing costs. We utilized the proceeds received from the term loan to repay the $220.0 million loan secured by the Hilton San Diego Bayfront. We also paid $1.6 million in scheduled principal payments on our loan secured by the JW Marriott New Orleans.
Future. We expect our primary sources of cash will continue to be our operating activities, working capital, borrowing under our credit facility, additional issuances of notes payable, dispositions of hotel properties and proceeds from offerings of common and preferred stock. However, there can be no assurance that our future asset sales, debt issuances or equity offerings will be successfully completed. As a result of potential increases in inflation rates and interest rates, as well as possible recessionary periods in the future, certain sources of capital may not be as readily available to us as they have in the past or may only be available at higher costs.
We expect our primary uses of cash to be for operating expenses, capital investments in our hotels, repayment of principal on our notes payable and credit facility, interest expense, repurchases of our common stock, distributions on our common stock, dividends on our preferred stock and acquisitions of hotels or interests in hotels. In October 2024, we paid $0.2 million to repurchase 18,209 shares of our outstanding common stock, leaving $428.3 million available for repurchase under our stock repurchase program.
While both inflation and interest rates began to decrease in the third quarter of 2024, the recent increases in inflation and interest rates have had a negative effect on our operations. We have experienced increases in wages, employee-related benefits, food costs, commodity costs, including those used to renovate or reposition our hotels, property taxes, property and liability insurance, utilities and borrowing costs. The ability of our hotel operators to adjust rates has mitigated the impact of increased operating costs on our financial position and results of operations. However, the increases in interest rates negatively affected our variable rate debt, resulting in increased interest payments during the first nine months of 2024.
Cash Balance. As of September 30, 2024, our unrestricted cash balance was $115.5 million. We believe that our current unrestricted cash balance and our ability to draw the $500.0 million capacity available for borrowing under the unsecured revolving credit facility will enable us to successfully manage our Company.
Debt. As of September 30, 2024, we had $817.4 million of debt, $192.6 million of cash and cash equivalents, including restricted cash, and total assets of $3.1 billion. We believe that by maintaining appropriate debt levels, staggering maturity dates and maintaining a highly flexible structure, we will have lower capital costs than more highly leveraged companies, or companies with limited flexibility due to restrictive covenants.
As of September 30, 2024, 51.1% of our outstanding debt had fixed interest rates or had been swapped to fixed interest rates, including the loan secured by the JW Marriott New Orleans, unsecured corporate-level Term Loan 1 and two unsecured corporate-level senior notes.
The Company’s floating rate debt as of September 30, 2024 included the $175.0 million unsecured corporate-level Term Loan 2 and the $225.0 million unsecured corporate-level Term Loan 3.
On November 7, 2024, the Company entered into a new delayed draw $100.0 million term loan agreement with several financial institutions. The new term loan will bear interest pursuant to a leverage-based pricing grid ranging from 1.35% to 2.20% over the applicable adjusted term SOFR and we may elect to swap some or all of the loan balance to fixed rates. The new term loan has an initial term of one year with two six-month extension options at the Company’s election, resulting in an extended maturity of November 7, 2026. The Company expects to fully draw the new term loan in early December and use most of the proceeds received to repay the loan secured by the JW Marriott New Orleans, which matures December 11, 2024 and is projected to have a balance of $72.1 million.
We may in the future seek to obtain mortgages on one or more of our 14 unencumbered hotels (subject to certain provisions under our unsecured term loans and senior notes), all of which were held by subsidiaries whose interests were pledged to our credit facility as of September 30, 2024. Should we obtain secured financing on any of our unencumbered hotels, the amount of capital available through our credit facility or future unsecured borrowings may be reduced. Following the repayment of the loan secured by the JW Marriott New Orleans in December 2024, all of our hotels will be unencumbered and held by subsidiaries whose interests are pledged to our credit facility.
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Contractual Obligations. The following table summarizes our payment obligations and commitments as of September 30, 2024 (in thousands):
Payment due by period
Less Than
1 to 3
3 to 5
More than
1 year
years
5 years
Notes payable (1)
465,000
280,000
Interest obligations on notes payable (1) (2)
118,560
44,365
66,927
7,268
Operating lease obligations, including imputed interest (3)
11,687
5,881
3,057
1,765
984
Construction commitments
79,339
1,027,023
202,022
534,984
289,033
Capital Expenditures and Reserve Funds
We believe we maintain each of our hotels in good repair and condition and in general conformity with applicable franchise and management agreements, ground lease, laws and regulations. Our capital expenditures primarily relate to the ongoing maintenance of our hotels and are budgeted in the reserve accounts described in the following paragraph. We also incur capital expenditures for cyclical renovations, hotel repositionings and development. We invested $110.2 million and $73.9 million in our portfolio and other assets during the first nine months of 2024 and 2023, respectively. As of September 30, 2024, we have contractual construction commitments totaling $79.3 million for ongoing renovations. During the remainder of 2024, we will continue to incur significant capital expenditures as we complete the substantial renovation and rebranding of The Confidante Miami Beach to Andaz Miami Beach. If we renovate additional hotels in the future, our capital expenditures will likely increase.
With respect to our hotels that are operated under management or franchise agreements with major national hotel brands and our hotel subject to a first mortgage lien, we are obligated to maintain an FF&E reserve account for future planned and emergency-related capital expenditures at these hotels. The amount funded into each of these reserve accounts is determined pursuant to the management, franchise and loan agreements for each of the respective hotels, ranging between 2.0% and 5.5% of the respective hotel’s applicable annual revenue. As of September 30, 2024, our balance sheet includes restricted cash of $76.4 million, which was held in FF&E reserve accounts for future capital expenditures at the majority of our hotels. According to certain loan and management agreements, reserve funds are to be held by the lender or managers in restricted cash accounts, and we are not required to spend the entire amount in such reserve accounts each year.
Inflation
Inflation affects our expenses, including, without limitation, by increasing such costs as wages, employee-related benefits, food costs, commodity costs, including those used to renovate or reposition our hotels, property taxes, property and liability insurance, utilities and borrowing costs. We rely on our hotel operators to adjust room rates and pricing for hotel services to reflect the effects of inflation. However, previously contracted rates, competitive pressures or other factors may limit the ability of our operators to respond to inflation. As a result, our expenses may increase at higher rates than our revenue.
Seasonality and Volatility
As is typical of the lodging industry, we experience seasonality in our business. Demand at certain of our hotels is affected by seasonal business patterns that can cause quarterly fluctuations in our revenues.
Quarterly revenue also may be adversely affected by renovations and repositionings, our managers’ effectiveness in generating business and by events beyond our control, such as economic and business conditions, including a U.S. recession or increased inflation, trade conflicts and tariffs, changes impacting global travel, regional or global economic slowdowns, any flu or disease-related pandemic that impacts travel or the ability to travel, weather patterns, the adverse effects of climate change, the threat of terrorism, terrorist events, civil unrest, government shutdowns, events that reduce the capacity or availability of air travel, increased
37
competition from other hotels in our markets, new hotel supply or alternative lodging options and unexpected changes in business, commercial travel, leisure travel and tourism.
Critical Accounting Estimates
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities.
We evaluate our estimates on an ongoing basis. We base our estimates on historical experience, information that is currently available to us and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the most significant judgments and estimates used in the preparation of our consolidated financial statements.
Recoverability of assets that will continue to be used is measured by comparing the carrying amount of the asset to the related total future undiscounted net cash flows. If an asset’s carrying value is not recoverable through those cash flows, the asset is considered to be impaired. The impairment is measured by the difference between the asset’s carrying amount and its fair value. We perform a fair value assessment using valuation techniques such as discounted cash flows and comparable sales transactions in the market to estimate the fair value of the hotel and, if appropriate and available, current estimated net sales proceeds from pending offers. Our judgment is required in determining the discount rate, terminal capitalization rate, the estimated growth of revenues and expenses, revenue per available room and margins, as well as specific market and economic conditions.
Accounting for the acquisition of a hotel property or other entity requires either allocating the purchase price to the assets acquired and the liabilities assumed in the transaction at their respective relative fair values for an asset acquisition or recording the assets and liabilities at their estimated fair values with any excess consideration above net assets going to goodwill for a business combination. The most difficult estimations of individual fair values are those involving long-lived assets, such as property, equipment and intangible assets, together with any finance or operating lease right-of-use assets and their related obligations. When we acquire a hotel property or other entity, we use all available information to make these fair value determinations, including discounted cash flow analyses, market comparable data and replacement cost data. In addition, we make significant estimations regarding capitalization rates, discount rates, average daily rates, revenue growth rates and occupancy. We also engage independent valuation specialists to assist in the fair value determinations of the long-lived assets acquired and the liabilities assumed. The determination of fair value is subjective and is based in part on assumptions and estimates that could differ materially from actual results in future periods.
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We review any uncertain tax positions and, if necessary, we will record the expected future tax consequences of uncertain tax positions in the consolidated financial statements. Tax positions not deemed to meet the “more-likely-than-not” threshold are recorded as a tax benefit or expense in the current year. We are required to analyze all open tax years, as defined by the statute of limitations, for all major jurisdictions, which includes federal and certain states.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
To the extent that we incur debt with variable interest rates, our future income, cash flows and fair values relevant to financial instruments are dependent upon prevailing market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. We have no derivative financial instruments held for trading purposes. We use derivative financial instruments, which are intended to manage interest rate risks on our floating rate debt.
As of September 30, 2024, 51.1% of our debt obligations were fixed in nature or were subject to interest rate swap derivatives, which mitigates the effect of changes in interest rates on our cash interest payments. If the market rate of interest on our variable rate debt increases or decreases by 50 basis points, interest expense on an annualized basis would increase or decrease, respectively, our future consolidated earnings and cash flows by approximately $2.0 million based on the debt balances and variable rates at September 30, 2024.
Item 4. Controls and Procedures
Attached as exhibits to this Form 10-Q are the certifications required by Rule 13a-14 of the Securities Exchange Act of 1934, as amended. This section includes information concerning the controls and control evaluations referred to in the certifications.
Evaluation of Disclosure Controls and Procedures. Based upon an evaluation of the effectiveness of disclosure controls and procedures, our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) have concluded that as of the end of the period covered by this Quarterly Report on Form 10-Q our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act) were effective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Securities and Exchange Commission and is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting. During our fiscal quarter to which this Quarterly Report on Form 10-Q relates, there has not occurred any change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
In September 2024, the Company withheld 91,439 shares of its restricted stock at an average market value of $10.31 per share and used the proceeds to satisfy the tax obligations in connection with the vesting of restricted common shares issued to employees.
Maximum Number (or
Total Number of
Appropriate Dollar
Shares Purchased
Value) of Shares that
Total Number
as Part of Publicly
May Yet Be Purchased
Average Price Paid
Announced Plans
Under the Plans or
Period
Purchased
per Share
or Programs
Programs
July 1, 2024 - July 31, 2024
451,078,555
August 1, 2024 - August 31, 2024
1,694,337
9.75
434,559,637
September 1, 2024 - September 30, 2024
708,467
9.95
617,028
428,452,987
2,402,804
9.81
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
The following Exhibits are filed as a part of this report:
Exhibit Number
Description
3.1
Articles of Amendment and Restatement of Sunstone Hotel Investors, Inc. (incorporated by reference to Exhibit 3.1 to the registration statement on Form S-11 (File No. 333-117141) filed by the Company).
3.2
Third Amended and Restated Bylaws of Sunstone Hotel Investors, Inc. effective as of February 9, 2023 (incorporated by reference to Exhibit 3.1 to Form 8-K, filed by the Company on February 10, 2023).
3.3
Articles Supplementary Prohibiting the Company From Electing to be Subject to Section 3-803 of the Maryland General Corporation Law Absent Shareholder Approval (incorporated by reference to Exhibit 3.1 to Form 8-K, filed by the Company on April 29, 2013).
3.4
Articles Supplementary for Series G preferred stock (incorporated by reference to Exhibit 3.1 to Form 8-K, filed by the Company on April 28, 2021).
3.5
Articles Supplementary for Series H preferred stock (incorporated by reference to Exhibit 3.3 to the registration statement on Form 8-A, filed by the Company on May 20, 2021).
3.6
Articles Supplementary for Series I preferred stock (incorporated by reference to Exhibit 3.3 to the registration statement on Form 8-A, filed by the company on July 15, 2021).
3.7
Eighth Amended and Restated Limited Liability Agreement of Sunstone Hotel Partnership LLC (incorporated by reference to Exhibit 3.2 to Form 8-K, filed by the Company on July 16, 2021).
31.1
Certification of Principal Executive Officer Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
31.2
Certification of Principal Financial Officer Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
32.1
Certification of Principal Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
101.INS
XBRL Instance Document - The instance document does not appear in the interactive data file because its XBRL tags are embedded within the Inline XBRL document.*
101.SCH
Inline XBRL Taxonomy Extension Schema Document. *
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document. *
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document. *
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document. *
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document. *
104
Cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2024 formatted in Inline XBRL (included in Exhibit 101).
*
Filed herewith.
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 thereunto duly authorized.
Date: November 12, 2024
By:
/s/ Aaron R. Reyes
Aaron R. Reyes(Chief Financial Officer and Duly Authorized Officer)