<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 10, 1998
REGISTRATION NO. 333-55807
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 2 TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
HOST MARRIOTT, L.P.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS GOVERNING INSTRUMENT)
DELAWARE 7011 52-2095412
(STATE OR OTHER (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
JURISDICTION OF CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
INCORPORATION OR
ORGANIZATION)
10400 FERNWOOD ROAD
BETHESDA, MARYLAND 20817
(301) 380-9000
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
----------------
CHRISTOPHER G. TOWNSEND
GENERAL COUNSEL
HOST MARRIOTT, L.P.
10400 FERNWOOD ROAD
BETHESDA, MARYLAND 20817
(301) 380-9000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
----------------
COPIES TO:
J. WARREN GORRELL, JR., ESQ.
BRUCE W. GILCHRIST, ESQ.
HOGAN & HARTSON L.L.P.
555 THIRTEENTH STREET, N.W.
WASHINGTON, D.C. 20004-1109
(202) 637-5600
----------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If the securities being registered on this form are being offered in
connection with the formation of a holding company and there is compliance
with General Instruction G, check the following box. [_]
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<PAGE>
HOST MARRIOTT, L.P.
SUPPLEMENT DATED , 1998 FOR
PROSPECTUS/CONSENT SOLICITATION STATEMENT DATED , 1998 FOR
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP
On the terms described in the Prospectus/Consent Solicitation Statement (the
"Consent Solicitation"), dated , 1998, of which this Supplement (the
"Supplement") is a part, Host Marriott Corporation, ("Host") has adopted a
plan to restructure its business operations so that it will qualify as a real
estate investment trust ("REIT"). As part of this restructuring (the "REIT
Conversion"), Host and its consolidated subsidiaries will contribute their
full-service hotel properties and certain other businesses and assets to Host
Marriott, L.P. (the "Operating Partnership") in exchange for units of limited
partnership interest in the Operating Partnership ("OP Units") and the
assumption of liabilities. The sole general partner of the Operating
Partnership will be Host Marriott Trust ("Host REIT"), the entity into which
Host will merge as part of the REIT Conversion. The Operating Partnership and
Host REIT will operate together as an umbrella partnership REIT. Host REIT
expects to qualify as a REIT beginning with its first full taxable year after
the closing of the REIT Conversion, which Host REIT currently expects to be
the year beginning January 1, 1999.
Following the REIT Conversion and the Blackstone Acquisition, the Operating
Partnership and its subsidiaries initially will own outright, or have
controlling interests in, approximately 120 full-service hotels operating
primarily under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt
brand names (the "Hotels").
As part of the REIT Conversion, the Operating Partnership is proposing to
acquire by merger (the "Mergers") Atlanta Marriott Marquis II Limited
Partnership, a Delaware limited partnership ("Atlanta Marquis" or the
"Partnership"), and up to seven other limited partnerships (the
"Partnerships") that own full-service hotels in which Host or its subsidiaries
are general partners. As more fully described in the Consent Solicitation,
limited partners of those Partnerships that participate in the Mergers will
receive either OP Units or, at their election, unsecured % Callable Notes due
December 15, 2005 issued by the Operating Partnership ("Notes"), in exchange
for their partnership interests in such Partnerships (with respect to the
Partnerships, those limited partners of the Partnerships who are unaffiliated
with Host are referred to herein as the "Limited Partners," and with respect
to Atlanta Marquis, the "Atlanta Marquis Limited Partners").
Beginning one year after the Mergers, Limited Partners who retain OP Units
will have the right to redeem their OP Units at anytime and receive, at the
election of Host REIT, either freely tradeable, New York Stock Exchange listed
Common Shares of Host REIT on a one-for-one basis (subject to adjustment) or
cash in an amount equal to the market value of such shares (the "Unit
Redemption Right").
The number of OP Units to be allocated to Atlanta Marquis will be based upon
(i) its Exchange Value (as defined herein) and (ii) the price attributed to an
OP Unit following the Merger, determined as described herein (but in no event
greater than $ per OP Unit). The principal amount of Notes that Atlanta
Marquis Limited Partners may elect to receive in exchange for the OP Units
received in the Merger will be based upon Atlanta Marquis' Note Election
Amount (as defined herein). See "Determination of Exchange Value of Atlanta
Marquis and Allocation of OP Units." The estimated Exchange Value and Note
Election Amount set forth herein may increase or decrease as a result of
various adjustments, and will be finally calculated shortly before the
Effective Date. Pursuant to the Merger, Atlanta Marquis Limited Partners have
an estimated Exchange Value of $45,425 per Partnership Unit and a Note
Election Amount of $27,255 per Partnership Unit.
RISK FACTORS
In deciding whether to approve the Merger, Atlanta Marquis Limited Partners
should consider certain risks and other factors. The General Partner believes
that Atlanta Marquis Limited Partners should particularly consider the
following, which should be read in conjunction with the information in the
Consent Solicitation under "Risk Factors" and "Federal Income Tax
Consequences:"
Atlanta Marquis Supp-1
<PAGE>
. Substantial Benefits to Related Parties. Host REIT and its subsidiaries
will realize substantial benefits from the Mergers and the REIT
Conversion, including savings from a substantial reduction in corporate-
level income taxes expected as a result of the REIT Conversion. To the
extent that such anticipated benefits of the REIT Conversion are
reflected in the value of Host's common stock prior to the Effective
Date, such benefits will not be shared with the Limited Partners. Because
of Host's significant ownership position in certain Partnerships
(including Atlanta Marquis), the failure of one or more of these
Partnerships, including Atlanta Marquis, to participate in a Merger
likely would require that Host contribute some or all of its ownership
interest in the Non-Participating Partnership to a taxable Non-Controlled
Subsidiary, which would materially reduce the benefit to Host of the REIT
Conversion as it applies to that interest.
. Absence of Arm's Length Negotiations. No independent representative was
retained to negotiate on behalf of the Atlanta Marquis Limited Partners
or the other Limited Partners. Although the General Partner has obtained
the Appraisal and the Fairness Opinion from AAA, AAA has not negotiated
with the General Partner or Host and has not participated in establishing
the terms of the Mergers. Consequently, the terms and conditions of the
Mergers may have been more favorable to the Atlanta Marquis Limited
Partners or the other Limited Partners if such terms and conditions were
the result of arm's length negotiations.
. Other Conflicts of Interest. The Mergers, the REIT Conversion and the
recommendations of the General Partner involve the following conflicts of
interest because of the relationships among Host, the Operating
Partnership, the General Partners and SLC: (i) the General Partners,
which are all subsidiaries of Host (except for PHLP, in which Host is the
General Partner), must assess whether a Merger is fair and equitable to
the Limited Partners of its Partnership, which involves considerations
for Host and its subsidiaries that are different from those that affect
the Limited Partners, (ii) the terms of the Leases of the Hotels,
including Atlanta Marquis' Hotel, will be determined by Host, which will
distribute the common stock of SLC, the parent of the Lessees, to its
shareholders after such terms have been set and (iii) the terms of the
Partnership Agreement, including provisions which benefit Host REIT, have
been determined by Host. Such conflicts may result in decisions that do
not fully reflect the interests of all Limited Partners, including the
Atlanta Marquis Limited Partners.
. Uncertainties at the Time of Voting Include the Number of OP Units to be
Received. There are several other uncertainties at the time the Atlanta
Marquis Limited Partners must vote on the Merger, including (i) the exact
Exchange Value for Atlanta Marquis (which will be adjusted for changes in
lender and capital expenditure reserves, indebtedness, deferred
maintenance and other items prior to the Effective Date), (ii) the price
of the OP Units for purposes of the Merger, which will be determined by
reference to the post-Merger trading prices of Host REIT's Common Shares
and which, together with the Exchange Value, will determine the number of
OP Units the Atlanta Marquis Limited Partners will receive and (iii) the
exact principal amount of the Notes that may be received in exchange for
OP Units, which cannot be known until after the vote on the Merger. For
these reasons, the Atlanta Marquis Limited Partners cannot know at the
time they vote on the Merger these important aspects of the Merger.
. Sale of Personal Property May Result in Gain to Atlanta Marquis Limited
Partners. In order to facilitate the participation of Atlanta Marquis in
the Merger without adversely affecting Host REIT's qualification as a
REIT, the Operating Partnership will require, as part of the Merger, that
Atlanta Marquis sell a portion of the personal property associated with
the Hotel owned by Atlanta Marquis to a Non-Controlled Subsidiary. This
sale would be a taxable transaction and may (although is not expected to)
result in an allocation of a relatively modest amount of ordinary
recapture income by Atlanta Marquis to Atlanta Marquis Limited Partners.
This income, if any, will be allocated to each Atlanta Marquis Limited
Partner in the same proportion and to the same extent that such Atlanta
Marquis Limited Partner was allocated any deductions directly or
indirectly giving rise to the treatment of such income as recapture
income. An Atlanta Marquis Limited Partner who receives such an
allocation of recapture income would not be entitled to any special
distribution from Atlanta Marquis in connection with the sale of personal
property.
Atlanta Marquis Supp-2
<PAGE>
. Exchange Value May Not Equal Fair Market Value of Atlanta Marquis'
Hotel. Each Atlanta Marquis Limited Partner who retains OP Units will
receive consideration with a deemed value equal to the Exchange Value of
such Atlanta Marquis Limited Partner's Partnership Interest. The
determination of the Exchange Value of Atlanta Marquis involves numerous
estimates and assumptions. There is no assurance that the Exchange Value
of Atlanta Marquis will equal the fair market value of the Hotel and
other assets contributed by Atlanta Marquis. See "Determination of
Exchange Value of Atlanta Marquis and Allocation of OP Units."
. Price of OP Units Might Be Less than the Fair Market Value of the
Partnership Interests. The price of an OP Unit, for purposes of the
Mergers and the REIT Conversion, will be equal to the average closing
price on the NYSE of a Host REIT Common Share for the first 20 trading
days after the Effective Date of the Mergers (but in no event greater
than $ per share). It is likely that, over time, the value of the
publicly traded Common Shares of Host REIT (and therefore the value of
the OP Units) will diverge from the deemed value of the OP Units used for
purposes of the Mergers. This could result in the Atlanta Marquis Limited
Partners receiving OP Units with an actual value that is less than either
the price of the OP Units for purposes of the Mergers or the fair market
value of their Partnership Interests.
. Inability of Atlanta Marquis Limited Partners to Redeem OP Units for One
Year. Atlanta Marquis Limited Partners who elect to retain OP Units
received in the Merger will be unable to redeem such OP Units for one
year following the Merger. Until then, Atlanta Marquis Limited Partners
will bear the risk of illiquidity.
. Current Host Common Stock Price May Not Necessarily Be Indicative of the
Price of Host REIT Common Shares Following the REIT Conversion. Host's
current stock price is not necessarily indicative of how the market will
value Host REIT Common Shares following the REIT Conversion. The current
stock price of Host reflects the current market valuation of Host's
current business and assets (including the SLC common stock and the cash
or securities to be distributed in connection with the REIT Conversion)
and not the business and assets of Host REIT following the REIT
Conversion.
. Value of the Notes Will Be Less than the Exchange Value. At the same time
that he votes on the Merger, each Atlanta Marquis Limited Partner also
may elect to receive, at the time of the Merger in exchange for OP Units,
an unsecured, seven-year Note of the Operating Partnership with a
principal amount equal to the Note Election Amount of his Partnership
Interest. The deemed value of the OP Units to be received by the Atlanta
Marquis Limited Partners will exceed the principal amount of the
corresponding Notes (because the Exchange Value will be higher than the
Note Election Amount) and there is no assurance that the Note an Atlanta
Marquis Limited Partner receives will have a value equal to either (i)
the fair market value of the Atlanta Marquis Limited Partner's share of
the Hotel and other assets owned by Atlanta Marquis or (ii) the principal
amount of the Note. There will be no public market for the Notes. If the
Notes are sold, they may sell at prices substantially below their
issuance price. Noteholders are likely to receive the full principal
amount of a Note only if they hold the Note to maturity, which is
December 15, 2005, or if the Operating Partnership repays the Notes prior
to maturity. Because the Notes are unsecured obligations of the Operating
Partnership, they will be effectively subordinated to all secured debt of
the Operating Partnership and all obligations of both Atlanta Marquis and
the Operating Partnership's other subsidiaries. See "Description of the
Notes." As of June 19, 1998, on a pro forma basis assuming the Full
Participation Scenario, the Operating Partnership would have had
aggregate consolidated debt of approximately $5.1 billion to which the
Notes were effectively subordinated or which rank equally with such
Notes.
. Fundamental Change in Nature of Investment; Potential
Underperformance. The Mergers and the REIT Conversion involve a
fundamental change in the nature of an Atlanta Marquis Limited Partner's
investment from holding an interest in Atlanta Marquis, which was
structured as a tax shelter and tax credit investment, is a finite-life
entity, has a fixed portfolio of one Hotel and distributes the cash flow
from the operation of such Hotel to the Atlanta Marquis Limited Partners,
to holding an interest in an infinite-life, operating real estate company
with a portfolio of approximately 120 Hotels that (i) collects and
distributes to its limited partners rents received from the Lessees
(which will bear the risks and
Atlanta Marquis Supp-3
<PAGE>
receive the direct benefits of the Hotels' operations), (ii) has the
ability to acquire additional hotels, (iii) is able to reinvest proceeds
from sales or refinancings of existing Hotels in other hotels and (iv) has
a publicly traded general partner. In addition, each Atlanta Marquis
Limited Partner's investment will change from one that allows an Atlanta
Marquis Limited Partner to receive a return of capital in the form of
distributions from any net proceeds of a sale or refinancing of Atlanta
Marquis' assets to an investment in which an Atlanta Marquis Limited
Partner who retains OP Units likely would realize a return of capital only
through the exercise of the Unit Redemption right. An Atlanta Marquis
Limited Partner's share of the liquidation proceeds, if any, from the sale
of the Atlanta Marquis Hotel could be higher than the amount realized upon
exercise of the Unit Redemption Right (or payments on any Note received by
an Atlanta Marquis Limited Partner who elects to exchange his OP Units for
such Note). An investment in the Operating Partnership may not outperform
an investment in Atlanta Marquis. See "Comparison of Ownership of
Partnership Interests, OP Units and Common Shares."
. Exposure to Market and Economic Conditions of Other Hotels. As a result
of the Mergers, Atlanta Marquis Limited Partners who elect to retain OP
Units will own interests in a much larger enterprise with a broader range
of assets than Atlanta Marquis individually. A material adverse change
affecting the Operating Partnership's assets will affect all Limited
Partners, including Atlanta Marquis Limited Partners, regardless of
whether a particular Limited Partner previously was an investor in such
affected assets. Atlanta Marquis owns discrete assets and the Mergers and
the REIT Conversion will significantly diversify the types and geographic
locations of the Hotels in which the Atlanta Marquis Limited Partners
will have interests. As a result, the Hotels owned by the Operating
Partnership may be affected differently by economic and market conditions
than the Hotel previously owned by Atlanta Marquis.
. Atlanta Marquis Limited Partners Have No Cash Appraisal Rights. Atlanta
Marquis Limited Partners who vote against the Merger have no right to
receive cash based upon an appraisal of their Partnership Interests.
. Uncertainties as to the Size and Leverage of the Operating Partnership.
The Atlanta Marquis Limited Partners cannot know at the time they vote on
the Merger the exact size and amount of leverage of the Operating
Partnership. Host is an existing operating company that regularly issues
and repays debt, acquires additional hotels and disposes of existing
hotels. Also, some or all of the Partnerships may elect not to
participate in a Merger. In addition, outside partners in certain Private
Partnerships may not consent to a lease of their partnership's Hotel(s).
In either such case, Host will contribute its interests in such
Partnerships and Private Partnerships to the Operating Partnership, but
the Operating Partnership may, in turn, contribute such interests to a
Non-Controlled Subsidiary, which will be subject to corporate-level
income taxation. Host also may repurchase outstanding securities or issue
new debt or equity securities prior to the consummation of the Mergers
and the REIT Conversion.
. Lack of Control over Hotel Operations. Due to current federal income tax
law restrictions on a REIT's ability to derive revenues directly from the
operation of a hotel, the Operating Partnership will lease virtually all
of its consolidated Hotels to the Lessees, which will operate the Hotels
by continuing to retain the Managers pursuant to the Management
Agreements. The Operating Partnership will not operate the Hotels or
participate in the decisions affecting the daily operations of the
Hotels. The Operating Partnership will have only a limited ability to
require the Lessees or the Managers to operate or manage the Hotels in
any particular manner and no ability to govern any particular aspect of
their day-to-day operation or management. Therefore, the Operating
Partnership will be dependent for its revenue upon the ability of the
Lessees and the Managers to operate and manage the Hotels.
. Expiration of Leases and Possible Inability to Find Other Lessees. The
Leases will expire seven to ten years after the Effective Date and there
can be no assurance that such Leases will be renewed (or if renewed, will
be renewed on terms as favorable to the Operating Partnership). If the
Leases are not renewed, the Operating Partnership will be required to
find other lessees, which lessees must meet certain requirements set
forth in the Management Agreements. There can be no assurance that
satisfactory lessees could be found or as to the terms and conditions on
which the Operating Partnership would be able to renew the Leases or
enter into new leases with such lessees.
Atlanta Marquis Supp-4
<PAGE>
. Requisite Vote of Atlanta Marquis Limited Partners Binds All Atlanta
Marquis Limited Partners. For Atlanta Marquis, approval by a majority of
the Class A Limited Partners is required to approve the Merger, as
described in "Voting Procedures--Required Vote and Other Conditions."
Such approval will cause Atlanta Marquis to participate in the Merger and
will bind all Atlanta Marquis Limited Partners, including Atlanta Marquis
Limited Partners who voted against or abstained from voting with respect
to the Merger.
. Substantial Indebtedness of the Operating Partnership. The Operating
Partnership will have substantial indebtedness. As of June 19, 1998, on a
pro forma basis assuming the Full Participation Scenario, the Operating
Partnership had outstanding indebtedness totaling approximately $5.1
billion, which represents a % debt-to-total market capitalization ratio
on a pro forma basis at such date (based upon a price per Common Share of
Host REIT of $ ). The Operating Partnership's business is capital
intensive and it will have significant capital requirements in the
future. The Operating Partnership's leverage level could affect its
ability to (i) obtain financing in the future, (ii) undertake
refinancings on terms and subject to conditions deemed acceptable by the
Operating Partnership, (iii) make distributions to partners, (iv) pursue
its acquisition strategy or (v) compete effectively or operate
successfully under adverse economic conditions.
. No Limitation on Debt. There are no limitations in Host REIT's or the
Operating Partnership's organizational documents which limit the amount
of indebtedness either may incur, although both the Notes and the
Operating Partnership's other debt instruments will contain certain
restrictions on the amount of indebtedness that the Operating Partnership
may incur.
. Rental Revenues from Hotels Subject to Rights of Lenders. In accordance
with the mortgage loan agreements with respect to outstanding
indebtedness of certain Hotel Partnerships, the rental revenues received
by such Hotel Partnerships under certain Leases first will be used to
satisfy the debt service on such outstanding indebtedness with only the
cash flow remaining after debt service being available to satisfy other
obligations of the Hotel Partnership (including paying property taxes and
insurance, funding the required FF&E reserves for the Hotels and capital
improvements and paying debt service with respect to unsecured debt) and
to make distributions to holders of OP Units.
. Ownership Limitations. No person or group may own, actually or
constructively (as determined under the applicable Code provisions), (i)
in excess of 9.8% of the number or value of outstanding Common Shares of
Host REIT or (ii) in excess of 4.9% of the value of the OP Units (other
than Host REIT and The Blackstone Group), subject to waiver or
modification by Host REIT or the Operating Partnership, as the case may
be, in certain limited circumstances.
. Timing of the REIT Conversion. If the REIT Conversion does not occur in
time for Host REIT to elect REIT status effective January 1, 1999, the
effectiveness of Host REIT's election could be delayed to January 1,
2000, which would result in Host REIT continuing to pay corporate-level
income taxes in 1999 and could cause the Blackstone Acquisition not to be
consummated.
. Effect of Subsequent Events upon Recognition of Gain. Even though the
Atlanta Marquis Limited Partners (other than those who elect to receive a
Note in exchange for OP Units) generally are not expected to recognize
significant taxable gain at the time of the Merger, there are a variety
of events and transactions (including the sale of the Hotel currently
owned by Atlanta Marquis or the reduction of indebtedness securing the
Hotel) that could cause an Atlanta Marquis Limited Partner to recognize
all or a part of the gain that otherwise has been deferred through the
REIT Conversion. See "Federal Income Tax Consequences--Tax Treatment of
Atlanta Marquis Limited Partners Who Hold OP Units Following the Merger."
Certain Hotels (including the Blackstone Hotels) will be covered by
agreements with third parties which will restrict the Operating
Partnership's ability to dispose of those properties or refinance their
debt. If Atlanta Marquis elects to participate in the Merger, the
Operating Partnership will succeed to an existing agreement that will
restrict its ability to dispose of the Atlanta Marquis Hotel or to
refinance the debt secured by such Hotel without compensating certain
outside partners for the resulting adverse tax consequences. As for the
remaining initial properties, the partnership agreement of the Operating
Atlanta Marquis Supp-5
<PAGE>
Partnership, which is substantially in the form attached to the Consent
Solicitation as Appendix A (the "Partnership Agreement"), does not impose
any restrictions on the Operating Partnership's ability to dispose of the
Hotels or to refinance debt secured by the Hotels (but the Operating
Partnership is obligated to pay any taxes Host REIT incurs as a result of
such transactions). In addition, the Partnership Agreement provides that
Host REIT, as general partner of the Operating Partnership, is not
required to take into account the tax consequences of the limited partners
in deciding whether to cause the Operating Partnership to undertake
specific transactions (but the Operating Partnership is obligated to pay
any taxes that Host REIT incurs as a result of such transactions) and the
limited partners have no right to approve or disapprove such transactions.
See "Description of OP Units--Sales of Assets."
. Election to Exchange OP Units for Notes. An Atlanta Marquis Limited
Partner who elects to receive a Note in connection with the Merger in
exchange for his OP Units will be treated as having made a taxable
disposition of his Partnership Interest. An Atlanta Marquis Limited
Partner who receives a Note may be eligible to defer only a small
portion, but not all, of that gain under the "installment sale" rules. An
Atlanta Marquis Limited Partner with a "negative capital account" with
respect to his Partnership Interest who elects to receive a Note will
recognize "phantom income" in that amount at the time of the Merger in
any event. See "Federal Income Tax Consequences--Tax Treatment of Atlanta
Marquis Limited Partners Who Exercise Their Right to Make the Note
Election."
. Competition in the Lodging Industry. The profitability of the Hotels is
subject to general economic conditions, the management abilities of the
Managers (including primarily Marriott International), competition, the
desirability of particular locations and other factors relating to the
operation of the Hotels. The full-service segment of the lodging
industry, in which virtually all of the Hotels operate, is highly
competitive, and the Hotels generally operate in geographical markets
that contain numerous competitors. The Hotels' success will be dependent,
in large part, upon their ability to compete in such areas as access,
location, quality of accommodations, room rate structure, the quality and
scope of food and beverage facilities and other services and amenities.
The lodging industry, including the Hotels (and thus the Operating
Partnership), may be adversely affected in the future by (i) national and
regional economic conditions, (ii) changes in travel patterns, (iii)
taxes and government regulations which influence or determine wages,
prices, interest rates, construction procedures and costs, (iv) the
availability of credit and (v) other factors beyond the control of the
Operating Partnership.
. Failure of Host REIT to Qualify as a REIT for Tax Purposes. Taxation of
Host REIT as a corporation if it fails to qualify as a REIT, and Host
REIT's subsequent liability for federal, state and local taxes on its
income and property, would, among other things, have the effect of
reducing cash available for distribution to Host REIT's shareholders and
materially reducing the value of the Common Shares and OP Units.
. Failure of the Operating Partnership to Qualify as a Partnership for Tax
Purposes. Taxation of the Operating Partnership as a corporation if it
fails to qualify as a partnership and the Operating Partnership's
subsequent liability for federal, state and local income taxes would,
among other things, have the effect of reducing cash available for
distribution to holders of OP Units, would cause Host REIT to fail to
qualify as a REIT for tax purposes and would cause the holders of OP
Units to recognize substantial taxable gain at the time the Operating
Partnership ceases to qualify as a partnership.
. Failure of the Leases to Qualify as Leases. If the Lease of the Hotel to
the Lessee were to be disregarded for tax purposes (for example, because
the Lease was determined to lack economic substance), Host REIT could
fail to qualify as a REIT and the Operating Partnership might be treated
as a corporation for federal income tax purposes, which would have a
material adverse impact on the Atlanta Marquis Limited Partners and the
value of the OP Units.
. Change in Tax Laws. No assurance can be provided that new legislation,
Treasury Regulations, administrative interpretations or court decisions
will not significantly change the tax laws with respect to Host REIT's
qualification as a REIT or the federal income tax consequences of such
qualification.
Atlanta Marquis Supp-6
<PAGE>
. Atlanta Marquis Limited Partners Need to Consult with Their Own Tax
Advisors. Because the specific tax attributes of an Atlanta Marquis
Limited Partner and the facts regarding such Atlanta Marquis Limited
Partner's interest in Atlanta Marquis could have a material impact on the
tax consequences to such Atlanta Marquis Limited Partner of the Merger,
the subsequent ownership and disposition of OP Units or Notes and/or the
subsequent ownership and disposition of Common Shares, it is essential
that each Atlanta Marquis Limited Partner consult with his own tax
advisors regarding the application of federal, foreign and state and
local tax laws to such Atlanta Marquis Limited Partner's personal tax
situation.
. Effect of Possible Classification as a Publicly Traded Partnership on
Passive Losses. There is a significant possibility that the Operating
Partnership could be classified as a "publicly traded partnership," in
which event the Atlanta Marquis Limited Partners would not be able to use
suspended passive activity losses from other investments (including from
Atlanta Marquis) to offset income from the Operating Partnership. It is
estimated that each Atlanta Marquis Limited Partner who purchased his
Partnership Interest at the time of the original offering of such
Interests, has held such Partnership Interest continuously since that
time and whose Partnership Interest has been his only investment in a
passive activity would have a significant passive activity loss
carryforward as of December 31, 1998.
. Host's Substantial Deferred Tax and Contingent Liabilities. Host will
have substantial deferred tax liabilities that are likely to be
recognized in the next ten years (notwithstanding Host REIT's status as a
REIT), and the IRS could assert substantial additional liabilities for
taxes against Host for taxable years prior to the time Host REIT
qualifies as a REIT. Under the terms of the REIT Conversion and the
Partnership Agreement, the Operating Partnership will be responsible for
paying (or reimbursing Host REIT for the payment of) all such tax
liabilities as well as any other liabilities (including contingent
liabilities and liabilities attributable to litigation that Host REIT may
incur) whether such liabilities are incurred by reason of Host's
activities prior to the REIT Conversion or the activities of Host REIT
subsequent thereto.
Because REITs are not permitted under current federal income tax law to
derive revenues directly from the operation of hotels, the Operating
Partnership will lease the Hotels to lessees (the "Lessees") that will operate
the Hotels under the existing management agreements and pay rent to the
Operating Partnership, as more fully described herein. The Lessees generally
will be indirect controlled subsidiaries of HMC Senior Communities, Inc.
("SLC"), which currently is a wholly owned subsidiary of Host. SLC will become
a separate public company when Host distributes the common stock of SLC and
other consideration to its existing shareholders and the Blackstone Entities
in connection with Host's distribution of its accumulated earnings and
profits, which Host REIT is required to do in order to qualify as a REIT.
Shares of Host REIT and SLC will become separately traded securities and the
companies will operate independently. There will be no overlap between the
boards of Host REIT and SLC. There will be a substantial overlap of
shareholders of the two companies initially, but this likely will diverge over
time.
MARRIOTT MARQUIS CORPORATION (THE "GENERAL PARTNER"), THE GENERAL PARTNER OF
ATLANTA MARQUIS, BELIEVES THAT THE MERGER PROVIDES SUBSTANTIAL BENEFITS AND IS
FAIR TO THE ATLANTA MARQUIS LIMITED PARTNERS AND RECOMMENDS THAT ALL ATLANTA
MARQUIS LIMITED PARTNERS VOTE FOR THE MERGER.
The effects of the Mergers may be different for Limited Partners of the
various Partnerships. This Supplement has been prepared to highlight for
Atlanta Marquis Limited Partners the specific risks, benefits, effects and
fairness of the Merger to them and to provide other information specific to
Atlanta Marquis. Supplements have also been prepared for each of the other
Partnerships. This Supplement, together with the supplements of the other
Partnerships (collectively, the "Supplements"), are part of the Consent
Solicitation. Upon receipt of a written request by a Limited Partner or his
representative, so designated in writing, the General Partner will send a copy
of any Supplement without charge. All requests for a copy of a Supplement
should be directed to: Investor Relations, 10400 Fernwood Road, Bethesda,
Maryland 20817, telephone number 301-380-2070 (between the hours of 9:00 a.m.
and 4:00 p.m., eastern time).
Atlanta Marquis Supp-7
<PAGE>
All cross-references refer to the Consent Solicitation unless the context
indicates otherwise. Capitalized terms not defined herein shall have the
meaning set forth in the Consent Solicitation. The information contained
herein, unless otherwise indicated, assumes the REIT Conversion occurs with
all Partnerships participating and no Notes being issued (the "Full
Participation Scenario").
EXPECTED BENEFITS OF THE MERGER
The General Partner believes that participating in the Merger would likely
be beneficial to the Atlanta Marquis Limited Partners for the reasons set
forth below. This information is qualified by and should be read in
conjunction with the information in the Consent Solicitation under "Background
and Reasons for the Mergers and the REIT Conversion--Reasons for the Mergers."
These benefits, which should be viewed as alternatives to continuing the
business and operations of Atlanta Marquis, are expected to include:
. Exchange Value of Atlanta Marquis. Atlanta Marquis Limited Partners who
elect to retain OP Units in the Merger will receive OP Units with an
estimated Exchange Value equal to $45,425 per Partnership Unit.
. Enhanced Liquidity of Investment. The REIT Conversion will offer Atlanta
Marquis Limited Partners significantly enhanced liquidity with respect to
their investments in Atlanta Marquis because, commencing one year
following the Effective Date, Atlanta Marquis Limited Partners who retain
OP Units will be able to exercise their Unit Redemption Right at any
time, subject to certain limited exceptions. Host has approximately 204
million shares of common stock outstanding and is expected to have a
total common equity market capitalization of approximately $ billion
after giving effect to the estimated $ million earnings and profits
distribution (based on Host's $ closing price per share on the NYSE on
, 1998). The exercise of the Unit Redemption Right, however,
generally would result in recognition of taxable income or gain at that
time.
. Public Market Valuation of Assets. The Partnership Units of Atlanta
Marquis currently trade at a discount to the net asset value of Atlanta
Marquis' assets. In contrast, the General Partner believes that by
exchanging interests in Atlanta Marquis, which is a non-traded, finite-
life limited partnership with a fixed portfolio for interests in an
infinite-life real estate company focused primarily on a more diverse and
growing full-service hotel portfolio and providing valuation based upon
publicly traded Common Shares of Host REIT, the Atlanta Marquis Limited
Partners will have the opportunity to participate in the recent trend
toward ownership of real estate through a publicly traded entity, which,
in many instances, has resulted in market valuations of public real
estate companies in excess of the estimated net asset values of those
companies. There can be no assurance, however, that the Common Shares of
Host REIT will trade at a premium to the private market values of the
Operating Partnership's assets or that the relative pricing differential
will not change or be eliminated in the future. Also, the benefit of
Host's conversion to a REIT will not be shared by the Atlanta Marquis
Limited Partners if and to the extent that such benefit is reflected in
the market valuation of Host's common stock prior to the REIT Conversion.
. Regular Quarterly Cash Distributions. The General Partner expects that
the Operating Partnership will make regular quarterly cash distributions
to holders of OP Units. The General Partner expects that these
distributions will be higher than the estimated cash distributions for
1998 of Atlanta Marquis, and in any event, the ability to receive
distributions quarterly and in regular amounts would be enhanced. For
additional information regarding historical and estimated future
distributions for Atlanta Marquis and the other Partnerships, see
"Background and Reasons for the Mergers and the REIT Conversion--Reasons
for the Mergers."
. Substantial Tax Deferral. The General Partner expects that Atlanta
Marquis Limited Partners who do not elect to receive a Note in exchange
for OP Units generally should be able to obtain the benefits of the
Merger while continuing to defer recognition for federal income tax
purposes of at least a substantial portion, if not all, of the gain with
respect to their Partnership Interests that otherwise would be recognized
in the event of a liquidation of Atlanta Marquis or a sale or other
disposition of its assets in a
Atlanta Marquis Supp-8
<PAGE>
taxable transaction (although Atlanta Marquis Limited Partners may
(although are not expected to) recognize a relatively modest amount of
ordinary income as the result of required sales of personal property to a
Non-Controlled Subsidiary in order to facilitate Host REIT's qualification
as a REIT). Thereafter, such Atlanta Marquis Limited Partners generally
should be able to defer at least a substantial portion of such built-in
gain until they elect to exercise their Unit Redemption Right or the Hotel
currently owned indirectly by Atlanta Marquis is sold or otherwise
disposed of in a taxable transaction by the Operating Partnership or the
debt now secured by the Hotel is repaid, prepaid or substantially reduced.
If Atlanta Marquis participates in the Merger, the Operating Partnership
will succeed to an existing agreement that will restrict its ability to
dispose of the hotel owned indirectly by Atlanta Marquis or to refinance
the debt secured by such hotel for approximately 11 1/2 years beyond the
consummation of the Merger without compensating certain outside partners
for the resulting adverse tax consequences. The federal income tax
consequences of the Merger are highly complex and, with respect to each
Atlanta Marquis Limited Partner, are dependent upon many variables,
including the particular circumstances of such Atlanta Marquis Limited
Partner. See "Federal Income Tax Consequences--Tax Consequences of the
Merger." Each Atlanta Marquis Limited Partner is urged to consult with his
own tax advisors as to the consequences of the Merger in light of his
particular circumstances.
. Risk Diversification. Participation in the Merger, as well as future
hotel acquisitions by the Operating Partnership, will reduce the
dependence of Atlanta Marquis Limited Partners upon the performance of,
and the exposure to the risks associated with, Atlanta Marquis' Hotel and
spread such risk over a broader and more varied portfolio, including more
diverse geographic locations and multiple brands. See "Business and
Properties--Business Objectives."
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a significantly lower leverage to value
ratio than Atlanta Marquis currently, which has a leverage ratio of 71%
(calculated as a percentage of Appraised Value), resulting in significant
interest and debt service savings and greater financial stability.
. Growth Potential. The General Partner believes that the Atlanta Marquis
Limited Partners, by owning interests in a publicly traded real estate
company focused primarily on a more diverse and growing upscale and
luxury full-service hotel portfolio, will be able to participate in
growth opportunities that would not otherwise be available to them.
. Greater Access to Capital. With publicly traded equity securities, a
larger base of assets and a substantially greater equity value than
Atlanta Marquis individually, Host REIT expects to have greater access to
the capital necessary to fund the Operating Partnership's operations and
to consummate acquisitions on more attractive terms than would be
available to Atlanta Marquis individually. This greater access to capital
should provide greater financial stability to the Operating Partnership
and reduce the level of risk associated with refinancing existing loans
upon maturity, as compared to Atlanta Marquis individually.
If Atlanta Marquis does not participate in the Merger, its business will
continue in its current manner; however, the Operating Partnership may elect
to contribute some or all of its interest in Atlanta Marquis to a Non-
Controlled Subsidiary.
DETERMINATION OF EXCHANGE VALUE OF ATLANTA MARQUIS AND ALLOCATION OF OP UNITS
GENERAL. The Exchange Value of Atlanta Marquis will be equal to the greatest
of its Adjusted Appraised Value, Continuation Value and Liquidation Value,
each of which has been determined as follows:
. Adjusted Appraised Value. The General Partner has retained AAA to
determine the market value of the Hotel as of March 1, 1998 (the
"Appraised Value"). The "Adjusted Appraised Value" of Atlanta Marquis
equals the Appraised Value of its Hotel, adjusted as of the Final
Valuation Date for lender reserves, capital expenditure reserves,
existing indebtedness (including a "mark to market" adjustment to reflect
the market value of such indebtedness), certain deferred maintenance
costs, deferred management fees and transfer and recordation taxes and
fees.
Atlanta Marquis Supp-9
<PAGE>
. Continuation Value. The "Continuation Value" of Atlanta Marquis
represents AAA's estimate, as adopted by the General Partner, of the
discounted present value, as of January 1, 1998, of the Atlanta Marquis
limited partners' share of estimated future cash distributions and
estimated net sales proceeds (plus lender reserves), assuming that
Atlanta Marquis continues as an operating business for twelve years and
its assets are sold on December 31, 2009 for their then estimated market
value.
. Liquidation Value. The "Liquidation Value" of Atlanta Marquis represents
the General Partner's estimate of the net proceeds to Atlanta Marquis
limited partners resulting from the assumed sale as of December 31, 1998
of the Hotel of Atlanta Marquis, at its Adjusted Appraised Value (after
eliminating any "mark to market" adjustment and adding back the deduction
for transfer and recordation taxes and fees, if any, made in deriving the
Adjusted Appraised Value), less (i) estimated liquidation costs, expenses
and contingencies equal to 2.5% of Appraised Value and (ii) prepayment
penalties or defeasance costs, as applicable.
Final determination of the Exchange Value of Atlanta Marquis will be made as
of the end of the four week accounting period ending at least 20 days prior to
the Effective Date (the "Final Valuation Date") and will be equal to the
greatest of Adjusted Appraised Value, Continuation Value and Liquidation Value
as of such date. Adjusted Appraised Value, Continuation Value and Liquidation
Value will be adjusted as of the Final Valuation Date (i) to reflect the
amount of lender and capital expenditure reserves and the amount of deferred
management fees as of such date, (ii) to increase the Adjusted Appraised Value
by any amounts actually expended by Atlanta Marquis after the Initial
Valuation Date to perform deferred maintenance that were previously subtracted
in determining the estimated Adjusted Appraised Value of Atlanta Marquis and
(iii) to reflect any changes in Atlanta Marquis' other reserves, such as for
litigation expenses and indemnification costs and any revised estimates of
transfer and recordation taxes and fees.
APPRAISED VALUE. Atlanta Marquis' Hotel was appraised as of March 1, 1998 by
AAA, an independent, nationally recognized hotel valuation and financial
advisory firm experienced in the appraisals of lodging properties such as
Atlanta Marquis' Hotel. The appraisal (the "Appraisal") was reviewed by a
Member Appraisal Institute ("MAI") appraiser and certified by such MAI
appraiser as having been prepared in accordance with the requirements of the
Standards of Professional Practice of the Appraisal Institute and the Uniform
Standards of Professional Appraisal Practice of the Appraisal Foundation.
The purpose of the Appraisal is to provide an estimate of the "Market Value"
of the Hotel. "Market Value" means the most probable price which a property
should bring in a competitive and open market under all conditions requisite
to a fair sale, the buyer and seller each acting prudently and knowledgeably
and assuming the price is not affected by undue stimuli. Implicit in this
definition is the consummation of a sale as of a specified date and the
passing of title from seller to buyer under conditions whereby: (i) the buyer
and seller are equally motivated; (ii) both parties are well informed or well
advised, and each is acting in what he considers his own best interest; (iii)
a reasonable time frame is allowed for exposure in the open market; (iv)
payment is made in terms of cash in U.S. dollars or in terms of financial
arrangements comparable thereto and (v) the price represents the normal
consideration for the property sold unaffected by special or creative
financing or sales concessions granted by anyone associated with the sale. AAA
made a site visit at Atlanta Marquis' Hotel for purposes of the Appraisal.
In preparing the Appraisal, AAA relied primarily on the income
capitalization method of valuation, and then compared the value estimated by
this method with recent sales of comparable properties, as a check on the
reasonableness of the value determined through the income capitalization
method. AAA employed the following procedures for determining the Appraised
Value of Atlanta Marquis' Hotel:
. Historical 1997 and Projected Year's Earnings. AAA reviewed the
historical 1997 net operating income (i.e., income before interest,
taxes, depreciation and amortization) ("NOI") prior to incentive
management fees and certain capital expenditures for the Hotel. AAA also
prepared a projection of the net operating income prior to incentive
management fees and certain capital expenditures for the Hotel for the
twelve month period ending February 28, 1999 (the "Projected Year"),
using historical financial
Atlanta Marquis Supp-10
<PAGE>
information for the Hotel, budget information, a survey with the manager
of the Hotel addressing the physical condition of the Hotel, local market
conditions (including business mix, demand generators, future trends and
predictability of business), changes in the competitive environment,
comparison with direct competitors of the Hotel and risk factors relating
to the Hotel. The resulting gross margin (ratio of total revenues to NOI
prior to incentive management fees) was checked against AAA's database of
the gross margins for similar hotels for reasonableness.
. Impact of Incentive Management Fees. AAA estimated a normalized annual
amount of incentive management fees payable under the applicable
management agreement and subtracted this amount from the net operating
income prior to incentive management fees and certain capital
expenditures for 1997 and the Projected Year.
. Impact of Owner Funded Capital Expenditures. AAA estimated normalized
annual amounts of owner funded capital expenditures (over and above the
FF&E reserve) based in part on projected owner funded capital
expenditures estimated in the Engineering Study, including, in the case
of Atlanta Marquis, certain identified 1998 capital expenditures for
which reserves have been set aside. The normalized amounts were then
subtracted from the NOI prior to owner funded capital expenditures for
1997 and the Projected Year.
. Capitalization of Adjusted NOI. AAA then capitalized the amount resulting
from the foregoing adjustments ("Adjusted NOI") for 1997 and the
Projected Year by dividing such amounts by capitalization rates that AAA
determined to be appropriate. A capitalization rate represents the
relationship between net operating income and sales prices of income
producing property. AAA selected the capitalization rates based upon its
review of current published surveys reflecting the opinions of investors
and participants such as REITs, hotel acquisition/management companies
and pension funds, lenders, brokers and consultants as to current
capitalization rates, and its own database of capitalization rates
reflected in recent transactions, adjusted for factors specific to the
Hotel, such as location, physical condition, reserve policies, local
market volatility and competition, guest mix, renovation influences and
other income characteristics. AAA used separate capitalization rates that
it deemed appropriate to capitalize 1997 historical Adjusted NOI and
estimated Projected Year's Adjusted NOI. AAA then estimated the value of
the Hotel based upon each of the values estimated by capitalizing 1997
and Projected Year's Adjusted NOI and its professional judgment. The
following table sets forth the effective capitalization rates for 1997
and Projected Year's Adjusted NOI resulting from AAA's estimated
Appraised Value of Atlanta Marquis' Hotel.
RESULTING EFFECTIVE CAPITALIZATION RATES FOR APPRAISALS OF ATLANTA MARQUIS'
HOTEL
<TABLE>
<CAPTION>
PROJECTED YEAR
1997 (ENDING FEBRUARY 28, 1999)
---- --------------------------
<S> <C>
9.4% 9.4%
</TABLE>
The resulting Appraised Value of Atlanta Marquis' Hotel, as estimated by
AAA, is $ 255,000,000.
. Comparison with Comparable Sales. AAA checked the Appraised Value of the
Hotel derived by the foregoing procedures against its database of
comparable sale transactions for reasonableness.
The Appraised Value assumes all contractual provisions for FF&E reserves are
adequate and have not been reduced to reflect deferred maintenance or
environmental remediation costs with respect to Atlanta Marquis' Hotel (but
estimated deferred maintenance costs have been deducted in estimating the
Adjusted Appraised Value of the Atlanta Marquis' Hotel). The Appraised Value
did not take into account the costs that might be incurred in selling the
Hotel (but estimated costs for transfer and recordation taxes and fees have
been deducted in estimating the Adjusted Appraised Value of the Hotel).
The Appraisal is not a guarantee of present or future values and no
assurance can be given as to the actual value of Atlanta Marquis' Hotel. The
Appraisal should be read in conjunction with other information, such as, but
not limited to, the audited financial statements of Atlanta Marquis.
Atlanta Marquis Supp-11
<PAGE>
The Appraised Value, and the assumptions underlying the projections on which
the Appraised Value is based, are contingent upon a series of future events,
the outcomes of which are not necessarily within the Operating Partnership's
control and cannot be determined at this time. There can be no assurance that
another appraiser would not have arrived at a different result. Some of the
assumptions inevitably will not materialize and unanticipated events and
circumstances will occur subsequent to the date of the Appraisal. Furthermore,
the actual results achieved from Atlanta Marquis' Hotel will vary from the
results projected in the Appraisal and the variations may be material.
ADJUSTED APPRAISED VALUE. The Adjusted Appraised Value of Atlanta Marquis
was determined by making various adjustments to the Appraised Value of Atlanta
Marquis' Hotel, as described below.
. Lender Reserves. Atlanta Marquis' debt service reserves are required to
be held by third-party lenders. The amount of these lender reserves as of
the Initial Valuation Date was added to the Appraised Value of the Hotel.
A final determination of the lender reserves of Atlanta Marquis will be
made on the Final Valuation Date and any changes in such reserves will be
reflected in the Adjusted Appraised Value.
. 1998 Capital Expenditure Reserve. For Atlanta Marquis, an amount equal to
the capital expenditure reserve which was set aside as of March 1, 1998
for various identified capital improvements in 1998 (which amounts
resulted in reductions in the Appraised Value as described above) was
added back to the Appraised Value.
. Mortgage and Other Debt. The estimated principal balance and accrued
interest as of the Effective Date (assumed to be December 31, 1998) of
all mortgage and other debt of Atlanta Marquis has been subtracted from
the Appraised Value.
. Mark to Market Adjustments. The third-party loans of the Partnerships
have various interest rates and terms to maturity. In order to reflect
the market value of the third-party loans of Atlanta Marquis, the
estimated Adjusted Appraised Value for Atlanta Marquis has been increased
to "mark to market" the interest rate for such loans. This adjustment has
been estimated by comparing the interest cost using the applicable
interest rates on existing third-party loans over their remaining term to
the interest cost using the interest rate that the Operating Partnership
believes it would be able to obtain for unsecured debt in the market as
of the Final Valuation Date (which would have been % per annum based on
a 225 basis point (2.25 percent) spread over the yield on seven-year U.S.
Treasury securities as of , 1998). The mark to market adjustment for
the loan was calculated by determining the difference between the present
values, as of December 31, 1998, of the interest payments over the
remaining term of the loan from January 1, 1999 to maturity using the
actual interest rate as the discount rate as compared to using the
assumed market rate as the discount rate.
. Deferred Management Fees. The amount of deferred management fees
(management fees earned by the manager pursuant to the management
agreement and not paid currently) estimated to be payable under the
Management Agreement of Atlanta Marquis as of December 31, 1998 have been
subtracted from the Appraised Value. The amount of such deferred
management fees will be recalculated as of the Final Valuation Date.
. Deferred Maintenance Costs. The estimated cost to complete any deferred
maintenance items identified in the Engineering Study relating to the
Atlanta Marquis' Hotel have been subtracted from the Appraised Value. The
adjustments for this item will be reduced at the Final Valuation Date to
reflect amounts expended after the Initial Valuation Date to perform such
deferred maintenance. No adjustments have been made for previously
budgeted capital expenditures or deferred maintenance costs estimated in
the Engineering Study that are reflected in the cash flow projections
used for purposes of estimating the Appraised Value.
Atlanta Marquis Supp-12
<PAGE>
The following table sets forth the adjustments to the Appraised Value of
Atlanta Marquis' Hotel made to derive the estimated Adjusted Appraised Value
for Atlanta Marquis as of the Initial Valuation Date.
CALCULATION OF ESTIMATED ADJUSTED APPRAISED VALUE FOR ATLANTA MARQUIS
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................................................ $ 255,000
Lender reserves................................................ 3,600
Capital expenditure reserve.................................... 16,750
Mortgage debt.................................................. (162,047)
Other debt..................................................... (20,134)
Mark to market adjustment...................................... 4,693
Deferred maintenance costs..................................... (607)
---------
Estimated Adjusted Appraised Value............................. $ 97,255
=========
Limited partners' share........................................ $ 22,255
Per Partnership Unit........................................... $ 41,991
</TABLE>
CONTINUATION VALUE. AAA estimated the Continuation Value of Atlanta Marquis
using the following methodology:
. Estimated Future Cash Distributions. AAA prepared estimates of future
partnership cash flow for Atlanta Marquis for the 12-year period from
January 1, 1998 through December 31, 2009 based upon the estimated 1998
NOI before incentive management fees used in the Appraisals and for each
subsequent year applying an assumed annual stabilized growth rate (as
shown in the table below) developed by AAA for this analysis. For each
year in the projection period, AAA estimated the amount of cash available
for distribution to Atlanta Marquis' limited partners after payment of
all management fees, debt service, owner funded capital expenditures
based on the Engineering Study and other partnership expenses and after
application of the applicable partnership agreement provisions. AAA
assumed that Atlanta Marquis' FF&E reserve was adequate and understood
that Host determined that there were no reserve shortfalls or surpluses.
. Determination of Residual Value. To estimate the residual value of the
Atlanta Marquis limited partners' interest in Atlanta Marquis at the end
of the 12-year period, AAA assumed that the Atlanta Marquis Hotel would
be sold as of December 31, 2009 at its then market value. AAA estimated
the market value of the Hotel as of such date by applying an exit
capitalization rate that it deemed appropriate, using the factors
described above in connection with the "--Appraised Value," which is set
forth in the table below, to the estimated Adjusted NOI for 2009
(estimated as described above). AAA then subtracted estimated sales costs
of 2.0% of the estimated market value, added lender reserves and
subtracted the estimated outstanding principal balance of debt as of
December 31, 2009 and deferred management fees to arrive at net sales
proceeds available for distribution to partners. AAA then determined what
portion of such estimated net sales proceeds would be distributable to
Atlanta Marquis' limited partners under the partnership and debt
agreements.
. Discounting Distributions to Present Value. As a final step, AAA
discounted the estimated future cash distributions to Atlanta Marquis'
limited partners from operations and estimated net sales proceeds to
their present value as of January 1, 1998, using a discount rate of 20%
per annum. AAA believes that this discount rate reflects the return on
investment that investors expect from leveraged investments of this
nature.
Atlanta Marquis Supp-13
<PAGE>
The growth rate and exit capitalization rate used to determine the estimated
Continuation Value for Atlanta Marquis are as set forth below:
GROWTH RATE, EXIT CAPITALIZATION RATE
AND ESTIMATED CONTINUATION VALUE FOR ATLANTA MARQUIS
<TABLE>
<CAPTION>
ESTIMATED
EXIT CAPITALIZATION RATE CONTINUATION VALUE
GROWTH RATE (2009) (PER PARTNERSHIP UNIT)
----------- ------------------------ ----------------------
<S> <C> <C>
4.40% 9.80% $45,425
</TABLE>
LIQUIDATION VALUE. The Liquidation Value of Atlanta Marquis was estimated by
the General Partner and represents the estimated value of Atlanta Marquis if
all of its assets were sold as of December 31, 1998. Such value was based upon
the Adjusted Appraised Value of Atlanta Marquis, with the following
adjustments: (i) the "mark to market" adjustment used to estimate the Adjusted
Appraised Value was eliminated and instead prepayment or defeasance costs that
would be payable under existing debt agreements (regardless of whether the
debt in fact can be prepaid on December 31, 1998) were deducted from the
Appraised Value; and (ii) the deduction for transfer and recordation taxes and
fees used to estimate the Adjusted Appraised Value was eliminated and instead
an amount equal 2.5% of the Appraised Value of Atlanta Marquis' Hotel was
subtracted from the Appraised Value for estimated liquidation costs, expenses
and contingencies. The General Partner then determined the portion of the
estimated Liquidation Value that would be distributable to Atlanta Marquis'
limited partners under the terms of the partnership agreement and other
contractual arrangements.
The following table sets forth the adjustments made to the Adjusted
Appraised Value to estimate the Liquidation Value of Atlanta Marquis as of the
Initial Valuation Date:
CALCULATION OF ESTIMATED LIQUIDATION VALUE OF ATLANTA MARQUIS
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................................................ $ 255,000
Lender reserves................................................ 3,600
Capital expenditure reserve.................................... 16,750
Mortgage debt.................................................. (162,047)
Other debt..................................................... (20,134)
Prepayment/defeasance costs.................................... (10,972)
Deferred maintenance costs..................................... (607)
Sales costs.................................................... (6,375)
---------
Estimated Liquidation Value.................................... $ 75,215
=========
Limited partners' share........................................ $ 215
Per Partnership Unit........................................... $ 406
</TABLE>
ESTIMATED EXCHANGE VALUE. The following table sets forth the estimated
Exchange Value of Atlanta Marquis (based upon the greatest of its estimated
Adjusted Appraised Value, estimated Continuation Value and estimated
Liquidation Value), the estimated minimum and pro forma number of OP Units to
be received and the estimated Note Election Amount for Atlanta Marquis, all on
a per Partnership Unit basis as of the Initial Valuation Date. The estimated
Exchange Value for Atlanta Marquis will be received by each Atlanta Marquis
Limited Partner retaining OP Units in the Merger. The estimated Note Election
Amount for Atlanta Marquis (which will be received by Atlanta Marquis Limited
Partners electing to receive Notes in exchange for OP Units) is equal to 60%
of its Exchange Value for Atlanta Marquis. The estimated values set forth
below may increase
Atlanta Marquis Supp-14
<PAGE>
or decrease as a result of various adjustments, which will be finally
calculated as of the Final Valuation Date but will not change as a result of
less than all of the Partnerships participating in the Mergers. The actual
number of OP Units to be received by the Atlanta Marquis Limited Partners will
be based on the average closing price on the NYSE of a Host REIT Common Share
for the 20 trading days after the Effective Date.
ESTIMATED EXCHANGE VALUE,
NUMBER OF OP UNITS AND NOTE ELECTION AMOUNT
OF ATLANTA MARQUIS
PER PARTNERSHIP UNIT(1)
<TABLE>
<CAPTION>
ESTIMATED ESTIMATED ESTIMATED ESTIMATED
ADJUSTED ESTIMATED ESTIMATED ESTIMATED MINIMUM PRO FORMA NOTE
APPRAISED CONTINUATION LIQUIDATION EXCHANGE NUMBER OF NUMBER OF ELECTION
VALUE VALUE VALUE VALUE(2) OP UNITS(3) OP UNITS(4) AMOUNT(5)
--------- ------------ ----------- --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
$41,991 $45,425 $406 $45,425 2,271 $27,255
</TABLE>
- --------
(1) A Partnership Unit in Atlanta Marquis represents an original investment of
$100,000.
(2) The estimated Exchange Value is equal to the greatest of estimated
Adjusted Appraised Value, estimated Continuation Value and estimated
Liquidation Value.
(3) Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Merger.
(4) Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
(5) The principal amount of Notes is equal to the greater of (i) the
Liquidation Value or (ii) 60% of the Exchange Value (the "Note Election
Amount").
Price of OP Units to Pay Exchange Value to Atlanta Marquis Limited
Partners. Each Atlanta Marquis Limited Partner will receive OP Units with a
deemed value equal to the Exchange Value of such Atlanta Marquis Limited
Partner's Partnership Interests. The price of an OP Unit for this purpose will
be equal to the average closing price on the NYSE of a Host REIT Common Share
for the 20 trading days after the Effective Date of the Mergers (but in no
event greater than $ per share). The closing price per share of Host
common stock on the NYSE was $ , on , 1998.
Atlanta Marquis Limited Partners at the Effective Date of the Merger who
retain OP Units will receive cash distributions from Atlanta Marquis for all
of 1998 and, if the Merger does not occur in 1998, any portion of 1999 prior
to the Merger for which period they do not receive a cash distribution from
the Operating Partnership. Cash distributions will be made by Atlanta Marquis
in accordance with its partnership agreement on or before June 1, 1999 in
respect of 1998 operations and, if the Merger does not occur prior to January
1, 1999, within 90 days after the Effective Date of the Merger in respect of
any 1999 operations. Atlanta Marquis Limited Partners at the Effective Date of
the Merger who receive Notes in exchange for OP Units will participate in the
same distributions from Atlanta Marquis as Limited Partners who retain OP
Units but will not receive any distributions from the Operating Partnership
with respect to periods after the Effective Date of the Merger.
No fractional OP Units will be issued. Fractional amounts less than or equal
to 0.50 of an OP Unit will be rounded down to the next whole number and
fractional amounts greater than 0.50 will be rounded up to the next whole
number of OP Units.
VALUATION OF THE GENERAL PARTNER'S INTEREST IN ATLANTA MARQUIS AND ALLOCATION
OF OP UNITS TO THE GENERAL PARTNER
The value of the General Partner's interest will be equal to the aggregate
Exchange Value of Atlanta Marquis minus the aggregate Exchange Value of the
Atlanta Marquis Limited Partners' Partnership Interests (giving effect to the
applicable distribution preferences in the Atlanta Marquis partnership
agreement). The number of OP Units that will be received by the General
Partner will be equal to the value of its interest in Atlanta Marquis divided
by the same price per OP Unit used to determine the number of OP Units to be
received
Atlanta Marquis Supp-15
<PAGE>
by Atlanta Marquis Limited Partners. The total number of OP Units that will be
owned directly or indirectly by Host REIT (including OP Units owned by the
General Partner) will be equal to the number of outstanding shares of common
stock of Host at the Effective Date.
The following table sets forth the estimated value of the General Partner's
and its affiliate's interest in Atlanta Marquis based upon the estimated
aggregate Exchange Value of the Atlanta Marquis Limited Partners' Partnership
Interests as of the Initial Valuation Date and the minimum and pro forma
number of OP Units estimated to be received by the General Partner and its
affiliate in respect thereof.
ESTIMATED VALUE OF THE GENERAL PARTNER'S AND ITS AFFILIATE'S INTEREST AND
NUMBER OF OP UNITS
(IN THOUSANDS)
<TABLE>
<S> <C>
Aggregate Exchange Value............................................... $88,662
Limited Partners' share of aggregate Exchange Value.................... 24,075
-------
Value of General Partner's interest(1)................................. $64,587
Value of Host's limited partner interest............................... 68
-------
Total Host interest.................................................... $64,655
=======
Number of OP Units:
Minimum(2)............................................................
Pro Forma(3).......................................................... 3,233
</TABLE>
- --------
(1)Amount includes the Class B Limited Partner interest owned by an affiliate
of the General Partner.
(2)Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Mergers.
(3)Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
CASH DISTRIBUTIONS
Historical Cash Distributions Paid by Atlanta Marquis. The following table
sets forth the distributions paid to Atlanta Marquis Limited Partners (per
Partnership Unit) during the periods indicated. The information below should
be read in conjunction with the information in this Supplement under the
caption "Selected Financial Data."
HISTORICAL CASH DISTRIBUTIONS PAID BY ATLANTA MARQUIS
(PER PARTNERSHIP UNIT)(1)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS FISCAL YEAR
--------- --------------------------------
1998 1997 1996 1995 1994 1993
--------- ---- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
From net income.................... $ -- $-- $1,522 $4,386 $3,444 $2,979
Representing return of capital(2).. 5,000 -- -- -- -- --
Payments due to reallocation of
losses(3)......................... -- 284 -- -- 844 1,411
------ ---- ------ ------ ------ ------
Total............................ $5,000 $284 $1,522 $4,386 $4,288 $4,390
====== ==== ====== ====== ====== ======
</TABLE>
- --------
(1) A Partnership Unit represents a $100,000 original investment in Atlanta
Marquis.
(2) Computed as all distributions in excess of distributions from operating
cash flow.
(3) Represents amounts paid by the General Partner to the Atlanta Marquis
Limited Partners to compensate them for allocations of tax losses
resulting from the 1990 debt refinancing.
Compensation and Distributions to the General Partner. Under Atlanta
Marquis' partnership agreement, the General Partner does not receive fees or
compensation in connection with managing the affairs of Atlanta Marquis but
the General Partner and its affiliates are reimbursed for certain costs and
expenses incurred on behalf
Atlanta Marquis Supp-16
<PAGE>
of Atlanta Marquis. In addition, the General Partner is entitled to
distributions related to its interests in Atlanta Marquis. The following
information has been prepared to compare the amount of reimbursements paid and
cash distributions made by Atlanta Marquis to the General Partner and its
affiliates to the amounts that would have been paid if the reimbursement and
distribution structure which will be in effect after the REIT Conversion had
been in effect for the periods presented.
Following the REIT Conversion, Host REIT will be operated as a self-
administered REIT and as a result no reimbursements or other compensation will
be received by the General Partner.
The following table sets forth the reimbursements and distributions paid by
Atlanta Marquis to its General Partner and its affiliates for the last three
fiscal years and the First Two Quarters 1998 ("Historical") and the
reimbursements and distributions that would have been paid to the General
Partner and its affiliates for the last fiscal year and the First Two Quarters
1998 if the REIT Conversion had been in effect, assuming the Full
Participation Scenario ("Pro Forma") and assuming a distribution per OP Unit
of $1.05 per year during such period, which is the midpoint of the expected
distribution range for 1999.
HISTORICAL AND PRO FORMA
REIMBURSEMENTS AND DISTRIBUTIONS TO THE GENERAL PARTNER AND ITS AFFILIATES
(IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL YEAR
FIRST TWO QUARTERS ------------------------------------------
1998 1997 1996 1995
-------------------- -------------------- ---------- ----------
HISTORICAL PRO FORMA HISTORICAL PRO FORMA HISTORICAL HISTORICAL
---------- --------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Reimbursements(1)....... $684 $ -- $196 $ -- $65 $ 84
Distributions(2)........ -- 1,697 -- 3,394 10 30
---- ------ ---- ------ --- ----
Total................. $684 $1,697 $196 $3,394 $75 $114
==== ====== ==== ====== === ====
</TABLE>
- --------
(1) All expenses will be paid directly by the Operating Partnership,
accordingly, there are no expected reimbursements on a pro forma basis.
(2) The amount of distributions payable to the General Partner and its
affiliates on a pro forma basis reflect distributions at a rate of $1.05
per annum per OP Unit (which is the midpoint of the expected range of
distributions per OP Unit for 1999) with respect to the estimated number
of OP Units that the General Partner and its affiliates will receive in
exchange for its general and limited partner interests in Atlanta Marquis.
Such number does not reflect the aggregate number of OP Units Host will
receive in connection with the REIT Conversion.
CERTAIN INFORMATION REGARDING THE HOTEL OWNED BY ATLANTA MARQUIS
<TABLE>
<CAPTION>
NAME OF HOTEL LOCATION OF HOTEL NUMBER OF ROOMS DATE OPENED
- ------------- ----------------- --------------- -----------
<S> <C> <C> <C>
Atlanta Marriott Marquis
Hotel(1)....................... Atlanta, GA 1,671 1985
</TABLE>
- --------
(1) Atlanta Marquis has an 80% residual interest of the Atlanta Marriott
Marquis Hotel and, for 1998, is expected to receive 100% of the cash flow
from the Hotel.
Atlanta Marquis Supp-17
<PAGE>
The table below sets forth certain performance information for Atlanta
Marquis' Hotel for the indicated periods.
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS FISCAL YEAR
----------------- --------------------------
1998 1997 1997 1996 1995
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Average daily rate............... $138.66 $132.56 $127.36 $131.91 $116.02
Occupancy........................ 69.1 % 74.5% 69.8 % 68.6% 71.6%
REVPAR........................... $ 95.81 $ 98.76 $ 88.90 $ 90.49 $ 83.07
% REVPAR change.................. (3.0)% -- (1.7)% 8.9% --
</TABLE>
The Atlanta Marriott Marquis is a full-service Marriott hotel. It is located
on approximately 3.6 acres of land in the heart of downtown Atlanta. The Hotel
is in the Peachtree Center area of Atlanta's central business district and
occupies most of the block that is bordered by Baker Street to the north,
Courtland Street to the east, Harris Street to the south and Peachtree Center
Avenue to the west. The Hotel is located within walking distance of Atlanta's
convention facilities, as well as restaurants, lounges, a gift shop and
several retail shops.
The Hotel opened on July 1, 1985. The 1,671 room Hotel includes 72 suites
and contains over 122,000 square feet of meeting and exhibition space and five
restaurants and lounges. Recreational facilities include a complimentary
health club, an indoor/outdoor swimming pool, hydro-therapy pool, sundeck,
steam room and sauna, a rub-down area and a game room. The Hotel features a
spectacular 50-story atrium that soars to an enormous rooftop skylight.
Capital Improvements. In 1997, the Hotel completed a $7.0 million
refurbishment of approximately half its guest rooms which included the
replacement of the carpeting, bedspreads, upholstery, drapes and other similar
items ("Softgoods") and also the dressers, chairs, beds and other furniture
("Casegoods"). The refurbishment of the remaining 711 rooms and 16 suites will
begin in mid-1998. This portion of the refurbishment will be funded from a
reserve which was established by Atlanta Marquis with the lender on the New
Maturity Date (as defined). Also in 1997, the facade repair project was
started, which entails a repair of the entire facade of the building. The
project is expected to cost $7.5 million and will be funded by Atlanta Marquis
from a reserve which was also established with the lender on the New Maturity
Date. The project is expected to be completed by mid-1999.
Competition. The primary competition for the Hotel comes from the following
four first-class hotels in downtown Atlanta: (i) the 1,278 room Hyatt Regency
Atlanta Hotel, (ii) the 1,222 room Atlanta Hilton & Towers Hotel, (iii) the
1,068 room Westin Peachtree Plaza Hotel and (iv) the 747 room Radisson Hotel
Atlanta. These four competitors contain an aggregate of approximately 4,315
rooms and approximately 332,000 square feet of meeting space. Hotel management
has formed an alliance with the Westin, Hyatt and Hilton (the "Atlanta
Alliance"). The Atlanta Alliance is a formal arrangement among the four hotels
to present a meeting alternative to customers' groups that are too large for a
single hotel but too small for the Georgia World Congress Center, Atlanta's
convention center.
In addition, other hotels in the Atlanta area compete with the Hotel;
however, these differ from the Atlanta Marquis Hotel in terms of size, room
rates, facilities, amenities and services offered, market orientation and/or
location. As a major convention facility, the Hotel also competes with similar
facilities throughout the country.
No new full-service hotels opened in the Atlanta market in 1997 and none are
expected to open in 1998. However, during 1997, 38 new limited service hotels
opened thus adding 3,422 new rooms to the market and approximately 13 more
properties containing a total of 1,498 rooms are expected to open in 1998 in
the Atlanta suburbs. These additions are not expected to have a significant
impact on the Hotel's revenues as these hotels target a significantly
different market segment. In 1997, the Atlanta properties generally reported
decreased results due to higher activity in 1996 related to the Summer
Olympics and the impact of additional supply added to the suburban areas. In
1998, construction began on a 320-room Doubletree Guest Suites hotel which is
expected to open in mid-1999.
Atlanta Marquis Supp-18
<PAGE>
LEGAL PROCEEDINGS
Texas Multi-Partnership Lawsuit. On March 16, 1998, limited partners in
several limited partnerships sponsored by Host, including Atlanta Marquis,
filed a lawsuit, Robert M. Haas, Sr. and Irwin Randolph Joint Tenants, et al.
v. Marriott International, Inc., et al., Case No. CI-04092, in the 57th
Judicial District Court of Bexar County, Texas, alleging that the defendants
conspired to sell hotels to the partnerships for inflated prices and that they
charged the partnerships excessive management fees to operate the
partnerships' hotels. The plaintiffs further allege that the Defendants
committed fraud, breached fiduciary duties and violated the provisions of
various contracts. The plaintiffs are seeking unspecified damages. Although
the partnerships have not been named as defendants, their partnership
agreements include provisions which require the partnerships to indemnify the
general partners against losses, expenses and fees. The defendants filed
answers and defenses to the petition.
Atlanta Marquis. Certain limited partners of Atlanta Marriott Marquis
Limited Partnership ("AMMLP"), filed a putative class-action lawsuit Hiram and
Ruth Sturm v. Marriott Marquis Corporation, et al., Case No. 97-CV-3706, in
the U.S. District Court for the Northern District of Georgia, on December 12,
1997, against AMMLP's general partner, its directors and Host, regarding the
merger of AMMLP into a new partnership (the "AMMLP Merger") as part of a
refinancing of the partnerships' debt. The plaintiffs allege that the
defendants misled the limited partners in order to induce them to approve the
AMMLP Merger, violated securities regulations and federal roll-up regulations
and breached their fiduciary duties to the partners. The plaintiffs sought to
enjoin, or in the alternative, rescind, the AMMLP Merger and damages. The
partnership agreement includes provisions which require the partnership to
indemnify the general partners against losses, expenses and fees. The
defendants filed a motion to dismiss.
Another limited partner of AAMLP sought similar relief and filed a separate
lawsuit, styled Poorvu v. Marriott Marquis Corporation, et al., Civil Action
No. 16095-NC, on December 19, 1997, in Delaware State Chancery Court. The
defendants have filed an answer to the complaint.
AMENDMENTS TO THE ATLANTA MARQUIS PARTNERSHIP AGREEMENT
In order to allow the Hotel of Atlanta Marquis to be leased to SLC in
connection with the Merger and the REIT Conversion, Atlanta Marquis'
partnership agreement must be amended. Currently, there is no provision in
Atlanta Marquis' partnership agreement to allow Atlanta Marquis' Hotel to be
leased. Therefore, Section 5.02B of Atlanta Marquis' partnership agreement
must be amended to add a new paragraph 5.02B(6) to read as follows:
(6) lease (or consent to the lease), directly or indirectly, in one
transaction or a series of related transactions of the Hotel.
Other Amendments. Amendments to certain terms and sections of Atlanta
Marquis' partnership agreement would be made in order to (i) reduce to one the
number of appraisals of the fair market value of Atlanta Marquis Hotel that
Atlanta Marquis must provide to the Atlanta Marquis Limited Partners before
the General Partner can cause Atlanta Marquis to sell its assets to the
General partner of an affiliate (ii) delete certain obsolete references to
entities and agreements that are no longer in existence, (iii) update Atlanta
Marquis' partnership agreement to reflect the passage of time since the
formation of Atlanta Marquis and (iv) make any other amendments to Atlanta
Marquis' partnership agreement deemed necessary or advisable, in the sole
discretion of the General Partner, in connection with the consummation of the
Merger and the REIT Conversion. The General Partner does not believe that
these amendments would affect the rights of the Atlanta Marquis Limited
Partners in any material respect nor the duties and obligations of the General
Partner. These changes are included, along with the other proposed amendments,
in the copy of Atlanta Marquis' partnership agreement, as proposed to be
amended, which is attached hereto. The amended Atlanta Marquis partnership
agreement is marked to indicate the revisions made to the existing Atlanta
Marquis partnership agreement and should be read in its entirety. Deleted
provisions are contained in brackets and struck through and added provisions
are in bold type and underlined.
Atlanta Marquis Supp-19
<PAGE>
FAIRNESS ANALYSIS AND OPINION
FAIRNESS ANALYSIS
The General Partner believes that the Merger provides substantial benefits
and are fair to the Limited Partners of Atlanta Marquis and recommends that
all Limited Partners of Atlanta Marquis consent to the Merger. The General
Partner bases this recommendation primarily on (i) its view that the expected
benefits of the Merger for the Atlanta Marquis Limited Partners outweigh the
risks and potential detriments of the Merger to the Atlanta Marquis Limited
Partners (see "Background and Reasons for the Mergers and the REIT
Conversion--Reasons for the Mergers" and "Risk Factors"), (ii) its view that
the value of the OP Units allocable to the Atlanta Marquis Limited Partners on
the basis of the Exchange Value established for Atlanta Marquis represents
fair consideration for the Partnership Interests held by the Atlanta Marquis
Limited Partners and is fair to the Atlanta Marquis Limited Partners from a
financial point of view and (iii) the Appraisal and Fairness Opinion of AAA.
The Merger is not conditioned upon the consummation of any of the other
Mergers. The General Partner has considered this fact in evaluating the
fairness of the Merger. The General Partner believes that the fairness of the
Merger will not be materially affected by the presence or absence of any other
individual Partnership or by any particular combination of other Partnerships
and that the Merger will be fair to the Atlanta Marquis Limited Partners,
individually and as a whole, if it is consummated with any combination of
other Participating Partnerships. The General Partner bases this belief
primarily on the fact that the consideration to be paid to the Atlanta Marquis
Limited Partners has been established based upon Atlanta Marquis' Exchange
Value, without regard to any possible combination of other Partnerships.
In reaching the conclusions implicit in the above recommendation, the
General Partner has taken into account the following considerations, placing
the greatest weight on the first two considerations:
. The General Partner has concluded that the Exchange Value for Atlanta
Marquis, which is equal to its Continuation Value, represents fair
consideration for the Partnership Interests of the Atlanta Marquis
Limited Partners in the Merger in relation to Atlanta Marquis. The
General Partner also has concluded that the Exchange Value established
for the Atlanta Marquis Limited Partners fairly reflects the value of the
assets held by Atlanta Marquis. In addition, the Fairness Opinion
supports these conclusions.
. Atlanta Marquis Limited Partners will be able to defer recognition of
gain until such time as they choose to realize such gain based on their
own personal circumstances.
. The General Partner has concluded that the potential benefits of the
Merger to the Atlanta Marquis Limited Partners, as described under
"Background and Reasons for the Mergers and the REIT Conversion--Reasons
for the Mergers," outweigh the potential risks and detriments of the
Merger for the Atlanta Marquis Limited Partners, as described in "Risk
Factors."
. The Fairness Opinion, in the view of the General Partner, supports the
fairness of the Merger, even though it includes qualifications,
limitations and assumptions relating to its scope and other factors that
Atlanta Marquis Limited Partners should consider carefully. The
availability of the Fairness Opinion is particularly significant in light
of the absence of arm's length negotiations in establishing the terms of
the Merger.
. Host will contribute its wholly owned full-service hotel assets,
substantially all of its interests in the Hotel Partnerships and its
other assets (excluding its senior living assets and the cash or
securities to be distributed to its shareholders) to the Operating
Partnership in exchange for (i) a number of OP Units equal to the number
of outstanding shares of common stock of Host, (ii) preferred partnership
interests in the Operating Partnership corresponding to any shares of
Host preferred stock outstanding at the time of the REIT Conversion and
(iii) the assumption by the Operating Partnership of all liabilities of
Host (including past and future tax liabilities), other than liabilities
of SLC. Following these contributions, the Operating Partnership and its
subsidiaries will directly own all of Host's wholly owned hotels and all
of Host's interests in the Hotel Partnerships and Host's assets. Host
will receive OP Units in respect of its general and limited partner
interests in Atlanta Marquis on substantially the same basis as the
Partnership
Atlanta Marquis Supp-20
<PAGE>
Units held by Atlanta Marquis Limited Partners. Host REIT will not receive
any compensation for its services as general partner to the Operating
Partnership following the REIT Conversion and will benefit from the
operations of the Operating Partnership only to the extent of the
distributions received based upon its percentage interest in the Operating
Partnership to the same extent as the other limited partners. Because Host
REIT will share in the value of the Operating Partnership solely through
distributions and not through any separate compensation structure, the
General Partner believes that this is a factor supporting the fairness of
the Merger to the Atlanta Marquis Limited Partners.
. The General Partner believes that the value of the consideration to be
received by the Atlanta Marquis Limited Partners in the Merger is fair in
relation to the value which would be derived by such Limited Partners
under any of the alternatives described under "Background and Reasons for
the Mergers and the REIT Conversion--Alternatives to the Mergers,"
especially since the Exchange Value of Atlanta Marquis is equal to its
Continuation Value, which is the greatest of the Adjusted Appraised
Value, the Continuation Value and the Liquidation Value and the historic
prices paid for Atlanta Marquis Partnership Units. The General Partner
does not believe that the sale of Atlanta Marquis' Hotel and liquidation
of Atlanta Marquis will obtain for Atlanta Marquis Limited Partners as
much value as the value to be received by such Atlanta Marquis Limited
Partners following the Merger. In addition, while the Continuation Values
of three of the Partnerships, including Atlanta Marquis, are higher than
the Adjusted Appraised Values of such Partnerships, the General Partners
believe that the Mergers provide substantial benefits to such Atlanta
Marquis Limited Partners and other Limited Partners, including those
benefits described under "Background and Reasons for the Mergers and the
REIT Conversion--Reasons for the Mergers," especially enhanced liquidity
and regular quarterly cash distributions. The General Partner believes
that the following benefits are of the greatest value and importance to
the Atlanta Marquis Limited Partners:
. Enhanced Liquidity. The Merger and the REIT Conversion will offer
Atlanta Marquis Limited Partners significantly enhanced liquidity
with respect to their investments in the Partnerships because,
commencing one year following the Effective Date, Atlanta Marquis
Limited Partners who retain OP Units will be able to exercise their
Unit Redemption Right at any time, subject to certain limited
exceptions. Host has approximately 204 million shares of common stock
outstanding and is expected to have a total common equity market
capitalization of approximately $ billion after giving effect to the
estimated $ million earnings and profits distribution (based on
Host's $ closing price per share on the NYSE on , 1998). The
exercise of the Unit Redemption Right, however, generally would
result in recognition of taxable income or gain at that time.
. Risk Diversification. Upon consummation of the REIT Conversion, each
Atlanta Marquis Limited Partner's investment will be converted from
an investment in Atlanta Marquis, which owns one hotel into an
investment in an enterprise that initially will own or control
approximately 120 Hotels and will have a total market capitalization
of approximately $ billion, thereby reducing the dependence upon the
performance of, and the exposure to the risks associated with, the
Hotel currently owned by Atlanta Marquis and spreading such risk over
a broader and more varied portfolio, including more diverse
geographic locations and multiple brands.
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a significantly lower leverage to
value ratio than Atlanta Marquis currently, which has a leverage
ratio of 71% (calculated as a percentage of Appraised Value),
resulting in significant interest and debt service savings and
greater financial stability.
. Regular Quarterly Cash Distributions. The General Partner expects
that the Operating Partnership will make regular quarterly cash
distributions to holders of OP Units. Host expects that these
distributions will be higher than the estimated cash distributions
for 1998 of Atlanta Marquis and, in any event, the ability to receive
distributions quarterly and in regular amounts would be enhanced.
. Substantial Tax Deferral. The General Partner expects that Atlanta
Marquis Limited Partners who do not elect to receive Notes in
exchange for OP Units generally should be able to obtain the
Atlanta Marquis Supp-21
<PAGE>
benefits of the Merger while continuing to defer recognition for
federal income tax purposes of at least a substantial portion, if not
all, of the gain with respect to their Partnership Interests that
otherwise would be recognized in the event of a liquidation of
Atlanta Marquis or a sale or other disposition of its assets in a
taxable transaction (although Atlanta Marquis Limited Partners may
(although are not expected to) recognize a relatively modest amount
of ordinary income as the result of required sales of personal
property by Atlanta Marquis to a Non-Controlled Subsidiary in order
to facilitate Host REIT's qualification as a REIT).
. The General Partner believes that the economic terms of the lease of the
Atlanta Marquis Hotel are fair and reasonable from the standpoint of the
Operating Partnership.
The General Partner believes that the factors described above, which support
the fairness of the Merger to the Atlanta Marquis Limited Partners, when
weighed against the factors that may be disadvantageous, taken as a whole,
indicate that the Merger is fair to the Atlanta Marquis Limited Partners.
Fairness Opinion
AAA, an independent financial advisory firm with substantial real estate and
partnership transaction experience, was engaged by the General Partner and the
other General Partners to perform the Appraisals and to render the Fairness
Opinion that (i) the Exchange Value and the methodologies and underlying
assumptions used to determine the Exchange Value, the Adjusted Appraised
Value, the Continuation Value and the Liquidation Value of Atlanta Marquis and
each other Partnership (including, without limitation, the assumptions used to
determine the various adjustments to the Appraised Values of the Hotels) are
fair and reasonable, from a financial point of view, to the Atlanta Marquis
Limited Partners and the Limited Partners of each other Partnership and (ii)
the methodologies used to determine the value of an OP Unit and to allocate
the equity in the Operating Partnership to be received by the Atlanta Marquis
Limited Partners and the partners of each other Partnership are fair and
reasonable to the Atlanta Marquis Limited Partners and the Limited Partners of
each other Partnership. The Fairness Opinion is addressed to each Partnership
and it may be relied upon by each of the Atlanta Marquis Limited Partners and
the Limited Partners of the other Partnerships. The full text of the Fairness
Opinion, which contains a description of the assumptions and qualifications
applicable to the review and analysis by AAA, is set forth in Appendix B to
the Consent Solicitation and should be read in its entirety. The material
assumptions and qualifications to the Fairness Opinion are summarized below,
although this summary does not purport to be a complete description of the
various inquiries and analyses undertaken by AAA in rendering the Fairness
Opinion. Arriving at a fairness opinion is a complex analytical process not
necessarily susceptible to partial analysis or amenable to summary
description. For a more complete description of the assumptions and
qualifications that limit the scope of the Fairness Opinion, see "--
Qualifications to Fairness Opinion" and "--Assumptions" below.
Although the General Partner advised AAA that certain assumptions were
appropriate in its view, the General Partner imposed no conditions or
limitations on the scope of the investigation by AAA or the methods and
procedures to be followed by AAA in rendering the Fairness Opinion. The fees
and expenses of AAA will be treated as a Merger Expense and will be paid by
the Operating Partnership. In addition, the General Partner has agreed to
indemnify AAA against certain liabilities. See "--Compensation and Material
Relationships."
Qualifications to Fairness Opinion. In the Fairness Opinion, AAA
specifically states that it did not: (a) specifically consider other
methodologies for allocation of the OP Units, (b) address or conclude that
other methodologies for allocation of the OP Units to the Atlanta Marquis and
the other Partnerships might not have been more favorable to the Limited
Partners in certain of the Partnerships, (c) negotiate with the General
Partner, the General Partners of other Partnerships or Host, (d) participate
in establishing the terms of the Merger and the other Mergers, (e) provide an
opinion as to the terms and conditions of the Merger and the other Mergers
other than those explicitly stated in the Fairness Opinion, (f) make any
independent review of the capital expenditure estimates set forth in the
Engineering Study or (g) make any estimates of Atlanta Marquis' and each other
Partnership's contingent liabilities. In addition, with respect to the
specific reference to the allocation of the equity interest in the Operating
Partnership to be received by the limited partners of each Partnership, AAA
has assumed that the average closing price on the NYSE of a Host REIT Common
Share for the 20 trading days after the Effective Date of the Mergers
represents a fair price.
Atlanta Marquis Supp-22
<PAGE>
In connection with preparing the Fairness Opinion, AAA was not engaged to,
and consequently did not, prepare any written report or compendium of its
analysis for internal or external use beyond the analysis set forth in
Appendix B. AAA will not deliver any additional written opinion of the
analysis, other than to update the written opinion if requested by the
Operating Partnership.
Experience of AAA. AAA is the world's largest independent valuation
consulting firm and is regularly and continually engaged in the valuation of
commercial real estate and businesses and their securities in connection with
tender offers, mergers and acquisitions, recapitalizations and
reorganizations, divestitures, employee stock ownership plans, leveraged
buyout plans, private placements, limited partnerships, estate and corporate
matters, other financial advisory matters and other valuation purposes.
AAA was selected because of its experience in the valuation of businesses
and their securities in connection with tender offers, mergers and
acquisitions, recapitalizations and reorganizations, including transactions
involving hotel partnerships. In addition, Host and its affiliates have
previously engaged AAA to provide appraisals and fairness opinions in
connection with other transactions. The General Partner and the other General
Partners considered two other firms for purposes of performing the appraisals
and rendering the Fairness Opinion and received proposals from each. The
General Partners selected AAA based upon price and experience.
Summary of Materials Considered and Investigation Undertaken. As a basis for
rendering the Fairness Opinion, AAA has made such reviews, studies and
analyses as it deemed necessary and pertinent in order to provide it with a
reasonable basis for the Fairness Opinion, including, but not limited to, the
following: (i) reviewed the transaction documents and SEC reporting and/or
filing documents, including drafts of the Form S-4 for the Mergers; (ii)
provided the Market Value of each Hotel owned by each Partnership in a
separate short form appraisal report and each such report was reviewed and
certified by an MAI appraiser as to its preparation in accordance with the
requirements of the Standards of Professional Practice of the Appraisal
Institute and the Uniform Standards of Professional Appraisal Practice of the
Appraisal Foundation; as part of the Appraisals, AAA reviewed historical
operating statements, 1998 budget and year-to-date results and other financial
information as it deemed necessary as a basis for the Fairness Opinion and the
Appraisals also considered market transactions of similar lodging properties
as appropriate as a basis for the Market Value of each Hotel; (iii) reviewed
the methodologies used by each of the General Partners in their determination
of the Exchange Value of each Partnership, including the nature and amount of
all adjustments to the Appraised Values in determining such Exchange Values;
AAA reviewed and tested for the fairness and reasonableness of all adjustments
as well as for consideration of all adjustments deemed to be appropriate by
AAA; (iv) reviewed the methodologies used by each of the General Partners in
their determination of the value of an OP Unit and the allocation of the
equity interest in the Operating Partnership to be received by the partners of
each Partnership, and AAA reviewed and tested for the fairness and
reasonableness of the methods and measurements made by the General Partners;
(v) reviewed the General Partners' determination of the Liquidation Value of
each Partnership, and AAA reviewed and tested for the fairness and
reasonableness of all adjustments proposed by the General Partners, as well as
for consideration of all adjustments deemed appropriate by AAA; (vi) provided
an estimate of the Continuation Value of each Partnership based upon the
estimated present value of expected benefits to be received by each limited
partner interest as though the Mergers did not occur and each Partnership's
assets were sold within a twelve year period; AAA, as part of its analysis and
review, determined appropriate rates of growth in house profit or net
operating income, as well as reviewed other key variables affecting
partnership cash flows and other economic/financial factors affecting the
Partnerships' expected operations and results; (vii) reviewed the terms of the
ground leases of the Hotels and the partnership agreement of each Partnership;
(viii) reviewed audited and unaudited historical income statements, balance
sheets and statements of sources and uses of funds of each Partnership and
Host and pro forma financial information for Host REIT; (ix) reviewed audited
and unaudited historical operating statements of each Hotel, as well as
current operating statements and budgets; (x) conducted real estate valuation
and financial due diligence with respect to the Partnerships and their
underlying assets, liabilities and equity; (xi) reviewed internal Marriott
International, Host and Partnership financial analyses and other internally
generated data for each Hotel; and (xii) discussed all of the foregoing
information, where appropriate, with management of Marriott International,
Host and the Partnerships and their respective employees.
Atlanta Marquis Supp-23
<PAGE>
Assumptions. In rendering its opinion, AAA relied, without independent
verification, on the accuracy and completeness in all material respects of
certain relevant publicly available information and information provided to
AAA by Host and the Hotels. AAA assumed that all information furnished by
Host, the Hotels and the Partnerships and their representatives, upon which
AAA relied, presented an accurate description in all material respects of the
current and prospective status of the Hotels and the Partnerships from an
operational and financial point of view. AAA also noted that the Fairness
Opinion was based upon financial, economic, market and other considerations as
they existed and could be evaluated on the date thereof.
Conclusions. AAA concluded that, based upon and subject to its analysis and
assumptions and limiting conditions, and as of the date of the Fairness
Opinion: (i) the Exchange Value and the methodologies used to determine the
Exchange Value, the Adjusted Appraised Value, the Continuation Value and the
Liquidation Value of each Partnership (including, without limitation, the
assumptions used to determine the various adjustments to the Appraised Values
of each of the Hotels) are fair and reasonable, from a financial point of
view, to the Atlanta Marquis Limited Partners and the Limited Partners of each
other Partnership and (ii) the methodologies used to determine the value of an
OP Unit and to allocate the equity interest in the Operating Partnership to be
received by the Atlanta Marquis Limited Partners and the Limited Partners of
each Partnership are fair and reasonable to the Atlanta Marquis Limited
Partners and the Limited Partners of each other Partnership.
Compensation and Material Relationships. AAA has been paid a fee of $335,000
for its services as described herein, including the Appraisals and preparing
to deliver the Fairness Opinion. In addition, AAA will be reimbursed for all
reasonable out-of-pocket expenses, including legal fees, and will be
indemnified against certain liabilities, including certain liabilities under
the securities laws. The fee was negotiated between Host, the General Partners
and AAA. Payment of the fee to AAA is not dependent upon completion of the
Mergers. AAA has been previously engaged by Host and its affiliates to provide
appraisals, fairness opinions and solvency opinions in connection with other
transactions.
VOTING PROCEDURES
The consent of Atlanta Marquis Limited Partners holding a majority of the
outstanding Class A limited partner interests is required for participation in
the Merger. The General Partner holds 0.28% of the outstanding Class A limited
partner interests. The General Partner also owns a Class B limited partners
interest representing a 58.35% limited partner interest in the Partnership.
The General Partner intends to vote its Class A limited partner interests FOR
the Merger.
An Atlanta Marquis Limited Partner may mark the Consent Form to vote "FOR,"
"AGAINST" or "ABSTAIN" with respect to participation in the Merger by Atlanta
Marquis. THE FAILURE OF AN ATLANTA MARQUIS LIMITED PARTNER TO VOTE OR AN
ABSTENTION WILL HAVE THE SAME EFFECT AS IF SUCH LIMITED PARTNER HAD VOTED HIS
PARTNERSHIP INTERESTS "AGAINST" THE MERGER. ATLANTA MARQUIS LIMITED PARTNERS
WHO RETURN A SIGNED CONSENT FORM BUT FAIL TO INDICATE THEIR APPROVAL OR
DISAPPROVAL AS TO ANY MATTER (INCLUDING THE MERGER) WILL BE DEEMED TO HAVE
VOTED TO APPROVE SUCH MATTER. The voting procedures applicable to Atlanta
Marquis Limited Partners are set forth in the Consent Solicitation under the
heading "Voting Procedures--Required Vote and Other Conditions."
As of June 19, 1998, no person owned of record, or to the Partnership's
knowledge owns beneficially, more than 5% of the total number of Partnership
Units.
FEDERAL INCOME TAX CONSEQUENCES
In addition to the federal income tax consequences discussed in the sections
of the Consent Solicitation entitled "Federal Income Tax Consequences" and
"Risk Factors--Federal Income Tax Risks," Atlanta Marquis Limited Partners
should read carefully the following discussion of federal income tax
consequences applicable specifically to the Atlanta Marquis Limited Partners.
The information included in this discussion is based upon various factual
assumptions and information which are believed by the Operating Partnership
and the General
Atlanta Marquis Supp-24
<PAGE>
Partner to be reliable. However, some of these assumptions inevitably will not
materialize, and unanticipated events and circumstances will occur. Therefore,
there likely will be differences between the information provided herein,
including the numerical data and estimates, and actual results, and the
variations may be material and adverse.
Applicability of Tax Opinions
Hogan & Hartson L.L.P. ("Hogan & Hartson"), counsel to Host REIT, Host and
the Operating Partnership, has provided to Host REIT and the Operating
Partnership an opinion letter (substantially in the form of Appendix C to the
Consent Solicitation) as to certain federal income tax consequences to the
Operating Partnership and the Atlanta Marquis Limited Partners resulting from
the Mergers and the REIT Conversion. The opinion letter is based upon certain
assumptions and certain representations provided by Host REIT, Host, the
Operating Partnership and the General Partners. These representations
generally involve factual matters relating to the organization, ownership and
operations (including the income, assets, businesses, liabilities and
properties) of the Partnerships and Hotels contributed to the Operating
Partnership by Host and the Blackstone Entities prior to the Mergers and the
REIT Conversion and of Host REIT, the Operating Partnership and the
Partnerships following the Mergers and the REIT Conversion. In addition, on
the Effective Date, Hogan & Hartson expects to provide to Host REIT and the
Operating Partnership an opinion letter (substantially in the form of Appendix
D to the Consent Solicitation) as to the qualification and taxation of Host
REIT as a REIT under the Code following the REIT Conversion. The receipt of
this opinion letter is a condition to the REIT Conversion and each of the
Mergers. See "Federal Income Tax Consequences--Summary of Tax Opinions" in the
Consent Solicitation.
Each opinion provided by Hogan & Hartson in the opinion letter that is
substantially in the form of Appendix C to the Consent Solicitation is
applicable to the Atlanta Marquis Limited Partners.
The opinions already rendered by Hogan & Hartson are based on the Code and
Treasury Regulations in effect on the date hereof, current administrative
interpretations and positions of the IRS and existing court decisions, and the
opinions to be rendered by Hogan & Hartson on the Effective Date will be based
on the same authorities as of the Effective Date. No assurance can be given
that future legislation, Treasury Regulations, administrative interpretations
and court decisions will not significantly change the law or the above
conclusions reached by counsel. In addition, any such change could apply
retroactively to transactions preceding the date of change. Moreover, opinions
of counsel merely represent counsel's best judgment with respect to the
probable outcome on the merits and are not binding on the IRS or the courts.
Accordingly, even if there is no change in applicable law, no assurance can be
provided that such opinions (which do not bind the IRS or the courts) will not
be challenged by the IRS or will be sustained by a court if so challenged.
With the one exception described below (see--"Tax Consequences of the Merger--
Deemed Cash Distribution and Resulting Taxable Gain") and in the Consent
Solicitation under "Federal Income Tax Consequences--Tax Consequences of the
Mergers--IRS Ruling Request Regarding Allocation of Partnership Liabilities,"
neither Host REIT, the Operating Partnership nor the General Partners have
requested or plan to request any rulings from the IRS concerning the tax
consequences of the Mergers or the treatment of either the Operating
Partnership or Host REIT subsequent to the REIT Conversion.
Tax Consequences of the Merger
Overview. Hogan & Hartson has provided an opinion to the effect that, except
for any gain attributable to the sale of personal property by Atlanta Marquis
to a Non-Controlled Subsidiary in connection with the REIT Conversion, the
Merger will not result in the recognition of taxable gain or loss at the time
of the Merger to an Atlanta Marquis Limited Partner (i) who does not exercise
his Unit Redemption Right on a date sooner than the date two years after the
date of the consummation of the Merger; (ii) who does not receive a cash
distribution (or a deemed cash distribution resulting from relief from
liabilities, including as a result of any repayment of the Ivy Street Mortgage
Debt) in connection with the Merger or the REIT Conversion in excess of his
aggregate adjusted basis in his Atlanta Marquis Partnership Units at the time
of the Merger; (iii) who does not elect to
Atlanta Marquis Supp-25
<PAGE>
receive a Note in exchange for his OP Units in connection with the Merger (the
"Note Election"); (iv) who is not required to recognize gain by reason of the
exercise by another Atlanta Marquis Limited Partner of his right to make the
Note Election (which, in counsel's opinion, described below, should not be the
result of such election); and (v) who does not have his "at risk" amount fall
below zero as a result of the Merger or the REIT Conversion. See "Federal
Income Tax Consequences--Summary of Tax Opinions" in the Consent Solicitation.
With respect to the foregoing exceptions to nonrecognition treatment, the
Operating Partnership and the General Partner believe as follows: (i) an
Atlanta Marquis Limited Partner who acquired his Atlanta Marquis Partnership
Units in the original offering of such Partnership Units and who has held such
Partnership Units at all times since would not be considered to receive, as a
result of the Merger, a distribution (or a deemed cash distribution resulting
from relief from liabilities) that exceeds his aggregate adjusted basis in his
Atlanta Marquis Partnership Units at the time of the Merger, and would not
have his "at risk" amount fall below zero as a result of the Merger (in this
regard, the Operating Partnership has no plan to prepay or repay the Ivy
Street Mortgage Debt in connection with the REIT Conversion), and (ii) a
portion of the personal property associated with the Atlanta Marquis Hotel
will need to be sold to a Non-Controlled Subsidiary in connection with the
REIT Conversion, which may (although is not expected to) result in the
recognition of a relatively modest amount of income by the Atlanta Marquis
Limited Partners. See "Federal Income Tax Consequences--Tax Consequences of
the Mergers--Overview" in the Consent Solicitation and "Tax Allocations upon
the Sale of Certain Personal Property Associated with the Atlanta Marquis
Hotel" below.
With respect to the effects of an Atlanta Marquis Limited Partner's election
to receive a Note in exchange for his OP Units in connection with the Merger,
Hogan & Hartson is of the opinion that, although the matter is not free from
doubt, an Atlanta Marquis Limited Partner who does not make the Note Election
in connection with the Merger should not be required to recognize gain by
reason of another Atlanta Marquis Limited Partner's exercise of such right.
With respect to the exercise of a Unit Redemption Right, Hogan & Hartson is of
the opinion that it is more likely than not that an Atlanta Marquis Limited
Partner's exercise of his Unit Redemption Right more than one year after the
date of consummation of the Merger but less than two years after such date
will not cause the Merger itself to be a taxable transaction for the Atlanta
Marquis Limited Partner (or the other Atlanta Marquis Limited Partners). See
"Federal Income Tax Consequences--Summary of Tax Opinions" in the Consent
Solicitation. Opinions of counsel, however, do not bind the IRS or the courts,
and no assurances can be provided that such opinions will not be challenged by
the IRS or will be sustained by a court if so challenged.
Deemed Cash Distribution and Resulting Taxable Gain. With respect to his
Atlanta Marquis Partnership Units, an Atlanta Marquis Limited Partner will
receive no actual cash distribution in connection with the Merger but would be
deemed to receive a cash distribution in connection with the Merger to the
extent that his share of Operating Partnership liabilities immediately after
the Merger and the REIT Conversion is less than his share of Atlanta Marquis
liabilities immediately prior to the Merger. For example, any repayment of the
Ivy Street Mortgage Debt or debt encumbering other Hotels may result in a
deemed cash distribution to the Atlanta Marquis Limited Partners. See "Federal
Income Tax Consequences--Tax Consequences of the Mergers--Relief from
Liabilities/Deemed Cash Distribution" in the Consent Solicitation. Even though
the Ivy Street Mortgage Debt and the debt encumbering other Hotels is not
expected to be repaid or refinanced in connection with the Mergers and the
REIT Conversion (except as described in the Consent Solicitation), an Atlanta
Marquis Limited Partner's share of indebtedness following the Mergers and the
REIT Conversion may nonetheless decrease in comparison to the Limited
Partner's estimated aggregate share of Atlanta Marquis indebtedness as of
December 31, 1998 (calculated based on the assumption that the Mergers did not
occur) by reason of the manner in which the debt allocation rules work when
multiple assets with different levels of leverage are consolidated into a
single partnership.
An Atlanta Marquis Limited Partner, however, would recognize taxable gain as
a result of any deemed cash distribution only to the extent that the deemed
cash distribution were to exceed his adjusted tax basis in his Atlanta Marquis
Partnership Units immediately prior to the Merger. As noted above, the
Operating Partnership and the General Partner believe, based upon and subject
to the assumptions and other limitations described below, that an Atlanta
Marquis Limited Partner who acquired his Atlanta Marquis Partnership Units in
the original offering of such Partnership Units and has held the Partnership
Units at all times since the offering will
Atlanta Marquis Supp-26
<PAGE>
have an adjusted tax basis in excess of the deemed cash distribution that might
occur in connection with the Merger and the REIT Conversion. Therefore, such an
Atlanta Marquis Limited Partner should not recognize gain due to such deemed
cash distribution resulting from the relief from liabilities in connection with
the Merger and the REIT Conversion.
The adjusted tax basis of an Atlanta Marquis Limited Partner who did not
acquire his Atlanta Marquis Partnership Units in the original offering of such
Partnership Units or who has not held his Atlanta Marquis Partnership Units at
all times since such offering could vary materially from that of an Atlanta
Marquis Limited Partner who did so. If an Atlanta Marquis Limited Partner has
an adjusted tax basis in his Atlanta Marquis Partnership Units (per Atlanta
Marquis Partnership Unit) that is substantially less than the adjusted tax
basis of an Atlanta Marquis Limited Partner who acquired his Atlanta Marquis
Partnership Units in the original offering of such Partnership Units and has
held such Partnership Units at all times since, he could recognize gain due to
any deemed cash distribution resulting from the relief from liabilities in
connection with the Merger and the REIT Conversion.
The Operating Partnership has no current plan or intention to cause the
prepayment of the Ivy Street Mortgage Debt or, except as described in the
Consent Solicitation, any of the nonrecourse liabilities encumbering the Hotels
owned by the other Partnerships. The Operating Partnership, however, will have
to repay mortgage indebtedness securing the Hotels owned by the Partnerships at
the time such indebtedness matures. There can be no assurance that at such time
the Operating Partnership will be able to secure nonrecourse mortgage
indebtedness secured only by those Hotels in an amount sufficient to avoid a
deemed cash distribution to the former Limited Partners in those Partnerships,
including Atlanta Marquis. Moreover, the Operating Partnership's current long-
term financing strategy is to have as little debt as possible that is secured
by individual Hotels and to have as much debt as possible in the form of
unsecured debt, held either by the public or by institutional investors, which
debt may or may not be recourse to Host REIT, as general partner of the
Operating Partnership. In view of these considerations and the potential
adverse consequences to Limited Partners in certain Partnerships, including the
Atlanta Marquis Limited Partners, the Operating Partnership has requested from
the IRS a ruling to the effect that such unsecured indebtedness of the
Operating Partnership that is issued initially to institutional investors and
is not recourse to Host REIT (i) would qualify as "nonrecourse liabilities" for
purposes of Code Section 752, (ii) to the extent the proceeds thereof are
applied to repay existing nonrecourse mortgage indebtedness secured by one or
more Hotels (including the Ivy Street Mortgage Debt), would be considered to be
"secured" by those Hotels for purposes of allocating the liabilities for tax
basis purposes (and thus would be allocable, at least in substantial part, to
the former Limited Partners in the Partnership owning those Hotels, including
the Atlanta Marquis Limited Partners), and (iii) would constitute "qualified
nonrecourse financing" secured by such Hotels for purposes of Code Section 465.
The IRS has recently issued a ruling to that effect to another taxpayer, and
has indicated to the Operating Partnership's representatives that it is
favorably inclined to issue that ruling to the Operating Partnership.
Each Atlanta Marquis Limited Partner will gradually begin to recognize income
over the term of his ownership of OP Units (beginning, perhaps, in his first
year of ownership of OP Units) attributable to deemed cash distributions
resulting from the relief from liabilities, as the aggregate principal amount
of nonrecourse indebtedness encumbering (or deemed to encumber) the Atlanta
Marquis Hotel amortizes in accordance with its terms. The Operating Partnership
will make regular quarterly cash distributions to the Atlanta Marquis Limited
Partners that may or may not be sufficient to allow the Atlanta Marquis Limited
Partners to pay the federal and state income tax owed on the income allocated
to such Limited Partners by reason of the amortization of the debt secured by
the Atlanta Marquis Hotel.
Section 465(e) Recapture. As discussed in the Consent Solicitation, see
"Federal Income Tax Consequences--Tax Consequences of the Mergers--Section
465(e) Recapture," the "at risk" rules of Section 465 of the Code generally
apply to limit the use of partnership losses by a partner. Under Section 465(e)
of the Code, a partner may be required to include in gross income, or
"recapture," losses previously allowed to such partner with respect to his
investment in a partnership if the amount for which the partner is "at risk" in
relation to his investment in the partnership is less than zero at the close of
the taxable year.
Atlanta Marquis Supp-27
<PAGE>
It is possible that the consummation of the Mergers and the REIT Conversion
or the repayment of certain "qualified nonrecourse financing" of the Operating
Partnership, the Hotel Partnerships or the Hotels contributed to the Operating
Partnership by the Blackstone Entities at the time of or following the Merger
and the REIT Conversion could, singularly or in combination, cause an Atlanta
Marquis Limited Partner's amount at risk in relation to his investment in
Atlanta Marquis (and, after the Mergers, in the Operating Partnership) to be
reduced below zero, resulting in an income inclusion to the Limited Partner
under Section 465(e) of the Code. Currently, a sufficient portion of the
current debt of Atlanta Marquis constitutes "qualified nonrecourse financing"
so that the Atlanta Marquis Limited Partners have positive at risk amounts,
and the Operating Partnership expects that most of the current debt with
respect to the other Hotel Partnerships and the Hotels contributed by the
Blackstone Entities that will be assumed by the Operating Partnership as part
of the Mergers and the REIT Conversion should qualify as "qualified
nonrecourse financing." The Operating Partnership and the General Partner
believe, based upon and subject to the assumptions and other limitations
described below, that an Atlanta Marquis Limited Partner who acquired his
Atlanta Marquis Partnership Units in the original offering of such Partnership
Units and has held the Partnership Units at all times since will have a
positive at risk amount immediately following the Merger and the REIT
Conversion.
It is possible, however, that a former Atlanta Marquis Limited Partner's at
risk amount could decline in the future, either because of the allocation of
losses from the Operating Partnership to that former Atlanta Marquis Limited
Partner or because of cash distributions by the Operating Partnership to that
former Atlanta Marquis Limited Partner in excess of the taxable income
allocable to him with respect to his OP Units. Moreover, there can be no
assurance that debt incurred by the Operating Partnership in the future to
refinance the Ivy Street Mortgage Debt or outstanding mortgage debt of the
other Hotel Partnerships or the Hotels contributed by the Blackstone Entities
will qualify as "qualified nonrecourse financing." If, however, the Operating
Partnership were to obtain the requested ruling from the IRS and were to
refinance existing mortgage indebtedness of the Partnerships, including the
Ivy Street Mortgage Debt, with the type of indebtedness described in the
ruling, such indebtedness should constitute "qualified nonrecourse financing"
for purposes of the "at risk" rules.
Impact of Assumption of Atlanta Marquis Liabilities by the Operating
Partnership. As described in the Consent Solicitation, see "Federal Income Tax
Consequences--Tax Consequences of the Mergers--Disguised Sale Regulations," an
Atlanta Marquis Limited Partner will recognize gain to the extent he is
treated as having sold all or part of his Atlanta Marquis Partnership Interest
in a "disguised sale." For purposes of these rules, certain reductions in a
partner's share of partnership liabilities are treated as a transfer of money
or other property from the partnership to the partner which may give rise to a
disguised sale, even if that reduction would not otherwise result in a taxable
deemed cash distribution in excess of the partner's basis in his partnership
interest. However, if a transfer of property by a partner to a partnership is
not otherwise treated as part of a disguised sale, then any reduction in the
partner's share of "qualified liabilities" also will not be treated as part of
a disguised sale. A "qualified liability" in connection with a transfer of
property to a partnership includes (i) any liability incurred more than two
years prior to the earlier of the transfer of the property or the date the
partner agrees in writing to the transfer, as long as the liability has
encumbered the transferred property throughout the two-year period; (ii) a
liability that was not incurred in anticipation of the transfer of the
property to a partnership, but that was incurred by the partner within the
two-year period prior to the earlier of the date the partner agrees in writing
to transfer the property or the date the partner transfers the property to a
partnership and that has encumbered the transferred property since it was
incurred; (iii) a liability that is traceable under the Treasury Regulations
to capital expenditures with respect to the property; and (iv) a liability
that was incurred in the ordinary course of the trade or business in which
property transferred to the partnership was used or held, but only if all the
assets related to that trade or business are transferred, other than assets
that are not material to a continuation of the trade or business. However, a
recourse liability is not a "qualified liability" unless the amount of the
liability does not exceed the fair market value of the transferred property
(less any other liabilities that are senior in priority and encumber such
property or any allocable liabilities described in (iii) or (iv), above) at
the time of transfer.
The General Partner and the Operating Partnership believe, based upon their
review of the facts and circumstances surrounding each liability, that all
liabilities of Atlanta Marquis (including its share of the Ivy
Atlanta Marquis Supp-28
<PAGE>
Street Mortgage Debt) fall into one of the four categories of "qualified
liabilities" described above and, accordingly, that the mere assumption by the
Operating Partnership of the outstanding liabilities of Atlanta Marquis will
not give rise to a "disguised sale" by any of the Atlanta Marquis Limited
Partners.
Tax Treatment of Atlanta Marquis Limited Partners Who Hold OP Units Following
the Merger
Initial Basis in Units. In general, an Atlanta Marquis Limited Partner will
have an initial tax basis in his OP Units received in the Merger with respect
to his Atlanta Marquis Partnership Units equal to the basis in his Atlanta
Marquis Partnership Units at the time of the Merger, reduced to reflect any
deemed cash distributions resulting from a reduction in his share of Atlanta
Marquis liabilities and increased to reflect his share of other liabilities of
the Operating Partnership and any gain required to be recognized in connection
with the Mergers and the REIT Conversion (including income, if any,
attributable to the sale of a portion of the personal property associated with
the Atlanta Marquis Hotel, as described below under "--Tax Allocations upon
the Sale of Certain Personal Property Associated with the Atlanta Marquis
Hotel"). For a discussion of the federal income tax consequences for an
Atlanta Marquis Limited Partner from a reduction in basis that may result from
the Merger and the REIT Conversion, see "Federal Income Tax Consequences--Tax
Treatment of Limited Partners Who Hold OP Units Following the Mergers--Initial
Tax Basis of OP Units" in the Consent Solicitation.
Tax Allocations upon a Sale by the Operating Partnership of Atlanta Marquis
Hotel. Pursuant to Section 704(c) of the Code, income, gain, loss and
deduction attributable to appreciated or depreciated property that is
contributed to a partnership must be allocated for federal income tax purposes
in a manner such that the contributor is charged with, or benefits from, the
unrealized gain or unrealized loss associated with the property at the time of
contribution. The amount of such unrealized gain or unrealized loss is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution (referred to as the "Book-Tax
Difference"). The Operating Partnership and the General Partner estimate,
based upon and subject to the assumptions and other limitations described
below, that the Book-Tax Difference for all Atlanta Marquis Limited Partners
(but excluding all of Host's interests) with respect to the Atlanta Marquis
Hotel will be $107,243,380 upon the consummation of the Merger.
If the Operating Partnership were to sell the Atlanta Marquis Hotel, the
former partners of Atlanta Marquis (including Host REIT with respect to Host's
interest in Atlanta Marquis held through Marriott Marquis Corporation) would
be specially allocated by the Operating Partnership an aggregate amount of
taxable gain equal to the aggregate Book-Tax Difference with respect to the
Atlanta Marquis Hotel. The share of such gain allocable to an Atlanta Marquis
Limited Partner who acquired his Atlanta Marquis Partnership Units in the
original offering of such Partnership Units and held such Partnership Units at
all times since would be $202,346 per Atlanta Marquis Partnership Unit. The
share of such gain of an Atlanta Marquis Limited Partner who did not acquire
his Atlanta Marquis Partnership Units in the original offering of such
Partnership Units or who has not held his Atlanta Marquis Partnership Units at
all times since such offering could vary materially from this amount. If the
Operating Partnership were to sell the Atlanta Marquis Hotel, the remaining
Book-Tax Difference at the time the Hotel is sold would be required to be
allocated exclusively to the former Atlanta Marquis Limited Partners and the
General Partner, even though the proceeds of such sale would be allocated
proportionately among all the partners in the Operating Partnership (and would
likely be retained by the Operating Partnership, rather than distributed to
holders of OP Units and Common Shares of Host REIT). The Atlanta Marquis
Limited Partners would not be entitled to any special distributions from the
Operating Partnership in connection with such a sale, and thus would not
necessarily receive cash distributions from the Operating Partnership
sufficient to pay such additional taxes. Although the Partnership Agreement
does not impose any restrictions upon the Operating Partnership preventing it
from causing the sale of the Atlanta Marquis Hotel at any time following the
Merger, the Operating Partnership does not have current plans to pursue a sale
of such Hotel. See "Federal Income Tax Consequences--Tax Treatment of Limited
Partners Who Hold OP Units Following the Mergers--Sale of Individual Hotels"
in the Consent Solicitation.
Atlanta Marquis Supp-29
<PAGE>
Tax Allocations upon the Sale of Certain Personal Property Associated with
the Atlanta Marquis Hotel. As discussed in the Consent Solicitation, see
"Federal Income Tax Consequences--Federal Income Taxation of Host REIT
Following the REIT Conversion--Income Tests Applicable to REITs" and "--
Taxable Income Attributable to Sales of Personal Property in Connection with
the REIT Conversion," if the rent attributable to personal property leased in
connection with the lease of each Hotel is greater than 15% of the total rent
received under the lease of such Hotel, the portion of the rent attributable
to the personal property will not constitute qualifying income to Host REIT
(the "15% Personal Property Test"). The Operating Partnership and the General
Partner have determined that the percentage of rent attributable to the
personal property to be leased in connection with the lease of the Atlanta
Marquis Hotel would not satisfy the 15% Personal Property Test. The 15%
Personal Property Test is a mechanical test that is based not on the relative
fair market value of the assets subject to lease, or the relative fair rental
value of those assets, but, rather, is based on the average relative adjusted
tax bases of the assets subject to the lease. Accordingly, immediately prior
to the Merger, the Operating Partnership will require Atlanta Marquis, if it
chooses to participate in the Merger, to sell to a Non-Controlled Subsidiary
of a portion of the personal property associated with the Atlanta Marquis
Hotel. This sale, which will be a taxable transaction, may (although is not
expected to) result in the recognition by Atlanta Marquis (and the allocation
to the Atlanta Marquis Limited Partners) of a relatively modest amount of
taxable gain to the extent of Atlanta Marquis' share of the difference, if
any, between the fair market value of the personal property at the time of the
sale and the adjusted tax basis of such property at that time. The actual
amount of such gain, if any, will be determinable only at the time of the sale
and will be affected by the specific personal property selected to be sold and
the fair market value and adjusted basis of that personal property. Pursuant
to the Atlanta Marquis partnership agreement, any such taxable gain will be
characterized as ordinary recapture income and will be allocated by Atlanta
Marquis to the former Atlanta Marquis Limited Partners in the same proportions
and to the same extent that such Limited Partners were allocated any
deductions directly or indirectly giving rise to the treatment of such gain as
recapture income prior to the Merger. The Atlanta Marquis Limited Partners
would not be entitled to any special distributions from Atlanta Marquis in
connection with such a sale of personal property.
Tax Allocations with Respect to Contributed Hotel Generally. The tax
allocations of depreciation to the Atlanta Marquis Limited Partners may change
significantly as a result of the Mergers and the REIT Conversion for two
reasons. First, as described above, pursuant to Section 704(c) of the Code,
the Atlanta Marquis Limited Partners' share of depreciation and deductions
attributable to the Atlanta Marquis Hotel will be required to be allocated for
federal income tax purposes in a manner such that the Atlanta Marquis Limited
Partners are charged with their share of the Book-Tax Difference associated
with the Atlanta Marquis Hotel at the time of the consummation of the Merger.
Consequently, an Atlanta Marquis Limited Partner will be allocated less
depreciation with respect to the Atlanta Marquis Hotel than would be the case
if the Mergers had not occurred and the Atlanta Marquis Limited Partner had
continued to hold his Atlanta Marquis Partnership Units. (On the other hand, a
former Atlanta Marquis Limited Partner will be allocated depreciation with
respect to other Hotels acquired by the Operating Partnership in connection
with the Mergers and the REIT Conversion, including the Hotels owned by the
other Hotel Partnerships and the Hotels being contributed to the Operating
Partnership by Host and the Blackstone Entities in connection with the Merger
and the REIT Conversion.) Second, the Merger will cause the technical
termination under Section 708(b)(1)(B) of the Code of Atlanta Marquis and most
of the other Hotel Partnerships that participate in the Merger. Section
168(i)(7) of the Code provides, in effect, that when a partnership terminates
under Section 708(b)(1)(B) of the Code, the partnership must begin new
depreciation periods for its property. As a result, the remaining bases of the
real estate components of the Atlanta Marquis Hotel (in which Atlanta Marquis
owns an indirect interest through its interest in Ivy Street Hotel Limited
Partnership) and the Hotels held by the other Hotel Partnerships that
terminate will be depreciated over 39 years, rather than over the remaining
current lives of such Hotels (which range from less than one year to 39
years). See "Federal Income Tax Consequences--Tax Treatment of Limited
Partners Who Hold OP Units Following the Mergers--Effect of Mergers on
Depreciation" in the Consent Solicitation.
In light of the complexity of the governing rules affecting the calculation
and allocation of depreciation with respect to properties contributed to a
partnership, particularly when a number of those properties are subject to
Atlanta Marquis Supp-30
<PAGE>
the separate adjustments required in connection with a technical termination
under Section 708 of the Code, the number of Hotels that the Operating
Partnership will be acquiring in connection with the Mergers and the REIT
Conversion, and the impact on these calculations of other outside events,
including equity offerings by Host or Host REIT and other acquisitions
undertaken by Host, Host REIT or the Operating Partnership prior to or in
connection with the REIT Conversion, the Operating Partnership and the General
Partner believe that it is impossible to predict with any degree of precision
the impact that the Mergers and the REIT Conversion will have on the future
depreciation (and, consequently, the amount of taxable income) allocable to an
Atlanta Marquis Limited Partner.
Impact on Passive Activity Losses of an Investment in a Publicly Traded
Partnership. The passive loss limitation rules generally provide that
individuals, estates, trusts and certain closely held corporations and
personal service corporations can only deduct losses from passive activities
(generally activities in which the taxpayer does not materially participate,
which would include the Operating Partnership for Atlanta Marquis Limited
Partners) to the extent that such losses are not in excess of the taxpayer's
income from passive activities or investments. An Atlanta Marquis Limited
Partner would be able to offset losses from other passive activities against
income from the Operating Partnership that is considered passive income (but
not portfolio income) so long as the Operating Partnership is not treated as a
publicly traded partnership. The Operating Partnership and the General Partner
believe, however, that there is a substantial risk that the Operating
Partnership will be treated as a publicly traded partnership for purposes of
the passive loss limitation rules. In this event, any losses or deductions of
the Operating Partnership allocable to an Atlanta Marquis Limited Partner
after the Merger could not be used to offset passive income from other passive
activities. Similarly, losses from other passive activities (including losses
attributable to Atlanta Marquis for periods prior to the Merger) could not be
applied to offset income of the Operating Partnership allocated to an Atlanta
Marquis Limited Partner. An Atlanta Marquis Limited Partner, however, would be
able to offset any passive losses from his investment in Atlanta Marquis (or
other investments) against any gain recognized by the Atlanta Marquis Limited
Partner as a result of the Merger. The Operating Partnership and the General
Partner estimate that, as of December 31, 1998, an Atlanta Marquis Limited
Partner who purchased his Partnership Units at the time of the original
offering, has held those Partnership Units continuously since that time, and
whose Partnership Units have been his only investment in a passive activity
would have a passive activity loss carryforward of approximately $127,233, on
a per Partnership Unit basis.
State and Local Taxes. Atlanta Marquis Limited Partners holding OP Units
will be subject to state and local taxation in a number of jurisdictions in
which the Operating Partnership directly or indirectly holds real property and
would be required to file periodic tax returns in those jurisdictions. In this
regard, immediately following the Mergers and the REIT Conversion, the
Operating Partnership expects that it will own properties in approximately 28
states across the United States and the District of Columbia. Currently,
Atlanta Marquis owns, indirectly, property in only one state. See "Federal
Income Tax Consequences--Tax Treatment of Limited Partners Who Hold OP Units
Following the Mergers--State and Local Taxes" in the Consent Solicitation.
Assumptions Used in Determining Tax Consequences of the Merger
In preparing the discussion set forth above, the Operating Partnership and
the General Partner made several key assumptions, which are described below.
If any such assumption is not accurate with respect to a particular Atlanta
Marquis Limited Partner, the tax consequences of the Merger to such Limited
Partner could be substantially different from those reflected above.
ACCORDINGLY, EACH ATLANTA MARQUIS LIMITED PARTNER IS STRONGLY URGED TO CONSULT
WITH HIS OWN TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH ATLANTA MARQUIS
LIMITED PARTNER'S PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES
OF PARTICIPATING IN THE MERGER.
First, with respect to an Atlanta Marquis Limited Partner's basis in his
Atlanta Marquis Partnership Units prior to the Merger, the Operating
Partnership and the General Partner assumed that an Atlanta Marquis Limited
Partner acquired his Atlanta Marquis Partnership Units in the original
offering of such Partnership Units and has held such Partnership Units at all
times since the offering (the "Original Limited Partner's Adjusted Basis"). In
Atlanta Marquis Supp-31
<PAGE>
general, each Atlanta Marquis Limited Partner had an initial tax basis in his
Atlanta Marquis Partnership Units ("Initial Basis") equal to his cash
investment in Atlanta Marquis (plus his proportionate share of Atlanta
Marquis's nonrecourse liabilities at the time he acquired his Atlanta Marquis
Partnership Units). An Atlanta Marquis Limited Partner's Initial Basis
generally has been increased by (a) such Limited Partner's share of Atlanta
Marquis taxable income and (b) any increases in his share of liabilities of
Atlanta Marquis. Generally, such Limited Partner's Initial Basis has been
decreased (but not below zero) by (i) his share of Atlanta Marquis cash
distributions, (ii) any decreases in his share of liabilities of Atlanta
Marquis, (iii) his share of losses of Atlanta Marquis and (iv) his share of
nondeductible expenditures of Atlanta Marquis that are not chargeable to
capital.
The General Partner has set forth on Appendix E to the Consent Solicitation
for Atlanta Marquis (i) the Original Limited Partner's Adjusted Basis as of
December 31, 1997 for each such Atlanta Marquis Limited Partner, and (ii) an
estimate of such Atlanta Marquis Limited Partner's Original Limited Partner's
Adjusted Basis as of December 31, 1998 (computed without regard to the Mergers
and based upon the assumptions set forth in Appendix E to the Consent
Solicitation). The Atlanta Marquis General Partner also has set forth on
Appendix E to the Consent Solicitation for each Atlanta Marquis Limited
Partner whose adjusted basis in his Atlanta Marquis Partnership Interest is
the same as the Original Limited Partner's Adjusted Basis (i) the Atlanta
Marquis liabilities allocable to such Atlanta Marquis Limited Partner as of
December 31, 1997, and (ii) an estimate of the Atlanta Marquis liabilities
allocable to such Limited Partner as of December 31, 1998 (computed without
regard to the Mergers and based upon the assumptions set forth in Appendix E
to the Consent Solicitation).
The adjusted tax basis of an Atlanta Marquis Limited Partner who did not
acquire his Atlanta Marquis Partnership Units in the original offering of such
Partnership Units could vary materially from that of an Atlanta Marquis
Limited Partner who did so for various reasons. If an Atlanta Marquis Limited
Partner has an adjusted tax basis in his Atlanta Marquis Partnership Units
that is less than the Original Limited Partner's Adjusted Tax Basis, the
Merger might result in the receipt by the Atlanta Marquis Limited Partner of a
deemed distribution of cash in excess of his adjusted tax basis in his Atlanta
Marquis Partnership Units, which could result in the recognition of income or
gain.
Second, the Operating Partnership and the General Partner assumed that the
method expected to be used by the Operating Partnership to allocate
liabilities among the partners will be respected for federal income tax
purposes. The Operating Partnership will allocate liabilities associated with
the Atlanta Marquis Hotel as described in "Federal Income Tax Consequences--
Tax Consequences of the Mergers--Relief from Liabilities/Deemed Cash
Distribution" in the Consent Solicitation. If the method used by the Operating
Partnership were not respected for federal income tax purposes and the
nonrecourse liabilities actually allocable to an Atlanta Marquis Limited
Partner are less than the amount assumed by the Operating Partnership and the
General Partner, the Merger might result in the receipt by such Atlanta
Marquis Limited Partner of a deemed distribution of cash that is greater than
the deemed distribution of cash expected to be received by such Atlanta
Marquis Limited Partner as described above in "Tax Consequences of the
Merger--Deemed Cash Distribution and Resulting Taxable Gain." For an Atlanta
Marquis Limited Partner who did not acquire his Atlanta Marquis Partnership
Units in the original offering of such Partnership Units and who has not held
such Partnership Units at all times since, this deemed distribution of cash
could exceed his adjusted tax basis in his Atlanta Marquis Partnership Units,
which could result in the recognition of income or gain.
Finally, the Operating Partnership and the General Partner assumed that the
Merger will be treated for federal income tax purposes as the transfer by the
Atlanta Marquis Limited Partners of their interests in the Partnership to the
Operating Partnership in exchange for OP Units. There can be no assurance,
however, that the IRS will not seek to recharacterize each Merger as either
(i) the liquidation of a Partnership followed by the distribution by the
Partnership of its assets to its partners and the subsequent transfers by such
partners of such assets to the Operating Partnership in exchange for OP Units,
or (ii) the transfer by a Partnership of its assets to the Operating
Partnership in exchange for OP Units (and possibly Notes) and the subsequent
distribution of such OP Units (and possibly Notes) to its partners. If the
Merger is recharacterized in the manner described in (ii) in
Atlanta Marquis Supp-32
<PAGE>
the preceding sentence, the tax consequences of the Merger to the Atlanta
Marquis Limited Partners likely would be materially affected.
EACH ATLANTA MARQUIS LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS
OWN TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH ATLANTA MARQUIS LIMITED
PARTNER'S PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF
PARTICIPATING IN THE MERGER. THE TAX CONSEQUENCES OF PARTICIPATING IN THE
MERGER TO A PARTICULAR ATLANTA MARQUIS LIMITED PARTNER COULD VARY
SUBSTANTIALLY FROM THE CONSEQUENCES DESCRIBED ABOVE.
Tax Treatment of Atlanta Marquis Limited Partners Who Exercise Their Right to
Make the Note Election
An Atlanta Marquis Limited Partner who exercises his right to make the Note
Election and receives a Note in connection with the Merger will be treated as
having made a taxable disposition of his OP Units. The amount realized in
connection with such disposition will equal the sum of the "issue price" of
the Notes (i.e., the face amount of the Note, currently estimated as $27,255
per Atlanta Marquis Partnership Unit) plus the portion of Atlanta Marquis
liabilities allocable to the Atlanta Marquis Limited Partner for federal
income tax purposes immediately prior to the disposition of the OP Units
(estimated as $162,595 per Atlanta Marquis Partnership Unit as of December 31,
1998). To the extent the amount realized exceeds the Atlanta Marquis Limited
Partner's adjusted basis in his Atlanta Marquis Partnership Units, the Atlanta
Marquis Limited Partner will recognize gain. The Operating Partnership and the
General Partner estimate (assuming the Atlanta Marquis Limited Partner
acquired his Atlanta Marquis Partnership Units at the time of the original
offering and has held such Partnership Units at all times since the offering)
that the amount of gain that would be recognized by an Atlanta Marquis Limited
Partner who made the Note Election would be approximately $192,800 per Atlanta
Marquis Partnership Unit, as of December 31, 1998. This assumes that an
Atlanta Marquis Limited Partner has treated the prior year payment from the
General Partner to compensate the Atlanta Marquis Limited Partners for certain
tax loss reallocations as an adjustment to the original purchase price of his
Partnership Unit(s). These payments totaled $8,624 per Partnership Unit. For a
discussion of the federal income tax rates applicable to the net capital gain
from the sale of a capital asset, see "Federal Income Tax Consequences--Tax
Treatment of Limited Partners Who Hold OP Units Following the Mergers--
Disposition of OP Units by Limited Partners" in the Consent Solicitation. In
this regard, the General Partner estimates that, as of December 31, 1998, if
Atlanta Marquis sold its Hotel in a fully taxable transaction for a net
amount, after payment of liabilities, determined by reference to the Note
Election Amount of Atlanta Marquis, the "unrecognized Section 1250 gain" per
Atlanta Marquis Partnership Unit would be $137,463 and the gain subject to tax
as ordinary income under Code Section 1245 per Atlanta Marquis Partnership
Unit would be $4,131. An Atlanta Marquis Limited Partner who makes the Note
Election would be able to treat any per Partnership Unit passive activity loss
carryforward with respect to the activities of Atlanta Marquis, to the extent
the sum of such losses exceeds his passive activity income for 1998, as losses
that are not from a passive activity and, therefore, not subject to the
passive activity loss limitation rules. For purposes of determining the gain
recognized by a Limited Partner as a result of making the Note Election, an
original Limited Partner's Adjusted Basis does not reflect such Limited
Partner's share of the syndication costs incurred by his Partnership at
formation. An original Atlanta Marquis Limited Partner's share of syndication
costs was $11,898 per Atlanta Marquis Partnership Unit.
An Atlanta Marquis Limited Partner who elects to receive a Note will be
eligible to defer only a small portion of that gain under the "installment
sale" rules. To the extent that the face amount of the Note (and any other
installment obligations received by the taxpayer during the year) outstanding
at the end of the taxable year in which the Merger occur exceeds $5,000,000,
the "installment sale" rules will require that the Atlanta Marquis Limited
Partner who defers gain pay to the IRS interest on the resulting tax that has
been deferred. The Atlanta Marquis Limited Partner will not be eligible to
defer gain recognized upon the receipt of the Note to the extent that his
share of Atlanta Marquis liabilities at the time of the Merger exceeds his
adjusted tax basis in his Atlanta Marquis Partnership Units immediately prior
to the Merger (that is, to the extent that he has a "negative capital account"
for tax purposes). In addition, the Atlanta Marquis Limited Partner will not
be eligible to defer gain to
Atlanta Marquis Supp-33
<PAGE>
the extent that such gain would be taxed as ordinary income under Sections 1245
and 1250 of the Code. Lastly, if an Atlanta Marquis Limited Partner disposes of
his Note, any gain that had been deferred would be recognized in the year of
disposition.
THE SPECIFIC TAX ATTRIBUTES OF A PARTICULAR ATLANTA MARQUIS LIMITED PARTNER
COULD HAVE A MATERIAL IMPACT ON THE TAX CONSEQUENCES OF THE MERGER, AND THE
SUBSEQUENT OWNERSHIP AND DISPOSITION OF NOTES. THEREFORE, IT IS ESSENTIAL THAT
ATLANTA MARQUIS LIMITED PARTNERS CONSIDERING ELECTING TO RECEIVE NOTES CONSULT
WITH THEIR OWN TAX ADVISORS WITH REGARD TO THE APPLICATION OF THE FEDERAL
INCOME TAX LAWS TO SUCH ATLANTA MARQUIS LIMITED PARTNERS' RESPECTIVE PERSONAL
TAX SITUATIONS, AS WELL AS ANY TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY
STATE, LOCAL, OR FOREIGN TAXING JURISDICTION.
Tax Consequences if Atlanta Marquis Does Not Participate in the Merger
If Atlanta Marquis does not participate in the Merger, the Atlanta Marquis
Limited Partners would not have any tax consequences resulting from the Merger.
The consequences of continued ownership of Atlanta Marquis Partnership Units
will be the same as would have resulted if the Merger had not been proposed.
* * *
The above description is not exhaustive of all possible tax considerations
associated with the Merger and the REIT Conversion. This summary does not
discuss foreign tax considerations, nor does it discuss all of the aspects of
federal income taxation or state and local taxation that may be relevant to
Atlanta Marquis Limited Partners in light of their particular circumstances.
EACH ATLANTA MARQUIS LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN
TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH ATLANTA MARQUIS LIMITED PARTNER'S
PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING
IN THE MERGER.
Atlanta Marquis Supp-34
<PAGE>
SELECTED FINANCIAL DATA
The following table presents selected historical financial data derived from
Atlanta Marriott Marquis Limited Partnership ("AMMLP") financial statements
for the five most recent fiscal years in the period ended December 31, 1997
and the unaudited condensed financial statements for the First Two Quarters
1998 and the First Two Quarters 1997. The following data should be read in
conjunction with AMMLP financial statements and the notes thereto,
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the other financial information included elsewhere herein.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
-------------------- ---------------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- ----------- ----------- ----------- ----------- -----------
(UNAUDITED) (AMOUNTS IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT) (3)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................ $ 19,060 $ 20,173 $ 36,471 $ 38,654 $ 34,831 $ 32,201 $ 29,563
Operating profit........ 12,897 12,808 23,933 24,782 21,770 19,071 16,008
Income (loss) before
extraordinary item(1).. 5,087 2,325 (569) 2,543 (413) (3,073) (5,935)
Net income (loss)....... 9,261 2,325 (569) 2,543 (413) (3,073) (5,935)
Distributions:
General partner........ -- -- -- 8 23 19 16
Limited partners--Class
A..................... 2,650 -- -- 811 2,324 1,870 1,581
Limited partners--Class
B(2).................. -- -- -- -- -- -- --
--------- --------- ----------- ----------- ----------- ----------- ----------
Total.................. 2,650 -- -- 819 2,347 1,889 1,597
Per Partnership Unit--
Class A(3)
Net income (loss)...... 0 4,343 (1,062) 4,751 (772) (5,740) (11,087)
Distributions.......... 5,000 -- 284 1,522 4,386 4,288 4,390
Cash provided by (used
in) operating
activities............. (4,909) 15,068 21,608 9,893 10,062 5,602 4,422
Cash used in investing
activities............. (4,764) (2,310) (4,403) (4,483) (3,740) (3,099) (3,002)
Cash provided by (used
in) financing
activities............. (5,638) -- (1,304) (819) (5,847) (4,589) 518
Increase (decrease) in
cash and cash
equivalents............ (15,311) 12,758 15,901 4,591 475 (2,086) 1,938
Ratio of earnings to
fixed charges
(unaudited)(4)......... 1.64x 1.21x -- 1.10x -- -- --
Deficiency of earnings
to fixed charges
(unaudited)(4)......... -- -- 569 -- 413 3,073 5,935
Total assets at book
value.................. 209,192 195,701 194,376 181,508 175,963 179,821 186,138
Cash and cash
equivalents............ 6,191 18,359 21,502 5,601 1,010 535 2,621
Total debt(5)........... 183,366 236,638 229,543 235,708 233,877 235,723 235,658
Total liabilities....... 185,689 250,914 246,484 239,047 235,226 236,324 237,679
Partner's capital
(deficit):
Limited partners--Class
A..................... (60,238) (54,723) (57,588) (57,025) (58,732) (55,999) (51,087)
Limited partner--Class
B..................... 84,261 0 6,000 -- -- -- --
General partner........ (520) (491) (520) (514) (531) (504) (454)
Book Value per
Partnership Unit (Class
A) (unaudited)(3)...... (113,657) (103,251) (108,657) (107,594) (110,815) (105,658) (96,391)
Exchange value per
Partnership Unit
(unaudited)(3)......... 45,425 -- -- -- -- -- --
</TABLE>
- --------
(1) During the First Two Quarters 1998, AMMLP recorded an extraordinary gain
of $4,174,000 from the forgiveness of deferred incentive management fees
and early extinguishment of debt recorded in conjunction with the
refinancing of the mortgage debt of AMMLP.
(2) The Class B Limited Partner is Host Marriott Corporation, which does not
own Units, but is entitled to a preferred return.
(3) A Partnership Unit represents a $100,000 original investment in Atlanta
Marquis.
(4) The ratio of earnings to fixed charges is computed by dividing net income
(loss) before interest expense and other fixed charges by total fixed
charges, including interest expense, amortization of debt issuance costs
and the portion of rent expense that is deemed to represent interest. The
deficiency of earnings to fixed charges is largely the result of
depreciation and amortization of $5,250,000, $6,608,000, $7,464,000 and
$7,406,000 as of December 31, 1997, 1995, 1994 and 1993, respectively.
(5) Total debt includes amounts due to Host Marriott under the Term Loan of
$20,134,000 as of June 19, 1998 and $30,524,000, $23,634,000 and
$26,334,000 as of December 31, 1997, 1994 and 1993, respectively, and
$20,134,000 as of December 31, 1996 and 1995 under the Original Debt
Service, Commitment and Interest Guarantees.
Atlanta Marquis Supp-35
<PAGE>
THE AMMLP MERGER
On December 31, 1997 limited partners holding a majority of the limited
partner Units in AMMLP consented to the merger of AMMLP with and into Atlanta
Marquis. The merger was part of a series of transactions. On December 31, 1997,
AMMLP merged with and into Atlanta Marquis pursuant to an agreement and plan of
merger (the "AMMLP Merger"). The requisite number of AMMLP limited partners
approved the AMMLP Merger in accordance with the applicable provisions of the
partnership agreement and the Delaware Revised Uniform Limited Partnership Act.
In conjunction with the AMMLP Merger and the refinancing of the mortgage
debt, the following transactions occurred:
. AMMLP was merged with and into Atlanta Marquis. With the AMMLP Merger,
the separate existence of AMMLP ceased and AMMLP limited partnership
units ("Units") were converted on a one-for-one basis into Class A
limited partnership new units ("Partnership Units"). AMMLP limited
partners who held fractional interests in Units received the same
interest in the Partnership Units.
. On December 31, 1997, the General Partner made an initial capital
contribution of $6 million to the Partnership. On January 30, 1998 the
General Partner contributed an additional $69 million. In return for such
additional capital contributions, the General Partner received a new
Class B limited partnership interest in Atlanta Marquis entitling the
General Partner to a 13.5% cumulative, compounding annual preferred
return and priority return of such capital. The General Partner also
surrendered its then existing Class B interest on distributions.
. Partnership Class A limited partners will receive an annual return of 5%
on their initial investment in AMMLP, ratably with a 5% return to the
General Partner on its initial investment in AMMLP, after payment of the
preferred return on the Class B interest. To the extent unpaid in any
year, such return will accumulate and compound and be payable from sale
or refinancing proceeds.
. The General Partner caused the Partnership to contribute the Land to a
subsidiary of Ivy Street Hotel Limited Partnership ("Ivy"), in return for
a credit to the Partnership's capital account of $26.5 million
(represented by a Class C limited partnership interest in Ivy) and a 10%
cumulative, compounding annual preferred return and a priority return.
The General Partner also caused the Partnership to reinvest the capital
contributions received from the General Partner in Ivy (represented by a
Class B partnership interest in Ivy) for a 13.5% cumulative, compounding
annual preferred return and priority return of such capital.
. To facilitate the refinancing of Ivy's mortgage debt, the Hotel and the
Land were conveyed to a special purpose, bankruptcy remote entity, HMA
Realty Limited Partnership ("HMA"). The sole general partner of HMA, with
a 1% interest, is HMA-GP, Inc., a wholly-owned subsidiary of Ivy. The
sole limited partner, with a 99% interest, is Ivy. Accordingly, the new
mortgage debt agreements were entered into by HMA.
. Host Marriott waived its existing right to priority repayment of the
$20.1 million in prior non-interest bearing Interest Guarantee advances
to Ivy and restructured such advances as a loan with a 15-year term
(interest only for the first five years) bearing interest at a rate of 9%
per annum (the "Term Loan"). Payments are due monthly in arrears from
cash available after payment of debt service on the New Mortgage Debt.
Upon a sale of the Hotel, the Term Loan will accelerate and become due
and payable.
. The outstanding amount of the Interest Guarantee of $10.4 million and
related interest was repaid to Host Marriott.
. The $30 million Principal Guarantee provided by Host Marriott was
eliminated.
. The Partnership distributed funds to Class A limited partners of
approximately $5,000 per Partnership Unit. This distribution represented
the excess of the Partnership's reserve after payment of a majority of
the transaction costs related to the Mortgage Debt refinancing.
Atlanta Marquis Supp-36
<PAGE>
AMMLP's partnership agreement was amended (the "AMMLP-II Partnership
Agreement") as a result of the AMMLP Merger to incorporate the following
revisions: (i) a revised provision regarding a sale of the Hotel to permit
Atlanta Marquis to sell the Hotel to an unaffiliated third party without the
consent of the limited partners; (ii) a revised provision limiting the voting
rights of the General Partner and its affiliates to permit the General Partner
and its affiliates to have full voting rights with respect to all Partnership
Units currently held by or acquired by the General Partner and its affiliates;
(iii) extinguishment of the original Class B limited partner interest held by
the General Partner and replacement of it with a new Class B interest which is
entitled to a 13.5% cumulative, compounded annual return; (iv) addition of a
mechanism that allows the Class B limited partner to contribute up to an
additional $20 million should the Hotel require additional funding (such
contribution would also be entitled to the 13.5% return discussed above); (v) a
revised right of removal of the General Partner clause so that an affirmative
vote of 66 2/3% would be needed to effect a removal of the General Partner and;
(vi) revisions to the provisions for allocations and distributions (see Item 8
"Financial Statements and Supplementary Data" below). As a result of the
approval of the AMMLP Merger, the AMMLP-II Partnership Agreement became
effective December 31, 1997.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
Hotel revenues represent house profit of the Hotel since substantially all of
the operating decisions related to the generation of house profit of the Hotel
rest with the Manager. House profit reflects Hotel operating results and
represents gross Hotel sales less property-level expenses, excluding
depreciation and amortization, base and incentive management fees, property
taxes, equipment rent and certain other costs, which are disclosed separately
in the consolidated statement of operations.
First Two Quarters 1998 Compared to First Two Quarters 1997
Revenues. Partnership revenues for the first two quarters 1998 decreased 6%,
or $1.1 million, to $19.1 million, when compared to the same period in 1997 due
to decreases in room and food and beverage sales. Room sales decreased 3%, or
$801,000, to $27.0 million for first two quarters 1998, when compared to the
same period in 1997. Food and beverage sales decreased 7%, or $1.0 million, to
$12.3 million for the first two quarters 1998 when compared to the same period
in 1997. The decrease in food and beverage sales is primarily due to lower
occupancy levels at the Hotel for the first two quarters 1998 as compared to
the same period in 1997. Room sales decreased due to a 3% decrease in REVPAR
for the first two quarters 1998 when compared to the same period in 1997.
REVPAR, or revenue per available room, represents the combination of the
average daily room rate charged and the average daily occupancy achieved and is
a commonly used indicator of hotel performance. (although it is not a GAAP, or
generally accepted accounting principles measure of revenue). REVPAR decreased
for the first two quarters 1998 due to a 5.4 percentage point decrease in
average occupancy to 69%, respectively, when compared to the same period in
1997. The decrease in occupancy was partially offset by a 5%, or $6, increase
in average room rate to $139 for the first two quarters 1998 when compared to
the same period in 1997. The increase in average room rate is due to a shift in
group mix to higher-rated group business. The decrease in average occupancy is
primarily due to a decrease in the number of city-wide conventions in the first
two quarters of 1998 when compared to the same period in 1997. Additional
supply added to the Atlanta suburbs has also impacted 1998 occupancy levels.
Operating Costs and Expenses. For first two quarters 1998, operating costs
and expenses decreased 16%, or $1.2 million, to $6.2 million when compared to
the same periods in 1997, primarily due to a decrease in incentive management
fees. For the first two quarters 1998, $90,000 of incentive management fees
were earned as compared to $2.0 million for 1997. Incentive management fees
decreased due to an increase in Owner's Priority. Pursuant to the new
management agreement, effective January 3, 1998, no incentive management fees
are payable to the Manager with respect to the first $29.7 million of operating
profit. Thereafter, the Manager will receive 20% of the profit in excess of
such figure. As a percentage of revenues, operating costs and expenses
represented 32% and 37% of revenues for the first two quarters 1998 and 1997,
respectively.
Atlanta Marquis Supp-37
<PAGE>
Operating Profit. As a result of the changes in revenues and expenses
discussed above, operating profit increased 1%, or $89,000, to $12.9 million
for the first two quarters 1998 when compared to the same period in 1997.
Interest Expense. Interest expense decreased 27%, or $2.9 million, to $8.0
million for the first two quarters 1998, when compared to the same period in
1997. The decrease is primarily due to the refinancing of the mortgage debt on
February 2, 1998. On that date, HMA obtained new 12-year first mortgage
financing of $164 million (the "Mortgage Debt") which, together with $35
million from the additional $69 million capital contributed by the General
Partner, was used to pay the $199 million maturing mortgage debt. The Mortgage
Debt bears interest at a fixed rate of 7.4% and required monthly principal and
interest payments based on a 25-year amortization schedule. The prior mortgage
debt bore interest at a fixed rate of 10.3%.
Net Income Before Extraordinary Items. Net income before extraordinary items
increased 119%, or $2.8 million, to $5.1 million for the first two quarters
1998 when compared to the same period in 1997. The increase is primarily due to
decreases in incentive management fees and interest expense.
Extraordinary Items. Pursuant to the terms of the new management agreement,
all unpaid incentive management fees accrued through December 31, 1997
amounting to $4.2 million were forgiven by the Manager. During the first two
quarters 1998, the Partnership recorded an extraordinary gain in conjunction
with the write off. In addition, the Partnership recorded a $19,000
extraordinary gain on extinguishment of debt during the first two quarters
1998.
1997 Compared to 1996:
Revenues. Partnership revenues for 1997 decreased 6% to $36.5 million from
$38.7 million in 1996. The decrease in revenues is primarily due to a 2%
decrease in REVPAR or revenue per available room. REVPAR decreased due to a 3%
decrease in average room rate to approximately $127 partially offset by a 1.2
percentage point increase in average occupancy to 69.8. These results are
primarily due to the impact of the 1996 summer Olympic Games. In 1996, the
Hotel was able to drive up the average room rate throughout the year as room
rates throughout the Atlanta market were high. Occupancy levels, however, were
more directly tied to the timing of the Olympic Games. While occupancy levels
were high during the course of the Olympic Games, there was a significant
decline in demand in the months immediately prior to and subsequent to the
Olympic Games.
No new full-service hotels opened in the Atlanta market in 1997 and none are
expected to open in 1998. However, during 1997, 38 new limited service hotels
opened thus adding 3,422 new rooms and 13 more properties containing a total of
1,498 rooms are expected to open in 1998 in the Atlanta suburbs. These
additions did not have and are not expected to have a significant impact on the
Hotel's revenues as these hotels target a significantly different market
segment. Construction has been started on a 320-room Doubletree guest suite
hotel which is expected to open in mid-1999. The number of city-wide
conventions is expected to be down only slightly, however, roomnights
associated with these conventions are expected to be down by 80,000. The
Hotel's strategy to mitigate the impact of this will be to continue to focus on
customer service, to work closely with the Atlanta Convention and Visitors
Bureau to generate short term business for 1998 and to put into effect the
marketing plan developed with the other Atlanta Marriott products targeting
leisure weekend and summer customers.
Operating Costs and Expenses. In 1997, operating costs and expenses decreased
$1.3 million to $12.5 million primarily due to a decrease in incentive
management fees. In 1997, $1.2 million of incentive management fees were earned
as compared to $2.0 million earned in 1996. The decrease in incentive
management fees earned was the result of decreased Hotel operating results. As
a percentage of revenues, operating costs and expenses represented 34% of
revenues for 1997 and 36% in 1996.
Operating Profit. In 1997, operating profit decreased $849,000 to $23.9
million primarily due to the changes in revenues and operating costs and
expenses discussed above. As a percentage of total revenues, operating profit
represented 66% in 1997 and 64% in 1996.
Atlanta Marquis Supp-38
<PAGE>
Interest Expense. In 1997, interest expense increased $2.5 million to $25.4
million primarily due to a 2.0 percentage point increase in the interest rate
charged on the mortgage debt for the period from the Maturity Date through the
New Maturity Date coupled with financing costs of $900,000 incurred in
connection with the extension of the maturity date of the Mortgage Debt.
Net Income (Loss). In 1997, the Partnership had a net loss of $569,000, a
decrease of $3.1 million over 1996's net income of $2.5 million. This decrease
was primarily due to lower Hotel revenues and an increase in the Partnership's
interest expense, partially offset by a decrease in incentive management fees.
1996 Compared to 1995:
Revenues. Partnership revenues for 1996 increased 11% to $38.7 million from
$34.8 million in 1995. The increase in revenues is the result of a 9% increase
in REVPAR. REVPAR increased due to a 14% increase in average room rate to
approximately $132 partially offset by a 3.0 percentage point decrease in
average occupancy to the high-60's. These changes in average room rate and
average occupancy are primarily due to the impact on the city of the 17-day
Centennial Olympic Games. The increase in average room rate was due to an
increase in room rates throughout the Atlanta market. The decline in average
occupancy was due to a decline in city-wide demand for the months prior to and
immediately after the Olympics. During the Olympic Games, the Hotel hosted the
"Olympic Family" which was comprised of the International Olympic Committee,
the Atlanta Committee for the Olympic Games and federations from each of the
participating countries.
Operating Costs and Expenses. In 1996, operating costs and expenses increased
$811,000 to $13.9 million. The increase was primarily due to the changes in the
following:
Depreciation. Depreciation decreased $1.1 million, or 16%, in 1996 when
compared to 1995 due to a portion of the Hotel's furniture and equipment
becoming fully depreciated in 1995.
Incentive Management Fees. In 1996, $2.0 million of incentive management fees
were earned as compared to $1.0 million earned in 1995. The increase in
incentive management fees earned was the result of improved Hotel operating
results resulting in certain cash flow priorities having been met.
Equipment Rent and Other. Equipment rent and other increased $460,000 due to
the inclusion of a property tax credit in 1995 results which did not occur in
1996.
As a percentage of revenues, operating costs and expenses represented 36% of
revenues for 1996 and 38% in 1995.
Operating Profit. In 1996, operating profit increased $3.0 million to $24.8
million primarily due to the changes in revenues and operating costs and
expenses discussed above. As a percentage of total revenues, operating profit
represented 64% in 1996 and 63% in 1995.
Net Income (Loss). In 1996, the Partnership had a net income of $2.5 million,
an increase of $3.0 million over 1995's net loss of $413,000. This increase was
primarily due to higher Hotel revenues.
Inflation
The rate of inflation has been relatively low and accordingly has not had a
significant impact on the Partnership's operating results. However, the Hotel's
room rates and occupancy levels are sensitive to inflation. The Manager is
generally able to pass through increased costs to customers through higher room
rates.
CAPITAL RESOURCES AND LIQUIDITY
AMMLP's financing needs have been historically funded through loan agreements
with independent financial institutions. As a result of the successful
refinancing of the Partnership's Mortgage Debt, the General
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<PAGE>
Partner believes that the Partnership will have sufficient capital resources
and liquidity to conduct its operations in the ordinary course of business.
Mortgage Debt
On February 2, 1998, the mortgage debt was successfully refinanced with a
third party lender. The Partnership's debt now consists of a $164 million
mortgage loan, which is nonrecourse to HMA, which bears interest at a fixed
rate of 7.4% for a 12-year term. The mortgage loan requires payments of
principal and interest based upon a 25-year amortization schedule. As part of
the refinancing, HMA was required to establish certain reserves which are held
by an agent of the lender including:
. $3.6 million debt service reserve--This reserve is equal to three months
of debt service.
. $10.1 million deferred maintenance and capital expenditure reserve--This
reserve will be expended for capital expenditures for repairs to the
facade of the Hotel as well as various renewals and replacements and site
improvements.
. $7.5 million rooms refurbishment reserve--This reserve will be expended
to refurbish the remaining 711 rooms and 16 suites at the Hotel which
have not already been refurbished.
. $1.3 million tax and insurance reserve--This reserve will be used to pay
real estate tax and insurance premiums for the Hotel.
In addition, HMA advanced an additional $2.6 million to the Manager for
working capital needs and used the remaining cash to pay transaction costs
associated with the refinancing.
PRINCIPAL SOURCES AND USES OF CASH
General
The Partnership's principal source of cash is cash from Hotel operations. Its
principal uses of cash are to pay debt service payments on the Partnership's
mortgage debt, to make guarantee repayments, to fund the property improvement
fund and to make cash distributions to the partners. Additionally, in 1998 the
Partnership received cash through an equity infusion by the General Partner and
utilized cash to pay financing costs incurred in connection with the
refinancing of the Partnership's mortgage debt and to establish reserves
required by the lender.
First Two Quarters 1998 Compared to First Two Quarters 1997
Total cash used in operating activities was $4.9 million for the first two
quarters 1998 as compared to total cash provided by operations of $15.1 million
for the first two quarters of 1997. In 1998, cash was used to pay accrued
interest on the Partnership's debt. In addition, pursuant to the terms of the
Mortgage Debt, the Partnership was required to establish with the lender a
separate reserve account for payments of insurance premiums and real estate
taxes for the mortgaged property as a result of the credit rating of Marriott
International, Inc. Thus, the Partnership has transferred $2.2 million into the
reserve through June 19, 1998. The reserve is included in restricted cash
reserves and the resulting tax and insurance liability is included in accounts
payable and accrued expenses in the accompanying balance sheet.
Cash used in investing activities was $4.8 million for the first two quarters
1998 as compared to $2.3 million for the first two quarters 1997. The increase
in cash used in investing activities is primarily due to an advance of $2.6
million to the Manager for working capital needs.
Cash used in financing activities was $5.6 million for the first two quarters
1998. For the first two quarters 1997, no cash was provided by or used in
financing activities. The increase in cash used in financing activities is
primarily the result of the restructuring and refinancing transactions. During
1998, the Partnership acquired new mortgage debt financing of $164 million and
received the remaining $69 million of the $75 million equity
Atlanta Marquis Supp-40
<PAGE>
infusion from the General Partner. These proceeds were used as follows: to
repay the $199.8 million of mortgage debt; to repay $10.4 million of the debt
service guarantee and related interest outstanding under the Host Marriott
interest guarantee; to establish $22.5 million of reserves required by the
lender; and, to pay financing costs of $3.0 million. The Partnership made a
cash distribution in February 1998 to the Class A limited partners of $2.7
million, or $5,000 per limited partner unit, from 1997 operations.
The General Partner believes that cash from Hotel operations and the reserves
established in conjunction with the refinancing will continue to meet the short
and long-term operational needs of the partnership.
1997, 1996 and 1995:
Cash used in investing activities was $4.4 million, $4.5 million and $3.7
million for the years ended December 31, 1997, 1996 and 1995, respectively.
Contributions to the property improvement fund for the years ended December 31,
1997, 1996, and 1995, were $3.9 million, $4.1 million, and $3.3 million,
respectively. Property and equipment additions increased in 1997 due to
increased expenditures at the Hotel associated with the first half of the rooms
refurbishment completed in 1997.
Cash used in financing activities was $1.3 million, $1.0 million and $5.8
million for the years ended December 31, 1997, 1996 and 1995, respectively. In
1997, the Partnership drew $10.4 million pursuant to the Interest Guarantee and
received $6 million of the $75 million total equity infusion from the General
Partner. The Partnership paid $28.5 million, $20.4 million and $20.4 million of
interest on the mortgage debt for the years ended December 31, 1997, 1996 and
1995, respectively. On the Maturity Date, the Partnership was required to pay
$17.6 million representing the Deferred Interest on the Mortgage Debt. No
guarantee repayments to Host Marriott were made in 1997 and 1996. The
Partnership made a guarantee repayment of $3.5 million in 1995. No
distributions to partners were made in 1997 as all cash flow was being reserved
in anticipation of the Mortgage Debt maturity. Distributions to partners were
$819,000 in 1996 and $2.3 million in 1995. Subsequent to year end, the
Partnership made a cash distribution to the Class A limited partners of
$2,648,562 ($5,000 per Partnership Unit).
Total cash provided from operations was $21.6 million, $9.9 million and $10.1
million for the years ended December 31, 1997, 1996 and 1995, respectively.
Partnership did not pay the interest payment of the Mortgage Debt which was due
on January 10, 1998 until January 9, 1998. In both 1996 and 1995, the majority
of the January interest payment was paid in December of the preceding year.
This difference in the timing of the interest payments accounts for the
difference in the total cash provided from operations.
The General Partner believes that cash from Hotel operations and the reserves
established in conjunction with the refinancing will continue to meet the short
and long-term operational needs of the Partnership. In addition, the General
Partner believes the property improvement fund and the capital reserves
established in conjunction with the refinancing will be adequate for the future
capital repairs and replacement needs of the Hotel.
Capital Expenditures
The Partnership is required to maintain the Hotel in good repair and
condition. The new management agreement provides for the establishment of a
property improvement fund to cover the cost of non-routine repairs and
maintenance and renewals and replacements to the Hotel's property and
equipment. Contributions to the fund are 5% of Hotel gross sales. Annual
contributions to the fund equaled 4% of gross Hotel sales through June 1995 and
are 5% thereafter. Per the terms of the New Management Agreement, contributions
to the property improvement fund will remain at 5%.
In 1997, the Hotel completed a $7.0 million refurbishment of approximately
half its guest rooms which included the replacement of the carpeting,
bedspreads, upholstery, drapes and other similar items and also the dressers,
chairs, beds and other furniture. The refurbishment of the remaining 711 rooms
and 16 suites began in
Atlanta Marquis Supp-41
<PAGE>
mid-1998. This portion of the refurbishment will be funded from a reserve
which was established by the Partnership with the lender on February 2, 1998.
The facade repair project which entails a repair of the entire facade of the
building is underway. The project is expected to cost $9.0 million and will be
funded by the Partnership from a reserve which was also established with the
lender in conjunction with the refinancing on the Maturity Date. The project
is expected to be completed by mid-1999.
INFLATION
For the three fiscal years ended December 31, 1997 and the First Two
Quarters 1998, the rate of inflation has been relatively low and, accordingly,
has not had a significant impact to the Partnership's revenues and net income.
The manager is generally able to pass through increased costs to customers
through higher room rates. In 1997, the increase in average room rates at the
Hotel exceeded those of direct competitors as well as the general level of
inflation. The amount of the Partnership's interest expense under floating
rate debt for a particular year will be affected by changes in short-term
interest rates.
YEAR 2000 ISSUES
Over the last few years, Host Marriott Corporation, the parent company of
the General Partner, has invested in implementing new accounting systems which
are Year 2000 compliant. Accordingly, the General Partner believes that future
costs associated with Year 2000 issues will be minimal and not material to the
Partnership's financial statements.
However, the Partnership does rely upon accounting software used by the
Manager of its property to obtain financial information. The General Partner
believes that the manager has begun to implement changes to the property
specific software to ensure the software will function properly in the Year
2000 and does not expect to incur significant costs related to these
modifications.
Atlanta Marquis Supp-42
<PAGE>
FINANCIAL STATEMENTS
Atlanta Marquis Supp-43
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE PARTNERS OF ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP:
We have audited the accompanying consolidated balance sheet of Atlanta
Marriott Marquis II Limited Partnership (a Delaware limited partnership) and
Ivy Street Hotel Limited Partnership, its majority-owned subsidiary
partnership, as of December 31, 1997 and 1996, and the related consolidated
statements of operations, changes in partners' deficit and cash flows for each
of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the General Partner's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Atlanta
Marriott Marquis II Limited Partnership and subsidiary as of December 31, 1997
and 1996, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1997 in conformity with
generally accepted accounting principles.
Arthur Andersen LLP
Washington, D.C.
March 11, 1998
Atlanta Marquis Supp-44
<PAGE>
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Property and equipment, net................................ $165,372 $162,111
Due from Marriott International, Inc....................... 4,425 6,390
Property improvement fund.................................. 2,756 6,864
Deferred financing costs, net of accumulated amortization.. 321 542
Cash and cash equivalents.................................. 21,502 5,601
-------- --------
$194,376 $181,508
======== ========
LIABILITIES AND PARTNERS' DEFICIT
LIABILITIES
Mortgage debt............................................ $199,019 $215,574
Due to Host Marriott under Original Debt Service
Guarantee and Commitment and Interest Guarantee......... 30,524 20,134
Due to Marriott International, Inc....................... 4,198 3,030
Accounts payable and accrued expenses.................... 12,743 309
-------- --------
Total Liabilities...................................... 246,484 239,047
-------- --------
PARTNERS' DEFICIT
General Partner
Capital contributions.................................. 536 536
Capital distributions.................................. (165) (165)
Cumulative net losses.................................. (891) (885)
-------- --------
(520) (514)
-------- --------
Class A Limited Partners
Capital contributions, net of offering costs of
$6,430................................................ 46,570 46,570
Capital distributions.................................. (15,982) (15,982)
Cumulative net losses.................................. (88,176) (87,613)
-------- --------
(57,588) (57,025)
-------- --------
Class B Limited Partner
Capital contribution................................... 6,000 --
-------- --------
Total Partners' Deficit................................ (52,108) (57,539)
-------- --------
$194,376 $181,508
======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
Atlanta Marquis Supp-45
<PAGE>
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
REVENUES (Note 3)............................... $ 36,471 $ 38,654 $ 34,831
-------- -------- --------
OPERATING COSTS AND EXPENSES
Depreciation.................................. 5,250 5,525 6,608
Property taxes................................ 2,754 2,858 2,692
Base management fee........................... 2,562 2,654 2,435
Incentive management fee...................... 1,167 2,018 969
Equipment rent and other...................... 805 817 357
-------- -------- --------
12,538 13,872 13,061
-------- -------- --------
OPERATING PROFIT................................ 23,933 24,782 21,770
Interest expense.............................. (25,389) (22,890) (22,712)
Interest income............................... 887 651 529
-------- -------- --------
NET (LOSS) INCOME............................... $ (569) $ 2,543 $ (413)
======== ======== ========
ALLOCATION OF NET (LOSS) INCOME
General Partner............................... $ (6) $ 25 $ (4)
Limited Partners.............................. (563) 2,518 (409)
-------- -------- --------
$ (569) $ 2,543 $ (413)
======== ======== ========
NET (LOSS) INCOME PER LIMITED PARTNER UNIT (530
Units)......................................... $ (1,062) $ 4,751 $ (772)
======== ======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
Atlanta Marquis Supp-46
<PAGE>
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
CLASS A CLASS B
GENERAL LIMITED LIMITED
PARTNER PARTNERS PARTNER TOTAL
------- -------- ------- --------
<S> <C> <C> <C> <C>
Balance, December 31, 1994................. $(504) $(55,999) $ -- $(56,503)
Capital distributions.................... (23) (2,324) -- (2,347)
Net loss................................. (4) (409) -- (413)
----- -------- ------ --------
Balance, December 31, 1995................. (531) (58,732) -- (59,263)
Capital distributions.................... (8) (811) -- (819)
Net income............................... 25 2,518 -- 2,543
----- -------- ------ --------
Balance, December 31, 1996................. (514) (57,025) -- (57,539)
Capital contributions.................... -- -- 6,000 6,000
Net loss................................. (6) (563) -- (569)
----- -------- ------ --------
Balance, December 31, 1997................. $(520) $(57,588) $6,000 $(52,108)
===== ======== ====== ========
</TABLE>
See Notes to Consolidated Financial Statements.
Atlanta Marquis Supp-47
<PAGE>
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- ------- -------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net (loss) income................................ $ (569) $ 2,543 $ (413)
Noncash items:
Depreciation................................... 5,250 5,525 6,608
Deferred interest.............................. 1,035 1,831 1,654
Amortization of financing costs as interest.... 325 621 619
(Gain) loss on disposition of assets........... -- (1) 64
Changes in operating accounts:
Accounts payable and accrued expenses.......... 12,434 24 (178)
Due from Marriott International, Inc........... 1,965 (2,616) 782
Due to Marriott International, Inc............. 1,168 1,966 926
-------- ------- -------
Cash provided by operating activities........ 21,608 9,893 10,062
-------- ------- -------
INVESTING ACTIVITIES
Additions to property and equipment, net......... (8,511) (3,444) (2,643)
Change in property improvement fund.............. 4,108 (1,039) (1,097)
-------- ------- -------
Cash used in investing activities............ (4,403) (4,483) (3,740)
-------- ------- -------
FINANCING ACTIVITIES
Advances under Original Debt Service Guarantee
and Commitment and Interest Guarantee........... 10,390 -- --
Payment of deferred interest on mortgage debt.... (17,590) -- --
Capital contributions from General Partner for
Class B Limited Partnership Interest............ 6,000 -- --
Payment of deferred financing costs.............. (104) -- --
Capital distributions............................ -- (819) (2,347)
Repayments under Original Debt Service Guarantee
and Commitment and Interest Guarantee........... -- -- (3,500)
-------- ------- -------
Cash used in financing activities............ (1,304) (819) (5,847)
-------- ------- -------
INCREASE IN CASH AND CASH EQUIVALENTS.............. 15,901 4,591 475
CASH AND CASH EQUIVALENTS at beginning of year..... 5,601 1,010 535
-------- ------- -------
CASH AND CASH EQUIVALENTS at end of year........... $ 21,502 $ 5,601 $ 1,010
======== ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for mortgage interest.................. $ 28,470 $20,438 $20,438
======== ======= =======
</TABLE>
See Notes to Consolidated Financial Statements.
Atlanta Marquis Supp-48
<PAGE>
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
NOTE 1. THE PARTNERSHIP
Description of the Partnership
Atlanta Marriott Marquis Limited Partnership ("AMMLP"), a Delaware limited
partnership, was formed on May 28, 1985 (the "Closing Date"), to (i) acquire an
80% general partnership interest in the Ivy Street Hotel Limited Partnership
("Ivy"), a partnership between John C. Portman, Jr. ("Portman") and Host
Marriott Corporation ("Host Marriott") that was formed to develop, own and
operate the 1,671 room Atlanta Marriott Marquis Hotel (the "Hotel"), and (ii)
purchase from Ivy the parcel of land (the "Land") on which the Hotel is
located. The sole general partner of the Partnership, with a 1% interest, is
Marriott Marquis Corporation (the "General Partner"), a wholly-owned subsidiary
of Host Marriott. Marriott International, Inc. serves as the manager of the
Hotel ("Marriott International" or the "Manager").
On the Closing Date, 530 Class A limited partnership interests of $100,000
per Unit ("Unit") were sold in a private placement. The General Partner made a
capital contribution of $536,000 on May 28, 1985 for its 1% general partnership
interest. In addition, the General Partner acquired a Class B limited
partnership interest without making any additional capital contribution.
The Partnership purchased its 80% general partnership interest in Ivy from
Host Marriott for a total price of $28.8 million. The Partnership also acquired
the Land from Ivy for $10 million in a separate transaction. The Partnership
subsequently leased the Land to Ivy under a 99-year lease with rentals based
primarily on Hotel sales.
On July 9, 1997, Atlanta Marriott Marquis II Limited Partnership (the
"Partnership") was formed in anticipation of the merger discussed below. The
general partner of the Partnership is also Marriott Marquis Corporation. Prior
to December 31, 1997, the Partnership did not engage in any active business and
was organized solely to succeed AMMLP's interest in Ivy. Effective December 31,
1997, the Partnership succeeded AMMLP as the managing general partner of Ivy.
On December 31, 1997, AMMLP merged with and into the Partnership (the
"Merger"). The Merger of AMMLP and AMMLP-II was treated as a reorganization of
affiliated entities and AMMLP's basis in its assets and liabilities were
carried over. In conjunction with the Merger, the following transactions
occurred:
. AMMLP was merged with and into the Partnership. With the Merger, the
separate existence of AMMLP ceased and AMMLP limited partner units
("Units") were converted on a one-for-one basis into Partnership Class A
limited partnership units ("Partnership Units"). AMMLP limited partners
who held fractional interests in Units received the same interest in
Partnership Units.
. On December 31, 1997, the General Partner made an initial capital
contribution of $6 million to the Partnership. Subsequent to year end, on
January 30, 1998, the General Partner contributed an additional $69
million. In return for such additional capital contributions, the General
Partner received a new Class B limited partnership interest in the
Partnership entitling the General Partner to a 13.5% cumulative,
compounding annual preferred return and priority return of such capital.
The General Partner also surrendered its then existing Class B interest
on distributions.
. The Partnership Class A limited partners will receive an annual return of
5% on their initial investment in AMMLP, ratably with a 5% return to the
General Partner on its initial investment in AMMLP, after payment of the
preferred return on the Class B interest. To the extent unpaid in any
year, such return will accumulate and compound and be payable from sale
or refinancing proceeds.
AMMLP's partnership agreement was amended (the "AMMLP-II Partnership
Agreement") as a result of the Merger to incorporate the following revisions:
(i) a revised provision regarding a sale of the Hotel to permit
Atlanta Marquis Supp-49
<PAGE>
the Partnership to sell the Hotel to an unaffiliated third party without the
consent of the limited partners; (ii) a revised provision limiting the voting
rights of the General Partner and its affiliates to permit the General Partner
and its affiliates to have full voting rights with respect to all Partnership
Units currently held by or acquired by the General Partner and its affiliates;
(iii) extinguishment of the original Class B limited partner interest held by
the General Partner and replacement of it with a new Class B interest which is
entitled to a 13.5% cumulative, compounded annual return; (iv) addition of a
mechanism that allows the Class B limited partner to contribute up to an
additional $20 million should the Hotel require additional funding (such
contribution would also be entitled to the 13.5% return discussed above); (v) a
revision of the right of removal of the General Partner clause so that an
affirmative vote of 66 2/3% would be needed to effect a removal of the General
Partner and; (v) revised provisions for allocations and distributions (see Note
9). As a result of the approval of the Merger, the AMMLP-II Partnership
Agreement became effective December 31, 1997.
Partnership Allocations and Distributions
Ivy generally allocates operating income, gains and losses, deductions and
cash available for distribution 80% to the Partnership and 20% to Portman.
However, the first $1 million plus 5% of annual gross room sales of annual cash
available for distribution from Ivy was paid to AMMLP unless Ivy exercised its
option to repurchase the Land.
During 1990, AMMLP determined that the probability of collecting the minority
interest receivable from Portman was remote. Thus, AMMLP wrote off this
receivable which totaled $3,542,000 and began recording 100% of the losses of
Ivy. In future years, if AMMLP-II records income, 100% of the income will be
allocated to AMMLP-II until such excess income allocated to AMMLP-II equals the
excess losses previously recorded by AMMLP. Thereafter, any income would be
allocated 80% to AMMLP-II and 20% to Portman. As of December 31, 1997 and 1996,
excess losses recognized by AMMLP and the Partnership were $621,000 and
$50,000, respectively. AMMLP net losses, as defined, were generally allocated
as follows:
(i) beginning in 1991 and continuing until the Class A limited partners
and the General Partner had received sale or refinancing proceeds ("Capital
Receipts") equal to their total cumulative capital contributions ("Original
Capital"), 1% to the General Partner, 80% to the Class A limited partners
and 19% to the Class B limited partner; and
(ii) thereafter, 1% to the General Partner, 65% to the Class A Limited
Partners and 34% to the Class B Limited Partner.
These allocations could have been subject to certain special allocations of
net profit or net loss to the General Partner required by Federal income tax
regulations.
Cash Available for Distribution, as defined, generally was distributed as
follows:
(i) beginning in 1991, and continuing until the Class A Limited Partners
and the General Partner had received distributions of Capital Receipts
equal to their Original Capital, 1% to the General Partner, 80% to the
Class A Limited Partners and 19% to the Class B Limited Partner; and
(ii) thereafter, 1% to the General Partner, 65% to the Class A Limited
Partners and 34% to the Class B Limited Partner. However, until the General
Partner and the Class A Limited Partners had received a return of their
Original Capital through distributions of Capital Receipts, the Class B
Limited Partner will subordinate its cash distributions to an annual non-
cumulative 10% return on Original Capital to the General Partner and the
Class A Limited Partners.
Net profits, as defined, generally were allocated in the same ratio as Cash
Available for Distribution. Excess net profits were then to be applied to
offset prior net losses in excess of the partners' remaining invested capital.
Notwithstanding the above allocations, the Partnership Agreement provided for
specific allocation to the partners of gain realized and proceeds received by
the Partnership upon sale, condemnation or other disposition of the Hotel or
assets of the Partnership. In addition, the Partnership Agreement provided for
specific allocations of any excess refinancing or land sale proceeds.
Atlanta Marquis Supp-50
<PAGE>
As discussed above, on December 31, 1997, the Partnership executed the AMMLP-
II Partnership Agreement which provides for a change in the above allocations
(see Note 9).
For financial reporting purposes, profits and losses are allocated among the
partners based upon their stated interests in cash available for distribution.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting
The Partnership's records are maintained on the accrual basis of accounting,
and its fiscal year coincides with the calendar year. The Partnership's
financial statements consolidate the financial statements of Ivy, its majority-
owned subsidiary partnership. All material intercompany transactions, including
the land lease between the Partnership and Ivy described in Note 8, have been
eliminated. All assets and liabilities of AMMLP have been carried over to the
Partnership at their historical basis.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Revenues and Expenses
Hotel revenues represent house profit of the Hotel since substantially all of
the operating decisions related to the generation of house profit of the Hotel
rests with the Manager. House profit reflects Hotel operating results and
represents gross Hotel sales less property-level expenses, excluding
depreciation and amortization, base and incentive management fees, property
taxes, equipment rent and certain other costs, which are disclosed separately
in the accompanying consolidated statement of operations.
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding property-level revenues and operating expenses of the Hotel from its
statements of operations (see Note 3). If the Partnership concludes that EITF
97-2 should be applied to the Hotel, it would include operating results of this
managed operation in its financial statements. Application of EITF 97-2 to
financial statements as of and for the year ended December 31, 1997 would have
increased both revenues and operating expenses by approximately $48,926,000 and
would have had no impact on net loss.
Property and Equipment
Property and equipment is recorded at cost which includes interest, rent and
real estate taxes incurred during development. Depreciation is computed using
the straight-line method over the following estimated useful lives of the
assets:
<TABLE>
<S> <C>
Building and improvements................................... 50 years
Furniture and equipment..................................... 3 to 20 years
</TABLE>
All land, property and equipment is pledged as security for the mortgage debt
described in Note 6.
Atlanta Marquis Supp-51
<PAGE>
The Partnership assesses impairment of its real estate property based on
whether estimated undiscounted future cash flows for the property will be less
than its net book value. If the property is impaired, its basis is adjusted to
fair market value.
Deferred Financing Costs
Financing costs incurred in connection with obtaining the mortgage debt have
been deferred and are being amortized using the straight-line method, which
approximates the effective interest rate method, over three to ten years. A
portion of the deferred financing costs totaling $4,249,000 were fully
amortized as of July 10, 1997. Additional financing costs of $104,000 were
incurred in 1997 in connection with the refinancing of the Partnership's
mortgage debt. Accumulated amortization of the deferred financing costs totaled
$4,413,000 and $4,090,000 at December 31, 1997 and 1996, respectively. This
amount includes amortization of deferred financing costs for both Ivy and the
Partnership. Of the total, the Partnership has accumulated amortization of
$164,000 and $151,000 at December 31, 1997 and 1996, respectively.
Cash and Cash Equivalents
The Partnership considers all highly liquid investments with a maturity of
three months or less at date of purchase to be cash equivalents.
Income Taxes
Provision for Federal and state income taxes has not been made in the
accompanying financial statements since the Partnership does not pay income
taxes but rather allocates its profits and losses to the individual partners.
There are significant differences between the net income/loss reported in these
financial statements and the net income/loss determined for income tax
purposes. These differences are due primarily to the use, for tax purposes, of
accelerated depreciation methods and shorter depreciable lives for the assets,
the timing of the recognition of incentive management fee expense and the
treatment of the minority interest receivable. As a result of these
differences, the (deficit)/excess of the tax basis in net Partnership
liabilities and the net liabilities reported in the accompanying financial
statements is $(90,642,000) and $72,111,000 as of December 31, 1997 and 1996,
respectively. For tax purposes, the assets of the Partnership were stepped up
to fair market value on December 31, 1997 when the General Partner made an
initial capital contribution of $6.0 million to the Partnership for a Class B
limited partnership interest in the Partnership.
Statement of Financial Accounting Standards
In 1996, AMMLP adopted Statement of Financial Accounting Standards ("SFAS")
No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." Adoption of SFAS No. 121 did not have an effect on
its financial statements.
Atlanta Marquis Supp-52
<PAGE>
NOTE 3. HOTEL REVENUES
Revenues consist of Hotel operating results for the three years ended
December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
HOTEL SALES
Rooms............................................. $54,102 $56,115 $50,515
Food and beverage................................. 25,821 25,968 25,379
Other............................................. 5,474 6,381 5,277
------- ------- -------
85,397 88,464 81,171
------- ------- -------
HOTEL EXPENSES
Departmental direct costs
Rooms........................................... 11,485 11,508 10,821
Food and beverage............................... 17,776 18,003 17,289
Other hotel operating expenses.................... 19,665 20,299 18,230
------- ------- -------
48,926 49,810 46,340
------- ------- -------
HOTEL REVENUES...................................... $36,471 $38,654 $34,831
======= ======= =======
</TABLE>
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Leased land acquisition costs and land................... $ 12,617 $ 12,617
Building and improvements................................ 182,629 182,597
Furniture and equipment.................................. 42,621 34,142
-------- --------
237,867 229,356
Less accumulated depreciation............................ (72,495) (67,245)
-------- --------
$165,372 $162,111
======== ========
</TABLE>
For financial reporting purposes the Land is carried at its historical
purchase cost of $10 million as required by generally accepted accounting
principles.
NOTE 5. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments are shown below. The fair
values of financial instruments not included in this table are estimated to be
equal to their carrying amounts (in thousands):
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997 AS OF DECEMBER 31, 1996
------------------------ ------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------------------------ ------------------------
<S> <C> <C> <C> <C>
Mortgage debt............. $ 199,019 $ 199,019 $ 215,574 $ 215,574
Due to Host Marriott under
Original Debt Service
Guarantee and Commitment
and Interest Guarantee... 30,524 30,524 20,134 14,300
Incentive management fees
due to Marriott
International, Inc....... 4,155 -- 2,987 --
</TABLE>
The 1997 and 1996 estimated fair value of the mortgage debt is stated at its
carrying value as it was repaid on February 2, 1998. The amounts held in Due to
Host Marriott under original debt service and commitment consist of the
interest guarantee in the amount of $10,390,000 and the original debt service
commitment in the
Atlanta Marquis Supp-53
<PAGE>
amount of $20,134,000. The estimated fair value of the interest guarantee is
the carrying value as it was also repaid on February 2, 1998. The estimated
fair value of the original debt service commitment is its carrying value as the
obligation earns interest at 9% as of February 2, 1998. The estimated fair
value of incentive management fees due to Marriott International is zero. As
part of the new management agreement effective January 3, 1998, all accrued
incentive management fees were waived by the Manager and the Partnership's
accrued liability was written off to income in 1998.
NOTE 6. MORTGAGE DEBT
As of December 31, 1996, the AMMLP's mortgage debt consisted of a total of
$215,574,000 in nonrecourse mortgage notes (the "Mortgage Debt"). Through July
10, 1997 (the "Maturity Date"), interest accrued on the Mortgage Debt at a
fixed rate of 10.3%. Interest only was payable semiannually in arrears. The
cash payment rate was 10.17%. The difference between the cash payment rate and
the accrual rate (the "Deferred Interest") was added to the balance of the
Mortgage Debt. The cumulative Deferred Interest added to the Mortgage Debt
balance amounted to $17.6 million and $16.5 million at July 10, 1997 and
December 31, 1996, respectively. On the Maturity Date, the Mortgage Debt
matured, at which time AMMLP and Ivy entered into a letter agreement (the
"Letter Agreement") with the lender which effectively extended the maturity of
the Mortgage Debt until February 2, 1998 (the "New Maturity Date"). On the
Maturity Date, AMMLP and Ivy were required to pay $17.6 million representing
the Deferred Interest on the Mortgage Debt in addition to the scheduled
interest payment of $ 10.1 million. As a result, the Mortgage Debt balance
outstanding was reduced to $ 199,019,000.
The payment of Deferred Interest was funded from $7.2 million of Ivy cash
reserves established by the General Partner in anticipation of the Mortgage
Debt maturity and $10.4 million drawn pursuant to the Host Marriott interest
guarantee (the "Interest Guarantee"). Host Marriott had agreed to advance up to
$50 million to cover interest and principal shortfalls. Had cash flow from
operations been insufficient to fully fund interest due, $20 million was
available under the Interest Guarantee through the Maturity Date. The remaining
$30 million was available under the Principal Guarantee. Prior to the payment
of Deferred Interest in the amount of $10.4 million on the Maturity Date, there
were no amounts outstanding under either the Principal Guarantee or the
Interest Guarantee. In conjunction with the extension, Host Marriott reaffirmed
its obligations pursuant to these guarantees through the New Maturity Date. The
Principal Guarantee was available in case of a sale, refinancing or
acceleration of the principal amount of the underlying notes resulting from an
Event of Default, as defined. To the extent the Interest Guarantee was not
used, it became available as a Principal Guarantee.
During the term of the Letter Agreement, the Mortgage Debt continued to be
nonrecourse, and accrued interest at 12.3% with interest payments due on
January 10 and February 2, 1998. Additionally, all funds remitted by the
Manager during the term of the extension were held for the benefit of the
lender. In conjunction with the Letter Agreement, Ivy paid an extension fee of
$500,000 as well as approximately $410,000 representing costs and expenses
related to the transaction.
Host Marriott had guaranteed up to $33 million of the original debt (the
"Original Debt Service Guarantee" and the "Commitment") under which Host
Marriott was obligated to make certain required debt service payments and
restore any cash flow deficits to the extent that Partnership cash flow, as
defined, was insufficient. Pursuant to the terms of the Mortgage Debt, the
Commitment was modified to fund only certain furniture, fixtures and equipment
expenditures and ground rent shortfalls. Any interest, principal or guarantee
loans made at a time when the Commitment was not fully funded reduced, dollar
for dollar, but not below zero, the remaining unfunded amount of the
Commitment. Advances under the Principal Guarantee, Interest Guarantee and
Original Debt Service Guarantee and Commitment up to cumulative fundings of $33
million did not bear interest. Amounts advanced in excess of $33 million
accrued interest at 1% over the prime rate. As of December 31, 1997, cumulative
fundings equaled $41.6 million, exceeding the $33 million by $8.6 million. The
excess fundings accrued interest until they were repaid subsequent to year-end.
Total accrued interest on the cumulative advances for the period from the
Maturity Date through December 31, 1997 equaled $398,000. As of December 31,
1997 and 1996, Ivy had $20.1 million due to Host Marriott under the Commitment.
Atlanta Marquis Supp-54
<PAGE>
On March 24, 1994, the note holders of the Mortgage Debt voted to accept the
Manager as a back-up guarantor and on December 21, 1994, the agreement was
finalized. The Manager, as back-up guarantor, was required to perform the
obligations under the guarantees in the event that Host Marriott failed to do
so. In conjunction with the extension, the Manager reaffirmed its obligations
pursuant to these guarantees through the New Maturity Date.
Subsequent to year-end, the Mortgage Debt was refinanced (see Note 9).
NOTE 7. HOTEL MANAGEMENT AGREEMENT
Ivy entered into a hotel management agreement (the "Management Agreement")
with the Manager to manage the Hotel for a term of 25 years, renewable at Ivy's
or the Manager's option for five additional 10-year terms. The Manager was
entitled to compensation for its services in the form of a base management fee
equal to 3% of gross sales. Base management fees paid in 1997, 1996 and 1995
were $2,562,000, $2,654,000 and $2,435,000, respectively.
In addition, the Manager earned an incentive management fee equal to 50% of
assumed net cash flow of the Hotel, as defined. However, once total cumulative
incentive management fees reached an amount equal to or greater than 20% of
total cumulative Hotel profit, as defined, the Manager earned an incentive
management fee equal to the average of (i) 50% of assumed net cash flow and
(ii) 20% of Hotel profit. The incentive management fee was paid out of cash
flow available for incentive management fees, as defined, and was subordinated
to the Mortgage Debt, guarantee repayments and rent under the Land lease. Any
incentive management fees earned but not paid were deferred without interest
and paid out of the first cash flow available for the incentive management fee.
During 1997 and 1996, $1,167,000 and $2,018,000, respectively, in incentive
management fees had been earned. Through December 31, 1997, no incentive
management fees had ever been paid. Deferred incentive management fees as of
December 31, 1997 and 1996 were $4,154,000 and $2,987,000, respectively, and
are included in Due to Marriott International, Inc. in the accompanying
consolidated balance sheet. Subsequent to year-end, a new management agreement
was entered into. As part of this new agreement, all accrued incentive
management fees were waived by the Manager (see Note 9) and the Partnership's
accrued liability was written off in 1998 (see Note 9).
Pursuant to the terms of the Management Agreement, the Manager is required to
furnish the Hotel with certain services ("Chain Services") which are generally
provided on a central or regional basis to all domestic full-service hotels
managed, owned or leased by the Manager or its subsidiaries. Chain Services
include central training, advertising and promotion, a national reservation
system, computerized payroll and accounting services and such additional
services as needed which may be more efficiently performed on a centralized
basis. Costs and expenses incurred in providing such services are allocated
among all hotels in the Manager's full-service hotel system. In addition, the
Hotel also participates in the Manager's Marriott Rewards Program ("MRP"). This
program succeeded the Honored Guest Awards Program. The cost of this program is
charged to all hotels in the Manager's hotel system. The total amount of Chain
Services and MRP costs allocated to the Hotel were $2,685,000 in 1997,
$1,968,000 in 1996 and $2,431,000 in 1995.
Pursuant to the terms of the Management Agreement, the Partnership is
required to provide the Manager with working capital and supplies to meet the
operating needs of the Hotel. The Manager converts cash advanced by the
Partnership into other forms of working capital consisting primarily of
operating cash, inventories, and trade receivables and payables which are
maintained and controlled by the Manager. Upon termination of the Management
Agreement, the working capital and supplies will be returned to the
Partnership. As of December 31, 1997 and 1996, $3,077,000 has been advanced to
the Manager for working capital and supplies which is included in Due from
Marriott International, Inc. in the accompanying consolidated balance sheet.
The supplies advanced to the Manager are recorded at their estimated net
realizable value. At December 31, 1997 and 1996, accumulated amortization
related to the revaluation of these supplies totaled $177,000. Subsequent to
year-end, an additional $2,639,000 was advanced to the Manager for working
capital needs at the Hotel (see Note 9).
Atlanta Marquis Supp-55
<PAGE>
The Partnership is required to maintain the Hotel in good repair and
condition. Pursuant to the Agreement, annual contributions to a property
improvement fund provide for the replacement of furniture, fixtures and
equipment. Annual contributions to the fund equaled 4% of gross Hotel sales
through June 1995 and 5% thereafter. Total contributions to the property
improvement fund for the years ended December 31, 1997, 1996, and 1995 were
$3,929,000, $4,122,000 and $3,302,000, respectively.
NOTE 8. LAND LEASE
On the Closing Date, AMMLP acquired the Land on which the Hotel is located
from Ivy for $10 million. AMMLP has leased the Land to Ivy for a period of 99
years. Annual rent was equal to 5% of annual gross room sales from the Hotel.
Ivy had an option to repurchase the Land at any time through 1999. Through
1995, the option price was $25 million and for the ensuing four years the
option price will be adjusted for changes in the Consumer Price Index. At
December 31, 1997 and 1996, the option price was $26,500,000 and $25,825,000,
respectively. Total rentals under the lease, which were eliminated in
consolidation, were $2,705,000 in 1997, $2,806,000 in 1996 and $2,526,000 in
1995.
Subsequent to year-end, the Land lease was terminated (see Note 9) because
the Land was contributed to a subsidiary of Ivy.
NOTE 9. SUBSEQUENT EVENTS
Bankruptcy Remote Entity
To facilitate the refinancing of AMMLP's Mortgage Debt, on January 29, 1998
the Hotel and the Land were conveyed to a special purpose, bankruptcy remote
entity, HMA Realty Limited Partnership ("HMA"). The sole general partner of HMA
with a 1% interest, is HMA-GP, Inc., a wholly-owned subsidiary of Ivy. The sole
limited partner, with a 99% interest, is Ivy.
Mortgage Debt
On the New Maturity Date, the following transactions occurred:
. HMA obtained new 12-year first mortgage financing of $164 million (the
"New Mortgage Debt") which, together with $35 million from the additional
$69 million capital contributed by the General Partner were used to pay
the maturing Mortgage Debt. The New Mortgage Debt is nonrecourse to HMA,
bears interest at a fixed rate of 7.4% and will require monthly payments
of principal and interest calculated to fully amortize the loan over 25
years resulting in annual debt service of $14.1 million for 1998 and
$14.4 million annually until the end of the 12-year term.
. Host Marriott waived its existing right to priority repayment of the
$20.1 million in prior non-interest bearing Interest Guarantee advances
to Ivy and restructured such advances as a loan with a 15 year term
(interest only for the first five years) bearing interest at a rate of 9%
per annum (the "Term Loan"). Payments are due monthly in arrears from
cash available after payment of debt service on the New Mortgage Debt.
Upon a sale of the Hotel, the Term Loan will accelerate and become due
and payable.
. The outstanding amount of the Interest Guarantee of $10.4 million and
related interest was repaid to Host Marriott.
. The $30 million Principal Guarantee provided by Host Marriott was
eliminated.
. The Partnership distributed funds to Class A limited partners of
approximately $5,000 per Partnership Unit. This distribution represented
the excess of the Partnership's reserve after payment of a majority of
the transaction costs related to the Mortgage Debt refinancing.
As part of the refinancing, HMA was required to establish certain reserves
which are held by an agent of the lender including:
. $3.6 million debt service reserve--This reserve is equal to three months
of debt service.
Atlanta Marquis Supp-56
<PAGE>
. $10.1 million deferred maintenance and capital expenditure reserve--This
reserve will be expended for capital expenditures for repairs to the
facade of the Hotel as well as various renewals and replacements and site
improvements.
. $7.5 million rooms refurbishment reserve--This reserve will be expended
to refurbish the remaining 711 rooms and 16 suites at the Hotel which
have not already been refurbished.
. $1.3 million tax and insurance reserve--This reserve will be used to pay
real estate tax and insurance premiums for the Hotel.
In addition, HMA advanced an additional $2,639,000 to the Manager for working
capital needs and used the remaining cash to pay transaction costs associated
with the refinancing.
New Management Agreement
To facilitate the refinancing effective January 3, 1998, a new management
agreement (the "New Management Agreement") was entered into by HMA and the
Manager. The New Agreement expires on July 1, 2010 and is renewable at the
Manager's option for five additional 10-year terms. Pursuant to the terms of
the New Management Agreement, no incentive management fees are payable to the
Manager with respect to the first $29.7 million of operating profit (the
"Owner's Priority"). Thereafter, the Manager will receive 20% of the profit in
excess of such Owner's Priority. The amount of the Owner's Priority will not be
reduced but may be increased to take into account additional capital
contributions by the General Partner or its affiliates. As part of the New
Management Agreement, all accrued incentive management fees amounting to $4.5
million were waived by the Manager and the Partnership's accrued liability was
written off in 1998.
Land Lease
As part of the Merger transactions, the Partnership contributed the Land to a
subsidiary of Ivy. This transaction terminated the Land lease and resulted in
cessation of Land lease payments from Ivy to the Partnership. The Partnership
received a credit to its capital account in Ivy of $26.5 million in
consideration of the Land contribution. For financial reporting purposes the
Land will continue to be carried at its historical purchase cost of $10 million
as required by generally accepted accounting principles.
New Partnership Agreement
AMMLP's partnership agreement was amended (the "AMMLP-II Partnership
Agreement") as a result of the Merger to incorporate the following revisions:
(i) a revised provision regarding a sale of the Hotel to permit the
Partnership to sell the Hotel to an unaffiliated third party without the
consent of the limited partners;
(ii) a revised provision limiting the voting rights of the General
Partner and its affiliates to permit the General Partner and its affiliates
to have full voting rights with respect to all Partnership Units currently
held by or acquired by the General Partner and its affiliates;
(iii) extinguishment of the original Class B limited partner interest
held by the General Partner and replacement of it with a new Class B
interest which is entitled to a 13.5% cumulative, compounded annual return;
(iv) addition of a mechanism that allows the Class B limited partner to
contribute up to an additional $20 million should the Hotel require
additional funding (such contribution would also be entitled to the 13.5%
return discussed above);
(v) a revised right of removal of the General Partner clause so that an
affirmative vote of 66 2/3% would be needed to effect a removal of the
General Partner and;
(vi) a revision of AMMLP's allocations and distributions such that
Partnership cash available for distribution is generally allocated as
follows:
Atlanta Marquis Supp-57
<PAGE>
(a) to the General Partner, until the General Partner has received a
13.5% cumulative compounded annual return on its Class B invested
capital,
(b) to the General Partner and Class A limited partners, until the
General Partner and the Class A limited partners have received a non-
cumulative, non-compounded annual return of 5% on their initial
investment in AMMLP-II, and
(c) thereafter, in proportion to total invested capital through
completion of the Restructuring Transactions of approximately 41% to
limited partners and 59% to the General Partner; and
(vii) a revision of AMMLP's allocations and distributions such that
Partnership sale or refinancing proceeds are generally allocated as
follows:
(a) to the General Partner, until the General Partner has received a
13.5% cumulative compounded annual return on its Class B invested
capital,
(b) to the General Partner and Class A limited partners, until the
General Partner and the Class A limited partners have received a non-
cumulative, non-compounded annual return of 5% on their initial
investment in AMMLP-II,
(c) to the General Partner, until its Class B invested capital of up
to $75 million has been fully returned, taking into account all
distributions to such Partners following the effective date of the
Restructuring Transactions (other than the approximately $5,000 per
Partnership Unit distributed as part of the Restructuring
Transactions),
(d) to the General Partner and Class A limited partners until they
have received a cumulative, compounded return on their original
invested capital of 5% per annum from the effective date of the
Restructuring Transactions,
(e) to the General Partner and Class A limited partners, until such
partners' original invested capital of $536,000 and $53,000,000,
respectively, has been fully returned, and
(f) thereafter, in proportion to total invested capital through
completion of the Restructuring Transactions of approximately 41% to
limited partners and 59% to the General Partner.
As a result of the approval of the Merger, the AMMLP-II Partnership Agreement
became effective December 31, 1997.
Ivy Partnership Agreement
In conjunction with the Merger transactions, the Ivy partnership agreement
was amended to incorporate the following revisions: (i) provide that the $75
million contributed by the General Partner of the Partnership to Ivy will be
entitled to receive an annual preferred return equal to 13.5% compounding to
the extent unpaid; (ii) provide that the Land, after contribution by the
Partnership to Ivy at an agreed upon value of $26.5 million, will be entitled
to receive an annual compounding preferred return equal to 10%, after payment
of the 13.5% return described above; and (iii) allows the Partnership the
unilateral right, as managing general partner of Ivy, to make most major
decisions on behalf of Ivy, including, without limitation, the sale or other
disposition of the Hotel, except where such disposition is to a party related
to Host Marriott or an affiliate of Host Marriott.
Atlanta Marquis Supp-58
<PAGE>
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
FIRST TWO QUARTERS
--------------------
1998 1997
--------- ---------
<S> <C> <C>
REVENUES.......................................... $ 19,060 $ 20,173
--------- ---------
OPERATING COSTS AND
EXPENSES
Depreciation.................................... 2,891 2,349
Property taxes and
other.......................................... 1,923 1,707
Base management fees............................ 1,259 1,311
Incentive management
fees........................................... 90 1,998
--------- ---------
6,163 7,365
--------- ---------
OPERATING PROFIT.................................. 12,897 12,808
Interest expense................................ (7,964) (10,862)
Interest income................................. 154 379
--------- ---------
NET INCOME BEFORE
EXTRAORDINARY ITEMS.............................. 5,087 2,325
EXTRAORDINARY ITEMS
Gain on extinguishment
of debt........................................ 19 --
Gain on forgiveness of
incentive management
fees........................................... 4,155 --
--------- ---------
NET INCOME........................................ $ 9,261 $ 2,325
========= =========
ALLOCATION OF NET INCOME
General Partner................................. $ -- $ 23
Class A Limited
Partners....................................... -- 2,302
Class B Limited
Partner........................................ 9,261 --
--------- ---------
$ 9,261 $ 2,325
========= =========
NET INCOME PER CLASS A
LIMITED PARTNER UNIT (530
Units)........................................... $ -- $ 4,343
========= =========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
Atlanta Marquis Supp-59
<PAGE>
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 19, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Property and equipment, net........................... $164,005 $165,372
Due from Marriott International, Inc.................. 7,434 4,425
Property improvement fund............................. 3,357 2,756
Deferred financing costs, net of accumulated
amortization......................................... 3,174 321
Restricted cash reserves.............................. 25,031 --
Cash and cash equivalents............................. 6,191 21,502
-------- --------
$209,192 $194,376
======== ========
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)
LIABILITIES
Mortgage debt....................................... $163,232 $199,019
Due to Host Marriott Corporation under Original Debt
Service Guarantee and Commitment and Interest
Guarantee.......................................... -- 30,524
Term loan payable to Host Marriott Corporation...... 20,134 --
Due to Marriott International, Inc.................. 133 4,198
Accounts payable and accrued expenses............... 2,190 12,743
-------- --------
Total Liabilities................................. 185,689 246,484
-------- --------
PARTNERS' CAPITAL (DEFICIT)
General Partner..................................... (520) (520)
Class A Limited Partners............................ (60,238) (57,588)
Class B Limited Partner............................. 84,261 6,000
-------- --------
Total Partners' Capital (Deficit)................... 23,503 (52,108)
-------- --------
$209,192 $194,376
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
Atlanta Marquis Supp-60
<PAGE>
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
------------------
1998 1997
--------- -------
<S> <C> <C>
OPERATING ACTIVITIES
Net income............................................... $ 9,261 $ 2,325
Net extraordinary items.................................. (4,174) --
--------- -------
Income before extraordinary items........................ 5,087 2,325
Noncash items.......................................... 2,994 3,567
Changes in operating accounts.......................... (12,990) 9,176
--------- -------
Cash (used in) provided by operating activities...... (4,909) 15,068
--------- -------
INVESTING ACTIVITIES
Working capital provided to Marriott International,
Inc..................................................... (2,639) --
Additions to property and equipment, net................. (1,524) (1,109)
Change in property improvement fund...................... (601) (1,201)
--------- -------
Cash used in investing activities.................... (4,764) (2,310)
--------- -------
FINANCING ACTIVITIES
Proceeds from mortgage debt.............................. 164,000 --
Repayment of mortgage debt............................... (199,768) --
Capital contributions from General Partner for Class B
Limited Partnership Interest............................ 69,000 --
Changes in restricted lender reserves.................... (22,873) --
Repayments under Original Debt Service Guarantee and
Commitment and Interest Guarantee to Host Marriott
Corporation............................................. (10,390) --
Payment of financing costs............................... (2,957) --
Capital distributions.................................... (2,650) --
--------- -------
Cash used in financing activities.................... (5,638) --
--------- -------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........... (15,311) 12,758
CASH AND CASH EQUIVALENTS at beginning of period........... 21,502 5,601
--------- -------
CASH AND CASH EQUIVALENTS at end of period................. $ 6,191 $18,359
========= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for mortgage and other interest................ $ 19,127 $ 662
========= =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
Atlanta Marquis Supp-61
<PAGE>
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying condensed consolidated financial statements have been
prepared by the Atlanta Marriott Marquis II Limited Partnership (the
"Partnership" and "AMMLP-II") without audit. Certain information and footnote
disclosures normally included in financial statements presented in accordance
with generally accepted accounting principles have been condensed or omitted
from the accompanying statements. The Partnership believes the disclosures made
are adequate to make the information presented not misleading. However, the
condensed consolidated financial statements should be read in conjunction with
the Partnership's consolidated financial statements and notes thereto included
in the Partnership's Form 10-K for the year ended December 31, 1997.
In the opinion of the Partnership, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments (which include only
normal recurring adjustments) necessary to present fairly the financial
position of the Partnership as of June 19, 1998, the results of operations and
cash flows for the first two quarters 1998 and 1997. Interim results are not
necessarily indicative of fiscal year performance because of seasonal and
short-term variations.
Through December 31, 1997, for financial reporting purposes the net
income/(loss) of the Partnership was allocated 99% to the limited partners and
1% to Marriott Marquis Corporation (the "General Partner"), a wholly-owned
subsidiary of Host Marriott Corporation ("Host Marriott"). As reported in the
Partnership's Form 10-K for the fiscal year ended December 31, 1997, Atlanta
Marriott Marquis Limited Partnership's ("AMMLP") partnership agreement was
amended as a result of the Merger to incorporate a revision of AMMLP's
allocations and distributions such that Partnership net income is generally
allocated (i) to the General Partner, until the General Partner has received a
13.5% cumulative compounded annual return on its Class B invested capital, (ii)
to the General Partner and Class A limited partners, until the General Partner
and the Class A limited partners have received a non-cumulative, non-compounded
annual return of 5% on their initial investment in the Partnership, and (iii)
thereafter, in proportion to total invested capital through completion of the
merger transactions of approximately 41% to limited partners and 59% to the
General Partner. Net losses are generally allocated in proportion to the
partners capital accounts. Significant differences exist between the net
income/(loss) for financial reporting purposes and the net income/(loss)
reported for Federal income tax purposes. These differences are due primarily
to the use, for income tax purposes, of accelerated depreciation methods,
shorter depreciable lives for the assets, and differences in the timing of the
recognition of 1997 incentive management fee expense.
Through December 31, 1997, AMMLP owned an 80% general partnership interest in
Ivy Street Hotel Limited Partnership ("Ivy") which owned the Atlanta Marriott
Marquis Hotel (the "Hotel"). The Partnership also owned the land (the "Land")
on which the Hotel is located. On December 31, 1997 AMMLP merged (the "Merger")
with and into the Partnership. The Merger of AMMLP and the Partnership was
treated as a reorganization of affiliated entities and AMMLP's basis in its
assets and liabilities were carried over. On January 29, 1998, the Hotel and
the Land were conveyed to a special purpose, bankruptcy remote entity, HMA
Realty Limited Partnership ("HMA"). The sole general partner of HMA with a 1%
interest, is HMA-GP, Inc., a wholly-owned subsidiary of Ivy. The sole limited
partner, with a 99% interest, is Ivy. The Partnership consolidates Ivy and HMA,
and all significant intercompany transactions and balances between the
Partnership, Ivy and HMA have been eliminated. In 1990, the Partnership
determined that the probability of collecting the receivable from the minority
partner in Ivy was remote. Thus, the Partnership wrote off this receivable and
is now recording 100% of the income/(loss) of Ivy until excess income allocated
to the Partnership equals the excess losses previously recorded by the
Partnership.
Atlanta Marquis Supp-62
<PAGE>
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. Certain reclassifications were made to the prior year financial statements
to conform to the 1998 presentation.
3. Revenues represent house profit of the Hotel since HMA has delegated
substantially all of the operating decisions related to the generation of house
profit of the Hotel to Marriott International, Inc. (the "Manager"). House
profit reflects hotel operating results which flow to HMA as property owner and
represents gross hotel sales less property-level expenses, excluding
depreciation, base and incentive management fees, property taxes and certain
other costs, which are disclosed separately in the condensed consolidated
statement of operations.
Partnership revenues generated by the Hotel for 1998 and 1997 consist of (in
thousands):
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
---------------
1998 1997
------- -------
<S> <C> <C>
HOTEL SALES
Rooms........................................................ $26,909 $27,710
Food and beverage............................................ 12,269 13,254
Other........................................................ 2,779 2,800
------- -------
41,957 43,764
------- -------
HOTEL EXPENSES
Departmental direct costs
Rooms...................................................... 5,536 5,752
Food and beverage.......................................... 8,186 8,370
Other hotel operating expenses............................... 9,175 9,469
------- -------
22,897 23,591
------- -------
REVENUES....................................................... $19,060 $20,173
======= =======
</TABLE>
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding property-level revenues and operating expenses of the Hotel from its
statements of operations. If the Partnership concludes that EITF 97-2 should be
applied to the Hotel, it would include operating results of this managed
operation in its financial statements. Application of EITF 97-2 to financial
statements as of and for the first two quarters 1998, would have increased both
revenues and operating costs and expenses by approximately $22,897,000 and
would have had no impact on net income.
4. On February 2, 1998, HMA obtained new 12-year first mortgage financing of
$164 million which, together with $35 million from the additional $69 million
capital contributed by the General Partner, was used to pay the mortgage debt.
The mortgage debt is nonrecourse to HMA, bears interest at a fixed rate of 7.4%
and requires monthly payments of principal and interest calculated to fully
amortize the loan over 25 years. Annual debt service on the new mortgage debt
is $14.1 million for 1998 and $14.4 million annually until the end of the 12-
year term.
5. To facilitate the refinancing, effective January 3, 1998, a new management
agreement was entered into by HMA and the Manager. The new management agreement
expires on July 1, 2010 and is renewable at the
Atlanta Marquis Supp-63
<PAGE>
ATLANTA MARRIOTT MARQUIS II LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Manager's option for five additional 10-year terms. Pursuant to the terms of
the new management agreement, no incentive management fees are payable to the
Manager with respect to the first $29.7 million of operating profit (the
"Owner's Priority"). Thereafter, the Manager will receive 20% of the profit in
excess of such Owner's Priority. As part of the new management agreement, all
accrued incentive management fees totaling $4.2 million were forgiven by the
Manager. The Partnership recorded an extraordinary gain in conjunction with the
forgiveness in the accompanying condensed consolidated financial statements.
6. Pursuant to the terms of the Mortgage Debt, HMA was required to establish
with the lender a separate reserve account for payments of insurance premiums
and real estate taxes for the mortgaged property as a result of the credit
rating of Marriott International, Inc. Thus, the Partnership has transferred
$2.2 million into the reserve through June 19, 1998. The reserve is included in
restricted cash reserves and the resulting tax and insurance liability is
included in accounts payable and accrued expenses in the accompanying balance
sheet.
Additionally, HMA was required to establish the following reserves which are
classified as restricted cash reserves in the accompanying condensed
consolidated balance sheet and are held by the agent of the lender including:
.$3.6 million debt service reserve--This reserve is equal to three months
of debt service.
. $10.1 million deferred maintenance and capital expenditure reserve--This
reserve will be expended for capital expenditures for repairs to the
facade of the Hotel as well as various renewals and replacements and
site improvements.
. $7.5 million rooms refurbishment reserve--This reserve will be expended
to refurbish the remaining 711 rooms and 16 suites at the Hotel which
have not already been refurbished.
7. On April 17, 1998, Host Marriott, parent company of the General Partner of
the Partnership, announced that its Board of Directors authorized Host Marriott
to reorganize its business operations to qualify as a real estate investment
trust ("REIT") to become effective as of January 1, 1999. As part of the REIT
conversion, Host Marriott formed a new operating Partnership (the "Operating
Partnership") and limited partners in certain Host Marriott full-service hotel
partnerships and joint ventures, including the Atlanta Marriott Marquis II
Limited Partnership, are expected to be given an opportunity to receive, on a
tax-deferred basis, Operating Partnership units in the Operating Partnership in
exchange for their current Partnership interests. The Operating Partnership
units would be redeemable by the limited partner for freely traded Host
Marriott shares (or the cash equivalent thereof) at any time after one year
from the closing of the merger. In connection with the REIT conversion, the
Operating Partnership filed a Registration Statement on Form S-4 with the
Securities and Exchange Commission on June 2, 1998. Limited Partners will be
able to vote on this Partnership's participation in the merger later this year
through a consent solicitation.
Atlanta Marquis Supp-64
<PAGE>
HOST MARRIOTT, L.P.
SUPPLEMENT DATED , 1998 FOR
PROSPECTUS/CONSENT SOLICITATION STATEMENT DATED , 1998 FOR
MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.
On the terms described in the Prospectus/Consent Solicitation Statement (the
"Consent Solicitation"), dated , 1998, of which this Supplement (the
"Supplement") is a part, Host Marriott Corporation ("Host") has adopted a plan
to restructure its business operations so that it will qualify as a real
estate investment trust ("REIT"). As part of this restructuring (the "REIT
Conversion"), Host and its consolidated subsidiaries will contribute their
full-service hotel properties and certain other businesses and assets to Host
Marriott, L.P., (the "Operating Partnership") in exchange for units of limited
partnership interest in the Operating Partnership ("OP Units") and the
assumption of liabilities. The sole general partner of the Operating
Partnership will be Host Marriott Trust ("Host REIT"), the entity into which
Host will merge as part of the REIT Conversion. Host REIT expects to qualify
as a REIT beginning with its first full taxable year after closing of the REIT
Conversion, which Host REIT currently expects to be the year beginning January
1, 1999.
Following the REIT Conversion and the Blackstone Acquisition (defined
below), the Operating Partnership and its subsidiaries initially will own
outright, or have controlling interests in, approximately 120 full-service
hotels operating primarily under the Marriott, Ritz-Carlton, Four Seasons,
Swissotel and Hyatt brand names (the "Hotels").
As part of the REIT Conversion, the Operating Partnership is proposing to
acquire by merger (the "Mergers") Mutual Benefit Chicago Marriott Suite Hotel
Partners, L.P., a Rhode Island limited partnership ("Chicago Suites" or the
"Partnership"), and up to seven other limited partnerships (the
"Partnerships") that own full-service hotels in which Host or its subsidiaries
are general partners. As more fully described in the Consent Solicitation,
limited partners of those Partnerships that participate in the Mergers will
receive either OP Units or, at their election, unsecured % Callable Notes
due December 15, 2005 issued by the Operating Partnership ("Notes"), in
exchange for their partnership interests in such Partnerships (with respect to
the Partnerships, those limited partners of the Partnerships who are
unaffiliated with Host are referred to herein as the "Limited Partners," and
with respect to Chicago Suites, the "Chicago Suites Limited Partners").
Beginning one year after the Mergers, Limited Partners who retain OP Units
will have the right to redeem their OP Units at any time and receive, at the
election of Host REIT, either freely tradeable, New York Stock Exchange listed
Common Shares of Host REIT on a one-for-one basis (subject to adjustment) or
cash in an amount equal to the market value of such shares (the "Unit
Redemption Right").
The number of OP Units to be allocated to Chicago Suites will be based upon
(i) its Exchange Value (as defined herein) and (ii) the price attributed to an
OP Unit following the Merger, determined as described herein (but in no event
greater than $ per OP Unit). The principal amount of Notes that Chicago
Suites Limited Partners may elect to receive in exchange for the OP Units
received in the Merger will be based upon Chicago Suites' Note Election Amount
(as defined herein). See "Determination of Exchange Value of Chicago Suites
and Allocation of OP Units." The estimated Exchange Value and Note Election
Amount set forth herein may increase or decrease as a result of various
adjustments, and will be finally calculated shortly before the Effective Date.
Pursuant to the Merger, Chicago Suites Limited Partners have an estimated
Exchange Value of $33,131 per Partnership Unit and a Note Election Amount of
$31,467 per Partnership Unit.
RISK FACTORS
In deciding whether to approve the Merger, Chicago Suites Limited Partners
should consider certain risks and other factors. The General Partner believes
that Chicago Suites Limited Partners should particularly consider the
following, which should be read in conjunction with the information in the
Consent Solicitation under "Risk Factors" and "Federal Income Tax
Consequences:"
. Substantial Benefits to Related Parties. Host REIT and its subsidiaries
will realize substantial benefits from the Mergers and the REIT
Conversion, including savings from a substantial reduction in corporate-
Chicago Suites Supp-1
<PAGE>
level income taxes expected as a result of the REIT Conversion. To the
extent that such anticipated benefits of the REIT Conversion are reflected
in the value of Host's common stock prior to the Effective Date, such
benefits will not be shared with the Limited Partners. Because of Host's
significant ownership position in certain Partnerships, the failure of one
or more of these Partnerships to participate in a Merger likely would
require that Host contribute some or all of its ownership interest in the
Non-Participating Partnership to a taxable Non-Controlled Subsidiary,
which would materially reduce the benefit to Host of the REIT Conversion
as it applies to that interest.
. Absence of Arm's Length Negotiations. No independent representative was
retained to negotiate on behalf of the Chicago Suites Limited Partners or
the other Limited Partners. Although the General Partner has obtained the
Appraisal and the Fairness Opinion from AAA, AAA has not negotiated with
the General Partner or Host and has not participated in establishing the
terms of the Mergers. Consequently, the terms and conditions of the
Mergers may have been more favorable to the Chicago Suites Limited
Partners or the other Limited Partners if such terms and conditions were
the result of arm's length negotiations.
. Other Conflicts of Interest. The Mergers, the REIT Conversion and the
recommendations of the General Partner involve the following conflicts of
interest because of the relationships among Host, the Operating
Partnership, the General Partner and SLC: (i) the General Partners, which
are all subsidiaries of Host (except for PHLP, in which Host is the
General Partner), must assess whether a Merger is fair and equitable to
the Limited Partners of its Partnership, which involves considerations
for Host and its subsidiaries that are different from those that affect
the Limited Partners, (ii) the terms of the Leases of the Hotels,
including Chicago Suites' Hotel, will be determined by Host, which will
distribute the common stock of SLC, the parent of the Lessees, to its
shareholders after such terms have been set and (iii) the terms of the
Partnership Agreement, including provisions which benefit Host REIT, have
been determined by Host. Such conflicts may result in decisions that do
not fully reflect the interests of all Limited Partners, including the
Chicago Suites Limited Partners.
. Uncertainties at the Time of Voting Include the Number of OP Units to be
Received. There are several other uncertainties at the time the Chicago
Suites Limited Partners must vote on the Merger, including (i) the exact
Exchange Value for Chicago Suites (which will be adjusted for changes in
lender and capital expenditures reserves, indebtedness, deferred
maintenance and other items prior to the Effective Date), (ii) the price
of the OP Units for purposes of the Merger, which will be determined by
reference to the post-Merger trading prices of Host REIT's Common Shares
and which, together with the Exchange Value, will determine the number of
OP Units the Chicago Suites Limited Partners will receive and (iii) the
exact principal amount of the Notes that may be received in exchange for
OP Units, which cannot be known until after the vote on the Merger. For
these reasons, the Chicago Suites Limited Partners cannot know at the
time they vote on the Merger these important aspects of the Merger.
. Combined REVPAR for the Operating Partnership's Hotels is Significantly
Less than the REVPAR for the Chicago Suites Hotel. The Operating
Partnership's pro forma REVPAR for the First Two Quarters of 1998 is
significantly lower than the REVPAR attributable to Chicago Suites' Hotel
for the same period.
. Adverse Tax Consequences to the General Partner of a Sale of the
Hotel. In past years, Chicago Suites has disproportionately allocated tax
losses to the General Partner, with the result that if the Chicago Suites
Hotel were to be sold in a taxable transaction, the General Partner (and
thus Host) would incur a disproportionately larger tax gain than the
Chicago Suites Limited Partners. Accordingly, the General Partner and
Host have an additional conflict of interest in deciding the appropriate
course of action for Chicago Suites with respect to its Hotel.
. Exchange Value May Not Equal Fair Market Value of Chicago Suites'
Hotel. Each Chicago Suites Limited Partner who retains OP Units will
receive consideration with a deemed value equal to the Exchange Value of
such Chicago Suites Limited Partner's Partnership Interest. The
determination of the Exchange Value of Chicago Suites involves numerous
estimates and assumptions. There is no assurance that the Exchange Value
of Chicago Suites will equal the fair market value of the Hotel and other
assets contributed by Chicago Suites. See "Determination of Exchange
Value of Chicago Suites and Allocation of OP Units."
Chicago Suites Supp- 2
<PAGE>
. Price of OP Units Might Be Less than the Fair Market Value of the
Partnership Interests. The price of an OP Unit, for purposes of the
Mergers and the REIT Conversion, will be equal to the average closing
price on the NYSE of a Host REIT Common Share for the first 20 trading
days after the Effective Date of the Mergers (but in no event greater
than $ per share). It is likely that, over time, the value of the
publicly traded Common Shares of Host REIT (and therefore the value of
the OP Units) will diverge from the deemed value of the OP Units used for
purposes of the Mergers. This could result in the Chicago Suites Limited
Partners receiving OP Units with an actual value that is less than either
the price of the OP Units for purposes of the Mergers or the fair market
value of their Partnership Interests.
. Current Host Common Stock Price May Not Necessarily Be Indicative of the
Price of Host REIT Common Shares Following the REIT Conversion. Host's
current stock price is not necessarily indicative of how the market will
value Host REIT Common Shares following the REIT Conversion. The current
stock price of Host reflects the current market valuation of Host's
current business and assets (including the SLC common stock and the cash
or securities to be distributed in connection with the REIT Conversion)
and not the business and assets of Host REIT following the REIT
Conversion.
. Allocation of OP Units to Host REIT is Different from Allocation of OP
Units to Limited Partners. Host REIT will receive in the aggregate a
number of OP Units (including OP Units allocated to the General Partners
of the Partnerships) equal to the number of shares of Host common stock
outstanding on the Effective Date (and, if Host has outstanding shares of
preferred stock at the time of the REIT Conversion, a corresponding
number of preferred partnership interests in the Operating Partnership),
which should fairly represent the market value of Host REIT but may not
be equal to the fair market or net asset value of the Hotels and other
assets that Host will contribute to the Operating Partnership. The
Partnerships will receive OP Units in the Mergers with a deemed value
equal to the Exchange Value of such Partnership. The different methods of
allocating OP Units may result in Limited Partners not receiving the fair
market value of their Partnership Interests and Host REIT receiving a
higher percentage of the interests in the Operating Partnership. See
"Determination of Exchange Values and Allocation of OP Units."
. Inability of Chicago Suites Limited Partners to Redeem OP Units for One
Year. Chicago Suites Limited Partners who elect to retain OP Units
received in the Merger will be unable to redeem such OP Units for one
year following the Merger. Until then, Chicago Suites Limited Partners
will bear the risk of illiquidity.
. Value of the Notes Will Be Less than the Exchange Value. At the same time
that he votes on the Merger, each Chicago Suites Limited Partner also may
elect to receive, at the time of the Merger in exchange for OP Units, an
unsecured, seven-year Note of the Operating Partnership with a principal
amount equal to the Note Election Amount of his Partnership Interest. The
deemed value of the OP Units to be received by the Chicago Suites Limited
Partners will exceed the principal amount of the corresponding Notes
(because the Exchange Value will be higher than the Note Election Amount)
and there is no assurance that the Note a Chicago Suites Limited Partner
receives will have a value equal to either (i) the fair market value of
the Chicago Suites Limited Partner's share of the Hotel and other assets
owned by Chicago Suites or (ii) the principal amount of the Note. There
will be no public market for the Notes. If the Notes are sold, they may
sell at prices substantially below their issuance price. Noteholders are
likely to receive the full principal amount of a Note only if they hold
the Note to maturity, which is December 15, 2005, or if the Operating
Partnership repays the Notes prior to maturity. Because the Notes are
unsecured obligations of the Operating Partnership, they will be
effectively subordinated to all secured debt of the Operating Partnership
and all obligations of both Chicago Suites and the Operating
Partnership's other subsidiaries. See "Description of the Notes." As of
June 19, 1998, on a pro forma basis assuming the Full Participation
Scenario, the Operating Partnership would have had aggregate consolidated
debt of approximately $5.1 billion to which the Notes were effectively
subordinated or which rank equally with such Notes.
. Fundamental Change in Nature of Investment; Potential
Underperformance. The Mergers and the REIT Conversion involve a
fundamental change in the nature of a Chicago Suites Limited Partner's
investment from holding an interest in Chicago Suites, which is a finite-
life entity, has a fixed portfolio of one Hotel and distributes the cash
flow from the operation of such Hotel to the Chicago Suites Limited
Partners, to
Chicago Suites Supp-3
<PAGE>
holding an interest in an infinite-life, operating real estate company
with a portfolio of approximately 120 Hotels that (i) collects and
distributes to its limited partners rents received from the Lessees (which
will bear the risks and receive the direct benefits of the Hotels'
operations), (ii) has the ability to acquire additional hotels, (iii) is
able to reinvest proceeds from sales or refinancings of existing Hotels in
other hotels and (iv) has a publicly traded general partner. In addition,
each Chicago Suites Limited Partner's investment will change from one that
allows a Chicago Suites Limited Partner to receive a return of capital in
the form of distributions from any net proceeds of a sale or refinancing
of Chicago Suites' assets to an investment in which a Chicago Suites
Limited Partner who retains OP Units likely would realize a return of
capital only through the exercise of the Unit Redemption Right. A Chicago
Suites Limited Partner's share of the liquidation proceeds, if any, from
the sale of the Chicago Suites Hotel could be higher than the amount
realized upon exercise of the Unit Redemption Right (or payments on any
Note received by a Chicago Suites Limited Partner who elects to exchange
his OP Units for such Note). An investment in the Operating Partnership
may not outperform an investment in Chicago Suites. See "Comparison of
Ownership of Partnership Interests, OP Units and Common Shares".
. Lack of Control over Hotel Operations. Due to current federal income tax
law restrictions on a REIT's ability to derive revenues directly from the
operation of a hotel, the Operating Partnership will lease virtually all
of its consolidated Hotels to the Lessees, which will operate the Hotels
by continuing to retain the Managers pursuant to the Management
Agreements. The Operating Partnership will not operate the Hotels or
participate in the decisions affecting the daily operations of the
Hotels. The Operating Partnership will have only a limited ability to
require the Lessees or the Managers to operate or manage the Hotels in
any particular manner and no ability to govern any particular aspect of
their day-to-day operation or management. Therefore, the Operating
Partnership will be dependent for its revenue upon the ability of the
Lessees and the Managers to operate and manage the Hotels.
. Exposure to Market and Economic Conditions of Other Hotels. As a result
of the Mergers, Chicago Suites Limited Partners who elect to retain OP
Units will own interests in a much larger enterprise with a broader range
of assets than Chicago Suites individually. A material adverse change
affecting the Operating Partnership's assets will affect all Limited
Partners, including Chicago Suites Limited Partners, regardless of
whether a particular Limited Partner previously was an investor in such
affected assets. Chicago Suites owns discrete assets and the Mergers and
the REIT Conversion will significantly diversify the types and geographic
locations of the Hotels in which the Chicago Suites Limited Partners will
have interests. As a result, the Hotels owned by the Operating
Partnership may be affected differently by economic and market conditions
than the Hotel previously owned by Chicago Suites.
. Chicago Suites Limited Partners Have No Cash Appraisal Rights. Chicago
Suites Limited Partners who vote against the Merger have no right to
receive cash based upon an appraisal of their Partnership Interests.
. Uncertainties as to the Size and Leverage of the Operating
Partnership. The Chicago Suites Limited Partners cannot know at the time
they vote on the Merger the exact size and amount of leverage of the
Operating Partnership. Host is an existing operating company that
regularly issues and repays debt, acquires additional hotels and disposes
of existing hotels. Also, some or all of the Partnerships may elect not
to participate in a Merger. In addition, outside partners in certain
Private Partnerships may not consent to a lease of their partnership's
Hotel(s). In either such case, Host will contribute its interests in such
Partnerships and Private Partnerships to the Operating Partnership, but
the Operating Partnership may, in turn, contribute such interests to a
Non-Controlled Subsidiary, which will be subject to corporate-level
income taxation. Host also may repurchase outstanding securities or issue
new debt or equity securities prior to the consummation of the Mergers
and the REIT Conversion.
. Expiration of Leases and Possible Inability to Find Other Lessees. The
Leases will expire seven to ten years after the Effective Date and there
can be no assurance that such Leases will be renewed (or if renewed, will
be renewed on terms as favorable to the Operating Partnership). If the
Leases are not renewed, the Operating Partnership will be required to
find other lessees, which lessees must meet certain requirements set
forth in the Management Agreements. There can be no assurance that
satisfactory lessees
Chicago Suites Supp-4
<PAGE>
could be found or as to the terms and conditions on which the Operating
Partnership would be able to renew the Leases or enter into new leases
with such lessees.
. Requisite Vote of Chicago Suites Limited Partners Binds All Chicago
Suites Limited Partners. For Chicago Suites, approval by a majority of
the Partnership Interests of Chicago Suites that are eligible to be voted
is required to approve the Merger, as described in "Voting Procedures--
Required Vote and Other Conditions." Such approval will cause Chicago
Suites to participate in the Merger and will bind all Chicago Suites
Limited Partners, including Chicago Suites Limited Partners who voted
against or abstained from voting with respect to the Merger.
. Substantial Indebtedness of the Operating Partnership. The Operating
Partnership will have substantial indebtedness. As of June 19, 1998, on a
pro forma basis assuming the Full Participation Scenario, the Operating
Partnership had outstanding indebtedness totaling approximately $5.1
billion, which represents a % debt-to-total market capitalization ratio
on a pro forma basis at such date (based upon a price per Common Share of
Host REIT of $ ). The Operating Partnership's business is capital
intensive and it will have significant capital requirements in the
future. The Operating Partnership's leverage level could affect its
ability to (i) obtain financing in the future, (ii) undertake
refinancings on terms and subject to conditions deemed acceptable by the
Operating Partnership, (iii) make distributions to partners, (iv) pursue
its acquisition strategy or (v) compete effectively or operate
successfully under adverse economic conditions.
. No Limitation on Debt. There are no limitations in Host REIT's or the
Operating Partnership's organizational documents which limit the amount
of indebtedness either may incur, although both the Notes and the
Operating Partnership's other debt instruments will contain certain
restrictions on the amount of indebtedness that the Operating Partnership
may incur.
. Rental Revenues from Hotels Subject to Rights of Lenders. In accordance
with the mortgage loan agreements with respect to outstanding
indebtedness of certain Hotel Partnerships, the rental revenues received
by such Hotel Partnerships under certain Leases first will be used to
satisfy the debt service on such outstanding indebtedness with only the
cash flow remaining after debt service being available to satisfy other
obligations of the Hotel Partnership (including paying property taxes and
insurance, funding the required FF&E reserves for the Hotels and capital
improvements and paying debt service with respect to unsecured debt) and
to make distributions to holders of OP Units.
. Ownership Limitations. No person or group may own, actually or
constructively (as determined under the applicable Code provisions), (i)
in excess of 9.8% of the number or value of outstanding Common Shares of
Host REIT or (ii) in excess of 4.9% of the value of the OP Units (other
than Host REIT and The Blackstone Group), subject to waiver or
modification by Host REIT or the Operating Partnership, as the case may
be, in certain limited circumstances.
. Timing of the REIT Conversion. If the REIT Conversion does not occur in
time for Host REIT to elect REIT status effective January 1, 1999, the
effectiveness of Host REIT's election could be delayed to January 1,
2000, which would result in Host REIT continuing to pay corporate-level
income taxes in 1999 and could cause the Blackstone Acquisition not to be
consummated.
. Effect of Subsequent Events upon Recognition of Gain. Even though the
Chicago Suites Limited Partners (other than those who elect to receive a
Note in exchange for OP Units) generally are not expected to recognize
significant taxable gain at the time of the Merger, there are a variety
of events and transactions (including the sale of the Hotel currently
owned by Chicago Suites or the reduction of indebtedness securing the
Hotel) that could cause a Chicago Suites Limited Partner to recognize all
or a part of the gain that otherwise has been deferred through the REIT
Conversion. See "Federal Income Tax Consequences--Tax Treatment of
Chicago Suites Limited Partners Who Hold OP Units Following the Merger."
Certain Hotels (including the Blackstone Hotels) will be covered by
agreements with third parties which will restrict the Operating
Partnership's ability to dispose of those properties or refinance their
debt. In addition, if Atlanta Marquis participates in the Mergers, the
Operating Partnership will succeed to an existing agreement that will
restrict its ability to dispose of the Atlanta Marquis Hotel or to
refinance the debt secured by such Hotel without compensating certain
outside partners for the resulting
Chicago Suites Supp-5
<PAGE>
adverse tax consequences. As for the remaining initial properties
(including the Hotel owned by Chicago Suites), the partnership agreement
of the Operating Partnership, which is substantially in the form attached
to the Consent Solicitation as Appendix A (the "Partnership Agreement"),
does not impose any restrictions on the Operating Partnership's ability to
dispose of the Hotels or to refinance debt secured by the Hotels (but the
Operating Partnership is obligated to pay any taxes Host REIT incurs as a
result of such transactions). In addition, the Partnership Agreement
provides that Host REIT, as general partner of the Operating Partnership,
is not required to take into account the tax consequences of the limited
partners in deciding whether to cause the Operating Partnership to
undertake specific transactions (but the Operating Partnership is
obligated to pay any taxes that Host REIT incurs as a result of such
transactions) and the limited partners have no right to approve or
disapprove such transactions. See "Description of OP Units--Sales of
Assets."
. Election to Exchange OP Units for Notes. A Chicago Suites Limited Partner
who elects to receive a Note in connection with the Merger in exchange
for his OP Units will be treated as having made a taxable disposition of
his Partnership Interest. A Chicago Suites Limited Partner who receives a
Note may be eligible to defer at least a portion of that gain under the
"installment sale" rules. A Chicago Suites Limited Partner with a
"negative capital account" with respect to his Partnership Interest who
elects to receive a Note will recognize "phantom income" in that amount
at the time of the Merger in any event. See "Federal Income Tax
Consequences--Tax Treatment of Chicago Suites Limited Partners Who
Exercise Their Right to Make the Note Election."
. Competition in the Lodging Industry. The profitability of the Hotels is
subject to general economic conditions, the management abilities of the
Managers (including primarily Marriott International), competition, the
desirability of particular locations and other factors relating to the
operation of the Hotels. The full-service segment of the lodging
industry, in which virtually all of the Hotels operate, is highly
competitive, and the Hotels generally operate in geographical markets
that contain numerous competitors. The Hotels' success will be dependent,
in large part, upon their ability to compete in such areas as access,
location, quality of accommodations, room rate structure, the quality and
scope of food and beverage facilities and other services and amenities.
The lodging industry, including the Hotels (and thus the Operating
Partnership), may be adversely affected in the future by (i) national and
regional economic conditions, (ii) changes in travel patterns, (iii)
taxes and government regulations which influence or determine wages,
prices, interest rates, construction procedures and costs, (iv) the
availability of credit and (v) other factors beyond the control of the
Operating Partnership.
. Failure of Host REIT to Qualify as a REIT for Tax Purposes. Taxation of
Host REIT as a corporation if it fails to qualify as a REIT, and Host
REIT's subsequent liability for federal, state and local taxes on its
income and property, would, among other things, have the effect of
reducing cash available for distribution to Host REIT's shareholders and
materially reducing the value of the Common Shares and OP Units.
. Failure of the Operating Partnership to Qualify as a Partnership for Tax
Purposes. Taxation of the Operating Partnership as a corporation if it
fails to qualify as a partnership and the Operating Partnership's
subsequent liability for federal, state and local income taxes would,
among other things, have the effect of reducing cash available for
distribution to holders of OP Units, would cause Host REIT to fail to
qualify as a REIT for tax purposes and would cause the holders of OP
Units to recognize substantial taxable gain at the time the Operating
Partnership ceases to qualify as a partnership.
. Failure of the Leases to Qualify as Leases. If the Lease of the Hotel to
the Lessee were to be disregarded for tax purposes (for example, because
the Lease was determined to lack economic substance), Host REIT could
fail to qualify as a REIT and the Operating Partnership might be treated
as a corporation for federal income tax purposes, which would have a
material adverse impact on the Chicago Suites Limited Partners and the
value of the OP Units.
. Change in Tax Laws. No assurance can be provided that new legislation,
Treasury Regulations, administrative interpretations or court decisions
will not significantly change the tax laws with respect to Host REIT's
qualification as a REIT or the federal income tax consequences of such
qualification.
Chicago Suites Supp-6
<PAGE>
. Chicago Suites Limited Partners Need to Consult with Their Own Tax
Advisors. Because the specific tax attributes of a Chicago Suites
Limited Partner and the facts regarding such Chicago Suites Limited
Partner's interest in Chicago Suites could have a material impact on the
tax consequences to such Chicago Suites Limited Partner of the Merger,
the subsequent ownership and disposition of OP Units or Notes and/or the
subsequent ownership and disposition of Common Shares, it is essential
that each Chicago Suites Limited Partner consult with his own tax
advisors regarding the application of federal, foreign and state and
local tax laws to such Chicago Suites Limited Partner's personal tax
situation.
. Effect of Possible Classification as a Publicly Traded Partnership on
Passive Losses. There is a significant possibility that the Operating
Partnership could be classified as a "publicly traded partnership," in
which event the Chicago Suites Limited Partners would not be able to use
suspended passive activity losses from other investments (including from
Chicago Suites) to offset income from the Operating Partnership. It is
estimated that each Chicago Suites Limited Partner who purchased his
Partnership Interest at the time of the original offering of such
Interests, has held such Partnership Interest continuously since that
time and whose Partnership Interest has been his only investment in a
passive activity, would have a passive activity loss carryforward as of
December 31, 1998.
. Host's Substantial Deferred Tax and Contingent Liabilities. Host will
have substantial deferred tax liabilities that are likely to be
recognized in the next ten years (notwithstanding Host REIT's status as a
REIT), and the IRS could assert substantial additional liabilities for
taxes against Host for taxable years prior to the time Host REIT
qualifies as a REIT. Under the terms of the REIT Conversion and the
Partnership Agreement, the Operating Partnership will be responsible for
paying (or reimbursing Host REIT for the payment of) all such tax
liabilities as well as any other liabilities (including contingent
liabilities and liabilities attributable to litigation that Host REIT may
incur) whether such liabilities are incurred by reason of Host's
activities prior to the REIT Conversion or the activities of Host REIT
subsequent thereto.
Because REITs are not permitted under current federal income tax law to
derive revenues directly from the operation of hotels, the Operating
Partnership will lease the Hotels to lessees (the "Lessees") that will operate
the Hotels under the existing management agreements and pay rent to the
Operating Partnership, as more fully described herein. The Lessees generally
will be indirect controlled subsidiaries of HMC Senior Communities, Inc.
("SLC"), which currently is a wholly owned subsidiary of Host. SLC will become
a separate public company when Host distributes the common stock of SLC and
other consideration to its existing shareholders and the Blackstone Entities
in connection with Host's distribution of its accumulated earnings and
profits, which Host REIT is required to do in order to qualify as a REIT.
Shares of Host REIT and SLC will become separately traded securities and the
companies will operate independently. There will be no overlap between the
boards of Host REIT and SLC. There will be a substantial overlap of
shareholders of the two companies initially, but this likely will diverge over
time.
MOHS CORPORATION (THE "GENERAL PARTNER"), THE GENERAL PARTNER OF CHICAGO
SUITES, BELIEVES THAT THE MERGER PROVIDES SUBSTANTIAL BENEFITS AND IS FAIR TO
THE CHICAGO SUITES LIMITED PARTNERS AND RECOMMENDS THAT ALL CHICAGO SUITES
LIMITED PARTNERS VOTE FOR THE MERGER.
The effects of the Mergers may be different for Limited Partners of the
various Partnerships. This Supplement has been prepared to highlight for
Chicago Suites Limited Partners the specific risks, benefits, effects and
fairness of the Merger to them and to provide other information specific to
Chicago Suites. Supplements have also been prepared for each of the other
Partnerships. This Supplement, together with the supplements of the other
Partnerships (collectively, the "Supplements"), are part of the Consent
Solicitation. Upon receipt of a written request by a Limited Partner or his
representative so designated in writing, the General Partner will send a copy
of any Supplement without charge. All requests for a copy of a Supplement
should be directed to: Investor Relations, 10400 Fernwood Road, Bethesda,
Maryland 20817, telephone number 301-380-2070 (between the hours of 9:00 a.m.
and 4:00 p.m., eastern time).
Chicago Suites Supp-7
<PAGE>
All cross-references refer to the Consent Solicitation unless the context
indicates otherwise. Capitalized terms not defined herein shall have the
meaning set forth in the Consent Solicitation. The information contained
herein, unless otherwise indicated, assumes the REIT Conversion occurs with
all Partnerships participating and no Notes being issued (the "Full
Participation Scenario").
EXPECTED BENEFITS OF THE MERGER
The General Partner believes that participating in the Merger would likely
be beneficial to the Chicago Suites Limited Partners for the reasons set forth
below. This information is qualified by and should be read in conjunction with
the information in the Consent Solicitation under "Background and Reasons for
the Mergers and the REIT Conversion--Reasons for the Mergers." These benefits,
which should be viewed as alternatives to continuing the business and
operations of Chicago Suites, are expected to include:
. Exchange Value of Chicago Suites. Chicago Suites Limited Partners who
elect to retain OP Units in the Merger will receive OP Units with an
estimated Exchange Value equal to $33,131 per Partnership Unit.
. Enhanced Liquidity of Investment. The REIT Conversion will offer Chicago
Suites Limited Partners significantly enhanced liquidity with respect to
their investments in Chicago Suites because, commencing one year
following the Effective Date, Chicago Suites Limited Partners who retain
OP Units will be able to exercise their Unit Redemption Right at any
time, subject to certain limited exceptions. Host has approximately 204
million shares of common stock outstanding and is expected to have a
total common equity market capitalization of approximately $ billion
after giving effect to the estimated $ million earnings and profits
distribution (based on Host's $ closing price per share on the NYSE on
, 1998). The exercise of the Unit Redemption Right, however,
generally would result in recognition of taxable income or gain at that
time.
. Public Market Valuation of Assets. The Partnership Units of Chicago
Suites currently trade at a discount to the net asset value of Chicago
Suites' assets. In contrast, the General Partner believes that by
exchanging interests in Chicago Suites, which is a non-traded, finite-
life limited partnership with a fixed portfolio for interests in an
infinite-life real estate company focused primarily on a more diverse and
growing full-service hotel portfolio and providing valuation based upon
publicly traded Common Shares of Host REIT, the Chicago Suites Limited
Partners will have the opportunity to participate in the recent trend
toward ownership of real estate through a publicly traded entity, which,
in many instances, has resulted in market valuations of public real
estate companies in excess of the estimated net asset values of those
companies. There can be no assurance, however, that the Common Shares of
Host REIT will trade at a premium to the private market values of the
Operating Partnership's assets or that the relative pricing differential
will not change or be eliminated in the future. Also, the benefit of
Host's conversion to a REIT will not be shared by the Chicago Suites
Limited Partners if and to the extent that such benefit is reflected in
the market valuation of Host's common stock prior to the REIT Conversion.
. Regular Quarterly Cash Distributions. The General Partner expects that
the Operating Partnership will make regular quarterly cash distributions
to holders of OP Units. Host expects that these distributions will be
higher than the estimated cash distributions for 1998 of Chicago Suites,
and in any event, the ability to receive distributions quarterly and in
regular amounts would be enhanced. For additional information regarding
historical and estimated future distributions for Chicago Suites and the
other Partnerships, see "Background and Reasons for the Mergers and the
REIT Conversion--Reasons for the Mergers."
. Substantial Tax Deferral. The General Partner expects that Chicago Suites
Limited Partners who do not elect to receive a Note in exchange for OP
Units generally should be able to obtain the benefits of the Merger while
continuing to defer recognition for federal income tax purposes of at
least a substantial portion, if not all, of the gain with respect to
their Partnership Interests that otherwise would be recognized in the
event of a liquidation of Chicago Suites or a sale or other disposition
of its assets in a taxable transaction. Thereafter, such Chicago Suites
Limited Partners generally should be able to defer at least a substantial
portion of such built-in gain until they elect to exercise their Unit
Redemption Right or
Chicago Suites Supp-8
<PAGE>
the Hotel currently owned by Chicago Suites is sold or otherwise disposed
of in a taxable transaction by the Operating Partnership or the debt now
secured by the Hotel is repaid, prepaid or substantially reduced. The
federal income tax consequences of the Merger are highly complex and, with
respect to each Chicago Suites Limited Partner, are dependent upon many
variables, including the particular circumstances of such Chicago Suites
Limited Partner. See "Federal Income Tax Consequences--Tax Consequences of
the Merger." Each Chicago Suites Limited Partner is urged to consult with
his own tax advisors as to the consequences of the Merger in light of his
particular circumstances.
. Risk Diversification. Participation in the Merger, as well as future
hotel acquisitions by the Operating Partnership, will reduce the
dependence of Chicago Suites Limited Partners upon the performance of,
and the exposure to the risks associated with, Chicago Suites' Hotel and
spread such risk over a broader and more varied portfolio, including more
diverse geographic locations and multiple brands.
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a significantly lower leverage to value
ratio than Chicago Suites currently, which has a leverage ratio of 66%
(calculated as a percentage of Appraised Value), resulting in significant
interest and debt service savings and greater financial stability.
. Growth Potential. The General Partner believes that the Chicago Suites
Limited Partners, by owning interests in a publicly traded real estate
company focused primarily on a more diverse and growing upscale and
luxury full-service hotel portfolio, will be able to participate in
growth opportunities that would not otherwise be available to them.
. Greater Access to Capital. With publicly traded equity securities, a
larger base of assets and a substantially greater equity value than
Chicago Suites individually, Host REIT expects to have greater access to
the capital necessary to fund the Operating Partnership's operations and
to consummate acquisitions on more attractive terms than would be
available to Chicago Suites individually. This greater access to capital
should provide greater financial stability to the Operating Partnership
and reduce the level of risk associated with refinancing existing loans
upon maturity, as compared to Chicago Suites individually.
If Chicago Suites does not participate in the Merger, its business will
continue in the same manner; however, the Operating Partnership may elect to
contribute some or all of its interest in Chicago Suites to a Non-Controlled
Subsidiary.
DETERMINATION OF EXCHANGE VALUE OF CHICAGO SUITES AND ALLOCATION OF OP UNITS
GENERAL. The Exchange Value of Chicago Suites will be equal to the greatest
of its Adjusted Appraised Value, Continuation Value and Liquidation Value,
each of which has been determined as follows:
. Adjusted Appraised Value. The General Partner has retained AAA to
determine the market value of the Hotel as of March 1, 1998 (the
"Appraised Value"). The "Adjusted Appraised Value" of Chicago Suites
equals the Appraised Value of its Hotel, adjusted as of the Final
Valuation Date for lender reserves, capital expenditure reserves,
existing indebtedness (including a "mark to market" adjustment to reflect
the market value of such indebtedness), certain deferred maintenance
costs, deferred management fees and transfer and recordation taxes and
fees.
. Continuation Value. The "Continuation Value" of Chicago Suites represents
AAA's estimate, as adopted by the General Partner, of the discounted
present value, as of January 1, 1998, of the Chicago Suites limited
partners' share of estimated future cash distributions and estimated net
sales proceeds (plus lender reserves), assuming that Chicago Suites
continues as an operating business for twelve years and its assets are
sold on December 31, 2009 for their then estimated market value.
. Liquidation Value. The "Liquidation Value" of Chicago Suites represents
the General Partner's estimate of the net proceeds to Chicago Suites
limited partners resulting from the assumed sale as of December 31, 1998
of the Hotel of Chicago Suites, at its Adjusted Appraised Value (after
eliminating any "mark to market" adjustment and adding back the deduction
for transfer and recordation taxes and
Chicago Suites Supp-9
<PAGE>
fees, if any, made in deriving the Adjusted Appraised Value), less (i)
estimated liquidation costs, expenses and contingencies equal to 2.5% of
Appraised Value and (ii) prepayment penalties or defeasance costs, as
applicable.
Final determination of the Exchange Value of Chicago Suites will be made as
of the end of the four week accounting period ending at least 20 days prior to
the Effective Date (the "Final Valuation Date") and will be equal to the
greatest of Adjusted Appraised Value, Continuation Value and Liquidation Value
as of such date. Adjusted Appraised Value, Continuation Value and Liquidation
Value will be adjusted as of the Final Valuation Date (i) to reflect the
amount of lender and capital expenditure reserves and the amount of deferred
management fees as of such date, (ii) to increase the Adjusted Appraised Value
by any amounts actually expended by Chicago Suites after the Initial Valuation
Date to perform deferred maintenance that were previously subtracted in
determining the estimated Adjusted Appraised Value of Chicago Suites and (iii)
to reflect any changes in Chicago Suites' other reserves, such as for
litigation expenses and indemnification costs and any revised estimates of
transfer and recordation taxes and fees.
APPRAISED VALUE. Chicago Suites' Hotel was appraised as of March 1, 1998 by
AAA, an independent, nationally recognized hotel valuation and financial
advisory firm experienced in the appraisals of lodging properties such as
Chicago Suites' Hotel. The appraisal (the "Appraisal") was reviewed by a
Member Appraisal Institute ("MAI") appraiser and certified by such MAI
appraiser as having been prepared in accordance with the requirements of the
Standards of Professional Practice of the Appraisal Institute and the Uniform
Standards of Professional Appraisal Practice of the Appraisal Foundation.
The purpose of the Appraisal is to provide an estimate of the "Market Value"
of the Hotel. "Market Value" means the most probable price which a property
should bring in a competitive and open market under all conditions requisite
to a fair sale, the buyer and seller each acting prudently and knowledgeably
and assuming the price is not affected by undue stimuli. Implicit in this
definition is the consummation of a sale as of a specified date and the
passing of title from seller to buyer under conditions whereby: (i) the buyer
and seller are equally motivated; (ii) both parties are well informed or well
advised, and each is acting in what he considers his own best interest; (iii)
a reasonable time frame is allowed for exposure in the open market; (iv)
payment is made in terms of cash in U.S. dollars or in terms of financial
arrangements comparable thereto and (v) the price represents the normal
consideration for the property sold unaffected by special or creative
financing or sales concessions granted by anyone associated with the sale. AAA
made a site visit at Chicago Suites' Hotel for purposes of the Appraisal.
In preparing the Appraisal, AAA relied primarily on the income
capitalization method of valuation, and then compared the value estimated by
this method with recent sales of comparable properties, as a check on the
reasonableness of the value determined through the income capitalization
method. AAA employed the following procedures for determining the Appraised
Value of Chicago Suites' Hotel:
. Historical 1997 and Projected Year's Earnings. AAA reviewed the
historical 1997 net operating income (i.e., income before interest,
taxes, depreciation and amortization) ("NOI") prior to incentive
management fees and certain capital expenditures for the Hotel. AAA also
prepared a projection of the net operating income prior to incentive
management fees and certain capital expenditures for the Hotel for the
twelve month period ending February 28, 1999 (the "Projected Year"),
using historical financial information for the Hotel, budget information,
a survey with the manager of the Hotel addressing the physical condition
of the Hotel, local market conditions (including business mix, demand
generators, future trends and predictability of business), changes in the
competitive environment, comparison with direct competitors of the Hotel
and risk factors relating to the Hotel. The resulting gross margin (ratio
of total revenues to NOI prior to incentive management fees) was checked
against AAA's database of the gross margins for similar hotels for
reasonableness.
. Impact of Incentive Management Fees. AAA estimated a normalized annual
amount of incentive management fees payable under the applicable
management agreement and subtracted this amount from the net operating
income prior to incentive management fees and certain capital
expenditures for 1997 and the Projected Year.
Chicago Suites Supp-10
<PAGE>
. Impact of Owner Funded Capital Expenditures. AAA estimated normalized
annual amounts of owner funded capital expenditures (over and above the
FF&E reserve) based in part on projected owner funded capital
expenditures estimated in the Engineering Study. The normalized amounts
were then subtracted from the NOI prior to owner funded capital
expenditures for 1997 and the Projected Year.
. Capitalization of Adjusted NOI. AAA then capitalized the amount resulting
from the foregoing adjustments ("Adjusted NOI") for 1997 and the
Projected Year by dividing such amounts by capitalization rates that AAA
determined to be appropriate. A capitalization rate represents the
relationship between net operating income and sales prices of income
producing property. AAA selected the capitalization rates based upon its
review of current published surveys reflecting the opinions of investors
and participants such as REITs, hotel acquisition/management companies
and pension funds, lenders, brokers and consultants as to current
capitalization rates, and its own database of capitalization rates
reflected in recent transactions, adjusted for factors specific to the
Hotel, such as location, physical condition, reserve policies, local
market volatility and competition, guest mix, renovation influences and
other income characteristics. AAA used separate capitalization rates that
it deemed appropriate to capitalize 1997 historical Adjusted NOI and
estimated Projected Year's Adjusted NOI. AAA then estimated the value of
the Hotel based upon each of the values estimated by capitalizing 1997
and Projected Year's Adjusted NOI and its professional judgment. The
following table sets forth the effective capitalization rates for 1997
and Projected Year's Adjusted NOI resulting from AAA's estimated
Appraised Value of Chicago Suites' Hotel.
RESULTING EFFECTIVE CAPITALIZATION RATES FOR APPRAISAL OF CHICAGO SUITES'
HOTEL
<TABLE>
<CAPTION>
PROJECTED YEAR
1997 (ENDING FEBRUARY 28, 1999)
---- --------------------------
<S> <C>
9.4% 10.3%
</TABLE>
The resulting Appraised Value of Chicago Suites' Hotel, as estimated by
AAA, is $34,300,000.
. Comparison with Comparable Sales. AAA checked the Appraised Value of the
Hotel derived by the foregoing procedures against its database of
comparable sale transactions for reasonableness.
Chicago Suites' Hotel was encumbered by a ground lease as of the date of the
Appraisal. Accordingly, the Appraised Value of the Hotel has been decreased to
reflect the encumbrance of the ground lease and the interest of the ground
lessor in the operating cash flows of the Hotel. The Appraised Value assumes
all contractual provisions for FF&E reserves are adequate and have not been
reduced to reflect deferred maintenance or environmental remediation costs
with respect to Chicago Suites' Hotel (but estimated deferred maintenance
costs have been deducted in estimating the Adjusted Appraised Value of Chicago
Suites' Hotel). The Appraised Value did not take into account the costs that
might be incurred in selling the Hotel (but estimated costs for transfer and
recordation taxes and fees have been deducted in estimating the Adjusted
Appraised Value of the Hotel).
The Appraisal is not a guarantee of present or future values and no
assurance can be given as to the actual value of Chicago Suites' Hotel. The
Appraisal should be read in conjunction with other information, such as, but
not limited to, the audited financial statements of Chicago Suites.
The Appraised Value, and the assumptions underlying the projections on which
the Appraised Value is based, are contingent upon a series of future events,
the outcomes of which are not necessarily within the Operating Partnership's
control and cannot be determined at this time. There can be no assurance that
another appraiser would not have arrived at a different result. Some of the
assumptions inevitably will not materialize and unanticipated events and
circumstances will occur subsequent to the date of the Appraisal. Furthermore,
the actual results achieved from Chicago Suites' Hotel will vary from the
results projected in the Appraisal and the variations may be material.
Chicago Suites Supp-11
<PAGE>
ADJUSTED APPRAISED VALUE. The Adjusted Appraised Value of Chicago Suites was
determined by making various adjustments to the Appraised Value of Chicago
Suites' Hotel, as described below.
. Mortgage and Other Debt. The estimated principal balance and accrued
interest as of the Effective Date (assumed to be December 31, 1998) of
all mortgage and other debt of Chicago Suites has been subtracted from
the Appraised Value.
. Mark to Market Adjustment. The third-party loans of the Partnerships have
various interest rates and terms to maturity. In order to reflect the
market value of the third-party loans of Chicago Suites, the estimated
Adjusted Appraised Value for Chicago Suites has been increased to "mark
to market" the interest rate for such loans. This adjustment has been
estimated by comparing the interest cost using the applicable interest
rates on existing third-party loans over their remaining term to the
interest cost using the interest rate that the Operating Partnership
believes it would be able to obtain for unsecured debt in the market as
of the Final Valuation Date (which would have been % per annum based on
a 225 basis point (2.25 percent) spread over the yield on seven-year U.S.
Treasury securities as of , 1998). The mark to market adjustment for
each loan was calculated by determining the difference between the
present values, as of December 31, 1998, of the interest payments over
the remaining term of the loan from January 1, 1999 to maturity using the
actual interest rate as the discount rate as compared to using the
assumed market rate as the discount rate.
. Deferred Maintenance Costs. The estimated cost to complete any deferred
maintenance items identified in the Engineering Study relating to the
Chicago Suites' Hotel has been subtracted from the Appraised Value. The
adjustments for this item will be reduced at the Final Valuation Date to
reflect amounts expended after the Initial Valuation Date to perform such
deferred maintenance. No adjustments have been made for previously
budgeted capital expenditures or deferred maintenance costs estimated in
the Engineering Study that are reflected in the cash flow projections
used for purposes of estimating the Appraised Value.
. Transfer and Recordation Taxes and Fees. The estimated transfer and
recordation taxes and fees required to be paid by Chicago Suites in
connection with the Merger have been subtracted from the Appraised Value.
The actual transfer and recordation taxes and fees will be paid by the
Operating Partnership as part of the Merger Expenses.
The following table sets forth the adjustments to the Appraised Value made
to derive the estimated Adjusted Appraised Value for Chicago Suites as of the
Initial Valuation Date.
CALCULATION OF ESTIMATED ADJUSTED APPRAISED VALUE FOR CHICAGO SUITES
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value.................................................. $ 34,300
Mortgage debt.................................................... (22,284)
Other debt....................................................... (464)
Mark to market adjustment........................................ 94
Deferred maintenance costs....................................... (46)
Transfer taxes................................................... (274)
--------
Estimated Adjusted Appraised Value............................... $ 11,326
========
Limited partners' share.......................................... $ 11,213
Per Partnership Unit............................................. $ 33,131
</TABLE>
CONTINUATION VALUE. AAA estimated the Continuation Value of Chicago Suites
using the following methodology:
. Estimated Future Cash Distributions. AAA prepared estimates of future
partnership cash flow for Chicago Suites for the 12-year period from
January 1, 1998 through December 31, 2009 based upon the
Chicago Suites Supp-12
<PAGE>
estimated 1998 NOI before incentive management fees used in the Appraisal
and for each subsequent year applying an assumed annual stabilized growth
rate (as shown in the table below) developed by AAA for this analysis. For
each year in the projection period, AAA estimated the amount of cash
available for distribution to Chicago Suites' limited partners after
payment of all management fees, debt service, owner funded capital
expenditures based on the Engineering Study and other partnership expenses
and after application of the applicable partnership agreement provisions.
AAA assumed that Chicago Suites FF&E reserve was adequate and understood
that Host determined that there were no reserve shortfalls or surpluses.
. Refinancing Assumptions. AAA assumed that Chicago Suites' first mortgage
loan, which matures in 2001, would be refinanced with interest rate at
7.25% per annum and a 20-year amortization schedule, with estimated
refinancing costs of 2% of the refinanced amount being paid from
operating cash flow.
. Determination of Residual Value. To estimate the residual value of the
Chicago Suites limited partners' interest in Chicago Suites at the end of
the 12-year period, AAA assumed that the Hotel would be sold as of
December 31, 2009 at its then market value. AAA estimated the market
value of the Hotel as of such date by applying an exit capitalization
rate that it deemed appropriate, using the factors described above in
connection with the "--Appraised Value," which are set forth in the table
below, to the estimated Adjusted NOI for 2009 (estimated as described
above). AAA then subtracted estimated sales costs of 2.0% of the
estimated market value, added lender reserves and subtracted the
estimated outstanding principal balance of debt as of December 31, 2009
and deferred management fees to arrive at net sales proceeds available
for distribution to Chicago Suites' partners. AAA then determined what
portion of such estimated net sales proceeds would be distributable to
Chicago Suites' limited partners under the partnership and debt
agreements.
. Discounting Distributions to Present Value. As a final step, AAA
discounted the estimated future cash distributions to Chicago Suites
limited partners from operations and estimated net sales proceeds to
their present value as of January 1, 1998, using a discount rate of 20%
per annum. AAA believes that this discount rate reflects the return on
investment that investors expect from leveraged investments of this
nature.
The growth rate and exit capitalization rate used to determine the estimated
Continuation Value for Chicago Suites are as set forth below:
GROWTH RATE, EXIT CAPITALIZATION RATE
AND ESTIMATED CONTINUATION VALUE FOR CHICAGO SUITES
<TABLE>
<CAPTION>
ESTIMATED
EXIT CAPITALIZATION RATE CONTINUATION VALUE
GROWTH RATE (2009) (PER PARTNERSHIP UNIT)
----------- ------------------------- ----------------------
<S> <C> <C>
3.7% 9.9% $24,184
</TABLE>
LIQUIDATION VALUE. The Liquidation Value of Chicago Suites was estimated by
the General Partner and represents the estimated value of Chicago Suites if
all of its assets were sold as of December 31, 1998. Such value was based upon
the Adjusted Appraised Value of Chicago Suites, with the following
adjustments: (i) the "mark to market" adjustment used to estimate the Adjusted
Appraised Value was eliminated and instead prepayment or defeasance costs that
would be payable under existing debt agreements (regardless of whether the
debt in fact can be prepaid on December 31, 1998) were deducted from the
Appraised Value and (ii) the deduction for transfer and recordation taxes and
fees used to estimate the Adjusted Appraised Value was eliminated and instead
an amount equal 2.5% of the Appraised Value of Chicago Suites Hotel was
subtracted from the Appraised Value for estimated liquidation costs, expenses
and contingencies. The General Partner then determined the portion of the
estimated Liquidation Value that would be distributable to Chicago Suites
limited partners under the terms of the partnership agreement and other
contractual arrangements.
Chicago Suites Supp-13
<PAGE>
The following table sets forth the adjustments made to the Adjusted
Appraised Value to estimate the Liquidation Value of Chicago Suites as of the
Initial Valuation Date:
CALCULATION OF ESTIMATED LIQUIDATION VALUE OF CHICAGO SUITES
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value.................... $ 34,300
Mortgage debt...................... (22,284)
Other debt......................... (464)
Deferred maintenance costs......... (46)
Sales costs........................ (858)
--------
Estimated Liquidation Value........ $ 10,648
========
Limited partners' share............ $ 10,541
Per Partnership Unit............... $ 31,467
</TABLE>
ESTIMATED EXCHANGE VALUE. The following table sets forth the estimated
Exchange Value of Chicago Suites (based upon the greatest of its estimated
Adjusted Appraised Value, estimated Continuation Value and estimated
Liquidation Value), the estimated minimum and pro forma number of OP Units to
be received and the estimated Note Election Amount for Chicago Suites, all on
a per Partnership Unit basis as of the Initial Valuation Date. The estimated
Exchange Value for Chicago Suites will be received by each Chicago Suites
Limited Partner retaining OP Units in the Merger. The estimated Note Election
Amount for Chicago Suites (which will be received by Chicago Suites Limited
Partners electing to receive Notes in exchange for OP Units) is equal to the
Liquidation Value for Chicago Suites. The estimated values set forth below may
increase or decrease as a result of various adjustments, which will be finally
calculated as of the Final Valuation Date but will not change as a result of
less than all of the Partnerships participating in the Mergers. The actual
number of OP Units to be received by the Chicago Suites Limited Partners will
be based on the average closing price on the NYSE of a Host REIT Common Share
for the 20 trading days after the Effective Date.
ESTIMATED EXCHANGE VALUE,
NUMBER OF OP UNITS AND NOTE ELECTION AMOUNT
OF CHICAGO SUITES PER PARTNERSHIP UNIT(1)
<TABLE>
<CAPTION>
ESTIMATED ESTIMATED
ESTIMATED ESTIMATED ESTIMATED ESTIMATED MINIMUM PRO FORMA ESTIMATED
ADJUSTED APPRAISED CONTINUATION LIQUIDATION EXCHANGE NUMBER OF NUMBER OF NOTE ELECTION
VALUE VALUE VALUE VALUE(2) OP UNITS(3) OP UNITS(4) AMOUNT(5)
------------------ ------------ ----------- --------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
$33,131 $24,184 $31,467 $33,471 1,674 $31,467
</TABLE>
- --------
(1) A Partnership Unit in Chicago Suites represents an original investment of
$35,000.
(2) The estimated Exchange Value is equal to the greatest of estimated
Adjusted Appraised Value, estimated Continuation Value and estimated
Liquidation Value.
(3) Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Merger.
(4) Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
(5) The principal amount of Notes is equal to the greater of (i) the
Liquidation Value or (ii) 60% of the Exchange Value (the "Note Election
Amount").
Price of OP Units to Pay Exchange Value to Chicago Suites Limited
Partners. Each Chicago Suites Limited Partner will receive OP Units with a
deemed value equal to the Exchange Value of such Chicago Suites Limited
Partner's Partnership Interests. The price of an OP Unit for this purpose will
be equal to the average closing price on the NYSE of a Host REIT Common Share
for the 20 trading days after the Effective Date of the
Chicago Suites Supp-14
<PAGE>
Mergers (but in no event greater than $ per share). The closing price per
share of Host common stock on the NYSE was $ , on , 1998.
Chicago Suites Limited Partners at the Effective Date of the Merger who
retain OP Units will receive cash distributions from Chicago Suites for all of
1998 and, if the Merger does not occur in 1998, any portion of 1999 prior to
the Merger for which period they do not receive a cash distribution from the
Operating Partnership. Cash distributions will be made by Chicago Suites in
accordance with its partnership agreement on or before June 1, 1999 in respect
of 1998 operations and, if the Merger does not occur prior to January 1, 1999,
within 90 days after the Effective Date of the Merger in respect of any 1999
operations. Chicago Suites Limited Partners at the Effective Date of the
Merger who receive Notes in exchange for OP Units will participate in the same
distributions from Chicago Suites as Limited Partners who retain OP Units but
will not receive any distributions from the Operating Partnership with respect
to periods after the Effective Date of the Merger.
No fractional OP Units will be issued. Fractional amounts less than or equal
to 0.50 of an OP Unit will be rounded down to the next whole number and
fractional amounts greater than 0.50 will be rounded up to the next whole
number of OP Units.
VALUATION OF THE GENERAL PARTNER'S INTEREST IN CHICAGO SUITES AND ALLOCATION
OF OP UNITS TO THE GENERAL PARTNER
The value of the General Partner's interest will be equal to the aggregate
Exchange Value of Chicago Suites minus the aggregate Exchange Value of the
Chicago Suites Limited Partners' Partnership Interests (giving effect to the
applicable distribution preferences in the Chicago Suites partnership
agreement). The number of OP Units that will be received by the General
Partner will be equal to the value of its interest in Chicago Suites divided
by the same price per OP Unit used to determine the number of OP Units to be
received by the Chicago Suites Limited Partners. The total number of OP Units
that will be owned directly or indirectly by Host REIT (including OP Units
owned by the General Partner) will be equal to the number of outstanding
shares of common stock of Host at the Effective Date.
The following table sets forth the estimated value of the General Partner's
interests in Chicago Suites based upon the estimated aggregate Exchange Value
of the Chicago Suites Limited Partners' Partnership Interests as of the
Initial Valuation Date and the minimum and pro forma number of OP Units
estimated to be received by the General Partner in respect thereof.
ESTIMATED VALUES OF THE GENERAL PARTNER'S INTEREST AND NUMBER OF OP UNITS
(DOLLARS IN THOUSANDS)
<TABLE>
<S> <C>
Aggregate Exchange Value............................................... $11,326
Limited partners' share of aggregate Exchange Value.................... 11,213
-------
Value of General Partner's interest.................................... $ 113
-------
Total Host interest.................................................... $ 113
=======
Number of OP Units:
Minimum(1)...........................................................
Pro Forma(2)......................................................... 6
</TABLE>
- --------
(1)Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Mergers.
(2)Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
CASH DISTRIBUTIONS
Historical Cash Distributions Paid by Chicago Suites. Chicago Suites has not
paid any cash distributions to its Limited Partners in the First Two Quarters
1998 and for the fiscal years 1993 through 1997.
Chicago Suites Supp-15
<PAGE>
Compensation and Distributions to the General Partner. Under Chicago Suites'
partnership agreement, the General Partner does not receive fees or
compensation in connection with managing the affairs of Chicago Suites but the
General Partner and its affiliates are reimbursed for certain costs and
expenses incurred on behalf of Chicago Suites. In addition, the General
Partner is entitled to distributions related to its interests in Chicago
Suites. The following information has been prepared to compare the amount of
reimbursements paid and cash distributions made by Chicago Suites to the
General Partner and its affiliates to the amounts that would have been paid if
the reimbursement and distribution structure which will be in effect after the
REIT Conversion had been in effect for the periods presented.
Following the REIT Conversion, Host REIT will be operated as a self-
administered REIT and as a result no reimbursements or other compensation will
be received by the General Partner.
The following table sets forth the reimbursements and distributions paid by
Chicago Suites to its General Partner for the last three fiscal years and the
First Two Quarters 1998 ("Historical") and the reimbursements and
distributions that would have been paid to the General Partner for the last
fiscal year and the First Two Quarters 1998 if the REIT Conversion had been in
effect, assuming the Full Participation Scenario ("Pro Forma") and assuming a
distribution per OP Unit of $1.05 per year during such period, which is the
midpoint of the expected distribution range for 1999.
HISTORICAL AND PRO FORMA REIMBURSEMENTS AND DISTRIBUTIONS TO THE GENERAL
PARTNER
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO FISCAL YEAR
QUARTERS --------------------------------------
1998 1997 1996 1995
---------------- ---------------- ---------- ----------
PRO PRO
HISTORICAL FORMA HISTORICAL FORMA HISTORICAL HISTORICAL
---------- ----- ---------- ----- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Reimbursements(1)...... $82 $-- $59 $-- $119 $--
Distributions(2)....... -- 3 -- 6 -- --
--- --- --- --- ---- ---
Total ............. $82 $ 3 $59 $ 6 $119 $--
=== === === === ==== ===
</TABLE>
- --------
(1) All expenses will be paid directly by the Operating Partnership,
accordingly, there are no expected reimbursements on a pro forma basis.
(2) The amount of distributions payable to the General Partner on a pro forma
basis reflect distributions at a rate of $1.05 per annum per OP Unit
(which is the midpoint of the expected range of distributions per OP Unit
for 1999) with respect to the estimated number of OP Units that the
General Partner will receive with respect to its general and limited
partner interests in Chicago Suites. Such number does not reflect the
aggregate number of OP Units Host will receive in connection with the REIT
Conversion.
CERTAIN INFORMATION REGARDING THE HOTEL OWNED BY CHICAGO SUITES
<TABLE>
<CAPTION>
NUMBER OF DATE
NAME OF HOTEL LOCATION OF HOTEL ROOMS OPENED
- ------------- ----------------- --------- ------
<S> <C> <C> <C>
Marriott Suites O'Hare...................... Chicago, IL 256 1988
</TABLE>
The table below sets forth certain performance information for Chicago
Suites' Hotel for the indicated periods.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
-------------------- -------------------------
1998 1997 1997 1996 1995
--------- --------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Average daily rate............. $ 159.98 $ 142.86 $146.83 $128.74 $120.80
Occupancy...................... 82.0% 83.4% 83.2% 84.0% 81.4%
REVPAR......................... $ 131.18 $ 119.15 $122.16 $108.14 $ 98.33
% REVPAR change................ 10.1% -- 13.0% 10.0% --
</TABLE>
Chicago Suites Supp-16
<PAGE>
Marriott Suites O'Hare Hotel, Chicago, Illinois
The Marriott Suites O'Hare Hotel is a full-service Marriott suites hotel
located approximately ten miles northwest of downtown Chicago and two miles
east of O'Hare International Airport (the "Airport") on approximately four
acres of leased land. The Hotel is part of the 29-acre Riverway office and
retail park developed by Simon/Rosemont Developers.
The Hotel opened in November 1988 with 256 guest suites. The Hotel has
approximately 2,600 square feet of meeting space including a 2,000 square foot
meeting room and 600 square foot board room. There is one food and beverage
outlet available in the Hotel, which includes a 94-seat restaurant, 20-seat
private dining restaurant and 33-seat lounge. Recreational amenities include
an indoor pool, a whirlpool and an exercise room. The Hotel also offers a gift
shop and parking for 272 vehicles on site. Chicago Suites purchased the Hotel
in 1989 for approximately $35 million.
Competition. The following table provides selected data on the Hotel and its
seven main competitors in the vicinity of the Airport:
<TABLE>
<CAPTION>
NUMBER YEAR OF MEETING SPACE
PROPERTY OF ROOMS OPENING (SQUARE FOOTAGE)
-------- -------- ------- ----------------
<S> <C> <C> <C>
O'HARE SUITES............................ 256 1988 2,600
Hyatt Regency............................ 1,100 1971 81,600
Hilton................................... 856 1972 33,900
O'Hare Marriott.......................... 681 1968 27,000
Westin................................... 525 1984 38,700
Sofitel.................................. 300 1987 20,300
Sheraton Gateway Suites.................. 297 1986 12,500
Rosemont Suites.......................... 296 1987 6,800
</TABLE>
The O'Hare Marriott is owned by Host and managed by Marriott International,
and other than limited joint marketing efforts, the Hotel and the O'Hare
Marriott are direct competitors. In addition, other hotels in the Chicago area
also compete with the Hotel; however, these differ in terms of size, room
rates, facilities, market orientation and/or location. New competition is
expected to open in the area in the near future; however, it is expected to
have minimal impact on the Hotel as it appeals to a different segment of the
market.
Ground Lease. The Hotel is located on a 4.3-acre site that is leased from an
unrelated third party for an initial term expiring in 2014. The Ground Lease
may be renewed at the option of the Partnership for five successive terms of
ten years each. The lease provides for annual rental during its term equal to
the greater of $300,000 or 3% of annual gross room sales. Under the lease, the
Partnership pays all costs, expenses, taxes and assessments relating to the
land, including real estate taxes. The Partnership has a first right of
negotiation in the event the ground lessor decides to sell the leased
premises. Upon expiration or termination of the Ground Lease, title to the
land and all improvements, including the Hotel, reverts to the ground lessor.
AMENDMENTS TO THE CHICAGO SUITES' PARTNERSHIP AGREEMENT
In order to allow the Hotel of Chicago Suites to be leased to SLC in
connection with the Merger and the REIT Conversion, Chicago Suites'
partnership agreement must be amended to allow for the lease of Chicago
Suites' Hotel in connection with the REIT Conversion. Therefore, Section 5.02B
of Chicago Suites' partnership agreement will be amended to restate paragraph
5.02B(ii) in its entirety:
(ii) sell, lease or otherwise dispose (or consent to the sale, lease or
other disposition), directly or indirectly, in one transaction or a series
of related transactions, of the Hotel.
Other Amendments. Amendments to certain terms and sections of the Chicago
Suites partnership agreement would be made in order to (i) delete certain
obsolete references to entities and agreements that are no longer in
existence, (ii) update the Chicago Suites partnership agreement to reflect the
passage of time since the
Chicago Suites Supp-17
<PAGE>
formation of Chicago Suites and (iii) make any other amendments to the Chicago
Suites partnership agreement deemed necessary or advisable, in the sole
discretion of the General Partner, in connection with the consummation of the
Mergers and the REIT Conversion. The General Partner does not believe that
these amendments would affect the rights of the Chicago Suites Limited
Partners in any material respect nor the duties and obligations of the General
Partner. These changes are included, along with the other proposed amendments,
in the copy of Chicago Suites partnership agreement, as proposed to be
amended, which is attached hereto. The amended Chicago Suites partnership
agreement is marked to indicate the revisions made to the existing Chicago
Suites partnership agreement and should be read in its entirety. Deleted
provisions are contained in brackets and struck through and added provisions
are in bold type and underlined.
FAIRNESS ANALYSIS AND OPINION
FAIRNESS ANALYSIS
The General Partner believes that the Merger provides substantial benefits
and is fair to the Limited Partners of Chicago Suites and recommends that all
Limited Partners of Chicago Suites consent to the Merger. The General Partner
bases this recommendation primarily on (i) its view that the expected benefits
of the Merger for the Chicago Suites Limited Partners outweigh the risks and
potential detriments of the Merger to the Chicago Suites Limited Partners (see
"Background and Reasons for the Mergers and the REIT Conversion--Reasons for
the Mergers" and "Risk Factors"), (ii) its view that the value of the OP Units
allocable to the Chicago Suites Limited Partners on the basis of the Exchange
Value established for Chicago Suites represents fair consideration for the
Partnership Interests held by the Chicago Suites Limited Partners and is fair
to the Chicago Suites Limited Partners from a financial point of view and
(iii) the Appraisal and Fairness Opinion of AAA.
The Merger is not conditioned upon the consummation of any of the other
Mergers. The General Partner has considered this fact in evaluating the
fairness of the Merger. The General Partner believes that the fairness of the
Merger will not be materially affected by the presence or absence of any other
individual Partnership or by any particular combination of other Partnerships
and that the Merger will be fair to the Chicago Suites Limited Partners,
individually and as a whole, if it is consummated with any combination of
other Participating Partnerships. The General Partner bases this belief
primarily on the fact that the consideration to be paid to the Chicago Suites
Limited Partners has been established based upon Chicago Suites' Exchange
Value, without regard to any possible combination of other Partnerships.
In reaching the conclusions implicit in the above recommendation, the
General Partner has taken into account the following considerations, placing
the greatest weight on the first two considerations:
. The General Partner has concluded that the Exchange Value for Chicago
Suites, which is equal to its Adjusted Appraised Value, represents fair
consideration for the Partnership Interests of the Chicago Suites Limited
Partners in the Merger in relation to Chicago Suites. The General Partner
also has concluded that the Exchange Value established for the Chicago
Suites Limited Partners fairly reflects the value of the assets held by
Chicago Suites. In addition, the Fairness Opinion supports these
conclusions.
. Chicago Suites Limited Partners will be able to defer recognition of gain
for tax purposes until such time as they choose to realize such gain
based on their own personal circumstances.
. The General Partner has concluded that the potential benefits of the
Merger to the Chicago Suites Limited Partners, as described under
"Background and Reasons for the Mergers and the REIT Conversion--Reasons
for the Mergers," outweigh the potential risks and detriments of the
Merger for the Chicago Suites Limited Partners, as described in "Risk
Factors."
. The Fairness Opinion, in the view of the General Partner, supports the
fairness of the Merger, even though it includes qualifications,
limitations and assumptions relating to its scope and other factors that
Chicago Suites Limited Partners should consider carefully. The
availability of the Fairness Opinion is particularly significant in light
of the absence of arm's length negotiations in establishing the terms of
the Merger.
Chicago Suites Supp-18
<PAGE>
. Host will contribute its wholly owned full-service hotel assets,
substantially all of its interests in the Hotel Partnerships and its
other assets (excluding its senior living assets and the cash or
securities to be distributed to its shareholders) to the Operating
Partnership in exchange for (i) a number of OP Units equal to the number
of outstanding shares of common stock of Host, (ii) preferred partnership
interests in the Operating Partnership corresponding to any shares of
Host preferred stock outstanding at the time of the REIT Conversion and
(iii) the assumption by the Operating Partnership of all liabilities of
Host (including past and future tax liabilities), other than liabilities
of SLC. Following these contributions, the Operating Partnership and its
subsidiaries will directly own all of Host's wholly owned hotels and all
of Host's interests in the Hotel Partnerships and Host's other assets.
Host will receive OP Units in respect of its general partner interests in
Chicago Suites on substantially the same basis as the Partnership Units
held by Chicago Suites Limited Partners. Host REIT will not receive any
compensation for its services as general partner to the Operating
Partnership following the REIT Conversion and will benefit from the
operations of the Operating Partnership only to the extent of the
distributions received based upon its percentage interest in the
Operating Partnership to the same extent as the other limited partners.
Because Host REIT will share in the value of the Operating Partnership
solely through distributions and not through any separate compensation
structure, the General Partner believes that this is a factor supporting
the fairness of the Merger to the Chicago Suites Limited Partners.
. The General Partner believes that the value of the consideration to be
received by the Chicago Suites Limited Partners in the Merger is fair in
relation to the value which would be derived by such Limited Partners
under any of the alternatives described under "Background and Reasons for
the Mergers and the REIT Conversion--Alternatives to the Mergers,"
especially since the Exchange Value of Chicago Suites is equal to its
Adjusted Appraised Value, which is the greatest of the Adjusted Appraised
Value, the Continuation Value and the Liquidation Value and the historic
prices paid for Chicago Suites Partnership Units. The General Partner
does not believe that the sale of Chicago Suites' Hotel and liquidation
of Chicago Suites will obtain for Chicago Suites' Limited Partners as
much value as the value to be received by such Chicago Suites Limited
Partners following the Merger. The General Partner believes that the
following benefits are of the greatest value and importance to the
Chicago Suites Limited Partners:
. Enhanced Liquidity. The Merger and the REIT Conversion will offer
Chicago Suites Limited Partners significantly enhanced liquidity
with respect to their investment in Chicago Suites because,
commencing one year following the Effective Date, Chicago Suites
Limited Partners who retain OP Units will be able to exercise their
Unit Redemption Right at any time, subject to certain limited
exceptions. Host has approximately 204 million shares of common
stock outstanding and is expected to have a total common equity
market capitalization of approximately $ billion after giving
effect to the estimated $ million earnings and profits distribution
(based on Host's $ closing price per share on the NYSE on ,
1998). The exercise of the Unit Redemption Right, however, generally
would result in recognition of taxable income or gain at that time.
. Risk Diversification. Upon consummation of the REIT Conversion, each
Chicago Suites Limited Partner's investment will be converted from
an investment in Chicago Suites, which owns one hotel, into an
investment in an enterprise that initially will own or control
approximately 120 Hotels and will have a total market capitalization
of approximately $ billions, thereby reducing the dependence upon
the performance of, and the exposure to the risks associated with,
the Hotel currently owned by Chicago Suites and spreading such risk
over a broader and more varied portfolio, including more diverse
geographic locations and multiple brands.
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a significantly lower leverage to
value ratio than Chicago Suites currently, which has a leverage
ratio of 66% (calculated as a percentage of Appraised Value),
resulting in significant interest and debt service savings and
greater financial stability.
. Regular Quarterly Cash Distributions. The General Partner expects
that the Operating Partnership will make regular quarterly cash
distributions to holders of OP Units. Host expects that these
distributions will be higher than the estimated cash distributions
for 1998 of Chicago
Chicago Suites Supp-19
<PAGE>
Suites and, in any event, the ability to receive distributions
quarterly and in regular amounts would be enhanced.
. Substantial Tax Deferral. The General Partner expects that Chicago
Suites Limited Partners who do not elect to receive Notes in exchange
for OP Units generally should be able to obtain the benefits of the
Merger while continuing to defer recognition for federal income tax
purposes of at least a substantial portion, if not all, of the gain
with respect to their Partnership Interests that otherwise would be
recognized in the event of a liquidation of Chicago Suites or a sale
or other disposition of its assets in a taxable transaction.
. The General Partner believes that the economic terms of the lease of the
Chicago Suites Hotel is fair and reasonable from the standpoint of the
Operating Partnership.
The General Partner believes that the factors described above, which support
the fairness of the Merger to the Chicago Suites Limited Partners, when
weighed against the factors that may be disadvantageous, taken as a whole,
indicate that the Merger is fair to the Chicago Suites Limited Partners.
FAIRNESS OPINION
AAA, an independent financial advisory firm with substantial real estate and
partnership transaction experience, was engaged by the General Partner and the
other General Partners to perform the Appraisals and to render the Fairness
Opinion that (i) the Exchange Value and the methodologies and underlying
assumptions used to determine the Exchange Value, the Adjusted Appraised
Value, the Continuation Value and the Liquidation Value of Chicago Suites and
each other Partnership (including, without limitation, the assumptions used to
determine the various adjustments to the Appraised Values of the Hotels) are
fair and reasonable, from a financial point of view, to the Chicago Suites
Limited Partners and the Limited Partners of each other Partnership and
(ii) the methodologies used to determine the value of an OP Unit and to
allocate the equity in the Operating Partnership to be received by the limited
partners of Chicago Suites and the limited partners of each other Partnership
are fair and reasonable to the Chicago Suites Limited Partners and the Limited
Partners of each other Partnership. The Fairness Opinion is addressed to each
Partnership and it may be relied upon by each of the Chicago Suites Limited
Partners and the Limited Partners of the other Partnerships. The full text of
the Fairness Opinion, which contains a description of the assumptions and
qualifications applicable to the review and analysis by AAA, is set forth in
Appendix B to the Consent Solicitation and should be read in its entirety. The
material assumptions and qualifications to the Fairness Opinion are summarized
below, although this summary does not purport to be a complete description of
the various inquiries and analyses undertaken by AAA in rendering the Fairness
Opinion. Arriving at a fairness opinion is a complex analytical process not
necessarily susceptible to partial analysis or amenable to summary
description. For a more complete description of the assumptions and
qualifications that limit the scope of the Fairness Opinion, see "--
Qualifications to Fairness Opinion" and "--Assumptions" below.
Although the General Partner advised AAA that certain assumptions were
appropriate in its view, the General Partner imposed no conditions or
limitations on the scope of the investigation by AAA or the methods and
procedures to be followed by AAA in rendering the Fairness Opinion. The fees
and expenses of AAA will be treated as a Merger Expense and will be paid by
the Operating Partnership. In addition, the General Partner has agreed to
indemnify AAA against certain liabilities. See "--Compensation and Material
Relationships."
Qualifications to Fairness Opinion. In the Fairness Opinion, AAA
specifically states that it did not: (a) specifically consider other
methodologies for allocation of the OP Units, (b) address or conclude that
other methodologies for allocation of the OP Units to Chicago Suites and the
other Partnerships might not have been more favorable to the Limited Partners
in certain of the Partnerships, (c) negotiate with the General Partner, the
General Partners of other Partnerships or Host, (d) participate in
establishing the terms of the Merger and the other Mergers, (e) provide an
opinion as to the terms and conditions of the Merger and the other Mergers
other than those explicitly stated in the Fairness Opinion, (f) make any
independent review of the capital expenditure estimates set forth in the
Engineering Study or (g) make any estimates of Chicago Suites' and each other
Partnership's contingent liabilities. In addition, with respect to the
specific reference to the allocation of the equity interest in the Operating
Partnership to be received by the limited partners of each Partnership, AAA
has assumed that the average closing price on the NYSE of a Host REIT Common
Share for the 20 trading days after the Effective Date of the Mergers
represents a fair price.
Chicago Suites Supp-20
<PAGE>
In connection with preparing the Fairness Opinion, AAA was not engaged to,
and consequently did not, prepare any written report or compendium of its
analysis for internal or external use beyond the analysis set forth in
Appendix B. AAA will not deliver any additional written opinion of the
analysis, other than to update the written opinion if requested by the
Operating Partnership.
Experience of AAA. AAA is the world's largest independent valuation
consulting firm and is regularly and continually engaged in the valuation of
commercial real estate and businesses and their securities in connection with
tender offers, mergers and acquisitions, recapitalizations and
reorganizations, divestitures, employee stock ownership plans, leveraged
buyout plans, private placements, limited partnerships, estate and corporate
matters, other financial advisory matters and other valuation purposes.
AAA was selected because of its experience in the valuation of businesses
and their securities in connection with tender offers, mergers and
acquisitions, recapitalizations and reorganizations, including transactions
involving hotel partnerships. In addition, Host and its affiliates have
previously engaged AAA to provide appraisals and fairness opinions in
connection with other transactions. The General Partner and the other General
Partners considered two other firms for purposes of performing the appraisals
and rendering the Fairness Opinion and received proposals from each. The
General Partner selected AAA based upon price and experience.
Summary of Materials Considered and Investigation Undertaken. As a basis for
rendering the Fairness Opinion, AAA has made such reviews, studies and
analyses as it deemed necessary and pertinent in order to provide it with a
reasonable basis for the Fairness Opinion, including, but not limited to, the
following: (i) reviewed the transaction documents and SEC reporting and/or
filing documents, including drafts of the Form S-4 for the Mergers; (ii)
provided the Market Value of each Hotel owned by each Partnership in a
separate short form appraisal report and each such report was reviewed and
certified by an MAI appraiser as to its preparation in accordance with the
requirements of the Standards of Professional Practice of the Appraisal
Institute and the Uniform Standards of Professional Appraisal Practice of the
Appraisal Foundation; as part of the Appraisals, AAA reviewed historical
operating statements, 1998 budget and year-to-date results, and other
financial information as it deemed necessary as a basis for the Fairness
Opinion and the Appraisals also considered market transactions of similar
lodging properties as appropriate as a basis for the Market Value of each
Hotel; (iii) reviewed the methodologies used by each of the General Partners
in their determination of the Exchange Value of each Partnership, including
the nature and amount of all adjustments to the Appraised Values in
determining such Exchange Values; AAA reviewed and tested for the fairness and
reasonableness of all adjustments as well as for consideration of all
adjustments deemed to be appropriate by AAA; (iv) reviewed the methodologies
used by each of the General Partners in their determination of the value of an
OP Unit and the allocation of the equity interest in the Operating Partnership
to be received by the partners of each Partnership, and AAA reviewed and
tested for the fairness and reasonableness of the methods and measurements
made by the General Partners; (v) reviewed the General Partners' determination
of the Liquidation Value of each Partnership, and AAA reviewed and tested for
the fairness and reasonableness of all adjustments proposed by the General
Partners, as well as for consideration of all adjustments deemed appropriate
by AAA; (vi) provided an estimate of the Continuation Value of each
Partnership based upon the estimated present value of expected benefits to be
received by each limited partner interest as though the Mergers did not occur
and each Partnership's assets were sold within a twelve year period; AAA, as
part of its analysis and review, determined appropriate rates of growth in
house profit or net operating income, as well as reviewed other key variables
affecting partnership cash flows and other economic/financial factors
affecting the Partnerships' expected operations and results; (vii) reviewed
the terms of the ground leases of the Hotels and the partnership agreement of
each Partnership; (viii) reviewed audited and unaudited historical income
statements, balance sheets and statements of sources and uses of funds of each
Partnership and Host and pro forma financial information for Host REIT; (ix)
reviewed audited and unaudited historical operating statements of each Hotel,
as well as current operating statements and budgets; (x) conducted real estate
valuation and financial due diligence with respect to the Partnerships and
their underlying assets, liabilities and equity; (xi) reviewed internal
Marriott International, Host and Partnership financial analyses and other
internally generated data for each Hotel and (xii) discussed all of the
foregoing information, where appropriate, with management of Marriott
International, Host and the Partnerships and their respective employees.
Chicago Suites Supp-21
<PAGE>
Assumptions. In rendering its opinion, AAA relied, without independent
verification, on the accuracy and completeness in all material respects of
certain relevant publicly available information and information provided to
AAA by Host and the Hotels. AAA assumed that all information furnished by
Host, the Hotels and the Partnerships and their representatives, upon which
AAA relied, presented an accurate description in all material respects of the
current and prospective status of the Hotels and the Partnerships from an
operational and financial point of view. AAA also noted that the Fairness
Opinion was based upon financial, economic, market and other considerations as
they existed and could be evaluated on the date thereof.
Conclusions. AAA concluded that, based upon and subject to its analysis and
assumptions and limiting conditions, and as of the date of the Fairness
Opinion: (i) the Exchange Value and the methodologies used to determine the
Exchange Value, the Adjusted Appraised Value, the Continuation Value and the
Liquidation Value each Partnership (including, without limitation, the
assumptions used to determine the various adjustments to the Appraised Values
of each of the Hotels) are fair and reasonable, from a financial point of
view, to the Chicago Suites Limited Partners and the Limited Partners of each
other Partnership and (ii) the methodologies used to determine the value of an
OP Unit and to allocate the equity interest in the Operating Partnership to be
received by the Chicago Suites limited partners and the limited partners of
each other Partnership are fair and reasonable to the Chicago Suites Limited
Partners and the Limited Partners of each other Partnership.
Compensation and Material Relationships. AAA has been paid a fee of $335,000
for its services as described herein, including the Appraisals and preparing
to deliver the Fairness Opinion. In addition, AAA will be reimbursed for all
reasonable out-of-pocket expenses, including legal fees and will be
indemnified against certain liabilities, including certain liabilities under
the securities laws. The fee was negotiated between Host, the General Partners
and AAA. Payment of the fee to AAA is not dependent upon completion of the
Mergers. AAA has been previously engaged by Host and its affiliates to provide
appraisals, fairness opinions and solvency opinions in connection with other
transactions.
VOTING PROCEDURES
The consent of Limited Partners holding more than 50% of the outstanding
limited partner interests is required for participation in the Merger. The
General Partner does not own any limited partner interests.
A Chicago Suites Limited Partner may mark the Consent Form to vote "FOR,"
"AGAINST" or "ABSTAIN" with respect to participation in the Merger by Chicago
Suites. THE FAILURE OF A LIMITED PARTNER OF CHICAGO SUITES TO VOTE OR AN
ABSTENTION WILL HAVE THE SAME EFFECT AS IF SUCH LIMITED PARTNER HAD VOTED HIS
PARTNERSHIP INTERESTS "AGAINST" THE MERGER. LIMITED PARTNERS WHO RETURN A
SIGNED CONSENT FORM BUT FAIL TO INDICATE THEIR APPROVAL OR DISAPPROVAL AS TO
ANY MATTER (INCLUDING THE MERGER) WILL BE DEEMED TO HAVE VOTED TO APPROVE SUCH
MATTER. The voting procedures applicable to Chicago Suites' Limited Partners
are set forth in the Consent Solicitation under the heading "Voting
Procedures--Required Vote and Other Conditions."
As of June 19, 1998, the following persons owned more than 5% of the total
number of Partnership Units of Chicago Suites: Marriott Suite Hotel
Association owned 8.80%; Landmark Capital LLC owned 7.51%; and Michael T.
Sullivan owned 7.46%. No other person owned of record, or to the Partnership's
knowledge owned beneficially, more than 5% of the total number of Partnership
Units of Chicago Suites.
FEDERAL INCOME TAX CONSEQUENCES
In addition to the federal income tax consequences discussed in the sections
of the Consent Solicitation entitled "Federal Income Tax Consequences" and
"Risk Factors--Federal Income Tax Risks," Chicago Suites Limited Partners
should read carefully the following discussion of federal income tax
consequences applicable specifically to the Chicago Suites Limited Partners.
The information included in this discussion is based upon various factual
assumptions and information which are believed by the Operating Partnership
and the General Partner to be reliable. However, some of these assumptions
inevitably will not materialize, and unanticipated events and circumstances
will occur. Therefore, there likely will be differences between the
information provided
Chicago Suites Supp-22
<PAGE>
herein, including the numerical data and estimates, and actual results, and
the variations may be material and adverse.
Applicability of Tax Opinions
Hogan & Hartson L.L.P. ("Hogan & Hartson"), counsel to Host REIT, Host and
the Operating Partnership, has provided to Host REIT and the Operating
Partnership an opinion letter (substantially in the form of Appendix C to the
Consent Solicitation) as to certain federal income tax consequences to the
Operating Partnership and the Chicago Suites' Limited Partners resulting from
the Mergers and the REIT Conversion. The opinion letter is based upon certain
assumptions and certain representations provided by Host REIT, Host, the
Operating Partnership and the General Partners. These representations
generally involve factual matters relating to the organization, ownership and
operations (including the income, assets, businesses, liabilities and
properties) of the Partnerships and Hotels contributed to the Operating
Partnership by Host and the Blackstone Entities prior to the Mergers and the
REIT Conversion and of Host REIT, the Operating Partnership and the
Partnerships following the Mergers and the REIT Conversion. In addition, on
the Effective Date, Hogan & Hartson expects to provide to Host REIT and the
Operating Partnership an opinion letter (substantially in the form of Appendix
D to the Consent Solicitation) as to the qualification and taxation of Host
REIT as a REIT under the Code following the REIT Conversion. The receipt of
this opinion letter is a condition to the REIT Conversion and each of the
Mergers. See "Federal Income Tax Consequences--Summary of Tax Opinions" in the
Consent Solicitation.
Each opinion provided by Hogan & Hartson in the opinion letter that is
substantially in the form of Appendix C to the Consent Solicitation is
applicable to the Chicago Suites Limited Partners.
The opinions already rendered by Hogan & Hartson are based on the Code and
Treasury Regulations in effect on the date hereof, current administrative
interpretations and positions of the IRS and existing court decisions, and the
opinions to be rendered by Hogan & Hartson on the Effective Date will be based
on the same authorities as of the Effective Date. No assurance can be given
that future legislation, Treasury Regulations, administrative interpretations
and court decisions will not significantly change the law or the above
conclusions reached by counsel. In addition, any such change could apply
retroactively to transactions preceding the date of change. Moreover, opinions
of counsel merely represent counsel's best judgment with respect to the
probable outcome on the merits and are not binding on the IRS or the courts.
Accordingly, even if there is no change in applicable law, no assurance can be
provided that such opinions (which do not bind the IRS or the courts) will not
be challenged by the IRS or will be sustained by a court if so challenged.
With the one exception described below (see "--Tax Consequences of the
Merger--Deemed Cash Distribution and Resulting Taxable Gain") and in the
Consent Solicitation under "Federal Income Tax Consequences--Tax Consequences
of the Mergers--IRS Ruling Request Regarding Allocation of Partnership
Liabilities," neither Host REIT, the Operating Partnership nor the General
Partners have requested or plan to request any rulings from the IRS concerning
the tax consequences of the Mergers or the treatment of either the Operating
Partnership or Host REIT subsequent to the REIT Conversion.
Tax Consequences of the Merger
Overview. Hogan & Hartson has provided an opinion to the effect that the
Merger will not result in the recognition of taxable gain or loss at the time
of the Merger to a Chicago Suites Limited Partner (i) who does not exercise
his Unit Redemption Right on a date sooner than the date two years after the
date of the consummation of the Merger; (ii) who does not receive a cash
distribution (or a deemed cash distribution resulting from relief from
liabilities, including as a result of any prepayment of the Chicago Suites
Mortgage Debt) in connection with the Merger or the REIT Conversion in excess
of his aggregate adjusted basis in his Chicago Suites Partnership Units at the
time of the Merger; (iii) who does not elect to receive a Note in exchange for
his OP Units in connection with the Merger (the "Note Election"); (iv) who is
not required to recognize gain by reason of the exercise by another Chicago
Suites Limited Partner of his right to make the Note Election;
Chicago Suites Supp-23
<PAGE>
and (v) who does not have his "at risk" amount fall below zero as a result of
the Merger or the REIT Conversion. See "Federal Income Tax Consequences--
Summary of Tax Opinions" in the Consent Solicitation.
With respect to the foregoing exceptions to nonrecognition treatment, the
Operating Partnership and the General Partner believe as follows: (i) a
Chicago Suites Limited Partner who acquired his Chicago Suites Partnership
Units in the original offering of such Partnership Units and who has held such
Partnership Units at all times since would not be considered to receive, as a
result of the Merger, a distribution (or a deemed cash distribution resulting
from relief from liabilities) that exceeds his aggregate adjusted basis in his
Chicago Suites Partnership Units at the time of the Merger, and would not have
his "at risk" amount fall below zero as a result of the Merger, even if all of
the Chicago Suites Mortgage Debt were to be repaid in connection with the
Merger or the REIT Conversion, and (ii) none of the personal property owned by
Chicago Suites will need to be sold to a Non-Controlled Subsidiary in
connection with the REIT Conversion. See "Federal Income Tax Consequences--Tax
Consequences of the Mergers--Overview" in the Consent Solicitation.
With respect to the effects of a Chicago Suites Limited Partner's election
to receive a Note in exchange for his OP Units in connection with the Merger,
Hogan & Hartson is of the opinion that although the matter is not free from
doubt, a Chicago Suites Limited Partner who does not make the Note Election
should not be required to recognize gain by reason of another Chicago Suites
Limited Partner's exercise of such right. With respect to the exercise of a
Unit Redemption Right, Hogan & Hartson is of the opinion that it is more
likely than not that a Chicago Suites Limited Partner's exercise of his Unit
Redemption Right more than one year after the date of consummation of the
Merger but less than two years after such date will not cause the Merger
itself to be a taxable transaction for the Chicago Suites Limited Partner (or
the other Chicago Suites Limited Partners). See "Federal Income Tax
Consequences--Summary of Tax Opinions" in the Consent Solicitation. Opinions
of counsel, however, do not bind the IRS or the courts, and no assurances can
be provided that such opinions will not be challenged by the IRS or will be
sustained by a court if so challenged.
Deemed Cash Distribution and Resulting Taxable Gain. With respect to his
Chicago Suites Partnership Units, a Chicago Suites Limited Partner will
receive no actual cash distribution in connection with the Merger but would be
deemed to receive a cash distribution in connection with the Merger to the
extent that his share of Operating Partnership liabilities immediately after
the Merger and the REIT Conversion is less than his share of Chicago Suites
liabilities immediately prior to the Merger. For example, any prepayment of
the Chicago Suites Mortgage Debt or debt encumbering other Hotels may result
in a deemed cash distribution to the Chicago Suites Limited Partners. See
"Federal Income Tax Consequences--Tax Consequences of the Mergers--Relief from
Liabilities/Deemed Cash Distribution" in the Consent Solicitation. Even though
the Chicago Suites Mortgage Debt and the debt encumbering other Hotels is not
expected to be repaid or refinanced in connection with the Mergers and the
REIT Conversion (except as described in the Consent Solicitation), a Chicago
Suites Limited Partner's share of indebtedness following the Mergers and the
REIT Conversion may nonetheless decrease in comparison to the Limited
Partner's estimated aggregate share of Chicago Suites indebtedness as
ofDecember 31, 1998 (calculated based on the assumption that the Mergers did
not occur) by reason of themanner in which the debt allocation rules work when
multiple assets with different levels of leverage are consolidated into a
single partnership.
A Chicago Suites Limited Partner, however, would recognize taxable gain as a
result of any deemed cash distribution only to the extent that the deemed cash
distribution were to exceed his adjusted tax basis in his Chicago Suites
Partnership Units immediately prior to the Merger. As noted above, the
Operating Partnership and the General Partner believe, based upon and subject
to the assumptions and other limitations described below, that a Chicago
Suites Limited Partner who acquired his Chicago Suites Partnership Units in
the original offering of such Partnership Units and has held the Partnership
Units at all times since the offering will have an adjusted tax basis in
excess of the deemed cash distribution that might occur in connection with the
Merger and the REIT Conversion, even if all of the Chicago Suites Mortgage
Debt were to be repaid in connection with the Merger and the REIT Conversion,
and the Chicago Suites Limited Partner were to have no share of any Operating
Partnership indebtedness following the Merger and the REIT Conversion.
Therefore, such a Chicago Suites Limited Partner should not recognize gain due
to such deemed cash distribution resulting from the relief from liabilities in
connection with the Merger and the REIT Conversion in any event.
Chicago Suites Supp-24
<PAGE>
The adjusted tax basis of a Chicago Suites Limited Partner who did not
acquire his Chicago Suites Partnership Units in the original offering of such
Partnership Units or who has not held his Chicago Suites Partnership Units at
all times since such offering could vary materially from that of a Chicago
Suites Limited Partner who did so. If a Chicago Suites Limited Partner has an
adjusted tax basis in his Chicago Suites Partnership Units (per Chicago Suites
Partnership Unit) that is substantially less than the adjusted tax basis of a
Chicago Suites Limited Partner who acquired his Chicago Suites Partnership
Units in the original offering of such Partnership Units and has held such
Partnership Units at all times since, he could recognize gain due to any
deemed cash distribution resulting from the relief from liabilities in
connection with the Merger and the REIT Conversion.
The Operating Partnership has no current plan or intention to cause the
prepayment of the Chicago Suites Mortgage Debt or, except as described in the
Consent Solicitation, any of the nonrecourse liabilities encumbering the
Hotels owned by the other Partnerships. The Operating Partnership, however,
will have to repay mortgage indebtedness securing the Hotels owned by the
Partnerships at the time such indebtedness matures. There can be no assurance
that at such time the Operating Partnership will be able to secure nonrecourse
mortgage indebtedness secured only by those Hotels in an amount sufficient to
avoid a deemed cash distribution to the former Limited Partners in those
Partnerships, including Chicago Suites (although such a deemed distribution of
cash may or may not result in the recognition of taxable income or gain by the
former Chicago Suites Limited Partners). Moreover, the Operating Partnership's
current long-term financing strategy is to have as little debt as possible
that is secured by individual Hotels and to have as much debt as possible in
the form of unsecured debt, held either by the public or by institutional
investors, which debt may or may not be recourse to Host REIT, as general
partner of the Operating Partnership. In view of these considerations and the
potential adverse consequences to Limited Partners in certain Partnerships,
the Operating Partnership has requested from the IRS a ruling to the effect
that such unsecured indebtedness of the Operating Partnership that is issued
initially to institutional investors and is not recourse to Host REIT (i)
would qualify as "nonrecourse liabilities" for purposes of Code Section 752,
(ii) to the extent the proceeds thereof are applied to repay existing
nonrecourse mortgage indebtedness secured by one or more Hotels (including the
Chicago Suites Mortgage Debt), would be considered to be "secured" by those
Hotels for purposes of allocating the liabilities for tax basis purposes (and
thus would be allocable, at least in substantial part, to the former Limited
Partners in the Partnerships owning those Hotels, including the Chicago Suites
Limited Partners), and (iii) would constitute "qualified nonrecourse
financing" secured by such Hotels for purposes of Code Section 465. The IRS
has recently issued a ruling to that effect to another taxpayer, and has
indicated to the Operating Partnership's representatives that it is favorably
inclined to issue that ruling to the Operating Partnership.
Section 465(e) Recapture. As discussed in the Consent Solicitation, see
"Federal Income Tax Consequences--Tax Consequences of the Mergers--Section
465(e) Recapture," the "at risk" rules of Section 465 of the Code generally
apply to limit the use of partnership losses by a partner. Under Section
465(e) of the Code, a partner may be required to include in gross income, or
"recapture," losses previously allowed to such partner with respect to his
investment in a partnership if the amount for which the partner is "at risk"
in relation to his investment in the partnership is less than zero at the
close of the taxable year.
It is possible that the consummation of the Mergers and the REIT Conversion
or the repayment of certain "qualified nonrecourse financing" of the Operating
Partnership, the Hotel Partnerships or the Hotels contributed to the Operating
Partnership by the Blackstone Entities at the time of or following the Mergers
and the REIT Conversion could, singularly or in combination, cause a Chicago
Suites Limited Partner's amount at risk in relation to his investment in
Chicago Suites (and, after the Mergers, in the Operating Partnership) to be
reduced below zero, resulting in an income inclusion to the Limited Partner
under Section 465(e) of the Code. Currently, a sufficient portion of the
current debt of Chicago Suites constitutes "qualified nonrecourse financing"
so that the Chicago Suites Limited Partners have positive at risk amounts, and
the Operating Partnership expects that most of the current debt with respect
to the other Hotel Partnerships and the Hotels contributed by the Blackstone
Entities that will be assumed by the Operating Partnership as part of the
Mergers and the REIT Conversion should qualify as "qualified nonrecourse
financing." The Operating Partnership and the General Partner believe,
Chicago Suites Supp-25
<PAGE>
based upon and subject to the assumptions and other limitations described
below, that a Chicago Suites Limited Partner who acquired his Chicago Suites
Partnership Units in the original offering of such Partnership Units and has
held the Partnership Units at all times since will have a positive at risk
amount immediately following the Mergers and the REIT Conversion, even if all
of the Chicago Suites Mortgage Debt were to be repaid in connection with the
Mergers and the REIT Conversion and the Chicago Suites Limited Partners were
to have no share of any other "qualified nonrecourse financing" following the
Mergers and the REIT Conversion.
It is possible, however, that a former Chicago Suites Limited Partner's at
risk amount could decline in the future, either because of the allocation of
losses from the Operating Partnership to that former Chicago Suites Limited
Partner or because of cash distributions by the Operating Partnership to that
former Chicago Suites Limited Partner in excess of the taxable income
allocable to him with respect to his OP Units. In that event, it may be
necessary for the former Chicago Suites Limited Partner to have a share of
"qualified nonrecourse financing" from the Operating Partnership in order to
avoid recognizing income by reason of his at risk amount falling below zero.
Moreover, there can be no assurance that debt incurred by the Operating
Partnership in the future to refinance the Chicago Suites Mortgage Debt or
outstanding mortgage debt of the other Hotel Partnerships or the Hotels
contributed by the Blackstone Entities will qualify as "qualified nonrecourse
financing." The Operating Partnership's current long-term financing strategy
is to have as little debt as possible that is secured by individual Hotels and
to have as much debt as possible in the form of unsecured debt, held either by
the public or by institutional investors, which debt may or may not be
recourse to Host REIT, as general partner of the Operating Partnership. If,
however, the Operating Partnership were to obtain the requested ruling from
the IRS and were to refinance existing mortgage indebtedness of the
Partnerships with the type of indebtedness described in the ruling, such
indebtedness should constitute "qualified nonrecourse financing" for purposes
of the "at risk" rules.
Impact of Assumption of Chicago Suites Liabilities by the Operating
Partnership. As described in the Consent Solicitation, see "Federal Income Tax
Consequences--Tax Consequences of the Mergers--Disguised Sale Regulations," a
Chicago Suites Limited Partner will recognize gain to the extent he is treated
as having sold all or part of his Chicago Suites Partnership Interest in a
"disguised sale." For purposes of these rules, certain reductions in a
partner's share of partnership liabilities are treated as a transfer of money
or other property from the partnership to the partner which may give rise to a
disguised sale, even if that reduction would not otherwise result in a taxable
deemed cash distribution in excess of the partner's basis in his partnership
interest. However, if a transfer of property by a partner to a partnership is
not otherwise treated as part of a disguised sale, then any reduction in the
partner's share of "qualified liabilities" also will not be treated as part of
a disguised sale. A "qualified liability" in connection with a transfer of
property to a partnership includes (i) any liability incurred more than two
years prior to the earlier of the transfer of the property or the date the
partner agrees in writing to the transfer, as long as the liability has
encumbered the transferred property throughout the two-year period; (ii) a
liability that was not incurred in anticipation of the transfer of the
property to a partnership, but that was incurred by the partner within the
two-year period prior to the earlier of the date the partner agrees in writing
to transfer the property or the date the partner transfers the property to a
partnership and that has encumbered the transferred property since it was
incurred; (iii) a liability that is traceable under the Treasury Regulations
to capital expenditures with respect to the property; and (iv) a liability
that was incurred in the ordinary course of the trade or business in which
property transferred to the partnership was used or held, but only if all the
assets related to that trade or business are transferred, other than assets
that are not material to a continuation of the trade or business. However, a
recourse liability is not a "qualified liability" unless the amount of the
liability does not exceed the fair market value of the transferred property
(less any other liabilities that are senior in priority and encumber such
property or any allocable liabilities described in (iii) or (iv), above) at
the time of transfer.
The General Partner and the Operating Partnership believe, based upon their
review of the facts and circumstances surrounding each liability, that all
liabilities of Chicago Suites fall into one of the four categories of
"qualified liabilities" described above and, accordingly, that the mere
assumption by the Operating Partnership of the outstanding liabilities of
Chicago Suites will not give rise to a "disguised sale" by any of the Chicago
Suites Limited Partners.
Chicago Suites Supp-26
<PAGE>
Tax Treatment of Chicago Suites Limited Partners Who Hold OP Units Following
the Merger
Initial Basis in Units. In general, a Chicago Suites Limited Partner will
have an initial tax basis in his OP Units received in the Merger with respect
to his Chicago Suites Partnership Units equal to the basis in his Chicago
Suites Partnership Units at the time of the Merger, reduced to reflect any
deemed cash distributions resulting from a reduction in his share of Chicago
Suites liabilities and increased to reflect his share of other liabilities of
the Operating Partnership and any gain required to be recognized in connection
with the Merger and the REIT Conversion. For a discussion of the federal
income tax consequences for a Chicago Suites Limited Partner from a reduction
in basis that may result from the Merger and the REIT Conversion, see "Federal
Income Tax Consequences--Tax Treatment of Limited Partners Who Hold OP Units
Following the Mergers--Initial Tax Basis of OP Units" in the Consent
Solicitation.
Tax Allocations by the Operating Partnership upon a Sale of Marriott Suites
O'Hare Hotel. Pursuant to Section 704(c) of the Code, income, gain, loss and
deduction attributable to appreciated or depreciated property that is
contributed to a partnership must be allocated for federal income tax purposes
in a manner such that the contributor is charged with, or benefits from, the
unrealized gain or unrealized loss associated with the property at the time of
contribution. The amount of such unrealized gain or unrealized loss is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution (referred to as the "Book-Tax
Difference"). The Operating Partnership and the General Partner estimate,
based upon and subject to the assumptions and other limitations described
below, that the Book-Tax Difference for all Chicago Suited Limited Partners
(but excluding all of Host's interests) with respect to the Marriott Suites
O'Hare Hotel will be $4,873,177 upon the consummation of the Merger.
If the Operating Partnership were to sell the Marriott Suites O'Hare Hotel,
the former partners of Chicago Suites (including Host REIT with respect to the
interests in Chicago Suites currently held indirectly by Host through the
General Partner) would be specially allocated by the Operating Partnership an
aggregate amount of taxable gain equal to the aggregate Book-Tax Difference
with respect to the Marriott Suites O'Hare Hotel. The share of such gain
allocable to a Chicago Suites Limited Partner who acquired his Chicago Suites
Partnership Units in the original offering of such Partnership Units and held
such Partnership Units at all times since would be $14,933 per Chicago Suites
Partnership Unit. The share of such gain of a Chicago Suites Limited Partner
who did not acquire his Chicago Suites Partnership Units in the original
offering of such Partnership Units or who has not held his Chicago Suites
Partnership Units at all times since such offering could vary materially from
this amount. If the Operating Partnership were to sell the Marriott Suites
O'Hare Hotel, the remaining Book-Tax Difference at the time the Hotel is sold
would be required to be allocated exclusively to the former Chicago Suites
Limited Partners and the General Partner, even though the proceeds of such
sale would be allocated proportionately among all the partners in the
Operating Partnership (and would likely be retained by the Operating
Partnership, rather than distributed to holders of OP Units and Common Shares
of Host REIT). The Chicago Suites Limited Partners would not be entitled to
any special distributions from the Operating Partnership in connection with
such a sale, and thus would not necessarily receive cash distributions from
the Operating Partnership sufficient to pay such additional taxes. Although
the Partnership Agreement does not impose any restrictions upon the Operating
Partnership preventing it from causing the sale of the Marriott Suites O'Hare
Hotel at any time following the Merger, the Operating Partnership does not
have current plans to pursue a sale of the Hotel. See "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--Sale of Individual Hotels" in the Consent Solicitation.
Tax Allocations with Respect to Contributed Hotels Generally. The tax
allocations of depreciation to the Chicago Suites Limited Partners may change
significantly as a result of the Mergers and the REIT Conversion for two
reasons. First, as described above, pursuant to Section 704(c) of the Code,
depreciation and deductions attributable to the Marriott Suites O'Hare Hotel
will be required to be allocated for federal income tax purposes in a manner
such that the Chicago Suites Limited Partners are charged with the Book-Tax
Difference associated with the Marriott Suites O'Hare Hotel at the time of the
consummation of the Merger. Consequently, a Chicago
Chicago Suites Supp-27
<PAGE>
Suites Limited Partner will be allocated less depreciation with respect to the
Marriott Suites O'Hare Hotel than would be the case if the Mergers had not
occurred and the Chicago Suites Limited Partner had continued to hold his
Chicago Suites Partnership Units. (On the other hand, a former Chicago Suites
Limited Partner will be allocated depreciation with respect to other Hotels
acquired by the Operating Partnership in connection with the Mergers and the
REIT Conversion, including the Hotels owned by the other Hotel Partnerships
and the Hotels being contributed to the Operating Partnership by Host and the
Blackstone Entities in connection with the Mergers and the REIT Conversion.)
Second, the Mergers will cause the technical termination under Section
708(b)(1)(B) of the Code of Chicago Suites and most of the other Hotel
Partnerships that participate in the Mergers. Section 168(i)(7) of the Code
provides, in effect, that when a partnership terminates under Section
708(b)(1)(B) of the Code, the partnership must begin new depreciation periods
for its property. As a result, the remaining bases of the real estate
components of the Marriott Suites O'Hare Hotel and the Hotels held by the
other Hotel Partnerships that terminate will be depreciated over 39 years,
rather than over the remaining current lives of such Hotels (which range from
less than one year to 39 years). See "Federal Income Tax Consequences--Tax
Treatment of Limited Partners Who Hold OP Units Following the Mergers--Effect
of Mergers on Depreciation" in the Consent Solicitation.
In light of the complexity of the governing rules affecting the calculation
and allocation of depreciation with respect to properties contributed to a
partnership, particularly when a number of those properties are subject to the
separate adjustments required in connection with a technical termination under
Section 708 of the Code, the number of Hotels that the Operating Partnership
will be acquiring in connection with the Merger and the REIT Conversion, and
the impact on these calculations of other outside events, including equity
offerings by Host or Host REIT and other acquisitions undertaken by Host, Host
REIT or the Operating Partnership prior to or in connection with the REIT
Conversion, the Operating Partnership and the General Partner believe that it
is impossible to predict with any degree of precision the impact that the
Mergers and the REIT Conversion will have on the future depreciation (and,
consequently, the amount of taxable income) allocable to a Chicago Suites
Limited Partner.
Taxation of Tax-Exempt Limited Partners of Chicago Suites. Chicago Suites
has a number of Limited Partners that qualify as tax-exempt entities pursuant
to the Code. Substantially all of the partnership income allocated by Chicago
Suites to its Limited Partners for tax purposes constitutes unrelated business
taxable income ("UBTI") to those Limited Partners that qualify as tax-exempt
entities. Following the Merger and the REIT Conversion, a substantial portion
of the income derived by the Operating Partnership pursuant to its investments
in the Hotels and allocated to the holders of OP Units would be excluded from
UBTI as "rents from real property," interest or dividends. Some portion of the
Operating Partnership's income, however, inevitably will not qualify for
exclusion from UBTI, and other income that otherwise would qualify for
exclusion from UBTI may constitute "unrelated debt-financed income" to tax-
exempt holders of OP Units. The Operating Partnership and the General Partner
cannot predict at this time the percentage of total income to be allocated by
the Operating Partnership following the Merger and the REIT Conversion to a
tax-exempt Limited Partner that would constitute either UBTI or "unrelated
debt-financed income" to such Limited Partner. The Operating Partnership and
the General Partner believe, however, that, following the Merger, the amount
of taxable income allocated by the Operating Partnership to the former tax-
exempt Chicago Suites Limited Partners will be substantially less than the
amount of taxable income that would be allocated to such Limited Partners by
Chicago Suites if Chicago Suites did not participate in the Merger.
Impact on Passive Activity Losses of an Investment in a Publicly Traded
Partnership. The passive loss limitation rules generally provide that
individuals, estates, trusts and certain closely held corporations and
personal service corporations can only deduct losses from passive activities
(generally activities in which the taxpayer does not materially participate,
which would include the Operating Partnership for Chicago Suites Limited
Partners) to the extent that such losses are not in excess of the taxpayer's
income from passive activities or investments. A Chicago Suites Limited
Partner would be able to offset losses from other passive activities against
income from the Operating Partnership that is considered passive income (but
not portfolio income) so long as the Operating Partnership is not treated as a
publicly traded partnership. The Operating Partnership and
Chicago Suites Supp-28
<PAGE>
the General Partner believe, however, that there is a substantial risk that
the Operating Partnership will be treated as a publicly traded partnership for
purposes of the passive loss limitation rules. In this event, any losses or
deductions of the Operating Partnership allocable to a Chicago Suites Limited
Partner after the Merger could not be used to offset passive income from other
passive activities. Similarly, losses from other passive activities (including
losses attributable to Chicago Suites for periods prior to the Merger) could
not be applied to offset income of the Operating Partnership allocated to a
Chicago Suites Limited Partner. A Chicago Suites Limited Partner, however,
would be able to offset any passive losses from his investment in Chicago
Suites (or other investments) against any gain recognized by the Chicago
Suites Limited Partner as a result of the Merger. The Operating Partnership
and the General Partner estimate that, as of December 31, 1998, a Chicago
Suites Limited Partner who purchased his Partnership Units at the time of the
original offering, has held those Partnership Units continuously since that
time, and whose Partnership Units have been his only investment in a passive
activity would have a passive activity loss carryforward of approximately
$3,339, on a per Partnership Unit basis.
State and Local Taxes. Chicago Suites Limited Partners holding OP Units will
be subject to state and local taxation in a number of jurisdictions in which
the Operating Partnership directly or indirectly holds real property and would
be required to file periodic tax returns in those jurisdictions. In this
regard, immediately following the Mergers and the REIT Conversion, the
Operating Partnership expects that it will own properties in approximately 28
states across the United States and the District of Columbia. Currently,
Chicago Suites owns property in only one state. See "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--State and Local Taxes" in the Consent Solicitation.
Assumptions Used in Determining Tax Consequences of the Merger
In preparing the discussion set forth above, the Operating Partnership and
the General Partner made several key assumptions, which are described below.
If any such assumption is not accurate with respect to a particular Chicago
Suites Limited Partner, the tax consequences of the Merger to such Chicago
Suites Limited Partner could be substantially different from those reflected
above. ACCORDINGLY, EACH CHICAGO SUITES LIMITED PARTNER IS STRONGLY URGED TO
CONSULT WITH HIS OWN TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH CHICAGO
SUITES LIMITED PARTNER'S PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX
CONSEQUENCES OF PARTICIPATING IN THE MERGER.
First, with respect to a Chicago Suites Limited Partner's basis in his
Chicago Suites Partnership Units prior to the Merger, the Operating
Partnership and the General Partner assumed that a Chicago Suites Limited
Partner acquired his Chicago Suites Partnership Units in the original offering
of such Partnership Units and has held such Partnership Units at all times
since the offering (the "Original Limited Partner's Adjusted Basis"). In
general, each Chicago Suites Limited Partner had an initial tax basis in his
Chicago Suites Partnership Units ("Initial Basis") equal to his cash
investment in Chicago Suites (plus his proportionate share of Chicago Suites'
nonrecourse liabilities at the time he acquired his Chicago Suites Partnership
Units). A Chicago Suites Limited Partner's Initial Basis generally has been
increased by (a) such Limited Partner's share of Chicago Suites' taxable
income and (b) any increases in his share of liabilities of Chicago Suites.
Generally, such Limited Partner's Initial Basis has been decreased (but not
below zero) by (i) his share of Chicago Suites cash distributions, (ii) any
decreases in his share of liabilities of Chicago Suites, (iii) his share of
losses of Chicago Suites, and (iv) his share of nondeductible expenditures of
Chicago Suites that are not chargeable to capital.
The General Partner has set forth on Appendix E to the Consent Solicitation
for Chicago Suites (i) the Original Limited Partner's Adjusted Basis as of
December 31, 1997 for each such Chicago Suites Limited Partner, and (ii) an
estimate of such Chicago Suites Limited Partner's Original Limited Partner's
Adjusted Basis as of December 31, 1998 (computed without regard to the Mergers
and based upon the assumptions set forth in Appendix E to the Consent
Solicitation). The General Partner also has set forth on Appendix E to the
Consent Solicitation for each Chicago Suites Limited Partner whose adjusted
basis in his Chicago Suites Partnership Interest is the same as the Original
Limited Partner's Adjusted Basis (i) the Chicago Suites liabilities allocable
to such Chicago Suites Limited Partner as of December 31, 1997, and (ii) an
estimate of the Chicago Suites
Chicago Suites Supp-29
<PAGE>
liabilities allocable to such Limited Partner as of December 31, 1998
(computed without regard to the Mergers and based upon the assumptions set
forth in Appendix E to the Consent Solicitation).
The adjusted tax basis of a Chicago Suites Limited Partner who did not
acquire his Chicago Suites Partnership Units in the original offering of such
Partnership Units could vary materially from that of a Chicago Suites Limited
Partner who did so for various reasons. If a Chicago Suites Limited Partner
has an adjusted tax basis in his Chicago Suites Partnership Units that is less
than the Original Limited Partner's Adjusted Tax Basis, the Merger might
result in the receipt by the Chicago Suites Limited Partner of a deemed
distribution of cash in excess of his adjusted tax basis in his Chicago Suites
Partnership Units, which could result in the recognition of income or gain.
Finally, the Operating Partnership and the General Partner assumed that the
Merger will be treated for federal income tax purposes as the transfer by the
Chicago Suites Limited Partners of their interests in the Partnership to the
Operating Partnership in exchange for OP Units. There can be no assurance,
however, that the IRS will not seek to recharacterize each Merger as either
(i) the liquidation of a Partnership followed by the distribution by the
Partnership of its assets to its partners and the subsequent transfers by such
partners of such assets to the Operating Partnership in exchange for OP Units,
or (ii) the transfer by a Hotel Partnership of its assets to the Operating
Partnership in exchange for OP Units (and possibly Notes) and the subsequent
distribution of such OP Units (and possibly Notes) to its partners. If the
Merger is recharacterized in the manner described in (ii) in the preceding
sentence, the tax consequences of the Merger to the Chicago Suites Limited
Partners likely would be materially affected.
EACH CHICAGO SUITES LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS
OWN TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH CHICAGO SUITES LIMITED
PARTNER'S PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF
PARTICIPATING IN THE MERGER. THE TAX CONSEQUENCES OF PARTICIPATING IN THE
MERGER TO A PARTICULAR CHICAGO SUITES LIMITED PARTNER COULD VARY SUBSTANTIALLY
FROM THE CONSEQUENCES DESCRIBED ABOVE.
Tax Treatment of Chicago Suites Limited Partners Who Exercise Their Right to
Make the Note Election
A Chicago Suites Limited Partner who exercises his right to make the Note
Election and receive a Note in connection with the Merger will be treated as
having made a taxable disposition of his OP Units. The amount realized in
connection with such disposition will equal the sum of the "issue price" of
the Notes (i.e., the face amount of the Note, currently estimated as $31,467
per Chicago Suites Partnership Unit) plus the portion of the Chicago Suites
liabilities allocable to the Chicago Suites Limited Partner for federal income
tax purposes immediately prior to the disposition of the OP Units (estimated
as $36,295 per Chicago Suites Partnership Unit as of December 31, 1998). To
the extent the amount realized exceeds the Chicago Suites Limited Partner's
adjusted basis in his Chicago Suites Partnership Units, the Chicago Suites
Limited Partner will recognize gain. The Operating Partnership and the General
Partner estimate (assuming the Chicago Suites Limited Partner acquired his
Chicago Suites Partnership Units at the time of the original offering and has
held such Partnership Units at all times since the offering) that the amount
of gain that would be recognized by a Chicago Suites Limited Partner who made
the Note Election would be approximately $12,929 per Chicago Suites
Partnership Unit, as of December 31, 1998. For a discussion of the federal
income tax rates applicable to the net capital gain from the sale of a capital
asset, see "Federal Income Tax Consequences--Tax Treatment of Limited Partners
Who Hold OP Units Following the Mergers--Disposition of OP Units by Limited
Partners" in the Consent Solicitation. In this regard, the General Partner
estimates that, as of December 31, 1998, if Chicago Suites sold the Marriott
Suites O'Hare Hotel in a fully taxable transaction for a net amount, after
payment of liabilities, equal to the Liquidation Value of Chicago Suites, the
"unrecognized Section 1250 gain" per Chicago Suites Partnership Unit would be
$7,525 and the gain subject to tax as ordinary income under Code Section 1245
per Chicago Suites Partnership Unit would be $887. A Chicago Suites Limited
Partner who makes the Note Election would be able to treat any per Partnership
Unit passive activity loss carryforward with respect to the activities of
Chicago Suites, to the extent the sum of such losses exceeds his passive
activity income for 1998, as losses that
Chicago Suites Supp-30
<PAGE>
are not from a passive activity and, therefore, not subject to the passive
activity loss limitation rules. For purposes of determining the gain
recognized by a Limited Partner as a result of making the Note Election, an
Original Limited Partner's Adjusted Basis does not reflect such Limited
Partner's share of the syndication costs incurred by his Partnership at
formation. An original Chicago Suites Limited Partner's share of syndication
costs was $4,517 per Chicago Suites Partnership Unit.
A Chicago Suites Limited Partner who elects to receive a Note may be
eligible to defer at least a portion of that gain under the "installment sale"
rules. Those rules, however, will not permit the Chicago Suites Limited
Partner to defer all of the gain, and, to the extent that the face amount of
the Note (and any other installment obligations received by the taxpayer
during the year) outstanding at the end of the taxable year in which the
Merger occur exceeds $5,000,000, will require that the Chicago Suites Limited
Partner who defers gain pay to the IRS interest on the resulting tax that has
been deferred. The Chicago Suites Limited Partner will not be eligible to
defer gain recognized upon the receipt of the Note to the extent that his
share of Chicago Suites liabilities at the time of the Merger exceeds his
adjusted tax basis in his Chicago Suites Partnership Units immediately prior
to the Merger (that is, to the extent that he has a "negative capital account"
for tax purposes). In addition, the Chicago Suites Limited Partner will not be
eligible to defer gain to the extent that such gain would be taxed as ordinary
income under Section 1245 and 1250 of the Code. Lastly, if a Chicago Suites
Limited Partner disposes of his Note, any gain that had been deferred would be
recognized in the year of disposition.
THE SPECIFIC TAX ATTRIBUTES OF A PARTICULAR CHICAGO SUITES LIMITED PARTNER
COULD HAVE A MATERIAL IMPACT ON THE TAX CONSEQUENCES OF THE MERGER, AND THE
SUBSEQUENT OWNERSHIP AND DISPOSITION OF NOTES. THEREFORE, IT IS ESSENTIAL THAT
CHICAGO SUITES LIMITED PARTNERS CONSIDERING ELECTING TO RECEIVE NOTES CONSULT
WITH THEIR OWN TAX ADVISORS WITH REGARD TO THE APPLICATION OF THE FEDERAL
INCOME TAX LAWS TO SUCH CHICAGO SUITES LIMITED PARTNERS' RESPECTIVE PERSONAL
TAX SITUATIONS, AS WELL AS ANY TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY
STATE, LOCAL, OR FOREIGN TAXING JURISDICTION.
Tax Consequences if Chicago Suites Does Not Participate in the Merger
If Chicago Suites does not participate in the Merger, the Chicago Suites
Limited Partners would not have any tax consequences resulting from the
Merger. The consequences of continued ownership of Chicago Suites Partnership
Units will be the same as would have resulted if the Merger had not been
proposed.
* * *
The above description is not exhaustive of all possible tax considerations
associated with the Merger and the REIT Conversion. This summary does not
discuss foreign tax considerations, nor does it discuss all of the aspects of
federal income taxation or state and local taxation that may be relevant to
Chicago Suites Limited Partners in light of their particular circumstances.
EACH CHICAGO SUITES LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN
TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH CHICAGO SUITES LIMITED PARTNER'S
PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING
IN THE MERGER.
Chicago Suites Supp-31
<PAGE>
SELECTED FINANCIAL DATA
The following table presents selected historical financial data derived from
the audited financial statements for the five most recent fiscal years in the
period ended December 31, 1997 and the unaudited condensed financial
statements for the First Two Quarters 1998 and First Two Quarters 1997. The
following data should be read in conjunction with the audited financial
statements and the notes thereto, Management's Discussion and Analysis of
Financial Condition and Results of Operations and the other financial
information included elsewhere herein.
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS FISCAL YEAR
---------------- -----------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
------- ------- ---------- ----------- ---------- ---------- ----------
(UNAUDITED) (AMOUNTS IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT)(1)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................ $ 3,358 $ 2,952 $ 6,568 $ 5,660 $ 4,913 $ 4,509 $ 4,311
Operating profit........ 1,412 1,236 2,673 1,772 788 567 444
Net income (loss)....... 437 266 582 (565) (1,655) (1,920) (2,031)
Distributions:
General partner........ -- -- -- -- -- -- --
Limited partners....... -- -- -- -- -- -- --
Per Partnership Unit:(1)
Net income (loss)...... 1,281 776 1,701 (1,651) (4,839) (5,617) (5,941)
Distributions.......... -- -- -- -- -- -- --
Cash provided by (used
in) operating
activities............. 1,244 1,076 1,881 798 636 881 (739)
Cash used in investing
activities............. (300) (244) (1,052) (517) (486) (343) (315)
Cash used in financing
activities............. (118) (477) (721) (342) -- -- --
Increase (decrease) in
cash and cash
equivalents............ 826 355 108 (61) 150 538 (1,054)
Ratio of earnings to
fixed charges
(unaudited)(2)......... 1.41x 1.25x 1.26x -- -- -- --
Deficiency of earnings
to fixed charges
(unaudited)(2) ........ -- -- -- 565 1,655 1,920 2,031
Total assets at book
value.................. 26,710 26,056 25,962 25,701 25,975 27,002 27,701
Cash and cash
equivalents............ 1,667 1,088 841 733 794 644 106
Total debt.............. 24,885 25,220 25,003 25,361 25,500 25,500 25,500
Total liabilities....... 29,094 29,193 28,783 29,104 28,813 28,185 26,964
Partner's capital
(deficit)(3):
Limited partners....... (2,378) (3,124) (2,811) (3,387) (2,821) (1,200) 682
General partner........ (6) (13) (10) (16) (17) 17 55
Book Value per
Partnership Unit
(unaudited)(1)......... (7,081) (9,287) (8,361) (10,063) (8,421) (3,582) 2,036
Exchange Value per
Partnership Unit
(unaudited)(1)......... 33,131 -- -- -- -- -- --
</TABLE>
- --------
(1) A Partnership Unit represents a $35,000 original investment in Chicago
Suites and excludes MB Investment Properties 1% limited partner interest.
(2) The ratio of earnings to fixed charges is computed by dividing net income
before interest expense and other fixed charges by total fixed charges,
including interest expense, amortization of debt issuance costs and the
portion of rent expense that is deemed to represent interest. The
deficiency of earnings to fixed charges is largely the result of
depreciation of $1,234,000, $1,644,000, $1,541,000 and $1,637,000 for
fiscal years ended December 31, 1996, 1995, 1994 and 1993, respectively.
(3) On August 26, 1996, MB Investment Properties, Inc. withdrew as a general
partner of the Partnership and converted its 1% interest to a Limited
Partner interest.
Chicago Suites Supp-32
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
First Two Quarters 1998 Compared to First Two Quarters 1997
Revenues. For the first two quarters 1998, revenues increased 14% or
$406,000, over the same period in 1997 from $3.0 million to $3.4 million.
Revenues and operating profit were impacted primarily by growth in revenue per
available room ("REVPAR") of 10% over the comparable period in 1997 from $119
to $131. REVPAR represents the combination of the average daily room rate
charged and the average daily occupancy achieved and is a commonly used
indicator of hotel performance. REVPAR does not include food and beverage or
other ancillary revenues generated by the property. The increase in REVPAR was
the result of a 12% increase in average room rate from $143 to $160, slightly
offset by a 1.4 percentage point decrease in average occupancy to 82%. The
increase in average room rate for the first two quarters 1998 was primarily
due to the Hotel limiting the sale of discounted rooms, creating a breakfast-
included rate which raised the non-corporate premium rate, and increasing its
corporate room rate $10 to $199, which represents a $30 increase over the
corporate rate charged in the second quarter of 1997. The slight decrease in
occupancy was the result of the Hotel's corporate rate increase.
Operating Costs and Expenses. Operating costs and expenses increased 13% to
$1.9 million for the first two quarters 1998 when compared to the same period
in 1997. The increase in operating costs and expenses was primarily due to the
21% or $82,000 increase in depreciation expense and the 18% or $70,000
increase in incentive management fees. The increase in depreciation expense
was due to the completion of the rooms renovation in 1997. The increase in
incentive management fees was the result of the improvement in revenues
discussed above. As a percentage of revenues, operating costs and expenses
remained stable at 58% for the first two quarters 1998 when compared to the
same period in 1997.
Operating Profit. As a result of the changes in revenues and operating costs
and expenses discussed above, operating profit increased $176,000 to $1.4
million for the first two quarters 1998 from $1.2 million for the same period
in 1997. Operating profit was 42% of revenues during both time periods.
Interest expense. Interest expense increased for the first two quarters 1998
when compared to the same period in 1997 due primarily to interest expense
from the roof and facade loan with a subsidiary of the Manager. The loan,
which matures in June 2000, bears interest at 9% and will be repaid from the
Partnership's cash flow from operations after defined priorities. Payments of
approximately $19,000 per month began in June 1998, following the final
disbursement of loan proceeds.
Net income. For the first two quarters 1998, net income increased $171,000
to $437,000, compared to $266,000 for the same period in 1997. This increase
was primarily due to an increase in hotel revenues, offset by the changes in
expenses discussed above.
1997 Compared to 1996
Revenues. Revenues increased $908,000 or 16%, to $6.6 million in 1997 from
$5.7 million in 1996 as a result of strong growth in REVPAR of 13%. Hotel
sales increased $1.4 million, or 10%, to $14.4 million in 1997 also reflecting
improvements in REVPAR for the year. The increase in REVPAR was the result of
a 14% increase in average room rates from $129 in 1996 to $147 in 1997, while
average occupancy decreased one percentage point to 83%. The decrease in
occupancy was primarily the result of the Hotel's suites refurbishment which
displaced approximately 1,000 roomnights during the First Quarter 1997.
Operating Costs and Expenses. Operating costs and expenses remained stable
at $3.9 million in 1997 compared to 1996. As a percentage of revenues,
operating costs and expenses decreased to 59% of revenues in 1997 from 69% in
1996. Operating costs and expenses remained stable primarily due to the
$399,000 decrease in depreciation expense as a result of the majority of the
Hotel's furniture and equipment becoming fully
Chicago Suites Supp-33
<PAGE>
depreciated in 1996, offset by the $171,000 increase in combined incentive and
base management fees and the $33,000 increase in ground rent due to improved
revenues as discussed above.
Operating Profit. As a result of the changes in revenues and operating costs
and expenses discussed above, operating profit increased $901,000 to $2.7
million, or 41% of total revenues, in 1997 from $1.8 million, or 31% of
revenues in 1996.
Interest Expense. Interest expense decreased to $2.2 million in 1997 from
$2.4 million in 1996 due to regular and additional principal amortization on
the debt totaling $886,000. Additionally, the weighted average interest rate
on the mortgage debt in 1997 decreased to 7.69% from 9.31% in 1996 due to the
1996 refinancing. See "Refinancing."
Net Income. Net income increased $1.1 million to $582,000 in 1997 over 1996
due to the items discussed above.
1996 Compared to 1995
Revenues. Revenues increased $747,000, or 15%, to $5.7 million in 1996 from
$4.9 million in 1995 as a result of strong growth in REVPAR. REVPAR increased
10% to $108 in 1996. Hotel sales increased $1.4 million, or 12%, to $13
million in 1996 also reflecting improvements in REVPAR for the year. The
increase in REVPAR was the result of a 7% increase in average suite rate from
$121 in 1995 to $129 in 1996, combined with a three percentage point increase
in average occupancy to 84%.
Operating Costs and Expenses. Operating costs and expenses decreased
$237,000 to $3.9 million in 1996 from $4.1 million in 1995. As a percentage of
revenues, operating costs and expenses represented 69% of revenues in 1996 and
84% in 1995. The decrease in operating costs and expenses was primarily due to
a $410,000 decrease in depreciation expense due to the majority of the Hotel's
furniture and equipment becoming fully depreciated in early 1996.
Operating Profit. As a result of the changes in revenues and operating costs
and expenses discussed above, operating profit increased $984,000 to $1.8
million, or 31% of total revenues, in 1996 from $788,000, or 16% of revenues
in 1995.
Interest Expense. Interest expense was $2.4 million in 1996 and $2.5 million
in 1995.
Net Loss. Net loss decreased $1.1 million to a net loss of $565,000 in 1996
over the net loss of $1.7 million in 1995 due to the items discussed above.
CAPITAL RESOURCES AND LIQUIDITY
General
The General Partner believes that cash from operations will provide adequate
funds for the operational needs of the Partnership for the foreseeable future.
PRINCIPAL SOURCES AND USES OF CASH
The Partnership's principal source of cash is from operations. Its principal
uses of cash are to fund the property improvement fund of the Hotel and to pay
required principal amortization of the mortgage debt. Additionally, the
Partnership is required to use its excess annual cash flow to pay additional
principal on the mortgage debt.
Total cash provided by operating activities for the first two quarters 1998
and 1997, was $1.2 million and $1.1 million, respectively. The increase was
primarily due to an increase in hotel revenues when compared to 1997. See
"Results of Operations" above.
Chicago Suites Supp-34
<PAGE>
Cash provided by operating activities was $1.9 million in 1997, $798,000 in
1996 and $636,000 in 1995. The $1.1 million increase in cash provided by
operating activities between 1997 and 1996 was due primarily to the $908,000
increase in revenues, offset by $606,000 in incentive management fee paid, and
$1 million in reduced interest payments, due to the debt refinancing discussed
below. The $162,000 increase in cash provided by operating activities between
1996 and 1995 was due primarily to the $747,000 increase in revenues, offset
by $465,000 in increased interest payments. Interest payments increased
primarily as a result of the 1996 debt refinancing which resulted in one
additional debt service payment in 1996 compared to 1995.
For the first two quarters 1998 and 1997, cash used in investing activities
was $300,000 and $244,000, respectively, and consisted of contributions to and
expenditures from the property improvement fund.
Cash used in investing activities was $1.1 million, $517,000 and $486,000 in
1997, 1996 and 1995, respectively. The Partnership's cash investing activities
consist primarily of contributions to the property improvement fund and
capital expenditures for improvements to the Hotel. In 1997, the Hotel
completed a roof and facade restoration project, with funds provided by the
Partnership, for which approximately $528,000 was spent.
For the first two quarters 1998 and 1997, cash used in financing activities
was $118,000 and $477,000, respectively, and consisted primarily of repayments
on the mortgage debt. Additionally, during the second quarter of 1998, the
Partnership made its final draw of $35,000 on the roof and facade loan.
Cash used in financing activities was $721,000 in 1997 and $342,000 in 1996.
In 1997, the Partnership's cash financing activities consisted of repayment of
mortgage debt of $886,000, $528,000 in proceeds from a loan from a subsidiary
of Marriott International, and $363,000 in payments of financing costs related
to the 1996 refinancing. The Partnership made debt principal payments of
$139,000 and paid financing costs of $203,000 in 1996. Financing activity in
1995 consisted entirely of the $164,000 advance from, and subsequent repayment
into the property improvement fund, so that the Partnership could make its
First Quarter debt service payment in 1995. Prior to the debt refinancing in
1996, no repayments of mortgage principal were required prior to maturity. See
"Refinancing."
REFINANCING
On September 24, 1996, the Partnership successfully refinanced its $25.5
million mortgage debt. Proceeds from the new loan were used to repay the
existing mortgage debt and pay refinancing costs. The refinanced debt bears
interest at a floating rate of 200 basis points over the three-month LIBOR
rate, with an option to fix the interest rate during the first two years of
the loan term, and requires quarterly payments of principal and interest based
upon a 20-year amortization schedule for a five-year term expiring on the
maturity date of June 12, 2001. The weighted average interest rate on the
Partnership's debt in 1997, 1996 and 1995 was 7.69%, 9.31% and 9.575%,
respectively. The weighted average interest rate during the first two quarters
1998 was 7.69%, compared to 7.64% during the comparable period in 1997.
PROPERTY IMPROVEMENT FUND
The Partnership is required to maintain the Hotel in good condition. Under
the Management Agreement, the Partnership is required to make annual
contributions to the property improvement fund which provides funding for
capital expenditures and replacement of furniture, fixtures and equipment.
Contributions to the fund equaled 4% of gross Hotel sales in 1997, 1996 and
1995. The contribution amount will remain at 4% of gross Hotel sales in 1998
and 1999. In 2000 and thereafter, the Partnership is required to contribute 5%
of gross Hotel sales to the fund. In 1997, 1996 and 1995, the Partnership
contributed $577,000, $523,000 and $468,000, respectively, to the property
improvement fund. For the first two quarters 1998 and 1997, the Partnership
contributed $284,000 and $260,000, respectively, to the property improvement
fund.
Chicago Suites Supp-35
<PAGE>
The General Partner expects that contributions to the property improvement
fund will provide a sufficient reserve for the future capital repair and
replacement needs of the Hotel's property and equipment.
MANAGEMENT FEES
For 1997, the Partnership paid a base management fee equal to 3% of gross
Hotel sales to the Manager. In addition, the Partnership paid an incentive
management fee of $606,000 payable from cash flow remaining after payment of
ground rent, debt service and an owner's priority return of $1,020,000.
Payment of the incentive management fee is subordinated to the required
principal and interest payments on the Amended and Restated Mortgage Debt,
ground rent and an 8% annual priority return to the Partners. Of the remaining
amount, the Partnership pays 50% of the current year incentive management fee
to the extent of cash available. Fifty percent of any remaining cash is then
applied to 50% of the current year incentive management fee and unpaid
incentive management fees from prior years. Unpaid incentive management fees
are reflected as deferred incentive management fees due to Marriott
International, Inc. in the Partnership's balance sheet. The Manager waived its
right to any unpaid deferred incentive management fees due to Marriott
International which were earned during the period from June 12, 1989 to June
14, 1991. During the first two quarters of 1998 and 1997, the Manager received
$439,000 and $261,000, respectively, of incentive management fees. The
remaining $20,000 and $128,000, respectively, of incentive management fees
earned were accrued as deferred incentive management fees payable to Marriott
International. During 1997 the Manager received $606,000 of incentive
management fee, while the remaining $258,000 of incentive management fee
earned was accrued as a deferred incentive management fee payable to Marriott
International. In 1996 and 1995, incentive management fees earned and accrued
as deferred incentive management fees totaled $734,000 and $591,000,
respectively. No incentive management fees were paid prior to 1997. As of
December 31, 1997 and 1996 and June 19, 1998, the balance of deferred
incentive management fees was $3.6 million, $3.3 million and $3.6 million,
respectively.
INFLATION
For the first two quarters 1998 and the three fiscal years ended December
31, 1997, the rate of inflation has been relatively low and, accordingly, has
not had a significant impact on the Partnership's revenues and net income. The
Manager is generally able to pass through increased costs to customers through
higher room rates. In 1997, the increase in average room rates at the Hotel
exceeded the general level of inflation. The amount of the Partnership's
interest expense under floating rate debt for a particular year will be
affected by changes in short-term interest rates.
SEASONALITY
Demand, and thus occupancy and room rates, is affected by normally recurring
seasonal patterns. Demand tends to be higher during the months of March
through November than during the remainder of the year. This seasonality tends
to affect the results of operations, increasing hotel revenues during these
months. In addition, this seasonality may also increase the liquidity of the
Partnership during these months.
YEAR 2000 ISSUES
Over the last few years, Host Marriott Corporation, the parent company of
the General Partner, has invested in implementing new accounting systems which
are Year 2000 compliant. Accordingly, the General Partner believes that future
costs associated with Year 2000 issues will be minimal and not material to the
Partnership's financial statements.
However, the Partnership does rely upon accounting software used by the
Manager of its property to obtain financial information. The General Partner
believes that the Manager has begun to implement changes to the property
specific software to ensure that software will function properly in the Year
2000 and does not expect to incur significant costs related to these
modifications.
Chicago Suites Supp-36
<PAGE>
FINANCIAL STATEMENTS
Chicago Suites Supp-37
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE PARTNERS OF MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.:
We have audited the accompanying balance sheet of Mutual Benefit Chicago
Marriott Suite Hotel Partners, L.P. (a Rhode Island limited partnership) as of
December 31, 1997 and 1996 and the related statements of operations, changes
in partners' capital (deficit) and cash flows for the three years in the
period ended December 31, 1997. These financial statements are the
responsibility of the General Partner's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Mutual Benefit Chicago
Marriott Suite Hotel Partners, L.P. as of December 31, 1997 and 1996 and the
results of its operations and its cash flows for the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
Arthur Andersen LLP
Washington, D.C.
February 23, 1998
Chicago Suites Supp-38
<PAGE>
MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.
BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Property and equipment, net................................ $ 23,784 $ 23,640
Property improvement fund.................................. 402 329
Deferred financing costs, net.............................. 428 512
Due from Marriott International, Inc....................... 507 487
Cash and cash equivalents.................................. 841 733
-------- --------
$ 25,962 $ 25,701
======== ========
LIABILITIES AND PARTNERS' DEFICIT
LIABILITIES
Mortgage debt............................................ $ 24,475 $ 25,361
Deferred incentive management fees due to Marriott
International, Inc...................................... 3,587 3,329
Note payable to Marriott International, Inc.............. 528 --
Accounts payable and accrued expenses.................... 193 414
-------- --------
Total Liabilities.................................... 28,783 29,104
-------- --------
PARTNERS' DEFICIT
General Partner
Capital contribution................................... 120 120
Capital distributions.................................. (23) (23)
Cumulative net losses.................................. (107) (113)
-------- --------
(10) (16)
-------- --------
Limited Partners
Capital contribution, net of offering costs of $1,512.. 10,249 10,249
Capital distributions.................................. (2,819) (2,819)
Cumulative net losses.................................. (10,241) (10,817)
-------- --------
(2,811) (3,387)
-------- --------
Total Partners' Deficit.............................. (2,821) (3,403)
-------- --------
$ 25,962 $ 25,701
======== ========
</TABLE>
See Notes to financial statements.
Chicago Suites Supp-39
<PAGE>
MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
REVENUES
Hotel revenues (Note 3)........................... $ 6,568 $ 5,660 $ 4,913
------- ------- -------
OPERATING COSTS AND EXPENSES
Real estate taxes and other....................... 1,295 1,139 1,172
Incentive management fee.......................... 864 734 591
Depreciation...................................... 835 1,234 1,644
Base management fee............................... 433 392 351
Ground rent....................................... 341 308 300
Administrative and other.......................... 127 81 67
------- ------- -------
3,895 3,888 4,125
------- ------- -------
OPERATING PROFIT.................................... 2,673 1,772 788
Interest expense.................................. (2,150) (2,406) (2,526)
Interest income................................... 59 69 83
------- ------- -------
NET INCOME (LOSS)................................... $ 582 $ (565) $(1,655)
------- ------- -------
ALLOCATION OF NET INCOME (LOSS)
General Partner................................... $ 6 $ (6) $ (17)
MBIP Interest..................................... 6 (6) (17)
Limited Partner Unit Holders...................... 570 (553) (1,621)
------- ------- -------
$ 582 $ (565) $(1,655)
------- ------- -------
NET INCOME (LOSS) PER LIMITED PARTNER UNIT
(335 Units)....................................... $ 1,701 $(1,651) $(4,839)
======= ======= =======
</TABLE>
See Notes to financial statements.
Chicago Suites Supp-40
<PAGE>
MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNER PARTNERS TOTAL
------- -------- -------
<S> <C> <C> <C>
Balance, December 31, 1994............................ $ 17 $(1,200) $(1,183)
Net loss............................................ (34) (1,621) (1,655)
---- ------- -------
Balance, December 31, 1995............................ (17) (2,821) (2,838)
Transfer of MBIP 1% GP interest to 1% LP interest... 11 (11) --
Net income.......................................... (10) (555) (565)
---- ------- -------
Balance, December 31, 1996............................ (16) (3,387) (3,403)
Net income.......................................... 6 576 582
---- ------- -------
Balance, December 31, 1997............................ $(10) $(2,811) $(2,821)
==== ======= =======
</TABLE>
See Notes to financial statements.
Chicago Suites Supp-41
<PAGE>
MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)................................ $ 582 $ (565) $ (1,655)
Noncash items:
Depreciation................................... 835 1,234 1,644
Deferred incentive management fees............. 258 734 591
Amortization of deferred financing costs as
interest...................................... 124 33 46
Deferred interest on mortgage loan............. 63 -- --
Changes in operating accounts:
Accounts payable and accrued expenses.......... 39 (607) 30
Due from Marriott International, Inc........... (20) (31) (20)
------- ------- --------
Cash provided by operating activities........ 1,881 798 636
------- ------- --------
INVESTING ACTIVITIES
Additions to property and equipment, net......... (979) (1,013) (492)
Change in property improvement fund.............. (73) 496 6
------- ------- --------
Cash used in investing activities............ (1,052) (517) (486)
------- ------- --------
FINANCING ACTIVITIES
Repayment of mortgage debt....................... (886) (139) --
Proceeds from note payable to Marriott
International, Inc.............................. 528 -- --
Payment of financing costs....................... (363) (203) --
------- ------- --------
Cash used in financing activities............ (721) (342) --
------- ------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS... 108 (61) 150
CASH AND CASH EQUIVALENTS at beginning of year..... 733 794 644
------- ------- --------
CASH AND CASH EQUIVALENTS at end of year........... $ 841 $ 733 $ 794
======= ======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for mortgage interest.................. $ 1,947 $ 2,947 $ 2,482
======= ======= ========
</TABLE>
See Notes to financial statements.
Chicago Suites Supp-42
<PAGE>
MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
NOTE 1. THE PARTNERSHIP
Description of the Partnership
Mutual Benefit Chicago Marriott Suite Hotel Partners, L.P. (the
"Partnership"), a Rhode Island limited partnership, was formed in 1988 to
acquire and own the 256 suite Marriott Suites O'Hare Hotel (the "Hotel")
located near the O'Hare International Airport in Rosemont, Illinois. The
Hotel, which opened on November 28, 1988, is managed by Marriott
International, Inc. ("Marriott International") as part of its full service
hotel system.
In 1989, 335 limited partnership interests (the "Units"), representing a 98%
interest in the Partnership, were sold pursuant to a private placement
offering at $35,000 per Unit. Each general partner contributed $119,500 in
cash for their respective 1% general partner interests. Under the purchase and
sale agreement, Host Marriott Corporation ("Host Marriott") agreed to reduce
the purchase price of the Hotel up to an aggregate total of $3,000,000 to the
extent that the Hotel did not provide cash flow, after payment of ground rent
and debt service, equivalent to $1,000,000 for each of the three years ended
June 19, 1992 (the "Cash Flow Guaranty"). A total of $2,476,000 was paid to
the Partnership under the Cash Flow Guaranty. The price adjustments were
allocated as a reduction of the carrying value of the Partnership's property
and equipment in the accompanying balance sheet.
On August 23, 1996, MB Investment Properties, Inc. ("MBIP") withdrew as a
general partner of the Partnership and converted its 1% interest to a limited
partner. At December 31, 1997 the sole general partner is MOHS Corporation
("MOHS"), a Delaware corporation and subsidiary of Host Marriott.
Partnership Allocations and Distributions
Partnership allocations and distributions are generally made as follows:
(a) Cash available for distribution is distributed (i) first, 100% to the
limited partners (excluding MBIP) until they have received an annual 8%
cumulative preferred return on their invested capital; (ii) to Host
Marriott to repay principal and interest on advances made under the Debt
Service Guarantee, as defined in Note 5, if any; and (iii) 100% to the
general partner and MBIP until they have received an annual 8% cumulative
preferred return on their invested capital. The balance, if any, shall be
distributed (i) 1% to the general partner, 1% to MBIP and 98% to the
remaining limited partners until the general partner and the limited
partners (collectively, the "Partners") have received cumulative
distributions of net proceeds from capital transactions and/or refinancing
equal to $5,982,000; (ii) next, 10% to MOHS, 5% to MBIP and 85% to the
remaining limited partners until the Partners have received cumulative
distributions of net proceeds from capital transactions and/or refinancing
equal to $11,964,000; and (iii) thereafter, 20% to MOHS, 10% to MBIP and
70% to the remaining limited partners.
(b) Net proceeds from capital transactions and refinancing are generally
distributed in the following order of priority: (i) first, 1% to the
general partner, 1% to MBIP and 98% to the remaining limited partners until
the Partners have received their initial capital contribution to the extent
not previously distributed; (ii) then, to the limited partners (excluding
MBIP) in an amount equal to their 8% cumulative preferred return on their
invested capital; (iii) then, to the general partner and MBIP in an amount
equal to their 8% cumulative preferred return on their invested capital;
(iv) then, to Host Marriott to repay any advances made under the Debt
Service Guarantee, together with accrued interest thereon; (v) then, to
Marriott International to pay any unpaid deferred incentive management fee;
and (vi) the balance, if any, 20% to MOHS, 10% to MBIP and 70% to the
remaining limited partners.
(c) For financial reporting purposes, profits and losses are allocated
among the Partners based on their ownership interests.
Chicago Suites Supp-43
<PAGE>
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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 amount of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Revenues and Expenses
Revenues represent house profit from the Hotel because the Partnership has
delegated substantially all of the operating decisions related to the
generation of house profit of the Hotel to Marriott International. House
profit reflects the net revenues flowing to the Partnership as property owner
and represents hotel operating results less property-level expenses, excluding
depreciation and amortization, base management fee, real estate taxes, ground
rent, insurance and certain other costs, which are disclosed separately in the
statement of operations (see Note 3).
On November 20, 1997 the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding the property level revenues and operating expenses of its hotel from
its statements of operations (see Note 3). If the Partnership concludes that
EITF 97-2 should be applied to its hotel, it would include operating results
of those managed operations in its financial statements. Application of EITF
97-2 to the financial statements as of and for the year ended December 31,
1997, would have increased both revenues and operating expenses by
approximately $7.9 million and would have had no impact on taxable income.
Property and Equipment
Property and equipment is recorded at cost. Depreciation is computed using
the straight-line method over the useful lives of the assets as follows:
<TABLE>
<S> <C>
Leasehold improvements.......................................... 40 years
Furniture and equipment......................................... 7 years
</TABLE>
All property and equipment is pledged to secure the Amended and Restated
Mortgage Debt defined in Note 5.
The Partnership assesses impairment of the Hotel based on whether estimated
undiscounted future cash flows from the Hotel will be less than its net book
value. If the Hotel is impaired, its basis is adjusted to fair market value.
Deferred Financing Costs
Deferred financing costs represent the costs incurred in connection with
obtaining debt financing and are amortized over the term thereof. The original
mortgage debt (see Note 5) matured on June 12, 1996. Deferred financing costs
associated with that debt, totaling $320,000, were fully amortized at December
31, 1996 and were subsequently written off in 1997. Costs associated with the
mortgage debt refinancing (see Note 5) totaled $566,000 and will be amortized
over the term of the loan. Accumulated amortization of deferred financing
costs at December 31, 1997 and 1996 totaled $138,000 and $334,000,
respectively.
Chicago Suites Supp-44
<PAGE>
Cash and Cash Equivalents
The Partnership considers all highly liquid investments with a maturity of
three months or less at date of purchase to be cash equivalents.
Income Taxes
Provision for Federal and state income taxes has not been made in the
accompanying financial statements because the Partnership does not pay income
taxes but rather allocates profits and losses to the Partners in accordance
with the partnership agreement. Significant differences exist between the net
income for financial reporting purposes and the net income as reported on the
Partnership's tax return. These differences are due primarily to the use, for
income tax purposes, of accelerated depreciation methods and shorter
depreciable lives of the assets. As a result of these differences, the excess
of the tax basis in the net Partnership liabilities over the net Partnership
liabilities reported in the accompanying financial statements was $896,000 and
$969,000, respectively as of December 31, 1997 and 1996.
Statement of Financial Accounting Standards
In 1996, the Partnership adopted Statement of Financial Accounting Standards
("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." Adoption of SFAS No. 121 did not have an
effect on its financial statements.
Reclassifications
Certain reclassifications were made to prior year financial statements to
conform to the 1997 presentation.
NOTE 3. REVENUES
Hotel revenues consist of Hotel operating results for the three years ended
December 31 (in thousands) are:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
HOTEL SALES
Rooms............................................. $11,336 $10,224 $ 9,100
Food and beverage................................. 2,588 2,337 2,092
Other............................................. 505 509 497
------- ------- -------
14,429 13,070 11,689
------- ------- -------
HOTEL EXPENSES
Departmental direct costs
Rooms........................................... 2,541 2,509 2,311
Food and beverage............................... 2,088 1,896 1,722
Other hotel operating expenses.................... 3,232 3,005 2,743
------- ------- -------
7,861 7,410 6,776
------- ------- -------
HOTEL REVENUES...................................... $ 6,568 $ 5,660 $ 4,913
======= ======= =======
</TABLE>
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Leasehold improvements................................... $ 26,453 $ 26,015
Furniture and equipment.................................. 8,768 8,227
-------- --------
35,221 34,242
Less accumulated depreciation............................ (11,437) (10,602)
-------- --------
$ 23,784 $ 23,640
======== ========
</TABLE>
Chicago Suites Supp-45
<PAGE>
NOTE 5. DEBT
Mortgage Debt
The Partnership entered into a loan agreement on June 12, 1989 with a bank
to provide non-recourse mortgage debt of $25.5 million (the "Mortgage Debt")
to finance the acquisition of the Hotel. The Mortgage Debt initially bore
interest at a floating interest rate. On August 11, 1989 the Partnership
exercised its option to fix the interest rate at 9.575% until maturity on June
12, 1996. Interest on the Mortgage Debt was payable on the last day of March,
June, September and December of each year. No amortization of principal was
required prior to maturity or the sale or refinancing of the Hotel.
The Mortgage Debt matured on June 12, 1996 (the "Maturity Date"). On
September 24, 1996 (the "Closing Date"), the Partnership completed a
refinancing of the Mortgage Debt (the "Amended and Restated Mortgage Debt").
The lender granted the Partnership a forbearance of the loan for the period
between the Maturity Date and the Closing Date. During the forbearance period
from the Maturity Date until August 15, 1996 the Partnership continued to pay
interest at the contract rate of 9.575%. Thereafter, until the Closing Date,
the Partnership paid interest at a rate of 10.575%. The Amended and Restated
Mortgage Debt matures on June 12, 2001 and carries a floating interest rate of
200 basis points over the three-month London Interbank Offered Rate ("LIBOR"),
with an option to fix the interest rate during the first two years of the loan
term. The weighted average interest rate from the Closing Date through
December 31, 1996, was 7.62%. The weighted average interest rate for 1997 was
7.69%. The restructured loan requires minimum quarterly amortization payments
based on a 20-year schedule. Additionally, all excess cash flow after payment
of ground rent, required principal and interest payments, incentive management
fee, partnership administrative expenses and refinancing costs is to be
applied toward principal amortization. On June 24, 1997 the Partnership paid
$305,000 from excess cash flow generated during 1996 toward additional
principal amortization. The Partnership made a $766,000 principal payment in
June 1998 from excess cash flow generated during 1997.
As of the Closing Date, the lender deferred a $128,000 restructuring fee and
$302,000 of expenses incurred by the lender in connection with restructuring
the Mortgage Debt. On December 24, 1996, the Partnership paid $107,000 of
lender's expenses. A total of $323,000 was accrued as deferred financing costs
which is included in accounts payable and accrued expenses on the balance
sheet for the year ended December 31, 1996. This accrued liability was paid in
April 1997.
Scheduled debt maturities under the Amended and Restated Mortgage Debt are
as follows (in thousands):
<TABLE>
<S> <C>
1998............................................................. $ 627
1999............................................................. 676
2000............................................................. 728
2001............................................................. 22,444
-------
$24,475
=======
</TABLE>
The Amended and Restated Mortgage Debt is secured by the Hotel, an
assignment of the Partnership's interest under the Ground Lease (as defined in
Note 6), an assignment of the Hotel management agreement, and by the grant of
a security interest in the Partnership's cash accounts and the personal
property and fixtures of the Hotel.
Debt Guarantees
No debt service guarantee was provided on the Amended and Restated Mortgage
Debt. However, MOHS reaffirmed its guarantee to the lender, that in the event
of a foreclosure, proceeds payable to the lender would be at least $5,000,000.
Chicago Suites Supp-46
<PAGE>
Roof and Facade Loan
Marriott International Capital Corporation ("MICC"), a subsidiary of
Marriott International, provided $605,000 in available loan proceeds for the
completion of the facade and roof restoration project at the Hotel. As of
December 31, 1997, $528,000 has been disbursed under the loan. The loan
matures in June 2000, bears interest at 9% and will be repaid from the
Partnership's cash flow from operations after defined priorities. Payments of
approximately $19,000 in principal and interest per month began in June 1998
following the final loan disbursement.
Simultaneous with the execution of the loan agreement between the
Partnership and MICC, Host Marriott purchased a 50% participation interest in
the loan from MICC. Pursuant to the participation agreement, Host Marriott
reimbursed MICC for 50% of the loan advances made to-date and will continue to
reimburse MICC for 50% of any additional advances. Upon the final loan
disbursement, Host Marriott will be reimbursed by MICC for 50% of the loan
repayments as they are made by the Partnership to MICC.
NOTE 6. GROUND LEASE
In 1989, the leasehold interest in the land upon which the Hotel is located
was assigned to the Partnership by Host Marriott. The lease was created on
June 16, 1986 pursuant to a ground lease (the "Ground Lease") from the
landlord to Host Marriott. The initial term of the Ground Lease expires in
2014. The Ground Lease may be renewed at the option of the Partnership for
five successive terms of ten years each. Upon expiration or termination of the
Ground Lease, title to the Hotel and all improvements revert to the lessor.
Rent expense under the Ground Lease is calculated at an amount equal to the
greater of a minimum rental of $300,000 per year or a percentage rental equal
to 3% of annual gross room sales. Ground rent expense for 1997, 1996 and 1995
was $341,000, $308,000 and $300,000, respectively.
NOTE 7. MANAGEMENT AGREEMENT
The Partnership entered into a hotel management agreement (the "Management
Agreement") with Marriott International (the "Manager") to manage the Hotel as
part of Marriott International's full service hotel system. The Management
Agreement has an initial term expiring in 2008. The Manager may renew the
Management Agreement, at its option, for five successive ten-year terms. The
Partnership may terminate the Management Agreement if specified minimum
operating results are not achieved. However, the Manager may prevent
termination by paying the Partnership the amount by which the minimum
operating results were not achieved.
The Management Agreement provides for annual payments of (i) the base
management fee equal to 3% of gross sales from the Hotel, and (ii) the
incentive management fee equal to 20% of net house profit, as defined. Payment
of the incentive management fee is subordinated to the prior payment of
required principal and interest payments, ground rent and an 8% annual
priority return to the Partners. Unpaid incentive management fees are
reflected as deferred incentive management fees payable to Marriott
International in the accompanying balance sheet. The incentive management fee
earned in 1997 was $864,000. Of this amount $606,000 was paid to the Manager
and $258,000 was accrued as unpaid deferred incentive management fees. Unpaid
incentive management fees earned in 1996 and 1995 were $734,000 and $591,000,
respectively. The balance of deferred incentive management fees at December
31, 1997 and 1996 was $3.6 million and $3.3 million, respectively.
Pursuant to the terms of the Management Agreement, the Partnership is
required to provide the Manager with working capital and supplies to meet the
operating needs of the Hotel. The Manager converts cash advanced by the
Partnership into other forms of working capital consisting primarily of
operating cash, inventories, and trade receivables and payables which are
maintained and controlled by the Manager. Upon termination of the Management
Agreement, the working capital and supplies will be returned to the
Partnership. The individual components of working capital and supplies
controlled by the Manager are not reflected in the Partnership's balance
sheet. As of December 31, 1997 and 1996, $357,000 has been advanced to the
Manager for working capital and supplies and is reflected in Due from Marriott
International, Inc. on the accompanying balance sheet.
Chicago Suites Supp-47
<PAGE>
Pursuant to the terms of the Management Agreement, the Manager is required
to furnish the Hotel with certain services ("Chain Services") which are
generally provided on a central or regional basis to all hotels in Marriott
International's full service hotel system. Chain Services include central
training, advertising and promotion, a national reservation system and such
additional services, as needed, which may be more efficiently performed on a
centralized basis. Costs and expenses incurred in providing such services are
allocated among all domestic full service hotels managed, owned or leased by
Marriott International or its subsidiaries. In addition, the Hotel also
participates in Marriott International's Marriott's Rewards Program ("MRP"),
which was formerly called Marriott International's Honored Guest Awards
Program. The cost of this program is charged to all hotels in Marriott
International's hotel system based upon the MRP sales at each hotel. The total
amount of Chain Services and MRP costs charged to the Partnership was
$783,000, $757,000 and $649,000 for 1997, 1996 and 1995, respectively.
The Management Agreement provides for the establishment of a property
improvement fund for the Hotel which provides for the replacement of
furniture, fixtures and equipment. Contributions to the property improvement
fund are based on a percentage of gross Hotel sales equal to 4% for 1995
through 1999 and 5% thereafter. Contributions to the property improvement fund
for 1997, 1996 and 1995 were $577,000, $523,000 and $468,000, respectively.
NOTE 8. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments are shown below. The
estimated fair values of financial instruments not included in this table are
estimated to be equal to their carrying amounts (in thousands):
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997 AS OF DECEMBER 31, 1996
------------------------ ------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Mortgage Debt............ $ 24,475 $ 24,700 $ 25,361 $ 25,200
</TABLE>
The estimated fair value of the Mortgage Debt is based on the expected
future debt service payments discounted at estimated market rates.
Chicago Suites Supp-48
<PAGE>
MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.
CONDENSED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
---------------
1998 1997
------- ------
<S> <C> <C>
HOTEL REVENUES (Note 2)........................................ $ 3,358 $2,952
------- ------
OPERATING COSTS AND EXPENSES
Real estate taxes and other.................................. 594 579
Depreciation................................................. 467 385
Incentive management fees.................................... 459 389
Base management fees......................................... 213 195
Ground rent and administrative............................... 213 168
------- ------
1,946 1,716
------- ------
OPERATING PROFIT............................................... 1,412 1,236
Interest expense............................................. (1,006) (999)
Interest income.............................................. 31 29
------- ------
NET INCOME..................................................... $ 437 $ 266
======= ======
ALLOCATION OF NET INCOME
General Partner.............................................. $ 4 $ 3
MBIP Limited Partner Interest................................ 4 3
Limited Partner Unit Holders................................. 429 260
------- ------
$ 437 $ 266
======= ======
NET INCOME PER LIMITED PARTNER UNIT (335 Units)................ $ 1,281 $ 776
======= ======
</TABLE>
See Notes to Condensed Financial Statements.
Chicago Suites Supp-49
<PAGE>
MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.
CONDENSED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 19, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Property and equipment, net.......................... $23,733 $23,784
Due from Marriott International, Inc................. 652 507
Other assets......................................... 658 830
Cash and cash equivalents............................ 1,667 841
------- -------
$26,710 $25,962
======= =======
LIABILITIES AND PARTNERS' DEFICIT
Mortgage debt........................................ $24,322 $24,475
Deferred incentive management fees due to Marriott
International, Inc.................................. 3,607 3,587
Accounts payable and accrued expenses................ 602 193
Note payable to Marriott International, Inc.......... 563 528
------- -------
Total Liabilities................................ 29,094 28,783
------- -------
PARTNERS' DEFICIT
General Partner.................................... (6) (10)
MBIP Limited Partner Interest...................... (6) (10)
Limited Partner Unit Holders....................... (2,372) (2,801)
------- -------
Total Partners' Deficit.......................... (2,384) (2,821)
------- -------
$26,710 $25,962
======= =======
</TABLE>
See Notes to Condensed Financial Statements.
Chicago Suites Supp-50
<PAGE>
MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.
CONDENSED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
--------------
1998 1997
------ ------
<S> <C> <C>
OPERATING ACTIVITIES
Net income.................................................... $ 437 $ 266
Noncash items................................................. 572 597
Changes in operating accounts................................. 235 213
------ ------
Cash provided by operating activities....................... 1,244 1,076
------ ------
INVESTING ACTIVITIES
Additions to property and equipment........................... (416) (440)
Change in property improvement fund........................... 116 196
------ ------
Cash used in investing activities........................... (300) (244)
------ ------
FINANCING ACTIVITIES
Principal repayments of mortgage debt......................... (153) (336)
Proceeds from note payable to Marriott International, Inc..... 35 --
Payment of financing costs.................................... -- (141)
------ ------
Cash used in financing activities........................... (118) (477)
------ ------
INCREASE IN CASH AND CASH EQUIVALENTS........................... 826 355
CASH AND CASH EQUIVALENTS at beginning of period................ 841 733
------ ------
CASH AND CASH EQUIVALENTS at end of period...................... $1,667 $1,088
====== ======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for mortgage interest............................... $ 484 $ 481
====== ======
</TABLE>
See Notes to Condensed Financial Statements.
Chicago Suites Supp-51
<PAGE>
MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying condensed financial statements have been prepared by
Mutual Benefit Chicago Marriott Suite Hotel Partners, L.P. (the "Partnership")
without audit. Certain information and footnote disclosures normally included
in financial statements presented in accordance with generally accepted
accounting principles have been condensed or omitted from the accompanying
statements. The Partnership believes the disclosures made are adequate to make
the information presented not misleading. However, the condensed financial
statements should be read in conjunction with the Partnership's financial
statements and notes thereto for the fiscal year ended December 31, 1997
included in the Partnership's Form 10.
In the opinion of the Partnership, the accompanying unaudited condensed
financial statements reflect all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position of
the Partnership as of June 19, 1998, and the results of operations and cash
flows for the first two quarters 1998 and 1997. Interim results are not
necessarily indicative of fiscal year performance because of seasonal and
short-term variations.
For financial reporting purposes, net profits and net losses of the
Partnership are allocated 1% to MOHS Corporation (the "General Partner"), a
wholly owned subsidiary of Host Marriott Corporation ("Host Marriott"), 1% to
Mutual Benefit Investment Properties ("MBIP"), a limited partner, and 98% to
the remaining limited partners. Significant differences exist between the net
profits and net losses for financial reporting purposes and the net profits
and net losses reported for Federal income tax purposes. These differences are
due primarily to the use, for income tax purposes, of accelerated depreciation
methods, shorter depreciable lives of the assets, differences in the timing of
the recognition of management fee expense and the deduction of certain costs
incurred during construction which have been capitalized in the accompanying
condensed financial statements.
2. Hotel revenues represent house profit from the Hotel since the
Partnership has delegated substantially all of the operating decisions related
to the generation of house profit of the Hotel to Marriott International, Inc.
(the "Manager"). House profit reflects hotel operating results which flow to
the Partnership as property owner and represents gross hotel sales less
property-level expenses, excluding depreciation and amortization, base and
incentive management fees, property taxes and certain other costs, which are
disclosed separately in the condensed statement of operations.
On November 20, 1997 the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding the property level revenues and operating expenses of its hotel from
its statements of operations. If the Partnership concludes that EITF 97-2
should be applied to the Hotel, it would include operating results of the
managed operation in its financial statements. Application of EITF 97-2 to the
condensed financial statements as of and for the first two quarters 1998,
would have increased both revenues and operating costs and expenses by
approximately $3.7 million and would have had no impact on the operating
profit or net income.
Chicago Suites Supp-52
<PAGE>
MUTUAL BENEFIT CHICAGO MARRIOTT SUITE HOTEL PARTNERS, L.P.
NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED)
Hotel revenues consist of hotel operating results as follows (in thousands):
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
-------------
1998 1997
------ ------
<S> <C> <C>
HOTEL SALES
Rooms....................................................... $5,642 $5,106
Food and beverage........................................... 1,222 1,171
Other....................................................... 242 232
------ ------
7,106 6,509
------ ------
HOTEL EXPENSES
Departmental Direct Costs
Rooms..................................................... 1,198 1,145
Food and beverage......................................... 1,001 946
Other hotel operating expenses.............................. 1,549 1,466
------ ------
3,748 3,557
------ ------
HOTEL REVENUES................................................ $3,358 $2,952
====== ======
</TABLE>
3. On April 17, 1998, Host Marriott Corporation ("Host Marriott"), parent
company of the General Partner of the Partnership, announced that its Board of
Directors authorized Host Marriott to reorganize its business operations to
qualify as a real estate investment trust ("REIT") to become effective as of
January 1, 1999. As part of the REIT conversion, Host Marriott formed a new
operating partnership (the "Operating Partnership"), and limited partners in
certain Host Marriott full-service hotel partnerships and joint ventures,
including the Mutual Benefit Chicago Marriott Suite Hotel Partners, L.P., are
expected to be given an opportunity to receive, on a tax-deferred basis,
Operating Partnership units in the Operating Partnership in exchange for their
current limited partnership interests. The Operating Partnership units would
be redeemable by the limited partner for freely traded Host Marriott shares
(or the cash equivalent thereof) at any time after one year from the closing
of the merger. In connection with the REIT conversion, on June 2, 1998, the
Operating Partnership filed a Registration Statement on Form S-4 with the
Securities and Exchange Commission. Limited partners will be able to vote on
this Partnership's participation in the merger later this year through a
consent solicitation.
Chicago Suites Supp-53
<PAGE>
HOST MARRIOTT, L.P.
SUPPLEMENT DATED , 1998 FOR
PROSPECTUS/CONSENT SOLICITATION STATEMENT DATED , 1998 FOR
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP
On the terms described in the Prospectus/Consent Solicitation Statement (the
"Consent Solicitation"), dated , 1998, of which this Supplement (the
"Supplement") is a part, Host Marriott Corporation ("Host") has adopted a plan
to restructure its business operations so that it will qualify as a real
estate investment trust ("REIT"). As part of this restructuring (the "REIT
Conversion"), Host and its consolidated subsidiaries will contribute their
full-service hotel properties and certain other businesses and assets to Host
Marriott, L.P. (the "Operating Partnership") in exchange for units of limited
partnership interest in the Operating Partnership ("OP Units") and the
assumption of liabilities. The sole general partner of the Operating
Partnership will be Host Marriott Trust ("Host REIT"), the entity into which
Host will merge as part of the REIT Conversion. Host REIT expects to qualify
as a REIT beginning with its first full taxable year after closing of the REIT
Conversion, which Host REIT currently expects to be the year beginning January
1, 1999.
Following the REIT Conversion and the Blackstone Acquisition, the Operating
Partnership and its subsidiaries initially will own outright, or have
controlling interests in, approximately 120 full-service hotels operating
primarily under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt
brand names (the "Hotels").
As part of the REIT Conversion, the Operating Partnership is proposing to
acquire by merger (the "Mergers") Desert Springs Marriott Limited Partnership,
a Delaware limited partnership ("Desert Springs" or the "Partnership"), and up
to seven other limited partnerships (the "Partnerships") that own full-service
hotels in which Host or its subsidiaries are general partners. As more fully
described in the Consent Solicitation, limited partners of those Partnerships
that participate in the Mergers will receive either OP Units or, at their
election, unsecured % Callable Notes due December 15, 2005 issued by the
Operating Partnership ("Notes"), in exchange for their partnership interests
in such Partnerships (with respect to the Partnerships, those limited partners
of the Partnerships who are unaffiliated with Host are referred to herein as
the "Limited Partners," and with respect to Desert Springs, the "Desert
Springs Limited Partners").
Beginning one year after the Mergers, Limited Partners who retain OP Units
will have the right to redeem their OP Units at any time and receive, at the
election of Host REIT, either freely tradeable, New York Stock Exchange listed
Common Shares of Host REIT on a one-for-one basis (subject to adjustment) or
cash in an amount equal to the market value of such shares (the "Unit
Redemption Right").
The number of OP Units to be allocated to Desert Springs will be based upon
(i) its Exchange Value (as defined herein) and (ii) the price attributed to an
OP Unit following the Merger, determined as described herein (but in no event
greater than $ per OP Unit). The principal amount of Notes that Desert
Springs Limited Partners may elect to receive in exchange for the OP Units
received in the Merger will be based upon Desert Springs' Note Election Amount
(as defined herein). See "Determination of Exchange Value of Desert Springs
and Allocation of OP Units." The estimated Exchange Value and Note Election
Amount set forth herein may increase or decrease as a result of various
adjustments, and will be finally calculated shortly before the Effective Date.
Pursuant to the Merger, Desert Springs Limited Partners have an estimated
Exchange Value of $40,880 per Partnership Unit and a Note Election Amount of
$27,617 per Partnership Unit.
RISK FACTORS
In deciding whether to approve the Merger, Desert Springs Limited Partners
should consider certain risks and other factors. The General Partner believes
that Desert Springs Limited Partners should particularly consider the
following, which should be read in conjunction with the information in the
Consent Solicitation under "Risk Factors" and "Federal Income Tax
Consequences":
. Substantial Benefits to Related Parties. Host REIT and its subsidiaries
will realize substantial benefits from the Mergers and the REIT
Conversion, including savings from a substantial reduction in corporate-
Desert Springs Supp-1
<PAGE>
level income taxes expected as a result of the REIT Conversion. To the
extent that such anticipated benefits of the REIT Conversion are reflected
in the value of Host's common stock prior to the Effective Date, such
benefits will not be shared with the Limited Partners. Because of Host's
significant ownership position in certain Partnerships (including Desert
Springs), the failure of one or more of these Partnerships, including
Desert Springs, to participate in a Merger likely would require that Host
contribute some or all of its ownership interest in Desert Springs to a
taxable Non-Controlled Subsidiary, which would materially reduce the
benefit to Host of the REIT Conversion as it applies to Desert Springs.
. Absence of Arm's Length Negotiations. No independent representative was
retained to negotiate on behalf of the Desert Springs Limited Partners or
the other Limited Partners. Although the General Partner has obtained the
Appraisal and the Fairness Opinion from AAA, AAA has not negotiated with
the General Partner or Host and has not participated in establishing the
terms of the Mergers. Consequently, the terms and conditions of the
Mergers may have been more favorable to the Desert Springs Limited
Partners or the other Limited Partners if such terms and conditions were
the result of arm's length negotiations.
. Other Conflicts of Interest. The Mergers, the REIT Conversion and the
recommendations of the General Partner involve the following conflicts of
interest because of the relationships among Host, the Operating
Partnership, the General Partner and SLC: (i) the General Partners, which
are all subsidiaries of Host (except for PHLP, in which Host is the
General Partner), must assess whether a Merger is fair and equitable to
the Limited Partners of its Partnership, which involves considerations
for Host and its subsidiaries that are different from those that affect
the Limited Partners, (ii) the terms of the Leases of the Hotels,
including Desert Springs' Hotel, will be determined by Host, which will
distribute the common stock of SLC, the parent of the Lessees, to its
shareholders after such terms have been set and (iii) the terms of the
Partnership Agreement, including provisions which benefit Host REIT, have
been determined by Host. Such conflicts may result in decisions that do
not fully reflect the interests of all Limited Partners, including the
Desert Springs Limited Partners.
. Uncertainties at the Time of Voting Include the Number of OP Units to be
Received. There are several uncertainties at the time the Desert Springs
Limited Partners must vote on the Merger, including (i) the exact
Exchange Value for Desert Springs (which will be adjusted for changes in
lender and capital expenditures reserves, indebtedness, deferred
maintenance and other items prior to the Effective Date), (ii) the price
of the OP Units for purposes of the Mergers, which will be determined by
reference to the post-Merger trading prices of Host REIT's Common Shares
and which, together with the Exchange Value, will determine the number of
OP Units the Desert Springs Limited Partners will receive and (iii) the
exact principal amount of the Notes that may be received in exchange for
OP Units, which cannot be known until after the vote on the Merger. For
these reasons, the Desert Springs Limited Partners cannot know at the
time they vote on the Merger these important aspects of the Merger.
. Combined REVPAR for the Operating Partnership's Hotels is Significantly
Less than the REVPAR for the Desert Springs Hotel. The Operating
Partnership's pro forma REVPAR for the First Two Quarters 1998 is
significantly lower than the REVPAR attributable to Desert Springs' Hotel
for the same period.
. Exchange Value May Not Equal Fair Market Value of Desert Springs' Hotel.
Each Desert Springs Limited Partner who retains OP Units will receive
consideration with a deemed value equal to the Exchange Value of such
Desert Springs Limited Partner's Partnership Interest. The determination
of the Exchange Value of Desert Springs involves numerous estimates and
assumptions. There is no assurance that the Exchange Value of Desert
Springs will equal the fair market value of the Hotel and other assets
contributed by Desert Springs. See "Determination of Exchange Value of
Desert Springs and Allocation of OP Units."
. Price of OP Units Might Be Less than the Fair Market Value of the
Partnership Interests. The price of an OP Unit, for purposes of the
Mergers and the REIT Conversion, will be equal to the average closing
price on the NYSE of a Host REIT Common Share for the first 20 trading
days after the Effective Date of the Mergers (but in no event greater
than $ per share). It is likely that, over time, the value of the
publicly traded Common Shares of Host REIT (and therefore the value of
the OP Units) will diverge
Desert Springs Supp-2
<PAGE>
from the deemed value of the OP Units used for purposes of the Mergers.
This could result in the Desert Springs Limited Partners receiving OP
Units with an actual value that is less than either the price of the OP
Units for purposes of the Mergers or the fair market value of their
Partnership Interests.
. Adverse Tax Consequences to the General Partner of a Sale of the
Hotel. In past years, Desert Springs has disproportionately allocated tax
losses to the General Partner, with the result that if the Desert Springs
Hotel was to be sold in a taxable transaction, the General Partner (and
thus Host) would incur a disproportionately larger tax gain than the
Desert Springs Limited Partners. Accordingly, the General Partner has an
additional conflict of interest in deciding the appropriate course of
action for Desert Springs with respect to its Hotel.
. Allocation of OP Units to Host REIT is Different from Allocation of OP
Units to Limited Partners. Host REIT will receive in the aggregate a
number of OP Units (including OP Units allocated to the General Partners
of the Partnerships) equal to the number of shares of Host common stock
outstanding on the Effective Date (and, if Host has outstanding shares of
preferred stock at the time of the REIT Conversion, a corresponding
number of preferred partnership interests in the Operating Partnership),
which should fairly represent the market value of Host REIT but may not
be equal to the fair market or net asset value of the Hotels and other
assets that Host will contribute to the Operating Partnership. The
Partnerships will receive OP Units in the Mergers with a deemed value
equal to the Exchange Value of such Partnership. The different methods of
allocating OP Units may result in Limited Partners not receiving the fair
market value of their Partnership Interests and Host REIT receiving a
higher percentage of the interests in the Operating Partnership. See
"Determination of Exchange Values and Allocation of OP Units."
. Inability of Desert Springs Limited Partners to Redeem OP Units for One
Year. Desert Springs Limited Partners who elect to retain OP Units
received in the Merger will be unable to redeem such OP Units for one
year following the Merger. Until then, Desert Springs Limited Partners
will bear the risk of illiquidity.
. Value of the Notes Will Be Less Than the Exchange Value. At the same time
that he votes on the Merger, each Desert Springs Limited Partner also may
elect to receive at the time of the Merger, in exchange for OP Units, an
unsecured, seven-year Note of the Operating Partnership with a principal
amount equal to the Note Election Amount of his Partnership Interest,
which is based upon numerous assumptions and estimates. The deemed value
of the OP Units to be received by the Desert Springs Limited Partners
will exceed the principal amount of the corresponding Notes (because the
Exchange Value will be higher than the Note Election Amount) and there is
no assurance that the Note a Desert Springs Limited Partner receives will
have a value equal to either (i) the fair market value of the Desert
Springs Limited Partner's share of the Hotel and other assets owned by
Desert Springs or (ii) the principal amount of the Note. There will be no
public market for the Notes. If the Notes are sold, they may sell at
prices substantially below their issuance price. Noteholders are likely
to receive the full principal amount of a Note only if they hold the Note
to maturity, which is December 15, 2005, or if the Operating Partnership
repays the Notes prior to maturity. Because the Notes are unsecured
obligations of the Operating Partnership, they will be effectively
subordinated to all secured debt of the Operating Partnership and all
obligations of both Desert Springs and the Operating Partnership's other
subsidiaries. See "Description of the Notes." As of June 19, 1998, on a
pro forma basis assuming the Full Participation Scenario, the Operating
Partnership would have had aggregate consolidated debt of approximately
$5.1 billion to which the Notes were effectively subordinated or which
rank equally with such Notes.
. Current Host Common Stock Price May Not Necessarily Be Indicative of the
Price of Host REIT Common Shares Following the REIT Conversion. Host's
current stock price is not necessarily indicative of how the market will
value Host REIT Common Shares following the REIT Conversion. The current
stock price of Host reflects the current market valuation of Host's
current business and assets (including the SLC common stock and the cash
or securities to be distributed in connection with the REIT Conversion)
and not the business and assets of Host REIT following the REIT
Conversion.
Desert Springs Supp-3
<PAGE>
. Fundamental Change in Nature of Investment; Potential Underperformance.
The Mergers and the REIT Conversion involve a fundamental change in the
nature of a Desert Springs Limited Partner's investment from holding an
interest in Desert Springs, which was structured as a tax shelter
investment, is a finite-life entity, has a fixed portfolio of one Hotel
and distributes the cash flow from the operation of the Hotel to the
Desert Springs Limited Partners, to holding an interest in an infinite-
life, operating real estate company with a portfolio of approximately 120
Hotels that (i) collects and distributes to its limited partners rents
received from the Lessees (which will bear the risks and receive the
direct benefits of the Hotels' operations), (ii) has the ability to
acquire additional hotels, (iii) is able to reinvest proceeds from sales
or refinancings of existing Hotels in other hotels and (iv) has a
publicly traded general partner. In addition, each Desert Springs Limited
Partner's investment will change from one that allows a Desert Springs
Limited Partner to receive a return of capital in the form of
distributions from any net proceeds of a sale or refinancing of Desert
Springs' assets to an investment in which a Desert Springs Limited
Partner who retains OP Units likely would realize a return of capital
only through the exercise of the Unit Redemption Right. A Desert Springs
Limited Partner's share of the liquidation proceeds, if any, from the
sale of the Desert Springs Hotel could be higher than the amount realized
upon exercise of the Unit Redemption Right (or payments on any Note
received by a Desert Springs Limited Partner who elects to exchange his
OP Units for such Note). An investment in the Operating Partnership may
not outperform an investment in Desert Springs. See "Comparison of
Ownership of Partnership Interests, OP Units and Common Shares."
. Exposure to Market and Economic Conditions of Other Hotels. As a result
of the Mergers, Desert Springs Limited Partners who elect to retain OP
Units will own interests in a much larger enterprise with a broader range
of assets than Desert Springs individually. A material adverse change
affecting the Operating Partnership's assets will affect all Limited
Partners, including Desert Springs Limited Partners, regardless of
whether a particular Limited Partner previously was an investor in such
affected assets. Desert Springs owns discrete assets and the Mergers and
the REIT Conversion will significantly diversify the types and geographic
locations of the Hotels in which the Desert Springs Limited Partners will
have interests. As a result, the Hotels owned by the Operating
Partnership may be affected differently by economic and market conditions
than the Hotel previously owned by Desert Springs.
. Desert Springs Limited Partners Have No Cash Appraisal Rights. Desert
Springs Limited Partners who vote against the Merger have no right to
receive cash based upon an appraisal of their Partnership Interests.
. Uncertainties as to the Size and Leverage of the Operating
Partnership. The Desert Springs Limited Partners cannot know at the time
they vote on the Merger the exact size and amount of leverage of the
Operating Partnership. Host is an existing operating company that
regularly issues and repays debt, acquires additional hotels and disposes
of existing hotels. Also, some or all of the Partnerships may elect not
to participate in a Merger. In addition, outside partners in certain
Private Partnerships may not consent to a lease of their partnership's
Hotel(s). In either such case, Host will contribute its interests in such
Partnerships and Private Partnerships to the Operating Partnership, but
the Operating Partnership may, in turn, contribute such interests to a
Non-Controlled Subsidiary, which will be subject to corporate-level
income taxation. Host also may repurchase outstanding securities or issue
new debt or equity securities prior to the consummation of the Mergers
and the REIT Conversion.
. Lack of Control over Hotel Operations. Due to current federal income tax
law restrictions on a REIT's ability to derive revenues directly from the
operation of a hotel, the Operating Partnership will lease virtually all
of its consolidated Hotels to the Lessees, which will operate the Hotels
by continuing to retain the Managers pursuant to the Management
Agreements. The Operating Partnership will not operate the Hotels or
participate in the decisions affecting the daily operations of the
Hotels. The Operating Partnership will have only a limited ability to
require the Lessees or the Managers to operate or manage the Hotels in
any particular manner and no ability to govern any particular aspect of
their day-to-day operation or management. Therefore, the Operating
Partnership will be dependent for its revenue upon the ability of the
Lessees and the Managers to operate and manage the Hotels.
Desert Springs Supp-4
<PAGE>
. Expiration of Leases and Possible Inability to Find Other Lessees. The
Leases will expire seven to ten years after the Effective Date and there
can be no assurance that such Leases will be renewed (or if renewed, will
be renewed on terms as favorable to the Operating Partnership). If the
Leases are not renewed, the Operating Partnership will be required to
find other lessees, which lessees must meet certain requirements set
forth in the Management Agreements. There can be no assurance that
satisfactory lessees could be found or as to the terms and conditions on
which the Operating Partnership would be able to renew the Leases or
enter into new leases with such lessees.
. Requisite Vote of Desert Springs Limited Partners Binds All Desert
Springs Limited Partners. For Desert Springs, approval by a majority of
the Partnership Interests of Desert Springs that are eligible to be voted
is required to approve the Merger, as described in "Voting Procedures--
Required Vote and Other Conditions." Such approval will cause Desert
Springs to participate in the Merger and will bind all Desert Springs
Limited Partners, including Desert Springs Limited Partners who voted
against or abstained from voting with respect to the Merger.
. Substantial Indebtedness of the Operating Partnership. The Operating
Partnership will have substantial indebtedness. As of June 19, 1998, on a
pro forma basis assuming the Full Participation Scenario, the Operating
Partnership would have had outstanding indebtedness totaling
approximately $5.1 billion, which represents a % debt-to-total market
capitalization ratio on a pro forma basis at such date (based upon a
price per Common Share of Host REIT of $ ). The Operating
Partnership's business is capital intensive and it will have significant
capital requirements in the future. The Operating Partnership's leverage
level could affect its ability to (i) obtain financing in the future,
(ii) undertake refinancings on terms and subject to conditions deemed
acceptable by the Operating Partnership, (iii) make distributions to
partners, (iv) pursue its acquisition strategy or (v) compete effectively
or operate successfully under adverse economic conditions.
. No Limitation on Debt. There are no limitations in Host REIT's or the
Operating Partnership's organizational documents which limit the amount
of indebtedness either may incur, although both the Notes and the
Operating Partnership's other debt instruments will contain certain
restrictions on the amount of indebtedness that the Operating Partnership
may incur.
. Rental Revenues from Hotels Subject to Rights of Lenders. In accordance
with the mortgage loan agreements with respect to outstanding
indebtedness of certain Hotel Partnerships, the rental revenues received
by such Hotel Partnerships under certain Leases first will be used to
satisfy the debt service on such outstanding indebtedness with only the
cash flow remaining after debt service being available to satisfy other
obligations of the Hotel Partnership (including paying property taxes and
insurance, funding the required FF&E reserves for the Hotels and capital
improvements and paying debt service with respect to unsecured debt) and
to make distributions to holders of OP Units.
. Ownership Limitations. No person or group may own, actually or
constructively (as determined under the applicable Code provisions), (i)
in excess of 9.8% of the number or value of outstanding Common Shares of
Host REIT or (ii) in excess of 4.9% of the value of the OP Units (other
than Host REIT and The Blackstone Group), subject to waiver or
modification by Host REIT or the Operating Partnership, as the case may
be, in certain limited circumstances.
. Timing of the REIT Conversion. If the REIT Conversion does not occur in
time for Host REIT to elect REIT status effective January 1, 1999, the
effectiveness of Host REIT's election could be delayed to January 1,
2000, which would result in Host REIT continuing to pay corporate-level
income taxes in 1999 and could cause the Blackstone Acquisition not to be
consummated.
. Effect of Subsequent Events upon Recognition of Gain. Even though the
Desert Springs Limited Partners (other than those who elect to receive a
Note in exchange for OP Units) generally are not expected to recognize
significant taxable gain at the time of the Mergers, there are a variety
of events and transactions (including the sale of the Hotel currently
owned by Desert Springs or the reduction of indebtedness securing the
Hotel) that could cause a Desert Springs Limited Partner to recognize all
or a part of the gain that otherwise has been deferred through the REIT
Conversion. See "Federal Income Tax Consequences--Tax Treatment of Desert
Springs Limited Partners Who Hold OP Units Following
Desert Springs Supp-5
<PAGE>
the Merger." Certain Hotels (including the Blackstone Hotels) will be
covered by agreements with third parties which will restrict the Operating
Partnership's ability to dispose of those properties or refinance their
debt. In addition, if Atlanta Marquis participates in the Mergers, the
Operating Partnership will succeed to an existing agreement that will
restrict its ability to dispose of the Atlanta Marquis Hotel or to
refinance the debt secured by such Hotel without compensating certain
outside partners for the resulting adverse tax consequences. As for the
remaining initial properties (including the Hotel owned by Desert
Springs), the partnership agreement of the Operating Partnership, which is
substantially in the form attached to the Consent Solicitation as Appendix
A (the "Partnership Agreement"), does not impose any restrictions on the
Operating Partnership's ability to dispose of the Hotels or to refinance
debt secured by the Hotels (but the Operating Partnership is obligated to
pay any taxes Host REIT incurs as a result of any such transactions). In
addition, the Partnership Agreement provides that Host REIT, as general
partner of the Operating Partnership, is not required to take into account
the tax consequences of the limited partners in deciding whether to cause
the Operating Partnership to undertake specific transactions (but the
Operating Partnership is obligated to pay any taxes that Host REIT incurs
as a result of any such transaction) and the limited partners have no
right to approve or disapprove such transactions. See "Description of OP
Units--Sales of Assets."
. Election to Exchange OP Units for Notes. A Desert Springs Limited Partner
who elects to receive a Note in connection with the Merger in exchange
for his OP Units will be treated as having made a taxable disposition of
his Partnership Interest. A Desert Springs Limited Partner who receives a
Note may be eligible to defer at least a small portion, but not all, of
that gain under the "installment sale" rules. A Desert Springs Limited
Partner with a "negative capital account" with respect to his Partnership
Interest who elects to receive a Note will recognize "phantom income" in
that amount at the time of the Merger in any event. See "Federal Income
Tax Consequences--Tax Treatment of Desert Springs Limited Partners Who
Exercise Their Right to Make the Note Election."
. Competition in the Lodging Industry. The profitability of the Hotels is
subject to general economic conditions, the management abilities of the
Managers (including primarily Marriott International), competition, the
desirability of particular locations and other factors relating to the
operation of the Hotels. The full-service segment of the lodging
industry, in which virtually all of the Hotels operate, is highly
competitive and the Hotels generally operate in geographical markets that
contain numerous competitors. The Hotels' success will be dependent, in
large part, upon their ability to compete in such areas as access,
location, quality of accommodations, room rate structure, the quality and
scope of food and beverage facilities and other services and amenities.
The lodging industry, including the Hotels (and thus the Operating
Partnership), may be adversely affected in the future by (i) national and
regional economic conditions, (ii) changes in travel patterns, (iii)
taxes and government regulations which influence or determine wages,
prices, interest rates, construction procedures and costs, (iv) the
availability of credit and (v) other factors beyond the control of the
Operating Partnership.
. Failure of Host REIT to Qualify as a REIT for Tax Purposes. Taxation of
Host REIT as a corporation if it fails to qualify as a REIT, and Host
REIT's subsequent liability for federal, state and local taxes on its
income and property, would, among other things, have the effect of
reducing cash available for distribution to Host REIT's shareholders and
materially reducing the value of the Common Shares and OP Units.
. Failure of the Operating Partnership to Qualify as a Partnership for Tax
Purposes. Taxation of the Operating Partnership as a corporation if it
fails to qualify as a partnership and the Operating Partnership's
subsequent liability for federal, state and local income taxes would,
among other things, have the effect of reducing cash available for
distribution to holders of OP Units, would cause Host REIT to fail to
qualify as a REIT for tax purposes and would cause the holders of OP
Units to recognize substantial taxable gain at the time the Operating
Partnership ceases to qualify as a partnership.
. Failure of the Leases to Qualify as Leases. If the lease of the Hotel to
the Lessee were to be disregarded for tax purposes (for example, because
the Lease was determined to lack economic substance), Host REIT could
fail to qualify as a REIT and the Operating Partnership might be treated
as a corporation for federal
Desert Springs Supp-6
<PAGE>
income tax purposes, which could have a material adverse impact on the
Desert Springs Limited Partners and the value of the OP Units.
. Change in Tax Laws. No assurance can be provided that new legislation,
Treasury Regulations, administrative interpretations or court decisions
will not significantly change the tax laws with respect to Host REIT's
qualification as a REIT or the federal income tax consequences of such
qualification.
. Desert Springs Limited Partners Need to Consult with Their Own Tax
Advisors. Because the specific tax attributes of a Desert Springs
Limited Partner and the facts regarding such Desert Springs Limited
Partner's interest in Desert Springs could have a material impact on the
tax consequences to such Desert Springs Limited Partner of the Merger,
the subsequent ownership and disposition of OP Units or Notes and/or the
subsequent ownership and disposition of Common Shares, it is essential
that each Desert Springs Limited Partner consult with his own tax
advisors regarding the application of federal, foreign and state and
local tax laws to such Desert Springs Limited Partner's personal tax
situation.
. Effect of Possible Classification as a Publicly Traded Partnership on
Passive Losses. There is a significant possibility that the Operating
Partnership could be classified as a "publicly traded partnership," in
which event the Desert Springs Limited Partners would not be able to use
suspended passive activity losses from other investments (including from
Desert Springs) to offset income from the Operating Partnership. It is
estimated that each Desert Springs Limited Partner who purchased his
Partnership Interest at the time of the original offering of such
Interests, has held such Partnership Interest continuously since that
time and whose Partnership Interest has been his only investment in a
passive activity would have a passive activity loss carryforward as of
December 31, 1998.
. Host's Substantial Deferred Tax and Contingent Liabilities. Host will
have substantial deferred tax liabilities that are likely to be
recognized in the next ten years (notwithstanding Host REIT's status as a
REIT), and the IRS could assert substantial additional liabilities for
taxes against Host for taxable years prior to the time Host REIT
qualifies as a REIT. Under the terms of the REIT Conversion and the
Partnership Agreement, the Operating Partnership will be responsible for
paying (or reimbursing Host REIT for the payment of) all such tax
liabilities as well as any other liabilities (including contingent
liabilities and liabilities attributable to litigation that Host REIT may
incur) whether such liabilities are incurred by reason of Host's
activities prior to the REIT Conversion or the activities of Host REIT
subsequent thereto.
Because REITs are not permitted under current federal income tax law to
derive revenues directly from the operation of hotels, the Operating
Partnership will lease the Hotels to lessees (the "Lessees") that will operate
the Hotels under the existing management agreements and pay rent to the
Operating Partnership, as more fully described herein. The Lessees generally
will be indirect controlled subsidiaries of HMC Senior Communities, Inc.
("SLC"), which currently is a wholly owned subsidiary of Host. SLC will become
a separate public company when Host distributes the common stock of SLC and
other consideration to its existing shareholders and the Blackstone Entities
in connection with Host's distribution of its accumulated earnings and
profits, which Host REIT is required to do in order to qualify as a REIT.
Shares of Host REIT and SLC will become separately traded securities and the
companies will operate independently. There will be no overlap between the
boards of Host REIT and SLC. There will be a substantial overlap of
shareholders of the two companies initially, but this likely will diverge over
time.
MARRIOTT DESERT SPRINGS CORPORATION (THE "GENERAL PARTNER"), THE GENERAL
PARTNER OF DESERT SPRINGS, BELIEVES THAT THE MERGER PROVIDES SUBSTANTIAL
BENEFITS AND IS FAIR TO THE DESERT SPRINGS LIMITED PARTNERS AND RECOMMENDS
THAT ALL DESERT SPRINGS LIMITED PARTNERS VOTE FOR THE MERGER.
The effects of the Merger may be different for Limited Partners of the
various Partnerships. This Supplement has been prepared to highlight for
Desert Springs Limited Partners the specific risks, benefits, effects and
fairness of the Merger to them and to provide other information specific to
Desert Springs. Supplements have also been prepared for each of the other
Partnerships. This Supplement, together with the supplements of the other
Partnerships (collectively, the "Supplements"), are part of the Consent
Solicitation. Upon receipt of a written request by a Limited Partner or his
representative so designated in writing, the General Partner will send a copy
of any Supplement without charge. All requests for a copy of a Supplement
should be directed to: Investor
Desert Springs Supp-7
<PAGE>
Relations, 10400 Fernwood Road, Bethesda, Maryland 20817, telephone number
301-380-2070 (between the hours of 9:00 a.m. and 4:00 p.m., eastern time).
All cross-references refer to the Consent Solicitation unless the context
indicates otherwise. Capitalized terms not defined herein shall have the
meaning set forth in the Consent Solicitation. The information contained
herein, unless otherwise indicated, assumes the REIT Conversion occurs with
all Partnerships participating and no Notes being issued (the "Full
Participation Scenario").
EXPECTED BENEFITS OF THE MERGER
The General Partner believes that participating in the Merger would likely
be beneficial to the Desert Springs Limited Partners for the reasons set forth
below. This information is qualified by and should be read in conjunction with
the information in the Consent Solicitation under "Background and Reasons for
the Mergers and the REIT Conversion--Reasons for the Mergers." These benefits,
which should be viewed as alternatives to continuing the business and
operations of Desert Springs, are expected to include:
. Exchange Value of Desert Springs. Desert Springs Limited Partners who
elect to retain OP Units in the Merger will receive OP Units with an
estimated Exchange Value equal to $40,880 per Partnership Unit.
. Enhanced Liquidity of Investment. The REIT Conversion will offer Desert
Springs Limited Partners significantly enhanced liquidity with respect
to their investments in Desert Springs because, commencing one year
following the Effective Date, Desert Springs Limited Partners who retain
OP Units will be able to exercise their Unit Redemption Right at any
time, subject to certain limited exceptions. Host has approximately 204
million shares of common stock outstanding and is expected to have a
total common equity market capitalization of approximately $ billion
after giving effect to the estimated $ million earnings and profits
distribution (based on Host's $ closing price per share on the NYSE on
, 1998). The exercise of the Unit Redemption Right, however,
generally would result in recognition of taxable income or gain at that
time.
. Public Market Valuation of Assets. The Partnership Units of Desert
Springs currently trade at a discount to the net asset value of Desert
Springs' assets. In contrast, the General Partner believes that by
exchanging interests in Desert Springs, which is a non-traded, finite-
life limited partnership with a fixed portfolio for interests in an
infinite-life publicly traded real estate company focused primarily on a
more diverse and growing full-service hotel portfolio and providing
valuation based upon publicly traded Common Shares of Host REIT, the
Desert Springs Limited Partners will have the opportunity to participate
in the recent trend toward ownership of real estate through a publicly
traded entity, which, in many instances, has resulted in market
valuations of public real estate companies in excess of the estimated
net asset values of those companies. There can be no assurance, however,
that the Common Shares of Host REIT will trade at a premium to the
private market values of the Operating Partnership's assets or that the
relative pricing differential will not change or be eliminated in the
future. Also, the benefit of Host's conversion to a REIT will not be
shared by the Desert Springs Limited Partners if and to the extent that
such benefit is reflected in the market valuation of Host's common stock
prior to the REIT Conversion.
. Regular Quarterly Cash Distributions. The General Partner expects that
the Operating Partnership will make regular quarterly cash distributions
to holders of OP Units. The General Partner expects that these
distributions will be higher than the estimated cash distributions for
1998 of Desert Springs and, in any event, the ability to receive
distributions quarterly and in regular amounts would be enhanced. For
additional information regarding historical and estimated future
distributions for Desert Springs and the other Partnerships, see
"Background and Reasons for the Mergers and the REIT Conversion --
Reasons for the Mergers."
. Substantial Tax Deferral. The General Partner expects that Desert
Springs Limited Partners who do not elect to receive a Note in exchange
of OP Units generally should be able to obtain the benefits of the
Merger while continuing to defer recognition for federal income tax
purposes of at least a substantial portion, if not all, of the gain with
respect to their Partnership Interests that otherwise would be
recognized in the event of a liquidation of Desert Springs or a sale or
other disposition of its assets
Desert Springs Supp-8
<PAGE>
in a taxable transaction. Thereafter, such Desert Springs Limited
Partners generally should be able to defer at least a substantial
portion of such built-in gain until they elect to exercise their Unit
Redemption Right or the Hotel currently owned by Desert Springs is sold
or otherwise disposed of in a taxable transaction by the Operating
Partnership or the debt now secured by such Hotel is repaid, prepaid or
substantially reduced. The federal income tax consequences of the Merger
are highly complex and, with respect to each Desert Springs Limited
Partner, are dependent upon many variables, including the particular
circumstances of such Desert Springs Limited Partner. See "Federal
Income Tax Consequences--Tax Consequences of the Merger." Each Desert
Springs Limited Partner is urged to consult with his own tax advisors as
to the consequences of the Merger in light of his particular
circumstances.
. Risk Diversification. Participation in the Merger, as well as future
hotel acquisitions by the Operating Partnership, will reduce the
dependence of Desert Springs Limited Partners upon the performance of,
and the exposure to the risks associated with, Desert Springs' Hotel and
spread such risk over a broader and more varied portfolio, including
more diverse geographic locations and multiple brands. See "Business and
Properties--Business Objectives."
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a significantly lower leverage to value
ratio than Desert Springs currently, which has a leverage ratio of 81%
(calculated as a percentage of Appraised Value), resulting in
significant interest and debt service savings and greater financial
stability.
. Growth Potential. The General Partner believes that the Desert Springs
Limited Partners, by owning interests in a publicly traded real estate
company focused primarily on a more diverse and growing upscale and
luxury full-service hotel portfolio, will be able to participate in
growth opportunities that would not otherwise be available to them.
. Greater Access to Capital. With publicly traded equity securities, a
larger base of assets and a substantially greater equity value than
Desert Springs individually, Host REIT expects to have greater access to
the capital necessary to fund the Operating Partnership's operations and
to consummate acquisitions on more attractive terms than would be
available to Desert Springs individually. This greater access to capital
should provide greater financial stability to the Operating Partnership
and reduce the level of risk associated with refinancing existing loans
upon maturity, as compared to Desert Springs individually.
If Desert Springs does not participate in the Merger, its business will
continue in the same manner; however, the Operating Partnership may elect to
contribute some or all of its interests in Desert Springs to a Non-Controlled
Subsidiary.
DETERMINATION OF EXCHANGE VALUE OF DESERT SPRINGS AND ALLOCATION OF OP UNITS
GENERAL. The Exchange Value of Desert Springs will be equal to the greatest
of its Adjusted Appraised Value, Continuation Value and Liquidation Value,
each of which has been determined as follows:
. Adjusted Appraised Value. The General Partner has retained AAA to
determine the market value of the Hotel as of March 1, 1998 (the
"Appraised Value"). The "Adjusted Appraised Value" of Desert Springs
equals the Appraised Value of its Hotel, adjusted as of the Final
Valuation Date for lender reserves, capital expenditure reserves,
existing indebtedness (including a "mark to market" adjustment to
reflect the market value of such indebtedness), certain deferred
maintenance costs, deferred management fees and transfer and recordation
taxes and fees.
. Continuation Value. The "Continuation Value" of Desert Springs
represents AAA's estimate, as adopted by the General Partner, of the
discounted present value, as of January 1, 1998, of the Desert Springs
limited partners' share of estimated future cash distributions and
estimated net sales proceeds (plus lender reserves), assuming that
Desert Springs continues as an operating business for twelve years and
its assets are sold on December 31, 2009 for their then estimated market
value.
. Liquidation Value. The "Liquidation Value" of Desert Springs represents
the General Partner's estimate of the net proceeds to Desert Springs
limited partners resulting from the assumed sale as of December 31, 1998
of the Hotel of Desert Springs, at its Adjusted Appraised Value (after
eliminating
Desert Springs Supp-9
<PAGE>
any "mark to market" adjustment and adding back the deduction for
transfer and recordation taxes and fees, if any, made in deriving the
Adjusted Appraised Value), less (i) estimated liquidation costs,
expenses and contingencies equal to 2.5% of Appraised Value and (ii)
prepayment penalties or defeasance costs, as applicable.
Final determination of the Exchange Value of Desert Springs will be made as
of the end of the four week accounting period ending at least 20 days prior to
the Effective Date (the "Final Valuation Date") and will be equal to the
greatest of Adjusted Appraised Value, Continuation Value and Liquidation Value
as of such date. Adjusted Appraised Value, Continuation Value and Liquidation
Value will be adjusted as of the Final Valuation Date (i) to reflect the
amount of lender and capital expenditure reserves and the amount of deferred
management fees as of such date, (ii) to increase the Adjusted Appraised Value
by any amounts actually expended by Desert Springs after the Initial Valuation
Date to perform deferred maintenance that were previously subtracted in
determining the estimated Adjusted Appraised Value of Desert Springs and (iii)
to reflect any changes in Desert Springs' other reserves, such as for
litigation expenses and indemnification costs and any revised estimates of
transfer and recordation taxes and fees.
APPRAISED VALUE. Desert Springs' Hotel was appraised as of March 1, 1998 by
AAA, an independent, nationally recognized hotel valuation and financial
advisory firm experienced in the appraisals of lodging properties such as
Desert Springs' Hotel. The appraisal (an "Appraisal") was reviewed by a Member
Appraisal Institute ("MAI") appraiser and certified by such MAI appraiser as
having been prepared in accordance with the requirements of the Standards of
Professional Practice of the Appraisal Institute and the Uniform Standards of
Professional Appraisal Practice of the Appraisal Foundation.
The purpose of the Appraisal is to provide an estimate of the "Market Value"
of the Hotel. "Market Value" means the most probable price which a property
should bring in a competitive and open market under all conditions requisite
to a fair sale, the buyer and seller each acting prudently and knowledgeably
and assuming the price is not affected by undue stimuli. Implicit in this
definition is the consummation of a sale as of a specified date and the
passing of title from seller to buyer under conditions whereby: (i) the buyer
and seller are equally motivated; (ii) both parties are well informed or well
advised and each is acting in what he considers his own best interest; (iii) a
reasonable time frame is allowed for exposure in the open market; (iv) payment
is made in terms of cash in U.S. dollars or in terms of financial arrangements
comparable thereto and (v) the price represents the normal consideration for
the property sold unaffected by special or creative financing or sales
concessions granted by anyone associated with the sale. AAA made a site visit
at Desert Springs' Hotel for purposes of the Appraisal.
In preparing the Appraisal, AAA relied primarily on the income
capitalization method of valuation, and then compared the value estimated by
this method with recent sales of comparable properties, as a check on the
reasonableness of the value determined through the income capitalization
method. AAA employed the following procedures for determining the Appraised
Value of Desert Springs' Hotel:
. Historical 1997 and Projected Year's Earnings. AAA reviewed the
historical 1997 net operating income (i.e., income before interest,
taxes, depreciation and amortization) ("NOI") prior to incentive
management fees and certain capital expenditures for the Hotel. AAA also
prepared a projection of the net operating income prior to incentive
management fees and certain capital expenditures for the Hotel for the
twelve month period ending February 28, 1999 (the "Projected Year"),
using historical financial information for the Hotel, budget
information, a survey with the manager of the Hotel addressing the
physical condition of the Hotel, local market conditions (including
business mix, demand generators, future trends and predictability of
business), changes in the competitive environment, comparison with
direct competitors of the Hotel and risk factors relating to the Hotel.
The resulting gross margin (ratio of total revenues to NOI prior to
incentive management fees) was checked against AAA's database of the
gross margins for similar hotels for reasonableness.
. Impact of Incentive Management Fees. AAA estimated a normalized annual
amount of incentive management fees payable under the applicable
management agreement and subtracted this amount from the net operating
income prior to incentive management fees and certain capital
expenditures for 1997 and the Projected Year.
Desert Springs Supp-10
<PAGE>
. Impact of Owner Funded Capital Expenditures. AAA estimated normalized
annual amounts of owner funded capital expenditures (over and above the
FF&E reserve) based in part on projected owner funded capital
expenditures estimated in the Engineering Study, including, in the case
of Desert Springs, certain identified 1998 capital expenditures for
which reserves have been set aside. The normalized amounts were then
subtracted from the NOI prior to owner funded capital expenditures for
1997 and the Projected Year.
. Capitalization of Adjusted NOI. AAA then capitalized the amount
resulting from the foregoing adjustments ("Adjusted NOI") for 1997 and
the Projected Year by dividing such amounts by capitalization rates that
AAA determined to be appropriate. A capitalization rate represents the
relationship between net operating income and sales prices of income
producing property. AAA selected the capitalization rates based upon its
review of current published surveys reflecting the opinions of investors
and participants such as REITs, hotel acquisition/management companies
and pension funds, lenders, brokers and consultants as to current
capitalization rates, and its own database of capitalization rates
reflected in recent transactions, adjusted for factors specific to the
Hotel, such as location, physical condition, reserve policies, local
market volatility and competition, guest mix, renovation influences and
other income characteristics. AAA used separate capitalization rates
that it deemed appropriate to capitalize 1997 historical Adjusted NOI
and estimated Projected Year's Adjusted NOI. AAA then estimated the
value of the Hotel based upon each of the values estimated by
capitalizing 1997 and Projected Year's Adjusted NOI and its professional
judgment. The following table sets forth the effective capitalization
rates for 1997 and Projected Year's Adjusted NOI resulting from AAA's
estimated Appraised Value of Desert Springs' Hotel.
RESULTING EFFECTIVE CAPITALIZATION RATES FOR APPRAISAL OF DESERT SPRINGS'
HOTEL
<TABLE>
<CAPTION>
1997 PROJECTED YEAR (ENDING FEBRUARY 28, 1999)
---- -----------------------------------------
<S> <C>
8.9%............................... 9.3%
</TABLE>
The resulting Appraised Value of Desert Springs' Hotel, as estimated by AAA,
is $223,800,000.
. Comparison with Comparable Sales. AAA checked the Appraised Value of the
Hotel derived by the foregoing procedures against its database of
comparable sale transactions for reasonableness.
The Appraised Value assumes all contractual provisions for FF&E reserves are
adequate and have not been reduced to reflect deferred maintenance or
environmental remediation costs with respect to Desert Springs' Hotel (but
estimated deferred maintenance costs have been deducted in estimating the
Adjusted Appraised Value of Desert Springs' Hotel). The Appraised Value did
not take into account the costs that might be incurred in selling the Hotel
(but estimated costs for transfer and recordation taxes and fees have been
deducted in estimating the Adjusted Appraised Value of the Hotel).
The Appraisal is not a guarantee of present or future values and no
assurance can be given as to the actual value of Desert Springs' Hotel. The
Appraisal should be read in conjunction with other information, such as, but
not limited to, the audited financial statements of Desert Springs.
The Appraised Value, and the assumptions underlying the projections on which
the Appraised Value is based, are contingent upon a series of future events,
the outcomes of which are not necessarily within the Operating Partnership's
control and cannot be determined at this time. There can be no assurance that
another appraiser would not have arrived at a different result. Some of the
assumptions inevitably will not materialize and unanticipated events and
circumstances will occur subsequent to the date of the Appraisals.
Furthermore, the actual results achieved from Desert Springs' Hotel will vary
from the results projected in the Appraisal and the variations may be
material.
ADJUSTED APPRAISED VALUE. The Adjusted Appraised Value of Desert Springs was
determined by making various adjustments to the Appraised Value of Desert
Springs' Hotel, as described below.
. Lender Reserves. Desert Springs' debt service reserves are required to
be held by third-party lenders. The amount of these lender reserves as
of the Initial Valuation Date was added to the Appraised Value
Desert Springs Supp-11
<PAGE>
of the Hotel. A final determination of the lender reserves of Desert
Springs will be made on the Final Valuation Date and any changes in such
reserves will be reflected in the Adjusted Appraised Value.
. 1998 Capital Expenditure Reserves. For Desert Springs, an amount equal
to the capital expenditure reserves which were set aside as of March 1,
1998 for various identified capital improvements in 1998 (which amounts
resulted in reductions in the Appraised Value as described above) was
added back to the Appraised Value.
. Mortgage and Other Debt. The estimated principal balance and accrued
interest as of the Effective Date (assumed to be December 31, 1998) of
all mortgage and other debt of Desert Springs has been subtracted from
the Appraised Value.
. Mark to Market Adjustments. The third-party loans of the Partnerships
have various interest rates and terms to maturity. In order to reflect
the fair value of the third-party loans of Desert Springs, the estimated
Adjusted Appraised Value for Desert Springs has been increased to "mark
to market" the interest rate for such loans. This adjustment has been
estimated by comparing the interest cost using the applicable interest
rates on existing third-party loans over their remaining term to the
interest cost using the interest rate that the Operating Partnership
believes it would be able to obtain for unsecured debt in the market as
of the Final Valuation Date (which would have been % per annum based on
a 225 basis point (2.25 percent) spread over the yield on seven-year
U.S. Treasury securities as of , 1998). The mark to market adjustment
for each loan was calculated by determining the difference between the
present values, as of December 31, 1998, of the interest payments over
the remaining term of the loan from January 1, 1999 to maturity using
the actual interest rate as the discount rate as compared to using the
assumed market rate as the discount rate. In the case of the mezzanine
loan on Desert Springs, the adjustment reflects the prepayment penalty
that would be payable because it is less than the mark to market
adjustment.
. Deferred Maintenance Costs. The estimated cost to complete any deferred
maintenance items identified in the Engineering Study relating to Desert
Springs' Hotel have been subtracted from the Appraised Value. The
adjustments for this item will be reduced at the Final Valuation Date to
reflect amounts expended after the Initial Valuation Date to perform
such deferred maintenance. No adjustments have been made for previously
budgeted capital expenditures or deferred maintenance costs estimated in
the Engineering Study that are reflected in the cash flow projections
used for purposes of estimating Appraised Value.
The following table sets forth the adjustments to the Appraised Value made
to derive the estimated Adjusted Appraised Value for Desert Springs' Hotel as
of the Initial Valuation Date.
CALCULATION OF ESTIMATED ADJUSTED APPRAISED VALUE FOR DESERT SPRINGS
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................................................... $ 223,800
Lender reserves................................................... 6,173
Capital expenditure reserve....................................... 1,500
Mortgage debt..................................................... (101,632)
Other debt........................................................ (92,438)
Mark to market adjustment......................................... 411
Deferred maintenance costs........................................ (650)
---------
Estimated Adjusted Appraised Value................................ $ 37,164
=========
Limited partners' share........................................... $ 36,792
Per Partnership Unit.............................................. $ 40,880
</TABLE>
Desert Springs Supp-12
<PAGE>
CONTINUATION VALUE. AAA estimated the Continuation Value of Desert Springs
using the following methodology:
. Estimated Future Cash Distributions. AAA prepared estimates of future
partnership cash flow for Desert Springs for the 12-year period from
January 1, 1998 through December 31, 2009 based upon the estimated 1998
NOI before incentive management fees used in the Appraisal and for each
subsequent year applying an assumed annual stabilized growth rate (as
shown in the table below) developed by AAA for this analysis. For each
year in the projection period, AAA estimated the amount of cash
available for distribution to Desert Springs' limited partners after
payment of all management fees, debt service, owner funded capital
expenditures based on the Engineering Study and other partnership
expenses and after application of the applicable partnership agreement
provisions. AAA assumed that Desert Springs' FF&E reserve was adequate
and understood that Host determined that there were no reserve
shortfalls or surpluses.
. Determination of Residual Value. To estimate the residual value of the
Desert Springs limited partners' interest in Desert Springs at the end
of the 12-year period, AAA assumed that the Desert Springs Hotel would
be sold as of December 31, 2009 at its then market value. AAA estimated
the market value of the Hotel as of such date by applying an exit
capitalization rate that it deemed appropriate, using the factors
described above in connection with the "--Appraised Value," which are
set forth in the table below, to the estimated Adjusted NOI for 2009
(estimated as described above). AAA then subtracted estimated sales
costs of 2.0% of the estimated market value, added lende r reserves
and subtracted the estimated outstanding principal balance of debt as of
December 31, 2009
and deferred management fees to arrive at net sales proceeds available
for distribution to partners. AAA then determined what portion of such
estimated net sales proceeds would be distributable to Desert Springs'
limited partners under the partnership and debt agreements.
. Discounting Distributions to Present Value. As a final step, AAA
discounted the estimated future cash distributions to Desert Springs'
limited partners from operations and estimated net sales proceeds to
their present value as of January 1, 1998, using a discount rate of 20%
per annum. AAA believes that this discount rate reflects the return on
investment that investors expect from leveraged investments of this
nature.
The growth rate and exit capitalization rate used to determine the estimated
Continuation Value for Desert Springs are as set forth below:
GROWTH RATE, EXIT CAPITALIZATION RATEAND ESTIMATED CONTINUATION VALUE FOR
DESERT SPRINGS
<TABLE>
<CAPTION>
ESTIMATED
CONTINUATION VALUE
GROWTH RATE EXIT CAPITALIZATION RATE (2009) (PER PARTNERSHIP UNIT)
----------- ------------------------------- ----------------------
<S> <C> <C>
4.50% 9.66% $33,536
</TABLE>
LIQUIDATION VALUE. The Liquidation Value of Desert Springs was estimated by
the General Partner and represents the estimated value of Desert Springs if
all of its assets were sold as of December 31, 1998. Such value was based upon
the Adjusted Appraised Value of Desert Springs, with the following
adjustments: (i) the "mark to market" adjustment used to estimate the Adjusted
Appraised Value was eliminated and instead prepayment or defeasance costs that
would be payable under existing debt agreements (regardless of whether the
debt in fact can be prepaid on December 31, 1998) were deducted from the
Appraised Value; (ii) the deduction for transfer and recordation taxes and
fees used to estimate the Adjusted Appraised Value was eliminated and instead
an amount equal 2.5% of the Appraised Value of Desert Springs' Hotel was
subtracted from the Appraised Value for estimated liquidation costs, expenses
and contingencies; and (iii) the amount of participating interest payable on
the Desert Springs subordinated loan held by Host was deducted from the
Appraised Value to reflect the net proceeds available to partners of Desert
Springs. The General Partner then determined the portion of the estimated
Liquidation Value that would be distributable to Desert Springs' limited
partners under the terms of the partnership agreement and other contractual
arrangements.
Desert Springs Supp-13
<PAGE>
The following table sets forth the adjustments made to the Adjusted
Appraised Value to estimate the Liquidation Value of Desert Springs as of the
Initial Valuation Date:
CALCULATION OF ESTIMATED LIQUIDATION VALUE OF DESERT SPRINGS AS OF THE INITIAL
VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................................................... $ 223,800
Lender reserves................................................... 6,173
Capital expenditure reserve....................................... 1,500
Mortgage debt..................................................... (101,632)
Other debt........................................................ (89,669)
Prepayment/defeasance costs....................................... (8,821)
Deferred maintenance costs........................................ (650)
Sales costs....................................................... (5,595)
---------
Estimated Liquidation Value....................................... $ 25,106
=========
Limited partners' share........................................... $ 24,855
Per Partnership Unit.............................................. $ 27,617
</TABLE>
ESTIMATED EXCHANGE VALUE. The following table sets forth the estimated
Exchange Value of Desert Springs (based upon the greatest of its estimated
Adjusted Appraised Value, estimated Continuation Value and estimated
Liquidation Value), the estimated minimum and pro forma number of OP Units to
be received and the estimated Note Election Amount for Desert Springs, all on
a per Partnership Unit basis as of the Initial Valuation Date. The estimated
Exchange Value for Desert Springs will be received by each Desert Springs
Limited Partner retaining OP Units in the Merger. The estimated Note Election
Amount for Desert Springs (which will be received by Desert Springs Limited
Partners electing to receive Notes in exchange for OP Units) is equal to the
Liquidation Value for Desert Springs. The estimated values set forth below may
increase or decrease as a result of various adjustments, which will be finally
calculated as of the Final Valuation Date but will not change as a result of
less than all of the Partnerships participating in the Mergers. The actual
number of OP Units to be received by the Desert Springs Limited Partners will
be based on the average closing price on the NYSE of a Host REIT Common Share
for the 20 trading days after the Effective Date.
ESTIMATED EXCHANGE VALUE,
NUMBER OF OP UNITS AND NOTE ELECTION AMOUNT
OF DESERT SPRINGS PER PARTNERSHIP UNIT(1)
<TABLE>
<CAPTION>
ESTIMATED ESTIMATED
ESTIMATED ESTIMATED ESTIMATED ESTIMATED MINIMUM PRO FORMA ESTIMATED
ADJUSTED APPRAISED CONTINUATION LIQUIDATION EXCHANGE NUMBER OF NUMBER OF NOTE ELECTION
VALUE VALUE VALUE VALUE(2) OP UNITS(3) OP UNITS(4) AMOUNT(5)
------------------ ------------ ----------- --------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
$40,880 $33,536 $27,617 $40,880 2,044 $27,617
</TABLE>
- --------
(1) A Partnership Unit in Desert Springs represents an original investment of
$100,000.
(2) The estimated Exchange Value is equal to the greatest of estimated
Adjusted Appraised Value, estimated Continuation Value and estimated
Liquidation Value.
(3) Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Merger.
(4) Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
(5) The principal amount of Notes is equal to the greater of (i) the
Liquidation Value or (ii) 60% of the Exchange Value (the "Note Election
Amount").
Desert Springs Supp-14
<PAGE>
Price of OP Units to Pay Exchange Value to Desert Springs Limited
Partners. Each Desert Springs Limited Partner will receive OP Units with a
deemed value equal to the Exchange Value of such Desert Springs Limited
Partner's Partnership Interests. The price of an OP Unit for this purpose will
be equal to the average closing price on the NYSE of a Host REIT Common Share
for the 20 trading days after the Effective Date of the Mergers (but in no
event greater than $ per Share). The closing price per share of Host common
stock on the NYSE was $ , on , 1998.
Desert Springs Limited Partners at the Effective Date of the Merger who
retain OP Units will receive cash distributions from Desert Springs for all of
1998 and, if the Merger does not occur in 1998, any portion of 1999 prior to
the Merger for which period they do not receive a cash distribution from the
Operating Partnership. Cash distributions will be made by Desert Springs in
accordance with its partnership agreement on or before June 1, 1999 in respect
of 1998 operations and, if the Merger does not occur prior to January 1, 1999,
within 90 days after the Effective Date of the Merger in respect of any 1999
operations. Desert Springs Limited Partners at the Effective Date of the
Merger who receive Notes in exchange for OP Units will participate in the same
distributions from Desert Springs as Limited Partners who retain OP Units but
will not receive any distributions from the Operating Partnership with respect
to periods after the Effective Date of the Merger.
No fractional OP Units will be issued. Fractional amounts less than or equal
to 0.50 of an OP Unit will be rounded down to the next whole number and
fractional amounts greater than 0.50 will be rounded up to the next whole
number of OP Units.
VALUATION OF THE GENERAL PARTNER'S INTEREST IN DESERT SPRINGS AND ALLOCATION
OF OP UNITS TO THE GENERAL PARTNER
The value of the General Partner's interest will be equal to the aggregate
Exchange Value of Desert Springs minus the aggregate Exchange Value of the
Desert Springs Limited Partners' Partnership Interests (giving effect to the
applicable distribution preferences in the Desert Springs partnership
agreement). The number of OP Units that will be received by the General
Partner will be equal to the value of its interest in Desert Springs divided
by the same price per OP Unit used to determine the number of OP Units to be
received by the Desert Springs Limited Partners. The total number of OP Units
that will be owned directly or indirectly by Host REIT (including OP Units
owned by the General Partner) will be equal to the number of outstanding
shares of common stock of Host at the Effective Date.
The following table sets forth the estimated value of the General Partner's
interest in Desert Springs based upon the estimated aggregate Exchange Value
of the Desert Springs Limited Partners' Partnership Interests as of the
Initial Valuation Date and the minimum and pro forma number of OP Units
estimated to be received by the the General Partner in respect thereof.
ESTIMATED VALUE OF THE GENERAL PARTNER'S INTEREST AND NUMBER OF OP UNITS
(DOLLARS IN THOUSANDS)
<TABLE>
<S> <C>
Aggregate Exchange Value............................................... $37,164
Limited partners' share of aggregate Exchange Value.................... 36,792
-------
Value of General Partner's interest.................................... 372
Total Host interest.................................................... $ 372
=======
Number of OP Units:
Minimum(1)............................................................ --
Pro Forma(2).......................................................... 19
</TABLE>
- --------
(1)Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Mergers.
(2)Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
Desert Springs Supp-15
<PAGE>
CASH DISTRIBUTIONS
Historical Cash Distributions Paid by Desert Springs. The following table
sets forth the distributions paid to Desert Springs Limited Partners (per
Partnership Unit) during the periods indicated. The information below should
be read in conjunction with the information in this Supplement under the
caption "Selected Financial Data."
HISTORICAL CASH DISTRIBUTIONS PAID BY DESERT SPRINGS(PER PARTNERSHIP UNIT)(1)
<TABLE>
<CAPTION>
FISCAL YEAR
FIRST TWO QUARTERS ----------------------------------------
1998 1997 1996 1995 1994 1993
------------------ -------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
From net income......... $2,500 $ -- $ 1,702 $ 5,577 $ 4,404 $ 5,498
Representing return of
capital(2)............. -- 25,000 -- -- -- --
------ -------- ------- ------- ------- -------
Total................. $2,500 $ 25,000 $ 1,702 $ 5,577 $ 4,404 $ 5,498
====== ======== ======= ======= ======= =======
</TABLE>
- --------
(1) A Partnership Unit represents a $100,000 original investment in Desert
Springs.
(2) Computed as all distributions in excess of distributions from operating
cash flow.
Compensation and Distributions to the General Partner. Under Desert
Springs' partnership agreement, the General Partner does not receive fees or
compensation in connection with managing the affairs of Desert Springs but the
General Partner and its affiliates are reimbursed for certain costs and
expenses incurred on behalf of Desert Springs. In addition, the General
Partner is entitled to distributions related to its interests in Desert
Springs. The following information has been prepared to compare the amount of
reimbursements paid and cash distributions made by Desert Springs to the
General Partner and its affiliates to the amounts that would have been paid if
the reimbursement and distribution structure which will be in effect after the
REIT Conversion had been in effect for the periods presented.
Following the REIT Conversion, Host REIT will be operated as a self-
administered REIT and as a result no reimbursements or other compensation will
be received by the General Partner.
During the First Two Quarters 1998 and fiscal years 1997, 1996 and 1995,
amounts actually paid by Desert Springs to the General Partner are shown below
under "Historical" and the estimated amounts that would have been paid had the
REIT Conversion been in effect for the periods presented, assuming the Full
Participation Scenario, are shown under "Pro Forma" and assuming a
distribution per OP Unit of $1.05 per year during such period, which is the
midpoint of the expected distribution range for 1999.
HISTORICAL AND PRO FORMA REIMBURSEMENTS AND DISTRIBUTIONS TO THE GENERAL
PARTNER AND ITS AFFILIATES
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS FISCAL YEAR FISCAL YEAR
1998 1997 1996 1995
---------------- ---------------- ---------- ----------
PRO PRO
HISTORICAL FORMA HISTORICAL FORMA HISTORICAL HISTORICAL
---------- ----- ---------- ----- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Reimbursements(1)....... $ 281 $ -- $273 $ -- $250 $ 67
Interest on Host
Marriott Junior Loan... 776 -- -- -- -- --
Distributions(2)........ 23 10 227 20 15 51
------ ----- ---- ----- ---- ----
Total .............. $1,080 $ 10 $500 $ 20 $265 $118
====== ===== ==== ===== ==== ====
</TABLE>
- --------
(1) All expenses will be paid directly by the Operating Partnership,
accordingly, there are no expected reimbursements on a pro forma basis.
(2) The amount of distributions payable to the General Partner and its
affiliates on a pro forma basis reflect distributions at a rate of $1.05
per annum per OP Unit (which is the midpoint of the expected range of
distributions per OP Unit for 1999) with respect to the estimated number
of OP Units that the General Partner and its affiliates will receive with
respect to their general and limited partner interests in Desert Springs.
Such number does not reflect the aggregate number of OP Units Host will
receive in connection with the REIT Conversion.
Desert Springs Supp-16
<PAGE>
CERTAIN INFORMATION REGARDING THE HOTEL OWNED BY DESERT SPRINGS
<TABLE>
<CAPTION>
NAME OF HOTEL LOCATION OF HOTEL NUMBER OF ROOMS DATE OPENED
- ------------- ----------------- --------------- -----------
<S> <C> <C> <C>
Marriott's Desert Springs Resort
and Spa........................ Palm Desert, CA 884 1987
</TABLE>
The table below sets forth certain performance information for Desert
Springs' Hotel for the indicated periods.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
-------------------- ----------------------------
1998 1997 1997 1996 1995
--------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Average daily rate........... $214.47 $197.55 $ 169.55 $ 158.15 $ 150.34
Occupancy.................... 79.7% 78.6% 73.00% 71.40% 68.90%
REVPAR....................... $170.93 $155.27 $ 123.77 $ 112.92 $ 103.58
% REVPAR change.............. 10.00% -- 9.60% 9.00% --
</TABLE>
Marriott's Desert Springs Resort and Spa is a full-service Marriott hotel
and, including the second golf course, is located on approximately 185 acres
of land. It is located approximately 11 miles from the Palm Springs Airport
and two hours east of Los Angeles.
The Hotel opened on February 2, 1987. The Hotel consists of 884 large guest
rooms including 65 luxury suites. Each room has a private balcony, mini-bar
and other deluxe accommodations. The Hotel has an 18-hole championship golf
course owned by the Partnership, with an additional 18-hole course which is
leased by the Partnership. Twenty-three acres of man-made lakes are
interspersed throughout the resort grounds and lower level of the Hotel's main
lobby. Boats depart from inside the main lobby and carry guests to the various
resort functions. There are a total of five outdoor pools divided between
three guest areas. The main guest pool area, the Oasis, was expanded during
1995 and now has three pools and two spas, and the Spring Pool and Health Spa
areas each have one pool and one spa. The tennis complex includes a separate
tennis pro shop building, 20 tennis courts of various surfaces and badminton
and volleyball courts. The health spa is housed in a separate one-story
building. Within the health spa are separate men's and women's facilities, lap
pool, hot and cold plunge pools, saunas, steam rooms, aerobics and exercise
rooms, lounge and locker rooms. Food and beverage services within the resort
include four fine dining restaurants that range from casual American to
Japanese sushi and overlook the water. Additionally, there are two
grille/snack bars at the outdoor pools, two golf club snack bars, lobby
lounge, coffee bar and entertainment lounge. The 40,000 square foot lobby has
an eight-story high view of the nearby mountains. The Hotel has a three-story
garage with parking for approximately 1,500 vehicles. The meeting and exhibit
spaces total 51,300 square feet of flexible space with 33 meeting rooms,
including the 25,000 square foot "Desert" ballroom and the 21,000 square foot
"Springs" ballroom.
LEGAL PROCEEDINGS
The Partnership and the Hotel are involved in routine litigation and
administrative proceedings arising in the ordinary course of business, some of
which are expected to be covered by liability insurance and which collectively
are not expected to have a material adverse effect on the business, financial
conditions or results of operations of the Partnership.
On March 16, 1998, limited partners in several partnerships, including
Desert Springs, sponsored by Host Marriott Corporation ("Host Marriott") filed
a lawsuit, styled Robert M. Haas, Sr. and Irwin Randolph Joint Tenants, et al.
v. Marriott International, Inc., et al., Case No. 98-CI-04092, in the 57th
Judicial District Court of Bexar County, Texas, alleging that the defendants
conspired to sell hotels to the partnerships for inflated prices
Desert Springs Supp-17
<PAGE>
and that they charged the partnerships excessive management fees to operate
the partnerships' hotels. The plaintiffs further allege, among other things,
that the defendants committed fraud, breached fiduciary duties and violated
the provisions of various contracts. The plaintiffs are seeking unspecified
damages. Although the partnerships have not been named as defendants in the
lawsuit, the partnership agreements relating to the partnerships include an
indemnity provision which requires the partnerships, under certain
circumstances, to indemnify the general partners against losses, judgments,
expenses and fees. The defendants filed answers and defenses to the petition.
AMENDMENTS TO DESERT SPRINGS' PARTNERSHIP AGREEMENT
In order to allow the Hotel of Desert Springs to be leased to SLC in
connection with the Merger and the REIT Conversion, Desert Springs'
partnership agreement must be amended. Currently, there is no provision in
Desert Springs' partnership agreement to allow Desert Springs' Hotel to be
leased. Therefore, Section 5.02B of Desert Springs' partnership agreement must
be amended to add a new paragraph 5.02B(x) to read as follows:
(x) lease (or consent to the lease), directly or indirectly, in one
transaction or a series of related transactions, of the Hotel.
Other Amendments. Amendments to certain terms and sections of the Desert
Springs partnership agreement would be made in order to (i) reduce to one the
number of appraisals of the fair market value of Desert Springs' Hotel that
Desert Springs must provide to the Desert Springs Limited Partners before the
General Partner can cause Desert Springs to sell its assets to the General
Partner or an affiliate, (ii) delete certain obsolete references to entities
and agreements that are no longer in existence, (iii) update the Desert
Springs partnership agreement to reflect the passage of time since the
formation of Desert Springs and (iv) make any other amendments to the Desert
Springs partnership agreement deemed necessary or advisable, in the sole
discretion of the General Partner, in connection with the consummation of the
Merger and the REIT Conversion. The General Partner does not believe that
these amendments would affect the rights of the Desert Springs Limited
Partners in any material respect nor the duties and obligations of the General
Partner. These changes are included, along with the other proposed amendments,
in the copy of Desert Springs partnership agreement, as proposed to be
amended, which is attached hereto. The amended Desert Springs partnership
agreement is marked to indicate the revisions made to the existing Desert
Springs partnership agreement and should be read in its entirety. Deleted
provisions are contained in brackets and struck through and added provisions
are in bold type and underlined.
FAIRNESS ANALYSIS AND OPINION
FAIRNESS ANALYSIS
The General Partner believes that the Merger provides substantial benefits
and is fair to the Limited Partners of Desert Springs and recommends that all
Limited Partners of Desert Springs consent to the Merger. The General Partner
bases this recommendation primarily on (i) its view that the expected benefits
of the Merger for the Desert Springs Limited Partners outweigh the risks and
potential detriments of the Merger to the Desert Springs Limited Partners (see
"Background and Reasons for the Mergers and the REIT Conversion--Reasons for
the Mergers" and "Risk Factors"), (ii) its view that the value of the OP Units
allocable to the Desert Springs Limited Partners on the basis of the Exchange
Value established for Desert Springs represents fair consideration for the
Partnership Interests held by the Desert Springs Limited Partners and is fair
to the Desert Springs Limited Partners from a financial point of view and
(iii) the Appraisal and Fairness Opinion of AAA.
The Merger is not conditioned upon the consummation of any of the other
Mergers. The General Partner has considered this fact in evaluating the
fairness of the Merger. The General Partner believes that the fairness
Desert Springs Supp-18
<PAGE>
of the Merger will not be materially affected by the presence or absence of
any other individual Partnership or by any particular combination of other
Partnerships and that the Merger will be fair to the Desert Springs Limited
Partners, individually and as a whole, if it is consummated with any
combination of other Participating Partnerships. The General Partner bases
this belief primarily on the fact that the consideration to be paid to the
Desert Springs Limited Partners has been established based upon Desert
Springs' Exchange Value, without regard to any possible combination of other
Partnerships.
In reaching the conclusions implicit in the above recommendation, the
General Partner has taken into account the following considerations, placing
the greatest weight on the first two considerations:
. The General Partner has concluded that the Exchange Value for Desert
Springs, which is equal to its Adjusted Appraised Value, represents fair
consideration for the Partnership Interests of the Desert Springs
Limited Partners in the Merger in relation to Desert Springs. The
General Partner also has concluded that the Exchange Value established
for the Desert Springs Limited Partners fairly reflects the value of the
assets held by Desert Springs. In addition, the Fairness Opinion
supports these conclusions.
. Desert Springs Limited Partners will be able to defer recognition of
gain for tax purposes until such time as they choose to realize such
gain based on their own personal circumstances.
. The General Partner has concluded that the potential benefits of the
Merger to the Desert Springs Limited Partners, as described under
"Background and Reasons for the Mergers and the REIT Conversion--Reasons
for the Mergers," outweigh the potential risks and detriments of the
Merger for the Desert Springs Limited Partners, as described in "Risk
Factors."
. The Fairness Opinion, in the view of the General Partner, supports the
fairness of the Merger, even though it includes qualifications,
limitations and assumptions relating to its scope and other factors that
Desert Springs Limited Partners should consider carefully. The
availability of the Fairness Opinion is particularly significant in
light of the absence of arm's length negotiations in establishing the
terms of the Merger.
. Host will contribute its wholly owned full-service hotel assets,
substantially all of its interests in the Hotel Partnerships and its
other assets (excluding its senior living assets and the cash or
securities to be distributed to its shareholders) to the Operating
Partnership in exchange for (i) a number of OP Units equal to the number
of outstanding shares of common stock of Host, (ii) preferred
partnership interests in the Operating Partnership corresponding to any
shares of Host preferred stock outstanding at the time of the REIT
Conversion and (iii) the assumption by the Operating Partnership of all
liabilities of Host (including past and future tax liabilities), other
than liabilities of SLC. Following these contributions, the Operating
Partnership and its subsidiaries will directly own all of Host's wholly
owned hotels and all of Host's interests in the Hotel Partnerships and
Host's other assets. Host will receive OP Units in respect of its
general partner interests in Desert Springs on substantially the same
basis as the Partnership Units held by Desert Springs Limited Partners.
Host REIT will not receive any compensation for its services as general
partner to the Operating Partnership following the REIT Conversion and
will benefit from the operations of the Operating Partnership only to
the extent of the distributions received based upon its percentage
interest in the Operating Partnership to the same extent as the other
limited partners. Because Host REIT will share in the value of the
Operating Partnership solely through distributions and not through any
separate compensation structure, the General Partner believes that this
is a factor supporting the fairness of the Merger to the Desert Springs
Limited Partners.
. The General Partner believes that the value of the consideration to be
received by the Desert Springs Limited Partners in the Merger is fair in
relation to the value which would be derived by such Limited Partners
under any of the alternatives described under "Background and Reasons
for the Mergers and the REIT Conversion--Alternatives to the Mergers,"
especially since the Exchange Value of Desert Springs is equal to its
Adjusted Appraised Value, which is the greatest of the Adjusted
Appraised Value, the Continuation Value and the Liquidation Value. The
General Partner does not believe that the sale of Desert Springs' Hotel
and liquidation of Desert Springs will obtain for Desert Springs'
Desert Springs Supp-19
<PAGE>
Limited Partners as much value as the value to be received by such
Desert Springs Limited Partners following the Merger. The General
Partner believes that the following benefits are of the greatest value
and importance to the Desert Springs Limited Partners:
. Enhanced Liquidity. The Merger and the REIT Conversion will offer
Desert Springs Limited Partners significantly enhanced liquidity
with respect to their investment in Desert Springs because,
commencing one year following the Effective Date, Desert Springs
Limited Partners who retain OP Units will be able to exercise their
Unit Redemption Right at any time, subject to certain limited
exceptions. Host has approximately 204 million shares of common
stock outstanding and is expected to have a total common equity
market capitalization of approximately $ billion after giving
effect to the estimated $ million earnings and profits distribution
(based on Host's $ closing price per share on the NYSE on ,
1998). The exercise of the Unit Redemption Right, however, generally
would result in recognition of taxable income or gain at that time.
. Risk Diversification. Upon consummation of the REIT Conversion, each
Desert Springs Limited Partner's investment will be converted from
an investment in Desert Springs, which owns one hotel into an
investment in an enterprise that initially will own or control
approximately 120 Hotels and will have a total market capitalization
of approximately $ billion, thereby reducing the dependence upon
the performance of, and the exposure to the risks associated with,
the Hotel currently owned by Desert Springs and spreading such risk
over a broader and more varied portfolio, including more diverse
geographic locations and multiple brands.
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a significantly lower leverage to
value ratio than Desert Springs currently, which has a leverage
ratio of 81% (calculated as a percentage of Appraised Value),
resulting in significant interest and debt service savings and
greater financial stability.
. Regular Quarterly Cash Distributions. The General Partner expects
that the Operating Partnership will make regular quarterly cash
distributions to holders of OP Units. Host expects that these
distributions will be higher than the estimated cash distributions
for 1998 of Desert Springs and, in any event, the ability to receive
distributions quarterly and in regular amounts would be enhanced.
. Substantial Tax Deferral. The General Partner expects that Desert
Springs Limited Partners who do not elect to receive Notes in
exchange for OP Units generally should be able to obtain the
benefits of the Merger while continuing to defer recognition for
federal income tax purposes of at least a substantial portion, if
not all, of the gain with respect to their Partnership Interests
that otherwise would be recognized in the event of a liquidation of
Desert Springs or a sale or other disposition of its assets in a
taxable transaction.
. The General Partner believes that the economic terms of the lease of the
Desert Springs Hotel are fair and reasonable from the standpoint of the
Operating Partnership.
The General Partner believes that the factors described above, which support
the fairness of the Merger to the Desert Springs Limited Partners, when
weighed against the factors that may be disadvantageous, taken as a whole,
indicate that the Merger is fair to the Desert Springs Limited Partners.
FAIRNESS OPINION
AAA, an independent financial advisory firm with substantial real estate and
partnership transaction experience, was engaged by the General Partner and the
other General Partners to perform the Appraisals and to render the Fairness
Opinion that (i) the Exchange Value and the methodologies and underlying
assumptions used to determine the Exchange Value, the Adjusted Appraised
Value, the Continuation Value and the Liquidation Value of Desert Springs and
each other Partnership (including, without limitation, the assumptions used to
determine the various adjustments to the Appraised Values of the Hotels) are
fair and reasonable, from a financial
Desert Springs Supp-20
<PAGE>
point of view, to the Desert Springs Limited Partners and the Limited Partners
of each other Partnership and (ii) the methodologies used to determine the
value of an OP Unit and to allocate the equity in the Operating Partnership to
be received by the Desert Springs limited partners and the limited partners of
each other Partnership are fair and reasonable to the Desert Springs Limited
Partners and the Limited Partners of each other Partnership. The Fairness
Opinion is addressed to each Partnership and it may be relied upon by each of
the Desert Springs Limited Partners and the Limited Partners of each of the
other Partnerships. The full text of the Fairness Opinion, which contains a
description of the assumptions and qualifications applicable to the review and
analysis by AAA, is set forth in Appendix B to the Consent Solicitation and
should be read in its entirety. The material assumptions and qualifications to
the Fairness Opinion are summarized below, although this summary does not
purport to be a complete description of the various inquiries and analyses
undertaken by AAA in rendering the Fairness Opinion. Arriving at a fairness
opinion is a complex analytical process not necessarily susceptible to partial
analysis or amenable to summary description. For a more complete description
of the assumptions and qualifications that limit the scope of the Fairness
Opinion, see "--Qualifications to Fairness Opinion" and "--Assumptions" below.
Although the General Partner advised AAA that certain assumptions were
appropriate in its view, the General Partner imposed no conditions or
limitations on the scope of the investigation by AAA or the methods and
procedures to be followed by AAA in rendering the Fairness Opinion. The fees
and expenses of AAA will be treated as a Merger Expense and will be paid by
the Operating Partnership. In addition, the General Partner has agreed to
indemnify AAA against certain liabilities. See "--Compensation and Material
Relationships."
Qualifications to Fairness Opinion. In the Fairness Opinion, AAA
specifically states that it did not: (a) specifically consider other
methodologies for allocation of the OP Units, (b) address or conclude that
other methodologies for allocation of the OP Units to Desert Springs and the
other Partnerships might not have been more favorable to the Limited Partners
in certain of the Partnerships, (c) negotiate with the General Partner, the
General Partners of other Partnerships or Host, (d) participate in
establishing the terms of the Merger and the other Mergers, (e) provide an
opinion as to the terms and conditions of the Merger and the other Mergers
other than those explicitly stated in the Fairness Opinion, (f) make any
independent review of the capital expenditure estimates set forth in the
Engineering Study or (g) make any estimates of Desert Springs' and each other
Partnership's contingent liabilities. In addition, with respect to the
specific reference to the allocation of the equity interest in the Operating
Partnership to be received by the limited partners of each Partnership, AAA
has assumed that the average closing price on the NYSE of a Host REIT Common
Share for the 20 trading days after the Effective Date of the Mergers
represents a fair price.
In connection with preparing the Fairness Opinion, AAA was not engaged to,
and consequently did not, prepare any written report or compendium of its
analysis for internal or external use beyond the analysis set forth in
Appendix B. AAA will not deliver any additional written opinion of the
analysis, other than to update the written opinion if requested by the
Operating Partnership.
Experience of AAA. AAA is the world's largest independent valuation
consulting firm and is regularly and continually engaged in the valuation of
commercial real estate and businesses and their securities in connection with
tender offers, mergers and acquisitions, recapitalizations and
reorganizations, divestitures, employee stock ownership plans, leveraged
buyout plans, private placements, limited partnerships, estate and corporate
matters, other financial advisory matters and other valuation purposes.
AAA was selected because of its experience in the valuation of businesses
and their securities in connection with tender offers, mergers and
acquisitions, recapitalizations and reorganizations, including transactions
involving hotel partnerships. In addition, Host and its affiliates have
previously engaged AAA to provide appraisals and fairness opinions in
connection with other transactions. The General Partner and the other General
Partners considered two other firms for purposes of performing the appraisals
and rendering the Fairness Opinion and received proposals from each. The
General Partner selected AAA based upon price and experience.
Summary of Materials Considered and Investigation Undertaken. As a basis for
rendering the Fairness Opinion, AAA has made such reviews, studies and
analyses as it deemed necessary and pertinent in order to provide it with a
reasonable basis for the Fairness Opinion, including, but not limited to, the
following: (i) reviewed the transaction documents and SEC reporting and/or
filing documents, including drafts of the Form
Desert Springs Supp-21
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S-4 for the Mergers; (ii) provided the Market Value of each Hotel owned by
each Partnership in a separate short form appraisal report and each such
report was reviewed and certified by an MAI appraiser as to its preparation in
accordance with the requirements of the Standards of Professional Practice of
the Appraisal Institute and the Uniform Standards of Professional Appraisal
Practice of the Appraisal Foundation; as part of the Appraisals, AAA reviewed
historical operating statements, 1998 budget and year-to-date results, and
other financial information as it deemed necessary as a basis for the Fairness
Opinion and the Appraisals also considered market transactions of similar
lodging properties as appropriate as a basis for the Market Value of each
Hotel; (iii) reviewed the methodologies used by each of the General Partners
in their determination of the Exchange Value of each Partnership, including
the nature and amount of all adjustments to the Appraised Values in
determining such Exchange Values; AAA reviewed and tested for the fairness and
reasonableness of all adjustments as well as for consideration of all
adjustments deemed to be appropriate by AAA; (iv) reviewed the methodologies
used by each of the General Partners in their determination of the value of an
OP Unit and the allocation of the equity interest in the Operating Partnership
to be received by the partners of each Partnership, and AAA reviewed and
tested for the fairness and reasonableness of the methods and measurements
made by the General Partners; (v) reviewed the General Partners' determination
of the Liquidation Value of each Partnership, and AAA reviewed and tested for
the fairness and reasonableness of all adjustments proposed by the General
Partners, as well as for consideration of all adjustments deemed appropriate
by AAA; (vi) provided an estimate of the Continuation Value of each
Partnership based upon the estimated present value of expected benefits to be
received by each limited partner interest as though the Mergers did not occur
and each Partnership's assets were sold within a twelve year period; AAA, as
part of its analysis and review, determined appropriate rates of growth in
house profit or net operating income, as well as reviewed other key variables
affecting partnership cash flows and other economic/financial factors
affecting the Partnerships' expected operations and results; (vii) reviewed
the terms of the ground leases of the Hotels and the partnership agreement of
each Partnership; (viii) reviewed audited and unaudited historical income
statements, balance sheets and statements of sources and uses of funds of each
Partnership and Host and pro forma financial information for Host REIT; (ix)
reviewed audited and unaudited historical operating statements of each Hotel,
as well as current operating statements and budgets; (x) conducted real estate
valuation and financial due diligence with respect to the Partnerships and
their underlying assets, liabilities and equity; (xi) reviewed internal
Marriott International, Host and Partnership financial analyses and other
internally generated data for each Hotel and (xii) discussed all of the
foregoing information, where appropriate, with management of Marriott
International, Host and the Partnerships and their respective employees.
Assumptions. In rendering its opinion, AAA relied, without independent
verification, on the accuracy and completeness in all material respects of
certain relevant publicly available information and information provided to
AAA by Host and the Hotels. AAA assumed that all information furnished by
Host, the Hotels and the Partnerships and their representatives, upon which
AAA relied, presented an accurate description in all material respects of the
current and prospective status of the Hotels and the Partnerships from an
operational and financial point of view. AAA also noted that the Fairness
Opinion was based upon financial, economic, market and other considerations as
they existed and could be evaluated on the date thereof.
Conclusions. AAA concluded that, based upon and subject to its analysis and
assumptions and limiting conditions, and as of the date of the Fairness
Opinion: (i) the Exchange Value and the methodologies used to determine the
Exchange Value, the Adjusted Appraised Value, the Continuation Value and the
Liquidation Value each Partnership (including, without limitation, the
assumptions used to determine the various adjustments to the Appraised Values
of each of the Hotels) are fair and reasonable, from a financial point of
view, to the Desert Springs Limited Partners and the Limited Partners of each
other Partnership and (ii) the methodologies used to determine the value of an
OP Unit and to allocate the equity interest in the Operating Partnership to be
received by the Desert Springs limited partners and the limited partners of
each other Partnership are fair and reasonable to the Desert Springs Limited
Partners and the Limited Partners of each other Partnership.
Compensation and Material Relationships. AAA has been paid a fee of $335,000
for its services as described herein, including the Appraisals and preparing
to deliver the Fairness Opinion. In addition, AAA will
Desert Springs Supp-22
<PAGE>
be reimbursed for all reasonable out-of-pocket expenses, including legal fees
and will be indemnified against certain liabilities, including certain
liabilities under the securities laws. The fee was negotiated between Host,
the General Partners and AAA. Payment of the fee to AAA is not dependent upon
completion of the Mergers. AAA has been previously engaged by Host and its
affiliates to provide appraisals, fairness opinions and solvency opinions in
connection with other transactions.
VOTING PROCEDURES
A majority of the limited partner interests held by Limited Partners must be
present in person or by proxy for the vote to be recognized and a majority of
the limited partner interests actually voting on the Merger must vote for the
Merger to approve it.
A Desert Springs Limited Partner may mark the Consent Form to vote "FOR,"
"AGAINST" or "ABSTAIN" with respect to participation in the Merger by Desert
Springs. THE FAILURE OF A LIMITED PARTNER OF DESERT SPRINGS TO VOTE WILL MEAN
THAT SUCH LIMITED PARTNER'S PARTNERSHIP INTEREST WILL NOT BE COUNTED FOR
PURPOSES OF ESTABLISHING THE NUMBER OF LIMITED PARTNER INTERESTS REQUIRED TO
RECOGNIZE THE VOTE AND MAY AFFECT THE MANNER IN WHICH HOST IS REQUIRED TO VOTE
ITS LIMITED PARTNER INTERESTS. AN ABSTENTION OF A DESERT SPRINGS LIMITED
PARTNER WILL BE COUNTED FOR PURPOSES OF ESTABLISHING THE NUMBER OF LIMITED
PARTNER INTERESTS REQUIRED TO RECOGNIZE THE VOTE BUT WILL BE EFFECTIVELY
COUNTED AS A VOTE "AGAINST" THE MERGER. A CONSENT FORM THAT IS PROPERLY SIGNED
BUT NOT MARKED WILL BE VOTED FOR THE MERGER. The voting procedures applicable
to Desert Springs Limited Partners are set forth in the Consent Solicitation
under the heading "Voting Procedures--Required Vote and Other Conditions."
As of June 19, 1998, no person owned of record, or to the Partnership's
knowledge owns beneficially, more than 5% of the total number of limited
Partner Units.
FEDERAL INCOME TAX CONSEQUENCES
In addition to the federal income tax consequences discussed in the sections
of the Consent Solicitation entitled "Federal Income Tax Consequences" and
"Risk Factors--Federal Income Tax Risks," Desert Springs Limited Partners
should read carefully the following discussion of federal income tax
consequences applicable specifically to the Desert Springs Limited Partners.
The information included in this discussion is based upon various factual
assumptions and information which are believed by the Operating Partnership
and the General Partner to be reliable. However, some of these assumptions
inevitably will not materialize, and unanticipated events and circumstances
will occur. Therefore, there likely will be differences between the
information provided herein, including the numerical data and estimates, and
actual results, and the variations may be material and adverse.
Applicability of Tax Opinions
Hogan & Hartson L.L.P. ("Hogan & Hartson"), counsel to Host REIT, Host and
the Operating Partnership, has provided to Host REIT and the Operating
Partnership an opinion letter (substantially in the form of Appendix C to the
Consent Solicitation) as to certain federal income tax consequences to the
Operating Partnership and the Desert Springs Limited Partners resulting from
the Mergers and the REIT Conversion. The opinion letter is based upon certain
assumptions and certain representations provided by Host REIT, Host, the
Operating Partnership and the General Partners. These representations
generally involve factual matters relating to the organization, ownership and
operations (including the income, assets, businesses, liabilities and
properties) of the Partnerships and Hotels contributed to the Operating
Partnership by Host and the Blackstone Entities prior to the Mergers and the
REIT Conversion and of Host REIT, the Operating Partnership and the
Partnerships following the Mergers and the REIT Conversion. In addition, on
the Effective Date, Hogan & Hartson expects to provide to Host REIT and the
Operating Partnership an opinion letter (substantially in the form of Appendix
D to the Consent Solicitation) as to the qualification and taxation of Host
REIT as a REIT under the Code following the REIT Conversion. The receipt of
this opinion letter is a condition to the REIT Conversion and each of the
Mergers. See "Federal Income Tax Consequences--Summary of Tax Opinions" in the
Consent Solicitation.
Desert Springs Supp-23
<PAGE>
Each opinion provided by Hogan & Hartson in the opinion letter that is
substantially in the form of Appendix C to the Consent Solicitation is
applicable to the Desert Springs Limited Partners.
The opinions already rendered by Hogan & Hartson are based on the Code and
Treasury Regulations in effect on the date hereof, current administrative
interpretations and positions of the IRS and existing court decisions, and the
opinions to be rendered by Hogan & Hartson on the Effective Date will be based
on the same authorities as of the Effective Date. No assurance can be given
that future legislation, Treasury Regulations, administrative interpretations
and court decisions will not significantly change the law or the above
conclusions reached by counsel. In addition, any such change could apply
retroactively to transactions preceding the date of change. Moreover, opinions
of counsel merely represent counsel's best judgment with respect to the
probable outcome on the merits and are not binding on the IRS or the courts.
Accordingly, even if there is no change in applicable law, no assurance can be
provided that such opinions (which do not bind the IRS or the courts) will not
be challenged by the IRS or will be sustained by a court if so challenged.
With the one exception described below (see "--Tax Consequences of the
Merger--Deemed Cash Distribution and Resulting Taxable Gain") and in the
Consent Solicitation under "Federal Income Tax Consequences--Tax Consequences
of the Mergers--IRS Ruling Request Regarding Allocation of Partnership
Liabilities," neither Host REIT, the Operating Partnership nor the General
Partners have requested or plan to request any rulings from the IRS concerning
the tax consequences of the Mergers or the treatment of either the Operating
Partnership or Host REIT subsequent to the REIT Conversion.
Tax Consequences of the Merger
Overview. Hogan & Hartson has provided an opinion to the effect that the
Merger will not result in the recognition of taxable gain or loss at the time
of the Merger to a Desert Springs Limited Partner (i) who does not exercise
his Unit Redemption Right on a date sooner than the date two years after the
date of the consummation of the Merger; (ii) who does not receive a cash
distribution (or a deemed cash distribution resulting from relief from
liabilities, including as a result of any repayment of the GMAC Senior Loan or
the Goldman Sachs Mezzanine Loan) in connection with the Merger or the REIT
Conversion in excess of his aggregate adjusted basis in his Desert Springs
Partnership Units at the time of the Merger; (iii) who does not elect to
receive a Note in exchange for his OP Units in connection with the Merger (the
"Note Election"); (iv) who is not required to recognize gain by reason of the
exercise by another Desert Springs Limited Partner of his right to make the
Note Election (which, in counsel's opinion, described below, should not be the
result of such election); and (v) who does not have his "at risk" amount fall
below zero as a result of the Merger or the REIT Conversion. See "Federal
Income Tax Consequences--Summary of Tax Opinions" in the Consent Solicitation.
With respect to the foregoing exceptions to nonrecognition treatment, the
Operating Partnership and the General Partner believe as follows: (i) a Desert
Springs Limited Partner who acquired his Desert Springs Partnership Units in
the original offering of such Partnership Units and who has held such
Partnership Units at all times since would not be considered to receive, as a
result of the Merger, a distribution (or a deemed cash distribution resulting
from relief from liabilities) that exceeds his aggregate adjusted basis in his
Desert Springs Partnership Units at the time of the Merger, and would not have
his "at risk" amount fall below zero as a result of the Merger (in this
regard, the Operating Partnership has no plan to prepay or repay either the
GMAC Senior Loan or the Goldman Sachs Mezzanine Loan in connection with the
REIT Conversion), and (ii) none of the personal property owned by Desert
Springs will need to be sold to a Non-Controlled Subsidiary in connection with
the REIT Conversion. See "Federal Income Tax Consequences--Tax Consequences of
the Mergers--Overview" in the Consent Solicitation.
With respect to the effects of a Desert Springs Limited Partner's election
to receive a Note in exchange for his OP Units in connection with the Merger,
Hogan & Hartson is of the opinion that, although the matter is not free from
doubt, a Desert Springs Limited Partner who does not make the Note Election
should not be required to recognize gain by reason of another Desert Springs
Limited Partner's exercise of such right. With respect to the exercise of a
Unit Redemption Right, Hogan & Hartson is of the opinion that it is more
likely than not that a
Desert Springs Supp-24
<PAGE>
Desert Springs Limited Partner's exercise of his Unit Redemption Right more
than one year after the date of consummation of the Merger but less than two
years after such date will not cause the Merger itself to be a taxable
transaction for the Desert Springs Limited Partner (or the other Desert
Springs Limited Partners). See "Federal Income Tax Consequences--Summary of
Tax Opinions" in the Consent Solicitation. Opinions of counsel, however, do
not bind the IRS or the courts, and no assurances can be provided that such
opinions will not be challenged by the IRS or will be sustained by a court if
so challenged.
Deemed Cash Distribution and Resulting Taxable Gain. With respect to his
Desert Springs Partnership Units, a Desert Springs Limited Partner will
receive no actual cash distribution in connection with the Merger but would be
deemed to receive a cash distribution in connection with the Merger to the
extent that his share of Operating Partnership liabilities immediately after
the Merger and the REIT Conversion is less than his share of Desert Springs
liabilities immediately prior to the Merger. For example, any repayment of the
GMAC Senior Loan or the Goldman Sachs Mezzanine Loan or debt encumbering other
Hotels may result in a deemed cash distribution to the Desert Springs Limited
Partners. See "Federal Income Tax Consequences--Tax Consequences of the
Mergers--Relief from Liabilities/Deemed Cash Distribution" in the Consent
Solicitation. Even though the GMAC Senior Loan, the Goldman Sachs Mezzanine
Loan and the debt encumbering other Hotels is not expected to be repaid or
refinanced in connection with the Mergers and the REIT Conversion (except as
described in the Consent Solicitation), a Desert Springs Limited Partner's
share of indebtedness following the Mergers and the REIT Conversion may
nonetheless decrease in comparison to the Limited Partner's estimated
aggregate share of Desert Springs indebtedness as of December 31, 1998
(calculated based on the assumption that the Mergers did not occur) by reason
of the manner in which the debt allocation rules work when multiple assets
with different levels of leverage are consolidated into a single partnership.
A Desert Springs Limited Partner, however, would recognize taxable gain as a
result of any deemed cash distribution only to the extent that the deemed cash
distribution were to exceed his adjusted tax basis in his Desert Springs
Partnership Units immediately prior to the Merger. As noted above, the
Operating Partnership and the General Partner believe, based upon and subject
to the assumptions and other limitations described below, that a Desert
Springs Limited Partner who acquired his Desert Springs Partnership Units in
the original offering of such Partnership Units and has held the Partnership
Units at all times since the offering will have an adjusted tax basis in
excess of the deemed cash distribution that might occur in connection with the
Merger and the REIT Conversion. Therefore, such a Desert Springs Limited
Partner should not recognize gain due to such deemed cash distribution
resulting from the relief from liabilities in connection with the Merger and
the REIT Conversion.
The adjusted tax basis of a Desert Springs Limited Partner who did not
acquire his Desert Springs Partnership Units in the original offering of such
Partnership Units or who has not held his Desert Springs Partnership Units at
all times since such offering could vary materially from that of a Desert
Springs Limited Partner who did so. If a Desert Springs Limited Partner has an
adjusted tax basis in his Desert Springs Partnership Units (per Desert Springs
Partnership Unit) that is substantially less than the adjusted tax basis of a
Desert Springs Limited Partner who acquired his Desert Springs Partnership
Units in the original offering of such Partnership Units and has held such
Partnership Units at all times since, he could recognize gain due to any
deemed cash distribution resulting from the relief from liabilities in
connection with the Merger and the REIT Conversion.
The Operating Partnership has no current plan or intention to cause the
prepayment of the GMAC Senior Loan or the Goldman Sachs Mezzanine Loan or,
except as described in the Consent Solicitation, any of the nonrecourse
liabilities encumbering the Hotels owned by the other Partnerships. The
Operating Partnership, however, will have to repay mortgage indebtedness
securing the Hotels owned by the Partnerships at the time such indebtedness
matures. There can be no assurance that at such time the Operating Partnership
will be able to secure nonrecourse mortgage indebtedness secured only by those
Hotels in an amount sufficient to avoid a deemed cash distribution to the
former Limited Partners in those Partnerships, including Desert Springs.
Moreover, the Operating Partnership's current long-term financing strategy is
to have as little debt as possible
Desert Springs Supp-25
<PAGE>
that is secured by individual Hotels and to have as much debt as possible in
the form of unsecured debt, held either by the public or by institutional
investors, which debt may or may not be recourse to Host REIT, as general
partner of the Operating Partnership. In view of these considerations and the
potential adverse consequences to Limited Partners in certain Partnerships,
including the Desert Springs Limited Partners, the Operating Partnership has
requested from the IRS a ruling to the effect that such unsecured indebtedness
of the Operating Partnership that is issued initially to institutional
investors and is not recourse to Host REIT (i) would qualify as "nonrecourse
liabilities" for purposes of Code Section 752, (ii) to the extent the proceeds
thereof are applied to repay existing nonrecourse mortgage indebtedness
secured by one or more Hotels (including the GMAC Senior Loan or the Goldman
Sachs Mezzanine Loan), would be considered to be "secured" by those Hotels for
purposes of allocating the liabilities for tax basis purposes (and thus would
be allocable, at least in substantial part, to the former Limited Partners in
the Partnerships owning those Hotels, including the Desert Springs Limited
Partners), and (iii) would constitute "qualified nonrecourse financing"
secured by such Hotels for purposes of Code Section 465. The IRS has recently
issued a ruling to that effect to another taxpayer, and has indicated to the
Operating Partnership's representatives that it is favorably inclined to issue
that ruling to the Operating Partnership.
Each Desert Springs Limited Partner will gradually begin to recognize income
over the term of his ownership of OP Units (beginning, perhaps, in his first
year of ownership of OP Units) attributable to deemed cash distributions
resulting from the relief from liabilities, as the aggregate principal amount
of nonrecourse indebtedness encumbering (or deemed to encumber) the Hotel
amortizes in accordance with its terms. The Operating Partnership will make
regular quarterly cash distributions to the Desert Springs Limited Partners
that may or may not be sufficient to allow the Desert Springs Limited Partners
to pay the federal and state income tax owed on the income allocated to such
Limited Partners by reason of the amortization of the debt secured by the
Desert Springs Hotel.
Even if Desert Springs does not participate in the Merger, the General
Partner has estimated that the Desert Springs Limited Partners will be
required to recognize in taxable year 1998 income of approximately $1,700 per
Desert Springs Partnership Unit, as of December 31, 1998, resulting, in part,
from the amortization of the GMAC Senior Loan and the Goldman Sachs Mezzanine
Loan.
Section 465(e) Recapture. As discussed in the Consent Solicitation, see
"Federal Income Tax Consequences--Tax Consequences of the Mergers--Section
465(e) Recapture," the "at risk" rules of Section 465 of the Code generally
apply to limit the use of partnership losses by a partner. Under Section
465(e) of the Code, a partner may be required to include in gross income, or
"recapture," losses previously allowed to such partner with respect to his
investment in a partnership if the amount for which the partner is "at risk"
in relation to his investment in the partnership is less than zero at the
close of the taxable year.
It is possible that the consummation of the Mergers and the REIT Conversion
or the repayment of certain "qualified nonrecourse financing" of the Operating
Partnership, the Hotel Partnerships or the Hotels contributed to the Operating
Partnership by the Blackstone Entities at the time of or following the Mergers
and the REIT Conversion could, singularly or in combination, cause a Desert
Springs Limited Partner's amount at risk in relation to his investment in
Desert Springs (and, after the Mergers, in the Operating Partnership) to be
reduced below zero, resulting in an income inclusion to the Limited Partner
under Section 465(e) of the Code. Currently, a sufficient portion of the
current debt of Desert Springs constitutes "qualified nonrecourse financing"
so that the Desert Springs Limited Partners have positive at risk amounts, and
the Operating Partnership expects that most of the current debt with respect
to the other Hotel Partnerships and the Hotels contributed by the Blackstone
Entities that will be assumed by the Operating Partnership as part of the
Mergers and the REIT Conversion should qualify as "qualified nonrecourse
financing." The Operating Partnership and the General Partner believe, based
upon and subject to the assumptions and other limitations described below,
that a Desert Springs Limited Partner who acquired his Desert Springs
Partnership Units in the original offering of such Partnership Units and has
held the Partnership Units at all times since will have a positive at risk
amount immediately following the Mergers and the REIT Conversion.
Desert Springs Supp-26
<PAGE>
It is possible, however, that a former Desert Springs Limited Partner's at
risk amount could decline in the future, either because of the allocation of
losses from the Operating Partnership to that former Desert Springs Limited
Partner or because of cash distributions by the Operating Partnership to that
former Desert Springs Limited Partner in excess of the taxable income
allocable to him with respect to his OP Units. Moreover, there can be no
assurance that debt incurred by the Operating Partnership in the future to
refinance the GMAC Senior Loan, the Goldman Sachs Mezzanine Loan or
outstanding mortgage debt of the other Hotel Partnerships or the Hotels
contributed by the Blackstone Entities will qualify as "qualified nonrecourse
financing." If, however, the Operating Partnership were to obtain the
requested ruling from the IRS, and were to refinance existing mortgage
indebtedness of the Partnerships with the type of indebtedness described in
the ruling, such indebtedness should constitute "qualified nonrecourse
financing" for purposes of the "at risk" rules.
Impact of Assumption of Desert Springs Liabilities by the Operating
Partnership. As described in the Consent Solicitation, see "Federal Income
Tax Consequences--Tax Consequences of the Mergers--Disguised Sale
Regulations," a Desert Springs Limited Partner will recognize gain to the
extent he is treated as having sold all or part of his Desert Springs
Partnership Interest in a "disguised sale." For purposes of these rules,
certain reductions in a partner's share of partnership liabilities are treated
as a transfer of money or other property from the partnership to the partner
which may give rise to a disguised sale, even if that reduction would not
otherwise result in a taxable deemed cash distribution in excess of the
partner's basis in his partnership interest. However, if a transfer of
property by a partner to a partnership is not otherwise treated as part of a
disguised sale, then any reduction in the partner's share of "qualified
liabilities" also will not be treated as part of a disguised sale. A
"qualified liability" in connection with a transfer of property to a
partnership includes (i) any liability incurred more than two years prior to
the earlier of the transfer of the property or the date the partner agrees in
writing to the transfer, as long as the liability has encumbered the
transferred property throughout the two-year period; (ii) a liability that was
not incurred in anticipation of the transfer of the property to a partnership,
but that was incurred by the partner within the two-year period prior to the
earlier of the date the partner agrees in writing to transfer the property or
the date the partner transfers the property to a partnership and that has
encumbered the transferred property since it was incurred; (iii) a liability
that is traceable under the Treasury Regulations to capital expenditures with
respect to the property; and (iv) a liability that was incurred in the
ordinary course of the trade or business in which property transferred to the
partnership was used or held, but only if all the assets related to that trade
or business are transferred, other than assets that are not material to a
continuation of the trade or business. However, a recourse liability is not a
"qualified liability" unless the amount of the liability does not exceed the
fair market value of the transferred property (less any other liabilities that
are senior in priority and encumber such property or any allocable liabilities
described in (iii) or (iv), above) at the time of transfer.
The General Partner and the Operating Partnership believe, based upon their
review of the facts and circumstances surrounding each liability, that all
liabilities of Desert Springs fall into one of the four categories of
"qualified liabilities" described in the preceding paragraph. However, the
General Partner estimates that approximately $19.3 million of Desert Springs
indebtedness ($22,000 per $100,000 original investment in Desert Springs), as
of December 31, 1998, may be "qualified liabilities" solely by reason of
exception (ii) in the preceding paragraph (i.e., a liability incurred within
two years of the Merger but not in anticipation of the Merger) and, thus,
Desert Springs and the Desert Springs Limited Partners will be required to
disclose such indebtedness on a completed IRS Form 8275 or on a statement
attached to their tax returns for the taxable year in which the Merger occur.
There can be no assurance, however, that the IRS will not challenge the
position of Desert Springs that this indebtedness is a "qualified liability."
Tax Treatment of Desert Springs Limited Partners Who Hold OP Units Following
the Merger
Initial Basis in Units. In general, a Desert Springs Limited Partner will
have an initial tax basis in his OP Units received in the Merger with respect
to his Desert Springs Partnership Units equal to the basis in his Desert
Springs Partnership Units at the time of the Merger, reduced to reflect any
deemed cash distributions resulting from a reduction in his share of Desert
Springs liabilities and increased to reflect his share of other liabilities of
the Operating Partnership and any gain required to be recognized in connection
with the Merger and the REIT
Desert Springs Supp-27
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Conversion. For a discussion of the federal income tax consequences for a
Desert Springs Limited Partner from a reduction in basis that may result from
the Merger and the REIT Conversion, see "Federal Income Tax Consequences--Tax
Treatment of Limited Partners Who Hold OP Units Following the Mergers--Initial
Tax Basis of OP Units" in the Consent Solicitation.
Tax Allocations by the Operating Partnership upon a Sale of Desert Springs
Hotel. Pursuant to Section 704(c) of the Code, income, gain, loss and
deduction attributable to appreciated or depreciated property that is
contributed to a partnership must be allocated for federal income tax purposes
in a manner such that the contributor is charged with, or benefits from, the
unrealized gain or unrealized loss associated with the property at the time of
contribution. The amount of such unrealized gain or unrealized loss is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution (referred to as the "Book-Tax
Difference"). The Operating Partnership and the General Partner estimate,
based upon and subject to the assumptions and other limitations described
below, that the Book-Tax Difference for all Desert Springs Limited Partners
(but excluding all of Host's interests) with respect to the Desert Springs
Hotel will be $51,842,186 upon the consummation of the Merger.
If the Operating Partnership were to sell the Desert Springs Hotel, the
former partners of Desert Springs (including Host REIT with respect to Host's
interest in Desert Springs held through the General Partner) would be
specially allocated by the Operating Partnership an aggregate amount of
taxable gain equal to the aggregate Book-Tax Difference with respect to the
Desert Springs Hotel. The share of such gain allocable to a Desert Springs
Limited Partner who acquired his Desert Springs Partnership Units in the
original offering of such Partnership Units and held such Partnership Units at
all times since would be $57,753 per Desert Springs Partnership Unit for a
Limited Partner who acquired his Partnership Units for cash, and $57,552 per
Desert Springs Partnership Unit for a Limited Partner who acquired his
Partnership Units pursuant to the installment purchase plan. The share of such
gain of a Desert Springs Limited Partner who did not acquire his Desert
Springs Partnership Units in the original offering of such Partnership Units
or who has not held his Desert Springs Partnership Units at all times since
such offering could vary materially from this amount. If the Operating
Partnership were to sell the Desert Springs Hotel, the remaining Book-Tax
Difference at the time the Hotel is sold would be required to be allocated
exclusively to the former Desert Springs Limited Partners and the General
Partner, even though the proceeds of such sale would be allocated
proportionately among all the partners in the Operating Partnership (and would
likely be retained by the Operating Partnership, rather than distributed to
holders of OP Units and Common Shares of Host REIT). The Desert Springs
Limited Partners would not be entitled to any special distributions from the
Operating Partnership in connection with such a sale, and thus would not
necessarily receive cash distributions from the Operating Partnership
sufficient to pay such additional taxes. Although the Partnership Agreement
does not impose any restrictions upon the Operating Partnership preventing it
from causing the sale of the Desert Springs Hotel at any time following the
Merger, the Operating Partnership does not have current plans to pursue a sale
of the Desert Springs Hotel. See "Federal Income Tax Consequences--Tax
Treatment of Limited Partners Who Hold OP Units Following the Mergers--Sale of
Individual Hotels" in the Consent Solicitation.
Tax Allocations with Respect to Contributed Hotel Generally. The tax
allocations of depreciation to the Desert Springs Limited Partners may change
significantly as a result of the Mergers and the REIT Conversion for two
reasons. First, as described above, pursuant to Section 704(c) of the Code,
depreciation and deductions attributable to the Desert Springs Hotel will be
required to be allocated for federal income tax purposes in a manner such that
the Desert Springs Limited Partners are charged with the Book-Tax Difference
associated with the Desert Springs Hotel at the time of the consummation of
the Merger. Consequently, a Desert Springs Limited Partner will be allocated
less depreciation with respect to the Desert Springs Hotel than would be the
case if the Mergers had not occurred and the Desert Springs Limited Partner
had continued to hold his Desert Springs Partnership Units. (On the other
hand, a former Desert Springs Limited Partner will be allocated depreciation
with respect to other Hotels acquired by the Operating Partnership in
connection with the Mergers and the REIT Conversion, including the Hotels
owned by the other Hotel Partnerships and the Hotels being contributed to the
Desert Springs Supp-28
<PAGE>
Operating Partnership by Host and the Blackstone Entities in connection with
the Mergers and the REIT Conversion.) Second, the Mergers will cause the
technical termination under Section 708(b)(1)(B) of the Code of Desert Springs
and most of the other Hotel Partnerships that participate in the Mergers and
the REIT Conversion. Section 168(i)(7) of the Code provides, in effect, that
when a partnership terminates under Section 708(b)(1)(B) of the Code, the
partnership must begin new depreciation periods for its property. As a result,
the remaining bases of the real estate components of the Desert Springs Hotel
and the Hotels held by the other Hotel Partnerships that terminate will be
depreciated over 39 years, rather than over the remaining current lives of
such Hotels (which range from less than one year to 39 years). See "Federal
Income Tax Consequences--Tax Treatment of Limited Partners Who Hold OP Units
Following the Mergers--Effect of Mergers on Depreciation" in the Consent
Solicitation.
In light of the complexity of the governing rules affecting the calculation
and allocation of depreciation with respect to properties contributed to a
partnership, particularly when a number of those properties are subject to the
separate adjustments required in connection with a technical termination under
Section 708 of the Code, the number of Hotels that the Operating Partnership
will be acquiring in connection with the Mergers and the REIT Conversion, and
the impact on these calculations of other outside events, including equity
offerings by Host or Host REIT and other acquisitions undertaken by Host, Host
REIT or the Operating Partnership prior to or in connection with the REIT
Conversion, the Operating Partnership and the General Partner believe that it
is impossible to predict with any degree of precision the impact that the
Mergers and the REIT Conversion will have on the future depreciation (and,
consequently, the amount of taxable income) allocable to a Desert Springs
Limited Partner.
Impact on Passive Activity Losses of an Investment in a Publicly Traded
Partnership. The passive loss limitation rules generally provide that
individuals, estates, trusts and certain closely held corporations and
personal service corporations can only deduct losses from passive activities
(generally activities in which the taxpayer does not materially participate,
which would include the Operating Partnership for Desert Springs Limited
Partners) to the extent that such losses are not in excess of the taxpayer's
income from passive activities or investments. A Desert Springs Limited
Partner would be able to offset losses from other passive activities against
income from the Operating Partnership that is considered passive income (but
not portfolio income) so long as the Operating Partnership is not treated as a
publicly traded partnership. The Operating Partnership and the General Partner
believe, however, that there is a substantial risk that the Operating
Partnership will be treated as a publicly traded partnership for purposes of
the passive loss limitation rules. In this event, any losses or deductions of
the Operating Partnership allocable to a Desert Springs Limited Partner after
the Merger could not be used to offset passive income from other passive
activities. Similarly, losses from other passive activities (including losses
attributable to Desert Springs for periods prior to the Merger) could not be
applied to offset income of the Operating Partnership allocated to a Desert
Springs Limited Partner. A Desert Springs Limited Partner, however, would be
able to offset any passive losses from his investment in Desert Springs (or
other investments) against any gain recognized by the Desert Springs Limited
Partner as a result of the Merger. The Operating Partnership and the Desert
Springs General Partner estimate that, as of December 31, 1998, a Desert
Springs Limited Partner who purchased his Desert Springs Partnership Units at
the time of the original offering, has held those Partnership Units
continuously since that time, and whose Partnership Units have been his only
investment in a passive activity would have a passive activity loss
carryforward of approximately $2,110, on a per Unit basis, if such Partnership
Units were acquired for cash, and $9,179, on a per Unit basis, if such
Partnership Units were acquired on the installment purchase plan.
State and Local Taxes. Desert Springs Limited Partners holding OP Units will
be subject to state and local taxation in a number of jurisdictions in which
the Operating Partnership directly or indirectly holds real property and would
be required to file periodic tax returns in those jurisdictions. In this
regard, immediately following the Mergers and the REIT Conversion, the
Operating Partnership expects that it will own properties in approximately 28
states across the United States and the District of Columbia. Currently,
Desert Springs owns property in only one state. See "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--State and Local Taxes" in the Consent Solicitation.
Desert Springs Supp-29
<PAGE>
Assumptions Used in Determining Tax Consequences of the Merger
In preparing the discussion set forth above, the Operating Partnership and
the General Partner made several key assumptions, which are described below.
If any such assumption is not accurate with respect to a particular Desert
Springs Limited Partner, the tax consequences of the Merger to such Desert
Springs Limited Partner could be substantially different from those reflected
above. ACCORDINGLY, EACH DESERT SPRINGS LIMITED PARTNER IS STRONGLY URGED TO
CONSULT WITH HIS OWN TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH DESERT
SPRINGS LIMITED PARTNER'S PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX
CONSEQUENCES OF PARTICIPATING IN THE MERGER.
First, with respect to a Desert Springs Limited Partner's basis in his
Desert Springs Partnership Units prior to the Merger, the Operating
Partnership and the Desert Springs General Partner assumed that a Desert
Springs Limited Partner acquired his Desert Springs Partnership Units in the
original offering of such Partnership Units and has held such Partnership
Units at all times since the offering (the "Original Limited Partner's
Adjusted Basis"). In general, each Desert Springs Limited Partner had an
initial tax basis in his Desert Springs Partnership Units ("Initial Basis")
equal to his cash investment in Desert Springs (plus his proportionate share
of Desert Spring's nonrecourse liabilities at the time he acquired his Desert
Springs Partnership Units). A Desert Springs Limited Partner's Initial Basis
generally has been increased by (a) such Limited Partner's share of Desert
Springs taxable income and (b) any increases in his or her share of
liabilities of Desert Springs. Generally, such Limited Partner's Initial Basis
has been decreased (but not below zero) by (i) his share of Desert Springs
cash distributions, (ii) any decreases in his share of liabilities of Desert
Springs, (iii) his share of losses of Desert Springs and (iv) his share of
nondeductible expenditures of Desert Springs that are not chargeable to
capital.
The General Partner has set forth on Appendix E to the Consent Solicitation
for Desert Springs (i) the Original Limited Partner's Adjusted Basis as of
December 31, 1997 for each such Desert Springs Limited Partner, and (ii) an
estimate of such Desert Springs Limited Partner's Original Limited Partner's
Adjusted Basis as of December 31, 1998 (computed without regard to the Mergers
and based upon the assumptions set forth in Appendix E to the Consent
Solicitation). The General Partner also has set forth on Appendix E to the
Consent Solicitation for each Desert Springs Limited Partner whose adjusted
basis in his Desert Springs Partnership Interest is the same as the Original
Limited Partner's Adjusted Basis (i) the Desert Springs liabilities allocable
to such Desert Springs Limited Partner as of December 31, 1997, and (ii) an
estimate of the Desert Springs liabilities allocable to such Limited Partner
as of December 31, 1998 (computed without regard to the Mergers and based upon
the assumptions set forth in Appendix E to the Consent Solicitation). Each of
these estimates is shown separately for those Desert Springs Limited Partners
who acquired their Partnership Units at the time of the original offering
pursuant to the installment purchase plan.
The adjusted tax basis of a Desert Springs Limited Partner who did not
acquire his Desert Springs Partnership Units in the original offering of such
Partnership Units could vary materially from that of a Desert Springs Limited
Partner who did so for various reasons. If a Desert Springs Limited Partner
has an adjusted tax basis in his Desert Springs Partnership Units that is less
than the Original Limited Partner's Adjusted Tax Basis, the Merger might
result in the receipt by the Desert Springs Limited Partner of a deemed
distribution of cash in excess of his adjusted tax basis in his Desert Springs
Partnership Units, which could result in the recognition of income or gain.
Second, the Operating Partnership and the General Partner assumed that the
method expected to be used by the Operating Partnership to allocate
liabilities among the partners will be respected for federal income tax
purposes. The Operating Partnership will allocate liabilities associated with
the Desert Springs Hotel as described in "Federal Income Tax Consequences--Tax
Consequences of the Mergers--Relief from Liabilities/Deemed Cash Distribution"
in the Consent Solicitation. If the method used by the Operating Partnership
were not respected for federal income tax purposes and the nonrecourse
liabilities actually allocable to a Desert Springs Limited Partner are less
than the amount assumed by the Operating Partnership and the General Partner,
the Merger might result in the receipt by such Desert Springs Limited Partner
of a deemed distribution of cash that is greater than the deemed distribution
of cash expected to be received by such Desert Springs Limited Partner
Desert Springs Supp-30
<PAGE>
as described above in "Tax Consequences of the Merger--Deemed Cash
Distribution and Resulting Taxable Gain." For a Desert Springs Limited Partner
who did not acquire his Desert Springs Partnership Units in the original
offering of such Partnership Units or who did not hold such Partnership Units
at all times since, this deemed distribution of cash could exceed his adjusted
tax basis in his Desert Springs Partnership Units, which could result in the
recognition of income or gain.
Finally, the Operating Partnership and the General Partner assumed that the
Merger will be treated for federal income tax purposes as the transfer by the
Desert Springs Limited Partners of their interests in Partnership to the
Operating Partnership in exchange for OP Units. There can be no assurance,
however, that the IRS will not seek to recharacterize each Merger as either
(i) the liquidation of a Partnership followed by the distribution by the
Partnership of its assets to its partners and the subsequent transfers by such
partners of such assets to the Operating Partnership in exchange for OP Units,
or (ii) the transfer by a Partnership of its assets to the Operating
Partnership in exchange for OP Units (and possibly Notes) and the subsequent
distribution of such OP Units (and possibly Notes) to its partners. If the
Merger is recharacterized in the manner described in (ii) in the preceding
sentence, the tax consequences of the Merger to the Desert Springs Limited
Partners likely would be materially affected.
EACH DESERT SPRINGS LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS
OWN TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH DESERT SPRINGS LIMITED
PARTNER'S PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF
PARTICIPATING IN THE MERGER. THE TAX CONSEQUENCES OF PARTICIPATING IN THE
MERGER TO A PARTICULAR DESERT SPRINGS LIMITED PARTNER COULD VARY SUBSTANTIALLY
FROM THE CONSEQUENCES DESCRIBED ABOVE.
Tax Treatment of Desert Springs Limited Partners Who Exercise Their Right to
Make the Note Election
A Desert Springs Limited Partner who exercises his right to make the Note
Election and receives a Note in connection with the Merger will be treated as
having made a taxable disposition of his OP Units. The amount realized in
connection with such disposition will equal the sum of the "issue price" of
the Note (i.e., the face amount of the Note, currently estimated as $27,617
per Desert Springs Partnership Unit) plus the portion of Desert Springs
liabilities allocable to the Desert Springs Limited Partner for federal income
tax purposes immediately prior to the disposition of the OP Units (estimated
as $123,059 per Desert Springs Partnership Unit as of December 31, 1998). To
the extent the amount realized exceeds the Desert Springs Limited Partner's
adjusted basis in his Desert Springs Partnership Units, the Desert Springs
Limited Partner will recognize gain. The Operating Partnership and the Desert
Springs General Partner estimate (assuming the Desert Springs Limited Partner
acquired his Desert Springs Partnership Units at the time of the original
offering and has held such Partnership Units at all times since the offering)
that the amount of gain that would be recognized by a Desert Springs Limited
Partner who made the Note Election would be approximately $44,490 per Desert
Springs Partnership Unit, as of December 31, 1998 if such Partnership Unit was
acquired for cash, and $44,289 per Desert Springs Partnership Unit if such
Partnership Unit was acquired pursuant to an installment purchase plan. For a
discussion of the federal income tax rates applicable to the net capital gain
from the sale of a capital asset, see "Federal Income Tax Consequences--Tax
Treatment of Limited Partners Who Hold OP Units Following the Mergers--
Disposition of OP Units by Limited Partners" in the Consent Solicitation. In
this regard, the General Partner estimates that, as of December 31, 1998, if
Desert Springs sold its Hotel in a fully taxable transaction for a net amount,
after payment of liabilities, equal to the Liquidation Value of Desert
Springs, the "unrecognized Section 1250 gain" per Desert Springs Partnership
Unit would be $19,008 if the Desert Springs Partnership Unit were acquired for
cash, and $19,008 if such Partnership Unit were acquired pursuant to the
installment purchase plan. The gain subject to tax as ordinary income under
Code Section 1245 per Desert Springs Partnership Unit would be $1,252 if the
Desert Springs Partnership Unit were acquired for cash, and $1,252 if such
Partnership Unit were acquired pursuant to the installment purchase plan. A
Desert Springs Limited Partner who makes the Note Election would be able to
treat any per Partnership Unit passive activity loss carryforward with respect
to the activities of Desert Springs, to the extent the sum of such losses
exceeds his passive activity income for 1998, as losses that are not from a
passive activity and, therefore, not subject to
Desert Springs Supp-31
<PAGE>
the passive activity loss limitation rules. For purposes of determining the
gain recognized by the Limited Partner as a result of making the Note
Election, an Original Limited Partner's Adjusted Basis does not reflect such
Limited Partner's share of the syndication costs incurred by his Partnership
at formation. An original Desert Springs Limited Partner's share of
syndication costs was $10,015 per Desert Springs Partnership Unit.
A Desert Springs Limited Partner who elects to receive a Note may be
eligible to defer at least a small portion of that gain under the "installment
sale" rules. Those rules, however, will not permit the Desert Springs Limited
Partner to defer all of the gain, and, to the extent that the face amount of
the Note (and any other installment obligations received by the taxpayer
during the year) outstanding at the end of the taxable year in which the
Merger occurs exceeds $5,000,000, will require that the Desert Springs Limited
Partner who defers gain pay to the IRS interest on the resulting tax that has
been deferred. The Desert Springs Limited Partner will not be eligible to
defer gain recognized upon the receipt of the Note to the extent that its
share of Desert Springs liabilities at the time of the Merger exceeds his
adjusted tax basis in his Desert Springs Partnership Units immediately prior
to the Merger (that is, to the extent that he has a "negative capital account"
for tax purposes). In addition, the Desert Springs Limited Partner will not be
eligible to defer gain to the extent that such gain would be taxed as ordinary
income under Sections 1245 and 1250 of the Code. Lastly, if a Desert Springs
Limited Partner disposes of its Note, any gain that had been deferred would be
recognized in the year of disposition.
THE SPECIFIC TAX ATTRIBUTES OF A PARTICULAR DESERT SPRINGS LIMITED PARTNER
COULD HAVE A MATERIAL IMPACT ON THE TAX CONSEQUENCES OF THE MERGER, AND THE
SUBSEQUENT OWNERSHIP AND DISPOSITION OF NOTES. THEREFORE, IT IS ESSENTIAL THAT
DESERT SPRINGS LIMITED PARTNERS CONSIDERING ELECTING TO RECEIVE NOTES CONSULT
WITH THEIR OWN TAX ADVISORS WITH REGARD TO THE APPLICATION OF THE FEDERAL
INCOME TAX LAWS TO SUCH DESERT SPRINGS LIMITED PARTNERS' RESPECTIVE PERSONAL
TAX SITUATIONS, AS WELL AS ANY TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY
STATE, LOCAL OR FOREIGN TAXING JURISDICTION.
Tax Consequences if Desert Springs Does Not Participate in the Merger
If Desert Springs does not participate in the Merger, the Desert Springs
Limited Partners would not have any tax consequences resulting from the
Merger. The consequences of continued ownership of Desert Springs Partnership
Units will be the same as would have resulted if the Merger had not been
proposed.
* * *
The above description is not exhaustive of all possible tax considerations
associated with the Merger and the REIT Conversion. This summary does not
discuss foreign tax considerations, nor does it discuss all of the aspects of
federal income taxation or state and local taxation that may be relevant to
Desert Springs Limited Partners in light of their particular circumstances.
EACH DESERT SPRINGS LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN
TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH DESERT SPRINGS LIMITED PARTNER'S
PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING
IN THE MERGER.
Desert Springs Supp-32
<PAGE>
SELECTED FINANCIAL DATA
The following table presents selected historical financial data derived from
the audited financial statements for the five most recent fiscal years in the
period ended December 31, 1997 and the unaudited financial statements for the
First Two Quarters 1998 and First Two Quarters 1997. The following data should
be read in conjunction with the financial statements and the notes thereto,
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the other financial information included elsewhere herein.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
-------------------- ----------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- ---------- ---------- ---------- ---------- ----------
(UNAUDITED) (AMOUNTS IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT)(3)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues(1)............. $ 27,291 $ 12,488 $ 27,233 $ 25,781 $ 24,351 $ 22,641 $ 21,571
Operating profit........ 18,545 7,756 16,381 14,510 13,293 9,873 9,990
Income (loss) before
extraordinary item(2).. 10,196 1,199 2,161 109 1,585 (2,264) (3,099)
Net income (loss)....... 10,196 1,199 29,699 109 1,585 (2,264) (3,099)
Distributions:
General partner....... 23 -- 227 15 51 40 50
Limited partners...... 2,248 -- 22,500 1,532 5,020 3,964 4,948
--------- --------- ---------- ---------- ---------- ---------- ----------
Total................. 2,271 -- 22,727 1,547 5,071 4,004 4,998
Per Partnership Unit:(3)
Net income (loss)..... 11,216 1,319 32,669 120 1,743 (2,490) (3,409)
Distributions......... 2,500 -- 25,000 1,702 5,577 4,404 5,498
Cash provided by
operating activities... 14,881 14,862 12,441 7,017 6,724 5,859 5,541
Cash used in investing
activities............. (3,948) (1,787) (3,862) (3,096) (2,050) (4,437) (3,760)
Cash used in financing
activities............. (1,842) (11,921) (9,781) (8,379) (1,399) (740) (2,855)
Increase (decrease) in
cash and cash
equivalents............ 9,091 1,154 (1,202) (4,458) 3,275 682 (1,074)
Ratio of earnings to
fixed charges(4)
(unaudited)............ 2.16x 1.18x 1.14x 1.01x 1.12x -- --
Deficiency of earnings
to fixed charges(4)
(unaudited)............ -- -- -- -- -- 2,264 3,099
Total assets at book
value.................. 181,624 175,567 172,156 164,882 173,742 172,238 175,451
Cash and cash
equivalents............ 13,644 6,909 4,553 5,755 10,213 6,938 6,256
Total debt(5)........... 181,644 187,136 182,727 185,913 190,087 186,415 183,196
Total liabilities....... 188,364 196,005 186,821 186,519 193,941 188,951 185,941
Partner's capital
(deficit):
Limited partners...... (6,798) (20,359) (14,644) (21,546) (20,122) (16,671) (10,511)
General partner....... 58 (79) (21) (91) (77) (42) 21
Book Value per
Partnership Unit
(unaudited)(3)......... (7,553) (22,621) (16,271) (23,940) (22,358) (18,523) (11,679)
Exchange Value per
Partnership Unit
(unaudited)(3)......... 40,880 -- -- -- -- -- --
</TABLE>
- --------
(1) On November 25, 1997, the Partnership converted its Operating Lease with
Marriott Hotel Services, Inc. to a management agreement.
(2) In 1997, Desert Springs Marriott Limited Partnership recognized an
extraordinary gain of $27,538,000 on the forgiveness of additional rental
paid by hotel lessee at the conversion of the Operating Lease to a
management agreement.
(3) A Partnership Unit represents a $100,000 original investment in Desert
Springs.
(4) The ratio of earnings to fixed charges is computed by dividing net income
before interest expense and other fixed charges by total fixed charges,
including interest expense, amortization of debt issuance costs and the
portion of rent expense
Desert Springs Supp-33
<PAGE>
that is deemed to represent interest. The deficiency of earnings of fixed
charges is largely the result of depreciation and amortization of
$8,932,000 and $8,502,000 as of December 31, 1994 and 1993, respectively.
(5) Total debt includes amounts due Host Marriott under the Junior Loan of
$59,727,000 as of June 19, 1998 and December 31, 1997.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
GENERAL
The following discussion and analysis addresses the results of operations of
the Partnership for the First Two Quarters 1998 and the fiscal years ended
December 31, 1997, 1996 and 1995.
Growth in the Partnership's total Hotel room sales, and thus rental income
and revenue, is primarily a function of average occupancy and average room
rates, as well as control of hotel operating costs. In addition, due to the
amount of meeting/convention business at the Hotel, food and beverage and golf
and spa operations have a direct effect on the Partnership's rental income and
revenue. REVPAR, or revenue per available room, represents the combination of
the average daily room rate charged and the average daily occupancy achieved
and is a commonly used indicator of hotel performance. REVPAR does not include
food and beverage or other ancillary revenues generated by the Hotel. REVPAR
for the years ended December 31, 1997, 1996 and 1995 was $124, $113 and $104,
respectively. Food and beverage sales increased to $40.4 million in 1997 from
$38.4 million in 1996 from $33.5 million in 1995 due to increased group sales.
Revenue for the period of November 25 through December 31, 1997 and net
rental income from the Hotel rental and the airline equipment lease with Trans
World Airline, Inc. (the "Equipment") are applied to debt service, property
taxes, partnership administrative costs, Partnership funded capital
expenditures and cash distributions to the partners.
RESULTS OF OPERATIONS
First Two Quarters 1998 Compared to First Two Quarters 1997
Revenues. As discussed in Note 3 to the Condensed Consolidated Financial
Statements, the Partnership changed its method of reporting revenues in
connection with the Conversion. As a result, Hotel Revenues reported for the
first two quarters 1998 are not comparable to the Hotel Revenues reported for
the first two quarters 1997. Prior to the Conversion, the Partnership
recognized estimated annual hotel rental income on a straight-line basis
thorughout the year. The profits from the Hotel are seasonal and first and
second quarter results are generally higher than the last two quarters of the
year. Lease payments in excess of the income recognized by the Partnership
were deferred and, to the extent not subject to possible future repayment to
the Hotel lessee, were recognized as income during the remainder of the year.
Pursuant to the terms of the Operating Lease, Annual Rental, as defined, was
equal to the greater of Basic Rental (80% of Operating Profit, as defined) and
Owner's Priority, as defined. Additionally, the Hotel tenant was required to
pay taxes, make contributions equal to a percentage of Hotel sales to a
property improvement fund (4.5% in 1997 and 5.5% thereafter) and pay rental on
the second golf course.
Subsequent to the Conversion, the Partnership records revenue based on house
profit generated by the Hotel. House profit reflects Hotel operating results,
and represents gross hotel sales less property-level expenses, excluding
depreciation, base and incentive management fees, property taxes, and certain
other costs, which are disclosed separately in the accompanying condensed
statement of operations. Revenues are recorded based on house profit because
the Partnership has delegated substantially all of the operating decisions
related to the generation of house profit to MHS.
For the first two quarters 1998, house profit increased $2.6 million or 10%
over the same period of the prior year due primarily to increases in rooms
revenues. For the year, REVPAR increased 10% over the same period of the prior
year to approximately $171 due primarily to a 9% increase in the average room
rate to approximately
Desert Springs Supp-34
<PAGE>
$214 coupled with a 1.1 percentage point increase in average occupancy to
approximately 80%. Room sales and profit increased 10% and 9% respectively,
due to strong demand in the leisure transient segment and improvements in the
Hotel's rooms amenity package and guest services. With the increase in
transient demand, the hotel increased its group average room rate by
approximately 12% for the first two quarters 1998 compared to the same period
in 1997.
Operating Costs and Expenses. Operating costs and expenses increased $4.0
million from $4.7 million for the first two quarters 1997 to $8.7 million for
the first two quarters 1998. The increase is primarily due to the impact of
the Conversion. Prior to the Conversion, incentive management fee expense was
not a component of operating expense. Rather, accrued incentive management fee
expense was deducted from the additional lease payments in excess of rental
income that were deferred by the Partnership. Additionally, base management
fees, though a component in the calculation of Operating Profit prior to the
Conversion, were not a component of the Partnership's operating costs.
Depreciation. For the first two quarters 1998, depreciation decreased
$254,000, or 7%, when compared to the same quarters in 1997 as the
Partnership's original 10-year equipment became fully depreciated during 1997.
Interest Expense. On November 25, 1997 the Partnership refinanced its $160
million mortgage debt with $182.7 million of debt. The increase in debt along
with an increase in the weighted average interest rate from 8.3% in the first
two quarters 1997 to 9.8% in the first two quarters 1998 resulted in an
increase in interest expense of approximately $2.0 million, or 30%, from $6.8
million to $8.8 million. For the first two quarters 1998, the weighted average
interest rate increased from 8.3% in 1997 to 9.8% in 1998.
Interest Income and Other. Interest income and other includes $132,000 for
the first two quarters which represents payments made to the Partnership by
Marriott Vacation Club International ("MVCI") for the rental of a gallery and
marketing desk in the Hotel's lobby. For the first two quarters 1997, $140,000
was recognized and included in the $12.5 million of Hotel rental income.
Net Income. Net income increased $9.0 million for the first two quarters
1998 to $10.2 million for the first two quarters 1997 as a result of the
changes discussed above, primarily the Conversion, and improved hotel
operating results.
1997 Compared to 1996
Hotel Rental Income. On November 25, 1997, in connection with the
refinancing, the General Partner and the Tenant/Manager converted the
Operating Lease to a management agreement (the "Management Agreement"). As a
result of this conversion, full year 1997 hotel rental income is not
comparable to full year 1996 hotel rental income. Hotel rental income for the
period January 1 through November 25, 1997 was $24 million. For the year,
total Hotel sales increased 6% due primarily to a 7.6% increase in rooms
revenue. REVPAR improved 10% to $124 due to a 7% increase in average room rate
to approximately $170 and a 2.0 percentage point increase in average daily
occupancy to approximately 73%.
Hotel Revenues. Effective November 25, 1997, the Partnership records
revenues which represent gross hotel sales less property-level expenses,
excluding depreciation and amortization, base and incentive fees, property
taxes, insurance and certain other costs. As a result of the conversion from
an Operating Lease to a Management Agreement, Partnership hotel revenues were
$2.6 million. This consists of the Hotel's operating results for the period of
November 25 through December 31, 1997.
Desert Springs Supp-35
<PAGE>
Airline Equipment Rental Income. Airline equipment rental income was $1.2
million in 1996. The airline equipment lease was terminated in April 1996. On
April 24, 1996, Trans World Airlines, Inc. ("TWA"), the lessee, terminated the
lease and purchased the equipment, as permitted under the lease agreement.
Other Income. Other income decreased 45% from $1.1 million in 1996 to
$607,000 in 1997. The decrease is primarily due to the Partnership utilizing
$8.2 million of cash and cash equivalents to reduce the balance of its
outstanding mortgage debt combined with paying $2.7 million in refinancing
costs which decreased the cash balance on which interest income is earned.
Interest Expense. Interest expense decreased 5% from $15.5 million in 1996
to $14.8 million in 1997 due to a decrease in the Partnership's weighted
average interest rate from 9.0% to 8.4%. The Partnership's $160 million Bridge
Loan accrued interest at LIBOR plus 2.75 percentage points from January 1
through November 25, 1997, the closing date of the Bridge Loan refinancing.
The weighted average interest rate for the Bridge Loan (see "--Debt
financing") for this period was 8.4% compared to 9.0% in 1996. The refinancing
of the Bridge Loan consists of three tiers of debt: a senior loan which bears
interest at a fixed rate of 7.8%; a mezzanine loan, which bears interest at a
fixed rate of 10.365%; and a Host Marriott junior loan which bears interest at
a fixed rate of 13%.
Depreciation. Depreciation and amortization decreased by $550,000 due to the
retirement of $7 million of equipment in 1997.
Property Taxes. Property taxes were unchanged at $2.0 million for both 1997
and 1996.
Partnership Administration and Other. Partnership administration and other
decreased from $474,000 in 1996 to $445,000 in 1997 due to a slight decrease
in administrative costs related to the refinancing.
Base Management Fee. As a result of the conversion to a management
agreement, the Partnership recorded base management fees from November 26
through December 31, 1997. Base management fees are calculated as 3% of sales
or $281,000 for 1997.
Insurance and Other. As a result of the conversion to a management
agreement, insurance and other expense was $256,000. This expense includes a
loss of $163,000 on the retirement of fixed assets, $65,000 of insurance
expense and $28,000 in equipment rental and permits and licenses.
Incentive Management Fee. As a result of the conversion to a management
agreement, the Partnership's incentive management fee expense from November 26
through December 31, 1997 was $123,000. As further explained in Note 7 to the
financial statements, Marriott International is entitled to a total of $2
million in fees for 1997, $123,000 of which is incentive management fee
expense.
Extraordinary Items. The Partnership recognized an extraordinary gain in
1997 of $27.5 million representing the forgiveness of additional rental by the
Tenant/Manager.
1996 Compared to 1995
Hotel Rental Income. Hotel rental income for 1996 increased 18% from $19.9
million in 1995 to $23.4 million in 1996. For the year, total Hotel revenues
increased 15% due to increases in all areas of the Hotel including rooms, food
and beverage, golf and spa and other ancillary revenues. REVPAR improved 9% to
$113 due to a 5% increase in average room rate to approximately $158 and a 2.5
percentage point increase in average daily occupancy to approximately 71%.
Food and beverage revenues increased 15% from $33.5 million in 1995 to $38.4
million in 1996.
Airline Equipment Rental Income. Airline equipment rental income decreased
56% from $2.8 million in 1995 to $1.2 million in 1996 due to the termination
of the airline equipment lease in April 1996. On April 24, 1996, TWA, the
lessee, terminated the lease and purchased the equipment, as permitted under
the lease agreement.
Desert Springs Supp-36
<PAGE>
Other Income. Other income decreased 34% from $1.6 million in 1995 to $1.1
million in 1996. The decrease is primarily due to $692,000 of income
recognized in 1995 on the funding of the pool expansion by Marriott Vacation
Club International ("MVCI") offset by a $108,000 increase in interest income
earned in 1996 on the Partnership's cash held for refinancing.
Interest Expense. Interest expense increased 16% from $13.4 million in 1995
to $15.5 million in 1996 due to an increase in the weighted average interest
rate. The mortgage debt matured on July 27, 1996 and went into default on the
maturity date. Pursuant to the loan documents, the mortgage debt accrued
interest at the default rate of 10.75% until the refinancing on December 23,
1996. The weighted average interest rate on the first mortgage debt was 9.0%
in 1996 and 7.8% in 1995.
Depreciation. Depreciation and amortization decreased by $91,000 due to the
write-off in 1995 of the airline equipment partially offset by an increase in
building and equipment depreciation due to the $9.1 million rooms renovation.
Property Taxes. Property tax expense increased 61% to $2.0 million in 1996
from $1.2 million in 1995 primarily due to a nonrecurring $600,000 refund
received in 1995 related to property taxes paid in prior years.
Partnership administration and other. Partnership administration and other
increased 34% primarily due to an increase in administrative costs due to the
refinancing of the mortgage debt.
CAPITAL RESOURCES AND LIQUIDITY
The Partnership's financing needs have historically been funded primarily
through loan agreements with independent financial institutions. The General
Partner believes that the Partnership will have sufficient capital resources
and liquidity to continue to conduct its operations in the ordinary course of
business.
Principal Sources and Uses of Cash
The Partnership's principal source of cash is from Hotel operations. Its
principal uses of cash are to make debt service payments, fund the Hotel's
property improvement fund and establish reserves required by the lender.
Cash provided by operating activities for the first two quarters 1998 and
1997 was $14.9 million. Cash provided by operating activities increased
$19,000 primarily due to the Conversion, as discussed in Note 3, combined with
improved hotel operations. Prior to the Conversion, the Partnership recognized
estimated annual hotel rental income on a straight-line basis throughout the
year. This charge combined with an overall improvement in hotel operations, an
increase in accounts payable of $2.8 million due to increased accrued interest
liability, offset by the payment of $2.0 million of accrued incentive
management fees to MHS in second quarter 1998 resulted in the increase in cash
from operations. Additionally, through June 19, 1998, an additional $1.5
million was transferred into the tax and insurance reserve account and
$984,000 was disbursed to pay accrued real estate taxes. The tax and insurance
reserve is included in restricted cash reserves and the resulting tax and
insurance liability is included in accounts payable and accrued expenses in
the accompanying balance sheet.
Cash used in investing activities for the first two quarters 1998 and 1997
was $3.9 million and $1.8 million, respectively. The Partnership's cash used
in investing activities consists primarily of contributions to the property
improvement fund and capital expenditures for improvements at the hotel.
Contributions to the property improvement fund for the first two quarters 1998
were $3.6 million and $2.7 million for the first two quarters 1997.
Contributions in 1998 increased due to a $5.7 million increase in gross hotel
sales and an increase in the contribution rate from 4.5% in 1997 to 5.5% in
1998. Capital expenditures from the property improvement fund were $2.3
million and $1.3 million for the first two quarters 1998 and 1997,
respectively.
Cash used in financing activities for the first two quarters 1998 and 1997
was $1.8 million and $11.9 million, respectively. The Partnership's cash used
in financing activities consists primarily of payments of the mortgage
Desert Springs Supp-37
<PAGE>
debt, contributions to the restricted cash reserves and cash distributions.
Contributions for the first two quarters 1998 to the restricted cash reserves
consist of $500,000 for the replacement of the Hotel's air conditioning system
and interest income earned for the first two quarters 1998 of $153,000.
Disbursements from the reserves include $270,000 for the air conditioning work
and $2.0 million for accrued incentive management fees payable to MHS.
Contributions for the first two quarters 1998 to the restricted cash reserves
in 1997 consisted of $10.9 million of excess cash from Hotel operations held
for future debt service. During the second quarter of 1998, the Partnership
distributed $2.3 million to the partners ($2,500 per limited partner unit)
from 1997 operations. Additionally, for the first two quarters 1998 and 1997,
the Partnership made $900,000 of loan repayments from the property improvement
fund on the rooms refurbishment loan from Marriott International, Inc.
The Partnership's principal source of cash was from the Hotel Operating
Lease up until November 25, 1997, at which time the Operating Lease was
converted to the Management Agreement. Prior to the Equipment Lease
termination, the Partnership's principal sources of cash included rents
received under the Equipment Lease and proceeds from Equipment sales. Its
principal uses of cash are to fund the property improvement fund, pay debt
service and cash distributions to the partners. Additionally, during 1996 and
1997, the Partnership utilized cash to pay financing costs incurred in
connection with the refinancing of the mortgage debt.
The Hotel Operating Lease provided for the payment of the greater of Basic
Rental or Owner's Priority. Basic Rental equaled 80% of Operating Profit, as
defined in the Hotel Operating Lease. Owner's Priority equaled the greater of
(i) $20 million plus debt service on certain additional debt to expand the
Hotel or (ii) Debt Service, as defined.
Pursuant to an agreement reached with Marriott International, for fiscal
year 1997, the $20 million Owner's Priority was increased to $20.5 million.
Marriott International was entitled only to the next $2 million of Operating
Profit. Any additional Operating Profit in excess of $22.5 million was
remitted entirely to the Partnership. For 1997, Operating Profit was $23.7
million, Marriott International earned $2.0 million and the remaining $1.2
million was remitted to the Partnership. In connection with the long-term
financing, Marriott International agreed to waive any and all claims to
Additional Rental (as defined in the Operating Lease) that accrued prior to
the consummation of the loan ($27.5 million).
On November 25, 1997, in connection with the refinancing, the General
Partner also negotiated with the Tenant/Manager to convert the Operating Lease
to a management agreement (the "Management Agreement"). The Tenant/Manager
would become manager of the Hotel (the "Manager"). The initial term of the
Management Agreement continues through 2022 with four successive renewal
options of ten years each.
Beginning with fiscal year 1998 forward, the Management Agreement provides
that no incentive fee will be paid to the Manager with respect to the first
$21.5 million of Operating Profit (the "Owner's Priority"). Thereafter the
Manager will receive the next $1.8 million of Operating Profit as an incentive
management fee and any Operating Profit in excess of the $23.3 million will be
divided 75% to the Partnership and 25% to the Manager. Any such payments will
be made annually after completion of the audit of the Partnership's books.
Total cash provided by operations of the Hotel was $12.4 million, $7.0
million and $6.7 million for the years ended December 31, 1997, 1996 and 1995,
respectively. Proceeds from the sale of airline equipment were $2.5 million
for the year ended December 31, 1996, and $4.0 million for the year ended
December 31, 1995 due to the sale of the equipment in 1996. Cash contributed
to the property improvement fund of the Hotel was $4.6 million, $4.4 million
and $3.8 million for the years ended December 31, 1997, 1996 and 1995,
respectively. Cash distributed to the partners was $22.7 million, $1.5 million
and $5.1 million during the years ended December 31, 1997, 1996 and 1995,
respectively. Financing costs related to refinancing the mortgage debt were
$1.2 million in 1997 and $2.7 million in 1996. There were no refinancing costs
in 1995.
The General Partner expects that contributions to the property improvement
fund will be a sufficient reserve for the future capital repair and
replacement needs of the Hotel's property and equipment.
Desert Springs Supp-38
<PAGE>
Pursuant to the terms of the Hotel Operating Lease and Management Agreement,
the Partnership is obligated to fund major improvements for the Hotel's
mechanical and heating systems. During 1998, the Partnership expects to fund
approximately $2.0 million for improvements to the Hotel's HVAC system
(heating, ventilating and air conditioning). Also, during 1998, the
Partnership expects to fund approximately $350,000 on roof repair projects.
The Partnership has established a reserve to pay for these improvements which
is expected to be sufficient. This reserve is being held by the mortgage loan
lender. There are currently no additional Partnership funded capital
expenditure items expected for 1998.
DEBT FINANCING
On December 23, 1996, pursuant to an agreement with the Partnership, GMAC
Commercial Mortgage Corporation ("GMAC") purchased the existing mortgage debt
of the Partnership and amended and restated certain terms thereof (as amended
and restated, the "Bridge Loan"). The Bridge Loan consisted of a $160 million
nonrecourse mortgage loan. The Partnership utilized $8.2 million from its
refinancing reserve to reduce the outstanding principal balance of the
existing mortgage debt to the $160 million outstanding under the Bridge Loan.
In addition, the Partnership utilized $2.6 million from the refinancing
reserve to pay costs associated with the financing including lender's fees,
property appraisals, environmental studies and legal fees. Approximately half
of the $2.6 million was for fees related to the long-term financing. The
Bridge Loan was originated by Goldman Sachs Mortgage Company ("GSMC"), matured
on October 31, 1997 and bore interest at the London Interbank Offered Rate
("LIBOR") plus 2.75 percentage points and required that all excess cash from
Hotel operations, if any, be held in a debt service reserve for future debt
service or to reduce the outstanding principal balance of the Bridge Loan upon
maturity. For the year ended December 31, 1996, the weighted-average interest
rate on the Partnership's mortgage debt was 9.0%. For the period of January 1
through November 25, 1997 the weighted average interest rate was 8.4%.
The Bridge Loan was secured by the Partnership's fee interest in the Hotel,
a security interest in certain personal property associated with the Hotel
including furniture and equipment, contracts and other general intangibles and
a security interest in the Partnership's rights under the Hotel operating
lease, the Hotel purchase agreement and other related agreements.
Pursuant to the terms of the debt refinancing, there are no continuing
requirements for a debt service guarantee. Host and the General Partner were
released from their obligations to the Partnership under their original debt
service guarantee with the refinancing of the Partnership's mortgage debt.
In conjunction with the refinancing of the mortgage debt, the General
Partner reaffirmed a foreclosure guarantee to the lender in the amount of $50
million. Pursuant to the terms of the foreclosure guarantee, amounts would be
payable only upon a foreclosure of the Hotel and only to the extent that the
gross proceeds from a foreclosure sale were less than $50 million. The
foreclosure guarantee was not reaffirmed with the refinancing of the Bridge
Loan.
On September 26, 1997, the General Partner received unrevoked consents
approving a new loan structure and certain amendments to the Partnership
Agreement which were necessary to refinancing negotiations of the Bridge Loan.
An extension agreement was signed with the current lender on October 30, 1997,
extending the maturity date and loan terms of the Bridge Loan from October 31,
1997 until December 31, 1997, without penalty.
On November 25, 1997, the Partnership secured long-term refinancing for its
$160 million Bridge Loan. The new financing consists of three tranches: 1) a
$103 million senior loan, 2) a $20 million loan and 3) a $59.7 million junior
loan. The $103 million senior loan (the "Senior Loan") is from GMAC Commercial
Mortgage Company ("GMAC") to a newly formed bankruptcy remote subsidiary of
the Partnership, DS Hotel LLC, which owns the Hotel and related assets. The
Senior Loan matures in December, 2022 and is secured by a first mortgage lien
on the Hotel. The loan bears interest at a fixed rate of 7.8% and requires
monthly payments of interest and principal with amortization over its twenty-
five year term. On June 11, 2010 the interest rate increases to 200
Desert Springs Supp-39
<PAGE>
basis points over the then current yield on 12 year U.S. treasuries and also
additional principal payments will be required as defined in the loan
agreement.
The second tranche of debt consists of a $20 million loan (the "Mezzanine
Loan") from Goldman Sachs Mortgage Company ("GSMC") to a newly formed
bankruptcy remote subsidiary of the Partnership, Marriott DSM LLC, which
secures the loan. Marriott DSM LLC owns a 100% interest in DS Hotel LLC. The
Mezzanine Loan consists of a fully amortizing $20 million loan maturing in
December, 2010. The loan bears interest at a fixed rate of 10.365% and
requires monthly payments of interest and principal with amortization over a
twelve and one-half year term.
The third tranche of debt consists of a junior loan, (the "HM Junior Loan")
to the Partnership from MDSM Finance LLC ("MDSM"), a wholly owned subsidiary
of the General Partner. The HM Junior Loan has a term of thirty years and
requires no principal amortization for the first twelve and one-half years
with a seventeen and one-half year amortization schedule thereafter. Security
for the HM Junior Loan is the Partnership's 100% interest in Marriott DSM LLC.
If remaining cash flow is insufficient to pay interest on the HM Junior Loan,
interest is deferred and will accrue and compound and be payable from future
cash flow. The HM Junior Loan also entitles MDSM to receive 30% of any excess
cash flow, as defined, available annually, plus 30% of any net
capital/residual proceeds after full repayment of the Senior Loan, the
Mezzanine Loan and the HM Junior Loan.
In conjunction with the refinancing of the mortgage debt, the Partnership
was required to establish cash reserves which are held by an agent of the
lender including:
. $6.2 million debt service reserve
. $1.5 million reserve for capital expenditures
. $2.0 million reserve for payment of fees to the Tenant/Manager
The reserves were established from the Partnership's restricted cash related
to the Bridge Loan in addition to Partnership operating cash.
In addition, the Partnership is required to establish with the lender a
separate escrow account for payments of insurance premiums and real estate
taxes for the Hotel if the credit rating of Marriott International is
downgraded by Standard and Poor's Rating Services. The Manager is a wholly-
owned subsidiary of Marriott International. In March 1997, Marriott
International acquired the Renaissance Hotel Group N.V., adding greater
geographic diversity and growth potential to its lodging portfolio. The
assumption of additional debt associated with this transaction resulted in a
single downgrade of Marriott International's long-term senior unsecured debt
effective April, 1997. Therefore, the Partnership was required to establish a
reserve account for insurance and real estate tax. As of December 31, 1997,
$581,000 remains available to pay insurance and real estate taxes. The escrow
reserve is included in restricted cash and the resulting tax and insurance
liability is included in accounts payable and accrued liabilities in the
accompanying balance sheet.
The Partnership utilized $1.2 million from the refinancing reserve to pay
costs associated with the financing including lender or subsidiary fees,
property appraisals, environmental studies and legal fees.
Debt to Marriott International
On April 30, 1996, the Partnership entered into a short-term loan with
Marriott International in the amount of $1,700,000 to fund a portion of the
Hotel's rooms refurbishment project. The loan's stated maturity was June 13,
1997, bore interest at 8.5% and was to be repaid from the property improvement
fund as contributions were made during the year. At December 31, 1996, the
loan balance was $900,000. The loan was fully repaid on March 28, 1997.
Property Improvement Fund
The Partnership is required to maintain the Hotel in good repair and
condition. The Hotel Operating Lease agreement and Management Agreement
require the Tenant/Manager to make annual contributions to the property
Desert Springs Supp-40
<PAGE>
improvement fund for the Hotel on behalf of the Partnership. Contributions to
the fund are equal to 4.5% of Hotel gross revenues through 1997 increasing to
5.5% thereafter. Total contributions to the fund were $3.8 million in 1995,
$4.4 million in 1996 and $4.6 million in 1997. The balance of the Hotel's
property improvement fund was $1.6 million as of December 31, 1997.
During the summer of 1996, a $9.1 million rooms refurbishment was completed
at the Hotel. The property improvement fund was not sufficient to fund the
refurbishment. The Partnership arranged a short-term loan from Marriott
International of up to $1.7 million at a fixed rate of 8.5% to finance the
anticipated shortfall. The loan was repaid from the property improvement fund
prior to its maturity on June 13, 1997. The General Partner believes that
funds available from the property improvement fund will be adequate for
anticipated renewal and replacement expenditures.
During 1995, the Hotel's main swimming pool was expanded. This $2.1 million
expansion was funded partially with $692,000 in proceeds received from
Marriott Vacation Club International ("MVCI") pursuant to an agreement between
the Partnership and MVCI for the development of additional time share units on
land adjacent to the Hotel. The Partnership funded the remaining $1.4 million
from cash reserves.
Equipment Lease
The Partnership leased airline equipment to TWA under an operating lease
which expired in April 1995. On April 20, 1995, the Partnership reached an
agreement with TWA whereby TWA was obligated to pay quarterly payments of
$780,000 plus interest in arrears at 17%. At the end of the lease in July 1996
(or earlier if a termination option was exercised), TWA had the option to
purchase the equipment for one dollar ($1). The lease generated $5.4 million
in cash flow during the 1995 fiscal year. As a result of the lease renewal
terms, the Partnership recorded a receivable for the future lease payments due
from TWA and deferred the gain on the transaction. The deferred gain was
recognized as income as lease payments were received. Total rental income
recognized in 1995 and 1996 on the lease was $2.8 million and $1.2 million,
respectively. The original cost of the airline equipment was depreciated over
the life of the operating lease. Depreciation expense on the airline equipment
was $526,000 for the year ended December 31, 1995.
On April 24, 1996, TWA exercised its early termination option under the
airline equipment lease and paid the rent due on that date of $847,000 along
with the termination value of $780,000 plus the $1 purchase option. Rental
income of $1,248,000 was generated by the lease in 1996.
Golf Course Lease
The Second Golf Course is located near the Hotel on approximately 100 acres
of land and is leased to the Partnership by a subsidiary of Marriott
International. The Second Golf Course and related facilities were subleased by
the Partnership to the Tenant/Manager pursuant to an operating lease with
annual rental equal to $100,000. The term of the lease for the Second Golf
Course expires on December 31, 2011, with five 10-year renewal periods at the
option of the Partnership. Under the terms of the lease for the Second Golf
Course, the Partnership pays annual rent equal to $100,000 and is responsible
for all costs of operating and maintaining the Second Golf Course. Upon
termination of the lease for the Second Golf Course, the Second Golf Course
and all facilities and improvements thereon will become the property of
Marriott's Desert Springs Development Corporation. All costs of operating and
maintaining the course are deductions from gross revenues and all revenues
from operation of the course are items of gross revenues of the Hotel. In
conjunction with the refinancing of the mortgage debt, the golf course is no
longer subleased to the Operating Tenant. The Manager manages the golf course
for the Partnership pursuant to the terms of the Golf Course Lease.
Homeowners Agreement
A subsidiary of Marriott International, MVCI has been developing a portion
of land adjacent to the golf courses for time shares. The Partnership,
Marriott International, Marriott's Desert Springs Development Corporation and
MVCI entered into an Agreement (the "Homeowners Agreement") whereby it was
agreed that
Desert Springs Supp-41
<PAGE>
each purchaser of a time share unit will receive certain golf course and other
privileges (including preferred tee times at the golf courses equal to one tee
time per week per time share unit) at the Hotel. Time share purchasers will
not pay membership fees, but rather will pay regular green fees for use of the
golf courses, and do not receive preferred tennis court times or free access
to the health spa. Time share purchasers will have use of the latter
facilities and other Hotel facilities, if they are available, on the same
basis as regular Hotel guests and will pay the same fees as regular Hotel
guests.
Office Space Rental Agreement
On January 27, 1995, the Partnership entered into an agreement with MVCI
whereby MVCI occupies the space of eleven guest rooms and built a vacation
gallery. The initial term of the agreement is April 1, 1995 to March 31, 1999,
with initial annual rental of $150,000. The annual rental may be increased in
the second, third and fourth year of the lease by the local area Consumer
Price Index plus 1% subject to a maximum of 10%.
INFLATION
For the three fiscal years ended December 31, 1997 and the First Two
Quarters 1998, the rate of inflation has been relatively low and, accordingly,
has not had a significant impact on the Partnership's gross income and net
income. The Operating Tenant/Manager is generally able to pass through
increased costs to customers through higher room rates. In 1997, the increase
in average room rates at the Hotel exceeded those of direct competitors as
well as the general level of inflation.
SEASONALITY
Demand, and thus occupancy and room rates, is affected by normally recurring
seasonal patterns. Demand tends to be higher during the months of November
through April than during the remainder of the year. This seasonality tends to
affect the results of operations, increasing the revenue and rental income
during these months. In addition, this seasonality may also increase the
liquidity of the Partnership during these months.
YEAR 2000 ISSUES
Over the last few years, Host Marriott Corporation, the parent company of
the General Partner, has invested in implementing new accounting systems which
are Year 2000 compliant. Accordingly, the General Partner believes that future
costs associated with Year 2000 issues will be minimal and not material to the
Partnership's financial statements.
However, the Partnership does rely upon accounting software used by the
Manager of its property to obtain financial information. The General Partner
believes that the manager has begun to implement changes to the property
specific software to ensure the software will function properly in the Year
2000 and does not expect to incur significant costs related to these
modifications.
Desert Springs Supp-42
<PAGE>
FINANCIAL STATEMENTS
Desert Springs Supp-43
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE PARTNERS OF DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP:
We have audited the accompanying balance sheet of Desert Springs Marriott
Limited Partnership and subsidiaries (a Delaware limited partnership) as of
December 31, 1997 and 1996, and the related statements of operations, changes
in partners' (deficit) capital and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the General Partner's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Desert Springs Marriott
Limited Partnership and subsidiaries as of December 31, 1997 and 1996, and the
results of its operations and its cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Washington, D.C.
February 18, 1998
Desert Springs Supp-44
<PAGE>
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES
BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Property and equipment, net...................... $151,401 $155,441
Due from Marriott International, Inc............. 1,368 8
Property improvement fund........................ 1,598 1,041
Deferred financing, net of accumulated
amortization.................................... 3,000 2,637
Restricted cash.................................. 10,236 --
Cash and cash equivalents........................ 4,553 5,755
-------- --------
$172,156 $164,882
======== ========
LIABILITIES AND PARTNERS'
DEFICIT
LIABILITIES
Mortgage debt.................................... $103,000 $160,000
Note payable..................................... 20,000 --
Due to Host Marriott and affiliates.............. 59,727 --
Additional rental paid by hotel lessee........... -- 25,013
Due to Marriott International, Inc............... 2,122 1,022
Accounts payable and accrued expenses............ 1,972 484
-------- --------
Total Liabilities.............................. 186,821 186,519
======== ========
PARTNERS' DEFICIT
General Partner
Capital contribution............................ 909 909
Capital distributions........................... (829) (602)
Cumulative net losses........................... (101) (398)
-------- --------
(21) (91)
-------- --------
Limited Partners
Capital contributions, net of offering costs of
$10,576....................................... 77,444 77,444
Investor notes receivable...................... (22) (22)
Capital distributions.......................... (82,084) (59,584)
Cumulative net losses.......................... (9,982) (39,384)
-------- --------
(14,644) (21,546)
-------- --------
Total Partners' Deficit....................... (14,665) (21,637)
-------- --------
$172,156 $164,882
======== ========
</TABLE>
See Notes to financial statements.
Desert Springs Supp-45
<PAGE>
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
INCOME
Rentals
Hotel............................................... $24,016 $23,433 $19,851
Airline equipment (Note 6).......................... -- 1,248 2,837
Hotel revenues (Note 10)............................. 2,610 -- --
Other................................................ 607 1,100 1,663
------- ------- -------
27,233 25,781 24,351
------- ------- -------
EXPENSES
Interest............................................. 14,827 15,501 13,371
Depreciation......................................... 7,182 7,732 7,823
Property taxes....................................... 1,958 1,965 1,219
Partnership administration and other................. 445 474 353
Base management fee.................................. 281 -- --
Insurance and other.................................. 256 -- --
Incentive management fee............................. 123 -- --
------- ------- -------
25,072 25,672 22,766
------- ------- -------
NET INCOME BEFORE EXTRAORDINARY ITEM................... 2,161 109 1,585
------- ------- -------
EXTRAORDINARY ITEM
Gain on forgiveness of additional rental............. 27,538 -- --
------- ------- -------
NET INCOME............................................. $29,699 $ 109 $ 1,585
------- ------- -------
ALLOCATION OF NET INCOME
General Partner...................................... $ 297 $ 1 $ 16
Limited Partners..................................... 29,402 108 1,569
------- ------- -------
$29,699 $ 109 $ 1,585
------- ------- -------
NET INCOME PER LIMITED PARTNER UNIT (900 Units)........ $32,669 $ 120 $ 1,743
======= ======= =======
</TABLE>
See Notes to financial statements.
Desert Springs Supp-46
<PAGE>
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNER PARTNERS TOTAL
------- -------- --------
<S> <C> <C> <C>
Balance, December 31, 1994.......................... $ (42) $(16,671) $(16,713)
Net income........................................ 16 1,569 1,585
Capital distributions............................. (51) (5,020) (5,071)
----- -------- --------
Balance, December 31, 1995.......................... (77) (20,122) (20,199)
Net income........................................ 1 108 109
Capital distributions............................. (15) (1,532) (1,547)
----- -------- --------
Balance, December 31, 1996.......................... (91) (21,546) (21,637)
Net income........................................ 297 29,402 29,699
Capital distributions............................. (227) (22,500) (22,727)
----- -------- --------
Balance, December 31, 1997.......................... $ (21) $(14,644) $(14,665)
===== ======== ========
</TABLE>
See Notes to financial statements.
Desert Springs Supp-47
<PAGE>
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- -------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income.................................... $ 29,699 $ 109 $ 1,585
Extraordinary item............................ (27,538) -- --
--------- --------- -------
Income before extraordinary item.............. 2,161 109 1,585
Noncash items:
Depreciation................................. 7,182 7,732 7,823
Amortization of deferred financing costs as
interest expense............................ 807 104 135
Loss (gain) on dispositions of property and
equipment................................... 163 (1,248) (1,972)
Changes in operating accounts:
Due to/from Marriott International, Inc. and
affiliates.................................. 640 2,287 (2,241)
Due from airline equipment lessee............ -- -- 1,357
Accounts payable and accrued interest........ 1,488 (1,967) 37
--------- --------- -------
Cash provided by operations................. 12,441 7,017 6,724
--------- --------- -------
INVESTING ACTIVITIES
Additions to property and equipment........... (3,318) (9,989) (3,979)
Change in property improvement fund, net...... (544) 4,384 (2,035)
Proceeds from sales of airline equipment...... -- 2,509 3,964
--------- --------- -------
Cash used in investing activities........... (3,862) (3,096) (2,050)
--------- --------- -------
FINANCING ACTIVITIES
Proceeds from mortgage loan................... 182,727 160,000 --
Repayment of mortgage debt.................... (160,000) (168,239) --
Capital distributions to partners............. (22,727) (1,547) (5,071)
Change in restricted cash..................... (10,236) -- --
Additional rental paid by hotel lessee........ 2,525 3,165 3,672
Payment of refinancing costs.................. (1,170) (2,658) --
Repayment of note payable to Marriott
International, Inc........................... (900) (800) --
Advances from Marriott International, Inc..... -- 1,700 --
--------- --------- -------
Cash used in financing activities........... (9,781) (8,379) (1,399)
--------- --------- -------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS.................................... (1,202) (4,458) 3,275
CASH AND CASH EQUIVALENTS at beginning of year.. 5,755 10,213 6,938
--------- --------- -------
CASH AND CASH EQUIVALENTS at end of year........ $ 4,553 $ 5,755 $10,213
========= ========= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for mortgage interest and other..... $ 12,959 $ 17,372 $13,237
========= ========= =======
</TABLE>
See Notes to financial statements.
Desert Springs Supp-48
<PAGE>
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
NOTE 1. THE PARTNERSHIP
Description of the Partnership
Desert Springs Marriott Limited Partnership (the "Partnership"), a Delaware
limited partnership, was formed to acquire and own Marriott's Desert Springs
Resort and Spa and the land on which the 884-room hotel and a golf course are
located (the "Hotel") and airline equipment. The sole general partner of the
Partnership, with a 1% interest, is Marriott Desert Springs Corporation (the
"General Partner"), a wholly-owned subsidiary of Host Marriott Corporation
("Host Marriott"). The Hotel was leased to Marriott Hotel Services, Inc. (the
"Tenant"), a wholly-owned subsidiary of Marriott International, along with a
second golf course leased by the Partnership from Marriott Desert Springs
Development Corporation, also a wholly-owned subsidiary of Marriott
International. The airline equipment was leased to TransWorld Airlines, Inc.
("TWA") pursuant to the terms of an operating lease through April 20, 1995. On
April 20, 1995, the Partnership entered into a new sales-type lease agreement
which was due to expire on June 24, 1996. On April 24, 1996, TWA exercised its
early termination option under the airline equipment lease and paid the rent
due on that date of $847,000 along with the termination value of $780,000 plus
the $1 purchase option (see Note 6).
The Partnership was formed on February 26, 1987, and operations commenced on
April 24, 1987 (the "Unit Offering Closing Date"). Between March 20, 1987, and
the Unit Offering Closing Date, 900 limited partnership interests (the
"Units") were subscribed pursuant to a private placement offering. The
offering price per Unit was $100,000; $25,000 payable at subscription with the
balance due in three annual installments through June 15, 1990, or, as an
alternative, $87,715 in cash at closing as full payment of the subscription
price. Of the total 900 Units, 740.5 were purchased on the installment basis
and 159.5 Units were paid in full. The General Partner contributed $909,100 in
cash for its 1% general partnership interest.
In connection with the mortgage debt refinancing in 1997 (see Note 5), the
General Partner received unrevoked consents of limited partners approving
certain amendments to the partnership agreement. The amendments, among other
things, allowed the formation of certain subsidiaries of the Partnership
including DS Hotel LLC and Marriott DSM LLC. The Partnership contributed the
Hotel and its related assets to Marriott DSM LLC, which in turn contributed
them to DS Hotel LLC, a bankruptcy remote subsidiary. Marriott DSM LLC, a
bankruptcy remote subsidiary of the Partnership owns 100% interest in DS Hotel
LLC. The Partnership owns 100% interest in Marriott DSM LLC. In addition,
effective November 25, 1997, the Hotel is managed by the Tenant (the
"Manager").
Partnership Allocations and Distributions
Under the partnership agreement, Partnership allocations, for Federal income
tax purposes, and distributions are generally made as follows:
a. Cash available for distribution will generally be distributed (i) first,
1% to the General Partner and 99% to the limited partners until the General
Partner and the limited partners (collectively, the "Partners") have received
cumulative distributions of sale or refinancing proceeds ("Capital Receipts")
equal to $45,454,545; and (ii) thereafter, 10% to the General Partner and 90%
to the limited partners.
b. Refinancing proceeds and proceeds from the sale or other disposition of
less than substantially all of the assets of the Partnership, not retained by
the Partnership, will be distributed (i) first, 1% to the General Partner and
99% to the limited partners, until the Partners have received cumulative
distributions of Capital Receipts equal to $90,909,100; and (ii) thereafter,
10% to the General Partner and 90% to the limited partners.
Proceeds from the sale or other disposition of all or substantially all of
the assets of the Partnership or from the sale or other disposition of all or
substantially all of the Hotel will be distributed to the Partners pro rata in
accordance with their capital account balances as defined in the partnership
agreement.
Desert Springs Supp-49
<PAGE>
c. Net profits will be allocated as follows: (i) first, through and
including the year ended December 31, 1990, 99% to the General Partner and 1%
to the limited partners; (ii) next, through and including the year ending
December 31, 1992, 70% to the General Partner and 30% to the limited partners;
and (iii) thereafter, 10% to the General Partner and 90% to the limited
partners.
d. Net losses will be allocated 100% to the General Partner through December
31, 1990, and thereafter, 70% to the General Partner and 30% to the limited
partners, subject to certain limitations, as specified in the partnership
agreement, regarding allocations to the limited partners.
e. The deduction for interest on the Purchase Note, as defined, which
cumulatively will not exceed $12,285 per Unit will be allocated to those
limited partners owning the Units purchased on the installment basis.
f. In general, gain recognized by the Partnership will be allocated as
follows: (i) first, to all Partners whose capital accounts have negative
balances until such negative balances are brought to zero; (ii) next, to all
Partners up to the amount necessary to bring their respective capital account
balances to an amount equal to their respective invested capital, as defined;
(iii) third, in the case of gain arising from the sale or other disposition
(or from a related series of sales or dispositions) of all or substantially
all of the assets of the Partnership, (a) to the limited partners in an amount
equal to the excess, if any, of (1) the sum of the product of 12% times the
weighted-average of the limited partners' invested capital, as defined, each
year, minus (2) the sum of cumulative distributions to the limited partners of
cash available for distribution, and (b) next, to the General Partner until it
has been allocated an amount equal to 10/90 times the amount allocated to the
limited partners in (a); and (iv) thereafter, 12% to the General Partner and
88% to the limited partners.
For financial reporting purposes, profits and losses are allocated among the
Partners based upon their stated interests in cash available for distribution.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting
The Partnership records are maintained on the accrual basis of accounting
and its fiscal year coincides with the calendar year.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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 from those estimates.
Revenues and Expenses
Effective November 25, 1997, the Partnership records hotel revenues which
represent house profit of the hotel since the Partnership has delegated
substantially all of the operating decisions related to the generation of
house profit of the Hotel to the Manager. House profit reflects Hotel
operating results, and represents gross hotel sales less property-level
expenses, excluding depreciation, base and incentive management fees, property
taxes, insurance and certain other costs, which are disclosed separately in
the statement of operations.
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
Desert Springs Supp-50
<PAGE>
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding the property-level revenues and operating expenses of the Hotel from
its statements of operations (see Note 10). If the Partnership concludes that
EITF 97-2 should be applied to its hotels, it would include operating results
of those managed operations in its financial statements. Application of EITF
97-2 to financial statements as of and for the year ended December 31, 1997
would have increased both revenues and operating expenses by approximately
$6.7 million and would have had no impact on operating profit or net income.
Property and Equipment
Property and equipment is recorded at cost. Depreciation is computed using
the straight-line method over the following estimated useful lives of the
assets less an estimated residual value of 10% on the original building cost
and 20% on the airline equipment cost:
<TABLE>
<S> <C>
Building and improvements...... 50 years
Furniture and equipment........ 4 to 10 years
Airline equipment.............. 8 years
</TABLE>
All Hotel property and equipment is pledged as security for the Senior Loan
described in Note 5.
The Partnership assesses impairment of its real estate property based on
whether estimated undiscounted future cash flow from the hotel will be less
than its net book value. If the property is impaired, its basis is adjusted to
fair market value.
Deferred Financing Costs
Deferred financing costs represent the costs incurred in connection with
obtaining debt financing and are amortized over the term thereof. The original
Mortgage Debt (see Note 5) matured on July 27, 1996. Deferred financing costs
associated with that debt, totaling $943,000, were fully amortized at maturity
and removed from the Partnership's books. Costs associated with the Bridge
Loan totaled $2,658,000 at December 31, 1996. Total financing costs associated
with the Bridge Loan and long-term financing completed on November 25, 1997
totaled $3,828,000. At December 31, 1997 and 1996, accumulated amortization of
deferred financing costs totaled $828,000 and $21,000, respectively.
Restricted Cash Reserves
In conjunction with the refinancing of the mortgage debt, the Partnership
was required to establish cash reserves which are held by an agent of the
lender including:
. $6.2 million debt service reserve
. $1.5 million reserve for capital expenditures
. $2.0 million reserve for payment of fees to the Tenant/Manager
In addition, the Partnership is required to establish with the lender a
separate escrow account for payments of insurance premiums and real estate
taxes for the Hotel if the credit rating of Marriott International is
downgraded by Standard and Poor's Rating Services. The Manager is a wholly-
owned subsidiary of Marriott International. In March 1997, Marriott
International acquired the Renaissance Hotel Group N.V., adding greater
geographic diversity and growth potential to its lodging portfolio. The
assumption of additional debt associated with this transaction resulted in a
single downgrade of Marriott International's long-term senior unsecured debt
effective April, 1997. Therefore, the Partnership was required to establish a
reserve account for insurance and real estate tax. As of December 31, 1997,
$581,000 remains available to pay insurance and real estate taxes. The escrow
reserve is included in restricted cash and the resulting tax and insurance
liability is included in accounts payable and accrued liabilities in the
accompanying balance sheet.
The reserves were established from the Partnership's restricted cash related
to the Bridge Loan in addition to Partnership operating cash.
Desert Springs Supp-51
<PAGE>
Additional Rental
Under the terms of the Hotel operating lease (see Note 7), the Tenant paid
Additional Rental to the Partnership which was subject to possible repayment
under defined conditions; therefore, Additional Rental had been recorded as a
liability in the financial statements. At the termination of the Operating
Lease, all Additional Rental was forgiven and is recorded as an Extraordinary
Gain in the financial statements.
Cash and Cash Equivalents
The Partnership considers all highly liquid investments with a maturity of
less than three months at date of purchase to be cash equivalents.
Income Taxes
Provision for Federal and state income taxes has not been made in the
accompanying financial statements since the Partnership does not pay income
taxes, but rather, allocates its profits and losses to the individual
partners. Significant differences exist between the net loss/net income for
financial reporting purposes and the net loss/net income reported in the
Partnership's tax return. These differences are due primarily to the use for
income tax purposes of accelerated depreciation methods, shorter depreciable
lives for the assets and differences in the timing of recognition of rental
income. As a result of these differences, the excess of the tax basis in net
Partnership liabilities and the net liabilities reported in the accompanying
financial statements at December 31, 1997 and 1996 was $55.7 million and $26.0
million, respectively.
New Statements of Financial Accounting Standards
The Partnership adopted SFAS No. 121 "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of" during 1996.
Adoption of SFAS No. 121 did not have any effect on the Partnership's
financial statements.
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Land and land improvements............................... $ 13,690 $ 13,690
Building and improvements................................ 155,497 155,570
Furniture and equipment.................................. 44,090 47,800
-------- --------
213,277 217,060
Less accumulated depreciation............................ (61,876) (61,619)
-------- --------
$151,401 $155,441
======== ========
</TABLE>
NOTE 4. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of financial instruments are shown below. Fair
values of financial instruments not included in this table are estimated to be
equal to their carrying amounts (in thousands):
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997 AS OF DECEMBER 31, 1996
------------------------ ------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Mortgage debt............. $103,000 $103,000 $160,000 $160,000
Note payable.............. 20,000 20,000 -- --
Due to Host Marriott and
affiliates............... 59,727 59,727 -- --
Note Payable to Marriott
International............ -- -- 900 900
Additional rental paid by
Hotel lessee............. -- -- 25,013 --
</TABLE>
Desert Springs Supp-52
<PAGE>
The estimated fair value of mortgage debt and other long term obligations is
based on the expected future debt service payments discounted at estimated
market rates. Additional rental paid by the Hotel lessee was valued based on
the expected future payments from operating cash flow discounted at a risk-
adjusted rate. As further explained in Note 7, upon closing of the permanent
financing, Marriott International agreed to waive all claims to Additional
Rental that had accrued prior to the consummation of the loan. Consequently,
the estimated fair value of Additional Rental paid by the Hotel lessee is
zero.
NOTE 5. DEBT
In 1996, Partnership debt consisted of a $168.2 million nonrecourse mortgage
loan (the "Mortgage Debt") which matured on July 27, 1996. The Mortgage Debt
bore interest at a fixed rate of 7.76% and required no amortization of
principal prior to maturity. Upon maturity, the Mortgage Debt went into
default as the Partnership was unable to secure replacement financing or
negotiate a forbearance agreement with the lender. Pursuant to the loan
documents, the Mortgage Debt began to accrue interest at the Default Rate, as
defined, of 10.75% which was 2.5 percentage points above the Lender's
Corporate Base Rate, as defined, from the maturity date through December 23,
1996. The Mortgage Debt was refinanced on December 23, 1996.
As of December 31, 1996, Partnership debt consisted of a $160 million
nonrecourse mortgage loan (the "Bridge Loan"). The Bridge Loan was originated
by Goldman, Sachs & Co. ("Goldman Sachs") and the lender was GMAC Commercial
Mortgage Corporation providing an interim $160 million mortgage loan bearing
interest at LIBOR plus 2.75 percentage points which matured on October 31,
1997. Pursuant to the terms of the Bridge Loan, all excess cash from Hotel
operations, if any, was held in a debt service reserve for future debt service
or to reduce the outstanding principal balance upon maturity. Through November
25, 1997, the weighted average interest rate on the Bridge Loan was 8.4%.
On September 26, 1997, the General Partner received unrevoked consents
approving a new loan structure and certain amendments to the Partnership
Agreement which were necessary to refinancing negotiations of the Bridge Loan.
An extension agreement was signed with the current lender on October 30, 1997,
extending the maturity date of the Bridge Loan from October 31, 1997 to
December 31, 1997, without penalty.
On November 25, 1997, the Partnership secured long-term financing for its
$160 million Bridge Loan. The new financing consists of three tranches: 1) a
$103 million senior loan, 2) a $20 million loan and 3) a $59.7 million junior
loan. The $103 million senior loan (the "Senior Loan") is from GMAC Commercial
Mortgage Company ("GMAC") to a newly formed bankruptcy remote subsidiary of
the Partnership, DS Hotel LLC, which owns the Hotel and related assets. The
Senior Loan matures in December, 2022 and is secured by a first mortgage lien
on the Hotel. The loan bears interest at a fixed rate of 7.8% and requires
monthly payments of interest and principal with amortization over its twenty-
five year term.
The second tranche of debt consists of a $20 million loan (the "Mezzanine
Loan") from Goldman Sachs Mortgage Company ("GSMC") to a newly formed
bankruptcy remote subsidiary of the Partnership, Marriott DSM LLC, which
secures the loan. The Mezzanine Loan consists of a fully amortizing $20
million loan bearing interest at 10.365% for a twelve and one-half year term
maturing in December, 2010.
The third tranche of debt consists of a junior loan, (the "HM Junior Loan")
to the Partnership from MDSM Finance LLC ("MDSM"), a wholly owned subsidiary
of the General Partner. The HM Junior Loan has a term of thirty years and
requires no principal amortization for the first twelve and one-half years
with a seventeen and one-half year amortization schedule thereafter. If
remaining cash flow is insufficient to pay interest on the HM Junior Loan,
interest is deferred and will accrue and compound and be payable from future
cash flow. The HM Junior Loan also entitles MDSM to receive 30% of any excess
cash flow, as defined, available annually, plus 30% of any net
capital/residual proceeds after full repayment of the Senior Loan, the
Mezzanine Loan and the HM Junior Loan.
On the Closing Date, the Partnership was required to establish certain
reserves which are discussed in Note 2.
Desert Springs Supp-53
<PAGE>
The Partnership utilized $1.2 million in 1997 from the refinancing reserve
to pay costs associated with the financing including lender or subsidiary
fees, property appraisals, environmental studies and legal fees.
The required principal payments of the Senior Loan, Mezzanine Loan and the
HM Junior Loan at December 31, 1997 are as follows (in thousands):
<TABLE>
<S> <C>
1998............................................................. $ 2,186
1999............................................................. 2,389
2000............................................................. 2,581
2001............................................................. 2,850
2002............................................................. 3,116
Thereafter....................................................... 169,605
--------
$182,727
========
</TABLE>
Debt to Marriott International
On April 30, 1996, the Partnership entered into a short-term loan with
Marriott International in the amount of $1,700,000 to fund a portion of the
Hotel's rooms refurbishment project. The loan matured on June 13, 1997,
bearing interest at 8.5% and was repaid from the property improvement fund as
contributions were made during the year. The loan was fully repaid on March
28, 1997.
NOTE 6. AIRLINE EQUIPMENT LEASE
The Partnership leased airline equipment to TWA under the terms of an
operating lease which expired in April 1995. Pursuant to the terms of the
airline equipment lease, TWA was obligated to make semi-annual payments, in
arrears, based upon specified percentages of the Partnership's cost of the
airline equipment. Rental income under the operating lease is included in
"Airline equipment income" in the statement of operations and was $852,000 in
1995.
On April 20, 1995, the Partnership reached an agreement with TWA whereby TWA
was obligated to pay renewal rents under a 15-month lease agreement. The
renewal rents consisted of quarterly payments of $780,000 plus 17% interest
paid in arrears, all of which totaled $6.5 million. At the end of the lease
term, TWA had the option to purchase the equipment for one dollar ($1). The
Partnership classified the new lease as a sales-type lease and recorded a
receivable for the future lease payments due from TWA, along with a deferred
gain on the transaction. The deferred gain was recognized as income as lease
payments were received on the installment method as a component of the line
item "Airline Equipment Income" in the statement of operations. Deferred gain
amortization was $1,248,000 in 1996 and $1,985,000 in 1995. On April 24, 1996,
TWA exercised its early termination option under the airline equipment lease
and paid the rent due on that date of $847,000 along with the termination
value of $780,000 plus the $1 purchase option.
NOTE 7. OPERATING LEASE
The Partnership leased the Hotel to the Tenant pursuant to an agreement
which commenced on April 24, 1987, with an initial term of 25 years (the
"Operating Lease") with renewal options for five successive periods of 10
years each.
Annual Rental was equal to the greater of Basic Rental or Owner's Priority,
as described below:
1. Basic Rental equals 85% of Operating Profit, as defined, until
December 31, 1993, and 80% thereafter.
2. Owner's Priority equals the greater of (i) $20 million plus debt
service on certain additional debt to expand the Hotel ("Expansion Debt
Service") or (ii) Debt Service, as defined. If there is a new mortgage
Desert Springs Supp-54
<PAGE>
(in an amount which exceeds the outstanding balance of the existing
mortgage by at least $45,455,000), Owner's Priority will equal the greater
of (i) $20 million plus Expansion Debt Service, (ii) Debt Service or (iii)
the lesser of Debt Service on the new mortgage or $24 million plus
Expansion Debt Service. In no event will Owner's Priority for any year
exceed Operating Profit.
3. Additional Rental equals the cumulative amount by which Owner's
Priority exceeds Basic Rental plus $268,000 and is recorded as a liability
in the accompanying financial statements. If in any year Basic Rental
exceeds Owner's Priority, Annual Rental will be reduced to equal Basic
Rental minus the lower of (i) Additional Rental then outstanding or (ii)
25% of the amount by which Basic Rental exceeds Owner's Priority.
Pursuant to an agreement reached with Marriott International, for fiscal
year 1997 the $20 million Owner's Priority was increased to $20.5 million.
Marriott International was entitled only to the next $2 million of Operating
Profit. Any additional Operating Profit in excess of $22.5 million was
remitted entirely to the Partnership. In connection with the long-term
financing, Marriott International agreed to waive any and all claims to
Additional Rental that accrued prior to the consummation of the loan. The
Partnership recorded an extraordinary gain of $27.5 million in 1997 to
recognize the gain which resulted from the forgiveness of these fees.
Rental income for 1997 included Basic Rental of $17,608,000 and Additional
Rental of $4,402,000. Operating Profit in 1997 totaled $23,698,000. In
accordance with an agreement reached with Marriott International, the
Partnership was entitled to receive Owner's Priority of $20,500,000 and
Marriott International was entitled to the next $2,000,000 with the remaining
$1,198,000 to the Partnership.
In addition to the Annual Rental, the Tenant was required to pay property
taxes, make annual contributions equal to a percentage of Hotel sales to a
property improvement fund (4.5% through 1997 and 5.5% thereafter) and pay
rental on the second golf course.
Pursuant to the terms of the Hotel purchase agreement, the Tenant and its
affiliates may utilize a portion of the land adjacent to the Hotel for
development of residences and timeshare condominiums. Purchasers of the
residences have the opportunity to use certain Hotel facilities and services
for a fee. Purchasers of the timeshare condominiums also have the ability to
use the Hotel's facilities but such use is subject to the same fees charged to
Hotel guests.
During 1995, the Hotel's main swimming pool was expanded at a cost of
approximately $2.1 million. The project was funded partially by proceeds
received from Marriott Vacation Club International ("MVCI"), a wholly-owned
indirect subsidiary of Marriott International, pursuant to an agreement
between the Partnership and MVCI for the development of additional timeshare
units on land adjacent to the Hotel. As part of this agreement, the Hotel's
spa was also expanded during 1994. Pursuant to the terms of the agreement,
MVCI contributed a total of $1.3 million towards the pool expansion and the
spa expansion projects; the remaining costs were funded by Partnership cash
reserves. Funding by MVCI in 1995 was $692,000, and was included in "Other
Income" in the statement of operations.
NOTE 8. MANAGEMENT AGREEMENT
On November 25, 1997, in connection with the refinancing, the General
Partner also negotiated with the Tenant to convert the Operating Lease to a
management agreement (the "Management Agreement"). The Tenant would become
manager of the Hotel (the "Manager"). The initial term of the Management
Agreement continues through 2022 with four successive renewal options of ten
years each. The Manager is paid a base management fee equal to 3% of gross
hotel sales.
Beginning in fiscal year 1998, the Management Agreement provides that no
incentive fee will be paid to the Manager with respect to the first $21.5
million of Operating Profit (the "Owner's Priority"). Thereafter the
Desert Springs Supp-55
<PAGE>
Manager will receive the next $1.8 million of Operating Profit as incentive
management fee and any operating profit in excess of $23.3 million will be
divided 75% to the Partnership and 25% to the Manager. Any such payments will
be made annually after completion of the audit of the Partnership's books.
The Management Agreement provides that the owner may terminate the
Management Agreement if, in any two of three consecutive fiscal years,
Operating Profit is less than $15 million. The Manager may, however, prevent
termination by paying the owner such amounts as are necessary to achieve the
performance standards.
Pursuant to the Management Agreement, the Manager is required to furnish the
Hotel with certain services ("Chain Services") which are generally provided on
a central or regional basis to all hotels in the Manager's full-service hotel
system. Chain Services include central training, advertising and promotion, a
national reservations system, computerized payroll and accounting services and
such additional services as needed which may be more efficiently performed on
a centralized basis. Costs and expenses incurred in providing such services
are allocated among all domestic full-service hotels managed, owned or leased
by the Manager or its subsidiaries. In addition, the Hotels also participate
in the Manager's Marriott Rewards Program. The cost of this program is charged
to all hotels in the Manager's full-service hotel system based upon the
Marriott Rewards sales at each hotel. The total amount of Chain Services and
Marriott Rewards costs charged to the Partnership from November 25 through
December 31, 1997 were $169,000.
The Management Agreements provide for the establishment of a property
improvement fund for the Hotel to cover the cost of certain non-routine
repairs and maintenance to the Hotel which are normally capitalized and the
cost of replacements and renewals to the Hotel's property and improvements.
Contributions to the property improvement fund are based on a percentage of
gross sales. Contributions to the property improvement fund are 4.5% in 1997
and 5.5% thereafter. Contributions to the property improvement fund from
November 25 through December 31, 1997 were $421,000.
NOTE 9. HOTEL OPERATING RESULTS
The following is a summary of Hotel Operating Profit, as defined in the
Hotel lease agreement, for the three years ended December 31, 1997 (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------- ------- -------
<S> <C> <C> <C>
REVENUES
Rooms.............................................. $ 39,825 $37,031 $33,495
Food and beverage.................................. 40,366 38,431 33,453
Other.............................................. 23,130 22,437 18,450
-------- ------- -------
103,321 97,899 85,398
-------- ------- -------
EXPENSES
Departmental direct costs
Rooms............................................. 8,933 8,545 7,715
Food and beverage................................. 27,642 26,623 23,335
Other operating expenses........................... 43,048 41,686 35,987
-------- ------- -------
79,623 76,854 67,037
-------- ------- -------
OPERATING PROFIT.................................... $ 23,698 $21,045 $18,361
======== ======= =======
</TABLE>
Desert Springs Supp-56
<PAGE>
NOTE 10. REVENUES
Partnership revenues for the period of November 25 through December 31, 1997
consist of the Hotel's operating results (in thousands):
<TABLE>
<S> <C>
HOTEL SALES
Rooms............................................................... $3,620
Food and beverage................................................... 3,330
Other............................................................... 2,403
------
9,353
------
HOTEL EXPENSES
Departmental direct costs
Rooms............................................................... 801
Food and beverage................................................... 2,646
Other............................................................... 3,296
------
Other Hotel operating expenses...................................... 6,743
------
HOTEL REVENUES........................................................ $2,610
======
</TABLE>
Desert Springs Supp-57
<PAGE>
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
----------------
1998 1997
------- -------
<S> <C> <C>
REVENUES (Note 3)
Hotel revenues............................................. $27,291 $ --
Hotel rentals.............................................. -- 12,488
------- -------
27,291 12,488
------- -------
OPERATING COSTS AND EXPENSES
Depreciation............................................... 3,314 3,568
Base management fees....................................... 1,952 --
Incentive management fees.................................. 1,841 --
Property taxes and other................................... 1,639 1,164
------- -------
8,746 4,732
------- -------
OPERATING PROFIT............................................. 18,545 7,756
Interest expense (including first two quarters 1998 amount
related to Host Marriott debt of $3,937).................. (8,803) (6,770)
Interest income and other.................................. 454 213
------- -------
NET INCOME................................................... $10,196 $ 1,199
======= =======
ALLOCATION OF NET INCOME
General Partner............................................ $ 102 $ 12
Limited Partners........................................... 10,094 1,187
------- -------
$10,196 $ 1,199
======= =======
NET INCOME PER LIMITED PARTNER UNIT (900 Units).............. $11,216 $ 1,319
======= =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
Desert Springs Supp-58
<PAGE>
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 19, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Property and equipment, net........................... $150,679 $151,401
Due from Marriott Hotel Services, Inc................. 2,185 1,368
Property improvement fund............................. 2,954 1,598
Deferred financing, net of accumulated amortization... 2,971 3,000
Restricted cash reserves.............................. 9,191 10,236
Cash and cash equivalents............................. 13,644 4,553
-------- --------
$181,624 $172,156
======== ========
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)
LIABILITIES
Mortgage debt....................................... $102,318 $103,000
Note payable........................................ 19,599 20,000
Note payable to Host Marriott Corporation and affil-
iates.............................................. 59,727 59,727
Due to Marriott Hotel Services, Inc................. 1,963 2,122
Accounts payable and accrued expenses............... 4,757 1,972
-------- --------
Total Liabilities................................. 188,364 186,821
-------- --------
PARTNERS' CAPITAL (DEFICIT)
General Partner..................................... 58 (21)
Limited Partners.................................... (6,798) (14,644)
-------- --------
Total Partners' Deficit........................... (6,740) (14,665)
-------- --------
$181,624 $172,156
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
Desert Springs Supp-59
<PAGE>
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
-----------------
1998 1997
------- --------
<S> <C> <C>
OPERATING ACTIVITIES
Net income................................................. $10,196 $ 1,199
Noncash items.............................................. 3,429 4,006
Change in operating accounts............................... 1,256 9,657
------- --------
Cash provided by operating activities.................... 14,881 14,862
------- --------
INVESTING ACTIVITIES
Additions to property and equipment, net................... (2,592) (1,318)
Changes in property improvement fund....................... (1,356) (469)
------- --------
Cash used in investing activities........................ (3,948) (1,787)
------- --------
FINANCING ACTIVITIES
Capital distribution to partners........................... (2,271) --
Change in restricted cash reserves......................... 1,598 (10,931)
Repayment of mortgage debt................................. (682) --
Repayment of note payable.................................. (401) (900)
Payment of refinancing costs............................... (86) (90)
------- --------
Cash used in financing activities........................ (1,842) (11,921)
------- --------
INCREASE IN CASH AND CASH EQUIVALENTS........................ 9,091 1,154
CASH AND CASH EQUIVALENTS at beginning of period............. 4,553 5,755
------- --------
CASH AND CASH EQUIVALENTS at end of period................... $13,644 $ 6,909
======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for mortgage and other interest.................. $ 5,866 $ 6,169
======= ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
Desert Springs Supp-60
<PAGE>
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. The accompanying condensed consolidated financial statements have been
prepared by Desert Springs Marriott Limited Partnership and subsidiaries (the
"Partnership") without audit. Certain information and footnote disclosures
normally included in financial statements presented in accordance with
generally accepted accounting principles have been condensed or omitted from
the accompanying statements. The Partnership believes the disclosures made are
adequate to make the information presented not misleading. However, the
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto included in the
Partnership's Annual Report on Form 10-K for the year ended December 31, 1997.
In the opinion of the Partnership, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments (which include only
normal recurring adjustments) necessary to present fairly the financial
position of the Partnership as of June 19, 1998 and the results of operations
and cash flows for the first two quarters 1998 and 1997. Interim results are
not necessarily indicative of fiscal year performance because of seasonal and
short-term variations (see Note 3).
For financial reporting purposes, net income of the Partnership is allocated
99% to the limited partners and 1% to Marriott Desert Springs Corporation (the
"General Partner"). Significant differences exist between the net income for
financial reporting purposes and the net income for Federal income tax
purposes. These differences are due primarily to the use, for income tax
purposes, of accelerated depreciation methods, shorter depreciable lives, no
estimated salvage values for the assets and differences in the timing of the
recognition of rental income.
2. In connection with the mortgage debt refinancing in November 1997 (see
Note 3), the General Partner received unrevoked consents of limited partners
approving certain amendments to the partnership agreement. The amendments,
among other things, allowed the formation of certain subsidiaries of the
Partnership including Marriott DSM LLC and DS Hotel LLC. The Partnership
contributed the Hotel and its related assets to Marriott DSM LLC, which in
turn contributed them to DS Hotel LLC, a bankruptcy remote subsidiary.
Marriott DSM LLC, a bankruptcy remote subsidiary of the Partnership, owns 100%
interest in DS Hotel LLC. The Partnership owns 100% interest in Marriott DSM
LLC.
3. On November 25, 1997, the Partnership completed a refinancing of its
mortgage debt. In connection with the refinancing, the Partnership converted
its operating lease with Marriott Hotel Services, Inc. ("MHS") to a management
agreement (the "Conversion"). Prior to the Conversion, the Partnership
recognized estimated annual hotel rental income on a straight-line basis
throughout the year. The profits from the Marriott's Desert Springs Resort and
Spa (the "Hotel") are seasonal and first and second quarter results are
generally higher than the last two quarters of the year. Lease payments in
excess of the income recognized by the Partnership were deferred and, to the
extent not subject to possible future repayment to the Hotel tenant, were
recognized as income during the remainder of the year. Pursuant to the terms
of the Operating Lease, Annual Rental, as defined, was equal to the greater of
Basic Rental (80% of Operating Profit, as defined) and Owner's Priority, as
defined. Additionally, the Hotel tenant was required to pay property taxes,
make contributions equal to a percentage of Hotel sales to a property
improvement fund (4.5% in 1997 and 5.5% thereafter) and pay rental on the
second golf course.
Subsequent to the Conversion, the Partnership records revenue based on house
profit generated by the Hotel. House profit reflects Hotel operating results,
and represents gross hotel sales less property-level expenses, excluding
depreciation, base and incentive management fees, property taxes, and certain
other costs, which are disclosed separately in the accompanying condensed
consolidated statement of operations. Revenues are recorded based on house
profit because the Partnership has delegated substantially all of the
operating decisions related to the generation of house profit to MHS.
Desert Springs Supp-61
<PAGE>
On November 20, 1997 the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact to EITF 97-2 on its policy of
excluding the property level revenues and operating expenses of its hotel from
its statements of operations. If the Partnership concludes that EITF 97-2
should be applied to its Hotel, it would include operating results of this
managed operation in its financial statements. Application of EITF 97-2 to
financial statements as of and for the first two quarters 1998 would have
increased both revenues and operating expenses by approximately $37.8 million
and would have had no impact on operating profit or net income.
The following is a summary of hotel revenues, for the first two quarters
1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
---------------
1998 1997
------- -------
<S> <C> <C>
HOTEL SALES
Rooms........................................................ $25,394 $23,065
Food and beverage............................................ 24,737 22,987
Other........................................................ 14,920 13,323
------- -------
65,051 59,375
------- -------
HOTEL EXPENSES
Department direct costs
Rooms...................................................... 5,127 4,534
Food and beverage.......................................... 15,624 14,366
Other hotel operating expenses............................... 17,009 15,765
------- -------
37,760 34,665
------- -------
HOTEL REVENUES................................................. $27,291 $24,710
======= =======
</TABLE>
4. Pursuant to the terms of the management agreement, MHS earns an incentive
management fee based on Operating Profit as defined. For fiscal year 1998, the
Partnership is entitled to the first $21.5 million of Operating Profit (the
"Owners Priority"). Thereafter, MHS will receive the next $1.8 million of
Operating Profit as an incentive management fee and any operating profit in
excess of $23.3 million will be divided 75% to the Partnership and 25% to MHS.
Any such payments will be made annually after completion of the audit of the
Partnership's financial statements. Pursuant to the terms of the management
agreement, contributions to the property improvement fund in 1998 are 5.5% of
gross Hotel sales, a one percentage point increase over the prior year level.
5. Host Marriott Corporation ("Host Marriott"), the parent of the General
Partner of the Partnership, announced on April 17, 1998, that its Board of
Directors has authorized the company to reorganize its business operations to
qualify as a real estate investment trust ("REIT") to become effective as of
January 1, 1999. As part of the REIT conversion, Host Marriott formed a new
operating partnership (the "Operating Partnership") and limited partners in
certain Host Marriott full-service hotel partnerships and joint ventures,
including the Partnership, are expected to be given an opportunity to receive,
on a tax-deferred basis, Operating Partnership units in the new Operating
Partnership in exchange for their current partnership interests. The Operating
Partnership units would be redeemable by the limited partner for freely traded
Host Marriott shares (or the cash equivalent thereof) at any time after one
year from the closing of the merger. In connection with the REIT conversion,
the Operating Partnership filed a Registration Statement on Form S-4 with the
Securities and Exchange Commission on June 2, 1998. Limited partners will be
able to vote on the Partnership's participation in the merger later this year
through a consent solicitation.
Desert Springs Supp-62
<PAGE>
HOST MARRIOTT, L.P.
SUPPLEMENT DATED , 1998 FOR
PROSPECTUS/CONSENT SOLICITATION STATEMENT DATED , 1998 FOR
HANOVER MARRIOTT LIMITED PARTNERSHIP
On the terms described in the Prospectus/Consent Solicitation Statement (the
"Consent Solicitation"), dated , 1998, of which this Supplement (the
"Supplement") is a part, Host Marriott Corporation ("Host") has adopted a plan
to restructure its business operations so that it will qualify as a real
estate investment trust ("REIT"). As part of this restructuring (the "REIT
Conversion"), Host and its consolidated subsidiaries will contribute their
full-service hotel properties and certain other businesses and assets to Host
Marriott, L.P. (the "Operating Partnership") in exchange for units of limited
partnership interest in the Operating Partnership ("OP Units") and the
assumption of liabilities. The sole general partner of the Operating
Partnership will be Host Marriott Trust ("Host REIT"), the entity into which
Host will merge as part of the REIT Conversion. Host REIT expects to qualify
as a REIT beginning with its first full taxable year after closing of the REIT
Conversion, which Host REIT currently expects to be the year beginning January
1, 1999.
Following the REIT Conversion and the Blackstone Acquisition, the Operating
Partnership and its subsidiaries initially will own outright, or have
controlling interests in, approximately 120 full-service hotels operating
primarily under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt
brand names (the "Hotels").
As part of the REIT Conversion, the Operating Partnership is proposing to
acquire by merger (the "Mergers") Hanover Marriott Limited Partnership, a
Delaware limited partnership ("Hanover" or the "Partnership"), and up to seven
other limited partnerships (the "Partnerships") that own full-service hotels
in which Host or its subsidiaries are general partners. As more fully
described in the Consent Solicitation, limited partners of those Partnerships
that participate in the Mergers will receive either OP Units or, at their
election, unsecured % Callable Notes due December 15, 2005 issued by the
Operating Partnership ("Notes"), in exchange for their partnership interests
in such Partnerships (with respect to the Partnerships, those limited partners
of the Partnerships who are unaffiliated with Host are referred to herein as
the "Limited Partners," and with respect to Hanover, the "Hanover Limited
Partners").
Beginning one year after the Mergers, Limited Partners who retain OP Units
will have the right to redeem their OP Units at any time and receive, at the
election of Host REIT, either freely tradeable, New York Stock Exchange Listed
Common Shares of Host REIT on a one-for-one basis (subject to adjustment) or
cash in an amount equal to the market value of such shares (the "Unit
Redemption Right").
The number of OP Units to be allocated to Hanover will be based upon (i) its
Exchange Value (as defined herein) and (ii) the price attributed to an OP Unit
following the Merger, determined as described herein (but in no event greater
than $ per OP Unit). The principal amount of Notes that Hanover Limited
Partners may elect to receive in exchange for the OP Units received in the
Merger will be based upon Hanover's Note Election Amount (as defined herein).
See "Determination of Exchange Value of Hanover and Allocation of OP Units."
The estimated Exchange Value and Note Election Amount set forth herein may
increase or decrease as a result of various adjustments, and will be finally
calculated shortly before the Effective Date. Pursuant to the Merger, Hanover
Limited Partners have an estimated Exchange Value of $123,202 per Partnership
Unit and a Note Election Amount of $88,474 per Partnership Unit.
RISK FACTORS
In deciding whether to approve the Merger, Hanover Limited Partners should
consider certain risks and other factors. The General Partner believes that
Hanover Limited Partners should particularly consider the following, which
should be read in conjunction with the information in the Consent Solicitation
under "Risk Factors" and "Federal Income Tax Consequences:"
. Substantial Benefits to Related Parties. Host REIT and its subsidiaries
will realize substantial benefits from the Mergers and the REIT
Conversion, including savings from a substantial reduction in
Hanover Supp-1
<PAGE>
corporate-level income taxes expected as a result of the REIT
Conversion. To the extent that such anticipated benefits of the REIT
Conversion are reflected in the value of Host's common stock prior to
the Effective Date, such benefits will not be shared with the Limited
Partners. Because of Host's significant ownership position in certain
Partnerships (including Hanover), the failure of one or more of these
Partnerships, including Hanover, to participate in a Merger likely would
require Host to transfer some or all of its interests in the Non-
Participating Partnership to a taxable Non-Controlled Subsidiary, which
would materially reduce the benefit to Host of the REIT Conversion as it
applies to that interest.
. Absence of Arm's Length Negotiations. No independent representative was
retained to negotiate on behalf of the Hanover Limited Partners or the
other Limited Partners. Although the General Partner has obtained the
Appraisal and the Fairness Opinion from AAA. AAA has not negotiated with
the General Partner or Host and has not participated in establishing the
terms of the Mergers. Consequently, the terms and conditions of the
Mergers may have been more favorable to the Hanover Limited Partners or
the other Limited Partners if such terms and conditions were the result
of arm's length negotiations.
. Other Conflicts of Interest. The Mergers, the REIT Conversion and the
recommendations of the General Partner involve the following conflicts
of interest because of the relationships among Host, the Operating
Partnership, the General Partners and SLC: (i) the General Partners,
which are all subsidiaries of Host (except for PHLP, of which Host is
the General Partner), must assess whether a Merger is fair and equitable
to the Limited Partners of its Partnership, which involves
considerations for Host and its subsidiaries that are different from
those that affect the Limited Partners, (ii) the terms of the Leases of
the Hotels, including Hanover's Hotel, will be determined by Host, which
will distribute the common stock of SLC, the parent of the Lessees, to
its shareholders after such terms have been set and (iii) the terms of
the Partnership Agreement, including provisions which benefit Host REIT,
have been determined by Host. Such conflicts may result in decisions
that do not fully reflect the interests of all Limited Partners
including the Hanover Limited Partners.
. Uncertainties at the Time of Voting Include the Number of OP Units to be
Received. There are several uncertainties at the time the Hanover
Limited Partners must vote on the Merger, including (i) the exact
Exchange Value for Hanover (which will be adjusted for changes in lender
and capital expenditure reserves, indebtedness, deferred maintenance and
other items prior to the Effective Date), (ii) the price of the OP Units
for purposes of the Merger, which will be determined by reference to the
post-Merger trading prices of Host REIT's Common Shares and which,
together with the Exchange Value, will determine the number of OP Units
the Hanover Limited Partners will receive and (iii) the exact principal
amount of the Notes that may be received in exchange for OP Units, which
cannot be known until after the vote on the Merger. For these reasons,
the Hanover Limited Partners cannot know at the time they vote on the
Merger these important aspects of the Merger.
. Adverse Tax Consequences to the General Partner of a Sale of Hanover's
Hotel. In past years, Hanover has disproportionately allocated tax
losses to the General Partner, with the result that if Hanover's Hotel
were to be sold in a taxable transaction, the General Partner (and thus
Host) would incur a disproportionately larger tax gain than the Hanover
Limited Partners. Accordingly, the General Partner and Host have an
additional conflict of interest in deciding the appropriate course of
action for Hanover with respect to its Hotel.
. Exchange Value May Not Equal Fair Market Value of Hanover's Hotel. Each
Hanover Limited Partner who retains OP Units will receive consideration
with a deemed value equal to the Exchange Value of such Hanover Limited
Partner's Partnership Interest. The determination of the Exchange Value
of Hanover involves numerous estimates and assumptions. There is no
assurance that the Exchange Value of Hanover will equal the fair market
value of the Hotel and other assets contributed by Hanover. See
"Determination of Exchange Value of Hanover and Allocation of OP Units."
. Price of OP Units Might Be Less than the Fair Market Value of the
Hanover Limited Partners' Partnership Interests. The price of an OP
Unit, for purposes of the Mergers and the REIT Conversion, will be equal
to the average closing price on the NYSE of a Host REIT Common Share
Hanover Supp-2
<PAGE>
for the first 20 trading days after the Effective Date of the Mergers
(but in no event greater than $ per share). It is likely that, over
time, the value of the publicly traded Common Shares of Host REIT (and
therefore the value of the OP Units) will diverge from the deemed value
of the OP Units used for purposes of the Mergers. This could result in
the Hanover Limited Partners receiving OP Units with an actual value
that is less than either the price of the OP Units for purposes of the
Mergers or the fair market value of their Partnership Interests.
. Allocation of OP Units to Host REIT is Different from Allocation of OP
Units to Limited Partners. Host REIT will receive in the aggregate a
number of OP Units (including OP Units allocated to the General Partners
of the Partnerships) equal to the number of shares of Host common stock
outstanding on the Effective Date (and, if Host has outstanding shares
of preferred stock at the time of the REIT Conversion, a corresponding
number of preferred partnership interests in the Operating Partnership),
which should fairly represent the market value of Host REIT but may not
be equal to the fair market or net asset value of the Hotels and other
assets that Host will contribute to the Operating Partnership. The
Partnerships will receive OP Units in the Mergers with a deemed value
equal to the Exchange Value of such Partnership. The different methods
of allocating OP Units may result in Limited Partners not receiving the
fair market value of their Partnership Interests and Host REIT receiving
a higher percentage of the interests in the Operating Partnership. See
"Determination of Exchange Values and Allocation of OP Units."
. Inability of Hanover Limited Partners to Redeem OP Units for One
Year. Hanover Limited Partners who elect to retain OP Units received in
the Merger will be unable to redeem such OP Units for one year following
the Merger. Until then, Hanover Limited Partners will bear the risk of
illiquidity.
. Current Host Common Stock Price May Not Necessarily Be Indicative of the
Price of Host REIT Common Shares Following the REIT Conversion. Host's
current stock price is not necessarily indicative of how the market will
value Host REIT Common Shares following the REIT Conversion. The current
stock price of Host reflects the current market valuation of Host's
current business and assets (including the SLC common stock and the cash
or securities to be distributed in connection with the REIT Conversion)
and not the business and assets of Host REIT following the REIT
Conversion.
. Value of the Notes Will Be Less than the Exchange Value. At the same
time that he votes on the Merger, each Hanover Limited Partner also may
elect to receive, at the time of the Merger, in exchange for OP Units,
an unsecured, seven-year Note of the Operating Partnership with a
principal amount equal to the Note Election Amount of his Partnership
Interest. The deemed value of the OP Units to be received by the Hanover
Limited Partners will exceed the principal amount of the corresponding
Notes (because the Exchange Value will be higher than the Note Election
Amount) and there is no assurance that the Note a Hanover Limited
Partner receives will have a value equal to either (i) the fair market
value of the Hanover Limited Partner's share of the Hotel and other
assets owned by Hanover or (ii) the principal amount of the Note. There
will be no public market for the Notes. If the Notes are sold, they may
sell at prices substantially below their issuance price. Noteholders are
likely to receive the full principal amount of a Note only if they hold
the Note to maturity, which is December 15, 2005, or if the Operating
Partnership repays the Notes prior to maturity. Because the Notes are
unsecured obligations of the Operating Partnership, they will be
effectively subordinated to all secured debt of the Operating
Partnership and all obligations of both Hanover and the Operating
Partnership's other subsidiaries. See "Description of the Notes." As of
June 19, 1998, on a pro forma basis assuming the Full Participation
Scenario, the Operating Partnership would have had aggregate
consolidated debt of approximately $5.1 billion to which the Notes were
effectively subordinated or which rank equally with such Notes.
. Fundamental Change in Nature of Investment; Potential
Underperformance. The Mergers and the REIT Conversion involve a
fundamental change in the nature of a Hanover Limited Partner's
investment from holding an interest in Hanover, which was structured to
provide distributions of cash flow (some of which was sheltered from
federal income tax), is a finite-life entity, has a fixed portfolio of
one Hotel and distributes the cash flow from the operation of the Hotel
to the Hanover Limited
Hanover Supp-3
<PAGE>
Partners, to holding an interest in an infinite-life, operating real
estate company with a portfolio of approximately 120 Hotels that (i)
collects and distributes to its limited partners rents received from the
Lessees (which will bear the risks and receive the direct benefits of
the Hotels' operations), (ii) has the ability to acquire additional
hotels, (iii) is able to reinvest proceeds from sales or refinancings of
existing Hotels in other hotels and (iv) has a publicly traded general
partner. In addition, each Hanover Limited Partner's investment will
change from one that allows a Hanover Limited Partner to receive a
return of capital in the form of distributions from any net proceeds of
a sale or refinancing of Hanover's assets to an investment in which a
Hanover Limited Partner who retains OP Units likely would realize a
return of capital only through the exercise of the Unit Redemption
Right. A Hanover Limited Partner's share of the liquidation proceeds, if
any, from the sale of Hanover's Hotel could be higher than the amount
realized upon exercise of the Unit Redemption Right (or payments on any
Note received by a Hanover Limited Partner who elects to exchange his OP
Units for such Note). An investment in the Operating Partnership may not
outperform an investment in Hanover. See "Comparison of Ownership of
Partnership Interests, OP Units and Common Shares."
. Exposure to Market and Economic Conditions of Other Hotels. As a result
of the Mergers, Hanover Limited Partners who elect to retain OP Units
will own interests in a much larger enterprise with a broader range of
assets than Hanover individually. A material adverse change affecting
the Operating Partnership's assets will affect all Limited Partners,
including Hanover Limited Partners, regardless of whether a particular
Limited Partner previously was an investor in such affected assets.
Hanover owns discrete assets and the Mergers and the REIT Conversion
will significantly diversify the types and geographic locations of the
Hotels in which the Hanover Limited Partners will have interests. As a
result, the Hotels owned by the Operating Partnership may be affected
differently by economic and market conditions than the Hotel previously
owned by Hanover.
. Hanover Limited Partners Have No Cash Appraisal Rights. Hanover Limited
Partners who vote against the Merger have no right to receive cash based
upon an appraisal of their Partnership Interests.
. Uncertainties as to the Size and Leverage of the Operating
Partnership. The Hanover Limited Partners cannot know at the time they
vote on the Merger the exact size and amount of leverage of the
Operating Partnership. Host is an existing operating company that
regularly issues and repays debt, acquires additional hotels and
disposes of existing hotels. Also, some or all of the Partnerships may
elect not to participate in a Merger. In addition, outside partners in
certain Private Partnerships may not consent to a lease of their
partnership's Hotel(s). In either such case, Host will contribute its
interests in such Partnerships and Private Partnerships to the Operating
Partnership, but the Operating Partnership may, in turn, contribute such
interests to a Non-Controlled Subsidiary, which will be subject to
corporate-level income taxation. Host also may repurchase outstanding
securities or issue new debt or equity securities prior to the
consummation of the Mergers and the REIT Conversion.
. Lack of Control over Hotel Operations. Due to current federal income tax
law restrictions on a REIT's ability to derive revenues directly from
the operation of a hotel, the Operating Partnership will lease virtually
all of its consolidated Hotels to the Lessees, which will operate the
Hotels by continuing to retain the Managers pursuant to the Management
Agreements. The Operating Partnership will not operate the Hotels or
participate in the decisions affecting the daily operations of the
Hotels. The Operating Partnership will have only a limited ability to
require the Lessees or the Managers to operate or manage the Hotels in
any particular manner and no ability to govern any particular aspect of
their day-to-day operation or management. Therefore, the Operating
Partnership will be dependent for its revenue upon the ability of the
Lessees and the Managers to operate and manage the Hotels.
. Expiration of Leases and Possible Inability to Find Other Lessees. The
Leases will expire seven to ten years after the Effective Date and there
can be no assurance that such Leases will be renewed (or if renewed,
will be renewed on terms as favorable to the Operating Partnership). If
the Leases are not renewed, the Operating Partnership will be required
to find other lessees, which lessees must meet certain requirements set
forth in the Management Agreements. There can be no assurance that
satisfactory lessees could be found or as to the terms and conditions on
which the Operating Partnership would be able to renew the Leases or
enter into new leases with such lessees.
Hanover Supp-4
<PAGE>
. Requisite Vote of Hanover Limited Partners Binds All Hanover Limited
Partners. For Hanover, approval by a majority of the Partnership
Interests of Hanover that are eligible to be voted is required to
approve the Merger, as described in "Voting Procedures--Required Vote
and Other Conditions." Such approval will cause Hanover to participate
in the Merger and will bind all Hanover Limited Partners, including
Hanover Limited Partners who voted against or abstained from voting with
respect to the Merger.
. Substantial Indebtedness of the Operating Partnership. The Operating
Partnership will have substantial indebtedness. As of June 19, 1998, on
a pro forma basis assuming the Full Participation Scenario, the
Operating Partnership had outstanding indebtedness totaling
approximately $5.1 billion, which represents a % debt-to-total market
capitalization ratio on a pro forma basis at such date (based upon a
price per Common Share of Host REIT of $ ). The Operating
Partnership's business is capital intensive and it will have significant
capital requirements in the future. The Operating Partnership's leverage
level could affect its ability to (i) obtain financing in the future,
(ii) undertake refinancings on terms and subject to conditions deemed
acceptable by the Operating Partnership, (iii) make distributions to
partners, (iv) pursue its acquisition strategy or (v) compete
effectively or operate successfully under adverse economic conditions.
. No Limitation on Debt. There are no limitations in Host REIT's or the
Operating Partnership's organizational documents which limit the amount
of indebtedness either may incur, although both the Notes and the
Operating Partnership's other debt instruments will contain certain
restrictions on the amount of indebtedness that the Operating
Partnership may incur.
. Rental Revenues from Hotels Subject to Rights of Lenders. In accordance
with the mortgage loan agreements with respect to outstanding
indebtedness of certain Hotel Partnerships, the rental revenues received
by such Hotel Partnerships under certain Leases first will be used to
satisfy the debt service on such outstanding indebtedness with only the
cash flow remaining after debt service being available to satisfy other
obligations of the Hotel Partnership (including paying property taxes
and insurance, funding the required FF&E reserves for the Hotels and
capital improvements and paying debt service with respect to unsecured
debt) and to make distributions to holders of OP Units.
. Ownership Limitations. No person or group may own, actually or
constructively (as determined under the applicable Code provisions), (i)
in excess of 9.8% of the number or value of outstanding Common Shares of
Host REIT or (ii) in excess of 4.9% of the value of the OP Units (other
than Host REIT and The Blackstone Group), subject to waiver or
modification by Host REIT or the Operating Partnership, as the case may
be, in certain limited circumstances.
. Timing of the REIT Conversion. If the REIT Conversion does not occur in
time for Host REIT to elect REIT status effective January 1, 1999, the
effectiveness of Host REIT's election could be delayed to January 1,
2000, which would result in Host REIT continuing to pay corporate-level
income taxes in 1999 and could cause the Blackstone Acquisition not to
be consummated.
. Effect of Subsequent Events upon Recognition of Gain. Even though the
Hanover Limited Partners (other than those who elect to receive a Note
in exchange for OP Units) generally are not expected to recognize
significant taxable gain at the time of the Merger, there are a variety
of events and transactions (including the sale of the Hotel currently
owned by Hanover or the reduction of indebtedness securing the Hotel)
that could cause a Hanover Limited Partner to recognize all or a part of
the gain that otherwise has been deferred through the REIT Conversion.
See "Federal Income Tax Consequences--Tax Treatment of Hanover Limited
Partners Who Hold OP Units Following the Merger." Certain Hotels
(including the Blackstone Hotels) will be covered by agreements with
third parties which will restrict the Operating Partnership's ability to
dispose of those properties or refinance their debt. In addition, if
Atlanta Marquis participates in the Mergers, the Operating Partnership
will succeed to an existing agreement that will restrict its ability to
dispose of the Atlanta Marquis Hotel or to refinance the debt secured by
such Hotel without compensating certain outside partners for the
resulting adverse tax consequences. As for the remaining initial
properties (including the Hotel owned by Hanover), the partnership
agreement of the Operating Partnership, which is substantially in the
form
Hanover Supp-5
<PAGE>
attached to the Consent Solicitation as Appendix A (the "Partnership
Agreement"), does not impose any restrictions on the Operating
Partnership's ability to dispose of the Hotels or to refinance debt
secured by the Hotels (but the Operating Partnership is obligated to pay
any taxes Host REIT incurs as a result of such transactions). In
addition, the Partnership Agreement provides that Host REIT, as general
partner of the Operating Partnership, is not required to take into
account the tax consequences of the limited partners in deciding whether
to cause the Operating Partnership to undertake specific transactions
(but the Operating Partnership is obligated to pay any taxes that Host
REIT incurs as a result of such transactions) and the limited partners
have no right to approve or disapprove such transactions. See
"Description of OP Units--Sales of Assets."
. Election to Exchange OP Units for Notes. A Hanover Limited Partner who
elects to receive a Note in connection with the Merger in exchange for
his OP Units will be treated as having made a taxable disposition of his
Partnership Interest. A Hanover Limited Partner who receives a Note may
be eligible to defer a majority of that gain under the "installment
sale" rules. A Hanover Limited Partner with a "negative capital account"
with respect to his Partnership Interest who elects to receive a Note
will recognize "phantom income" in that amount at the time of the Merger
in any event. See "Federal Income Tax Consequences--Tax Treatment of
Hanover Limited Partners Who Exercise Their Right to Make the Note
Election."
. Competition in the Lodging Industry. The profitability of the Hotels is
subject to general economic conditions, the management abilities of the
Managers (including primarily Marriott International), competition, the
desirability of particular locations and other factors relating to the
operation of the Hotels. The full-service segment of the lodging
industry, in which virtually all of the Hotels operate, is highly
competitive, and the Hotels generally operate in geographical markets
that contain numerous competitors. The Hotels' success will be
dependent, in large part, upon their ability to compete in such areas as
access, location, quality of accommodations, room rate structure, the
quality and scope of food and beverage facilities and other services and
amenities. The lodging industry, including the Hotels (and thus the
Operating Partnership), may be adversely affected in the future by (i)
national and regional economic conditions, (ii) changes in travel
patterns, (iii) taxes and government regulations which influence or
determine wages, prices, interest rates, construction procedures and
costs, (iv) the availability of credit and (v) other factors beyond the
control of the Operating Partnership.
. Failure of Host REIT to Qualify as a REIT for Tax Purposes. Taxation of
Host REIT as a corporation if it fails to qualify as a REIT, and Host
REIT's subsequent liability for federal, state and local taxes on its
income and property, would, among other things, have the effect of
reducing cash available for distribution to Host REIT's shareholders and
materially reducing the value of the Common Shares and OP Units.
. Failure of the Operating Partnership to Qualify as a Partnership for Tax
Purposes. Taxation of the Operating Partnership as a corporation if it
fails to qualify as a partnership and the Operating Partnership's
subsequent liability for federal, state and local income taxes would,
among other things, have the effect of reducing cash available for
distribution to holders of OP Units, would cause Host REIT to fail to
qualify as a REIT for tax purposes and would cause the holders of OP
Units to recognize substantial taxable gain at the time the Operating
Partnership ceases to qualify as a partnership.
. Failure of the Leases to Qualify as Leases. If the Lease of the Hotel to
the Lessee was to be disregarded for tax purposes (for example, because
the Lease was determined to lack economic substance), Host REIT could
fail to qualify as a REIT and the Operating Partnership might be treated
as a corporation for federal income tax purposes, which would have a
material adverse impact on the Hanover Limited Partners and the value of
the OP Units.
. Change in Tax Laws. No assurance can be provided that new legislation,
Treasury Regulations, administrative interpretations or court decisions
will not significantly change the tax laws with respect to Host REIT's
qualification as a REIT or the federal income tax consequences of such
qualification.
. Hanover Limited Partners Need to Consult with Their Own Tax
Advisors. Because the specific tax attributes of a Hanover Limited
Partner and the facts regarding such Hanover Limited Partner's interest
Hanover Supp-6
<PAGE>
in Hanover could have a material impact on the tax consequences to such
Hanover Limited Partner of the Merger, the subsequent ownership and
disposition of OP Units or Notes and/or the subsequent ownership and
disposition of Common Shares, it is essential that each Hanover Limited
Partner consult with his own tax advisors regarding the application of
federal, foreign and state and local tax laws to such Hanover Limited
Partner's personal tax situation.
. Effect of Possible Classification as a Publicly Traded Partnership on
Passive Losses. There is a significant possibility that the Operating
Partnership could be classified as a "publicly traded partnership," in
which event the Hanover Limited Partners would not be able to use
suspended passive activity losses from other investments to offset
income from the Operating Partnership.
. Host's Substantial Deferred Tax and Contingent Liabilities. Host will
have substantial deferred tax liabilities that are likely to be
recognized in the next ten years (notwithstanding Host REIT's status as
a REIT), and the IRS could assert substantial additional liabilities for
taxes against Host for taxable years prior to the time Host REIT
qualifies as a REIT. Under the terms of the REIT Conversion and the
Partnership Agreement, the Operating Partnership will be responsible for
paying (or reimbursing Host REIT for the payment of) all such tax
liabilities as well as any other liabilities (including contingent
liabilities and liabilities attributable to litigation that Host REIT
may incur) whether such liabilities are incurred by reason of Host's
activities prior to the REIT Conversion or the activities of Host REIT
subsequent thereto.
Because REITs are not permitted under current federal income tax law to
derive revenues directly from the operation of hotels, the Operating
Partnership will lease the Hotels to lessees (the "Lessees") that will operate
the Hotels under the existing management agreements and pay rent to the
Operating Partnership, as more fully described herein. The Lessees generally
will be indirect controlled subsidiaries of HMC Senior Communities, Inc.
("SLC"), which currently is a wholly owned subsidiary of Host. SLC will become
a separate public company when Host distributes the common stock of SLC and
other considerations to its existing shareholders and the Blackstone Entities
in connection with Host's distribution of its accumulated earnings and
profits, which Host REIT is required to do in order to qualify as a REIT.
Shares of Host REIT and SLC will become separately traded securities and the
companies will operate independently. There will be no overlap between the
boards of Host REIT and SLC. There will be a substantial overlap of
shareholders of the two companies initially, but this likely will diverge over
time.
MARRIOTT HANOVER HOTEL CORPORATION (THE "GENERAL PARTNER"), THE GENERAL
PARTNER OF HANOVER, BELIEVES THAT THE MERGER PROVIDES SUBSTANTIAL BENEFITS AND
IS FAIR TO THE HANOVER LIMITED PARTNERS AND RECOMMENDS THAT ALL HANOVER
LIMITED PARTNERS VOTE FOR THE MERGER.
The effects of the Mergers may be different for Limited Partners of the
various Partnerships. This Supplement has been prepared to highlight for
Hanover Limited Partners the specific risks, benefits, effects and fairness of
the Merger to them and to provide other information specific to Hanover.
Supplements have also been prepared for each of the other Partnerships. This
Supplement, together with the supplements of the other Partnerships
(collectively, the "Supplements"), are part of the Consent Solicitation. Upon
receipt of a written request by a Limited Partner or his representative so
designated in writing, the General Partner will send a copy of any Supplement
without charge. All requests for a copy of a Supplement should be directed to:
Investor Relations, 10400 Fernwood Road, Bethesda, Maryland 20817, telephone
number 301-380-2070 (between the hours of 9:00 a.m. and 4:00 p.m., eastern
time).
All cross-references refer to the Consent Solicitation unless the context
indicates otherwise. Capitalized terms not defined herein shall have the
meaning set forth in the Consent Solicitation. The information contained
herein, unless otherwise indicated, assumes the REIT Conversion occurs with
all Partnerships participating and no Notes being issued (the "Full
Participation Scenario").
EXPECTED BENEFITS OF THE MERGER
The General Partner believes that participating in the Merger will likely be
beneficial to the Hanover Limited Partners for the reasons set forth below.
This information is qualified by and should be read in
Hanover Supp-7
<PAGE>
conjunction with the information in the Consent Solicitation under "Background
and Reasons for the Mergers and the REIT Conversion--Reasons for the Mergers."
These benefits, which should be viewed as alternatives to continuing the
business and operations of Hanover, are expected to include:
. Exchange Value of Hanover. Hanover Limited Partners who elect to retain
OP Units in the Merger will receive OP Units with an estimated Exchange
Value equal to $123,202 per Partnership Unit.
. Enhanced Liquidity of Investment. The REIT Conversion will offer Hanover
Limited Partners significantly enhanced liquidity with respect to their
investments in Hanover because, commencing one year following the
Effective Date, Hanover Limited Partners who retain OP Units will be
able to exercise their Unit Redemption Right at any time, subject to
certain limited exceptions. Host has approximately 204 million shares of
common stock outstanding and is expected to have a total common equity
market capitalization of approximately $ billion after giving effect
to the estimated $ million earnings and profits distribution (based on
Host's $ closing price per share on the NYSE on , 1998). The
exercise of the Unit Redemption Right, however, generally would result
in recognition of taxable income or gain at that time.
. Public Market Valuation of Assets. The Partnership Units of Hanover
currently trade at a discount to the net asset value of Hanover's
assets. In contrast, the General Partner believes that by exchanging
interests in Hanover, which is a non-traded, finite-life limited
partnership with a fixed portfolio for interests in an infinite-life
real estate company focused primarily on a more diverse and growing
full-service hotel portfolio and providing valuation based upon publicly
traded Common Shares of Host REIT, the Hanover Limited Partners will
have the opportunity to participate in the recent trend toward ownership
of real estate through a publicly traded entity, which, in many
instances, has resulted in market valuations of public real estate
companies in excess of the estimated net asset values of those
companies. There can be no assurance, however, that the Common Shares of
Host REIT will trade at a premium to the private market values of the
Operating Partnership's assets or that the relative pricing differential
will not change or be eliminated in the future. Also, the benefit of
Host's conversion to a REIT will not be shared by the Hanover Limited
Partners if and to the extent that such benefit is reflected in the
market valuation of Host's common stock prior to the REIT Conversion.
. Regular Quarterly Cash Distributions. The General Partner expects that
the Operating Partnership will make regular quarterly cash distributions
to holders of OP Units. The General Partner expects that these
distributions will be higher than the estimated cash distributions for
1998 of Hanover, and in any event, the ability to receive distributions
quarterly and in regular amounts would be enhanced. For additional
information regarding historical and estimated future distributions for
Hanover and the other Partnerships, see "Background and Reasons for the
Mergers and the REIT Conversion--Reasons for the Mergers."
. Substantial Tax Deferral. The General Partner expects that Hanover
Limited Partners who do not elect to receive a Note in exchange for OP
Units generally should be able to obtain the benefits of the Merger
while continuing to defer recognition for federal income tax purposes of
at least a substantial portion, if not all, of the gain with respect to
their Partnership Interests that otherwise would be recognized in the
event of a liquidation of Hanover or a sale or other disposition of its
assets in a taxable transaction. Thereafter, such Hanover Limited
Partners generally should be able to defer at least a substantial
portion of such built-in gain until they elect to exercise their Unit
Redemption Right or the Hotel currently owned by Hanover is sold or
otherwise disposed of in a taxable transaction by the Operating
Partnership or the debt now secured by such Hotel is repaid, prepaid or
substantially reduced. The federal income tax consequences of the Merger
are highly complex and, with respect to each Hanover Limited Partner,
are dependent upon many variables, including the particular
circumstances of such Hanover Limited Partner. See "Federal Income Tax
Consequences--Tax Consequences of the Merger." Each Hanover Limited
Partner is urged to consult with his own tax advisors as to the
consequences of the Merger in light of his particular circumstances.
. Risk Diversification. Participation in the Merger, as well as future
hotel acquisitions by the Operating Partnership, will reduce the
dependence of Hanover Limited Partners upon the performance of, and the
exposure to the risks associated with, its Hotel and spread such risk
over a broader and more varied
Hanover Supp-8
<PAGE>
portfolio, including more diverse geographic locations and multiple
brands. See "Business and Properties--Business Objectives."
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a significantly lower leverage to value
ratio than Hanover currently, which has a leverage ratio of 81%
(calculated as a percentage of Appraised Value), resulting in
significant interest and debt service savings and greater financial
stability.
. Growth Potential. The General Partner believes that the Hanover Limited
Partners, by owning interests in a publicly traded real estate company
focused primarily on a more diverse and growing upscale and luxury full-
service hotel portfolio, will be able to participate in growth
opportunities that would not otherwise be available to them.
. Greater Access to Capital. With publicly traded equity securities, a
larger base of assets and a substantially greater equity value than
Hanover individually, Host REIT expects to have greater access to the
capital necessary to fund the Operating Partnership's operations and to
consummate acquisitions on more attractive terms than would be available
to Hanover individually. This greater access to capital should provide
greater financial stability to the Operating Partnership and reduce the
level of risk associated with refinancing existing loans upon maturity,
as compared to Hanover individually.
If Hanover does not participate in the Merger, its business will be
continued in the same manner; however, the Operating Partnership may elect to
contribute some or all of its interest in Hanover to a Non-Controlled
Subsidiary.
DETERMINATION OF EXCHANGE VALUE OF HANOVER AND ALLOCATION OF OP UNITS
GENERAL. The Exchange Value of Hanover will be equal to the greatest of its
Adjusted Appraised Value, Continuation Value and Liquidation Value, each of
which has been determined as follows:
. Adjusted Appraised Value. The General Partner has retained AAA to
determine the market value of the Hotel as of March 1, 1998 (the
"Appraised Value"). The "Adjusted Appraised Value" of Hanover equals the
Appraised Value of its Hotel, adjusted for lender reserves, capital
expenditure reserves, existing indebtedness (including a "mark to
market" adjustment to reflect the market value of such indebtedness),
certain deferred maintenance costs, deferred management fees and
transfer and recordation taxes and fees.
. Continuation Value. The "Continuation Value" of Hanover represents AAA's
estimate, as adopted by the General Partner, of the discounted present
value, as of January 1, 1998, of the Hanover limited partners' share of
estimated future cash distributions and estimated net sales proceeds
(plus lender reserves), assuming that Hanover continues as an operating
business for twelve years and its assets are sold on December 31, 2009
for their then estimated market value.
. Liquidation Value. The "Liquidation Value" of Hanover represents the
General Partner's estimate of the net proceeds to Hanover limited
partners resulting from the assumed sale as of December 31, 1998 of the
Hotel of Hanover, at its Adjusted Appraised Value (after eliminating any
"mark to market" adjustment and adding back the deduction for transfer
and recordation taxes and fees, if any, made in deriving the Adjusted
Appraised Value), less (i) estimated liquidation costs, expenses and
contingencies equal to 2.5% of Appraised Value and (ii) prepayment
penalties or defeasance costs, as applicable.
Final determination of the Exchange Value of Hanover will be made as of the
end of the four week accounting period ending at least 20 days prior to the
Effective Date (the "Final Valuation Date") and will be equal to the greatest
of Adjusted Appraised Value, Continuation Value and Liquidation Value as of
such date. Adjusted Appraised Value, Continuation Value and Liquidation Value
will be adjusted as of the Final Valuation Date (i) to reflect the amount of
lender and capital expenditure reserves and the amount of deferred management
fees as of such date, (ii) to increase the Adjusted Appraised Value by any
amounts actually expended by Hanover after the Initial Valuation Date to
perform deferred maintenance that were previously subtracted in determining
the estimated Adjusted Appraised Value of Hanover and (iii) to reflect any
changes in Hanover's other reserves, such as for litigation expenses and
indemnification costs and any revised estimates of transfer and recordation
taxes and fees.
Hanover Supp-9
<PAGE>
APPRAISED VALUE. Hanover's Hotel was appraised as of March 1, 1998 by AAA,
an independent, nationally recognized hotel valuation and financial advisory
firm experienced in the appraisals of lodging properties such as Hanover's
Hotel. The appraisal ("Appraisal") was reviewed by a Member Appraisal
Institute ("MAI") appraiser and certified by such MAI appraiser as having been
prepared in accordance with the requirements of the Standards of Professional
Practice of the Appraisal Institute and the Uniform Standards of Professional
Appraisal Practice of the Appraisal Foundation.
The purpose of the Appraisal is to provide an estimate of the "Market Value"
of the Hotel. "Market Value" means the most probable price which a property
should bring in a competitive and open market under all conditions requisite
to a fair sale, the buyer and seller each acting prudently and knowledgeably
and assuming the price is not affected by undue stimuli. Implicit in this
definition is the consummation of a sale as of a specified date and the
passing of title from seller to buyer under conditions whereby: (i) the buyer
and seller are equally motivated; (ii) both parties are well informed or well
advised, and each is acting in what he considers his own best interest; (iii)
a reasonable time frame is allowed for exposure in the open market; (iv)
payment is made in terms of cash in U.S. dollars or in terms of financial
arrangements comparable thereto and (v) the price represents the normal
consideration for the property sold unaffected by special or creative
financing or sales concessions granted by anyone associated with the sale. AAA
made a site visit at Hanover's Hotel for purposes of the Appraisal.
In preparing the Appraisal, AAA relied primarily on the income
capitalization method of valuation, and then compared the value estimated by
this method with recent sales of comparable properties, as a check on the
reasonableness of the value determined through the income capitalization
method. AAA employed the following procedures for determining the Appraised
Value of the Hanover Hotel:
. Historical 1997 and Projected Year's Earnings. AAA reviewed the
historical 1997 net operating income (i.e., income before interest,
taxes, depreciation and amortization) ("NOI") prior to incentive
management fees and certain capital expenditures for the applicable
Hotel. AAA also prepared a projection of the net operating income prior
to incentive management fees and certain capital expenditures for the
applicable Hotel for the twelve month period ending February 28, 1999
(the "Projected Year"), using historical financial information for the
Hotel, budget information, a survey with the manager of the Hotel
addressing the physical condition of the Hotel, local market conditions
(including business mix, demand generators, future trends and
predictability of business), changes in the competitive environment,
comparison with direct competitors of the Hotel and risk factors
relating to the particular Hotel. The resulting gross margin (ratio of
total revenues to NOI prior to incentive management fees) was checked
against AAA's database of the gross margins for similar hotels for
reasonableness.
. Impact of Incentive Management Fees. AAA estimated a normalized annual
amount of incentive management fees payable under the applicable
management agreement and subtracted this amount from the net operating
income prior to incentive management fees and certain capital
expenditures for 1997 and the Projected Year.
. Impact of Owner Funded Capital Expenditures. AAA estimated normalized
annual amounts of owner funded capital expenditures (over and above the
FF&E reserve) based in part on projected owner funded capital
expenditures estimated in the Engineering Study, including, in the case
of Hanover, certain identified 1998 capital expenditures for which
reserves have been set aside. The normalized amounts were then
subtracted from the NOI prior to owner funded capital expenditures for
1997 and the Projected Year.
. Capitalization of Adjusted NOI. AAA then capitalized the amount
resulting from the foregoing adjustments ("Adjusted NOI") for 1997 and
the Projected Year by dividing such amounts by capitalization rates that
AAA determined to be appropriate. A capitalization rate represents the
relationship between net operating income and sales prices of income
producing property. AAA selected the capitalization rates based upon its
review of current published surveys reflecting the opinions of investors
and participants such as REITs, hotel acquisition/management companies
and
Hanover Supp-10
<PAGE>
pension funds, lenders, brokers and consultants as to current
capitalization rates, and its own database of capitalization rates
reflected in recent transactions, adjusted for factors specific to the
Hotel, such as location, physical condition, reserve policies, local
market volatility and competition, guest mix, renovation influences and
other income characteristics. AAA used separate capitalization rates
that it deemed appropriate to capitalize 1997 historical Adjusted NOI
and estimated Projected Year's Adjusted NOI. AAA then estimated the
value of each Hotel based upon each of the values estimated by
capitalizing 1997 and Projected Year's Adjusted NOI and its professional
judgment. The following table sets forth the effective capitalization
rates for 1997 and Projected Year's Adjusted NOI resulting from AAA's
estimated Appraised Value of Hanover's Hotel.
RESULTING EFFECTIVE CAPITALIZATION RATES FOR APPRAISAL OF HANOVER'S HOTEL
<TABLE>
<CAPTION>
PROJECTED YEAR
1997 (ENDING FEBRUARY 28, 1999)
---- --------------------------
<S> <C>
9.4% 10.1%
</TABLE>
The resulting Appraised Value of Hanover's Hotel, as estimated by AAA,
is $49,400,000.
. Comparison with Comparable Sales. AAA checked the Appraised Value of
Hanover's Hotel derived by the foregoing procedures against its database
of comparable sale transactions for reasonableness.
Hanover's Hotel was encumbered by a ground lease as of the date of the
Appraisal. Accordingly, the Appraised Value of Hanover's Hotel has been
decreased to reflect the encumbrance of the ground lease and the interest of
the ground lessor in the operating cash flows of the Hotel. The Appraised
Value assumes all contractual provisions for FF&E reserves are adequate and
have not been reduced to reflect deferred maintenance or environmental
remediation costs with respect to Hanover's Hotel (but estimated deferred
maintenance costs have been deducted in estimating the Adjusted Appraised
Value of Hanover's Hotel). The Appraised Value did not take into account the
costs that might be incurred in selling the Hotel (but estimated costs for
transfer and recordation taxes and fees have been deducted in estimating the
Adjusted Appraised Value of the Hotel).
The Appraisal is not a guarantee of present or future values and no
assurance can be given as to the actual value of Hanover's Hotel. The
Appraisals should be read in conjunction with other information, such as, but
not limited to, the audited financial statements of Hanover.
The Appraised Value, and the assumptions underlying the projections on which
the Appraised Value is based, are contingent upon a series of future events,
the outcomes of which are not necessarily within the Operating Partnership's
control and cannot be determined at this time. There can be no assurance that
another appraiser would not have arrived at a different result. Some of the
assumptions inevitably will not materialize and unanticipated events and
circumstances will occur subsequent to the date of the Appraisal. Furthermore,
the actual results achieved from Hanover's Hotel will vary from the results
projected in the Appraisal and the variations may be material.
ADJUSTED APPRAISED VALUE. The Adjusted Appraised Value of Hanover was
determined by making various adjustments to the Appraised Value of Hanover's
Hotel, as described below.
. 1998 Capital Expenditure Reserves. For Hanover, an amount equal to the
capital expenditure reserves which were set aside as of March 1, 1998
for various identified capital improvements in 1998 (which amounts
resulted in reductions in the Appraised Value as described above) was
added back to the Appraised Value.
. Mortgage and Other Debt. The estimated principal balance and accrued
interest as of the Effective Date (assumed to be December 31, 1998) of
all mortgage and other debt of Hanover has been subtracted from the
Appraised Value.
Hanover Supp-11
<PAGE>
. Mark to Market Adjustments. The third-party loans of the Partnerships
have various interest rates and terms to maturity. In order to reflect
the market value of the third-party loans of Hanover, the estimated
Adjusted Appraised Value for Hanover has been decreased to "mark to
market" the interest rate for such loans. This adjustment has been
estimated by comparing the interest cost using the applicable interest
rates on existing third-party loans over their remaining term to the
interest cost using the interest rate that the Operating Partnership
believes it would be able to obtain for unsecured debt in the market as
of the Final Valuation Date (which would have been % per annum based
on a 225 basis point (2.25 percent) spread over the yield on seven-year
U.S. Treasury securities as of , 1998). The mark to market adjustment
for each loan was calculated by determining the difference between the
present values, as of December 31, 1998, of the interest payments over
the remaining term of the loan from January 1, 1999 to maturity using
the actual interest rate as the discount rate as compared to using the
assumed market rate as the discount rate.
. Deferred Maintenance Costs. The estimated cost to complete any deferred
maintenance items identified in the Engineering Study relating to the
Hanover Hotel has been subtracted from the Appraised Value. The
adjustments for this item will be reduced at the Final Valuation Date to
reflect amounts expended after the Initial Valuation Date to perform
such deferred maintenance. No adjustments have been made for previously
budgeted capital expenditures or deferred maintenance costs estimated in
the Engineering Study that are reflected in the cash flow projections
used for purposes of estimating Appraised Values.
The following table sets forth the adjustments to the Appraised Value made
to derive the estimated Adjusted Appraised Value for Hanover as of the Initial
Valuation Date.
CALCULATION OF ESTIMATED ADJUSTED APPRAISED VALUE FOR HANOVER
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................................................. $ 49,400
Capital expenditure reserve..................................... 1,690
Mortgage debt................................................... (29,394)
Other debt...................................................... (10,398)
Mark to market adjustment....................................... (435)
Deferred maintenance costs...................................... (72)
--------
Estimated Adjusted Appraised Value.............................. $ 10,791
========
Limited partners' share......................................... $ 10,349
Per Partnership Unit............................................ $123,202
</TABLE>
CONTINUATION VALUE. AAA estimated the Continuation Value of Hanover using
the following methodology:
. Estimated Future Cash Distributions. AAA prepared estimates of future
partnership cash flow for Hanover for the 12-year period from January 1,
1998 through December 31, 2009 based upon the estimated 1998 NOI before
incentive management fees used in the Appraisal and for each subsequent
year applying an assumed annual stabilized growth rate (as shown in the
table below) developed by AAA for this analysis. For each year in the
projection period, AAA estimated the amount of cash available for
distribution to Hanover's limited partners after payment of all
management fees, debt service, owner funded capital expenditures based
on the Engineering Study and other partnership expenses and after
application of the applicable partnership agreement provisions. AAA
assumed that Hanover's FF&E reserve was adequate and understood that
Host determined that there were no reserve shortfalls or surpluses.
Hanover Supp-12
<PAGE>
. Refinancing Assumptions. For debt that matures during the 12-year
period, AAA assumed that Hanover's debt would be refinanced with an
interest rate of 8.58% per annum and a 25-year amortization schedule,
with estimated refinancing costs of 2% of the refinanced amount being
paid from operating cash flow.
. Determination of Residual Value. To estimate the residual value of the
Hanover limited partners' interest in Hanover at the end of the 12-year
period, AAA assumed that the Hanover Hotel would be sold as of December
31, 2009 at its then market value. AAA estimated the market value of the
Hotel as of such date by applying an exit capitalization rate that it
deemed appropriate, using the factors described above in connection with
the "--Appraised Value," which are set forth in the table below, to the
estimated Adjusted NOI for 2009 (estimated as described above). AAA then
subtracted estimated sales costs of 2.0% of the estimated market value,
added lender reserves and subtracted the estimated outstanding principal
balance of debt as of December 31, 2009 and deferred management fees to
arrive at net sales proceeds available for distribution to Hanover's
partners. AAA then determined what portion of such estimated net sales
proceeds would be distributable to Hanover's limited partners under the
partnership and debt agreements.
. Discounting Distributions to Present Value. As a final step, AAA
discounted the estimated future cash distributions to Hanover's limited
partners from operations and estimated net sales proceeds to their
present value as of January 1, 1998, using a discount rate of 20% per
annum. AAA believes that this discount rate reflects the return on
investment that investors expect from leveraged investments of this
nature.
The growth rate and exit capitalization rate used to determine the estimated
Continuation Value for Hanover are as set forth below:
GROWTH RATE, EXIT CAPITALIZATION RATE
AND ESTIMATED CONTINUATION VALUE FOR HANOVER
<TABLE>
<CAPTION>
ESTIMATED
CONTINUATION VALUE
GROWTH RATE EXIT CAPITALIZATION RATE (2009) (PER PARTNERSHIP UNIT)
----------- ------------------------------- ----------------------
<S> <C> <C>
3.7% 9.8% $98,090
</TABLE>
LIQUIDATION VALUE. The Liquidation Value of Hanover was estimated by the
General Partner and represents the estimated value of Hanover if all of its
assets were sold as of December 31, 1998. Such value was based upon the
Adjusted Appraised Value of Hanover, with the following adjustments: (i) the
"mark to market" adjustment used to estimate the Adjusted Appraised Value was
eliminated and instead prepayment or defeasance costs that would be payable
under existing debt agreements (regardless of whether the debt in fact can be
prepaid on December 31, 1998) were deducted from the Appraised Value and (ii)
the deduction for transfer and recordation taxes used to estimate the Adjusted
Appraised Value was eliminated and instead an amount equal 2.5% of the
Appraised Value of Hanover's Hotel was subtracted from the Appraised Value for
estimated liquidation costs, expenses and contingencies. The General Partner
then determined the portion of the estimated Liquidation Value that would be
distributable to Hanover's limited partners under the terms of the partnership
agreement and other contractual arrangements.
Hanover Supp-13
<PAGE>
The following table sets forth the adjustments made to the Adjusted
Appraised Value to estimate the Liquidation Value of Hanover as of the Initial
Valuation Date:
CALCULATION OF ESTIMATED LIQUIDATION VALUE OF HANOVER
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................................................. $ 49,400
Capital expenditure reserve..................................... 1,690
Mortgage debt................................................... (29,394)
Other debt...................................................... (10,398)
Prepayment/defeasance costs..................................... (2,168)
Deferred maintenance costs...................................... (72)
Sales costs..................................................... (1,235)
--------
Estimated Liquidation Value..................................... $ 7,823
========
Limited partners' share......................................... $ 7,432
Per Partnership Unit............................................ $ 88,474
</TABLE>
ESTIMATED EXCHANGE VALUE. The following table sets forth the estimated
Exchange Value of Hanover (based upon the greatest of its estimated Adjusted
Appraised Value, estimated Continuation Value and estimated Liquidation
Value), the estimated minimum and pro forma number of OP Units to be received
and the estimated Note Election Amount for Hanover, all on a per Partnership
Unit basis as of the Initial Valuation Date. The estimated Exchange Value for
Hanover will be received by each Hanover Limited Partner retaining OP Units in
the Merger. The estimated Note Election Amount for Hanover (which will be
received by Hanover Limited Partners electing to receive Notes in exchange for
OP Units) is equal to the Liquidation Value for Hanover. The estimated values
set forth below may increase or decrease as a result of various adjustments,
which will be finally calculated as of the Final Valuation Date but will not
change as a result of less than all of the Partnerships participating in the
Mergers. The actual number of OP Units to be received by the Hanover Limited
Partners will be based on the average closing price on the NYSE of a Host REIT
Common Share for the 20 trading days after the Effective Date.
ESTIMATED EXCHANGE VALUE,NUMBER OF OP UNITS AND NOTE ELECTION AMOUNTS
OF HANOVER PER PARTNERSHIP UNIT(1)
<TABLE>
<CAPTION>
ESTIMATED ESTIMATED
ESTIMATED MINIMUM PRO FORMA ESTIMATED
ESTIMATED ADJUSTED ESTIMATED ESTIMATED EXCHANGE NUMBER OF NUMBER OF NOTE ELECTION
APPRAISED VALUE CONTINUATION VALUE LIQUIDATION VALUE VALUE(2) OP UNITS(3) OP UNITS(4) AMOUNT(5)
- ------------------ ------------------ ----------------- --------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
$123,202 $98,090 $88,474 $123,202 6,160 $88,474
</TABLE>
- --------
(1) A Partnership Unit in Hanover represents an original investment of
$100,000.
(2) The estimated Exchange Value is equal to the greatest of estimated
Adjusted Appraised Value, estimated Continuation Value and estimated
Liquidation Value.
(3) Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Merger.
(4) Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
(5) The principal amount of Notes is equal to the greater of (i) the
Liquidation Value or (ii) 60% of the Exchange Value (the "Note Election
Amount").
Price of OP Units To Pay Exchange Value to Hanover Limited Partners. Each
Hanover Limited Partner will receive OP Units with a deemed value equal to the
Exchange Value of such Hanover Limited Partner's Partnership Interests. The
price of an OP Unit for this purpose will be equal to the average closing
price on the NYSE of a Host REIT Common Share for the 20 trading days after
the Effective Date of the Mergers (but in no event greater than $ per
share). The closing price per share of Host common stock on the NYSE was $ ,
on , 1998.
Hanover Supp-14
<PAGE>
Hanover Limited Partners at the Effective Date of the Merger who retain OP
Units will receive cash distributions from Hanover for all of 1998 and, if the
Merger does not occur in 1998, any portion of 1999 prior to the Merger for
which period they do not receive a cash distribution from the Operating
Partnership. Cash distributions will be made by Hanover in accordance with its
partnership agreement on or before June 1, 1999 in respect of 1998 operations
and, if the Merger does not occur prior to January 1, 1999, within 90 days
after the Effective Date of the Merger in respect of any 1999 operations.
Hanover Limited Partners at the Effective Date of the Merger will receive
Notes in exchange for OP Units will participate in the same distribution from
Hanover as Hanover Limited Partners who retain OP Units but will not receive
any distributions from the Operating Partnership with respect to periods after
the Effective Date of the Merger.
No fractional OP Units will be issued. Fractional amounts less than or equal
to 0.50 of an OP Unit will be rounded down to the next whole number and
fractional amounts greater than 0.50 will be rounded up to the next whole
number of OP Units.
VALUATION OF THE GENERAL PARTNER'S AND ITS AFFILIATE'S INTERESTS IN HANOVER
AND ALLOCATION OF OP UNITS TO THE GENERAL PARTNER AND ITS AFFILIATES
The value of the General Partner's interest will be equal to the aggregate
Exchange Value of Hanover minus the aggregate Exchange Value of the Hanover
Limited Partners' Partnership Interests (giving effect to the applicable
distribution preferences in the Hanover partnership agreement). The number of
OP Units that will be received by the General Partner will be equal to the
value of its interest in Hanover divided by the same price per OP Unit used to
determine the number of OP Units to be received by the Hanover Limited
Partners. The total number of OP Units that will be owned directly or
indirectly by Host REIT (including OP Units owned by the General Partner) will
be equal to the number of outstanding shares of common stock of Host at the
Effective Date.
The following table sets forth the estimated value of the General Partner's
and its affiliate's interests in Hanover based upon the estimated aggregate
Exchange Value of the Hanover Limited Partners' Partnership Interests as of
the Initial Valuation Date and the minimum and pro forma number of OP Units
estimated to be received by the General Partner and its affiliates in respect
thereof.
ESTIMATED VALUE OF THE GENERAL PARTNER'S AND ITS AFFILIATE'S INTERESTS AND
NUMBER OF OP UNITS
(DOLLARS IN THOUSANDS)
<TABLE>
<S> <C>
Aggregate Exchange Value............................................... $10,791
Limited partners' share of aggregate Exchange Value.................... 10,349
-------
Value of General Partner's Interest.................................... $ 442
Value of Host's limited partner interest............................... 4,928
-------
Total Host interest.................................................... 5,370
=======
Number of OP Units:
Minimum(1)...........................................................
Pro Forma(2)......................................................... 269
</TABLE>
- --------
(1) Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Mergers.
(2) Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
CASH DISTRIBUTIONS
Historical Cash Distributions Paid by Hanover. Hanover has not paid any cash
distributions to its Limited Partners in the First Two Quarters 1998 and for
the fiscal years 1993 through 1997.
Compensation and Distributions to the General Partner. Under Hanover's
partnership agreement, the General Partner does not receive fees or
compensation in connection with managing the affairs of Hanover but
Hanover Supp-15
<PAGE>
the General Partner and its affiliates are reimbursed for certain costs and
expenses incurred on behalf of Hanover. In addition, the General Partner is
entitled to distributions related to its interest in Hanover. The following
information has been prepared to compare the amount of reimbursements paid and
cash distributions made by Hanover to the General Partner and its affiliates
to the amounts that would have been paid if the reimbursement and distribution
structure which will be in effect after the REIT Conversion had been in effect
for the periods presented.
Following the REIT Conversion, Host REIT will be operated as a self-
administered REIT and as a result, no reimbursements or other compensation
will be received by the General Partner.
The following table sets forth the reimbursements and distributions paid by
Hanover to the General Partner and its affiliates for the last three fiscal
years and the First Two Quarters 1998 ("Historical") and the reimbursements
and distributions that would have been paid to the General Partner and its
affiliates for the last fiscal year and the First Two Quarters 1998 if the
REIT Conversion had been in effect, assuming the Full Participation Scenario
("Pro Forma") and assuming a distribution per OP Unit of $1.05 per year during
such period, which is the midpoint of the expected distribution range for
1999.
HISTORICAL AND PRO FORMA
REIMBURSEMENTS AND DISTRIBUTIONS TO THE GENERAL PARTNER AND ITS AFFILIATES
(IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL YEAR
FIRST TWO QUARTERS ------------------------------------------
1998 1997 1996 1995
-------------------- -------------------- ---------- ----------
HISTORICAL PRO FORMA HISTORICAL PRO FORMA HISTORICAL HISTORICAL
---------- --------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Reimbursements(1)....... $ 103 $ -- $ 191 $ -- $ 56 $ 43
Distributions(2)........ -- 141 -- 282 -- --
----- ----- ----- ----- ----- -----
Total................. $ 103 $ 141 $ 191 $ 282 $ 56 $ 43
===== ===== ===== ===== ===== =====
</TABLE>
- --------
(1) All expenses will be paid directly by the Operating Partnership,
accordingly, there are no expected reimbursements on a pro forma basis.
(2) The amount of distributions payable to the General Partner and its
affiliates on a pro forma basis reflect distributions at a rate of $1.05
per annum per OP Unit (which is the midpoint of the expected range of
distributions per OP Unit for 1999) with respect to the estimated number
of OP Units that the General Partner and its affiliates will receive with
respect to its general and limited partner interests in Hanover. Such
number does not reflect the aggregate number of OP Units Host will receive
in connection with the REIT Conversion.
CERTAIN INFORMATION REGARDING THE HOTEL OWNED BY HANOVER
<TABLE>
<CAPTION>
NUMBER OF
NAME OF HOTEL LOCATION OF HOTEL ROOMS DATE OPENED
------------- ----------------- --------- -----------
<S> <C> <C> <C>
Hanover Marriott Hotel Hanover, NJ 353 1986
</TABLE>
The table below sets forth certain performance information for Hanover's
Hotel for the indicated periods.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
-------------------- -------------------------
1998 1997 1997 1996 1995
--------- --------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Average daily rate.......... $142.62 $123.98 $123.55 $113.50 $108.39
Occupancy................... 71.5% 82.2% 80.8% 79.1% 74.4%
REVPAR...................... $101.97 $101.91 $ 99.83 $ 89.78 $ 80.64
% REVPAR change............. 0.1% -- 11.2% 11.3% --
</TABLE>
Hanover Supp-16
<PAGE>
The Hanover Marriott Hotel, Hanover, New Jersey
The Hotel is a full-service Marriott hotel located on approximately 13.41
acres in a business/industrial park district. The Hotel is near several major
highways, including New Jersey State Route 10 and I-287, as well as New Jersey
State Routes 202, 206, 15, 46 and 24. Such routes are well-maintained two to
six lane highways which run both north-south and east-west, providing easy
access to Newark International Airport, New York City and points west.
The Hotel is located within ten miles of many large corporations and
manufacturers, including several Fortune 500 companies. The Hotel is across
Route 10 from the Prudential Business Campus. Nearby Morristown is Morris
County's central business district and seat of government, and also provides
business, retail and historical attractions.
The Hotel, which opened July 30, 1986, has a total of 260,000 square feet of
building area and is operated as part of the Marriott Hotels, Resorts and
Suites system. The Hotel contains a total of 353 guest rooms, including four
suites. The Hotel also contains approximately 19,000 square feet of meeting
space in the form of a grand ballroom and smaller meeting rooms and conference
suites. The Hotel has one multi-purpose restaurant, one Japanese steak house
and a 60-seat lobby lounge. Other features of the Hotel include a gift shop,
business center, small hotel laundry, parking for 695 cars and a package of
recreational facilities that includes an indoor/outdoor swimming pool, sauna,
hydrotherapy pool and health club.
AMENDMENTS TO THE PARTNERSHIP AGREEMENT OF HANOVER
In order to allow the Hotel of Hanover to be leased to SLC in connection
with the Merger and the REIT Conversion, Hanover's partnership agreement must
be amended. Currently, there is no provision in Hanover's partnership
agreement to allow the Hanover Hotel to be leased. Therefore, Section 5.02B of
Hanover's partnership agreement must be amended to add a new paragraph
5.02B(x) to read as follows:
(x) lease (or consent to the lease), directly or indirectly, in one
transaction or a series of related transactions of the Hotel.
Other Amendments. Amendments to certain terms and sections of Hanover's
partnership agreement would be made in order to (i) reduce to one the number
of appraisals of the fair market value of Hanover's Hotel that Hanover must
provide to the Hanover Limited Partners before the General Partner can cause
Hanover to sell assets to the General Partner or an affiliate, (ii) delete
certain obsolete references to entities and agreements that are no longer in
existence, (iii) update Hanover's partnership agreement to reflect the passage
of time since the formation of Hanover and (iv) make any other amendments to
Hanover's partnership agreement deemed necessary or advisable, in the sole
discretion of the General Partner, in connection with the consummation of the
Merger and the REIT Conversion. The General Partner does not believe that
these amendments would affect the rights of the Hanover Limited Partners in
any material respect nor the duties and obligations of the General Partner.
These changes are included, along with the other proposed amendments, in the
copy of Hanover's partnership agreement, as proposed to be amended, which is
attached hereto. The amended Hanover partnership agreement is marked to
indicate the revisions made to the existing Hanover partnership agreement and
should be read in its entirety. Deleted provisions are contained in brackets
and struck through and added provisions are in bold type and underlined.
FAIRNESS ANALYSIS AND OPINION
FAIRNESS ANALYSIS
The General Partner believes that the Merger provides substantial benefits
and is fair to the Limited Partners of Hanover and recommends that all Limited
Partners of Hanover consent to the Merger. The General Partner bases this
recommendation primarily on (i) its view that the expected benefits of the
Merger for the Hanover Limited Partners outweigh the risks and potential
detriments of the Merger to the Hanover Limited Partners (see "Background and
Reasons for the Mergers and the REIT Conversion--Reasons for the Mergers" and
"Risk
Hanover Supp-17
<PAGE>
Factors"), (ii) its view that the value of the OP Units allocable to the
Hanover Limited Partners on the basis of the Exchange Value established for
Hanover represents fair consideration for the Partnership Interests held by
the Hanover Limited Partners and is fair to the Hanover Limited Partners from
a financial point of view and (iii) the Appraisal and Fairness Opinion of AAA.
The Merger is not conditioned upon the consummation of any of the other
Mergers. The General Partner has considered this fact in evaluating the
fairness of the Merger. The General Partner believes that the fairness of the
Merger will not be materially affected by the presence or absence of any other
individual Partnership or by any particular combination of other Partnerships
and that the Merger will be fair to the Hanover Limited Partners, individually
and as a whole, if it is consummated with any combination of other
Participating Partnerships. The General Partner bases this belief primarily on
the fact that the consideration to be paid to the Hanover Limited Partners has
been established based upon Hanover's Exchange Value, without regard to any
possible combination of other Partnerships.
In reaching the conclusions implicit in the above recommendation, the
General Partner has taken into account the following considerations, placing
the greatest weight on the first two considerations:
. The General Partner has concluded that the Exchange Value for Hanover,
which is equal to its Adjusted Appraised Value, represents fair
consideration for the Partnership Interests of the Hanover Limited
Partners in the Merger in relation to Hanover. The General Partner also
has concluded that the Exchange Value established for the Hanover
Limited Partners fairly reflects the value of the assets held by
Hanover. In addition, the Fairness Opinion supports these conclusions.
. Hanover Limited Partners will be able to defer recognition of gain for
tax purposes until such time as they choose to realize such gain based
on their personal circumstances.
. The General Partner has concluded that the potential benefits of the
Merger to the Hanover Limited Partners, as described under "Background
and Reasons for the Mergers and the REIT Conversion--Reasons for the
Mergers," outweigh the potential risks and detriments of the Merger for
the Hanover Limited Partners, as described in "Risk Factors."
. The Fairness Opinion, in the view of the General Partner, supports the
fairness of the Merger, even though it includes qualifications,
limitations and assumptions relating to its scope and other factors that
Hanover Limited Partners should consider carefully. The availability of
the Fairness Opinion is particularly significant in light of the absence
of arm's length negotiations in establishing the terms of the Merger.
. Host will contribute its wholly owned full-service hotel assets,
substantially all of its interests in the Hotel Partnerships and its
other assets (excluding its senior living assets and the cash or
securities to be distributed to its shareholders) to the Operating
Partnership in exchange for (i) a number of OP Units equal to the number
of outstanding shares of common stock of Host, (ii) preferred
partnership interests in the Operating Partnership corresponding to any
shares of Host preferred stock outstanding at the time of the REIT
Conversion and (iii) the assumption by the Operating Partnership of all
liabilities of Host (including past and future tax liabilities), other
than liabilities of SLC. Following these contributions, the Operating
Partnership and its subsidiaries will directly own all of Host's wholly
owned hotels and all of Host's interests in the Hotel Partnerships and
Host's other assets. Host will receive OP Units in respect of its
general and limited partner interests in Hanover on substantially the
same basis as the Partnership Units held by Hanover Limited Partners.
Host REIT will not receive any compensation for its services as general
partner to the Operating Partnership following the REIT Conversion and
will benefit from the operations of the Operating Partnership only to
the extent of the distributions received based upon its percentage
interest in the Operating Partnership to the same extent as the other
limited partners. Because Host REIT will share in the value of the
Operating Partnership solely through distributions and not through any
separate compensation structure, the General Partner believes that this
is a factor supporting the fairness of the Merger to the Hanover Limited
Partners.
Hanover Supp-18
<PAGE>
. The General Partner believes that the value of the consideration to be
received by the Hanover Limited Partners in the Merger is fair in
relation to the value which would be derived by such Limited Partners
under any of the alternatives described under "Background and Reasons
for the Mergers and the REIT Conversion--Alternatives to the Mergers,"
especially since the Exchange Value of Hanover is equal to its Adjusted
Appraised Value, which is the greatest of the Adjusted Appraised Value,
the Continuation Value and the Liquidation Value. The consideration to
be received by the Hanover Limited Partners in the Merger also is
greater than the amounts paid in recent reported sales of Hanover
Partnership Units, including the April 1997 tender offer by Host. The
General Partner does not believe that the sale of Hanover's Hotel and
liquidation of Hanover will obtain for Hanover Limited Partners as much
value as the value to be received by such Hanover Limited Partners
following the Merger. The General Partner believes that the following
benefits are of the greatest value and importance to the Hanover Limited
Partners:
. Enhanced Liquidity. The Merger and the REIT Conversion will offer
Hanover Limited Partners significantly enhanced liquidity with
respect to their investments in Hanover because, commencing one year
following the Effective Date, Hanover Limited Partners who retain OP
Units will be able to exercise their Unit Redemption Right at any
time, subject to certain limited exceptions. Host has approximately
204 million shares of common stock outstanding and is expected to
have a total common equity market capitalization of approximately $
billion after giving effect to the estimated $ million earnings and
profits distribution (based on Host's $ closing price per share on
the NYSE on , 1998). The exercise of the Unit Redemption Right,
however, generally would result in recognition of taxable income or
gain at that time.
. Risk Diversification. Upon consummation of the REIT Conversion, each
Hanover Limited Partner's investment will be converted from an
investment in Hanover, which owns one hotel, into an investment in
an enterprise that initially will own or control approximately 120
Hotels and will have a total market capitalization of approximately
$ billion, thereby reducing the dependence upon the performance of,
and the exposure to the risks associated with, the Hotel currently
owned by Hanover and spreading such risk over a broader and more
varied portfolio, including more diverse geographic locations and
multiple brands.
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a significantly lower leverage to
value ratio than Hanover currently, which has a leverage ratio of
81% (calculated as a percentage of Appraised Value), resulting in
significant interest and debt service savings and greater financial
stability.
. Regular Quarterly Cash Distributions. The General Partner expects
that the Operating Partnership will make regular quarterly cash
distributions to holders of OP Units. Host expects that these
distributions will be higher than the estimated cash distributions
for 1998 of Hanover, and, in any event, the ability to receive
distributions quarterly and in regular amounts would be enhanced.
. Substantial Tax Deferral. The General Partner expects that Hanover
Limited Partners who do not elect to receive Notes in exchange for
OP Units generally should be able to obtain the benefits of the
Merger while continuing to defer recognition for federal income tax
purposes of at least a substantial portion, if not all, of the gain
with respect to their Partnership Interests that otherwise would be
recognized in the event of a liquidation of Hanover or a sale or
other disposition of its assets in a taxable transaction (although
Hanover Limited Partners may (although are not expected to)
recognize a relatively modest amount of ordinary income as the
result of required sales of personal property by Hanover to a Non-
Controlled Subsidiary in order to facilitate Host REIT's
qualification as a REIT).
.The General Partner believes that the economic terms of the lease of the
Hanover Hotel is fair and reasonable from the standpoint of the Operating
Partnership.
Hanover Supp-19
<PAGE>
The General Partner believes that the factors described above, which support
the fairness of the Merger to the Hanover Limited Partners, when weighed
against the factors that may be disadvantageous, taken as a whole, indicate
that the Merger is fair to the Hanover Limited Partners.
FAIRNESS OPINION
AAA, an independent financial advisory firm with substantial real estate and
partnership transaction experience, was engaged by the General Partner and the
other General Partners to perform the Appraisals and to render the Fairness
Opinion that (i) the Exchange Value and the methodologies and underlying
assumptions used to determine the Exchange Value, the Adjusted Appraised
Value, the Continuation Value and the Liquidation Value of Hanover and each
other Partnership (including, without limitation, the assumptions used to
determine the various adjustments to the Appraised Values of the Hotels) are
fair and reasonable, from a financial point of view, to the Hanover Limited
Partners and the Limited Partners of each other Partnership and (ii) the
methodologies used to determine the value of an OP Unit and to allocate the
equity in the Operating Partnership to be received by the Hanover limited
partners and the limited partners of each other Partnership are fair and
reasonable to the Hanover Limited Partners and the Limited Partners of each
other Partnership. The Fairness Opinion is addressed to each Partnership and
it may be relied upon by each of the Hanover Limited Partners and the Limited
Partners of each of the other Partnerships. The full text of the Fairness
Opinion, which contains a description of the assumptions and qualifications
applicable to the review and analysis by AAA, is set forth in Appendix B to
the Consent Solicitation and should be read in its entirety. The material
assumptions and qualifications to the Fairness Opinion are summarized below,
although this summary does not purport to be a complete description of the
various inquiries and analyses undertaken by AAA in rendering the Fairness
Opinion. Arriving at a fairness opinion is a complex analytical process not
necessarily susceptible to partial analysis or amenable to summary
description. For a more complete description of the assumptions and
qualifications that limit the scope of the Fairness Opinion, see "--
Qualifications to Fairness Opinion" and "--Assumptions" below.
Although the General Partner advised AAA that certain assumptions were
appropriate in its view, the General Partner imposed no conditions or
limitations on the scope of the investigation by AAA or the methods and
procedures to be followed by AAA in rendering the Fairness Opinion. The fees
and expenses of AAA will be treated as a Merger Expense and will be paid by
the Operating Partnership. In addition, the General Partner has agreed to
indemnify AAA against certain liabilities. See "--Compensation and Material
Relationships."
Qualifications to Fairness Opinion. In the Fairness Opinion, AAA
specifically states that it did not: (a) specifically consider other
methodologies for allocation of the OP Units, (b) address or conclude that
other methodologies for allocation of the OP Units to Hanover and the other
Partnerships might not have been more favorable to the Limited Partners in
certain of the Partnerships, (c) negotiate with the General Partner, the
General Partners of other Partnerships or Host, (d) participate in
establishing the terms of the Merger and the other Mergers, (e) provide an
opinion as to the terms and conditions of the Merger and the other Mergers
other than those explicitly stated in the Fairness Opinion, (f) make any
independent review of the capital expenditure estimates set forth in the
Engineering Study or (g) make any estimates of Hanover's and each other
Partnership's contingent liabilities. In addition, with respect to the
specific reference to the allocation of the equity interest in the Operating
Partnership to be received by the limited partners of each Partnership, AAA
has assumed that the average closing price on the NYSE of a Host REIT Common
Share for the 20 trading days after the Effective Date of the Mergers
represents a fair price.
In connection with preparing the Fairness Opinion, AAA was not engaged to,
and consequently did not, prepare any written report or compendium of its
analysis for internal or external use beyond the analysis set forth in
Appendix B. AAA will not deliver any additional written opinion of the
analysis, other than to update the written opinion if requested by the
Operating Partnership.
Experience of AAA. AAA is the world's largest independent valuation
consulting firm and is regularly and continually engaged in the valuation of
commercial real estate and businesses and their securities in connection with
tender offers, mergers and acquisitions, recapitalizations and
reorganizations, divestitures, employee stock ownership plans, leveraged
buyout plans, private placements, limited partnerships, estate and corporate
matters, other financial advisory matters and other valuation purposes.
Hanover Supp-20
<PAGE>
AAA was selected because of its experience in the valuation of businesses
and their securities in connection with tender offers, mergers and
acquisitions, recapitalizations and reorganizations, including transactions
involving hotel partnerships. In addition, Host and its affiliates have
previously engaged AAA to provide appraisals and fairness opinions in
connection with other transactions. The General Partner and the other General
Partners considered two other firms for purposes of performing the appraisals
and rendering the Fairness Opinion and received proposals from each. The
General Partners selected AAA based upon price and experience.
Summary of Materials Considered and Investigation Undertaken. As a basis for
rendering the Fairness Opinion, AAA has made such reviews, studies and
analyses as it deemed necessary and pertinent in order to provide it with a
reasonable basis for the Fairness Opinion, including, but not limited to, the
following: (i) reviewed the transaction documents and SEC reporting and/or
filing documents, including drafts of the Form S-4 for the Mergers; (ii)
provided the Market Value of each Hotel owned by each Partnership in a
separate short form appraisal report and each such report was reviewed and
certified by an MAI appraiser as to its preparation in accordance with the
requirements of the Standards of Professional Practice of the Appraisal
Institute and the Uniform Standards of Professional Appraisal Practice of the
Appraisal Foundation; as part of the Appraisals, AAA reviewed historical
operating statements, 1998 budget and year-to-date results, and other
financial information as it deemed necessary as a basis for the Fairness
Opinion and the Appraisals also considered market transactions of similar
lodging properties as appropriate as a basis for the Market Value of each
Hotel; (iii) reviewed the methodologies used by each of the General Partners
in their determination of the Exchange Value of each Partnership, including
the nature and amount of all adjustments to the Appraised Values in
determining such Exchange Values; AAA reviewed and tested for the fairness and
reasonableness of all adjustments as well as for consideration of all
adjustments deemed to be appropriate by AAA; (iv) reviewed the methodologies
used by each of the General Partners in their determination of the value of an
OP Unit and the allocation of the equity interest in the Operating Partnership
to be received by the partners of each Partnership, and AAA reviewed and
tested for the fairness and reasonableness of the methods and measurements
made by the General Partners; (v) reviewed the General Partners' determination
of the Liquidation Value of each Partnership, and AAA reviewed and tested for
the fairness and reasonableness of all adjustments proposed by the General
Partners, as well as for consideration of all adjustments deemed appropriate
by AAA; (vi) provided an estimate of the Continuation Value of each
Partnership based upon the estimated present value of expected benefits to be
received by each limited partner interest as though the Mergers did not occur
and each Partnership's assets were sold within a twelve year period; AAA, as
part of its analysis and review, determined appropriate rates of growth in
house profit or net operating income, as well as reviewed other key variables
affecting partnership cash flows and other economic/financial factors
affecting the Partnerships' expected operations and results; (vii) reviewed
the terms of the ground leases of the Hotels and the partnership agreement of
each Partnership; (viii) reviewed audited and unaudited historical income
statements, balance sheets and statements of sources and uses of funds of each
Partnership and Host and pro forma financial information for Host REIT; (ix)
reviewed audited and unaudited historical operating statements of each Hotel,
as well as current operating statements and budgets; (x) conducted real estate
valuation and financial due diligence with respect to the Partnerships and
their underlying assets, liabilities and equity; (xi) reviewed internal
Marriott International, Host and Partnership financial analyses and other
internally generated data for each Hotel and (xii) discussed all of the
foregoing information, where appropriate, with management of Marriott
International, Host and the Partnerships and their respective employees.
Assumptions. In rendering its opinion, AAA relied, without independent
verification, on the accuracy and completeness in all material respects of
certain relevant publicly available information and information provided to
AAA by Host and the Hotels. AAA assumed that all information furnished by
Host, the Hotels and the Partnerships and their representatives, upon which
AAA relied, presented an accurate description in all material respects of the
current and prospective status of the Hotels and the Partnerships from an
operational and financial point of view. AAA also noted that the Fairness
Opinion was based upon financial, economic, market and other considerations as
they existed and could be evaluated on the date thereof.
Hanover Supp-21
<PAGE>
Conclusions. AAA concluded that, based upon and subject to its analysis and
assumptions and limiting conditions, and as of the date of the Fairness
Opinion: (i) the Exchange Value and the methodologies used to determine the
Exchange Value, the Adjusted Appraised Value, the Continuation Value and the
Liquidation Value of each Partnership (including, without limitation, the
assumptions used to determine the various adjustments to the Appraised Values
of each of the Hotels) are fair and reasonable, from a financial point of
view, to the Hanover Limited Partners and the Limited Partners of each other
Partnership and (ii) the methodologies used to determine the value of an OP
Unit and to allocate the equity interest in the Operating Partnership to be
received by the Hanover Limited Partners and the Limited Partners of each
other Partnership are fair and reasonable to the Hanover Limited Partners and
the Limited Partners of each other Partnership.
Compensation and Material Relationships. AAA has been paid a fee of $335,000
for its services as described herein, including the Appraisals and preparing
to deliver the Fairness Opinion. In addition, AAA will be reimbursed for all
reasonable out-of-pocket expenses, including legal fees and will be
indemnified against certain liabilities, including certain liabilities under
the securities laws. The fee was negotiated between Host, the General Partners
and AAA. Payment of the fee to AAA is not dependent upon completion of the
Mergers. AAA has been previously engaged by Host and its affiliates to provide
appraisals, fairness opinions and solvency opinions in connection with other
transactions.
VOTING PROCEDURES
The consent of Hanover Limited Partners holding more than 50% of the
outstanding limited partner interests is required for participation in the
Merger. An affiliate of the General Partner holds 47.62% of the outstanding
limited partner interests. The General Partner and its affiliate are required
to vote their limited partner interests in Hanover in the same manner as the
majority of the other limited partner interests vote so long as consents of a
majority of limited partners interests held by Limited Partners are returned
and not withdrawn prior to the end of the Solicitation Period.
A Hanover Limited Partner may mark the Consent Form to vote "FOR," "AGAINST"
or "ABSTAIN" with respect to participation in the Merger by Hanover. THE
FAILURE OF A LIMITED PARTNER OF HANOVER TO VOTE OR AN ABSTENTION WILL HAVE THE
SAME EFFECT AS IF SUCH LIMITED PARTNER HAD VOTED HIS PARTNERSHIP INTERESTS
"AGAINST" THE MERGER. LIMITED PARTNERS WHO RETURN A SIGNED CONSENT FORM BUT
FAIL TO INDICATE THEIR APPROVAL OR DISAPPROVAL AS TO ANY MATTER (INCLUDING THE
MERGER) WILL BE DEEMED TO HAVE VOTED TO APPROVE SUCH MATTER. The voting
procedures applicable to Hanover Limited Partners are set forth in the Consent
Solicitation under the heading "Voting Procedures--Required Vote and Other
Conditions."
As of June 19, 1998, Hanover Hotel Acquisition Corporation, a wholly owned
subsidiary of Host, holds 47.62% of the total number of Partnership Units. No
other person owned of record, or to the Partnership's knowledge owned
beneficially, more than 5% of the total number of Partnership Units.
FEDERAL INCOME TAX CONSEQUENCES
In addition to the federal income tax consequences discussed in the sections
of the Consent Solicitation entitled "Federal Income Tax Consequences" and
"Risk Factors--Federal Income Tax Risks," Hanover Limited Partners should read
carefully the following discussion of federal income tax consequences
applicable specifically to the Hanover Limited Partners. The information
included in this discussion is based upon various factual assumptions and
information which are believed by the Operating Partnership and the General
Partner to be reliable. However, some of these assumptions inevitably will not
materialize and unanticipated events and circumstances will occur. Therefore,
there likely will be differences between the information provided herein,
including the numerical data and estimates, and actual results, and the
variations may be material and adverse.
Hanover Supp-22
<PAGE>
Applicability of Tax Opinions
Hogan & Hartson L.L.P. ("Hogan & Hartson"), counsel to Host REIT, Host, and
the Operating Partnership, has provided to Host REIT and the Operating
Partnership an opinion letter (substantially in the form of Appendix C to the
Consent Solicitation) as to certain federal income tax consequences to the
Operating Partnership and the Hanover Limited Partners resulting from the
Mergers and the REIT Conversion. The opinion letter is based upon certain
assumptions and certain representations provided by Host REIT, Host, the
Operating Partnership and the General Partners. These representations
generally involve factual matters relating to the organization, ownership and
operations (including the income, assets, businesses, liabilities and
properties) of the Partnerships and Hotels contributed to the Operating
Partnership by Host and the Blackstone Entities prior to the Mergers and the
REIT Conversion of Host REIT, the Operating Partnership and the Partnerships
following the Mergers and the REIT Conversion. In addition, on the Effective
Date, Hogan & Hartson expects to provide to Host REIT and the Operating
Partnership an opinion letter (substantially in the form of Appendix D to the
Consent Solicitation) as to the qualification and taxation of Host REIT as a
REIT under the Code following the REIT Conversion. The receipt of this opinion
letter is a condition to the REIT Conversion and each of the Mergers. See
"Federal Income Tax Consequences--Summary of Tax Opinions" in the Consent
Solicitation.
Each opinion provided by Hogan & Hartson in the opinion letter that is
substantially in the form of Appendix E to the Consent Solicitation is
applicable to the Hanover Limited Partners.
The opinions already rendered by Hogan & Hartson are based on the Code and
Treasury Regulations in effect on the date hereof, current administrative
interpretations and positions of the IRS and existing court decisions, and the
opinions to be rendered by Hogan & Hartson on the Effective Date will be based
on the same authorities as of the Effective Date. No assurance can be given
that future legislation, Treasury Regulations, administrative interpretations
and court decisions will not significantly change the law or the above
conclusions reached by counsel. In addition, any such change could apply
retroactively to transactions preceding the date of change. Moreover, opinions
of counsel merely represent counsel's best judgment with respect to the
probable outcome on the merits and are not binding on the IRS or the courts.
Accordingly, even if there is no change in applicable law, no assurance can be
provided that such opinions (which do not bind the IRS or the courts) will not
be challenged by the IRS or will be sustained by a court if so challenged.
With the one exception described below (see "--Tax Consequences of the
Merger--Deemed Cash Distribution and Resulting Taxable Gain") and in the
Consent Solicitation under "Federal Income Tax Consequences--Tax Consequences
of the Mergers--IRS Ruling Request Regarding Allocation of Partnership
Liabilities," neither Host REIT, the Operating Partnership nor the General
Partners have requested or plan to request any rulings from the IRS concerning
the tax consequences of the Mergers or the treatment of either the Operating
Partnership or Host REIT subsequent to the REIT Conversion.
Tax Consequences of the Merger
Overview. Hogan & Hartson has provided an opinion to the effect that the
Merger will not result in the recognition of taxable gain or loss at the time
of the Merger to a Hanover Limited Partner (i) who does not exercise his Unit
Redemption Right on a date sooner than the date two years after the date of
the consummation of the Merger; (ii) who does not receive a cash distribution
(or a deemed cash distribution resulting from relief from liabilities,
including as a result of any prepayment of the Hanover Mortgage Debt) in
connection with the Merger or the REIT Conversion in excess of his aggregate
adjusted basis in his Hanover Partnership Units at the time of the Merger;
(iii) who does not elect to receive a Note in exchange for his OP Units in
connection with the Merger (the "Note Election"); (iv) who is not required to
recognize gain by reason of the exercise by another Hanover Limited Partner of
his right to make the Note Election (which, in counsel's opinion, described
below, should not be the result of such election); and (v) who does not have
his "at risk" amount fall below zero as a result of the Merger or the REIT
Conversion. See "Federal Income Tax Consequences--Summary of Tax Opinions" in
the Consent Solicitation.
With respect to the foregoing exceptions to nonrecognition treatment, the
Operating Partnership and the General Partner believe as follows: (i) a
Hanover Limited Partner who acquired his Hanover Partnership Units
Hanover Supp-23
<PAGE>
in the original offering of such Partnership Units and who has held such
Partnership Units at all times since would not be considered to receive, as a
result of the Merger, a distribution (or a deemed cash distribution resulting
from relief from liabilities) that exceeds his aggregate adjusted basis in his
Hanover Partnership Units at the time of the Merger, and would not have his
"at risk" amount fall below zero as a result of the Merger, even if all of the
Hanover Mortgage Debt were to be repaid in connection with the Merger or the
REIT Conversion, and (ii) a portion of the personal property owned by Hanover
will need to be sold to a Non-Controlled Subsidiary in connection with the
REIT Conversion, although this sale should not result in the recognition of
any income by the Hanover Limited Partners. See "Federal Income Tax
Consequences--Tax Consequences of the Mergers--Overview" in the Consent
Solicitation and "Tax Allocations upon the Sale of Certain Personal Property
Associated with the Hanover Marriott" below.
With respect to the effects of a Hanover Limited Partner's election to
receive a Note in exchange for his OP Units in connection with the Merger,
Hogan & Hartson is of the opinion that although the matter is not free from
doubt, a Hanover Limited Partner who does not elect to receive a Note in
connection with the Merger should not be required to recognize gain by reason
of another Hanover Limited Partner's exercise of such right. With respect to
the exercise of a Unit Redemption Right, Hogan & Hartson is of the opinion
that it is more likely than not that a Hanover Limited Partner's exercise of
his Unit Redemption Right more than one year after the date of consummation of
the Merger but less than two years after such date will not cause the Merger
itself to be a taxable transaction for the Hanover Limited Partner (or the
other Hanover Limited Partners). See "Federal Income Tax Consequences--Summary
of Tax Opinions" in the Consent Solicitation. Opinions of counsel, however, do
not bind the IRS or the courts, and no assurances can be provided that such
opinions will not be challenged by the IRS or will be sustained by a court if
so challenged.
Deemed Cash Distribution and Resulting Taxable Gain. With respect to his
Hanover Partnership Units, a Hanover Limited Partner will receive no actual
cash distribution in connection with the Merger but would be deemed to receive
a cash distribution in connection with the Merger to the extent that his share
of Operating Partnership liabilities immediately after the Merger and the REIT
Conversion is less than his share of Hanover liabilities immediately prior to
the Merger. For example, any prepayment of the Hanover Mortgage Debt or debt
encumbering other Hotels may result in a deemed cash distribution to the
Hanover Limited Partners. See "Federal Income Tax Consequences--Tax
Consequences of the Mergers--Relief from Liabilities/Deemed Cash Distribution"
in the Consent Solicitation. Even though the Hanover Mortgage Debt and the
debt encumbering other Hotels is not expected to be repaid or refinanced in
connection with the Mergers and the REIT Conversion (except as described in
the Consent Solicitation), a Hanover Limited Partner's share of indebtedness
following the Mergers and the REIT Conversion may nonetheless decrease in
comparison to the Limited Partner's estimated aggregate share of Hanover
indebtedness as of December 31, 1998 (calculated based on the assumption that
the Mergers did not occur) by reason of the manner in which the debt
allocation rules work when multiple assets with different levels of leverage
are consolidated into a single partnership.
A Hanover Limited Partner, however, would recognize taxable gain as a result
of any deemed cash distribution only to the extent that the deemed cash
distribution were to exceed his adjusted tax basis in his Hanover Partnership
Units immediately prior to the Merger. As noted above, the Operating
Partnership and the General Partner believe, based upon and subject to the
assumptions and other limitations described below, that a Limited Partner who
acquired his Hanover Partnership Units in the original offering of such
Partnership Units and has held the Partnership Units at all times since the
offering will have an adjusted tax basis in excess of the deemed cash
distribution that might occur in connection with the Merger and the REIT
Conversion. Therefore, such a Hanover Limited Partner should not recognize
gain due to such deemed cash distribution resulting from the relief from
liabilities in connection with the Merger and the REIT Conversion.
The adjusted tax basis of a Hanover Limited Partner who did not acquire his
Hanover Partnership Units in the original offering of such Partnership Units
or who has not held his Hanover Partnership Units at all times since such
offering could vary materially from that of a Hanover Limited Partner who did
so. If a Hanover Limited Partner has an adjusted tax basis in his Hanover
Partnership Units (per Hanover Partnership Unit) that is substantially less
than the adjusted tax basis of a Hanover Limited Partner who acquired his
Hanover Partnership
Hanover Supp-24
<PAGE>
Units in the original offering of such Partnership Units and has held such
Partnership Units at all times since, he could recognize gain due to any
deemed cash distribution resulting from the relief from liabilities in
connection with the Merger and the REIT Conversion.
The Operating Partnership has no current plan or intention to cause the
prepayment of the Hanover Mortgage Debt or, except as described in the Consent
Solicitation, any of the nonrecourse liabilities encumbering the Hotels owned
by the other Partnerships. The Operating Partnership, however, will have to
repay mortgage indebtedness securing the Hotels owned by the Partnerships at
the time such indebtedness matures. There can be no assurance that at such
time the Operating Partnership will be able to secure nonrecourse mortgage
indebtedness secured only by those Hotels in an amount sufficient to avoid a
deemed cash distribution to the former Limited Partners in those Partnerships,
including Hanover (although such a deemed distribution of cash may or may not
result in the recognition of taxable income or gain by the former Hanover
Limited Partners). Moreover, the Operating Partnership's current long-term
financing strategy is to have as little debt as possible that is secured by
individual Hotels and to have as much debt as possible in the form of
unsecured debt, held either by the public or by institutional investors, which
debt may or may not be recourse to Host REIT, as general partner of the
Operating Partnership. In view of these considerations and the potential
adverse consequences to Limited Partners in certain Partnerships, the
Operating Partnership has requested from the IRS a ruling to the effect that
such unsecured indebtedness of the Operating Partnership that is issued
initially to institutional investors and is not recourse to Host REIT (i)
would qualify as "nonrecourse liabilities" for purposes of Code Section 752,
(ii) to the extent the proceeds thereof are applied to repay existing
nonrecourse mortgage indebtedness secured by one or more Hotels (including the
Hanover Mortgage Debt), would be considered to be "secured" by those Hotels
for purposes of allocating the liabilities for tax basis purposes (and thus
would be allocable, at least in substantial part, to the former Limited
Partners in the Partnerships owning those Hotels, including the Hanover
Limited Partners), and (iii) would constitute "qualified nonrecourse
financing" secured by such Hotels for purposes of Code Section 465. The IRS
has recently issued a ruling to that effect to another taxpayer, and has
indicated to the Operating Partnership's representatives that it is favorably
inclined to issue that ruling to the Operating Partnership.
Section 465(e) Recapture. As discussed in the Consent Solicitation, see
"Federal Income Tax Consequences--Tax Consequences of the Mergers--Section
465(e) Recapture," the "at risk" rules of Section 465 of the Code generally
apply to limit the use of partnership losses by a partner. Under Section
465(e) of the Code, a partner may be required to include in gross income, or
"recapture," losses previously allowed to such partner with respect to his
investment in a partnership if the amount for which the partner is "at risk"
in relation to his investment in the partnership is less than zero at the
close of the taxable year. The "at risk" rules generally do not apply to
losses attributable to real property placed in service prior to January 1,
1987 by the taxpayer or to losses attributable to a partnership in which the
taxpayer acquired his interests before that date (the "grandfather" rule).
Thus, the "at risk" rules have not been applicable to date to those Hanover
Limited Partners who acquired their Partnership Units at the time of the
original offering in November of 1986 or at any time prior to January 1, 1987
and who have held those Partnership Units since the date of the acquisition.
The Hanover Limited Partners will, however, become subject to the "at risk"
rules as a result of the Merger and their receipt of OP Units in connection
therewith (since the OP Units do not qualify for the "grandfather" rule).
It is possible that the consummation of the Mergers and the REIT Conversion
or the repayment of certain "qualified nonrecourse financing" of the Operating
Partnership, the Hotel Partnerships or the Hotels contributed to the Operating
Partnership by the Blackstone Entities at the time of or following the Mergers
and the REIT Conversion could, singularly or in combination, cause a Hanover
Limited Partner's amount at risk in relation to his investment in Hanover
(and, after the Mergers, in the Operating Partnership) to be reduced below
zero, resulting in an income inclusion to the Limited Partner under Section
465(e) of the Code. Currently, a sufficient portion of the current debt of
Hanover constitutes "qualified nonrecourse financing" so that the Hanover
Limited Partners have positive at risk amounts, and the Operating Partnership
expects that most of the current debt with respect to the other Hotel
Partnerships and the Hotels contributed by the Blackstone Entities that will
be assumed by the Operating Partnership as part of the Mergers and the REIT
Conversion should qualify as "qualified
Hanover Supp-25
<PAGE>
nonrecourse financing." The Operating Partnership and the General Partner
believe, based upon and subject to the assumptions and other limitations
described below, that a Hanover Limited Partner who acquired his Hanover
Partnership Units in the original offering of such Partnership Units and has
held the Partnership Units at all times since will have a positive at risk
amount immediately following the Merger and the REIT Conversion, even if all
of the Hanover Mortgage Debt were to be repaid in connection with the Merger
and the REIT Conversion and such Hanover Limited Partners were to have no
share of any other "qualified nonrecourse financing" following the Mergers and
the REIT Conversion.
It is possible, however, that a former Hanover Limited Partner's at risk
amount could decline in the future, either because of the allocation of losses
from the Operating Partnership to that former Hanover Limited Partner or
because of cash distributions by the Operating Partnership to that former
Hanover Limited Partner in excess of the taxable income allocable to him with
respect to his OP Units. In that event, it may be necessary for the former
Hanover Limited Partner to have a share of "qualified nonrecourse financing"
from the Operating Partnership in order to avoid recognizing income by reason
of his at risk amount falling below zero. Moreover, there can be no assurance
that debt incurred by the Operating Partnership in the future to refinance the
Hanover Mortgage Debt or outstanding mortgage debt of the other Hotel
Partnerships or the Hotels contributed by the Blackstone Entities will qualify
as "qualified nonrecourse financing." If, however, the Operating Partnership
were to obtain the requested ruling from the IRS and were to refinance
existing mortgage indebtedness of the Partnerships with the type of
indebtedness described in the ruling, such indebtedness should constitute
"qualified nonrecourse financing" for purposes of the "at risk" rules.
Impact of Assumption of Hanover Liabilities by the Operating Partnership. As
described in the Consent Solicitation, see "Federal Income Tax Consequences--
Tax Consequences of the Mergers--Disguised Sale Regulations," a Hanover
Limited Partner will recognize gain to the extent he is treated as having sold
all or part of his Hanover Partnership Interest in a "disguised sale." For
purposes of these rules, certain reductions in a partner's share of
partnership liabilities are treated as a transfer of money or other property
from the partnership to the partner which may give rise to a disguised sale,
even if that reduction would not otherwise result in a taxable deemed cash
distribution in excess of the partner's basis in his partnership interest.
However, if a transfer of property by a partner to a partnership is not
otherwise treated as part of a disguised sale, then any reduction in the
partner's share of "qualified liabilities" also will not be treated as part of
a disguised sale. A "qualified liability" in connection with a transfer of
property to a partnership includes (i) any liability incurred more than two
years prior to the earlier of the transfer of the property or the date the
partner agrees in writing to the transfer, as long as the liability has
encumbered the transferred property throughout the twoyear period; (ii) a
liability that was not incurred in anticipation of the transfer of the
property to a partnership, but that was incurred by the partner within the
two-year period prior to the earlier of the date the partner agrees in writing
to transfer the property or the date the partner transfers the property to a
partnership and that has encumbered the transferred property since it was
incurred; (iii) a liability that is traceable under the Treasury Regulations
to capital expenditures with respect to the property; and (iv) a liability
that was incurred in the ordinary course of the trade or business in which
property transferred to the partnership was used or held, but only if all the
assets related to that trade or business are transferred, other than assets
that are not material to a continuation of the trade or business. However, a
recourse liability is not a "qualified liability" unless the amount of the
liability does not exceed the fair market value of the transferred property
(less any other liabilities that are senior in priority and encumber such
property or any allocable liabilities described in (iii) or (iv), above) at
the time of transfer.
The General Partner and the Operating Partnership believe, based upon their
review of the facts and circumstances surrounding each liability, that all
liabilities of Hanover fall into one of the four categories of "qualified
liabilities" described above and, accordingly, that the mere assumption by the
Operating Partnership of the outstanding liabilities of Hanover will not give
rise to a "disguised sale" by any of the Hanover Limited Partners.
Tax Treatment of Hanover Limited Partners Who Hold OP Units Following the
Merger
Initial Basis in Units. In general, a Hanover Limited Partner will have an
initial tax basis in his OP Units received in the Merger with respect to his
Hanover Partnership Units equal to the basis in his Hanover
Hanover Supp-26
<PAGE>
Partnership Units at the time of the Merger, reduced to reflect any deemed
cash distributions resulting from a reduction in his share of Hanover
liabilities and increased to reflect his share of other liabilities of the
Operating Partnership and any gain required to be recognized in connection
with the Merger and the REIT Conversion. For a discussion of the federal
income tax considerations for a Hanover Limited Partner from a reduction in
basis that may result from the Merger and the REIT Conversion, see "Federal
Income Tax Consequences--Tax Treatment of Limited Partners Who Hold OP Units
Following the Mergers--Initial Tax Basis of OP Units" in the Consent
Solicitation.
Tax Allocations by the Operating Partnership upon a Sale of Hanover Marriott
Hotel. Pursuant to Section 704(c) of the Code, income, gain, loss and
deduction attributable to appreciated or depreciated property that is
contributed to a partnership must be allocated for federal income tax purposes
in a manner such that the contributor is charged with, or benefits from, the
unrealized gain or unrealized loss associated with the property at the time of
contribution. The amount of such unrealized gain or unrealized loss is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution (referred to as the "Book-Tax
Difference"). The Operating Partnership and the General Partner estimate,
based upon and subject to the assumptions and other limitations described
below, that the Book-Tax Difference for all Hanover Limited Partners (but
excluding all of Host's interests) with respect to the Hanover Marriott Hotel
will be $2,020,537 upon the consummation of the Merger.
If the Operating Partnership were to sell the Hanover Marriott Hotel, the
former partners of Hanover (including Host REIT with respect to Host's
interest in Hanover currently held indirectly by Host through the General
Partner and Hanover Hotel Acquisition Corp.) would be specially allocated by
the Operating Partnership an aggregate amount of taxable gain equal to the
aggregate Book-Tax Difference with respect to the Hanover Marriott Hotel. The
share of such gain allocable to a Hanover Limited Partner who acquired his
Hanover Partnership Units in the original offering of such Partnership Units
and held such Partnership Units at all times since would be $56,489 per
Hanover Partnership Unit if such Limited Partner acquired his Hanover
Partnership Units for cash, and $44,089 per Hanover Partnership Unit if such
Limited Partner required his Partnership Units pursuant to an installment
purchase plan. The share of such gain of a Hanover Limited Partner who did not
acquire his Hanover Partnership Units in the original offering of such
Partnership Units or who has not held his Partnership Units at all times since
such offering could vary materially from this amount. If the Operating
Partnership were to sell the Hanover Marriott Hotel with a Book-Tax
Difference, the remaining Book-Tax Difference at the time the Hotel is sold
would be required to be allocated exclusively to the former Hanover Limited
Partners and the General Partner, even though the proceeds of such sale would
be allocated proportionately among all the partners in the Operating
Partnership (and would likely be retained by the Operating Partnership, rather
than distributed to holders of OP Units and Common Shares of Host REIT). The
Hanover Limited Partners would not be entitled to any special distributions
from the Operating Partnership in connection with such a sale, and thus would
not necessarily receive cash distributions from the Operating Partnership
sufficient to pay such additional taxes. Although the Partnership Agreement
does not impose any restrictions upon the Operating Partnership preventing it
from causing the sale of the Hanover Marriott Hotel at any time following the
Merger, the Operating Partnership does not have current plans to pursue a sale
of the Hotel. See "Federal Income Tax Consequences--Tax Treatment of Limited
Partners Who Hold OP Units Following the Mergers--Sale of Individual Hotels"
in the Consent Solicitation.
Tax Allocations upon the Sale of Certain Personal Property Associated with
the Hanover Marriott Hotel. As discussed in the Consent Solicitation, see
"Federal Income Tax Consequences--Federal Income Taxation of Host REIT
Following the REIT Conversion--Income Tests Applicable to REITs" and "--
Taxable Income Attributable to Sales of Personal Property in Connection with
the REIT Conversion," if the rent attributable to personal property leased in
connection with the lease of each Hotel is greater than 15% of the total rent
received under the lease of such Hotel, the portion of the rent attributable
to the personal property will not constitute qualifying income to Host REIT
(the "15% Personal Property Test"). The Operating Partnership and the General
Partner have determined that the percentage of rent attributable to the
personal property to be leased in
Hanover Supp-27
<PAGE>
connection with the lease of the Hanover Marriott Hotel would not satisfy the
15% Personal Property Test. The 15% Personal Property Test is a mechanical
test that is based not on the relative fair market value of the assets subject
to lease, or the relative fair rental value of those assets, but, rather, is
based on the average relative adjusted tax bases of the assets subject to the
lease. Accordingly, immediately prior to the Merger, the Operating Partnership
will require Hanover, if it chooses to participate in the Merger, to sell to a
Non-Controlled Subsidiary a portion of the personal property associated with
the Hanover Marriott Hotel. This sale, which will be a taxable transaction,
may (although is not expected to) result in the recognition by Hanover of an
amount of taxable gain to the extent of the difference, if any, between the
fair market value of the personal property at the time of the sale and the
adjusted tax basis of such property at that time. The actual amount of such
gain, if any, will be determinable only at the time of the sale and will be
affected by the specific personal property selected to be sold and the fair
market value and adjusted basis of that personal property. Pursuant to the
Hanover partnership agreement, any such taxable gain will be characterized as
ordinary recapture income and will be allocated by Hanover to the Hanover
partners in the same proportions and to the same extent that such partners
were allocated any deductions directly or indirectly giving rise to the
treatment of such gains as recapture income prior to the Merger. The Operating
Partnership and the General Partner have determined that any such recapture
income arising upon the sale of the personal property should properly be
allocated to the General Partner, which would not be entitled to any special
distribution from Hanover in connection with such a sale of personal property.
Tax Allocations with Respect to Contributed Hotels Generally. The tax
allocations of depreciation to the Hanover Limited Partners may change
significantly as a result of the Mergers and the REIT Conversion for two
reasons. First, as described above, pursuant to Section 704(c) of the Code,
depreciation and deductions attributable to the Hanover Marriott Hotel will be
required to be allocated for federal income tax purposes in a manner such that
the Hanover Limited Partners are charged with the Book-Tax Difference
associated with the Hotel at the time of the consummation of the Merger.
Consequently, a Hanover Limited Partner will be allocated less depreciation
with respect to the Hanover Marriott Hotel than would be the case if the
Mergers had not occurred and the Hanover Limited Partner had continued to hold
his Hanover Partnership Units. (On the other hand, a former Hanover Limited
Partner will be allocated depreciation with respect to other Hotels acquired
by the Operating Partnership in connection with the Mergers and the REIT
Conversion, including the Hotels owned by the other Hotel Partnerships and the
Hotels being contributed to the Operating Partnership by Host and the
Blackstone Entities in connection with the Merger and the REIT Conversion.)
Second, the Mergers will cause the technical termination under Section
708(b)(1)(B) of the Code of Hanover and most of the other Hotel Partnerships
that participate in the Mergers and the REIT Conversion. Section 168(i)(7) of
the Code provides, in effect, that when a partnership terminates under Section
708(b)(1)(B) of the Code, the partnership must begin new depreciation periods
for its property. As a result, the remaining bases of the real estate
components of the Hanover Marriott Hotel and the Hotels held by the other
Hotel Partnerships that terminate will be depreciated over 39 years, rather
than over the remaining current lives of such Hotels (which range from less
than one year to 39 years). See "Federal Income Tax Consequences--Tax
Treatment of Limited Partners Who Hold OP Units Following the Mergers--Effect
of Mergers on Depreciation" in the Consent Solicitation.
In light of the complexity of the governing rules affecting the calculation
and allocation of depreciation with respect to properties contributed to a
partnership, particularly when a number of those properties are subject to the
separate adjustments required in connection with a technical termination under
Section 708 of the Code, the number of Hotels that the Operating Partnership
will be acquiring in connection with the Mergers and the REIT Conversion, and
the impact on these calculations of other outside events, including equity
offerings by Host or Host REIT and other acquisitions undertaken by Host, Host
REIT or the Operating Partnership prior to or in connection with the REIT
Conversion, the Operating Partnership and the General Partner believe that it
is impossible to predict with any degree of precision the impact that the
Mergers and the REIT Conversion will have on the future depreciation (and,
consequently, the amount of taxable income) allocable to a Hanover Limited
Partner.
Impact on Passive Activity Losses of an Investment in a Publicly Traded
Partnership. The passive loss limitation rules generally provide that
individuals, estates, trusts and certain closely held corporations and
Hanover Supp-28
<PAGE>
personal service corporations can only deduct losses from passive activities
(generally activities in which the taxpayer does not materially participate,
which would include the Operating Partnership for Hanover Limited Partners) to
the extent that such losses are not in excess of the taxpayer's income from
passive activities or investments. A Hanover Limited Partner would be able to
offset losses from other passive activities against income from the Operating
Partnership that is considered passive income (but not portfolio income) so
long as the Operating Partnership is not treated as a publicly traded
partnership. The Operating Partnership and the General Partner believe,
however, that there is a substantial risk that the Operating Partnership will
be treated as a publicly traded partnership for purposes of the passive loss
limitation rules. In this event, any losses or deductions of the Operating
Partnership allocable to a Hanover Limited Partner after the Merger could not
be used to offset passive income from other passive activities. Similarly,
losses from other passive activities could not be applied to offset income of
the Operating Partnership allocated to a Hanover Limited Partner. A Hanover
Limited Partner, however, would be able to offset any passive losses from his
investments against any gain recognized by the Hanover Limited Partner as a
result of the Merger.
State and Local Taxes. Hanover Limited Partners holding OP Units will be
subject to state and local taxation in a number of jurisdictions in which the
Operating Partnership directly or indirectly holds real property and would be
required to file periodic tax returns in those jurisdictions. In this regard,
immediately following the Mergers and the REIT Conversion, the Operating
Partnership expects that it will own properties in approximately 28 states
across the United States and the District of Columbia. Currently, Hanover owns
property in only one state. See "Federal Income Tax Consequences--Tax
Treatment of Limited Partners Who Hold OP Units Following the Mergers--State
and Local Taxes" in the Consent Solicitation.
Assumptions Used in Determining Tax Consequences of the Merger
In preparing the discussion set forth above, the Operating Partnership and
the General Partner made several key assumptions, which are described below.
If any such assumption is not accurate with respect to a particular Hanover
Limited Partner, the tax consequences of the Merger to such Hanover Limited
Partner could be substantially different from those reflected above.
ACCORDINGLY, EACH HANOVER LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH
HIS OWN TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH HANOVER LIMITED PARTNER'S
PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING
IN THE MERGER.
First, with respect to a Hanover Limited Partner's basis in his Hanover
Partnership Units prior to the Merger, the Operating Partnership and the
General Partner assumed that a Hanover Limited Partner acquired his Hanover
Partnership Units in the original offering of such Partnership Units and has
held such Partnership Units at all times since the offering (the "Original
Limited Partner's Adjusted Basis"). In general, each Hanover Limited Partner
had an initial tax basis in his Hanover Partnership Units ("Initial Basis")
equal to his cash investment Hanover (plus his proportionate share of the
Hanover's nonrecourse liabilities at the time he acquired his Hanover
Partnership Units). A Hanover Limited Partner's Initial Basis generally has
been increased by (a) such Limited Partner's share of Hanover's taxable income
and (b) any increases in his share of the liabilities of Hanover. Generally,
such Limited Partner's Initial Basis has been decreased (but not below zero)
by (i) his share of Hanover cash distributions, (ii) any decreases in his
share of liabilities of Hanover, (iii) his share of losses of Hanover, and
(iv) his share of nondeductible expenditures of Hanover are not chargeable to
capital.
The General Partner has set forth on Appendix E to the Consent Solicitation
for Hanover (i) the Original Limited Partner's Adjusted Basis as of December
31, 1997 for each such Hanover Limited Partner, and (ii) an estimate of such
Hanover Limited Partner's Original Limited Partner's Adjusted Basis as of
December 31, 1998 (computed without regard to the Mergers and based upon the
assumptions set forth in Appendix E to the Consent Solicitation). The General
Partner also has set forth on Appendix E to the Consent Solicitation for each
Hanover Limited Partner whose adjusted basis in his Hanover Partnership
Interest is the same as the Original Limited Partner's Adjusted Basis (i) the
Hanover liabilities allocable to such Hanover Limited Partner as of December
31, 1997, and (ii) an estimate of the Hanover liabilities allocable to such
Limited Partner as of December 31,
Hanover Supp-29
<PAGE>
1998 (computed without regard to the Mergers and based upon the assumptions
set forth in Appendix E to the Consent Solicitation). Each of these estimates
is shown separately for those Hanover Limited Partners who required their
Partnership Units at the time of the original offering pursuant to an
installment purchase plan.
The adjusted tax basis of a Hanover Limited Partner who did not acquire his
Hanover Partnership Units in the original offering of such Partnership Units
could vary materially from that of a Hanover Limited Partner who did so for
various reasons. If a Hanover Limited Partner has an adjusted tax basis in his
Hanover Partnership Units that is less than the Original Limited Partner's
Adjusted Tax Basis, the Merger might result in the receipt by the Hanover
Limited Partner of a deemed distribution of cash in excess of his adjusted tax
basis in his Hanover Partnership Units, which could result in the recognition
of income or gain.
Finally, the Operating Partnership and the General Partner assumed that the
Merger will be treated for federal income tax purposes as the transfer by the
Hanover Limited Partners of their interests in the Partnership to the
Operating Partnership in exchange for OP Units. There can be no assurance,
however, that the IRS will not seek to recharacterize each Merger as either
(i) the liquidation of a Partnership followed by the distribution by the
Partnership of its assets to its partners and the subsequent transfers by such
partners of such assets to the Operating Partnership in exchange for OP Units,
or (ii) the transfer by a Partnership of its assets to the Operating
Partnership in exchange for OP Units (and possibly Notes) and the subsequent
distribution of such OP Units (and possibly Notes) to its partners. If the
Merger is recharacterized in the manner described in (ii) in the preceding
sentence, the tax consequences of the Merger to the Hanover Limited Partners
likely would be materially affected.
EACH HANOVER LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX
ADVISORS TO DETERMINE THE IMPACT OF SUCH HANOVER LIMITED PARTNER'S PARTICULAR
TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING IN THE
MERGER. THE TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER TO A PARTICULAR
HANOVER LIMITED PARTNER COULD VARY SUBSTANTIALLY FROM THE CONSEQUENCES
DESCRIBED ABOVE.
Tax Treatment of Hanover Limited Partners Who Exercise Their Right to Make
the Note Election
A Hanover Limited Partner who exercises right to make the Note Election and
receive a Note in connection with the Merger will be treated as having made a
taxable disposition of his OP Units. The amount realized in connection with
such disposition will equal the sum of the "issue price" of the Note (i.e.,
the face amount of the Notes, currently estimated as $88,474 per Hanover
Partnership Unit) plus the portion of the Hanover liabilities allocable to the
Hanover Limited Partner for federal income tax purposes immediately prior to
the disposition of the OP Units (estimated as $157,229 per Hanover Partnership
Unit as of December 31, 1998). To the extent the amount realized exceeds the
Hanover Limited Partner's adjusted basis in his Hanover Partnership Units, the
Hanover Limited Partner will recognize gain. The Operating Partnership and the
General Partner estimate (assuming the Hanover Limited Partner acquired his
Hanover Partnership Units at the time of the original offering, and has held
such Partnership Units at all times since the offering) that the amount of
gain that would be recognized by a Hanover Limited Partner who made the Note
Election would be approximately $21,761 per Hanover Partnership Unit, as of
December 31, 1998 if such Partnership Unit were acquired for cash, and $9,361
per Hanover Partnership Unit if such Partnership Unit were acquired pursuant
to an installment purchase plan. For a discussion of the federal income tax
rates applicable to the net capital gain from the sale of a capital asset, see
"Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Hold
OP Units Following the Mergers--Disposition of OP Units by Limited Partners"
in the Consent Solicitation. In this regard, the General Partner estimates
that, as of December 31, 1998, if Hanover sold the Hanover Marriott Hotel in a
fully taxable transaction for a net amount, after payment of liabilities,
equal to the Liquidation Value of Hanover, the "unrecognized Section 1250
gain" per Hanover Partnership Unit would be $14,352 if such Partnership Unit
were acquired for cash, and $8,325 per Hanover Partnership Unit if such
Partnership Unit were acquired pursuant to an installment purchase plan and
the gain subject to tax as ordinary income under Code Section 1245 per Hanover
Partnership Unit would be $1,036 if such Partnership Unit were acquired for
cash,
Hanover Supp-30
<PAGE>
and $1,036 per Hanover Partnership Unit if such Partnership Unit were acquired
pursuant to an installment purchase plan. A Hanover Limited Partner who makes
the Note Election would be able to treat any per Partnership Unit passive
activity loss carryforward with respect to the activities of Hanover, to the
extent the sum of such losses exceeds its passive activity income for 1998, as
losses that are not from a passive activity and, therefore, not subject to the
passive activity loss limitation rules. For purposes of determining the gain
recognized by a Limited Partner as a result of making the Note Election, an
Original Limited Partner's Adjusted Basis does not reflect such Limited
Partner's share of the syndication costs incurred by his Partnership at
Formation. An original Hanover Limited Partner's share of syndication costs
was $13,358 per Hanover Partnership Unit.
A Hanover Limited Partner who elects to receive a Note may be eligible to
defer a majority of that gain under the "installment sale" rules. Those rules,
however, will not permit the Hanover Limited Partner to defer all of the gain,
and, to the extent that the face amount of the Note (and any other installment
obligations received by the taxpayer during the year) outstanding at the end
of the taxable year in which the Merger occur exceeds $5,000,000, will require
that the Hanover Limited Partner who defers gain pay to the IRS interest on
the resulting tax that has been deferred. The Hanover Limited Partner would
not be eligible to defer gain recognized upon the receipt of the Note to the
extent that his share of Hanover liabilities at the time of the Merger exceeds
his adjusted tax basis in his Hanover Partnership Units immediately prior to
the Merger (that is, to the extent that he has a "negative capital account"
for tax purposes). In addition, the Hanover Limited Partner would not be
eligible to defer gain to the extent that such gain would be taxed as ordinary
income under Sections 1245 and 1250 of the Code. Lastly, if a Hanover Limited
Partner disposes of his Note, any gain that had been deferred would be
recognized in the year of disposition.
THE SPECIFIC TAX ATTRIBUTES OF A PARTICULAR HANOVER LIMITED PARTNER COULD
HAVE A MATERIAL IMPACT ON THE TAX CONSEQUENCES OF THE MERGER, AND THE
SUBSEQUENT OWNERSHIP AND DISPOSITION OF NOTES. THEREFORE, IT IS ESSENTIAL THAT
HANOVER LIMITED PARTNERS CONSIDERING ELECTING TO RECEIVE NOTES CONSULT WITH
THEIR OWN TAX ADVISORS WITH REGARD TO THE APPLICATION OF THE FEDERAL INCOME
TAX LAWS TO SUCH HANOVER LIMITED PARTNERS' RESPECTIVE PERSONAL TAX SITUATIONS,
AS WELL AS ANY TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY STATE, LOCAL, OR
FOREIGN TAXING JURISDICTION.
Tax Consequences if Hanover Does Not Participate in the Merger
If Hanover does not participate in the Merger, the Hanover Limited Partners
would not have any tax consequences resulting from the Merger. The
consequences of continued ownership of Hanover Partnership Units will be the
same as would have resulted if the Merger had not been proposed.
* * *
The above description is not exhaustive of all possible tax consequences
associated with the Merger and the REIT Conversion. This summary does not
discuss foreign tax consequences, nor does it discuss all of the aspects of
federal income taxation or state and local taxation that may be relevant to
Hanover Limited Partners in light of their particular circumstances. EACH
HANOVER LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX ADVISORS
TO DETERMINE THE IMPACT OF SUCH HANOVER LIMITED PARTNER'S PARTICULAR TAX
SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER.
Hanover Supp-31
<PAGE>
SELECTED FINANCIAL DATA
The following table presents selected historical financial data derived from
the Hanover financial statements for the five most recent fiscal years in the
period ended December 31, 1997 and the unaudited condensed financial
statements for the First Two Quarters 1998 and First Two Quarters 1997. The
following data should be read in conjunction with Hanover's audited financial
statements and the notes thereto, Management's Discussion and Analysis of
Financial Condition and Results of Operations and the other financial
information included elsewhere herein.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
------------------- ----------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- --------- -------- --------- --------- --------- ---------
(UNAUDITED) (AMOUNTS IN THOUSANDS,
EXCEPT PER PARTNERSHIP UNIT)(2)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues(5)............. $ 3,446 $ 3,070 $ 6,853 $ 5,296 $ 4,487 $ 3,727 $ 3,435
Operating profit........ 2,044 2,304 4,400 3,624 2,752 2,345 434
Income (loss) before
extraordinary item(1).. 199 665 663 940 (219) (1,206) (3,224)
Net income (loss)....... 199 665 5,757 940 (219) (1,206) (3,224)
Distributions:
General partner........ -- -- -- -- -- -- --
Limited partners....... -- -- -- -- -- -- --
Per Partnership Unit:(2)
Net income (loss)...... 2,250 7,524 65,107 10,631 (2,476) (13,643) (36,464)
Distributions.......... -- -- -- -- -- -- --
Cash provided by (used
in) operating
activities............. 889 1,557 2,167 1,918 2,561 331 (327)
Cash used in investing
activities............. (2,204) (528) (1,058) (830) (1,241) (715) (427)
Cash provided by (used
in) financing
activities............. (211) (910) (1,714) (272) -- (31) 690
Increase (decrease) in
cash and cash
equivalents............ (1,526) 119 (605) 816 1,320 (415) (64)
Ratio of earnings to
fixed
charges(unaudited)(3).. 1.11x 1.39x 1.17x 1.33x -- -- --
Deficiency of earnings
to fixed
charges(unaudited)(3).. -- -- -- -- 219 1,206 3,224
Total assets at book
value.................. 33,108 34,012 32,883 33,533 32,652 31,559 32,353
Cash and cash
equivalents............ 426 2,672 1,952 2,557 1,741 421 836
Total debt(4)........... 40,153 40,022 40,364 40,527 40,527 40,527 40,596
Total liabilities....... 41,429 47,628 41,403 47,810 47,869 46,557 46,145
Partner's deficit:
Limited partners....... (7,979) (13,005) (8,168) (13,637) (14,530) (14,322) (13,176)
General partner........ (342) (607) (352) (640) (687) (676) (616)
Book value per
Partnership
Unit(unaudited)(2)..... (94,988) (154,821) (97,238) (162,345) (172,976) (170,500) (156,857)
Exchange value per
Partnership
Unit(unaudited)(2)..... 123,202 -- -- -- -- -- --
</TABLE>
- --------
(1) During 1997, the Partnership recorded on extraordinary gain on the
forgiveness of additional rental recorded in conjunction with the
refinancing of the Partnership's mortgage debt.
(2) A Partnership Unit represents a $100,000 original investment in Hanover.
(3) The ratio of earnings to fixed charges is computed by dividing net income
before interest expense and other fixed charges by total fixed charges,
including interest expense, amortization of debt issuance costs and the
portion of rent expense that is deemed to represent interest. The
deficiency of earnings to fixed charges in 1995, 1994 and 1993 is largely
the result of depreciation and amortization of $1,178,000, $1,136,000 and
$2,213,000, respectively.
(4) Total debt includes amounts due to Host Marriott and affiliates, for the
Subordinated Loan of $7,015,000 and $7,077,000 as of June 19, 1998 and
December 31, 1997, respectively, and the Working Capital Loan and Debt
Service Guarantees of $127,000 and $3,400,000, respectively for June 19,
1998, June 20, 1997 and December 31, 1997--1994 and $89,000 and
$3,469,000, respectively as of December 31, 1993.
(5) On August 18, 1997, the Partnership converted its Operating Lease with
Marriott Hotel Services, Inc. to a management agreement.
Hanover Supp-32
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
On August 18, 1997, the Partnership completed a refinancing of its Mortgage
Debt. In addition, the Partnership converted the Operating Lease with MHS to
the Management Agreement (the "Conversion") on August 18, 1997. Prior to the
Conversion, the Partnership recorded revenue based on the rental income to be
received from MHS. Annual rental during the term of the Operating Lease was
equal to the greater of: (i) Minimum Rental of $100,000; or (ii) Basic Rental
equal to 80% of Operating Profit, as defined, reduced to 75% of Operating
Profit after the Partnership received $4,421,000 of cumulative capital
receipts; or (iii) Adjusted Rental equal to Debt Service plus the greater of:
(a) a preferred return equal to $840,000 or (b) 50% of the amount by which
Operating Profit exceeded Debt Service. In no event was Adjusted Rental to
exceed Operating Profit.
The amount by which Adjusted Rental exceeded Basic Rental in any fiscal year
was defined as Additional Rentals. Cumulative Additional Rentals were
recoverable by MHS in any fiscal year when Basic Rental exceeded Adjusted
Rentals, provided no loans from the General Partner or Host Marriott were then
outstanding. Annual Rental was reduced by 50% of such excess to the extent
cumulative Additional Rental existed. In addition to the Annual Rental, MHS
was required to pay real estate taxes.
Subsequent to the Conversion, the Partnership records revenue based on house
profit generated by the Hotel. House profit reflects Hotel operating results,
and represents gross hotel sales less property-level expenses, excluding
depreciation and amortization, base and incentive management fees, real estate
taxes, insurance and certain other costs, which are disclosed separately in
the statement of operations. Revenues are recorded based on house profit of
the Hotel because the Partnership has delegated substantially all of the
operating decisions related to the generation of house profit from the Hotel
to MHS. As a result, Hotel revenues reported for the first two quarters 1998
are not comparable with Hotel rental reported for the first two quarters 1997.
First Two Quarters 1998 Compared to First Two Quarters 1997
Revenues: For the first two quarters 1998, hotel revenues decreased
$586,000, or 15%, to $3.4 million when compared to the first two quarters
1997. The decrease in hotel revenues is primarily due to decreases in food and
beverage sales. Although the average occupancy decreased eleven percentage
points to 71% for the first two quarters 1998 when compared to the first two
quarters 1997, rooms sales remained constant at $6.0 million due to the
average daily rate increase of $19, or 15%, to $143. The decline in average
occupancy for the first two quarters 1998 is a result of an overall decline in
the Hanover market and rooms being temporarily out of inventory during the
rooms refurbishment that occurred during January through March 1998.
REVPAR, or revenue per available room, remained constant at $102 for the
first two quarters 1998 and 1997. REVPAR represents the combination of average
daily room rate charged and the average daily occupancy achieved and is a
commonly used indicator of hotel performance (although it is not a measure of
revenue under generally accepted accounting principles).
As a result of the decline in average occupancy, food and beverage sales
decreased $661,000, or 16%, to $3.5 million for the first two quarters 1998
when compared to the same period in 1997. For the remainder of the year,
operations are expected to improve as a result of the new rooms product and
expected increases in market occupancy and demand.
Operating Costs and Expenses: The Partnership's operating costs and expenses
increased $636,000, or 83%, to $1.4 million for the first two quarters 1998
when compared to the same period in 1997 due primarily to the Conversion. Of
the $636,000 increase, $467,000 relates to base and incentive management fees
and $36,000 relates to insurance costs. The Partnership is responsible for
these fees and costs under the Management Agreement but not under the
Operating Lease and insurance costs of $36,000 which are the Partnership's
responsibility under the Management Agreement. On a comparative basis, base
management fees for first two quarters 1998 increased $21,000, or 7%, to
$296,000 when compared to the same period in 1997. Subsequent to
Hanover Supp-33
<PAGE>
the Conversion, MHS receives an incentive management fee once Owner's Priority
has been met (see "Material Contracts" included in Item 1, "Business"). For
the first two quarters 1998, MHS received $171,000 in incentive management
fees. In addition, real estate taxes increased $50,000, or 27%, to $236,000
for the first two quarters 1998, when compared to the same period in 1997 due
to a re-assessment of the property in 1997.
Operating Profit. As a result of the changes in revenues and operating costs
and expenses discussed above, operating profit decreased $260,000, or 11%, to
$2.0 million for the first two quarters 1998 when compared to the same period
in 1997.
Interest Expense. Interest expense increased $146,000, or 9%, to $1.9
million for the first two quarters 1998, when compared to the same period in
1997 due to refinancing the Partnership's mortgage debt at a higher fixed
interest rate. The weighted average interest rate on the Partnership's debt,
which includes the Subordinated Loan, for the first two quarters 1998 and
1997, was 9.6% and 7.5%, respectively.
Net Income. Net income for the first two quarters 1998 and 1997 was $199,000
and $665,000, respectively, as a result of the items discussed above.
1997 Compared to 1996
Revenues: Total revenues increased by $1.6 million, or 29%, to $6.9 million
in 1997 when compared to 1996, and hotel rental income decreased by $1.2
million, or 24%, to $4.0 million in 1997 when compared to 1996 due to the
Conversion. For the period January 1, 1997 to August 17, 1997, the Partnership
received hotel rental income in accordance with the Operating Lease. For the
period August 18, 1997 to December 31, 1997 under the Management Agreement,
Hotel revenues represent hotel sales less direct hotel operating costs and
expenses. Under the Operating Lease, the hotel rental income was straight-
lined over the year as required by generally accepted accounting principles.
On a comparative basis, house profit increased $1.1 million, or 16%, to $8.0
million in 1997 when compared to 1996. The increase in house profit is
primarily due to an increase in REVPAR. REVPAR for 1997 increased $10, or 11%,
to $100 compared to 1996, primarily due to the increase in average room rate
of $10, or 9%, to $124 and a two percentage point increase in the average
occupancy to 81%.
During 1997, the Hotel increased its rates several times. The result was the
average transient and group rates increased 10% to $134 and 12% to $95,
respectively. As of December 31, 1997, the corporate rate, excluding
discounts, was approximately $195 representing a 37% increase from 1996. Due
to growth in the group segment, food and beverage sales also increased due to
a 16% increase in catering and audio visual sales in comparison to 1996.
As a result of the REVPAR increase, hotel sales increased $1.7 million, or
8%, to $22.5 million in 1997 when compared to 1996. Due to the continued high
average occupancy, the Partnership expects future increases in REVPAR to be
driven by room rate increases, rather than changes in occupancy. However,
there can be no assurance that REVPAR will continue to increase in the future.
Operating Costs and Expenses: The Partnership's operating costs and expenses
increased $781,000, or 47%, to $2.5 million in 1997 when compared to 1996
primarily due to the Conversion. Prior to the Conversion, the Partnership did
not record base management fees or insurance as components of the
Partnership's operating costs although they were components in the calculation
of Operating Profit. On a comparative basis, base management fees for 1997
increased $52,000, or 8%, due to increased hotel sales. The Hotel's real
estate taxes in 1997 increased $102,000 from 1996 due to a re-assessment of
the property during 1997. In addition, Partnership administration increased
due to administrative costs associated with the refinancing in August 1997.
Operating Profit: As a result of changes in revenues and operating costs and
expenses discussed above, operating profit increased $776,000, or 21%, to $4.4
million in 1997 when compared to 1996.
Hanover Supp-34
<PAGE>
Interest Expense: Interest expense increased $1.1 million, or 40%, to $3.9
million due to refinancing the Partnership's mortgage debt, which includes the
Subordinated Loan. The weighted average interest rate on the Partnership's
debt for 1997 and 1996 was 7.9% and 6.4%, respectively.
Income Before Extraordinary Items: Income before extraordinary items
decreased $277,000 to $663,000, or 10% of revenues, in 1997, from $940,000, or
18% of revenues, in 1996.
Extraordinary Items: The Partnership recognized an extraordinary gain in
1997 of $5.1 million representing the forgiveness of Additional Rental by MHS.
Net Income: Net income increased by $4.8 million in 1997 to $5.8 million
when compared to 1996 as a result of the items discussed above.
1996 Compared to 1995
Revenues: Revenue increased $809,000, or 18%, to $5.3 million in 1996 when
compared to 1995. The Partnership's rental income was impacted by improved
lodging results. The increase was driven primarily by growth in REVPAR. REVPAR
for 1996 increased $9, or 11%, to $90 compared to 1995, primarily due to the
increase in combined average room rate of $5, or 5%, to $114 and a five
percentage point increase in the average occupancy to 79%. As a result of the
REVPAR increase, hotel sales increased $2.4 million, or 13%, to $20.7 million
in 1996 when compared to 1995. Under the Operating Lease, the hotel rental
income was straight-lined over the year as required by generally accepted
accounting principles.
Operating Costs and Expenses: The Partnership's operating costs and expenses
decreased $63,000, or 4%, to $1.7 million in 1996 when compared to 1995,
primarily due to a decrease in Partnership administration.
Operating Profit: As a result of changes in revenues and operating costs and
expenses discussed above, operating profit increased $872,000, or 32%, to $3.6
million in 1996 when compared to 1995.
Interest Expense: Interest expense decreased $225,000, or 7%, to $2.8
million due to lower interest rates on the Partnership's mortgage debt. The
weighted average interest rate on the mortgage debt for 1996 and 1995 was 6.4%
and 7.2%, respectively.
Net Income (Loss): For 1996, the Partnership had net income of $940,000
compared to a net loss of $219,000 in 1995 as a result of the items discussed
above.
CAPITAL RESOURCES AND LIQUIDITY
The Partnership's financing needs have been historically funded through loan
agreements with independent financial institutions and Host Marriott. As a
result of the successful refinancing of the Partnership's mortgage debt, the
General Partner believes that the Partnership will have sufficient capital
resources and liquidity to conduct its operations in the ordinary course of
business.
Principal Sources and Uses of Cash
The Partnership's principal source of cash is cash from Hotel operations.
Cash provided by operations for the first two quarters 1998 and 1997 was
$889,000 and $1.6 million, respectively. Cash provided by operations was lower
for the first two quarters 1998 primarily due to a decrease in the Hotel's
food and beverage sales due to a decrease in occupancy as a result of the
rooms refurbishment discussed above.
Cash provided by operations was $2.2 million, $1.9 million and $2.6 million
for the years ended December 31, 1997, 1996 and 1995, respectively. The
decrease in cash from operations in 1996 from 1995 was primarily due to
repaying MHS $285,000 for Additional Rental earned in 1995. There was no
Additional Rental due MHS at December 31, 1996.
Hanover Supp-35
<PAGE>
The Partnership's cash investing activities consist primarily of
contributions to the property improvement fund and capital expenditures for
improvements to the Hotel. Cash used in investing activities was $2.2 million
and $528,000 for the first two quarters 1998 and 1997, respectively. The
increase in cash used in investing activities is due to payments for the rooms
refurbishment in 1998. Contributions, including interest income, to the
property improvement fund were $484,000 and $493,000 for the first two
quarters 1998 and 1997, respectively. Capital expenditures were $2.3 million
and $156,000 for the same periods, respectively.
Cash used in investing activities was $1.1 million, $830,000 and $1.2
million for the years ended December 31, 1997, 1996 and 1995, respectively.
Under the Operating Lease and Management Agreement, the Partnership is
required to make annual contributions to the property improvement fund which
provides funding for capital expenditures and replacement of furniture,
fixtures and equipment. Contributions to the fund equaled 4% of gross hotel
sales, net of interest income, in 1996 and 1995. In 1997, the contribution
increased to 5%, net of interest income. The General Partner believes that
cash contributions from the Hotel's property improvement fund will provide
adequate funds in the short and long-term to meet the Hotel's capital needs.
Capital expenditures were $1.4 million, $527,000 and $1.1 million for the
years ended December 31, 1997, 1996 and 1995, respectively. The increase in
capital expenditures in 1997 from 1996 is due to a $1.0 million payment in
December 1997 for the rooms refurbishment.
The Partnership's financing activities consist of repayments of debt and
payment of financing costs. Cash used in financing activities was $211,000 and
$910,000 for the first two quarters 1998 and 1997, respectively.
Cash used in financing activities was $1.7 million and $272,000 in 1997 and
1996, respectively. No cash was provided by or used in financing activities in
1995. The Partnership's $37.0 million Mortgage Debt required interest only
payments during the years 1996 and 1995. In 1997, the Partnership refinanced
the Mortgage Debt with the New Mortgage Debt of $29.9 million. In addition,
Host Marriott funded the $10 million Subordinated Loan to the Partnership
which was used to make a $10 million principal payment on the Mortgage Debt.
During 1997, the Partnership amortized $115,000 and $2.9 million of principal
on the New Mortgage Debt and Subordinated Loan, respectively. In addition, the
Partnership made a $1.4 million payment on debt service guarantees provided by
the General Partner in prior years.
DEBT
In April 1997, Host Marriott funded a fully-amortizing $10 million
subordinated loan to the Partnership (the "Subordinated Loan") that bears
interest at a fixed rate of 14.5% over a 15-year term with required monthly
payments. The Subordinated Loan matures June 1, 2012.
In August 1997, the General Partner refinanced all of the Partnership's
outstanding mortgage debt. The total amount of the mortgage debt decreased
from $37.0 million to $29.9 million due to the use of the proceeds from the
Subordinated Loan to repay mortgage debt principal. The new non-recourse loan
matures August 18, 2004, requires principal amortization on a 25-year term and
bears interest at a fixed rate of 8.58%.
Pursuant to the Subordinated Loan, any proceeds in excess of the $27 million
for the New Mortgage Debt were to be used to repay the Subordinated Loan.
Therefore, the Partnership repaid principal of $2.9 million on the
Subordinated Loan at refinancing.
PROPERTY IMPROVEMENT FUND
The Management Agreement and Operating Lease require annual contributions to
a property improvement fund to ensure that the physical condition and product
quality of the Hotel is maintained. Contributions to this fund are based on a
percentage of annual total Hotel sales, net of interest income earned on the
fund. Prior to 1997, the contribution rate was 4%, net of interest income and
the current contribution is 5% of gross Hotel sales, net of interest income.
The General Partner believes that the 5% contribution requirement is
consistent with industry standards. However, in accordance with the Management
Agreement, contributions to the property improvement fund may be increased or
decreased by MHS if the current contribution of 5% of gross Hotel sales,
Hanover Supp-36
<PAGE>
net of interest income, is either insufficient or excessive to make the
replacements, renewals and repairs to maintain the Hotel in accordance with
MHS's standards for a full-service Marriott hotel. Of the total $2.3 million
of net additions to property and equipment during the first two quarters 1998,
$1.7 million was owner funded. The balance in the fund totaled $185,000 as of
June 19, 1998 and $287,000 as of December 31, 1997.
The General Partner believes that cash contributions from the Hotel's
property improvement fund will provide adequate funds in the short and long
term to meet the Hotel's capital needs.
INFLATION
The rate of inflation has been relatively low in the past four years. MHS is
generally able to pass through increased costs to customers through higher
room rates and prices. In 1997, average rates of the Hotel exceeded
inflationary costs. On August 18, 1997, the Partnership refinanced its
mortgage debt and fixed its interest costs, thereby eliminating the
Partnership's exposure to the impact of inflation on future interest costs.
SEASONALITY
Demand, and thus occupancy, is affected by normally recurring seasonal
patterns. Demand is higher in the spring and summer months (March through
October) than during the remainder of the year.
YEAR 2000 ISSUES
Over the last few years, Host Marriott Corporation, the parent company of
the General Partner, has invested in implementing new accounting systems which
are Year 2000 compliant. Accordingly, the General Partner believes that future
costs associated with Year 2000 issues will be minimal and not material to the
Partnership's financial statements.
However, the Partnership does rely upon accounting software used by MHS, the
Manager of its property, to obtain financial information. The General Partner
believes that MHS has begun to implement changes to the property specific
software to ensure that software will function properly in the Year 2000 and
does not expect to incur significant costs related to these modifications.
Hanover Supp-37
<PAGE>
FINANCIAL STATEMENTS
Hanover Supp-38
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE PARTNERS OF HANOVER MARRIOTT LIMITED PARTNERSHIP:
We have audited the accompanying balance sheet of Hanover Marriott Limited
Partnership (a Delaware limited partnership, the "Partnership") as of December
31, 1997 and 1996 and the related statements of operations, changes in
partners' capital (deficit) and cash flows for the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the General Partner's management. Our responsibility is to express an opinion
on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Hanover Marriott Limited
Partnership as of December 31, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting
principles.
Arthur Andersen LLP
Washington, D.C.
February 18, 1998
Hanover Supp-39
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
STATEMENT OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
REVENUES
Hotel rental..................................... $ 3,950 $ 5,177 $ 4,377
Hotel revenues................................... 2,785 -- --
Other............................................ 118 119 110
------- ------- -------
6,853 5,296 4,487
------- ------- -------
OPERATING COSTS AND EXPENSES
Depreciation and amortization.................... 1,239 1,215 1,178
Real estate taxes................................ 483 381 371
Partnership administration....................... 269 76 186
Base management fee (see Note 6)................. 252 -- --
Insurance and other.............................. 131 -- --
Incentive management fee (see Note 6)............ 79 -- --
------- ------- -------
2,453 1,672 1,735
------- ------- -------
OPERATING PROFIT................................... 4,400 3,624 2,752
Interest expense................................. (3,934) (2,811) (3,036)
Interest income.................................. 197 127 65
------- ------- -------
NET INCOME (LOSS) BEFORE EXTRAORDINARY ITEM........ 663 940 (219)
EXTRAORDINARY ITEM
Gain on forgiveness of additional rental......... 5,094 -- --
------- ------- -------
NET INCOME (LOSS).................................. $ 5,757 $ 940 $ (219)
======= ======= =======
ALLOCATION OF NET INCOME (LOSS)
General Partner.................................. $ 288 $ 47 $ (11)
Limited Partners................................. 5,469 893 (208)
------- ------- -------
$ 5,757 $ 940 $ (219)
======= ======= =======
NET INCOME (LOSS) PER LIMITED PARTNER UNIT (84
Units)............................................ $65,107 $10,631 $(2,476)
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
Hanover Supp-40
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
BALANCE SHEET
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Property and equipment, net............................... $ 29,984 $ 29,850
Due from Marriott Hotel Services, Inc..................... 204 254
Property improvement fund................................. 287 645
Deferred financing costs, net of accumulated
amortization............................................. 456 227
Cash and cash equivalents................................. 1,952 2,557
-------- --------
$ 32,883 $ 33,533
======== ========
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)
LIABILITIES
Mortgage debt............................................. $ 29,760 $ 37,000
Due to Marriott Hotel Services, Inc. for Additional
Rental................................................... -- 5,094
Subordinated loan from Host Marriott Corporation.......... 7,077 --
Notes payable and related interest due to the General
Partner.................................................. 4,317 5,367
Deferred revenue.......................................... 169 287
Accounts payable and accrued expenses..................... 80 62
-------- --------
Total Liabilities..................................... 41,403 47,810
-------- --------
PARTNERS' DEFICIT
General Partner
Capital contribution, net of offering costs of $21...... 421 421
Cumulative net loss..................................... (773) (1,061)
-------- --------
(352) (640)
-------- --------
Limited Partners
Capital contributions, net of offering costs of $1,122.. 7,147 7,147
Cumulative net loss..................................... (14,693) (20,162)
Capital distributions................................... (622) (622)
-------- --------
(8,168) (13,637)
-------- --------
Total Partners' Capital (Deficit)..................... (8,520) (14,277)
-------- --------
$ 32,883 $ 33,533
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
Hanover Supp-41
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
STATEMENT OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNER PARTNERS TOTAL
------- -------- --------
<S> <C> <C> <C>
Balance, December 31, 1994......................... $(676) $(14,322) $(14,998)
Net loss......................................... (11) (208) (219)
----- -------- --------
Balance, December 31, 1995......................... (687) (14,530) (15,217)
Net income....................................... 47 893 940
----- -------- --------
Balance, December 31, 1996......................... (640) (13,637) (14,277)
Net income....................................... 288 5,469 5,757
----- -------- --------
Balance, December 31, 1997......................... $(352) $ (8,168) $ (8,520)
===== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
Hanover Supp-42
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- ------ -------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss).................................. $ 5,757 $ 940 $ (219)
Extraordinary item................................. (5,094) -- --
-------- ------ -------
Net income (loss) before extraordinary item........ 663 940 (219)
Noncash items:
Depreciation and amortization.................... 1,239 1,215 1,178
Interest on notes payable due to General
Partner......................................... -- 329 346
Amortization of deferred financing costs as
interest........................................ 272 75 35
Loss on disposition of property and equipment.... 43 -- 98
Changes in operating accounts:
Due to Marriott Hotel Services, Inc. for
Additional Rental............................... -- -- 285
Due from (to) Marriott Hotel Services, Inc....... 50 (530) 434
Deferred revenue................................. (118) (119) 406
Accounts payable and accrued expenses............ 18 8 (2)
-------- ------ -------
Cash provided by operating activities.......... 2,167 1,918 2,561
-------- ------ -------
INVESTING ACTIVITIES
Additions to property and equipment, net........... (1,427) (527) (1,046)
Change in property improvement fund................ 369 (303) (195)
-------- ------ -------
Cash used in investing activities.............. (1,058) (830) (1,241)
-------- ------ -------
FINANCING ACTIVITIES
Repayment of mortgage debt......................... (37,115) -- --
Proceeds from first mortgage loan.................. 29,875 -- --
Proceeds from subordinated loan from Host Marriott
Corporation....................................... 10,000 -- --
Repayment of subordinated loan from Host Marriott
Corporation....................................... (2,923) -- --
Repayment of notes payable and related interest due
to General Partner................................ (1,050) -- --
Payment of financing costs ........................ (501) (272) --
-------- ------ -------
Cash used in financing activities.............. (1,714) (272) --
-------- ------ -------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS... (605) 816 1,320
CASH AND CASH EQUIVALENTS at beginning of year..... 2,557 1,741 421
-------- ------ -------
CASH AND CASH EQUIVALENTS at end of year........... $ 1,952 $2,557 $ 1,741
======== ====== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for mortgage and other interest.......... $ 4,727 $2,418 $ 2,666
======== ====== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
Hanover Supp-43
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
NOTE 1. THE PARTNERSHIP
Description of the Partnership
Hanover Marriott Limited Partnership (the "Partnership") is a Delaware
limited partnership formed on October 8, 1986 to acquire and own the 353-room
Hanover Marriott Hotel and the land on which it is located (the "Hotel"). The
sole general partner of the Partnership, with a 5% interest, is Marriott
Hanover Hotel Corporation (the "General Partner"), a Delaware Corporation and
a wholly-owned subsidiary of Host Marriott Corporation ("Host Marriott"),
formerly Marriott Corporation. The Hotel, which opened on July 30, 1986, was
leased by the Partnership to Marriott Hotel Services, Inc. ("MHS"), a wholly-
owned subsidiary of Marriott International, Inc. ("MII"), under a long-term
operating lease (the "Operating Lease"). Effective August 18, 1997, the
Operating Lease was converted to a long-term management agreement with MHS
(the "Management Agreement") (see Note 6).
On November 24, 1986 (the "Closing Date"), 84 limited partnership interests
(the "Units"), representing a 95% interest in the Partnership, were sold at
$100,000 per Unit pursuant to a private placement. Each limited partner paid
$15,560 at subscription with the balance due in four annual installments
through March 15, 1990, or, as an alternative, $87,600 in cash at closing as
full payment of the subscription price. The limited partners paid $2,063,460
in cash on the Closing Date. Seventy-three and one-half Units were purchased
on the installment basis. The General Partner contributed $442,000 in cash for
its 5% general partnership interest.
On April 2, 1997, Hanover Hotel Acquisition Corporation (the "Purchaser"), a
wholly-owned subsidiary of Host Marriott, completed a tender offer for limited
partnership Units in the Partnership. The Purchaser acquired 40 units for an
aggregate consideration of $1.6 million or $40,000 per Unit. Combined with its
prior ownership position, Host Marriott now indirectly owns through
affiliates, over 50% of the Partnership. Additionally, in a Partnership vote
held in conjunction with the tender offer, the limited partners approved all
of the proposed amendments to the Amended and Restated Partnership Agreement
that were conditions to the tender offer. The most significant amendments (i)
revised the provisions limiting the voting rights of the General Partner and
its affiliates to permit the General Partner and its affiliates (including the
Purchaser) to have full voting rights with respect to all Units currently held
by the General Partner or acquired by its affiliates except on matters where
the General Partner or its affiliates have an actual economic interest other
than as a limited partner or General Partner (an "Interested Transaction"),
(ii) modified the voting provisions with respect to Interested Transactions to
permit action to be taken, if approved, by limited partners holding a majority
of the outstanding Units, with all Units held by the General Partner and its
affiliates being voted in the same manner as a majority of the Units actually
voted by limited partners other than the General Partner and its affiliates
and (iii) eliminated limited partner consent requirements relating to sale
transactions with third parties and vested the sole authority with respect to
such transactions to the General Partner. As a result of the approval of the
proposed amendments, the Amended and Restated Partnership Agreement was
amended and restated effective April 3, 1997 (the "Second Amended and Restated
Partnership Agreement").
Partnership Allocations and Distributions
Pursuant to the terms of the Second Amended and Restated Partnership
Agreement, Partnership allocations and distributions are generally made as
follows:
a. The Partnership generally allocates cash available for distribution
(after a 10% priority return to the limited partners on their invested
capital) and net profits as follows: (i) 5% to the General Partner and 95%
to the limited partners until cumulative distributions of sale or
refinancing proceeds ("Capital Receipts") equal to 50% of the partners'
capital contributions have been distributed; (ii) next, 15% to the General
Hanover Supp-44
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Partner and 85% to the limited partners until cumulative distributions of
Capital Receipts equal to the full amount of the partners' capital
contributions have been distributed; and (iii) thereafter, 35% to the
General Partner and 65% to the limited partners.
b. Net losses were allocated 100% to the limited partners in 1986.
Thereafter, net losses are allocated 100% to the General Partner.
c. Capital Receipts (other than from the sale of substantially all of the
Partnership assets) not retained by the Partnership will be distributed (i)
first, 5% to the General Partner and 95% to the limited partners until the
partners have received cumulative distributions of Capital Receipts equal
to their capital contributions and (ii) thereafter, 35% to the General
Partner and 65% to the limited partners.
Upon the sale of substantially all of the Partnership assets, gains and
sales proceeds will be allocated and (to the extent available) distributed
based on specific provisions of the partnership agreement in order to first
provide the limited partners with an annual 12% cumulative return on their
invested capital, to the extent not previously distributed.
For financial reporting purposes, profits and losses are allocated based on
the Partner's stated ownership interest in the Partnership.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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 from those estimates.
Revenues and Expenses
Hotel revenues since August 18, 1997 (see Note 1) represent house profit of
the Partnership's Hotel since the Partnership has delegated substantially all
of the operating decisions related to the generation of house profit of the
Hotel to MHS. House profit reflects Hotel operating results which flow to the
Partnership as property owner and represents Hotel sales less property-level
expenses, excluding depreciation and amortization, base and incentive
management fees, real estate taxes, insurance and certain other costs, which
are disclosed separately in the accompanying statement of operations.
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding the property-level revenues and operating expenses of the Hotel from
its statements of operations (see Note 3). If the Partnership concludes that
EITF 97-2 should be applied to the Hotel, it would include operating results
of those managed operations in its financial statements. Application of EITF
97-2 to financial statements as of and for the year ended December 31, 1997,
would have increased both revenues and operating expenses by approximately
$5.6 million and would have had no impact on operating profit or net income.
Hanover Supp-45
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Property and Equipment
Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets as
follows:
<TABLE>
<S> <C>
Building and improvements........................................ 40 years
Furniture and equipment.......................................... 7 years
</TABLE>
All property and equipment is pledged as security for the mortgage debt
described in Note 5.
The Partnership assesses impairment of the Hotel based on whether estimated
undiscounted future cash flows from the Hotel will be less than its net book
value. If the Hotel is impaired, its basis is adjusted to fair market value.
Deferred Financing Costs
Prior to 1997, deferred financing costs of $520,000 were incurred in
connection with obtaining and extending the Mortgage Debt (see Note 5) which
were fully amortized and written-off when the refinancing of such debt
occurred in 1997. Amortization expense on these deferred financing costs for
the years ended December 31, 1997 and 1996 totaled $247,000 and $75,000,
respectively. In connection with the refinancing of the Mortgage Debt, the
Partnership paid $481,000 of refinancing costs in 1997 and is amortizing the
costs over the related terms of the debt (see Note 5). At December 31, 1997
and 1996, accumulated amortization was $25,000 and $293,000, respectively.
Income Taxes
Provision for Federal and state income taxes has not been made in the
accompanying financial statements since the Partnership does not pay income
taxes but rather allocates its profits and losses to the individual partners.
Significant differences exist between the net income for financial reporting
purposes and the net income as reported on the Partnership's tax return. These
differences are due primarily to the use, for income tax purposes, of
accelerated depreciation methods, shorter depreciable lives of the assets, and
different treatments of additional rental. As a result of these differences,
the excess of the net Partnership liabilities reported in the accompanying
consolidated financial statements over the tax basis in the net Partnership
liabilities was $18,557,000 and $18,314,000, respectively as of December 31,
1997 and 1996.
Cash and Cash Equivalents
The Partnership considers all highly liquid investments with a maturity of
three months or less at date of purchase to be cash equivalents.
Statement of Financial Accounting Standards
In 1996, the Partnership adopted Statement of Financial Accounting Standards
("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." Adoption of SFAS No. 121 did not have an
effect on its financial statements.
NOTE 3. REVENUES
On August 18, 1997, the Partnership completed a refinancing of its Mortgage
Debt. In connection with the refinancing, the Partnership converted the
Operating Lease with MHS to the Management Agreement (the "Conversion"). Prior
to the Conversion, the Partnership recorded revenue based on the rental income
to be received from MHS.
Subsequent to the Conversion, the Partnership records revenue based on house
profit generated by the Hotel. House profit reflects Hotel operating results,
and represents gross hotel sales less property-level expenses,
Hanover Supp-46
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
excluding depreciation and amortization, base and incentive management fees,
real estate taxes, insurance and certain other costs, which are disclosed
separately in the statement of operations. Revenues are recorded based on
house profit of the Hotel because the Partnership has delegated substantially
all of the operating decisions related to the generation of house profit from
the Hotel to MHS.
The following is a summary of Hotel revenues, as defined in the Management
Agreement, for the years ended December 31, 1997, 1996 and 1995 (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
HOTEL SALES
Rooms............................................. $12,826 $11,710 $10,308
Food and beverage................................. 8,933 8,246 7,288
Other............................................. 691 767 764
------- ------- -------
22,450 20,723 18,360
------- ------- -------
HOTEL EXPENSES
Departmental direct costs
Rooms........................................... 2,904 2,631 2,374
Food and beverage............................... 6,267 5,964 5,356
Other hotel operating expenses.................... 5,288 5,214 4,739
------- ------- -------
14,459 13,809 12,469
------- ------- -------
HOTEL REVENUES...................................... $ 7,991 $ 6,914 $ 5,891
======= ======= =======
</TABLE>
Hotel revenues under the Management Agreement effective August 18, 1997
consist of Hotel operating results for the period August 18, 1997 to December
31, 1997 (in thousands):
<TABLE>
<CAPTION>
1997
------
<S> <C>
HOTEL SALES
Rooms.............................................................. $4,796
Food and beverage.................................................. 3,392
Other.............................................................. 226
------
8,414
------
HOTEL EXPENSES
Departmental direct costs
Rooms.............................................................. 1,130
Food and beverage.................................................. 2,534
Other hotel operating expenses....................................... 1,965
------
5,629
------
HOTEL REVENUES....................................................... $2,785
======
</TABLE>
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Land and improvements.................................... $ 3,219 $ 3,203
Building and improvements................................ 32,386 32,433
Furniture and equipment.................................. 10,770 9,879
-------- --------
46,375 45,515
Accumulated depreciation................................. (16,391) (15,665)
-------- --------
$ 29,984 $ 29,850
======== ========
</TABLE>
Hanover Supp-47
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 5. DEBT
The Partnership originally entered into a loan agreement on November 24,
1986 (the "Original Loan") with a bank that provided $36.5 million to finance
the acquisition of the Hotel. On October 26, 1989, the Partnership refinanced
the Original Loan with a $37 million nonrecourse first mortgage loan (the
"Mortgage Debt") which matured on October 16, 1996. The Mortgage Debt bore
interest at a floating rate from October 27, 1994, through October 28, 1996
equal to 70 basis points over either (i) the London Interbank Offer Rate
("LIBOR") or (ii) an adjusted certificate of deposit rate. On October 28,
1996, the Partnership's $37 million Mortgage Debt matured without replacement
financing in place. However, the Partnership secured an extension of the
Mortgage Debt until October 24, 1997 provided that the Partnership would make
a $10 million principal paydown on the Mortgage Debt by April 30, 1997. During
the extension period the debt bore interest at LIBOR plus 2.0 percentage
points and required quarterly principal amortization equal to all excess cash
flow as defined in the extension agreement.
On April 30, 1997, in connection with the tender offer for limited
partnership units (see Note 1), Host Marriott funded a fully-amortizing $10
million subordinated loan to the Partnership (the "Subordinated Loan") that
bears interest at a fixed rate of 14.5% over a 15-year term with required
monthly payments. The Partnership used the proceeds of the Subordinated Loan
to make the required principal payment under the mortgage loan extension
agreement. If cash flow is insufficient to service the Subordinated Loan, the
unpaid portion will be added to principal and interest will accrue.
On August 18, 1997, the Partnership refinanced its Mortgage Debt with a then
outstanding balance of $25.9 million with new mortgage debt ("New Mortgage
Debt") of $29.9 million. The New Mortgage Debt bears interest at a fixed rate
of 8.58% over its seven year term with required principal amortization based
on a 25-year schedule. Pursuant to the Subordinated Loan, any proceeds from
the New Mortgage Debt in excess of $27 million were to be used to repay the
Subordinated Loan. Therefore, on August 18, 1997, $2.9 million was repaid on
the Subordinated Loan. Pursuant to the limited partnership agreement, the
remaining proceeds and cash held at the Partnership for refinancing were used
to pay refinancing costs (see Note 2) and to repay debt service guarantee
advances made by the General Partner in prior years. For 1997 and 1996, the
weighted-average interest rate on the Partnership's mortgage debt was 7.9% and
6.4%, respectively.
The New Mortgage Debt is secured by the Hotel and substantially all other
assets of the Partnership, including furniture and equipment and the
Partnership's rights under the assignment of the rents and leases (the
"Collateral"). The Subordinated Loan is also secured by the Collateral but is
subordinate to the New Mortgage Debt. Host Marriott and the General Partner
also provided additional security on the Original Loan and the Mortgage Debt
in the form of debt service guarantees in the aggregate amount of $7,200,000
(the "Guarantees"). On October 27, 1994 Host Marriott and the General Partner
were released from their obligations to advance funds. As of December 31, 1997
and 1996, $3,400,000 remains outstanding under the Guarantees. All advances
made under the Guarantees accrue interest at one percent over the prime rate
as announced by Bankers Trust Company. Pursuant to the limited partnership
agreement, $1,382,000 was paid on the Guarantees from loan refinancing
proceeds. Accrued interest payable on the Guarantees as of December 31, 1997
and 1996, totaled $714,000 and $1,775,000, respectively. The weighted-average
interest rate on these advances was 9.3% for 1997 and 1996.
Prior to 1996, the General Partner advanced $127,000 to the Partnership as a
working capital advance which accrues interest at one percent over the prime
rate as announced by Bankers Trust Company. As of December 31, 1997 and 1996,
$203,000 and $192,000, including accrued interest, was outstanding on the
working capital advance, respectively, and is included in notes payable and
related interest due to the General Partner in the accompanying financial
statements.
Hanover Supp-48
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
In addition, the General Partner has provided a foreclosure guarantee to the
lender of the New Mortgage Debt in the amount of $10 million. Pursuant to the
terms of the foreclosure guarantee, amounts would be payable only upon a
foreclosure of the Hotel and only to the extent that the gross proceeds from a
foreclosure sale are less than $10 million.
NOTE 6. OPERATING LEASE AGREEMENT/MANAGEMENT AGREEMENT
The Partnership, through an assignment of a lease from Host Marriott on
November 24, 1986, acquired all rights to a 25-year operating lease with five
10-year renewal options to lease the Hotel to MHS. Effective August 18, 1997,
this agreement was converted to a long-term management agreement with MHS.
Operating Lease Agreement
Annual Rental during the term of the Operating Lease was equal to the
greater of:
(i) Minimum Rental of $100,000; or
(ii) Basic Rental equal to 80% of Operating Profit, as defined, reduced
to 75% of Operating Profit after the Partnership has received $4,421,000 of
cumulative Capital Receipts; or
(iii) Adjusted Rental equal to debt service on the mortgage debt plus
Partnership administration costs (collectively referred to as "Debt
Service") plus the greater of: (a) a preferred return equal to $840,000 or
(b) 50% of the amount by which Operating Profit exceeds Debt Service. In no
event will Adjusted Rental exceed Operating Profit.
The amount by which Adjusted Rental exceeded Basic Rental in any fiscal year
was defined as Additional Rentals. Cumulative Additional Rentals were
recoverable by MHS in any fiscal year when Basic Rental exceeded Adjusted
Rentals, provided no loans from the General Partner or Host Marriott were then
outstanding. Annual Rental was reduced by 50% of such excess to the extent
cumulative Additional Rentals existed.
For financial reporting purposes, Additional Rental was not recognized as
revenue but was deferred and recorded as a liability on the balance sheet. As
a result of the conversion of the Operating Lease to a management agreement,
MHS forgave $5.1 million of Additional Rental, which was recorded as a
liability in the Partnership's financial statements. The Partnership recorded
an extraordinary gain related to this forgiveness.
For 1997 and 1996, Basic Rental of $3,031,000 and $3,993,000, respectively
was remitted to the Partnership by MHS. In accordance with the Operating
Lease, MHS was entitled to $758,000 and $998,000 of Operating Profit for the
period from January 1, 1997 to August 17, 1997 and the year ended December 31,
1996, respectively. In addition to the Annual Rental, MHS was required to pay
real estate taxes and make annual contributions equal to 4% of sales net of
interest to the property improvement fund on behalf of the Partnership. In
accordance with the Operating Lease, annual contributions to the property
improvement fund increased to 5% of sales net of interest at the beginning of
1997.
Management Agreement
Effective August 18, 1997, in conjunction with the refinancing of the
Partnership's Mortgage Debt (see Note 5), the Operating Lease was converted to
a long-term management agreement with MHS. The Management Agreement has an
initial term expiring on December 31, 2011. Thereafter, the term is renewed
automatically for each of five successive 10-year periods. Pursuant to the
terms of the Management Agreement, MHS receives a base management fee equal to
3% of gross revenues. The Partnership is entitled to the first $4,650,000 of
operating profit generated by the Hotel each fiscal year ("Owner's Priority").
Owner's Priority is increased by 10% of any Additional Invested Capital, as
defined in the Management Agreement. In addition to a base
Hanover Supp-49
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
management fee, MHS will be paid an incentive management fee of the next
$400,000 from operating profit, as defined. Any cash remaining after the
payment of the Owner's Priority and the incentive management fee will be
allocated 75% to the Partnership and 25% to MHS. The Partnership may terminate
the Management Agreement if in any two of three consecutive fiscal years there
is an operating loss. MHS may, however, prevent termination by paying to the
Partnership such amounts equal to the operating losses during such two fiscal
years.
Pursuant to the terms of the Management Agreement, MHS is required to
furnish the Hotel with certain services ("Chain Services") which are generally
provided on a central or regional basis to all hotels in MII's full service
hotel system. Chain Services include central training, advertising and
promotion, a national reservation system and such additional services, as
needed, which may be more efficiently performed on a centralized basis. Costs
and expenses incurred in providing such services are allocated among all
domestic full service hotels managed, owned or leased by MII or its
subsidiaries. In addition, MHS is required to furnish the Hotel with certain
other services ("Central Office Services") such as executive supervision,
planning and policy making, corporate finance, in-house legal services,
research and development, and technical and operational expertise. The Hotel
also participates in MII's Marriott's Reward Program ("MRP"). The cost of this
program is charged to all hotels in MII's full service hotel system based upon
the MRP sales at each hotel. The total amount of Chain and Central Office
Services and MRP costs charged to the Partnership under the Management
Agreement was $186,000 for the period August 18, 1997 to December 31, 1997.
The Management Agreement and Operating Lease provide for the establishment
of a property improvement fund for the Hotel which provides for the
replacement of furniture, fixtures and equipment. Contributions to the
property improvement fund are based on a percentage of gross hotel sales, net
of interest income. Prior to 1997, contributions equaled 4% of hotel sales,
net of interest income. Beginning in 1997 and thereafter, contributions are
equal to 5% of hotel sales, net of interest income. Contributions to the
property improvement fund for 1997 were $1.1 million.
Under the Management Agreement, MHS received base and incentive management
fees of $252,000 and $79,000, respectively, for the period August 18, 1997
through December 31, 1997.
NOTE 7. OFFICE SPACE RENTAL AGREEMENT
On January 28, 1995, the Partnership entered into an agreement with Marriott
Vacation Club International ("MVCI"), formerly known as Marriott Ownership
Resorts, Inc., a wholly-owned subsidiary of MII. Under the terms of the five
year lease with MVCI expiring in January 2000, MVCI funded the renovation of a
portion of the Hotel's lounge into a junior ballroom (for use by the Hotel)
and a MVCI sales office. The total cost of the renovations was $516,000. The
lease with MVCI stipulates that $200,000 of those costs will be treated as
rent concessions. Therefore, the Partnership will begin receiving rental
payments of $18,123 in 1998, $55,600 in 1999 and $4,277 in 2000. In the event
MVCI chooses to exercise its right to terminate the lease agreement prior to
the end of the five year term, any prepayment of rent by MVCI is non-
refundable.
In accordance with generally accepted accounting principles, the Partnership
deferred the total rent due under the lease and is amortizing the deferred
revenue on a straight-line basis over the lease term. For the years ended
December 31, 1997, 1996 and 1995, the Partnership recognized $118,000,
$119,000 and $110,000 of rent under the lease which is included in other
revenues in the Statement of Operations. In addition, deferred revenue related
to the lease totaled $169,000, $287,000 and $406,000 for the years ended
December 31, 1997, 1996 and 1995.
Hanover Supp-50
<PAGE>
NOTE 8. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments are shown below. The
estimated fair values of financial instruments not included in this table are
estimated to be equal to their carrying amounts (in thousands):
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997AS OF DECEMBER 31, 1996
------------------------- -------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Mortgage debt............. $ 29,760 $ 29,760 $ 37,000 $ 37,000
Subordinated loan......... 7,077 7,077 -- --
Notes payable and related
interest due to General
Partner.................. 4,317 4,200 5,367 3,500
Additional Rental......... -- -- 6,099 2,000
</TABLE>
The estimated fair value of the mortgage debt is based on the expected
future debt service payments discounted at estimated market rates. Additional
rental paid by the Hotel lessee was valued based on the expected future
payments from operating cash flow discounted at a risk-adjusted rate. As
further explained in Note 6, upon the closing of the debt refinancing on
August 18, 1997, MHS agreed to waive all claims to Additional Rental that had
accrued prior to the conversion to a management agreement. Consequently, the
estimated fair value of Additional Rental paid by the Hotel lessee is zero.
Hanover Supp-51
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
CONDENSED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
--------------
1998 1997
------ ------
<S> <C> <C>
REVENUES
Hotel revenues................................................ $3,391 $ --
Hotel rental.................................................. -- 3,015
Other......................................................... 55 55
------ ------
3,446 3,070
------ ------
OPERATING COSTS AND EXPENSES
Depreciation and amortization................................. 572 561
Base management fees.......................................... 296 --
Incentive management fees..................................... 171 --
Real estate taxes............................................. 236 186
Insurance and other........................................... 127 19
------ ------
1,402 766
------ ------
OPERATING PROFIT................................................ 2,044 2,304
Interest expense.............................................. (1,863) (1,717)
Interest income............................................... 18 78
------ ------
NET INCOME...................................................... $ 199 $ 665
====== ======
ALLOCATION OF NET INCOME
General Partner............................................... $ 10 $ 33
Limited Partners.............................................. 189 632
------ ------
$ 199 $ 665
====== ======
NET INCOME PER LIMITED PARTNER UNIT (84 Units).................. $2,250 $7,524
====== ======
</TABLE>
See Notes to Condensed Financial Statements.
Hanover Supp-52
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
CONDENSED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 19, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Property and equipment, net........................... $31,718 $29,984
Due from Marriott Hotel Services, Inc................. 355 204
Other assets.......................................... 609 743
Cash and cash equivalents............................. 426 1,952
------- -------
$33,108 $32,883
======= =======
LIABILITIES AND PARTNERS' DEFICIT
LIABILITIES
Mortgage debt....................................... $29,611 $29,760
Subordinated loan from Host Marriott Corporation.... 7,015 7,077
Notes payable and related interest due to the
General Partner.................................... 4,473 4,317
Accounts payable and accrued expenses............... 216 80
Deferred revenue.................................... 114 169
------- -------
Total Liabilities................................. 41,429 41,403
------- -------
PARTNERS' DEFICIT
General Partner..................................... (342) (352)
Limited Partners.................................... (7,979) (8,168)
------- -------
Total Partners' Deficit........................... (8,321) (8,520)
------- -------
$33,108 $32,883
======= =======
</TABLE>
See Notes to Condensed Financial Statements.
Hanover Supp-53
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
CONDENSED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
---------------
1998 1997
------ -------
<S> <C> <C>
OPERATING ACTIVITIES
Net income................................................... $ 199 $ 665
Noncash items................................................ 703 796
Changes in operating accounts................................ (13) 96
------ -------
Cash provided by operating activities...................... 889 1,557
------ -------
INVESTING ACTIVITIES
Additions to property and equipment, net..................... (2,306) (156)
Change in property improvement fund.......................... 102 (372)
------ -------
Cash used in investing activities.......................... (2,204) (528)
------ -------
FINANCING ACTIVITIES
Proceeds from subordinated loan.............................. -- 10,000
Repayments on mortgage debt.................................. (148) (10,505)
Repayments on subordinated loan.............................. (63) --
Payment of financing costs................................... -- (405)
------ -------
Cash used in financing activities.......................... (211) (910)
------ -------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS............... (1,526) 119
CASH AND CASH EQUIVALENTS at beginning of period............... 1,952 2,557
------ -------
CASH AND CASH EQUIVALENTS at end of period..................... $ 426 $ 2,676
====== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for mortgage interest.............................. $1,488 $ 1,182
====== =======
</TABLE>
See Notes to Condensed Financial Statements.
Hanover Supp-54
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying condensed financial statements have been prepared by
Hanover Marriott Limited Partnership (the "Partnership") without audit.
Certain information and footnote disclosures normally included in financial
statements presented in accordance with generally accepted accounting
principles have been condensed or omitted from the accompanying statements.
The Partnership believes the disclosures made are adequate to make the
information presented not misleading. However, the condensed financial
statements should be read in conjunction with the Partnership's financial
statements and notes thereto for the fiscal year ended December 31, 1997
included elsewhere in the Form 10.
In the opinion of the Partnership, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments (which include only
normal recurring adjustments) necessary to present fairly the financial
position of the Partnership as of June 19, 1998; the results of operations and
cash flows for the first two quarters 1998 and 1997. Interim results are not
necessarily indicative of fiscal year performance because of seasonal and
short-term variations.
For financial reporting purposes, net income of the Partnership is allocated
95% to the Limited Partners and 5% to Marriott Hanover Hotel Corporation (the
"General Partner"). Net losses are allocated 100% to the General Partner.
Significant differences exist between the net income for financial reporting
purposes and the net income (loss) for Federal income tax purposes. These
differences are due primarily to the use, for income tax purposes, of
accelerated depreciation methods, shorter depreciable lives, no estimated
salvage values for the assets and differences in the timing of the recognition
of rental income.
2. On August 18, 1997, the Partnership completed a refinancing of its
mortgage debt. In addition to the refinancing, the Partnership converted the
Operating Lease with MHS to the Management Agreement (the "Conversion"). Prior
to the Conversion, the Partnership recorded revenue based on the rental income
to be received from MHS.
Annual rental during the term of the Operating Lease was equal to the
greater of: (i) Minimum Rental of $100,000; or (ii) Basic Rental equal to 80%
of Operating Profit, as defined, reduced to 75% of Operating Profit after the
Partnership received $4,421,000 of cumulative Capital Receipts, as defined in
the Operating Lease; or (iii) Adjusted Rental equal to debt service on the
mortgage debt plus Partnership administration costs (collectively referred to
as "Debt Service") plus the greater of: (a) a preferred return equal to
$840,000 or (b) 50% of the amount by which Operating Profit exceeded Debt
Service. In no event was Adjusted Rental to exceed Operating Profit.
The amount by which Adjusted Rental exceeded Basic Rental in any fiscal year
was defined as Additional Rentals. Cumulative Additional Rentals were
recoverable by MHS in any fiscal year when Basic Rental exceeded Adjusted
Rentals, provided no loans from the General Partner or Host Marriott were then
outstanding. Annual Rental was reduced by 50% of such excess to the extent
cumulative Additional Rentals existed. In addition to the Annual Rental, MHS
was required to pay real estate taxes.
Subsequent to the Conversion, the Partnership records revenue based on house
profit generated by the Hotel. House profit reflects Hotel operating results,
and represents gross hotel sales less property-level expenses, excluding
depreciation and amortization, base and incentive management fees, real estate
taxes, insurance and certain other costs, which are disclosed separately in
the statement of operations. Revenues are recorded based on house profit of
the Hotel because the Partnership has delegated substantially all of the
operating decisions related to the generation of house profit from the Hotel
to MHS.
On November 20, 1997 the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to
Hanover Supp-55
<PAGE>
HANOVER MARRIOTT LIMITED PARTNERSHIP
NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED)
Physician Practice Management Entities and Certain Other Entities with
Contractual Management Arrangements." EITF 97-2 addresses the circumstances in
which a management entity may include the revenues and expenses of a managed
entity in its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding the property level revenues and operating expenses of the Hotel from
its statements of operations. If the Partnership concludes that EITF 97-2
should be applied to the Hotel, it would include operating results of this
managed operation in its financial statements. Application of EITF 97-2 to
financial statements as of and for the first two quarters 1998 would have
increased both revenues and operating expenses by approximately $6.5 million
and would have no impact on operating profit or net income.
The following is a summary of Hotel revenues, as defined in the Management
Agreement (in thousands):
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
-------------
1998 1997
------ ------
<S> <C> <C>
HOTEL SALES
Rooms....................................................... $6,047 $6,047
Food and beverage........................................... 3,520 4,181
Other....................................................... 310 355
------ ------
9,877 10,583
------ ------
HOTEL EXPENSES
Departmental direct costs
Rooms..................................................... 1,413 1,308
Food and beverage......................................... 2,641 2,807
Other hotel operating expenses............................ 2,432 2,491
------ ------
6,486 6,606
------ ------
HOTEL REVENUES................................................ $3,391 $3,977
====== ======
</TABLE>
3. On April 17, 1998, Host Marriott Corporation ("Host Marriott"), parent
company of the General Partner of the Partnership, announced that its Board of
Directors authorized Host Marriott to reorganize its business operations to
qualify as a real estate investment trust ("REIT") to become effective as of
January 1, 1999. As part of the REIT conversion, Host Marriott formed a new
operating partnership (the "Operating Partnership"), and limited partners in
certain Host Marriott full-service hotel partnerships and joint ventures,
including Hanover Marriott Limited Partnership, are expected to be given an
opportunity to receive, on a tax-deferred basis, Operating Partnership units
in the Operating Partnership in exchange for their current limited partnership
interests. The Operating Partnership units would be redeemable by the limited
partner for freely traded Host Marriott shares (or the cash equivalent
thereof) at any time after one year from the closing of the merger. In
connection with the REIT conversion, on June 2, 1998, the Operating
Partnership filed a Registration Statement on Form S-4 with the Securities and
Exchange Commission. Limited partners will be able to vote on this
Partnership's participation in the merger later this year through a consent
solicitation.
Hanover Supp-56
<PAGE>
HOST MARRIOTT, L.P.
SUPPLEMENT DATED , 1998 FOR
PROSPECTUS/CONSENT SOLICITATION STATEMENT DATED , 1998 FOR
MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.
On the terms described in the Prospectus/Consent Solicitation Statement (the
"Consent Solicitation"), dated , 1998, of which this Supplement (the
"Supplement") is a part, Host Marriott Corporation ("Host") has adopted a plan
to restructure its business operations so that it will qualify as a real
estate investment trust ("REIT"). As part of this restructuring (the "REIT
Conversion"), Host and its consolidated subsidiaries will contribute their
full-service hotel properties and certain other businesses and assets to Host
Marriott, L.P. (the "Operating Partnership") in exchange for units of limited
partnership interest in the Operating Partnership ("OP Units") and the
assumption of liabilities. The sole general partner of the Operating
Partnership will be Host Marriott Trust ("Host REIT"), the entity into which
Host will merge as part of the REIT Conversion. Host REIT expects to qualify
as a REIT beginning with its first full taxable year after closing of the REIT
Conversion, which Host REIT currently expects to be the year beginning January
1, 1999.
Following the REIT Conversion and the Blackstone Acquisition, the Operating
Partnership and its subsidiaries initially will own outright, or have
controlling interests in, approximately 120 full-service hotels operating
primarily under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt
brand names (the "Hotels").
As part of the REIT Conversion, the Operating Partnership is proposing to
acquire by merger (the "Mergers") Marriott Diversified American Hotels, L.P.,
a Delaware limited partnership ("MDAH") or the "Partnership"), and up to seven
other limited partnerships (the "Partnerships") that own full-service hotels
in which Host or its subsidiaries are general partners. As more fully
described in the Consent Solicitation, limited partners of those Partnerships
that participate in the Mergers will receive either OP Units or, at their
election, unsecured % Callable Notes due December 15, 2005 issued by the
Operating Partnership ("Notes"), in exchange for their partnership interests
in such Partnerships (with respect to the Partnerships, those limited partners
of the Partnerships who are unaffiliated with Host are referred to herein as
the "Limited Partners," and with respect to MDAH, the "MDAH Limited
Partners").
Beginning one year after the Mergers, Limited Partners who retain OP Units
will have the right to redeem their OP Units at any time and receive, at the
election of Host REIT, either freely tradeable, New York Stock Exchange listed
Common Shares of Host REIT on a one-for-one basis (subject to adjustment) or
cash in an amount equal to the market value of such shares (the "Unit
Redemption Right").
The number of OP Units to be allocated to MDAH will be based upon (i) its
Exchange Value (as defined herein) and (ii) the price attributed to an OP Unit
following the Merger, determined as described herein (but in no event greater
than $ per OP Unit). The principal amount of Notes that MDAH Limited
Partners may elect to receive in exchange for the OP Units received in the
Merger will be based upon MDAH's Note Election Amount (as defined herein). See
"Determination of Exchange Value of MDAH and Allocation of OP Units." The
estimated Exchange Value and Note Election Amount set forth herein may
increase or decrease as a result of various adjustments, and will be finally
calculated shortly before the Effective Date. Pursuant to the Merger, MDAH
Limited Partners have an estimated Exchange Value of $109,216 per Partnership
Unit and a Note Election Amount of $98,343 per Partnership Unit.
RISK FACTORS
In deciding whether to approve the Merger, MDAH Limited Partners should
consider certain risks and other factors. The General Partner believes that
MDAH Limited Partners should particularly consider the following, which should
be read in conjunction with the information in the Consent Solicitation under
"Risk Factors" and "Federal Income Tax Consequences:"
. Substantial Benefits to Related Parties. Host REIT and its subsidiaries
will realize substantial benefits from the Mergers and the REIT
Conversion, including savings from a substantial reduction in corporate-
MDAH Supp-1
<PAGE>
level income taxes expected as a result of the REIT Conversion. To the
extent that such anticipated benefits of the REIT Conversion are reflected
in the value of Host's common stock prior to the Effective Date, such
benefits will not be shared with the Limited Partners. Because of Host's
significant ownership position in certain Partnerships, the failure of one
or more of these Partnerships to participate in a Merger likely would
require that Host contribute some or all of its ownership interest in the
Non-Participating Partnership to a taxable Non-Controlled Subsidiary,
which would materially reduce the benefit to Host of the REIT Conversion
as it applies to that interest.
. Absence of Arm's Length Negotiations. No independent representative was
retained to negotiate on behalf of the MDAH Limited Partners or the other
Limited Partners. Although the General Partner has obtained the
Appraisals and the Fairness Opinion from AAA, AAA has not negotiated with
the General Partner or Host and has not participated in establishing the
terms of the Mergers. Consequently, the terms and conditions of the
Mergers may have been more favorable to the MDAH Limited Partners or the
other Limited Partners if such terms and conditions were the result of
arm's length negotiations.
. Other Conflicts of Interest. The Mergers, the REIT Conversion and the
recommendations of the General Partner involve the following conflicts of
interest because of the relationships among Host, the Operating
Partnership, the General Partner and SLC: (i) the General Partners, which
are all subsidiaries of Host (except for PHLP, in which Host is the
General Partner), must assess whether a Merger is fair and equitable to
the Limited Partners of its Partnership, which involves considerations
for Host and its subsidiaries that are different from those that affect
the Limited Partners, (ii) the terms of the Leases of the Hotels,
including MDAH's Hotels, will be determined by Host, which will
distribute the common stock of SLC, the parent of the Lessees, to its
shareholders after such terms have been set and (iii) the terms of the
Partnership Agreement, including provisions which benefit Host REIT, have
been determined by Host. Such conflicts may result in decisions that do
not fully reflect the interests of all Limited Partners, including the
MDAH Limited Partners.
. Uncertainties at the Time of Voting Include the Number of OP Units to be
Received. There are several uncertainties at the time the MDAH Limited
Partners must vote on the Merger, including (i) the exact Exchange Value
for MDAH (which will be adjusted for changes in lender and capital
expenditures reserves, indebtedness, deferred maintenance and other items
prior to the Effective Date), (ii) the price of the OP Units for purposes
of the Merger, which will be determined by reference to the post-Merger
trading prices of Host REIT's Common Shares and which, together with the
Exchange Value, will determine the number of OP Units the MDAH Limited
Partners will receive and (iii) the exact principal amount of the Notes
that may be received in exchange for OP Units, which cannot be known
until after the vote on the Merger. For these reasons, the MDAH Limited
Partners cannot know at the time they vote on the Merger these important
aspects of the Merger.
. Exchange Value May Not Equal Fair Market Value of MDAH's Hotels. Each
MDAH Limited Partner who retains OP Units will receive consideration with
a deemed value equal to the Exchange Value of such MDAH Limited Partner's
Partnership Interest. The determination of the Exchange Value of MDAH
involves numerous estimates and assumptions. There is no assurance that
the Exchange Value of MDAH will equal the fair market value of the Hotels
and other assets contributed by MDAH. See "Determination of Exchange
Value of MDAH and Allocation of OP Units."
. Allocation of OP Units to Host REIT is Different from Allocation of OP
Units to Limited Partners. Host REIT will receive in the aggregate a
number of OP Units (including OP Units allocated to the General Partners
of the Partnerships) equal to the number of shares of Host common stock
outstanding on the Effective Date (and, if Host has outstanding shares of
preferred stock at the time of the REIT Conversion, a corresponding
number of preferred partnership interests in the Operating Partnership),
which should fairly represent the market value of Host REIT but may not
be equal to the fair market or net asset value of the Hotels and other
assets that Host will contribute to the Operating Partnership. The
Partnerships will receive OP Units in the Mergers with a deemed value
equal to the Exchange Value of such Partnership. The different methods of
allocating OP Units may result in Limited Partners not receiving the fair
market value of their Partnership Interests and Host REIT receiving a
higher percentage of the
MDAH Supp-2
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interests in the Operating Partnership. See "Determination of Exchange
Values and Allocation of OP Units."
. Price of OP Units Might Be Less than the Fair Market Value of the MDAH
Limited Partners' Partnership Interests. The price of an OP Unit, for
purposes of the Mergers and the REIT Conversion, will be equal to the
average closing price on the NYSE of a Host REIT Common Share for the
first 20 trading days after the Effective Date of the Mergers (but in no
event greater than $ per share). It is likely that, over time, the
value of the publicly traded Common Shares of Host REIT (and therefore
the value of the OP Units) will diverge from the deemed value of the OP
Units used for purposes of the Mergers. This could result in the MDAH
Limited Partners receiving OP Units with an actual value that is less
than either the price of the OP Units for purposes of the Mergers or the
fair market value of their Partnership Interests.
. Inability of MDAH Limited Partners to Redeem OP Units for One Year. MDAH
Limited Partners who elect to retain OP Units received in the Merger
will be unable to redeem such OP Units for one year following the
Merger. Until then, MDAH Limited Partners will bear the risk of
illiquidity.
. Value of the Notes Will Be Less than the Exchange Value of MDAH. At the
same time that he votes on the Merger, each MDAH Limited Partner also
may elect to receive at the time of the Merger, in exchange for OP
Units, an unsecured, seven-year Note of the Operating Partnership with a
principal amount equal to the Note Election Amount of his Partnership
Interest, which is based upon numerous assumptions and estimates. The
deemed value of the OP Units to be received by the MDAH Limited Partners
will exceed the principal amount of the corresponding Notes (because the
Exchange Value will be higher than the Note Election Amount) and there
is no assurance that the Note an MDAH Limited Partner receives will have
a value equal to either (i) the fair market value of the MDAH Limited
Partner's share of the Hotels and other assets owned by MDAH or (ii) the
principal amount of the Note. There will be no public market for the
Notes. If the Notes are sold, they may sell at prices substantially
below their issuance price. Noteholders are likely to receive the full
principal amount of a Note only if they hold the Note to maturity, which
is December 15, 2005, or if the Operating Partnership repays the Notes
prior to maturity. Because the Notes are unsecured obligations of the
Operating Partnership, they will be effectively subordinated to all
secured debt of the Operating Partnership and all obligations of both
the Participating Partnerships and the Operating Partnership's other
subsidiaries. See "Description of the Notes." As of June 19, 1998, on a
pro forma basis assuming the Full Participation Scenario, the Operating
Partnership would have had aggregate consolidated debt of approximately
$5.1 billion to which the Notes were effectively subordinated or which
rank equally with such Notes.
. Current Host Common Stock Price May Not Necessarily Be Indicative of the
Price of Host REIT Common Shares Following the REIT Conversion. Host's
current stock price is not necessarily indicative of how the market will
value Host REIT Common Shares following the REIT Conversion. The current
stock price of Host reflects the current market valuation of Host's
current business and assets (including the SLC common stock and the cash
or securities to be distributed in connection with the REIT Conversion)
and not the business and assets of Host REIT following the REIT
Conversion.
. Adverse Tax Consequences to the General Partner of a Sale of the
Hotel. In past years, MDAH has disproportionately allocated tax losses
to the General Partner, with the result that if the MDAH Hotels were to
be sold in a taxable transaction, the General Partner (and thus Host)
would incur a disproportionately larger tax gain than the MDAH Limited
Partners. Accordingly, the General Partner and Host have an additional
conflict of interest in deciding the appropriate course of action for
MDAH with respect to its Hotels.
. Fundamental Change in Nature of Investment; Potential
Underperformance. The Mergers and the REIT Conversion involve a
fundamental change in the nature of an MDAH Limited Partner's investment
from holding an interest in MDAH, which was structured to make cash flow
distributions (some of which were tax sheltered), is a finite-life
entity, has a fixed portfolio of six Hotels and distributes partially
tax sheltered cash flow from the operation of such Hotels to the MDAH
Limited Partners, to holding an interest in an infinite-life, operating
real estate company with a portfolio of approximately 120 Hotels that
(i) collects and distributes to its limited partners rents received from
the Lessees (which will bear the risks and receive
MDAH Supp-3
<PAGE>
the direct benefits of the Hotels' operations), (ii) has the ability to
acquire additional hotels, (iii) is able to reinvest proceeds from sales
or refinancings of existing Hotels in other hotels and (iv) has a publicly
traded general partner. In addition, each MDAH Limited Partner's
investment will change from one that allows an MDAH Limited Partner to
receive a return of capital in the form of distributions from any net
proceeds of a sale or refinancing of MDAH's assets to an investment in
which an MDAH Limited Partner who retains OP Units likely would realize a
return of capital only through the exercise of the Unit Redemption Right.
An MDAH Limited Partner's share of the liquidation proceeds, if any, from
the sale of an MDAH Hotel or Hotels could be higher than the amount
realized upon exercise of the Unit Redemption Right (or payments on any
Note received by an MDAH Limited Partner who elects to exchange his OP
Units for such Note). An investment in the Operating Partnership may not
outperform an investment in MDAH. See "Comparison of Ownership of
Partnership Interests, OP Units and Common Shares."
. Exposure to Market and Economic Conditions of Other Hotels. As a result
of the Merger, MDAH Limited Partners who elect to retain OP Units will
own interests in a much larger enterprise with a broader range of assets
than MDAH individually. A material adverse change affecting the
Operating Partnership's assets will affect all Limited Partners,
including MDAH Limited Partners, regardless of whether a particular
Limited Partner previously was an investor in such affected assets. MDAH
owns discrete assets and the Mergers and the REIT Conversion will
significantly diversify the types and geographic locations of the Hotels
in which the MDAH Limited Partners will have interests. As a result, the
Hotels owned by the Operating Partnership may be affected differently by
economic and market conditions than those Hotels previously owned by
MDAH.
. MDAH Limited Partners Have No Cash Appraisal Rights. MDAH Limited
Partners who vote against the Merger have no right to receive cash based
upon an appraisal of their Partnership Interests.
. Uncertainties as to the Size and Leverage of the Operating
Partnership. The MDAH Limited Partners cannot know at the time they vote
on the Merger the exact size and amount of leverage of the Operating
Partnership. Host is an existing operating company that regularly issues
and repays debt, acquires additional hotels and disposes of existing
hotels. Also, some or all of the Partnerships may elect not to
participate in a Merger. In addition, outside partners in certain
Private Partnerships may not consent to a lease of their partnership's
Hotel(s). In either such case, Host will contribute its interests in
such Partnerships and Private Partnerships to the Operating Partnership,
but the Operating Partnership may, in turn, contribute such interests to
a Non-Controlled Subsidiary, which will be subject to corporate-level
income taxation. Host also may repurchase outstanding securities or
issue new debt or equity securities prior to the consummation of the
Mergers and the REIT Conversion.
. Lack of Control over Hotel Operations. Due to current federal income tax
law restrictions on a REIT's ability to derive revenues directly from the
operation of a hotel, the Operating Partnership will lease virtually all
of its consolidated Hotels to the Lessees, which will operate the Hotels
by continuing to retain the Managers pursuant to the Management
Agreements. The Operating Partnership will not operate the Hotels or
participate in the decisions affecting the daily operations of the
Hotels. The Operating Partnership will have only a limited ability to
require the Lessees or the Managers to operate or manage the Hotels in
any particular manner and no ability to govern any particular aspect of
their day-to-day operation or management. Therefore, the Operating
Partnership will be dependent for its revenue upon the ability of the
Lessees and the Managers to operate and manage the Hotels.
. Expiration of Leases and Possible Inability to Find Other Lessees. The
Leases will expire seven to ten years after the Effective Date and there
can be no assurance that such Leases will be renewed (or if renewed, will
be renewed on terms as favorable to the Operating Partnership). If the
Leases are not renewed, the Operating Partnership will be required to
find other lessees, which lessees must meet certain requirements set
forth in the Management Agreements. There can be no assurance that
satisfactory lessees could be found or as to the terms and conditions on
which the Operating Partnership would be able to renew the Leases or
enter into new leases with such lessees.
. Requisite Vote of MDAH Limited Partners Binds All MDAH Limited
Partners. For MDAH, approval by a majority of the Partnership Interests
of MDAH that are eligible to be voted is required to approve
MDAH Supp-4
<PAGE>
the Merger, as described in "Voting Procedures--Required Vote and Other
Conditions." Such approval will cause MDAH to participate in the Merger
and will bind all MDAH Limited Partners, including MDAH Limited Partners
who voted against or abstained from voting with respect to the Merger.
. Substantial Indebtedness of the Operating Partnership. The Operating
Partnership will have substantial indebtedness. As of June 19, 1998, on
a pro forma basis assuming the Full Participation Scenario, the
Operating Partnership would have had outstanding indebtedness totaling
approximately $5.1 billion, which represents a % debt-to-total market
capitalization ratio on a pro forma basis at such date (based upon a
price per Common Share of Host REIT of $ ). The Operating Partnership's
business is capital intensive and it will have significant capital
requirements in the future. The Operating Partnership's leverage level
could affect its ability to (i) obtain financing in the future, (ii)
undertake refinancings on terms and subject to conditions deemed
acceptable by the Operating Partnership, (iii) make distributions to
partners, (iv) pursue its acquisition strategy or (v) compete
effectively or operate successfully under adverse economic conditions.
. No Limitation on Debt. There are no limitations in Host REIT's or the
Operating Partnership's organizational documents which limit the amount
of indebtedness either may incur, although both the Notes and the
Operating Partnership's other debt instruments will contain certain
restrictions on the amount of indebtedness that the Operating
Partnership may incur.
. Rental Revenues from Hotels Subject to Rights of Lenders. In accordance
with the mortgage loan agreements with respect to outstanding
indebtedness of certain Hotel Partnerships, the rental revenues received
by such Hotel Partnerships under certain Leases first will be used to
satisfy the debt service on such outstanding indebtedness with only the
cash flow remaining after debt service being available to satisfy other
obligations of the Hotel Partnership (including paying property taxes
and insurance, funding the required FF&E reserves for the Hotels and
capital improvements and paying debt service with respect to unsecured
debt) and make distributions to holders of OP Units.
. Ownership Limitations. No person or group may own, actually or
constructively (as determined under the applicable Code provisions), (i)
in excess of 9.8% of the number or value of outstanding Common Shares of
Host REIT or (ii) in excess of 4.9% of the value of the OP Units (other
than Host REIT and The Blackstone Group), subject to waiver or
modification by Host REIT or the Operating Partnership, as the case may
be, in certain limited circumstances.
. Timing of the REIT Conversion. If the REIT Conversion does not occur in
time for Host REIT to elect REIT status effective January 1, 1999, the
effectiveness of Host REIT's election could be delayed to January 1,
2000, which would result in Host REIT continuing to pay corporate-level
income taxes in 1999 and could cause the Blackstone Acquisition not to
be consummated.
. Effect of Subsequent Events upon Recognition of Gain. Even though the
MDAH Limited Partners (other than those who elect to receive a Note in
exchange for OP Units) generally are not expected to recognize
significant taxable gain at the time of the Merger, there are a variety
of events and transactions (including the sale of one or more of the
Hotels currently owned by MDAH or the reduction of indebtedness securing
one or more of the Hotels) that could cause an MDAH Limited Partner to
recognize all or a part of the gain that otherwise has been deferred
through the REIT Conversion. See "Federal Income Tax Consequences--Tax
Treatment of MDAH Limited Partners Who Hold OP Units Following the
Merger." Certain Hotels (including the Blackstone Hotels) will be
covered by agreements with third parties which will restrict the
Operating Partnership's ability to dispose of those properties or
refinance their debt. In addition, if Atlanta Marquis participates in
the Mergers, the Operating Partnership will succeed to an existing
agreement that will restrict its ability to dispose of the Atlanta
Marquis Hotel or to refinance the debt secured by such Hotel without
compensating certain outside partners for the resulting adverse tax
consequences. As for the remaining initial properties (including the
Hotels owned by MDAH), the partnership agreement of the Operating
Partnership, which is substantially in the form attached to the Consent
Solicitation as Appendix A (the "Partnership Agreement"), does not
impose any restrictions on the Operating Partnership's ability to
dispose of the Hotels or to refinance debt secured by the Hotels (but
the Operating Partnership is obligated to pay any taxes Host REIT incurs
as a result of such
MDAH Supp-5
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transactions). In addition, the Partnership Agreement provides that Host
REIT, as general partner of the Operating Partnership, is not required to
take into account the tax consequences of the limited partners in deciding
whether to cause the Operating Partnership to undertake specific
transactions (but the Operating Partnership is obligated to pay any taxes
that Host REIT incurs as a result of such transaction) and the limited
partners have no right to approve or disapprove such transactions. See
"Description of OP Units--Sales of Assets."
. Election to Exchange OP Units for Notes. An MDAH Limited Partner who
elects to receive a Note in connection with the Merger in exchange for
his OP Units will be treated as having made a taxable disposition of his
Partnership Interest. An MDAH Limited Partner who receives a Note may be
eligible to defer at least a portion, but not all, of that gain under
the "installment sale" rules. An MDAH Limited Partner with a "negative
capital account" with respect to his Partnership Interest who elects to
receive a Note will recognize "phantom income" in that amount at the
time of the Merger in any event. See "Federal Income Tax Consequences--
Tax Treatment of MDAH Limited Partners Who Exercise Their Right to Make
the Note Election."
. Competition in the Lodging Industry. The profitability of the Hotels is
subject to general economic conditions, the management abilities of the
Managers (including primarily Marriott International), competition, the
desirability of particular locations and other factors relating to the
operation of the Hotels. The full-service segment of the lodging
industry, in which virtually all of the Hotels operate, is highly
competitive and the Hotels generally operate in geographical markets
that contain numerous competitors. The Hotels' success will be
dependent, in large part, upon their ability to compete in such areas as
access, location, quality of accommodations, room rate structure, the
quality and scope of food and beverage facilities and other services and
amenities. The lodging industry, including the Hotels (and thus the
Operating Partnership), may be adversely affected in the future by (i)
national and regional economic conditions, (ii) changes in travel
patterns, (iii) taxes and government regulations which influence or
determine wages, prices, interest rates, construction procedures and
costs, (iv) the availability of credit and (v) other factors beyond the
control of the Operating Partnership.
. Failure of Host REIT to Qualify as a REIT for Tax Purposes. Taxation of
Host REIT as a corporation if it fails to qualify as a REIT, and Host
REIT's subsequent liability for federal, state and local taxes on its
income and property, would, among other things, have the effect of
reducing cash available for distribution to Host REIT's shareholders and
materially reducing the value of the Common Shares and OP Units.
. Failure of the Operating Partnership to Qualify as a Partnership for Tax
Purposes. Taxation of the Operating Partnership as a corporation if it
fails to qualify as a partnership and the Operating Partnership's
subsequent liability for federal, state and local income taxes would,
among other things, have the effect of reducing cash available for
distribution to holders of OP Units, would cause Host REIT to fail to
qualify as a REIT for tax purposes and would cause the holders of OP
Units to recognize substantial taxable gain at the time the Operating
Partnership ceases to qualify as a partnership.
. Failure of the Leases to Qualify as Leases. If the leases of the Hotels
to the Lessee were to be disregarded for tax purposes (for example,
because the Lease was determined to lack economic substance), Host REIT
could fail to qualify as a REIT and the Operating Partnership might be
treated as a corporation for federal income tax purposes, which would
have a material adverse impact on the MDAH Limited Partners and the value
of the OP Units.
. Change in Tax Laws. No assurance can be provided that new legislation,
Treasury Regulations, administrative interpretations or court decisions
will not significantly change the tax laws with respect to Host REIT's
qualification as a REIT or the federal income tax consequences of such
qualification.
. MDAH Limited Partners Need to Consult with Their Own Tax Advisors.
Because the specific tax attributes of an MDAH Limited Partner and the
facts regarding such MDAH Limited Partner's interest in MDAH could have a
material impact on the tax consequences to such MDAH Limited Partner of
the Merger, the subsequent ownership and disposition of OP Units or Notes
and/or the subsequent ownership
MDAH Supp- 6
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and disposition of Common Shares, it is essential that each MDAH Limited
Partner consult with his own tax advisors regarding the application of
federal, foreign and state and local tax laws to such MDAH Limited
Partner's personal tax situation.
. Effect of Possible Classification as a Publicly Traded Partnership on
Passive Losses. There is a significant possibility that the Operating
Partnership could be classified as a "publicly traded partnership," in
which event the MDAH Limited Partners would not be able to use suspended
passive activity losses from other investments (including from MDAH) to
offset income from the Operating Partnership. It is estimated that each
MDAH Limited Partner who purchased his Partnership Interest at the time
of the original offering of such Interests, has held such Partnership
Interest continuously since that time and whose Partnership Interest has
been his only investment in a passive activity, would have a passive
activity loss carryforward as of December 31, 1998.
Because REITs are not permitted under current federal income tax law to
derive revenues directly from the operation of hotels, the Operating
Partnership will lease the Hotels to lessees (the "Lessees") that will operate
the Hotels under the existing management agreements and pay rent to the
Operating Partnership, as more fully described herein. The Lessees generally
will be indirect controlled subsidiaries of HMC Senior Communities, Inc.
("SLC"), which currently is a wholly owned subsidiary of Host. SLC will become
a separate public company when Host distributes the common stock of SLC and
other considerations to its existing shareholders and the Blackstone Entities
in connection with Host's distribution of its accumulated earnings and
profits, which Host REIT is required to do in order to qualify as a REIT.
Shares of Host REIT and SLC will become separately traded securities and the
companies will operate independently. There will be no overlap between the
boards of Host REIT and SLC. There will be a substantial overlap of
shareholders of the two companies initially, but this likely will diverge over
time.
MARRIOTT MDAH ONE CORPORATION (THE "GENERAL PARTNER"), THE GENERAL PARTNER
OF MDAH, BELIEVES THAT THE MERGER PROVIDES SUBSTANTIAL BENEFITS AND IS FAIR TO
THE MDAH LIMITED PARTNERS AND RECOMMENDS THAT ALL MDAH LIMITED PARTNERS VOTE
FOR THE MERGER.
The effects of the Mergers may be different for Limited Partners of the
various Partnerships. This Supplement has been prepared to highlight for MDAH
Limited Partners the specific risks, benefits, effects and fairness of the
Merger to them and to provide other information specific to MDAH. Supplements
have also been prepared for each of the other Partnerships. This Supplement,
together with the supplements of the other Partnerships (collectively, the
"Supplements"), are part of the Consent Solicitation. Upon receipt of a
written request by a Limited Partner or his representative so designated in
writing, the General Partner will send a copy of any Supplement without
charge. All requests for a copy of a Supplement should be directed to:
Investor Relations, 10400 Fernwood Road, Bethesda, Maryland 20817, telephone
number 301-380-2070 (between the hours of 9:00 a.m. and 4:00 p.m., eastern
time).
All cross-references refer to the Consent Solicitation unless the context
indicates otherwise. Capitalized terms not defined herein shall have the
meaning set forth in the Consent Solicitation. The information contained
herein, unless otherwise indicated, assumes the REIT Conversion occurs with
all Partnerships participating and no Notes being issued (the "Full
Participation Scenario").
EXPECTED BENEFITS OF THE MERGER
The General Partner believes that participating in the Merger would likely
be beneficial to the MDAH Limited Partners for the reasons set forth below.
This information is qualified by and should be read in conjunction with the
information in the Consent Solicitation under "Background and Reasons for the
Mergers and the REIT Conversion--Reasons for the Mergers." These benefits,
which should be viewed as alternatives to continuing the business and
operations of MDAH, are expected to include:
. MDAH Limited Partners who elect to retain OP Units in the Merger will
receive OP Units with an estimated Exchange Value equal to $109,216 per
Partnership Unit.
MDAH Supp-7
<PAGE>
. Enhanced Liquidity of Investment. The REIT Conversion will offer MDAH
Limited Partners significantly enhanced liquidity with respect to their
investments in MDAH because, commencing one year following the Effective
Date, MDAH Limited Partners who retain OP Units will be able to exercise
their Unit Redemption Right at any time, subject to certain limited
exceptions. Host has approximately 204 million shares of common stock
outstanding and is expected to have a total common equity market
capitalization of approximately $ billion after giving effect to the
estimated $ million earnings and profits distribution (based on Host's
$ closing price per share on the NYSE on , 1998). The exercise of
the Unit Redemption Right, however, generally would result in recognition
of taxable income or gain at that time.
. Public Market Valuation of Assets. The Partnership Units of MDAH
currently trade at a discount to the net asset value of MDAH's assets.
In contrast, the General Partner believes that by exchanging interests
in MDAH, which is a non-traded, finite-life limited partnership with a
fixed portfolio for interests in an infinite-life publicly traded real
estate company focused primarily on a more diverse and growing full-
service hotel portfolio and providing valuations based upon publicly
traded Common Shares of Host REIT, the MDAH Limited Partners will have
the opportunity to participate in the recent trend of ownership toward
real estate through a publicly traded entity, which, in many instances,
has resulted in market valuations of public real estate companies in
excess of the estimated net asset values of those companies. There can
be no assurance, however, that the Common Shares of Host REIT will trade
at a premium to the private market values of the Operating Partnership's
assets or that the relative pricing differential will not change or be
eliminated in the future. Also, the benefit of Host's conversion to a
REIT will not be shared by the MDAH Limited Partners if and to the
extent that such benefit is reflected in the market valuation of Host's
common stock prior to the REIT Conversion.
. Regular Quarterly Cash Distributions. The General Partner expects that
the Operating Partnership will make regular quarterly cash distributions
to holders of OP Units. The General Partner expects that these
distributions will be higher than the estimated cash distributions for
1998 of MDAH, and, in any event, the ability to receive distributions
quarterly and in regular amounts would be enhanced. For additional
information regarding historical and estimated future distributions for
MDAH and the other Partnerships, see "Background and Reasons for the
Mergers and the REIT Conversion--Reasons for the Mergers."
. Substantial Tax Deferral. The General Partner expects that MDAH Limited
Partners who do not elect to receive a Note in exchange for OP Units
generally should be able to obtain the benefits of the Merger while
continuing to defer recognition for federal income tax purposes of at
least a substantial portion, if not all, of the gain with respect to
their Partnership Interests that otherwise would be recognized in the
event of a liquidation of MDAH or a sale or other disposition of its
assets in a taxable transaction. Thereafter, such MDAH Limited Partners
generally should be able to defer at least a substantial portion of such
built-in gain until they elect to exercise their Unit Redemption Right
or one or more of the Hotels currently owned by MDAH are sold or
otherwise disposed of in a taxable transaction by the Operating
Partnership or the debt now secured by such Hotels is repaid, prepaid or
substantially reduced. The federal income tax consequences of the Merger
are highly complex and, with respect to each MDAH Limited Partner, are
dependent upon many variables, including the particular circumstances of
such MDAH Limited Partner. See "Federal Income Tax Consequences--Tax
Consequences of the Merger." Each MDAH Limited Partner is urged to
consult with his own tax advisors as to the consequences of the Merger
in light of his particular circumstances.
. Risk Diversification. Participation in the Merger, as well as future
hotel acquisitions by the Operating Partnership, will reduce the
dependence of MDAH Limited Partners upon the performance of, and the
exposure to the risks associated with, MDAH's Hotels and spread such
risk over a broader and more varied portfolio, including more diverse
geographic locations and multiple brands. See "Business and Properties--
Business Objectives."
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a lower leverage to value ratio than
MDAH currently, which has a leverage ratio of 58% (calculated as a
MDAH Supp-8
<PAGE>
percentage of Appraised Value), resulting in interest and debt service
savings and greater financial stability.
. Growth Potential. The General Partner believes that the MDAH Limited
Partners, by owning interests in a publicly traded real estate company
focused primarily on a more diverse and growing luxury and upscale full-
service hotel portfolio, will be able to participate in growth
opportunities that would not otherwise be available to them.
. Greater Access to Capital. With publicly traded equity securities, a
larger base of assets and a substantially greater equity value than MDAH
individually, Host REIT expects to have greater access to the capital
necessary to fund the Operating Partnership's operations and to
consummate acquisitions on more attractive terms than would be available
to MDAH individually. This greater access to capital should provide
greater financial stability to the Operating Partnership and reduce the
level of risk associated with refinancing existing loans upon maturity
(including, specifically, the refinancing of the MDAH Mortgage Debt,
substantially all of which will mature on December 15, 1999), as
compared to MDAH individually.
If MDAH does not participate in the Merger, its business will continue in
its current manner; however, the Operating Partnership may elect to contribute
some of all of its interest in MDAH to a Non-Controlled Subsidiary.
DETERMINATION OF EXCHANGE VALUE OF MDAH AND ALLOCATION OF OP UNITS
GENERAL. The Exchange Value of MDAH will be equal to the greatest of its
Adjusted Appraised Value, Continuation Value and Liquidation Value, each of
which has been determined as follows:
. Adjusted Appraised Value. The General Partner has retained AAA to
determine the market value of each of the Hotels as of March 1, 1998
(the "Appraised Value"). The "Adjusted Appraised Value" of MDAH equals
the Appraised Value of its Hotels, adjusted as of the Final Valuation
Date for lender reserves, capital expenditure reserves, existing
indebtedness (including a "mark to market" adjustment to reflect the
market value of such indebtedness), certain deferred maintenance costs,
deferred management fees and transfer and recordation taxes and fees.
. Continuation Value. The "Continuation Value" of MDAH represents AAA's
estimate, as adopted by the General Partner, of the discounted present
value, as of January 1, 1998, of the MDAH limited partners' share of
estimated future cash distributions and estimated net sales proceeds
(plus lender reserves), assuming that MDAH continues as an operating
business for twelve years and its assets are sold on December 31, 2009
for their then estimated market value.
. Liquidation Value. The "Liquidation Value" of MDAH represents the
General Partner's estimate of the net proceeds to MDAH limited partners
resulting from the assumed sale as of December 31, 1998 of the Hotels of
MDAH, each at its Adjusted Appraised Value (after eliminating any "mark
to market" adjustment and adding back the deduction for transfer and
recordation taxes and fees, if any, made in deriving the Adjusted
Appraised Value), less (i) estimated liquidation costs, expenses and
contingencies equal to 2.5% of Appraised Value and (ii) prepayment
penalties or defeasance costs, as applicable.
Final determination of the Exchange Value of MDAH will be made as of the end
of the four week accounting period ending at least 20 days prior to the
Effective Date (the "Final Valuation Date") and will be equal to the greatest
of Adjusted Appraised Value, Continuation Value and Liquidation Value as of
such date. Adjusted Appraised Value, Continuation Value and Liquidation Value
will be adjusted as of the Final Valuation Date (i) to reflect the amount of
lender and capital expenditure reserves and the amount of deferred management
fees as of such date, (ii) to increase the Adjusted Appraised Value by any
amounts actually expended by MDAH after the Initial Valuation Date to perform
deferred maintenance that were previously subtracted in determining the
estimated Adjusted Appraised Value of MDAH and (iii) to reflect any changes in
MDAH's other reserves, such as for litigation expenses and indemnification
costs and any revised estimates of transfer and recordation taxes and fees.
APPRAISED VALUE. MDAH's Hotels were appraised as of March 1, 1998 by AAA, an
independent, nationally recognized hotel valuation and financial advisory firm
experienced in the appraisals of lodging properties such as MDAH's Hotels.
Each appraisal (an "Appraisal") was reviewed by a Member Appraisal
MDAH Supp-9
<PAGE>
Institute ("MAI") appraiser and certified by such MAI appraiser as having been
prepared in accordance with the requirements of the Standards of Professional
Practice of the Appraisal Institute and the Uniform Standards of Professional
Appraisal Practice of the Appraisal Foundation.
The purpose of each Appraisal is to provide an estimate of the "Market
Value" of the related Hotel. "Market Value" means the most probable price
which a property should bring in a competitive and open market under all
conditions requisite to a fair sale, the buyer and seller each acting
prudently and knowledgeably and assuming the price is not affected by undue
stimuli. Implicit in this definition is the consummation of a sale as of a
specified date and the passing of title from seller to buyer under conditions
whereby: (i) the buyer and seller are equally motivated; (ii) both parties are
well informed or well advised, and each is acting in what he considers his own
best interest; (iii) a reasonable time frame is allowed for exposure in the
open market; (iv) payment is made in terms of cash in U.S. dollars or in terms
of financial arrangements comparable thereto and (v) the price represents the
normal consideration for the property sold unaffected by special or creative
financing or sales concessions granted by anyone associated with the sale. AAA
made site visits at half of MDAH's Hotels for purposes of the Appraisals.
In preparing the Appraisals, AAA relied primarily on the income
capitalization method of valuation, and then compared the value estimated by
this method with recent sales of comparable properties, as a check on the
reasonableness of the value determined through the income capitalization
method. AAA employed the following procedures for determining the Appraised
Value of each MDAH Hotel:
. Historical 1997 and Projected Year's Earnings. AAA reviewed the
historical 1997 net operating income (i.e., income before interest,
taxes, depreciation and amortization) ("NOI") prior to incentive
management fees and certain capital expenditures for each Hotel. AAA
also prepared a projection of the net operating income prior to
incentive management fees and certain capital expenditures for each
Hotel for the twelve month period ending February 28, 1999 (the
"Projected Year"), using historical financial information for each
Hotel, budget information, a survey with the manager of each Hotel
addressing the physical condition of each Hotel, local market conditions
(including business mix, demand generators, future trends and
predictability of business), changes in the competitive environment,
comparison with direct competitors of each Hotel and risk factors
relating to the particular Hotel. The resulting gross margin (ratio of
total revenues to NOI prior to incentive management fees) was checked
against AAA's database of the gross margins for similar hotels for
reasonableness.
. Impact of Incentive Management Fees. AAA estimated a normalized annual
amount of incentive management fees payable under the applicable
management agreement and subtracted this amount from the net operating
income prior to incentive management fees and certain capital
expenditures for 1997 and the Projected Year.
. Impact of Owner Funded Capital Expenditures. AAA estimated normalized
annual amounts of owner funded capital expenditures (over and above the
FF&E reserve) based in part on projected owner funded capital
expenditures estimated in the Engineering Study. The normalized amounts
were then subtracted from the NOI prior to owner funded capital
expenditures for 1997 and the Projected Year.
. Capitalization of Adjusted NOI. AAA then capitalized the amount
resulting from the foregoing adjustments ("Adjusted NOI") for 1997 and
the Projected Year by dividing such amounts by capitalization rates that
AAA determined to be appropriate. A capitalization rate represents the
relationship between net operating income and sales prices of income
producing property. AAA selected the capitalization rates based upon its
review of current published surveys reflecting the opinions of investors
and participants such as REITs, hotel acquisition/management companies
and pension funds, lenders, brokers and consultants as to current
capitalization rates, and its own database of capitalization rates
reflected in recent transactions, adjusted for factors specific to the
Hotel, such as location, physical condition, reserve policies, local
market volatility and competition, guest mix, renovation influences and
other income characteristics. AAA used separate capitalization rates
that it deemed appropriate to capitalize 1997 historical Adjusted NOI
and estimated Projected Year's Adjusted NOI. AAA then estimated the
value of each Hotel based upon each of the values estimated by
capitalizing 1997 and Projected Year's Adjusted NOI and its professional
judgment. The following table sets forth the effective capitalization
rates for 1997 and Projected Year's Adjusted NOI resulting from AAA's
estimated Appraised Values of MDAH's Hotels.
MDAH Supp-10
<PAGE>
RESULTING EFFECTIVE CAPITALIZATION RATES FOR APPRAISALS OF MDAH'S HOTELS
<TABLE>
<CAPTION>
PROJECTED YEAR
1997 (ENDING FEBRUARY 28, 1999)
---- --------------------------
<S> <C>
9.1--9.9% 10.1--10.6%
</TABLE>
APPRAISED VALUES OF MDAH'S HOTELS
<TABLE>
<CAPTION>
APPRAISED VALUE
HOTEL (IN THOUSANDS)
----- ---------------
<S> <C>
Dayton Marriott Hotel................................... $ 40,500
Fairview Park Marriott Hotel............................ 58,900
Fullerton Marriott Hotel................................ 9,800
Livonia Marriott Hotel.................................. 19,600
Raleigh at Research Triangle Park Marriott Hotel........ 20,900
Southfield Marriott Hotel............................... 16,200
--------
$165,900
========
</TABLE>
. Comparison with Comparable Sales. AAA checked the Appraised Value of
each Hotel derived by the foregoing procedures against its database of
comparable sale transactions for reasonableness.
With respect to MDAH's Hotels, one property was encumbered by a ground lease
as of the date of the Appraisals. Accordingly, the Appraised Value of such
Hotel has been decreased to reflect the encumbrance of the ground lease and
the interest of the ground lessor in the operating cash flows of such Hotel.
The Appraised Value assumes all contractual provisions for FF&E reserves are
adequate and have not been reduced to reflect deferred maintenance or
environmental remediation costs with respect to MDAH's Hotels (but estimated
deferred maintenance costs have been deducted in estimating the Adjusted
Appraised Value of each of MDAH's Hotels). The Appraised Value did not take
into account the costs that might be incurred in selling the Hotels (but
estimated costs for transfer and recordation taxes and fees have been deducted
in estimating the Adjusted Appraised Value of each Hotel).
The Appraisals are not guarantees of present or future values and no
assurance can be given as to the actual value of MDAH's Hotels. The Appraisals
should be read in conjunction with other information, such as, but not limited
to, the audited financial statements of MDAH.
The Appraised Value, and the assumptions underlying the projections on which
the Appraised Value is based, are contingent upon a series of future events,
the outcomes of which are not necessarily within the Operating Partnership's
control and cannot be determined at this time. There can be no assurance that
another appraiser would not have arrived at a different result. Some of the
assumptions inevitably will not materialize and unanticipated events and
circumstances will occur subsequent to the date of the Appraisals.
Furthermore, the actual results achieved from MDAH's Hotels will vary from the
results projected in the Appraisals and the variations may be material.
ADJUSTED APPRAISED VALUE. The Adjusted Appraised Value of MDAH was
determined by totaling the Appraised Values of all of the Hotels of MDAH and
then making various adjustments to the aggregate Appraised Value, as described
below.
. Lender Reserves. MDAH's debt service reserves are required to be held by
third-party lenders. The amount of these lender reserves as of the
Initial Valuation Date was added to the Appraised Values of these
Hotels. A final determination of the lender reserves of MDAH will be
made on the Final Valuation Date and any changes in such reserves will
be reflected in the Adjusted Appraised Value.
MDAH Supp-11
<PAGE>
. Mortgage and Other Debt. The estimated principal balance and accrued
interest as of the Effective Date (assumed to be December 31, 1998) of
all mortgage and other debt of MDAH has been subtracted from the
Appraised Value.
. Mark to Market Adjustments. The third-party loans of the Partnerships
have various interest rates and terms to maturity. In order to reflect
the market value of the third-party loans of MDAH, the estimated
Adjusted Appraised Value for MDAH has been increased to "mark to market"
the interest rate for such loans. This adjustment has been estimated by
comparing the interest cost using the applicable interest rates on
existing third-party loans over their remaining term to the interest
cost using the interest rate that the Operating Partnership believes it
would be able to obtain for unsecured debt in the market as of the Final
Valuation Date (which would have been % per annum based on a 225 basis
point (2.25 percent) spread over the yield on seven-year U.S. Treasury
securities as of , 1998). The mark to market adjustment for each
loan was calculated by determining the difference between the present
values, as of December 31, 1998, of the interest payments over the
remaining term of the loan from January 1, 1999 to maturity using the
actual interest rate as the discount rate as compared to using the
assumed market rate as the discount rate.
. Deferred Maintenance Costs. The estimated cost to complete any deferred
maintenance items identified in the Engineering Study relating to MDAH's
Hotels has been subtracted from the Appraised Value. The adjustments for
this item will be reduced at the Final Valuation Date to reflect amounts
expended after the Initial Valuation Date to perform such deferred
maintenance. No adjustments have been made for previously budgeted
capital expenditures or deferred maintenance costs estimated in the
Engineering Study that are reflected in the cash flow projections used
for purposes of estimating Appraised Values.
The following table sets forth the adjustments to the aggregate Appraised
Values of MDAH's Hotels made to derive the estimated Adjusted Appraised Value
for MDAH as of the Initial Valuation Date.
CALCULATION OF ESTIMATED ADJUSTED APPRAISED VALUE FOR MDAH
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................................................. $165,900
Lender reserves................................................. 3,000
Mortgage debt................................................... (97,371)
Other debt...................................................... (25,355)
Mark to market adjustment....................................... 399
Deferred maintenance costs...................................... (825)
--------
Estimated Adjusted Appraised Value.............................. $ 45,748
========
Limited partners' share......................................... $ 45,215
Per Partnership Unit............................................ $109,216
</TABLE>
CONTINUATION VALUE. AAA estimated the Continuation Value of MDAH using the
following methodology:
. Estimated Future Cash Distributions. AAA prepared estimates of future
partnership cash flow for MDAH for the 12-year period from January 1, 1998
through December 31, 2009 based upon the estimated 1998 NOI before
incentive management fees used in the Appraisals and for each subsequent
year applying an assumed annual stabilized growth rate (as shown in the
table below) developed by AAA for this analysis. For each year in the
projection period, AAA estimated the amount of cash available for
distribution to MDAH's limited partners after payment of all management
fees, debt service, owner funded capital expenditures based on the
Engineering Study and other partnership expenses and after application of
the applicable partnership agreement provisions. AAA assumed that MDAH's
FF&E reserve was adequate and understood that Host determined that there
were no reserve shortfalls or surpluses.
MDAH Supp-12
<PAGE>
. Refinancing Assumptions. For MDAH's first mortgage loan, which matures
during the 12-year period, AAA assumed that the debt would be refinanced
with an interest rate of 7.25% per annum and a 20-year amortization
schedule, with estimated refinancing costs of 2% of the refinanced amount
being paid from operating cash flow.
. Determination of Residual Value. To estimate the residual value of the
MDAH limited partners' interest in MDAH at the end of the 12-year period,
AAA assumed that the MDAH Hotels would be sold as of December 31, 2009 at
their then market value. AAA estimated the market value of each Hotel as
of such date by applying an exit capitalization rate that it deemed
appropriate, using the factors described above in connection with the "--
Appraised Value," which are set forth in the table below, to the estimated
Adjusted NOI for 2009 (estimated as described above). AAA then subtracted
estimated sales costs of 2.0% of the estimated market value, added lender
reserves and subtracted the estimated outstanding principal balance of
debt as of December 31, 2009 and deferred management fees to arrive at net
sales proceeds available for distribution to partners. AAA then determined
what portion of such estimated net sales proceeds would be distributable
to MDAH's limited partners under the partnership and debt agreements.
. Discounting Distributions to Present Value. As a final step, AAA
discounted the estimated future cash distributions to MDAH's limited
partners from operations and estimated net sales proceeds to their present
value as of January 1, 1998, using a discount rate of 20% per annum. AAA
believes that this discount rate reflects the return on investment that
investors expect from leveraged investments of this nature.
The growth rate and exit capitalization rate used to determine the estimated
Continuation Value for MDAH are as set forth below:
GROWTH RATE, EXIT CAPITALIZATION RATE
AND ESTIMATED CONTINUATION VALUE FOR MDAH
<TABLE>
<CAPTION>
EXIT ESTIMATED
GROWTH CAPITALIZATION CONTINUATION VALUE
RATE RATE (2009) (PER PARTNERSHIP UNIT)
------ -------------- ----------------------
<S> <C> <C>
3.4% 10.1% $89,340
</TABLE>
LIQUIDATION VALUE. The Liquidation Value of MDAH was estimated by the
General Partner and represents the estimated value of MDAH if all of its
assets were sold as of December 31, 1998. Such value was based upon the
Adjusted Appraised Value of MDAH, with the following adjustments: (i) the
"mark to market" adjustment used to estimate the Adjusted Appraised Value was
eliminated and instead prepayment or defeasance costs that would be payable
under existing debt agreements (regardless of whether the debt in fact can be
prepaid on December 31, 1998) were deducted from the Appraised Value; and (ii)
the deduction for transfer and recordation taxes and fees used to estimate the
Adjusted Appraised Value was eliminated and instead an amount equal 2.5% of
the Appraised Value of MDAH's Hotels was subtracted from the Appraised Value
for estimated liquidation costs, expenses and contingencies. The General
Partner then determined the portion of the estimated Liquidation Value that
would be distributable to MDAH's limited partners under the terms of the
partnership agreement and other contractual arrangements.
MDAH Supp-13
<PAGE>
The following table sets forth the adjustments made to the Adjusted
Appraised Value to estimate the Liquidation Value of MDAH as of the Initial
Valuation Date:
CALCULATION OF ESTIMATED LIQUIDATION VALUE OF MDAH
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................................................. $165,900
Lender reserves................................................. 3,000
Mortgage debt................................................... (97,371)
Other debt...................................................... (25,355)
Deferred maintenance costs...................................... (825)
Sales costs..................................................... 4,148
--------
Estimated Liquidation Value..................................... $ 41,201
========
Limited partners' share......................................... $ 40,714
Per Partnership Unit............................................ $ 98,343
</TABLE>
ESTIMATED EXCHANGE VALUE. The following table sets forth the estimated
Exchange Value of MDAH (based upon the greatest of its estimated Adjusted
Appraised Value, estimated Continuation Value and estimated Liquidation
Value), the estimated minimum and pro forma number of OP Units to be received
and the estimated Note Election Amount for MDAH, all on a per Partnership Unit
basis as of the Initial Valuation Date. The estimated Exchange Value for MDAH
will be received by each MDAH Limited Partner retaining OP Units in the
Merger. The estimated Note Election Amount for MDAH (which will be received by
MDAH Limited Partners electing to receive Notes in exchange for OP Units) is
equal to the Liquidation Value for MDAH. The estimated values set forth below
may increase or decrease as a result of various adjustments, which will be
finally calculated as of the Final Valuation Date but will not change as a
result of less than all of the Partnerships participating in the Mergers. The
actual number of OP Units to be received by the MDAH Limited Partners will be
based on the average closing price on the NYSE of a Host REIT Common Share for
the 20 trading days after the Effective Date.
ESTIMATED EXCHANGE VALUE, NUMBER OF OP UNITS AND NOTE ELECTION AMOUNT OF MDAH
PER PARTNERSHIP UNIT(1)
<TABLE>
<CAPTION>
ESTIMATED
ESTIMATED ESTIMATED ESTIMATED ESTIMATED ESTIMATED PRO FORMA ESTIMATED NOTE
ADJUSTED CONTINUATION LIQUIDATION EXCHANGE MINIMUM NUMBER NUMBER OF ELECTION
APPRAISED VALUE VALUE VALUE VALUE(2) OF OP UNITS(3) OP UNITS(4) AMOUNT(5)
--------------- ------------ ----------- --------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
$109,216 $89,340 $98,343 $109,216 5,461 $98,343
</TABLE>
- --------
(1) A Partnership Unit in MDAH represents an original investment of $100,000.
(2) The estimated Exchange Value is equal to the greatest of estimated
Adjusted Appraised Value, estimated Continuation Value and estimated
Liquidation Value.
(3) Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Merger.
(4) Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
(5) The principal amount of Notes is equal to the greater of (i) the
Liquidation Value or (ii) 60% of the Exchange Value (the "Note Election
Amount").
Price of OP Units to Pay Exchange Value to MDAH Limited Partners. Each MDAH
Limited Partner will receive OP Units with a deemed value equal to the
Exchange Value of such MDAH Limited Partner's Partnership Interests. The price
of an OP Unit for this purpose will be equal to the average closing price on
the NYSE of a Host REIT Common Share for the 20 trading days after the
Effective Date of the Mergers (but in no
MDAH Supp-14
<PAGE>
event greater than $ per share). The closing price per share of Host common
stock on the NYSE was $ on , 1998.
MDAH Limited Partners at the Effective Date of the Merger who retain OP
Units will receive cash distributions from MDAH for all of 1998 and, if the
Merger does not occur in 1998, any portion of 1999 prior to the Merger for
which period they do not receive a cash distribution from the Operating
Partnership. Cash distributions will be made by MDAH in accordance with its
partnership agreement on or before June 1, 1999 in respect of 1998 operations
and, if the Merger does not occur prior to January 1, 1999, within 90 days
after the Effective Date of the Merger in respect of any 1999 operations. MDAH
Limited Partners at the Effective Date of the Mergers who receive Notes in
exchange for OP Units will participate in the same distributions from MDAH as
Limited Partners who retain OP Units but will not receive any distributions
from the Operating Partnership with respect to periods after the Effective
Date of the Merger.
No fractional OP Units will be issued. Fractional amounts less than or equal
to 0.50 of an OP Unit will be rounded down to the next whole number and
fractional amounts greater than 0.50 will be rounded up to the next whole
number of OP Units.
VALUATION OF THE GENERAL PARTNER'S INTEREST IN MHP2 AND ALLOCATION OF OP UNITS
TO THE GENERAL PARTNER
The value of the General Partner's interest will be equal to the aggregate
Exchange Value of MDAH minus the aggregate Exchange Value of the MDAH Limited
Partners' Partnership Interests (giving effect to the applicable distribution
preferences in the MDAH partnership agreement). The number of OP Units that
will be received by the General Partner will be equal to the value of its
interest in MDAH divided by the same price per OP Unit used to determine the
number of OP Units to be received by the MDAH Limited Partners. The total
number of OP Units that will be owned directly or indirectly by Host REIT
(including OP Units owned by the General Partner) will be equal to the number
of outstanding shares of common stock of Host at the Effective Date.
The following table sets forth the estimated value of the General Partner's
and its affiliate's interest in MDAH based upon the estimated aggregate
Exchange Value of the MDAH Limited Partners' Partnership Interests as of the
Initial Valuation Date and the minimum and pro forma number of OP Units
estimated to be received by the General Partner and its affiliates in respect
thereof.
ESTIMATED VALUE OF THE GENERAL PARTNER'S AND ITS AFFILIATE'S INTERESTS AND
NUMBER OF OP UNITS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
MDAH
-------
<S> <C>
Aggregate Exchange Value............................................ $45,748
Limited partners' share of aggregate Exchange Value................. 45,215
-------
Value of General Partner's interest................................. 533
Value of Host's limited partner interest............................ 218
-------
Total Host interest................................................. $ 751
=======
Number of OP Units:
Minimum(1)........................................................
Pro Forma(2)...................................................... 38
</TABLE>
- --------
(1)Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Mergers.
(2)Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
CASH DISTRIBUTIONS
Historical Cash Distributions Paid by MDAH. The following table sets forth
the distributions paid to MDAH Limited Partners (per Partnership Unit) for the
periods indicated. The information below should be read in conjunction with
the information in this Supplement under the caption "Selected Financial
Data."
MDAH Supp-15
<PAGE>
HISTORICAL CASH DISTRIBUTIONS PAID BY MDAH
(PER PARTNERSHIP UNIT)(1)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS FISCAL YEAR
--------- --------------------------------
1998 1997 1996 1995 1994 1993
--------- ------ ------ ------ ------ ----
<S> <C> <C> <C> <C> <C> <C>
From net income..................... $-- $3,453 $4,575 $4,481 $3,428 $--
Representing return of capital(2)... -- -- -- -- -- --
---- ------ ------ ------ ------ ----
Total............................. $-- $3,453 $4,575 $4,481 $3,428 $--
==== ====== ====== ====== ====== ====
</TABLE>
- --------
(1) A Partnership Unit represents a $100,000 original investment in MDAH.
(2) Computed as all distributions in excess of distributions from operating
cash flow.
Compensation and Distributions to the General Partner. Under MDAH's
partnership agreement, the General Partner does not receive fees or
compensation in connection with managing the affairs of MDAH but the General
Partner and its affiliates are reimbursed for certain costs and expenses
incurred on behalf of MDAH. In addition, the General Partner is entitled to
distributions related to its interests in MDAH. The following information has
been prepared to compare the amount of reimbursements paid and cash
distributions made by MDAH to the General Partner and its affiliates to the
amounts that would have been paid if the reimbursement and distribution
structure which will be in effect after the REIT Conversion had been in effect
for the periods presented.
Following the REIT Conversion, Host REIT will be operated as a self-
administered REIT and as a result no reimbursements or other compensation will
be received by the General Partner.
The following table sets forth the reimbursements and distributions paid by
MDAH to its General Partner and its affiliates on a combined basis for the
last three fiscal years and the First Two Quarters 1998 ("Historical") and the
reimbursements and distributions that would have been paid to the General
Partner for the last fiscal year and the First Two Quarters 1998 if the REIT
Conversion had been in effect, assuming the Full Participation Scenario ("Pro
Forma") and assuming a distribution per OP Unit of $1.05 per year during such
period, which is the midpoint of the expected distribution range for 1999.
HISTORICAL AND PRO FORMA REIMBURSEMENTS AND DISTRIBUTIONS TO THE GENERAL
PARTNER AND ITS AFFILIATES
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO FISCAL YEAR
QUARTERS --------------------------------------
1998 1997 1996 1995
---------------- ---------------- ---------- ----------
PRO PRO
HISTORICAL FORMA HISTORICAL FORMA HISTORICAL HISTORICAL
---------- ----- ---------- ----- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Reimbursements(1)....... $88 $-- $124 $-- $109 $68
Distributions(2)........ -- 20 21 39 28 27
--- ---- ---- ---- ---- ---
Total .................. $88 $ 20 $145 $ 39 $137 $95
=== ==== ==== ==== ==== ===
</TABLE>
- --------
(1) All expenses will be paid directly by the Operating Partnership,
accordingly, there are no expected reimbursements on a pro forma basis.
(2) The amount of distributions payable to the General Partner and its
affiliates on a pro forma basis reflect distributions at a rate of $1.05
per annum per OP Unit (which is the midpoint of the expected range of
distributions per OP Unit for 1999) with respect to the estimated number
of OP Units that the General Partner and its affiliates will receive with
respect to its general and limited partner interests in MDAH. Such number
does not reflect the aggregate number of OP Units Host will receive in
connection with the REIT Conversion.
MDAH Supp-16
<PAGE>
CERTAIN INFORMATION REGARDING THE HOTELS OWNED BY MDAH
<TABLE>
<CAPTION>
NUMBER OF DATE
NAME OF HOTEL LOCATION OF HOTEL ROOMS OPENED
- ------------- ------------------ --------- ------
<S> <C> <C> <C>
Dayton Marriott Hotel...................... Dayton, OH 399 1982
Fairview Park Marriott Hotel............... Fairfax County, VA 395 1989
Fullerton Marriott Hotel................... Orange County, CA 224 1989
Livonia Marriott Hotel..................... Livonia, MI 224 1989
Marriott Hotel at Research Triangle Park... Raleigh, NC 224 1988
Southfield Marriott Hotel.................. Southfield, MI 226 1989
-----
TOTAL.................................... 1,692
=====
</TABLE>
The table below sets forth certain performance information for MDAH's Hotels
for the indicated periods.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
-------------------- -----------------------
1998 1997 1997 1996 1995
--------- --------- ------- ------ ------
<S> <C> <C> <C> <C> <C>
Average daily rate............... $ 114.66 $ 102.29 $102.97 $93.33 $86.39
Occupancy........................ 77.0% 78.1% 76.4% 74.6% 76.1%
REVPAR........................... $ 88.29 $ 79.89 $ 78.66 $69.62 $65.74
% REVPAR change.................. 10.5% -- 13.0% 5.9% --
</TABLE>
Dayton Marriott Hotel, Dayton, Ohio
The Dayton Marriott Hotel is a full-service Marriott hotel located on 9.9
acres of fee-owned land approximately 1.5 miles south of downtown Dayton,
Ohio. The Hotel is situated at the intersection of South Patterson Boulevard
and River Park Drive, which is approximately one-half mile east of I-75. The
Hotel is visible from the interstate and is adjacent to both the University of
Dayton and the world headquarters of NCR Corporation. Because of its
recognized position in the market, the Dayton Marriott Hotel serves the entire
Dayton metropolitan area, including the Wright-Patterson Airforce Base and the
downtown convention center.
The Dayton Marriott Hotel originally opened in January 1982 with 299 rooms
and was expanded to 399 rooms in August 1987. The Dayton Hotel contains 399
guest rooms, of which nine are suites and 50 are concierge-level guest rooms
offering special amenities, decor and services. The Hotel has approximately
10,300 square feet of meeting and banquet space, including a 6,400 square foot
ballroom capable of accommodating up to 800 people for receptions and up to
580 people for banquets. In addition, the Hotel contains a restaurant capable
of seating 165 persons and a lounge capable of seating 112 persons. Other
amenities offered by the Hotel include an indoor/outdoor pool, a hydrotherapy
pool, an exercise room, a sauna, bicycle rentals, a gift/sundry shop and
parking for 547 cars.
Competition. The primary competition for the Hotel comes from three hotels
in the Dayton area: (i) the Crown Plaza; (ii) the Doubletree Hotel and (iii)
the Holiday Inn Fairborn. A comparison of these hotels and the Dayton Hotel is
shown below:
<TABLE>
<CAPTION>
APPROXIMATE
NO. OF YEAR MEETING SPACE
ROOMS OPENED (SQ. FT.)
------ ------ -------------
<S> <C> <C> <C>
DAYTON MARRIOTT HOTEL........................... 399 1982 10,300
Crown Plaza..................................... 284 1996 12,000
Doubletree Hotel................................ 189 1988 8,000
Holiday Inn Fairborn............................ 202 1987 8,000
</TABLE>
In addition to the properties described above, the Dayton Hotel faces
secondary competition from various other hotels. These other hotels, however,
differ from the Hotel in terms of size, room rates, facilities, amenities
MDAH Supp-17
<PAGE>
and services offered, market orientation and/or location. No new primary
competition is expected to open in the Dayton area. However, the Residence Inn
and Fairfield Inn Troy opened in January 1998.
Fairview Park Marriott Hotel, Fairfax County, Virginia
The Fairview Park Marriott Hotel is located approximately nine miles west of
downtown Washington, D.C., on a parcel of approximately 5.2 acres of fee-owned
land in the 220-acre Fairview Park development in Fairfax County, Virginia.
The Hotel is located at the interchange of U.S. Highway 50 and the heavily
traveled Capital Beltway (I-495), which circles Washington, D.C. The Hotel is
located directly across the Capital Beltway from the world headquarters of
Mobil Corporation, is four miles south of Tysons Corner, Virginia, a major
regional commercial and retail center and is near several middle-income and
upscale residential areas. At 15 stories, the Hotel is the tallest building in
the Fairview Park development and is visible from the Capital Beltway.
The Fairview Park Marriott Hotel opened in August 1989. The Hotel contains
395 guest rooms, of which eight are suites, two are parlors and 30 are
concierge-level guest rooms offering special amenities, decor and services.
The Hotel has approximately 13,000 square feet of meeting and banquet space
(including a ballroom of 10,300 square feet) and six hospitality suites which
are available to accommodate meetings of small groups. The Hotel has a
restaurant which seats 130 and one lounge which seats a total of 55, and
offers an indoor/outdoor pool and whirlpool, an exercise room, men and women's
locker rooms with saunas, a business center, a gift/sundry shop and
indoor/outdoor parking for 660 cars. More than half of the Fairview Park
development has been preserved as woodlands and the Hotel is located in a
wooded area which offers a park-like setting containing jogging and cycling
trails that connect with adjacent communities. The Hotel also is adjacent to a
small retail shopping center which offers a food court and shops.
Ground Lease. The Partnership leases the land on which the Fairview Park
Marriott Hotel parking garage is located. The lease expires in 2085 and
requires a nominal rental of $1 per year.
Competition. Four hotels, the Sheraton Tysons Corner, the Hilton McLean, the
Tysons Corner Marriott and the Ritz Carlton Tysons Corner (which is owned by
Host Marriott), provide the primary competition for the Fairview Park Marriott
Hotel. The Ritz Carlton Tysons Corner is also owned by Host and managed by
Marriott International. A comparison of these hotels and the Fairview Park
Marriott Hotel is shown in the table below:
<TABLE>
<CAPTION>
APPROXIMATE
NO. OF YEAR MEETING SPACE
ROOMS OPENED (SQ. FT.)
------ ------ -------------
<S> <C> <C> <C>
FAIRVIEW PARK
MARRIOTT HOTEL................................... 395 1989 13,000
Sheraton Tysons Corner........................... 455 1986 26,000
Hilton McLean.................................... 457 1987 22,000
Tysons Corner Marriott........................... 392 1981 13,600
Ritz Carlton Tysons Corner....................... 232 1989 18,500
</TABLE>
The Homewood Suites Hotel, a 109 room extended-stay hotel opened in February
1998, and is located four miles from Fairview Park.
Fullerton Marriott Hotel, Fullerton, California
The Fullerton Marriott Hotel is located in Fullerton, California on a 4.7
acre leased parcel of land located on the campus of California State
University at Fullerton. The Fullerton campus of California State University
has approximately 25,000 students, making it the seventh largest of the 20
campuses in the California State University system. Fullerton is located in
northern Orange County, California's third largest center of high technology
which includes the communities of Fullerton, Placentia, Brea, La Habra, Yorba
Linda and Buena Park. The Fullerton Marriott Hotel is located at the
interchange of State Highway 57 and Nutwood Avenue, approximately 20 miles
north of the John Wayne International Airport and approximately eight miles
north of
MDAH Supp-18
<PAGE>
Disneyland. The Fullerton Marriott Hotel is designed principally to
accommodate the needs of travelers visiting the University and the many
corporate facilities located in the area and to cater to the needs of group
meetings, but the General Partner expects the Hotel to attract a significant
number of leisure travelers as well.
The Hotel offers 224 guest rooms, of which three are suites and 39 are
concierge-level rooms offering special amenities, decor and services. The
Hotel has approximately 4,617 square feet of meeting and banquet space
(including a 2,749 square foot ballroom), a restaurant which seats 68, a
lounge which seats 44, an outdoor pool and whirlpool, an exercise room, men
and women's locker rooms with saunas, a gift/sundry shop and parking for 286
cars. The Hotel is a six-story building located on the southeast corner of the
University campus. The restaurant and lounge are located on the first floor
just off the lobby and the meeting and banquet space is located primarily on
the first floor. The guest rooms are located on floors one though six. Under
the Ground Lease, the Partnership will be prohibited from making any
structural or exterior alterations to the Hotel which are inconsistent with
the development project plans without the written consent of the Ground Lessor
and the Trustees of California State University.
Ground Lease. The Partnership leases the land on which the Fullerton
Marriott Hotel is located. The initial term expires on 2019 with four
successive 10-year renewals at the Partnership's option. The lease provides
for percentage rental equal to 4% of gross room sales for each year.
Competition. Four hotels, the Embassy Suites Anaheim, the Holiday Inn-
Fullerton, Chase Suites and the Embassy Suites Fullerton, provide the primary
competition for the Fullerton Marriott Hotel. A comparison of these hotels and
the Fullerton Marriott Hotel is shown in the following table:
<TABLE>
<CAPTION>
APPROXIMATE
NO. OF YEAR MEETING SPACE
ROOMS OPENED (SQ. FT.)
------ ------ -------------
<S> <C> <C> <C>
FULLERTON MARRIOTT HOTEL......................... 224 1989 4,617
Embassy Suites Anaheim........................... 224 1987 8,000
Holiday Inn Fullerton............................ 289 1973 9,200
Chase Suites..................................... 96 1995 2,700
Embassy Suites................................... 229 1987 9,000
</TABLE>
In addition to the properties described above, the Hotel faces secondary
competition from various other hotels. These other hotels, however, differ
from the Hotel in terms of size, room rates, facilities, amenities and
services offered, market orientation and/or location.
Detroit Marriott Livonia Hotel, Livonia, Michigan
The Detroit Marriott Hotel is located on four acres of fee-owned land within
Laurel Park Place, a 750,000 square foot upscale office and regional shopping
mall development in Livonia, Michigan, an affluent suburb of Detroit located
west of downtown in the rapidly expanding I-275 corridor. Laurel Park Place is
one of Livonia's three major shopping malls, containing over 60 specialty
shops and restaurants, a ten-screen cinema, over 300,000 square feet of office
space, the largest Jacobsen's department store ever built and space for
another anchor department store. The Hotel, which opened in September 1989, is
located approximately 15 miles west of downtown Detroit and is designed
principally to accommodate the needs of business travelers visiting the
automobile manufacturing and other corporate facilities located in the area.
The Hotel contains 226 guest rooms, of which four are suites and 39 are
concierge-level rooms offering special amenities, decor and services. The
Hotel is a six story building and has approximately 5,000 square feet of
meeting and banquet space (including a ballroom of 3,168 square feet), a
restaurant with a seating capacity of 75, a lounge with a seating capacity of
50, an indoor pool and whirlpool, an exercise room, men and women's locker
rooms with saunas, a gift/sundry shop and parking for 280 cars. The Hotel is
adjacent to the Laurel Park Place mall and has an entranceway that opens into
the retail section of the mall.
MDAH Supp-19
<PAGE>
Competition. Three hotels, the Novi Hilton, the Holiday Inn and the Embassy
Suites, provide the primary competition for the Livonia Hotel. A comparison of
these hotels and the Detroit Marriott Livonia Hotel is shown in the table
below:
<TABLE>
<CAPTION>
APPROXIMATE
NO. OF YEAR MEETING SPACE
ROOMS OPENED (SQ. FT.)
------ ------ -------------
<S> <C> <C> <C>
DETROIT MARRIOTT
LIVONIA HOTEL.................................... 226 1989 3,965
Novi Hilton...................................... 237 1985 15,344
Holiday Inn...................................... 212 1988 11,000
Embassy Suites................................... 137 1989 7,000
</TABLE>
In addition to the properties described above, the faces secondary
competition from various other hotels. These other hotels, however, differ
from the Hotel in terms of size, room rates, facilities, amenities and
services offered, market orientation and/or location. No new primary
competition is expected to open in the Livonia area in the near term.
Marriott Hotel at Research Triangle Park, Durham, North Carolina
The Marriott Hotel at Research Triangle Park is a full-service Marriott
hotel located in Durham, North Carolina, approximately 15 miles northwest of
Raleigh and approximately nine miles southeast of downtown Durham. The Hotel
is located on 10.3 acres of fee-owned land approximately 4.5 miles from the
Raleigh-Durham Airport and approximately one-half mile from Research Triangle
Park. The primary demand generator for the Hotel is Research Triangle Park, a
6,700 acre research park located in the triangle formed by Duke University,
the University of North Carolina and North Carolina State University. Research
Triangle Park contains facilities occupied by over 50 corporations,
institutions and government agencies, all of which are engaged in research,
development or science-oriented production. The Hotel is approximately 12.5
miles from Duke University, 12 miles from the University of North Carolina and
13 miles from North Carolina State University.
The Hotel, which opened in April 1988, is designed principally to meet the
needs of business travelers visiting Research Triangle Park, but it also
caters to the group meeting and leisure traveler segments of the hotel market.
The Hotel offers 224 guest rooms, of which four are suites or parlors and 50
are concierge-level rooms offering special amenities, decor and services. The
Hotel is a six story building and has approximately 4,000 square feet of
meeting space, including a 2,816 square foot ballroom. The Hotel also has a
restaurant which seats 75 persons, a lounge which seats 50 persons, an indoor
pool, a hydrotherapy pool, an exercise room, men and women's saunas, a
gift/sundry shop, a business center and parking for 351 cars.
Competition. Four hotels, the Sheraton Imperial Hotel, the Holiday Inn-
Research Triangle Park, Doubletree Suites and the Radisson Governors Inn,
provide the primary competition for the Research Triangle Park Hotel. A
comparison of these hotels and the Marriott Hotel at Research Triangle Park is
shown in the following table:
<TABLE>
<CAPTION>
APPROXIMATE
NO. OF YEAR MEETING SPACE
ROOMS OPENED (SQ. FT.)
------ ------ -------------
<S> <C> <C> <C>
MARRIOTT HOTEL at
RESEARCH TRIANGLE PARK........................... 224 1988 4,000
Sheraton Imperial Hotel.......................... 340 1986 31,000
Holiday Inn-RTP.................................. 250 1988 4,850
Doubletree Suites................................ 203 1987 3,000
Radisson Governors Inn........................... 200 1972 7,000
</TABLE>
In addition to the properties described above, the Hotel faces secondary
competition from various other hotels. These other hotels, however, differ
from the Hotel in terms of size, room rates, facilities, amenities and
MDAH Supp-20
<PAGE>
services offered, market orientation and/or location. An Embassy Suites and
several mid-priced hotels opened in the Research Triangle Park area in 1997. A
three hotel and multiple restaurant complex, is under development and
scheduled to open mid-year 1998.
Southfield Marriott Hotel, Southfield, Michigan
The Southfield Marriott Hotel is located along I-696 and Northwestern
Highway, adjacent to the First Center Office Park on 5.0 acres of fee-owned
land in Southfield, Michigan, a suburb of Detroit located approximately 15
miles northwest of downtown Detroit, Michigan. Over one million square feet of
office space are located within one mile of the Southfield Hotel. Southfield
is a major commercial center, which according to the Southfield Chamber of
Commerce, serves as headquarters for three Fortune 500 companies and 62 other
Fortune 500 companies have offices or other facilities there.
The Southfield Marriott Hotel which opened in September 1989, contains 226
guest rooms, of which four are suites and 39 are concierge-level rooms
offering special amenities, decor and services. The Southfield Marriott Hotel
is a six story building containing approximately 4,000 square feet of meeting
and banquet space, including a 2,816 square foot ballroom. In addition, the
Hotel contains a restaurant with a seating capacity of 75, a lounge with
seating capacity of 50, an indoor pool and whirlpool, an exercise room, men
and women's locker rooms with saunas, a gift/sundry shop and parking for 280
cars.
Competition. Four hotels--the Radisson Plaza, the Doubletree, the Holiday
Inn and the Hilton--provide the primary competition for the Southfield
Marriott Hotel. A comparison of these hotels and the Southfield Marriott Hotel
is shown in the following table:
<TABLE>
<CAPTION>
APPROXIMATE
NO. OF YEAR MEETING SPACE
ROOMS OPENED (SQ. FT.)
------ ------ -------------
<S> <C> <C> <C>
SOUTHFIELD MARRIOTT HOTEL........................ 226 1989 4,000
Westin......................................... 385 1987 11,000
Doubletree..................................... 239 1987 8,000
Holiday Inn.................................... 417 1965 8,000
Hilton......................................... 197 1988 3,000
</TABLE>
In addition to the properties described above, the Hotel faces secondary
competition from various other hotels. These other hotels, however, differ
from the Hotel in terms of size, room rates, facilities, amenities and
services offered, market orientation and/or location. No new primary
competition is expected to open in the Southfield market in the near term.
AMENDMENTS TO MDAH'S PARTNERSHIP AGREEMENT
In order to allow the Hotels of MDAH to be leased to SLC in connection with
the Merger and the REIT Conversion, MDAH's partnership agreement must be
amended. Currently, there is no provision in MDAH's partnership agreement to
allow MDAH's Hotels to be leased. Therefore, Section 5.02B of MDAH's
partnership agreement must be amended to add a new paragraph 5.02B(xiii) to
read as follows:
(xiii) lease or consent to the lease, directly or indirectly, in one
transaction or a series of related transactions, of any or all of the
Hotels.
Other Amendments. Amendments to certain terms and sections of MDAH's
partnership agreement would be made in order to (i) reduce to one the number
of appraisals of the fair market value of MDAH's Hotels that MDAH must provide
to the Limited Partners before the General Partner can cause MDAH to sell its
assets to the General Partner or an affiliate, (ii) delete certain obsolete
references to entities and agreements that are no longer in existence, (iii)
update MDAH's partnership agreement to reflect the passage of time since the
formation of MDAH and (iv) make any other amendments to MDAH's partnership
agreement deemed necessary or advisable, in the sole discretion of the General
Partner, in connection with the consummation of the Merger and
MDAH Supp-21
<PAGE>
the REIT Conversion. The General Partner does not believe that these
amendments would affect the rights of the MDAH Limited Partners in any
material respect nor the duties and obligations of the General Partner. These
changes are included, along with the other proposed amendments, in the copy of
MDAH's partnership agreement, as proposed to be amended, which is attached
hereto. The amended MDAH partnership agreement is marked to indicate the
revisions made to the existing MDAH partnership agreement and should be read
in its entirety. Deleted provisions are contained in brackets and struck
through and added provisions are in bold type and underlined.
FAIRNESS ANALYSIS AND OPINION
FAIRNESS ANALYSIS
The General Partner believes that the Merger provides substantial benefits
and is fair to the Limited Partners of MDAH and recommends that all Limited
Partners of MDAH consent to the Merger. The General Partner bases this
recommendation primarily on (i) its view that the expected benefits of the
Merger for the MDAH Limited Partners outweigh the risks and potential
detriments of the Merger to the MDAH Limited Partners (see "Background and
Reasons for the Mergers and the REIT Conversion--Reasons for the Mergers" and
"Risk Factors"), (ii) its view that the value of the OP Units allocable to the
MDAH Limited Partners on the basis of the Exchange Value established for MDAH
represents fair consideration for the Partnership Interests held by the MDAH
Limited Partners and is fair to the MDAH Limited Partners from a financial
point of view and (iii) the Appraisals and Fairness Opinion of AAA.
The Merger is not conditioned upon the consummation of any of the other
Mergers. The General Partner has considered this fact in evaluating the
fairness of the Merger. The General Partner believes that the fairness of the
Merger will not be materially affected by the presence or absence of any other
individual Partnership or by any particular combination of other Partnerships
and that the Merger will be fair to the MDAH Limited Partners, individually
and as a whole, if it is consummated with any combination of other
Participating Partnerships. The General Partner bases this belief primarily on
the fact that the consideration to be paid to the MDAH Limited Partners has
been established based upon MDAH's Exchange Value, without regard to any
possible combination of other Partnerships.
In reaching the conclusions implicit in the above recommendation, the
General Partner has taken into account the following considerations, placing
the greatest weight on the first two considerations:
. The General Partner has concluded that the Exchange Value for MDAH, which
is equal to its Adjusted Appraised Value, represents fair consideration
for the Partnership Interests of the MDAH Limited Partners in the Merger
in relation to MDAH. The General Partner also has concluded that the
Exchange Value established for the MDAH Limited Partners fairly reflects
the value of the assets held by MDAH. In addition, the Fairness Opinion
supports these conclusions.
. MDAH Limited Partners will be able to defer recognition of gain until
such time as they choose to realize such gain based on their own personal
circumstances.
. The General Partner has concluded that the potential benefits of the
Merger to the MDAH Limited Partners, as described under "Background and
Reasons for the Mergers and the REIT Conversion-- Reasons for the
Mergers," outweigh the potential risks and detriments of the Merger for
the MDAH Limited Partners, as described in "Risk Factors."
. The Fairness Opinion, in the view of the General Partner, supports the
fairness of the Merger, even though it includes qualifications,
limitations and assumptions relating to its scope and other factors that
MDAH Limited Partners should consider carefully. The availability of the
Fairness Opinion is particularly significant in light of the absence of
arm's length negotiations in establishing the terms of the Merger.
. Host will contribute its wholly owned full-service hotel assets,
substantially all of its interests in the Hotel Partnerships and its
other assets (excluding its senior living assets and the cash or
securities to be
MDAH Supp-22
<PAGE>
distributed to its shareholders) to the Operating Partnership in exchange
for (i) a number of OP Units equal to the number of outstanding shares of
common stock of Host, (ii) preferred partnership interests in the
Operating Partnership corresponding to any shares of Host preferred stock
outstanding at the time of the REIT Conversion and (iii) the assumption by
the Operating Partnership of all liabilities of Host (including past and
future tax liabilities), other than liabilities of SLC. Following these
contributions, the Operating Partnership and its subsidiaries will
directly own all of Host's wholly owned hotels and all of Host's interests
in the Hotel Partnerships and Host's other assets. Host will receive OP
Units in respect of its general partner interests in MDAH on substantially
the same basis as the Partnership Units held by MDAH Limited Partners.
Host REIT will not receive any compensation for its services as general
partner to the Operating Partnership following the REIT Conversion and
will benefit from the operations of the Operating Partnership only to the
extent of the distributions received based upon its percentage interest in
the Operating Partnership to the same extent as the other limited
partners. Because Host REIT will share in the value of the Operating
Partnership solely through distributions and not through any separate
compensation structure, the General Partner believes that this is a factor
supporting the fairness of the Merger to the MDAH Limited Partners.
. The General Partner believes that the value of the consideration to be
received by the MDAH Limited Partners in the Merger is fair in relation
to the value which would be derived by such Limited Partners under any of
the alternatives described under "Background and Reasons for the Mergers
and the REIT Conversion--Alternatives to the Mergers," especially since
the Exchange Value of MDAH is equal to its Adjusted Appraised Value,
which is the greatest of the Adjusted Appraisal Value, the Continuation
Value and the Liquidation Value and the historic prices paid for MDAH
Partnership Units. The General Partner does not believe that the sale of
any of MDAH's Hotels and liquidation of MDAH will obtain for MDAH Limited
Partners as much value as the value to be received by such MDAH Limited
Partners following the Merger. The General Partner believes that the
following benefits are of the greatest value and importance to the MDAH
Limited Partners:
. Enhanced Liquidity. The Merger and the REIT Conversion will offer
MDAH Limited Partners significantly enhanced liquidity with respect
to their investment in MDAH because, commencing one year following
the Effective Date, MDAH Limited Partners who retain OP Units will be
able to exercise their Unit Redemption Right at any time, subject to
certain limited exceptions. Host has approximately 204 million shares
of common stock outstanding and is expected to have a total common
equity market capitalization of approximately $ billion after giving
effect to the estimated $ million earnings and profits distribution
(based on Host's $ closing price per share on the NYSE on ,
1998). The exercise of the Unit Redemption Right, however, generally
would result in recognition of taxable income or gain at that time.
. Risk Diversification. Upon consummation of the REIT Conversion, each
MDAH Limited Partner's investment will be converted from an
investment in MDAH, which owns six hotels, into an investment in an
enterprise that initially will own or control approximately 120
Hotels and will have a total market capitalization of approximately
$ billion, thereby reducing the dependence upon the performance of,
and the exposure to the risks associated with, any particular Hotel
or group of Hotels currently owned by MDAH and spreading such risk
over a broader and more varied portfolio, including more diverse
geographic locations and multiple brands.
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a lower leverage to value ratio than
MDAH currently, which has a leverage ratio of 58% (calculated as a
percentage of Appraised Value), resulting in interest and debt
service savings and greater financial stability.
. Regular Quarterly Cash Distributions. The General Partner expects
that the Operating Partnership will make regular quarterly cash
distributions to holders of OP Units. Host expects that these
distributions will be higher than the estimated cash distributions
for 1998 of MDAH and, in any event, the ability to receive
distributions quarterly and in regular amounts would be enhanced.
MDAH Supp-23
<PAGE>
. Substantial Tax Deferral. The General Partner expects that MDAH
Limited Partners who do not elect to receive Notes in exchange for
OP Units generally should be able to obtain the benefits of the
Merger while continuing to defer recognition for federal income tax
purposes of at least a substantial portion, if not all, of the gain
with respect to their Partnership Interests that otherwise would be
recognized in the event of a liquidation of MDAH or a sale or other
disposition of its assets in a taxable transaction.
. The General Partner believes that the economic terms of the leases of the
MDAH Hotels are fair and reasonable from the standpoint of the Operating
Partnership.
The General Partner believes that the factors described above, which support
the fairness of the Merger to the MDAH Limited Partners, when weighed against
the factors that may be disadvantageous, taken as a whole, indicate that the
Merger is fair to the MDAH Limited Partners.
FAIRNESS OPINION
AAA, an independent financial advisory firm with substantial real estate and
partnership transaction experience, was engaged by the General Partner and the
other General Partners to perform the Appraisals and to render the Fairness
Opinion that (i) the Exchange Value and the methodologies and underlying
assumptions used to determine the Exchange Value, the Adjusted Appraised
Value, the Continuation Value and the Liquidation Value of MDAH and each other
Partnership (including, without limitation, the assumptions used to determine
the various adjustments to the Appraised Values of the Hotels) are fair and
reasonable, from a financial point of view, to the MDAH Limited Partners and
the Limited Partners of each other Partnership and (ii) the methodologies used
to determine the value of an OP Unit and to allocate the equity in the
Operating Partnership to be received by the MDAH Limited Partners and the
Limited Partners of each other Partnership are fair and reasonable to the MDAH
Limited Partners and the Limited Partners of each other Partnership. The
Fairness Opinion is addressed to each Partnership and it may be relied upon by
each of the MDAH Limited Partners and the Limited Partners of each of the
other Partnerships. The full text of the Fairness Opinion, which contains a
description of the assumptions and qualifications applicable to the review and
analysis by AAA, is set forth in Appendix B to the Consent Solicitation and
should be read in its entirety. The material assumptions and qualifications to
the Fairness Opinion are summarized below, although this summary does not
purport to be a complete description of the various inquiries and analyses
undertaken by AAA in rendering the Fairness Opinion. Arriving at a fairness
opinion is a complex analytical process not necessarily susceptible to partial
analysis or amenable to summary description. For a more complete description
of the assumptions and qualifications that limit the scope of the Fairness
Opinion, see "--Qualifications to Fairness Opinion" and "--Assumptions" below.
Although the General Partner advised AAA that certain assumptions were
appropriate in its view, the General Partner imposed no conditions or
limitations on the scope of the investigation by AAA or the methods and
procedures to be followed by AAA in rendering the Fairness Opinion. The fees
and expenses of AAA will be treated as a Merger Expense and will be paid by
the Operating Partnership. In addition, the General Partner has agreed to
indemnify AAA against certain liabilities. See "--Compensation and Material
Relationships."
Qualifications to Fairness Opinion. In the Fairness Opinion, AAA
specifically states that it did not: (a) specifically consider other
methodologies for allocation of the OP Units, (b) address or conclude that
other methodologies for allocation of the OP Units to MDAH and the other
Partnerships might not have been more favorable to the Limited Partners in
certain of the Partnerships, (c) negotiate with the General Partner, the
General Partners of the other Partnerships or Host, (d) participate in
establishing the terms of the Merger and the other Mergers, (e) provide an
opinion as to the terms and conditions of the Merger and the other Mergers
other than those explicitly stated in the Fairness Opinion, (f) make any
independent review of the capital expenditure estimates set forth in the
Engineering Study or (g) make any estimates of MDAH's and each other
Partnership's contingent liabilities. In addition, with respect to the
specific reference to the allocation of the equity interest in the Operating
Partnership to be received by the limited partners of each Partnership, AAA
has assumed that the average closing price on the NYSE of a Host REIT Common
Share for the 20 trading days after the Effective Date of the Merger
represents a fair price.
In connection with preparing the Fairness Opinion, AAA was not engaged to,
and consequently did not, prepare any written report or compendium of its
analysis for internal or external use beyond the analysis set
MDAH Supp-24
<PAGE>
forth in Appendix B. AAA will not deliver any additional written opinion of
the analysis, other than to update the written opinion if requested by the
Operating Partnership.
Experience of AAA. AAA is the world's largest independent valuation
consulting firm and is regularly and continually engaged in the valuation of
commercial real estate and businesses and their securities in connection with
tender offers, mergers and acquisitions, recapitalizations and
reorganizations, divestitures, employee stock ownership plans, leveraged
buyout plans, private placements, limited partnerships, estate and corporate
matters, other financial advisory matters and other valuation purposes.
AAA was selected because of its experience in the valuation of businesses
and their securities in connection with tender offers, mergers and
acquisitions, recapitalizations and reorganizations, including transactions
involving hotel partnerships. In addition, Host and its affiliates have
previously engaged AAA to provide appraisals and fairness opinions in
connection with other transactions. The General Partner and the other General
Partners considered two other firms for purposes of performing the appraisals
and rendering the Fairness Opinion and received proposals from each. The
General Partner selected AAA based upon price and experience.
Summary of Materials Considered and Investigation Undertaken. As a basis for
rendering the Fairness Opinion, AAA has made such reviews, studies and
analyses as it deemed necessary and pertinent in order to provide it with a
reasonable basis for the Fairness Opinion, including, but not limited to, the
following: (i) reviewed the transaction documents and SEC reporting and/or
filing documents, including drafts of the Form S-4 for the Mergers; (ii)
provided the Market Value of each Hotel owned by each Partnership in a
separate short form appraisal report and each such report was reviewed and
certified by an MAI appraiser as to its preparation in accordance with the
requirements of the Standards of Professional Practice of the Appraisal
Institute and the Uniform Standards of Professional Appraisal Practice of the
Appraisal Foundation; as part of the Appraisals, AAA reviewed historical
operating statements, 1998 budget and year-to-date results, and other
financial information as it deemed necessary as a basis for the Fairness
Opinion and the Appraisals also considered market transactions of similar
lodging properties as appropriate as a basis for the Market Value of each
Hotel; (iii) reviewed the methodologies used by each of the General Partners
in their determination of the Exchange Value of each Partnership, including
the nature and amount of all adjustments to the Appraised Values in
determining such Exchange Values; AAA reviewed and tested for the fairness and
reasonableness of all adjustments as well as for consideration of all
adjustments deemed to be appropriate by AAA; (iv) reviewed the methodologies
used by each of the General Partners in their determination of the value of an
OP Unit and the allocation of the equity interest in the Operating Partnership
to be received by the partners of each Partnership, and AAA reviewed and
tested for the fairness and reasonableness of the methods and measurements
made by the General Partners; (v) reviewed the General Partners' determination
of the Liquidation Value of each Partnership, and AAA reviewed and tested for
the fairness and reasonableness of all adjustments proposed by the General
Partners, as well as for consideration of all adjustments deemed appropriate
by AAA; (vi) provided an estimate of the Continuation Value of each
Partnership based upon the estimated present value of expected benefits to be
received by each limited partner interest as though the Mergers did not occur
and each Partnership's assets were sold within a twelve year period; AAA, as
part of its analysis and review, determined appropriate rates of growth in
house profit or net operating income, as well as reviewed other key variables
affecting partnership cash flows and other economic/financial factors
affecting the Partnerships' expected operations and results; (vii) reviewed
the terms of the ground leases of the Hotels and the partnership agreement of
each Partnership; (viii) reviewed audited and unaudited historical income
statements, balance sheets and statements of sources and uses of funds of each
Partnership and Host and pro forma financial information for Host REIT; (ix)
reviewed audited and unaudited historical operating statements of each Hotel,
as well as current operating statements and budgets; (x) conducted real estate
valuation and financial due diligence with respect to the Partnerships and
their underlying assets, liabilities and equity; (xi) reviewed internal
Marriott International, Host and Partnership financial analyses and other
internally generated data for each Hotel and (xii) discussed all of the
foregoing information, where appropriate, with management of Marriott
International, Host and the Partnerships and their respective employees.
Assumptions. In rendering its opinion, AAA relied, without independent
verification, on the accuracy and completeness in all material respects of
certain relevant publicly available information and information provided
MDAH Supp-25
<PAGE>
to AAA by Host and the Hotels. AAA assumed that all information furnished by
Host, the Hotels and the Partnerships and their representatives, upon which
AAA relied, presented an accurate description in all material respects of the
current and prospective status of the Hotels and the Partnerships from an
operational and financial point of view. AAA also noted that the Fairness
Opinion was based upon financial, economic, market and other considerations as
they existed and could be evaluated on the date thereof.
Conclusions. AAA concluded that, based upon and subject to its analysis and
assumptions and limiting conditions, and as of the date of the Fairness
Opinion: (i) the Exchange Value and methodologies used to determine the
Exchange Value, the Adjusted Appraised Value, the Continuation Value and the
Liquidation Value of each Partnership (including, without limitation, the
assumptions used to determine the various adjustments to the Appraised Values
of each of the Hotels) are fair and reasonable, from a financial point of
view, to the MDAH Limited Partners and the Limited Partners of each other
Partnership and (ii) the methodologies used to determine the value of an OP
Unit and to allocate the equity interest in the Operating Partnership to be
received by the MDAH Limited Partners and the Limited Partners of each other
Partnership are fair and reasonable to the MDAH Limited Partners and the
Limited Partners of each other Partnership.
Compensation and Material Relationships. AAA has been paid a fee of $335,000
for its services as described herein, including the Appraisals and preparing
to deliver the Fairness Opinion. In addition, AAA will be reimbursed for all
reasonable out-of-pocket expenses, including legal fees and will be
indemnified against certain liabilities, including certain liabilities under
the securities laws. The fee was negotiated between Host, the General Partners
and AAA. Payment of the fee to AAA is not dependent upon completion of the
Mergers. AAA has been previously engaged by Host and its affiliates to provide
appraisals, fairness opinions and solvency opinions in connection with other
transactions.
VOTING PROCEDURES
The consent of MDAH Limited Partners holding more than 50% of the
outstanding limited partner interests is required for participation in the
Merger. The General Partner may not vote its limited partner interests in
connection with the Merger.
An MDAH Limited Partner may mark the Consent Form to vote "FOR," "AGAINST"
or "ABSTAIN" participation in a Merger by MDAH. THE FAILURE OF AN MDAH LIMITED
PARTNER TO VOTE OR AN ABSTENTION WITH RESPECT THERETO WILL HAVE THE SAME
EFFECT AS IF SUCH LIMITED PARTNER HAD VOTED HIS PARTNERSHIP INTERESTS
"AGAINST" THE MERGER. LIMITED PARTNERS WHO RETURN A SIGNED CONSENT FORM BUT
FAIL TO INDICATE THEIR APPROVAL OR DISAPPROVAL AS TO ANY MATTER (INCLUDING THE
MERGER) WILL BE DEEMED TO HAVE VOTED TO APPROVE SUCH MATTER. The voting
procedures applicable to MDAH Limited Partners are set forth in the Consent
Solicitation under the heading "Voting Procedures-- Required Vote and Other
Conditions."
As of June 19, 1998, Palm Investors, LLC, owns 27.5 Partnership Units which
represents 6.6% of the total MDAH Partnership Units. No other person owned of
record, or to the Partnership's knowledge owned beneficially, more than 5% of
the total number of MDAH Partnership Units.
FEDERAL INCOME TAX CONSEQUENCES
In addition to the federal income tax consequences discussed in the sections
of the Consent Solicitation entitled "Federal Income Tax Consequences" and
"Risk Factors--Federal Income Tax Risks," MDAH Limited Partners should read
carefully the following discussion of federal income tax consequences
applicable specifically to the MDAH Limited Partners. The information included
in this discussion is based upon various factual assumptions and information
which are believed by the Operating Partnership and the General Partner to be
reliable. However, some of these assumptions inevitably will not materialize,
and unanticipated events and circumstances will occur. Therefore, there likely
will be differences between the information provided herein, including the
numerical data and estimates, and actual results, and the variations may be
material and adverse.
MDAH Supp-26
<PAGE>
Applicability of Tax Opinions
Hogan & Hartson L.L.P. ("Hogan & Hartson"), counsel to Host REIT, Host and
the Operating Partnership, has provided to Host REIT and the Operating
Partnership an opinion letter (substantially in the form of Appendix C to the
Consent Solicitation) as to certain federal income tax consequences to the
Operating Partnership and the MDAH Limited Partners resulting from the Mergers
and the REIT Conversion. The opinion letter is based upon certain assumptions
and certain representations provided by Host REIT, Host, the Operating
Partnership and the General Partners. These representations generally involve
factual matters relating to the organization, ownership and operations
(including the income, assets, businesses, liabilities and properties) of the
Partnerships and Hotels contributed to the Operating Partnership by Host and
the Blackstone Entities prior to the Mergers and the REIT Conversion and of
Host REIT, the Operating Partnership and the Partnerships following the
Mergers and the REIT Conversion. In addition, on the Effective Date, Hogan &
Hartson expects to provide to Host REIT and the Operating Partnership an
opinion letter (substantially in the form of Appendix D to the Consent
Solicitation) as to the qualification and taxation of Host REIT as a REIT
under the Code following the REIT Conversion. The receipt of this opinion
letter is a condition to the REIT Conversion and each of the Mergers. See
"Federal Income Tax Consequences--Summary of Tax Opinions" in the Consent
Solicitation.
Each opinion provided by Hogan & Hartson in the opinion letter that is
substantially in the form of Appendix C to the Consent Solicitation is
applicable to the MDAH Limited Partners.
The opinions already rendered by Hogan & Hartson are based on the Code and
Treasury Regulations in effect on the date hereof, current administrative
interpretations and positions of the IRS and existing court decisions, and the
opinions to be rendered by Hogan & Hartson on the Effective Date will be based
on the same authorities as of the Effective Date. No assurance can be given
that future legislation, Treasury Regulations, administrative interpretations
and court decisions will not significantly change the law or the above
conclusions reached by counsel. In addition, any such change could apply
retroactively to transactions preceding the date of change. Moreover, opinions
of counsel merely represent counsel's best judgment with respect to the
probable outcome on the merits and are not binding on the IRS or the courts.
Accordingly, even if there is no change in applicable law, no assurance can be
provided that such opinions (which do not bind the IRS or the courts) will not
be challenged by the IRS or will be sustained by a court if so challenged.
With the one exception described below (see "--Tax Consequences of the
Merger--Deemed Cash Distribution and Resulting Taxable Gain") and in the
Consent Solicitation under "Federal Income Tax Consequences--Tax Consequences
of the Mergers--IRS Ruling Request Regarding Allocation of Partnership
Liabilities," neither Host REIT, the Operating Partnership nor the General
Partners have requested or plan to request any rulings from the IRS concerning
the tax consequences of the Mergers or the treatment of either the Operating
Partnership or Host REIT subsequent to the REIT Conversion.
Tax Consequences of the Merger
Overview. Hogan & Hartson has provided an opinion to the effect that the
Merger will not result in the recognition of taxable gain or loss at the time
of the Merger to an MDAH Limited Partner (i) who does not exercise his Unit
Redemption Right on a date sooner than the date two years after the date of
the consummation of the Merger; (ii) who does not receive a cash distribution
(or a deemed cash distribution resulting from relief from liabilities,
including as a result of any prepayment of the MDAH Mortgage Debt) in
connection with the Merger or the REIT Conversion in excess of his aggregate
adjusted basis in his MDAH Partnership Units at the time of the Merger; (iii)
who does not elect to receive a Note in exchange for his OP Units in
connection with the Merger (the "Note Election"); (iv) who is not required to
recognize gain by reason of the exercise by another MDAH Limited Partner of
his right to make the Note Election; and (v) who does not have his "at risk"
amount fall below zero as a result of the Merger or the REIT Conversion. See
"Federal Income Tax Consequences--Summary of Tax Opinions" in the Consent
Solicitation.
With respect to the foregoing exceptions to nonrecognition treatment, the
Operating Partnership and the General Partner believe as follows: (i) an MDAH
Limited Partner who acquired his MDAH Partnership Units in
MDAH Supp-27
<PAGE>
the original offering of such Partnership Units and who has held such
Partnership Units at all times since would not be considered to receive, as a
result of the Merger, a distribution (or a deemed cash distribution resulting
from relief from liabilities) that exceeds his aggregate adjusted basis in his
MDAH Partnership Units at the time of the Merger, and would not have his "at
risk" amount fall below zero as a result of the Merger, even if all of the
MDAH Mortgage Debt were to be repaid in connection with the Merger or the REIT
Conversion, and (ii) none of the personal property owned by MDAH will need to
be sold to a Non-Controlled Subsidiary in connection with the REIT Conversion.
See "Federal Income Tax Consequences--Tax Consequences of the Mergers--
Overview" in the Consent Solicitation.
With respect to the effects of an MDAH Limited Partner's election to receive
a Note in exchange for his OP Units in connection with the Merger, Hogan &
Hartson is of the opinion that although the matter is not free from doubt, an
MDAH Limited Partner who does not make the Note Election should not be
required to recognize gain by reason of another MDAH Limited Partner's
exercise of such right. With respect to the exercise of a Unit Redemption
Right, Hogan & Hartson is of the opinion that it is more likely than not that
an MDAH Limited Partner's exercise of his Unit Redemption Right more than one
year after the date of consummation of the Merger but less than two years
after such date will not cause the Merger itself to be a taxable transaction
for the MDAH Limited Partner (or the other MDAH Limited Partners). See
"Federal Income Tax Consequences--Summary of Tax Opinions" in the Consent
Solicitation. Opinions of counsel, however, do not bind the IRS or the courts,
and no assurances can be provided that such opinions will not be challenged by
the IRS or will be sustained by a court if so challenged.
Deemed Cash Distribution and Resulting Taxable Gain. With respect to his
MDAH Partnership Units, an MDAH Limited Partner will receive no actual cash
distribution in connection with the Merger but would be deemed to receive a
cash distribution in connection with the Merger to the extent that his share
of Operating Partnership liabilities immediately after the Merger and the REIT
Conversion is less than his share of MDAH liabilities immediately prior to the
Merger. For example, any prepayment of the MDAH Mortgage Debt or debt
encumbering other Hotels may result in a deemed cash distribution to the MDAH
Limited Partners. See "Federal Income Tax Consequences--Tax Consequences of
the Mergers--Relief from Liabilities/Deemed Cash Distribution" in the Consent
Solicitation. Even though the MDAH Mortgage Debt and the debt encumbering the
other Hotels is not expected to be repaid or refinanced in connection with the
Mergers and the REIT Conversion (except as described in the Consent
Solicitation), an MDAH Limited Partner's share of indebtedness following the
Mergers and the REIT Conversion may nonetheless decrease in comparison to the
Limited Partner's estimated aggregate share of MDAH indebtedness as of
December 31, 1998 (calculated based on the assumption that the Mergers did not
occur) by reason of the manner in which the debt allocation rules work when
multiple assets with different levels of leverage are consolidated into a
single partnership.
An MDAH Limited Partner, however, would recognize taxable gain as a result
of any deemed cash distribution only to the extent that the deemed cash
distribution were to exceed his adjusted tax basis in his MDAH Partnership
Units immediately prior to the Merger. As noted above, the Operating
Partnership and the General Partner believe, based upon and subject to the
assumptions and other limitations described below, that an MDAH Limited
Partner who acquired his MDAH Partnership Units in the original offering of
such Partnership Units and has held the Partnership Units at all times since
the offering will have an adjusted tax basis in excess of the deemed cash
distribution that might occur in connection with the Merger and the REIT
Conversion, even if all MDAH Mortgage Debt were to be repaid. Therefore, such
an MDAH Limited Partner should not recognize gain due to such deemed cash
distribution resulting from the relief from liabilities in connection with the
Merger and the REIT Conversion.
The adjusted tax basis of an MDAH Limited Partner who did not acquire his
MDAH Partnership Units in the original offering of such Partnership Units or
who has not held his MDAH Partnership Units at all times since such offering
could vary materially from that of an MDAH Limited Partner who did so. If an
MDAH Limited Partner has an adjusted tax basis in his MDAH Partnership Units
(per MDAH Partnership Unit) that is substantially less than the adjusted tax
basis of an MDAH Limited Partner who acquired his MDAH Partnership
MDAH Supp-28
<PAGE>
Units in the original offering of such Partnership Units and has held such
Partnership Units at all times since, he could recognize gain due to any
deemed cash distribution resulting from the relief from liabilities in
connection with the Merger and the REIT Conversion.
The Operating Partnership has no current plan or intention to cause the
prepayment of the MDAH Mortgage Debt as part of the Merger and the REIT
Conversion or, except as described in the Consent Solicitation, any of the
nonrecourse liabilities encumbering the Hotels owned by the other
Partnerships. The Operating Partnership, however, will have to repay mortgage
indebtedness securing the Hotels owned by the Partnerships at the time such
indebtedness matures (including the MDAH Mortgage Debt which will mature on
December 15, 1999). There can be no assurance that at the time of any such
refinancing the Operating Partnership will be able to secure nonrecourse
mortgage indebtedness secured only by those Hotels in an amount sufficient to
avoid a deemed cash distribution to the former Limited Partners in certain of
those Partnerships, including MDAH in connection with the refinancing of the
MDAH Mortgage Debt (although such a deemed distribution of cash may or may not
result in the recognition of taxable income or gain by the former MDAH Limited
Partners). Moreover, the Operating Partnership's current long-term financing
strategy is to have as little debt as possible that is secured by individual
Hotels and to have as much debt as possible in the form of unsecured debt,
held either by the public or by institutional investors, which debt may or may
not be recourse to Host REIT, as general partner of the Operating Partnership.
In view of these considerations and the potential adverse consequences to
Limited Partners in certain Partnerships, the Operating Partnership has
requested from the IRS a ruling to the effect that such unsecured indebtedness
of the Operating Partnership that is issued initially to institutional
investors and is not recourse to Host REIT (i) would qualify as "nonrecourse
liabilities" for purposes of Code Section 752, (ii) to the extent the proceeds
thereof are applied to repay existing nonrecourse mortgage indebtedness
secured by one or more Hotels (including the MDAH Mortgage Debt), would be
considered to be "secured" by those Hotels for purposes of allocating the
liabilities for tax basis purposes (and thus would be allocable, at least in
substantial part, to the former Limited Partners in the Partnerships owning
those Hotels, including the MDAH Limited Partners), and (iii) would constitute
"qualified nonrecourse financing" secured by such Hotels for purposes of Code
Section 465. The IRS has recently issued a ruling to that effect to another
taxpayer, and has indicated to the Operating Partnership's representatives
that it is favorably inclined to issue that ruling to the Operating
Partnership.
Section 465(e) Recapture. As discussed in the Consent Solicitation, see
"Federal Income Tax Consequences--Tax Consequences of the Mergers--Section
465(e) Recapture," the "at risk" rules of Section 465 of the Code generally
apply to limit the use of partnership losses by a partner. Under Section
465(e) of the Code, a partner may be required to include in gross income, or
"recapture," losses previously allowed to such partner with respect to his
investment in a partnership if the amount for which the partner is "at risk"
in relation to his investment in the partnership is less than zero at the
close of the taxable year.
It is possible that the consummation of the Mergers and the REIT Conversion
or the repayment of certain "qualified nonrecourse financing" of the Operating
Partnership, the Hotel Partnerships or the Hotels contributed to the Operating
Partnership by the Blackstone Entities at the time of or following the Mergers
and the REIT Conversion could, singularly or in combination, cause an MDAH
Limited Partner's amount at risk in relation to his investment in MDAH (and,
after the Mergers, in the Operating Partnership) to be reduced below zero,
resulting in an income inclusion to the Limited Partner under Section 465(e)
of the Code. Currently, a sufficient portion of the current debt of MDAH
constitutes "qualified nonrecourse financing" so that the MDAH Limited
Partners have positive at risk amounts, and the Operating Partnership expects
that most of the current debt with respect to the other Hotel Partnerships and
the Hotels contributed by the Blackstone Entities that will be assumed by the
Operating Partnership as part of the Mergers and the REIT Conversion should
qualify as "qualified nonrecourse financing." The Operating Partnership and
the General Partner believe, based upon and subject to the assumptions and
other limitations described below, that an MDAH Limited Partner who acquired
his MDAH Partnership Units in the original offering of such Partnership Units
and has held the Partnership Units at all times since will have a positive at
risk amount immediately following the Merger and the REIT Conversion, even if
all of the MDAH Mortgage Debt were to be repaid in connection with the Merger
and the REIT Conversion and
MDAH Supp-29
<PAGE>
the MDAH Limited Partners were to have no share of any other "qualified
nonrecourse financing" following the Merger and the REIT Conversion.
It is possible, however, that a former MDAH Limited Partner's at risk amount
could decline in the future, either because of the allocation of losses from
the Operating Partnership to that former MDAH Limited Partner or because of
cash distributions by the Operating Partnership to that former MDAH Limited
Partner in excess of the taxable income allocable to him with respect to his
OP Units. In that event, it may be necessary for the former MDAH Limited
Partner to have a share of "qualified nonrecourse financing" from the
Operating Partnership in order to avoid recognizing income by reason of his at
risk amount falling below zero. Moreover, there can be no assurance that debt
incurred by the Operating Partnership in the future to refinance the MDAH
Mortgage Debt or outstanding mortgage debt of the other Hotel Partnerships or
the Hotels contributed by the Blackstone Entities will qualify as "qualified
nonrecourse financing." If, however, the Operating Partnership were to obtain
the requested ruling from the IRS and were to refinance existing mortgage
indebtedness of the Partnerships with the type of indebtedness described in
the ruling, such indebtedness should constitute "qualified nonrecourse
financing" for purposes of the "at risk" rules.
Impact of Assumption of MDAH Liabilities by the Operating Partnership. As
described in the Consent Solicitation, see "Federal Income Tax Consequences--
Tax Consequences of the Mergers--Disguised Sale Regulations," an MDAH Limited
Partner will recognize gain to the extent he is treated as having sold all or
part of his MDAH Partnership Interest in a "disguised sale." For purposes of
these rules, certain reductions in a partner's share of partnership
liabilities are treated as a transfer of money or other property from the
partnership to the partner which may give rise to a disguised sale, even if
that reduction would not otherwise result in a taxable deemed cash
distribution in excess of the partner's basis in his partnership interest.
However, if a transfer of property by a partner to a partnership is not
otherwise treated as part of a disguised sale, then any reduction in the
partner's share of "qualified liabilities" also will not be treated as part of
a disguised sale. A "qualified liability" in connection with a transfer of
property to a partnership includes (i) any liability incurred more than two
years prior to the earlier of the transfer of the property or the date the
partner agrees in writing to the transfer, as long as the liability has
encumbered the transferred property throughout the two-year period; (ii) a
liability that was not incurred in anticipation of the transfer of the
property to a partnership, but that was incurred by the partner within the
two-year period prior to the earlier of the date the partner agrees in writing
to transfer the property or the date the partner transfers the property to a
partnership and that has encumbered the transferred property since it was
incurred; (iii) a liability that is traceable under the Treasury Regulations
to capital expenditures with respect to the property; and (iv) a liability
that was incurred in the ordinary course of the trade or business in which
property transferred to the partnership was used or held, but only if all the
assets related to that trade or business are transferred, other than assets
that are not material to a continuation of the trade or business. However, a
recourse liability is not a "qualified liability" unless the amount of the
liability does not exceed the fair market value of the transferred property
(less any other liabilities that are senior in priority and encumber such
property or any allocable liabilities described in (iii) or (iv), above) at
the time of transfer.
The General Partner and the Operating Partnership believe, based upon their
review of the facts and circumstances surrounding such liability, that all
liabilities of MDAH fall into one of the four categories of "qualified
liabilities" described above and, accordingly, that the mere assumption by the
Operating Partnership of the outstanding liabilities of MDAH will not give
rise to a "disguised sale" by any of the MDAH Limited Partners.
Tax Treatment of MDAH Limited Partners Who Hold OP Units Following the Merger
Initial Basis in Units. In general, an MDAH Limited Partner will have an
initial tax basis in his OP Units received in the Merger with respect to his
MDAH Partnership Units equal to the basis in his MDAH Partnership Units at the
time of the Merger, reduced to reflect any deemed cash distributions resulting
from a reduction in his share of MDAH liabilities and increased to reflect his
share of other liabilities of the Operating Partnership and any gain required
to be recognized in connection with the Merger and the REIT Conversion. For a
discussion of the federal income tax consequences for an MDAH Limited Partner
from a reduction in basis that may result
MDAH Supp-30
<PAGE>
from the Merger and the REIT Conversion, see "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--Initial Tax Basis of OP Units" in the Consent Solicitation.
Tax Allocations by the Operating Partnership upon a Sale of MDAH
Hotels. Pursuant to Section 704(c) of the Code, income, gain, loss and
deduction attributable to appreciated or depreciated property that is
contributed to a partnership must be allocated for federal income tax purposes
in a manner such that the contributor is charged with, or benefits from, the
unrealized gain or unrealized loss associated with the property at the time of
contribution. The amount of such unrealized gain or unrealized loss is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution (referred to as the "Book-Tax
Difference"). The Operating Partnership and the General Partner estimate,
based upon and subject to the assumptions and other limitations described
below, that the Book-Tax Difference for all MDAH Limited Partners (but
excluding all of Host's interests) with respect to the MDAH Hotels will be
$28,255,544 upon the consummation of the Merger.
If the Operating Partnership were to sell all of the MDAH Hotels, the former
partners of MDAH (including Host REIT with respect to the interest in MDAH
held indirectly by Host through the General Partner) would be specially
allocated by the Operating Partnership an aggregate amount of taxable gain
equal to the aggregate Book-Tax Difference with respect to the MDAH Hotels.
The share of such gain allocable to an MDAH Limited Partner who acquired his
MDAH Partnership Units in the original offering of such Partnership Units and
held such Partnership Units at all times since would be $71,015 per MDAH
Partnership Unit for a Limited Partner who acquired his Partnership Units for
cash ($76,165 if such Limited Partner elected to reduce his basis in his MDAH
Partnership Units in lieu of recognizing cancellation of indebtedness income
in 1993), and $71,953 per MDAH Partnership Unit for a Limited Partner who
acquired his Partnership Units pursuant to the installment purchase plan
($77,105 if such Limited Partner elected to reduce his basis in his MDAH
Partnership Units in lieu of recognizing cancellation of indebtedness income
in 1993). The share of such gain of an MDAH Limited Partner who did not
acquire his MDAH Partnership Units in the original offering of such
Partnership Units or who has not held his MDAH Partnership Units at all times
since such offering could vary materially from these amounts. If the Operating
Partnership were to sell an MDAH Hotel with a Book-Tax Difference, the
remaining Book-Tax Difference at the time the Hotel is sold would be required
to be allocated exclusively to the former MDAH Limited Partners and the
General Partner, even though the proceeds of such sale would be allocated
proportionately among all the partners in the Operating Partnership (and would
likely be retained by the Operating Partnership, rather than distributed to
holders of OP Units and Common Shares of Host REIT). The MDAH Limited Partners
would not be entitled to any special distributions from the Operating
Partnership in connection with such a sale, and thus would not necessarily
receive cash distributions from the Operating Partnership sufficient to pay
such additional taxes. Although the Partnership Agreement does not impose any
restrictions upon the Operating Partnership preventing it from causing the
sale of any or all of the MDAH Hotels at any time following the Merger, the
Operating Partnership does not have current plans to pursue a sale of any of
the MDAH Hotels. See "Federal Income Tax Consequences--Tax Treatment of
Limited Partners Who Hold OP Units Following the Mergers--Sale of Individual
Hotels" in the Consent Solicitation.
Tax Allocations with Respect to Contributed Hotels Generally. The tax
allocations of depreciation to the MDAH Limited Partners may change
significantly as a result of the Mergers and the REIT Conversion for two
reasons. First, as described above, pursuant to Section 704(c) of the Code,
depreciation and deductions attributable to the MDAH Hotels will be required
to be allocated for federal income tax purposes in a manner such that the MDAH
Limited Partners are charged with the Book-Tax Difference associated with the
MDAH Hotels at the time of the consummation of the Merger. Consequently, an
MDAH Limited Partner will be allocated less depreciation with respect to the
MDAH Hotels than would be the case if the Mergers had not occurred and the
MDAH Limited Partner had continued to hold his MDAH Partnership Units. (On the
other hand, a former MDAH Limited Partner will be allocated depreciation with
respect to other Hotels acquired by the Operating Partnership in connection
with the Mergers and the REIT Conversion, including the Hotels owned
MDAH Supp-31
<PAGE>
by the other Hotel Partnerships and the Hotels being contributed to the
Operating Partnership by Host and the Blackstone Entities in connection with
the Mergers and the REIT Conversion.) Second, the Mergers will cause the
technical termination under Section 708(b)(1)(B) of the Code of MDAH and most
of the other Hotel Partnerships that participate in the Mergers. Section
168(i)(7) of the Code provides, in effect, that when a partnership terminates
under Section 708(b)(1)(B) of the Code, the partnership must begin new
depreciation periods for its property. As a result, the remaining bases of the
real estate components of the MDAH Hotels and the Hotels held by the other
Hotel Partnerships that terminate will be depreciated over 39 years, rather
than over the remaining current lives of such Hotels (which range from less
than one year to 39 years). See "Federal Income Tax Consequences--Tax
Treatment of Limited Partners Who Hold OP Units Following the Mergers--Effect
of Mergers on Depreciation" in the Consent Solicitation.
In light of the complexity of the governing rules affecting the calculation
and allocation of depreciation with respect to properties contributed to a
partnership, particularly when a number of those properties are subject to the
separate adjustments required in connection with a technical termination under
Section 708 of the Code, the number of Hotels that the Operating Partnership
will be acquiring in connection with the Mergers and the REIT Conversion, and
the impact on these calculations of other outside events, including equity
offerings by Host or Host REIT and other acquisitions undertaken by Host, Host
REIT or the Operating Partnership prior to or in connection with the REIT
Conversion, the Operating Partnership and the General Partner believe that it
is impossible to predict with any degree of precision the impact that the
Mergers and the REIT Conversion will have on the future depreciation (and,
consequently, the amount of taxable income) allocable to an MDAH Limited
Partner.
Special Depreciation Adjustment for Certain MDAH Limited
Partners. Currently, MDAH is reporting on an annual basis to the MDAH Limited
Partners each Limited Partner's proportionate share of depreciation from
MDAH's depreciable real property to assist those MDAH Limited Partners who
elected to exclude from their taxable income certain discharge of indebtedness
income realized by MDAH in taxable year 1993 (and thus to reduce their
adjusted basis in their MDAH Partnership Units). At this time, there is no
administrative guidance regarding the impact of the Merger upon the MDAH
Limited Partners who made the election to exclude such income. In the absence
of such guidance, it is impossible for the Operating Partnership and the
General Partner to predict the tax treatment of such MDAH Limited Partners
resulting from the Merger. More specifically, it is unclear how the MDAH
Limited Partners should account for the basis adjustments following the
Merger. One possible approach might be to continue to recognize as income each
year the depreciation that would have been foregone with respect to the MDAH
Hotels by reason of the basis adjustment if the Merger had not occurred. There
can be no assurance, however, that this method is the correct approach for
dealing with the basis adjustments following the Merger. It is important that
each MDAH Limited Partner who elected to adjust his basis in his Partnership
Units in lieu of recognizing cancellation of indebtedness income in 1993
consult with his personal tax advisors as to how to deal with these basis
adjustments following the Merger. If MDAH participates in the Merger, the
Operating Partnership will provide an annual report to the former MDAH Limited
Partners showing the proportionate share of depreciation from MDAH's
depreciable property that would have been reported to the MDAH Limited
Partners by MDAH if the Merger had not occurred.
Impact on Passive Activity Losses of an Investment in a Publicly Traded
Partnership. The passive loss limitation rules generally provide that
individuals, estates, trusts and certain closely held corporations and
personal service corporations can only deduct losses from passive activities
(generally activities in which the taxpayer does not materially participate,
which would include the Operating Partnership for MDAH Limited Partners) to
the extent that such losses are not in excess of the taxpayer's income from
passive activities or investments. An MDAH Limited Partner would be able to
offset losses from other passive activities against income from the Operating
Partnership that is considered passive income (but not portfolio income) so
long as the Operating Partnership is not treated as a publicly traded
partnership. The Operating Partnership and the General Partner believe,
however, that there is a substantial risk that the Operating Partnership will
be treated as a publicly traded partnership for purposes of the passive loss
limitation rules. In this event, any losses or deductions of the Operating
Partnership allocable to an MDAH Limited Partner after the Merger could not be
MDAH Supp-32
<PAGE>
used to offset passive income from other passive activities. Similarly, losses
from other passive activities (including losses attributable to MDAH for
periods prior to the Merger) could not be applied to offset income of the
Operating Partnership allocated to an MDAH Limited Partner. An MDAH Limited
Partner, however, would be able to offset any passive losses from his
investment in MDAH (or other investments) against any gain recognized by the
MDAH Limited Partner as a result of the Merger. The Operating Partnership and
the General Partner estimate that, as of December 31, 1998, an MDAH Limited
Partner who acquired his MDAH Partnership Units in the original offering of
such Partnership Units, has held those Partnership Units continuously since
that time, and whose Partnership Units have been his only investment in a
passive activity would have a passive activity loss carryforward of
approximately $8,184, on a per Partnership Unit basis, for an MDAH Limited
Partner whose MDAH Partnership Units were acquired for cash (approximately
$24,744 if such Limited Partner elected to reduce his basis in his MDAH
Partnership Units in lieu of recognizing cancellation of indebtedness income
in 1993), and approximately, $31,562, on a per Partnership Unit basis, for an
MDAH Limited Partner whose MDAH Partnership Units were acquired pursuant to
the installment purchase plan (approximately $36,714 if such Limited Partner
elected to reduce his basis in his MDAH Partnership Units in lieu of
recognizing cancellation of indebtedness income in 1993).
State and Local Taxes. MDAH Limited Partners holding OP Units will be
subject to state and local taxation in a number of jurisdictions in which the
Operating Partnership directly or indirectly holds real property and would be
required to file periodic tax returns in those jurisdictions. In this regard,
immediately following the Mergers and the REIT Conversion, the Operating
Partnership expects that it will own properties in approximately 28 states
across the United States and in the District of Columbia. Currently, MDAH
owns, directly and indirectly, properties in only five states. See "Federal
Income Tax Consequences--Tax Treatment of Limited Partners Who Hold OP Units
Following the Mergers--State and Local Taxes" in the Consent Solicitation.
Assumptions Used in Determining Tax Consequences of the Merger
In preparing the discussion set forth above, the Operating Partnership and
the General Partner made several key assumptions, which are described below.
If any such assumption is not accurate with respect to a particular MDAH
Limited Partner, the tax consequences of the Merger to such Limited Partner
could be substantially different from those reflected above. ACCORDINGLY, EACH
MDAH LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX ADVISORS TO
DETERMINE THE IMPACT OF SUCH MDAH LIMITED PARTNER'S PARTICULAR TAX SITUATION
ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER.
First, with respect to an MDAH Limited Partner's basis in his MDAH
Partnership Units prior to the Merger, the Operating Partnership and the
General Partner assumed that an MDAH Limited Partner acquired his MDAH
Partnership Units in the original offering of such Partnership Units and has
held such Partnership Units at all times since the offering (the "Original
Limited Partner's Adjusted Basis"). In general, each MDAH Limited Partner had
an initial tax basis in his MDAH Partnership Units ("Initial Basis") equal to
his cash investment in MDAH (plus his proportionate share of MDAH's
nonrecourse liabilities at the time he acquired his MDAH Partnership Units).
An MDAH Limited Partner's Initial Basis generally has been increased by (a)
such Limited Partner's share of MDAH taxable income and (b) any increases in
his share of the liabilities of MDAH. Generally, such Limited Partner's
Initial Basis has been decreased (but not below zero) by (i) his share of MDAH
cash distributions, (ii) any decreases in his share of liabilities of MDAH,
(iii) his share of losses of MDAH and (iv) his share of nondeductible
expenditures of MDAH that are not chargeable to capital. If an MDAH Limited
Partner has an adjusted tax basis in his MDAH Partnership Units that is less
than the tax basis of an MDAH Limited Partner who acquired his MDAH
Partnership Units in the original offering of such Partnership Units and has
held such Partnership Units at all times since, the Merger might result in the
receipt by the MDAH Limited Partner of a deemed distribution of cash in excess
of his adjusted tax basis in his MDAH Partnership Units, which could result in
the recognition of income or gain.
The General Partner has set forth on Appendix E to the Consent Solicitation
for MDAH (i) the Original Limited Partner's Adjusted Basis as of December 31,
1997 for each such MDAH Limited Partner, and (ii) an
MDAH Supp-33
<PAGE>
estimate of such MDAH Limited Partner's Original Limited Partner's Adjusted
Basis as of December 31, 1998 (computed without regard to the Mergers and
based upon the assumptions set forth in Appendix E to the Consent
Solicitation). The General Partner also has set forth on Appendix E to the
Consent Solicitation for each MDAH Limited Partner whose adjusted basis in his
MDAH Partnership Interest is the same as the Original Limited Partner's
Adjusted Basis (i) the MDAH liabilities allocable to such MDAH Limited Partner
as of December 31, 1997, and (ii) an estimate of the MDAH liabilities
allocable to such Limited Partner as of December 31, 1998 (computed without
regard to the Mergers and based upon the assumptions set forth in Appendix E
to the Consent Solicitation). Each of these estimates is shown separately for
those MDAH Limited Partners who acquired their Partnership Units at the time
of the original offering pursuant to an installment purchase plan and reflects
any adjustments attributable to an MDAH Limited Partner's election to reduce
his basis in his MDAH Partnership Units in lieu of recognizing cancellation of
indebtedness income in 1993.
The adjusted tax basis of an MDAH Limited Partner who did not acquire his
MDAH Partnership Units in the original offering of such Partnership Units
could vary materially from that of an MDAH Limited Partner who did so for
various reasons. If an MDAH Limited Partner has an adjusted tax basis in his
MDAH Partnership Units that is less than the Original Limited Partner's
Adjusted Tax Basis, the Merger might result in the receipt by the MDAH Limited
Partner of a deemed distribution of cash in excess of his adjusted tax basis
in his MDAH Partnership Units, which could result in the recognition of income
or gain.
Finally, the Operating Partnership and the General Partner assumed that the
Merger will be treated for federal income tax purposes as the transfer by the
MDAH Limited Partners of their interests in the Partnership to the Operating
Partnership in exchange for OP Units. There can be no assurance, however, that
the IRS will not seek to recharacterize each Merger as either (i) the
liquidation of a Partnership followed by the distribution by the Partnership
of its assets to its partners and the subsequent transfers by such partners of
such assets to the Operating Partnership in exchange for OP Units, or (ii) the
transfer by a Partnership of its assets to the Operating Partnership in
exchange for OP Units (and possibly Notes) and the subsequent distribution of
such OP Units (and possibly Notes) to its partners. If the Merger is
recharacterized in the manner described in (ii) in the preceding sentence, the
tax consequences of the Merger to the MDAH Limited Partners likely would be
materially affected.
EACH MDAH LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX
ADVISORS TO DETERMINE THE IMPACT OF SUCH MDAH LIMITED PARTNER'S PARTICULAR TAX
SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER.
THE TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER TO A PARTICULAR MDAH
LIMITED PARTNER COULD VARY SUBSTANTIALLY FROM THE CONSEQUENCES DESCRIBED
ABOVE.
Tax Treatment of MDAH Limited Partners Who Exercise Their Right to Make the
Note Election
An MDAH Limited Partner who exercises his right to make the Note Election
and receive a Note in connection with the Merger will be treated as having
made a taxable disposition of his OP Units. The amount realized in connection
with such disposition will equal the sum of the "issue price" of the Note
(i.e., the face amount of the Note, currently estimated as $98,343 per MDAH
Partnership Unit) plus the portion of the MDAH liabilities allocable to the
MDAH Limited Partner for federal income tax purposes immediately prior to the
disposition of the OP Units (estimated as $155,313 per MDAH Partnership Unit
as of December 31, 1998). To the extent the amount realized exceeds the MDAH
Limited Partner's adjusted basis in his MDAH Partnership Units, the MDAH
Limited Partner will recognize gain. The Operating Partnership and the General
Partner estimate (assuming the MDAH Limited Partner acquired his MDAH
Partnership Units at the time of the original offering and has held such
Partnership Units at all times since the offering) that the amount of gain
that would be recognized by an MDAH Limited Partner who made the Note Election
would be approximately $60,140 per MDAH Partnership Unit, as of December 31,
1998, if such Partnership Unit was acquired for cash ($65,292 if such Limited
Partner elected to reduce his basis in his MDAH Partnership Units in lieu of
recognizing cancellation of indebtedness income in 1993), and $61,080 per MDAH
Partnership Unit if such Partnership Unit
MDAH Supp-34
<PAGE>
was acquired pursuant to an installment purchase plan ($66,232 if such Limited
Partner elected to reduce his basis in his MDAH Partnership Units in lieu of
recognizing cancellation of indebtedness income in 1993). For a discussion of
the federal income tax rates applicable to the net capital gain from the sale
of a capital asset, see "Federal Income Tax Consequences--Tax Treatment of
Limited Partners Who Hold OP Units Following the Merger--Disposition of OP
Units by Limited Partners" in the Consent Solicitation. In this regard, the
General Partner estimates that, as of December 31, 1998, if MDAH sold all of
its Hotels in a fully taxable transaction for a net amount, after payment of
liabilities, equal to the Liquidation Value of MDAH, the "unrecognized Section
1250 gain" per MDAH Partnership Unit would be $32,941 if such Partnership Unit
were acquired for cash ($31,333 if such Limited Partner elected to reduce his
basis in his MDAH Partnership Units in lieu of recognizing cancellation of
indebtedness income in 1993), and $32,941 per MDAH Partnership Unit if such
Partnership Unit were acquired pursuant to an installment purchase plan
($31,333 if such Limited Partner elected to reduce his basis in his MDAH
Partnership Units in lieu of recognizing cancellation of indebtedness income
in 1993) and the gain subject to tax as ordinary income under Code Section
1245 per MDAH Partnership Unit would be $6,352 if such Partnership Unit was
acquired for cash ($6,236 if such Limited Partner elected to reduce his basis
in his MDAH Partnership Units in lieu of recognizing cancellation of
indebtedness income in 1993), and $6,352 per MDAH Partnership Unit if such
Partnership Unit was acquired pursuant to an installment purchase plan ($6,236
if such Limited Partner elected to reduce his basis in his MDAH Partnership
Units in lieu of recognizing cancellation of indebtedness income in 1993). An
MDAH Limited Partner who makes the Note Election would be able to treat any
per Partnership Unit passive activity loss carryforward with respect to the
activities of MDAH, to the extent the sum of such losses exceeds his passive
activity income for 1998, as losses that are not from a passive activity and,
therefore, not subject to the passive activity loss limitation rules. For
purposes of determining the gain recognized by a Limited Partner as a result
of making the Note Election, an Original Limited Partner's Adjusted Basis does
not reflect such Limited Partner's share of the syndication costs incurred by
his Partnership at formation. An original MDAH Limited Partner's share of
syndication costs was $11,559 per MDAH Partnership Unit.
An MDAH Limited Partner who elects to receive a Note may be eligible to
defer at least a portion of that gain under the "installment sale" rules.
Those rules, however, will not permit the MDAH Limited Partner to defer all of
the gain, and, to the extent that the face amount of the Note (and any other
installment obligations received by the taxpayer during the year) outstanding
at the end of the taxable year in which the Merger occur exceeds $5,000,000,
will require that the MDAH Limited Partner who defers gain pay to the IRS
interest on the resulting tax that has been deferred. The MDAH Limited Partner
will not be eligible to defer gain recognized upon the receipt of the Note to
the extent that his share of MDAH liabilities at the time of the Merger
exceeds his adjusted tax basis in his MDAH Partnership Units immediately prior
to the Merger (that is, to the extent that he has a "negative capital account"
for tax purposes). In addition, the MDAH Limited Partner will not be eligible
to defer gain to the extent that such gain would be taxed as ordinary income
under Sections 1245 and 1250 of the Code. Lastly, if an MDAH Limited Partner
disposes of his Note, any gain that had been deferred would be recognized in
the year of disposition.
THE SPECIFIC TAX ATTRIBUTES OF A PARTICULAR MDAH LIMITED PARTNER COULD HAVE
A MATERIAL IMPACT ON THE TAX CONSEQUENCES OF THE MERGER, AND THE SUBSEQUENT
OWNERSHIP AND DISPOSITION OF NOTES. THEREFORE, IT IS ESSENTIAL THAT MDAH
LIMITED PARTNERS CONSIDERING ELECTING TO RECEIVE NOTES CONSULT WITH THEIR OWN
TAX ADVISORS WITH REGARD TO THE APPLICATION OF THE FEDERAL INCOME TAX LAWS TO
SUCH MDAH LIMITED PARTNERS' RESPECTIVE PERSONAL TAX SITUATIONS, AS WELL AS ANY
TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY STATE, LOCAL, OR FOREIGN TAXING
JURISDICTION.
Tax Consequences if MDAH Does Not Participate in the Merger
If MDAH does not participate in the Merger, the MDAH Limited Partners would
not have any tax consequences resulting from the Merger. The consequences of
continued ownership of MDAH Partnership Units will be the same as would have
resulted if the Merger had not been proposed.
MDAH Supp-35
<PAGE>
* * *
The above description is not exhaustive of all possible tax considerations
associated with the Merger and the REIT Conversion. This summary does not
discuss foreign tax considerations, nor does it discuss all of the aspects of
federal income taxation or state and local taxation that may be relevant to
MDAH Limited Partners in light of their particular circumstances. EACH MDAH
LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX ADVISORS TO
DETERMINE THE IMPACT OF SUCH MDAH LIMITED PARTNER'S PARTICULAR TAX SITUATION
ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER.
MDAH Supp-36
<PAGE>
SELECTED FINANCIAL DATA
The following table presents selected historical financial data derived from
the audited financial statements for the five most recent fiscal years in the
period ended December 31, 1997, the unaudited condensed financial statements
for the First Two Quarters 1998 and the First Two Quarters 1997. The following
data should be read in conjunction with the audited financial statements and
the notes thereto, Management's Discussion and Analysis of Financial Condition
and Results of Operations and the other financial information included
elsewhere herein.
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS FISCAL YEAR
---------------- -------------------------------------------
1998 1997 1997 1996 1995 1994 1993
------- ------- ------- ------- ------- ------- -------
(UNAUDITED) (AMOUNTS IN THOUSANDS,
EXCEPT PER PARTNERSHIP UNIT)(1)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues.................. $14,521 $12,504 $26,699 $22,374 $19,715 $17,020 $15,148
Operating profit.......... 9,225 7,868 15,433 12,125 10,039 5,658 3,335
Income (loss) before
extraordinary item(2).... 5,396 3,784 6,986 3,418 393 (1,982) 158
Net income (loss)......... 5,396 3,784 6,986 3,418 393 (1,982) 4,152
Distributions:
General partner.......... -- 15 14 19 18 15 --
Limited partners......... -- 1,368 1,368 1,894 1,855 1,419 --
------- ------- ------- ------- ------- ------- -------
Total..................... -- 1,383 1,382 1,913 1,873 1,434 --
Per Partnership Unit(1):
Net income (loss)......... 12,903 9,048 16,705 8,174 940 (4,739) 9,928
Distributions............. -- 3,453 3,453 4,575 4,481 3,428 --
Cash provided by operating
activities............... 7,579 6,180 15,597 11,041 6,990 5,957 --
Cash used in investing
activities............... (920) (1,549) (3,133) (2,752) (1,686) (1,694) (504)
Cash used in financing
activities............... (6,378) (6,236) (14,089) (8,537) (4,898) (4,027) (4,110)
Increase (decrease) in
cash and cash
equivalents.............. 281 (1,605) (1,625) (248) 406 236 (4,614)
Ratio of earnings to fixed
charges (unaudited)(3)... 2.29x 1.90x 1.78x 1.37x 1.04x -- 1.00x
Deficiency of earnings to
fixed charges
(unaudited)(3)........... -- -- -- -- -- 1,982 --
Total assets at book
value.................... 124,009 126,620 129,831 129,918 130,360 133,073 137,310
Cash and cash
equivalents.............. 1,418 1,157 1,137 2,762 3,010 2,604 2,368
Total debt(4)............. 125,822 138,181 137,643 144,374 147,052 150,350 152,489
Total liabilities......... 135,092 146,301 146,310 152,001 153,948 155,181 156,032
Partner's deficit:
Limited partners......... (11,023) (19,534) (16,365) (21,913) (23,403) (21,937) (18,586)
General partner.......... (60) (147) (114) (170) (185) (171) (136)
Book value per Partnership
Unit(1) (unaudited)...... (26,626) (47,184) (39,529) (52,930) (56,529) (52,988) (44,894)
Exchange value per
Partnership Unit(1)
(unaudited)................109,216. -- -- -- -- -- --
</TABLE>
- --------
(1) A Partnership Unit represents a $100,000 original investment in MDAH.
(2) In 1993, the Partnership recorded an extraordinary gain of $3,994,000 for
the forgiveness of accrued incentive management fees in conjunction with
the refinancing of certain debt.
(3) The ratio of earnings to fixed charges is computed by dividing net income
before interest expense and other fixed charges by total fixed charges,
including interest expense, amortization of debt issuance costs and the
portion of rent expense that is deemed to represent interest. Interest
expense in 1993 includes a reduction of $2,884,000 related to rate swap
termination costs. The deficiency of earnings to fixed charges is largely
the result of depreciation and amortization of $6,548,000 in 1994.
(4) Total debt amounts includes amounts due to Host Marriott under Debt
Service guarantees, Notes Payable and Deferred Purchase Debt of
$15,629,000 as of June 19, 1998, June 20, 1997 and December 31, 1997 and
1996, $15,106,000 as of December 31, 1995 and $15,706,000 as of December
31, 1994 and 1993.
MDAH Supp-37
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
Hotel revenues represent house profit of the Hotels since substantially all
of the operating decisions related to the generation of house profit of the
Hotels rest with MHSI. House profit reflects Hotel operating results and
represents gross Hotel sales less property level expenses, excluding
depreciation and amortization, base management fees, property taxes, equipment
rent and certain other costs which are disclosed separately in the statement
of operations.
REVPAR, or revenue per available room, represents the combination of daily
room rate charged and the average daily occupancy achieved and is a commonly
used indicator of hotel performance (although it is not a GAAP, or generally
accepted accounting principles, measure of revenue). REVPAR does not include
food and beverage or other ancillary revenues generated by the properties.
First Two Quarters 1998 Compared to First Two Quarters 1997
Revenues. For the first two quarters 1998, revenues increased $2.0 million
or 16% to $14.5 million when compared to the same period in 1997. The increase
in revenues is primarily due to an 11% increase in REVPAR during the first two
quarters 1998, when compared to the same period in 1997. The increase in
REVPAR resulted primarily from a 12% increase in the combined average room
rate to approximately $115 in the first two quarters 1998 when compared to the
same period in 1997. This was offset by a decrease in the combined average
occupancy of one percentage point to 77% for the first two quarters 1998, when
compared to the same period in 1997.
Operating Costs and Expenses. Operating costs and expenses increased by
$660,000 or 14% to $5.3 million for the first two quarters 1998 when compared
to the same period in 1997. As a percentage of Hotel revenues, Hotel operating
costs and expenses remained at 37% for the first two quarters 1998 and 1997.
Operating Profit. As a result of the changes in revenues and expenses
discussed above, operating profit increased $1.4 million to $9.2 million for
the first two quarters 1998, as compared to the same period in 1997.
Interest Expense. For the first two quarters 1998, interest expense
decreased slightly by one percent when compared to the same period in 1997 due
to principal repayments of mortgage debt.
Net Income. For the first quarters 1998, net income increased $1.6 million
to $5.4 million as compared to the same period in 1997 due to the items
discussed above.
1997 Compared to 1996
Revenues. Revenues increased $4.3 million, or 19% in 1997 to $26.7 million
in 1997 as a result of strong growth in REVPAR of 13%. Hotel sales increased
$5.8 million, or 8%, to $75.3 million in 1997 also reflecting improvements in
REVPAR for the year. The increase in REVPAR was the result of an increase in
average room rates of 10% coupled with a 1.8 percentage point increase in
average occupancy.
Operating Costs and Expenses. Operating costs and expenses increased $1.0
million to $11.3 million in 1997 from $10.2 million in 1996. As a percentage
of Hotel revenues, Hotel operating costs and expenses represented 42% of
revenues for 1997 and 46% in 1996.
Operating Profit. As a result of the changes in revenues and operating costs
and expenses discussed above, operating profit increased $3.3 million to $15.4
million, or 58% of total revenues in 1997 from $12.1 million, or 54% of
revenues in 1996.
Interest Expense. Interest expense decreased $200,000 to $8.9 million in
1997 from $9.1 million in 1996.
MDAH Supp-38
<PAGE>
Net Income. Net income increased $3.6 million to $7.0 million in 1997, due
to the items discussed above.
1996 Compared to 1995
Revenues. Revenues increased $2.7 million, or 13%, to $22.4 million in 1996
from $19.7 million in 1995 as a result of strong growth in REVPAR of 6%. The
increase in REVPAR was primarily the result of a 8% increase in average room
rates offset by a 1.5 percentage point decrease in average occupancy.
Operating Costs and Expenses. Operating costs and expenses increased
$600,000 to $10.2 million, or 46% of Hotel revenues, in 1996 from $9.7
million, or 49% of Hotel revenues, in 1995.
Operating Profit. Operating profit increased $2.1 million to $12.1 million,
or 54% of Hotel revenues, in 1996 from $10.0 million, or 51% of Hotel
revenues, in 1995 due to the changes in Hotel revenues and Hotel operating
costs discussed above.
Interest Expense. Interest expense decreased $1.0 million to $9.1 million in
1996. This decrease can be attributed to a decline in interest rates, as well
as a lower outstanding principal balance due to principal amortization on the
Mortgage Debt.
Net Income. Net income increased to $3.4 million in 1996, from $393,000 in
1995 due to the items discussed above.
CAPITAL RESOURCES AND LIQUIDITY
The Partnership's financing needs have been historically funded through loan
agreements with independent financial institutions. The General Partner
believes that the Partnership will have sufficient capital resources and
liquidity to conduct its operations in the ordinary course of business.
The Partnership is required to maintain the Hotels in good condition. The
hotel management agreement provides for the establishment of a property
improvement fund for each Hotel. Contributions to the property improvement
fund are equal to a percentage of gross Hotel sales. Contributions to the fund
for the Fairview Park, Southfield, Livonia and Fullerton Hotels were 3% for
the years 1995 through 1999 and 4% for the year 2000 and thereafter. The
Dayton Hotel will contribute 4% annually. Annual contributions at the Research
Triangle Park Hotel were 3% through 1997 and will be 4% in 1998 and
thereafter. The Partnership believes that the contributions provide sufficient
reserve for the capital repair and replacement needs of the Hotel in 1998.
However, it is anticipated that shortfalls in the property improvement fund
will occur after 1998. The General Partner will work with the Manager to
resolve the expected shortfall.
For 1997, the Partnership paid a base management fee equal to 3% of gross
sales. No incentive management fees will be accrued by the Partnership or be
considered earned by the manager until the entire mortgage principal balance,
together with accrued interest, is paid in full. No incentive management fees
have been earned by or paid to MHSI since the inception of the Partnership.
Principal Sources and Uses of Cash
The Partnership's principal source of cash is from Hotel operations. Its
principal uses of cash are to pay debt service, fund the property improvement
fund and, until September 1996, make distributions to partners. Cash provided
by operations was $15.6 million, $11.0 million and $7.0 million for the years
ended December 31, 1997, 1996 and 1995, respectively and $7.6 million and $6.2
million for the first two quarters of 1998 and 1997, respectively. The
increase is primarily due to improved Hotel operations.
Cash used in investing activities was $3.1 million, $2.8 million and $1.7
million in 1997, 1996 and 1995, respectively. The Partnership's cash investing
activities consist primarily of contributions to the property improvement fund
and capital expenditures for improvements to existing hotels. Contributions to
the property
MDAH Supp-39
<PAGE>
improvement fund amounted to $2,442,000, $2,558,000 and $2,104,000 for the
years ended December 31, 1997, 1996 and 1995, respectively. Cash used in
investing activities for the first two quarters of 1998 and 1997 was $920,000
and $1,549,000, respectively. Contributions to the property improvement fund
were $1.3 million and $1.1 million for the first two quarters of 1998 and
1997, respectively.
Cash used in financing activities was $14.1 million, $8.5 million and $4.9
million in 1997, 1996 and 1995, respectively. The Partnership's cash financing
activities consist primarily of capital distributions to partners and payments
of the mortgage debt. The increase in cash used in financing activities in
1997 is primarily due to the increased principal amortization in 1997 as
compared to 1996 and 1995 as required under the loan agreement. For the first
two quarters of 1998 and 1997, cash used in financing activities was $6.4
million and $6.2 million, respectively. The increase in cash used during the
first two quarters of 1998 compared to the comparable period in the prior year
is due to increased principal amortization in 1998. Principal payments on the
mortgage debt increased due to improved operations at the hotel.
INFLATION
For the three fiscal years ended December 31, 1997 and the First Two
Quarters 1998, the rate of inflation has been relatively low and, accordingly,
has not had a significant impact to the Partnership's revenues and net income.
The manager is generally able to pass through increased costs to customers
through higher room rates. In 1997, the increase in average room rates at the
Hotels exceeded those of direct competitors as well as the general level of
inflation. The amount of the Partnership's interest expense under floating
rate debt for a particular year will be affected by changes in short-term
interest rates.
YEAR 2000 ISSUES
Over the last few years, Host Marriott, the parent company of the General
Partner, has invested in implementing new accounting systems which are Year
2000 compliant. Accordingly, the General Partner believes that future costs
associated with Year 2000 issues will be minimal and not material to the
Partnership's financial statements.
However, the Partnership does rely upon accounting software used by MHSI,
the manager of its properties to obtain financial information. The General
Partner believes that the manager has begun to implement changes to the
property specific software to ensure the software will function properly in
the Year 2000 and does not expect to incur significant costs related to these
modifications.
MDAH Supp-40
<PAGE>
FINANCIAL STATEMENTS
MDAH Supp-41
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE PARTNERS OF MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.:
We have audited the accompanying balance sheet of Marriott Diversified
American Hotels, L.P. (a Delaware limited partnership) as of December 31, 1997
and 1996, and the related statements of operations, changes in partners'
deficit and cash flows for each of the three years in the period ended
December 31, 1997. These financial statements are the responsibility of the
General Partner's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Marriott Diversified
American Hotels, L.P. as of December 31, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Washington, D.C.
April 8, 1998
MDAH Supp-42
<PAGE>
MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.
BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Property and equipment, net.............................. $108,153 $111,278
Mortgage escrow.......................................... 11,624 5,710
Due from Marriott Hotel Services, Inc.................... 3,714 4,571
Debt service reserve fund................................ 3,000 3,000
Property improvement fund................................ 1,667 1,781
Deferred financing costs, net............................ 536 816
Cash and cash equivalents................................ 1,137 2,762
-------- --------
Total Assets........................................... $129,831 $129,918
======== ========
LIABILITIES AND PARTNERS' DEFICIT
LIABILITIES
Mortgage debt............................................ $122,014 $128,745
Debt service guarantee and related interest payable to
Host Marriott Corporation................................ 19,762 18,600
Note payable and related interest due to the General
Partner................................................. 2,804 2,615
Deferred purchase debt and related interest payable to
Host Marriott Corporation................................ 676 675
Accounts payable and accrued expenses.................... 1,054 1,366
-------- --------
Total Liabilities...................................... 146,310 152,001
-------- --------
Partners' Deficit
General Partner
Capital contribution, net of offering costs of $15...... 403 403
Capital distributions................................... (98) (84)
Cumulative net losses................................... (419) (489)
-------- --------
(114) (170)
-------- --------
Limited Partners
Capital contributions, net of offering costs of $4,785.. 35,830 35,830
Investor notes receivable............................... (966) (966)
Capital distributions................................... (9,738) (8,370)
Cumulative net losses................................... (41,491) (48,407)
-------- --------
(16,365) (21,913)
-------- --------
Total Partners' Deficit................................ (16,479) (22,083)
-------- --------
$129,831 $129,918
======== ========
</TABLE>
See Notes to Financial Statements.
MDAH Supp-43
<PAGE>
MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- --------
<S> <C> <C> <C>
REVENUES
Hotel Revenues (Note 3).......................... $26,699 $22,374 $ 19,715
------- ------- --------
OPERATING COSTS AND EXPENSES
Depreciation and amortization.................... 6,398 6,032 5,534
Base management fee due to Marriott
Hotel Services, Inc.............................. 2,260 2,086 1,944
Property taxes and other......................... 2,608 2,131 2,198
------- ------- --------
11,266 10,249 9,676
------- ------- --------
OPERATING PROFIT................................... 15,433 12,125 10,039
Interest expense................................. (8,944) (9,129) (10,093)
Interest income.................................. 497 422 447
------- ------- --------
NET INCOME......................................... $ 6,986 $ 3,418 $ 393
======= ======= ========
ALLOCATION OF NET INCOME
General Partner.................................. $ 70 $ 34 $ 4
Limited Partners................................. 6,916 3,384 389
------- ------- --------
$ 6,986 $ 3,418 $ 393
------- ------- --------
NET INCOME PER LIMITED PARTNER UNIT (414 UNITS).... $16,705 $ 8,174 $ 940
======= ======= ========
</TABLE>
See Notes to Financial Statements.
MDAH Supp-44
<PAGE>
MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.
STATEMENTS OF CHANGES IN PARTNERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNER PARTNERS TOTAL
------- -------- --------
<S> <C> <C> <C>
Balance, December 31, 1994.......................... $(171) $(21,937) $(22,108)
Capital distributions............................. (18) (1,855) (1,873)
Net income........................................ 4 389 393
----- -------- --------
Balance, December 31, 1995.......................... (185) (23,403) (23,588)
Capital distributions............................. (19) (1,894) (1,913)
Net income........................................ 34 3,384 3,418
----- -------- --------
Balance, December 31, 1996.......................... (170) (21,913) (22,083)
Capital distributions............................. (14) (1,368) (1,382)
Net income........................................ 70 6,916 6,986
----- -------- --------
Balance, December 31, 1997.......................... $(114) $(16,365) $(16,479)
===== ======== ========
</TABLE>
See Notes to Financial Statements.
MDAH Supp-45
<PAGE>
MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- ------- -------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income........................................ $ 6,986 $ 3,418 $ 393
Noncash items:
Depreciation and amortization.................... 6,398 6,032 5,534
Deferred interest................................ 1,414 1,375 1,414
Amortization of deferred financing costs as
interest expense................................ 280 279 278
Loss on retirement of property and equipment..... 15 12 73
Changes in operating accounts:
Due to/from Marriott Hotel Services, Inc......... 816 (730) (153)
Accounts payable and accrued expenses............ (312) 55 104
Due to/from Host Marriott Corporation............ -- 600 (653)
-------- ------- -------
Cash provided by operations.................... 15,597 11,041 6,990
-------- ------- -------
INVESTING ACTIVITIES
Additions to property and equipment.............. (3,288) (3,588) (2,895)
Change in property improvement fund, net......... 114 786 609
Return of working capital from Marriott Hotel
Services, Inc................................... 41 50 600
-------- ------- -------
Cash used in investing activities.............. (3,133) (2,752) (1,686)
-------- ------- -------
FINANCING ACTIVITIES
Payment of mortgage debt......................... (6,731) (3,201) (2,698)
Mortgage escrow.................................. (5,914) (3,341) (326)
Capital distributions to partners................ (1,382) (1,913) (1,873)
Repayment of deferred purchase debt due to Host
Marriott Corporation............................ (62) (82) --
Deferred financing costs......................... -- -- (1)
-------- ------- -------
Cash used in financing activities.............. (14,089) (8,537) (4,898)
-------- ------- -------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS... (1,625) (248) 406
CASH AND CASH EQUIVALENTS at beginning of year..... 2,762 3,010 2,604
-------- ------- -------
CASH AND CASH EQUIVALENTS at end of year........... $ 1,137 $ 2,762 $ 3,010
======== ======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest:
Mortgage debt.................................... $ 7,373 $ 7,491 $ 8,362
Deferred purchase debt due to Host Marriott
Corporation..................................... 62 10 81
-------- ------- -------
$ 7,435 $ 7,501 $ 8,443
======== ======= =======
</TABLE>
See Notes to Financial Statements.
MDAH Supp-46
<PAGE>
MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
NOTE 1. THE PARTNERSHIP
Description of the Partnership
Marriott Diversified American Hotels, L.P. (the "Partnership"), a Delaware
limited partnership, was formed on October 4, 1989 to acquire, own and operate
the following hotels (the "Hotels") which are managed as part of the Marriott
full-service hotel system by Marriott Hotel Services, Inc. ("MHSI"), a wholly-
owned subsidiary of Marriott International, Inc. ("Marriott International"):
(i) the 395-room Fairview Park Marriott in Virginia; (ii) the 399-room Dayton
Marriott in Ohio; (iii) the 224-room Marriott at Research Triangle Park in
North Carolina; (iv) the 226-room Detroit Marriott Southfield in Michigan; (v)
the 224-room Detroit Marriott Livonia in Michigan; and (vi) the 224-room
Fullerton Marriott in California. The sole general partner of the Partnership,
with a 1% interest, is Marriott MDAH One Corporation (the "General Partner"),
a wholly-owned subsidiary of Host Marriott Corporation ("Host Marriott").
Partnership operations commenced on February 8, 1990 (the "Initial Closing
Date"). Between November 14, 1989 and the Initial Closing Date, 381 limited
partnership interests (the "Units") were sold pursuant to a private placement
offering. Between the Initial Closing Date and April 23, 1990 (the "Final
Closing Date"), the offering was completed with the sale of 33 additional
Units. The offering price per Unit was $100,000; $15,000 payable at
subscription with the balance due in three annual installments through June
20, 1992, or, alternatively, $88,396 in cash at closing as full payment of the
subscription price. As of the Final Closing Date, 348.5 Units were purchased
on the installment basis, and 65.5 Units were paid in full. The limited
partners' obligation to make the installment payments is evidenced by
promissory notes (the "Investor Notes") payable to the Partnership and secured
by the Units. The General Partner contributed $418,182 in cash on the Initial
Closing Date for its 1% general partnership interest.
On the Initial Closing Date, the Partnership executed a purchase agreement
with Host Marriott and certain of its affiliates to acquire the Hotels and the
Hotels' working capital and supplies for $157 million. Of the total purchase
price, $131.4 million was paid in cash from the proceeds of mortgage financing
and the initial installment on the sale of the Units with the remaining $25.6
million evidenced by a promissory note (the "Deferred Purchase Debt") payable
to Host Marriott.
Partnership Allocations and Distributions
Pursuant to the terms of the partnership agreement, Partnership allocations,
for Federal income tax purposes, and distributions are generally made as
follows:
a. Cash available for distribution will generally be distributed (i) first,
1% to the General Partner and 99% to the limited partners, until the partners
have received, with respect to such year, an amount equal to 10% of
contributed capital, as defined; (ii) second, remaining cash available for
distribution will be distributed as follows, depending on the amount of
cumulative distributions of net refinancing and/or sales proceeds ("Capital
Receipts") previously distributed:
(1) 1% to the General Partner and 99% to the limited partners, if the
partners have received aggregate cumulative distributions of Capital
Receipts of less than 50% of their original capital contributions; or
(2) 10% to the General Partner and 90% to the limited partners, if the
partners have received aggregate cumulative distributions of Capital
Receipts equal to or greater than 50% but less than 100% of their
original capital contributions; or
(3) 20% to the General Partner and 80% to the limited partners, if the
partners have received aggregate cumulative distributions of Capital
Receipts equal to 100% or more of their original capital contributions.
MDAH Supp-47
<PAGE>
b. Capital Receipts not retained by the Partnership will be distributed (i)
first, 1% to the General Partner and 99% to the limited partners until the
partners have received an amount equal to the unpaid portion of a cumulative
15% return on Net Invested Capital, defined as the excess of capital
contributions over cumulative distributions of Capital Receipts, plus
contributed capital, as defined; and (ii) thereafter, 20% to the General
Partner and 80% to the limited partners.
c. Proceeds from the sale of substantially all of the assets of the
Partnership will be distributed to the partners in accordance with their
capital account balances as adjusted to take into account gain or loss
resulting from such sale.
d. Net profits will generally be allocated to the partners in proportion to
the distributions of cash available for distribution.
e. Net losses will be allocated 75% to the General Partner and 25% to the
limited partners.
f. Deductions for interest on the Deferred Purchase Debt (see Note 6), which
cumulatively will not exceed $11,604 per Unit, will be allocated to those
limited partners owning the Units purchased on the installment basis.
g. Gain recognized by the Partnership will be allocated as follows: (i)
first, to all partners whose capital accounts have negative balances until
such balances are brought to zero; (ii) next, to all partners in amounts
necessary to bring their respective capital account balances to an amount
equal to their Net Invested Capital plus a cumulative 15% return on Net
Invested Capital; and (iii) thereafter, 20% to the General Partner and 80% to
the limited partners.
h. Losses will generally be allocated as follows: (i) first, to all partners
whose capital accounts have positive balances until such balances have been
eliminated; and (ii) thereafter, 100% to the General Partner.
For financial reporting purposes, profits and losses are allocated among the
partners based upon their stated interests in cash available for distribution.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting
The Partnership's records are maintained on the accrual basis of accounting,
and its fiscal year coincides with the calendar year.
Restricted Cash
In connection with the June 30, 1993 refinancing of the mortgage debt, a
debt service reserve in the amount of $3.0 million was required to be held by
the lender. In addition, the loan agreement requires that to the extent that
there was cash available after payment of principal and interest on Note A and
interest on Note B, then such remaining cash was split 50% to the Partnership
and 50% to the Mortgage Escrow. The Mortgage Escrow was applied annually 50%
to the payment of additional principal on Note A, and 50% to the principal on
Note B, until the Partnership received a cumulative amount equal to
$7,352,000. The Partnership reached this cumulative amount in September 1996.
Thereafter, 100% of remaining cash flow is reserved in the Mortgage Escrow and
applied annually 25% to Note A and 75% to Note B. At December 31, 1997, the
balance of the Mortgage Escrow was $11.6 million. This amount will be applied
toward principal amortization in 1998.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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 from those estimates.
MDAH Supp-48
<PAGE>
Revenues and Expenses
Revenues represent house profit of the Hotels since the Partnership has
delegated substantially all of the operating decisions related to the
generation of house profit from the Hotels to MHSI. House profit reflects
Hotel operating results which flow to the Partnership as property owner and
represents gross Hotel sales less property-level expenses, excluding
depreciation and amortization, base management fees, real and personal
property taxes, ground and equipment rent, insurance and certain other costs,
which are disclosed in the statement of operations (see Note 3).
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding the property-level revenues and operating expenses of its hotels
from its statements of operations. If the Partnership concludes that EITF 97-2
should be applied to its hotels, it would include operating results of those
managed operations in its financial statements. Application of EITF 97-2 to
financial statements as of and for the year ended December 31, 1997, would
have increased both revenues and operating expenses by approximately $48.6
million and would have no impact on operating profit or net income.
Property and Equipment
Property and equipment is recorded at cost. Depreciation and amortization
are computed using the straight-line method over the estimated useful lives of
the assets as follows:
<TABLE>
<S> <C>
Land improvements........................................... 40 years
Buildings and improvements.................................. 40 years
Leasehold improvements...................................... 40 years
Furniture and equipment..................................... 4 to 10 years
</TABLE>
All property and equipment is pledged as security for the mortgage debt
described in Note 6.
The Partnership assesses impairment of its real estate properties based on
whether estimated undiscounted future cash flows from such properties on an
individual hotel basis will be less than their net book value. If the property
is impaired, its basis is adjusted to fair market value.
Deferred Financing and Organization Costs
Deferred financing costs represent the costs incurred in connection with
obtaining the Mortgage Debt and are being amortized over the term thereof.
Organization costs incurred in the formation of the Partnership were amortized
on a straight-line basis over five years. Organization costs were fully
amortized and removed from the Partnership's accounts as of December 31, 1995.
As of December 31, 1997 and 1996, accumulated amortization of deferred
financing costs totaled $1,995,000 and $1,715,000, respectively.
Cash and Cash Equivalents
The Partnership considers all highly liquid investments with a maturity of
less than three months at date of purchase to be cash equivalents.
Income Taxes
Provision for Federal and state income taxes has not been made in the
accompanying financial statements since the Partnership does not pay income
taxes but rather allocates its profits and losses to the individual partners.
Significant differences exist between the net income (loss) for financial
reporting purposes and the net income (loss) reported in the Partnership's tax
return. These differences are primarily due to the use, for income tax
purposes, of accelerated depreciation methods and shorter depreciable lives of
the assets. As a result of these differences, the excess of the tax basis in
net Partnership liabilities over the net liabilities reported in the
MDAH Supp-49
<PAGE>
accompanying financial statements is $3,462,000 and $5,650,000 as of December
31, 1997 and 1996, respectively.
Statement of Financial Accounting Standards
In the first quarter of 1996, the Partnership adopted Statement of Financial
Accounting Standards ("SFAS") No. 121 "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of." Adoption of SFAS
No. 121 did not have an effect on the financial statements.
Reclassification
Certain prior year amounts have been reclassified to conform with the
current year presentation.
NOTE 3. HOTEL REVENUES
Hotel Revenues consist of Hotel operating results for the three years ended
December 31, (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
HOTEL SALES
Rooms.............................................. $48,427 $43,621 $40,201
Food and beverage.................................. 22,900 22,058 20,716
Other.............................................. 3,994 3,864 3,876
------- ------- -------
75,321 69,543 64,793
------- ------- -------
HOTEL EXPENSES
Departmental direct costs
Rooms............................................. 12,063 11,333 10,638
Food and beverage................................. 17,464 17,172 16,439
Other hotel operating expenses..................... 19,095 18,664 18,001
------- ------- -------
48,622 47,169 45,078
------- ------- -------
HOTEL REVENUES....................................... $26,699 $22,374 $19,715
======= ======= =======
</TABLE>
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Land and improvements.................................... $ 14,265 $ 14,265
Buildings and improvements............................... 95,477 94,368
Leasehold improvements................................... 15,717 15,173
Furniture and equipment.................................. 29,255 27,832
-------- --------
154,714 151,638
Less accumulated depreciation............................ (46,561) (40,360)
-------- --------
$108,153 $111,278
======== ========
</TABLE>
MDAH Supp-50
<PAGE>
NOTE 5. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments are shown below. The fair
values of financial instruments not included in this table are estimated to be
equal to their carrying amounts (in thousands):
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997 AS OF DECEMBER 31, 1996
------------------------ ------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Mortgage debt.............. $122,014 $113,300 $128,745 $117,231
Debt service guarantee and
related interest payable
to Host Marriott
Corporation............... 19,762 17,600 18,600 7,800
Note payable and related
interest due to the
General Partner........... 2,804 800 2,615 743
Deferred purchase debt and
related interest payable
to Host Marriott
Corporation............... 676 450 675 384
</TABLE>
The estimated fair value of mortgage debt obligations is based on the
expected future debt service payments discounted at estimated market rates.
Notes and other payables due to Host Marriott and affiliates are valued based
on the expected future payments from operating cash flow discounted at risk-
adjusted rates.
NOTE 6. DEBT
Mortgage Debt
On June 30, 1993, the General Partner completed a restructuring of the
Partnership's first mortgage (the "Mortgage Debt"). Pursuant to the terms of
the restructuring, the original Mortgage Debt of $128 million was divided into
two notes, Note A with a principal balance of $85 million and Note B with a
principal balance of $43 million, which mature on December 15, 1999. In
addition, interest rate swap termination costs of $9.3 million relating to the
original Mortgage Debt were established as Note C with a maturity date of
December 15, 2010. The Partnership paid $12.3 million to the lender which was
applied as follows: $7.6 million to the interest due through closing, $3.0
million to fund a new debt service reserve (the "Reserve"), $1.0 million as a
loan extension fee, and $.7 million to principal. The 1992 purchase price
adjustment made by Host Marriott to the Partnership was applied toward the
scheduled interest payment and to partially fund the Reserve. The remainder of
the payment was funded by a $2.0 million loan from the General Partner and
from the Partnership's operating cash account funds. The loan from the General
Partner bears interest at the prime lending rate plus 1% and matures on June
30, 2008.
Interest on Note A accrues at a floating rate, as elected by the
Partnership, equal to one percentage point over either one, two, three or six-
month London interbank offered rate ("LIBOR"). Principal amortization of
$600,000 was required in 1993 escalating annually to $1 million in 1998. To
the extent that operating profit is not sufficient to fund required Note A
interest and principal, then necessary funds will be drawn from the Reserve.
The weighted-average effective interest rate on Note A was 6.7% and 6.2% for
1997 and 1996, respectively. Interest on Note B accrues at LIBOR. To the
extent that operating profit is not sufficient to fund Note B interest in any
fiscal year, then Note B interest is limited to cash available after payment
of Note A principal and interest. Unpaid Note B interest for any fiscal year
is forgiven. The weighted-average effective interest rate on Note B was 5.7%
and 5.5% for 1997 and 1996, respectively. In addition, to the extent that
there was cash available after payment of principal and interest on Note A and
interest on Note B, then such remaining cash was split 50% to the Partnership
and 50% to the Mortgage Escrow. The Mortgage Escrow was applied annually 50%
to the payment of additional principal on Note A, and 50% to the principal on
Note B, until the Partnership received a cumulative amount equal to
$7,352,000. The Partnership reached this cumulative amount in September 1996.
Thereafter, 100% of remaining cash flow is applied 25% to Note A and 75% to
Note B. At December 31, 1997, the balance of the Mortgage Escrow was $11.6
million and is included in the accompanying balance sheet. Note C bears no
interest and has no required principal amortization prior to its maturity.
MDAH Supp-51
<PAGE>
The Mortgage Debt is secured by first mortgages on each of the Hotels, the
Partnership's interest in the Fullerton Hotel ground lease, the land on which
the remaining Hotels are located, the Partnership's interest in the Fairview
Park Hotel parking garage lease, a security interest in all of the personal
property associated with each Hotel, a security interest in the Partnership's
rights under the management and purchase agreement and a security interest in
the Partnership's deposit accounts.
Scheduled amortization and maturities of the Mortgage Debt at December 31,
1997 are (in thousands):
<TABLE>
<S> <C>
1998................................ $ 1,000
1999................................ 111,678
2000................................ 0
2001................................ 0
2002................................ 0
Thereafter.......................... 9,336
--------
$122,014
========
</TABLE>
As of December 31, 1993, Host Marriott's debt service guarantee on the
original Mortgage Debt totaling $13 million was fully exhausted. Advances
under the guarantee bear interest at the prime lending rate plus one-half
percentage point. For 1997 and 1996, the weighted-average effective interest
rate was 8.9% and 8.8%, respectively. These advances will be repaid from
available cash flow after payments of ground rent, Mortgage Debt Service,
Partnership administrative expenses in excess of Partnership interest income
and retention by the Partnership of an amount equal to 10% of the partners'
contributed capital, as defined. During 1997, no amounts were repaid to Host
Marriott pursuant to the debt service guarantees. In addition, the General
Partner has provided a foreclosure guarantee to the lender in the amount of
$25 million. Pursuant to the terms of the foreclosure guarantee, amounts would
be payable only upon a foreclosure on the Hotels and only to the extent that
the gross proceeds from the foreclosure sale were less than $25 million.
Deferred Purchase Debt
The Deferred Purchase Debt bears interest at 10% per annum and was due July
1, 1992. The note was required to be repaid from, and is secured by, the
proceeds of the Investor Notes which were due through June 20, 1992. Investor
Notes outstanding as of December 31, 1997 represent payments due from
defaulters and related interest payable under such notes. As a result of the
Partnership's failure to collect the Investor Notes in full, and subsequent
failure to repay the Deferred Purchase Debt in full, the Partnership is
currently in default under the terms of the Deferred Purchase Debt agreements.
Host Marriott has the right to perfect a security interest in the Units
securing the defaulted Investor Notes. However, Host Marriott agreed not to
foreclose on its interest in the Units prior to the earlier of the sale of the
Hotels or January 1, 1998. As of April 8, 1998, Host Marriott has not
exercised its option to foreclose on its interest in the Units. Total accrued
interest on the Deferred Purchase Debt at December 31, 1997 and 1996, was
$47,000 and $42,000, respectively.
NOTE 7. MANAGEMENT AGREEMENT
The Partnership entered into a hotel management agreement on the Initial
Closing Date with Marriott International to manage the Hotels for an initial
20-year term expiring December 31, 2009. During 1996, Marriott International
assigned all of its interest in the hotel management agreement to MHSI, a
wholly-owned subsidiary of Marriott International. MHSI has the option to
renew the hotel management agreement on one or more of the Hotels for up to
five successive 10-year terms (four successive 10-year terms for the Fullerton
Hotel). MHSI earns a base management fee equal to 3% of gross sales.
In connection with the 1993 loan restructuring, the hotel management
agreement was modified. During the restructured loan term, no incentive
management fees will be accrued by the Partnership or be considered earned by
the manager until the entire mortgage principal balance, together with accrued
interest, is paid in full. No incentive management fees have been paid to MHSI
since the inception of the Partnership.
MDAH Supp-52
<PAGE>
Pursuant to the terms of the hotel management agreement, MHSI is required to
furnish the Hotels with certain services ("Chain Services") which are
generally provided on a central or regional basis to all hotels in the
Marriott full-service hotel system. Chain Services include central training,
advertising and promotion, a national reservation system, computerized payroll
and accounting services, and such additional services as needed which may be
more efficiently performed on a centralized basis. Costs and expenses incurred
in providing such services are allocated among all domestic full-service
hotels managed, owned or leased by Marriott International or its subsidiaries.
In addition, the Hotels also participate in Marriott's Rewards Program ("MRP")
which succeeded the Marriott Honored Guest Awards Program. The cost of this
program is charged to all hotels in the Marriott full-service hotel system
based upon the MRP sales at each hotel. The total amount of Chain Services and
MRP costs charged to the Partnership was $3,874,000 for 1997, $3,497,000 for
1996, $3,316,000 for 1995.
Pursuant to the terms of the hotel management agreement, the Partnership is
required to provide MHSI with working capital and supplies to meet the
operating needs of the Hotels. MHSI converts cash advanced by the Partnership
into other forms of working capital consisting primarily of operating cash,
inventories, and trade receivables and payables which are maintained and
controlled by MHSI. Upon termination of the hotel management agreement, the
working capital and supplies will be returned to the Partnership. The
individual components of working capital and supplies controlled by MHSI are
not reflected in the Partnership's balance sheet. A total of $4,500,000 was
advanced to MHSI for working capital and supplies of which $600,000 was
returned to the Partnership during 1995, $50,000 was returned during 1996 and
$41,000 was returned in 1997 leaving a balance of $3,900,000, $3,850,000 and
$3,809,000 as of December 31, 1995, 1996 and 1997, respectively, which is
included in Due from Marriott Hotel Services, Inc. in the accompanying balance
sheet. The supplies advanced to MHSI are recorded at their estimated net
realizable value. At December 31, 1997 and 1996, accumulated amortization
related to the revaluation of these supplies totaled $473,000.
The hotel management agreement provides for the establishment of a property
improvement fund for each Hotel. Contributions to the property improvement
fund are equal to a percentage of gross Hotel sales. Contributions to the fund
for the Fairview Park, Southfield, Livonia and Fullerton Hotels were 3% for
the years 1995 through 1999 and 4% for the year 2000 and thereafter. The
Dayton Hotel contributes 4% annually. Annual contributions at the Research
Triangle Park Hotel were 3% through 1997 and will be 4% in 1998 and
thereafter. Aggregate contributions to the property improvement fund amounted
to $2,442,000, $2,258,000 and $2,104,000 for the years ended December 31,
1997, 1996 and 1995, respectively.
NOTE 8. GROUND LEASES
The Partnership leases the land on which the Fullerton Hotel is located. The
initial term expires in 2019 with four successive 10-year renewals at the
Partnership's option. The lease provides for percentage rental equal to 4% of
gross room sales for each year. Prior to October 1995, the lease provided for
percentage rent equal to 1% of gross room sales. Ground rent expense incurred
for this lease for the years ended December 31, 1997, 1996 and 1995 was
$199,000, $185,000 and $99,000, respectively. The Partnership also leases the
land on which the Fairview Park Hotel parking garage is located. The lease
expires in 2085 and requires a nominal rental of $1 per year.
MDAH Supp-53
<PAGE>
MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.
CONDENSED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
FIRST TWO QUARTERS
--------------------
1998 1997
--------- ---------
<S> <C> <C>
REVENUES.................................................. $ 14,521 $ 12,504
--------- ---------
OPERATING COSTS AND EXPENSES
Depreciation and amortization........................... 2,779 2,381
Base management fees.................................... 1,144 1,042
Property taxes and other................................ 1,373 1,213
--------- ---------
5,296 4,636
--------- ---------
OPERATING PROFIT.......................................... 9,225 7,868
Interest expense........................................ (4,139) (4,175)
Interest income......................................... 310 91
--------- ---------
NET INCOME................................................ $ 5,396 $ 3,784
========= =========
ALLOCATION OF NET INCOME
General Partner......................................... $ 54 $ 38
Limited Partners........................................ 5,342 3,746
--------- ---------
$ 5,396 $ 3,784
========= =========
NET INCOME PER LIMITED PARTNER UNIT (414 Units)........... $ 12,903 $ 9,048
========= =========
</TABLE>
See Notes To Condensed Financial Statements.
MDAH Supp-54
<PAGE>
MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.
CONDENSED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 19, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Property and equipment, net........................... $106,447 $108,153
Mortgage escrow....................................... 6,182 11,624
Due from Marriott Hotel Services, Inc................. 4,590 3,714
Debt service reserve fund............................. 3,000 3,000
Property improvement fund............................. 1,964 1,667
Deferred financing costs, net......................... 408 536
Cash and cash equivalents............................. 1,418 1,137
-------- --------
Total Assets...................................... $124,009 $129,831
======== ========
LIABILITIES AND PARTNERS' DEFICIT
LIABILITIES
Mortgage debt....................................... $110,193 $122,014
Debt service guarantee and related interest payable
to Host Marriott Corporation....................... 20,307 19,762
Note payable and related interest due to the General
Partner............................................ 2,893 2,804
Deferred purchase debt and related interest payable
to Host Marriott Corporation....................... 706 676
Accounts payable and accrued expenses............... 993 1,054
-------- --------
Total Liabilities................................. 135,092 146,310
-------- --------
PARTNERS' DEFICIT
General Partner..................................... (60) (114)
Limited Partners.................................... (11,023) (16,365)
-------- --------
Total Partners' Deficit........................... (11,083) (16,479)
-------- --------
$124,009 $129,831
======== ========
</TABLE>
See Notes To Condensed Financial Statements.
MDAH Supp-55
<PAGE>
MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.
CONDENSED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO QUARTERS
--------------------
1998 1997
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net income.............................................. $ 5,396 $ 3,784
Noncash items........................................... 3,570 3,108
Change in operating accounts............................ (1,387) (712)
--------- --------
Cash provided by operating activities................. 7,579 6,180
--------- --------
INVESTING ACTIVITIES
Additions to property and equipment, net................ (1,073) (2,135)
Change in property improvement fund..................... (297) 586
Return of working capital from Marriott Hotel Services,
Inc.................................................... 450 --
--------- --------
Cash used in investing activities..................... (920) (1,549)
--------- --------
FINANCING ACTIVITIES
Payment of mortgage debt................................ (11,821) (6,192)
Change in mortgage escrow............................... 5,443 1,339
Capital distributions to partners....................... -- (1,383)
--------- --------
Cash used in financing activities..................... (6,378) (6,236)
--------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.......... 281 (1,605)
CASH AND CASH EQUIVALENTS at beginning of period.......... 1,137 2,762
--------- --------
CASH AND CASH EQUIVALENTS at end of period................ $ 1,418 $ 1,157
========= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for mortgage and other interest............... $ 3,357 $ 3,532
========= ========
</TABLE>
See Notes To Condensed Financial Statements.
MDAH Supp-56
<PAGE>
MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying condensed financial statements have been prepared by
Marriott Diversified American Hotels, L.P. (the "Partnership") without audit.
Certain information and footnote disclosures normally included in financial
statements presented in accordance with generally accepted accounting
principles have been condensed or omitted from the accompanying statements.
The Partnership believes the disclosures made are adequate to make the
information presented not misleading. However, the condensed financial
statements should be read in conjunction with the Partnership's financial
statements and notes thereto for the fiscal year ended December 31, 1997
included in the Partnership's Form 10.
In the opinion of the Partnership, the accompanying unaudited condensed
financial statements reflect all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position of
the Partnership as of June 19, 1998, the results of operations and cash flows
for the first two quarters 1998 and 1997. Interim results are not necessarily
indicative of fiscal year performance because of seasonal and short-term
variations.
For financial reporting purposes, net income of the Partnership is allocated
99% to the Limited Partners and 1% to the General Partner. Significant
differences exist between the net income for financial reporting purposes and
the net income reported for Federal income tax purposes. These differences are
due primarily to the use, for income tax purposes, of accelerated depreciation
methods and shorter depreciable lives of the assets.
2. The Partnership owns and operates the Marriott Research Triangle Park,
Southfield Marriott, Detroit Marriott at Livonia, Fullerton Marriott, Fairview
Park Marriott and Dayton Marriott. The sole general partner of the
Partnership, with a 1% interest, is Marriott MDAH One Corporation (the
"General Partner"), a wholly-owned subsidiary of Host Marriott Corporation
("Host Marriott"). The remaining 99% interest in the Partnership is owned by
the limited partners.
3. Certain reclassifications were made to the prior year financial
statements to conform to the 1998 presentation.
4. Hotel revenues represent house profit of the Partnership's Hotels since
the Partnership has delegated substantially all of the operating decisions
related to the generation of house profit of the Hotels to Marriott Hotel
Services, Inc. (the "Manager"). House profit reflects hotel operating results
which flow to the Partnership as property owner and represents gross hotel
sales less property-level expenses, excluding depreciation and amortization,
base management fees, property taxes, ground rent, insurance and other costs,
which are disclosed separately in the condensed statement of operations.
MDAH Supp-57
<PAGE>
MARRIOTT DIVERSIFIED AMERICAN HOTELS, L.P.
NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED)
Partnership revenues generated by the Hotels for 1998 and 1997 consist of
(in thousands):
<TABLE>
<CAPTION>
FIRST TWO QUARTERS
-------------------
1998 1997
--------- ---------
<S> <C> <C>
HOTEL SALES
Rooms................................................. $ 25,093 $ 22,710
Food and beverage..................................... 11,054 10,216
Other................................................. 1,981 1,819
--------- ---------
38,128 34,745
--------- ---------
HOTEL EXPENSES
Departmental direct costs
Rooms............................................... 5,995 5,573
Food and beverage................................... 8,423 7,938
Other hotel operating expenses........................ 9,189 8,730
--------- ---------
23,607 22,241
--------- ---------
REVENUES................................................ $ 14,521 $ 12,504
========= =========
</TABLE>
5. On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding the property level revenues and operating expenses of its hotel from
its statements of operations (See Note 4). If the Partnership concludes that
EITF 97-2 should be applied, it would include operating results of the managed
operations in its financial statements. Application of EITF 97-2 to financial
statements as of and for the first two quarters 1998 would have increased both
revenues and operating expenses by $23.6 million and would have had no impact
on net income.
6. Pursuant to the terms of the Mortgage Debt, the Partnership was required
to establish with the lender a separate reserve account for payments of
insurance premiums and real estate taxes for the mortgaged property as a
result of the credit rating of Marriott International, Inc. Thus, the
Partnership has transferred $2.2 million into the reserve through June 19,
1998. The reserve is included in restricted cash reserves and the resulting
tax and insurance liability is included in accounts payable and accrued
expenses in the accompanying condensed balance sheet.
7. On April 17, 1998, Host Marriott, the General Partner of the Partnership,
announced that its Board of Directors has authorized the company to reorganize
its business operations to qualify as a real estate investment trust ("REIT")
to become effective as of January 1, 1999. As part of the REIT conversion,
Host Marriott expects to form a new operating partnership (the "Operating
Partnership") and limited partners in certain Host Marriott full-service hotel
partnerships and joint ventures, including the Marriott Diversified American
Hotels, L.P., are expected to be given an opportunity to receive, on a tax-
deferred basis, Operating Partnership units in the Operating Partnership in
exchange for their current limited partnership interests. The Operating
Partnership units would be redeemable by the limited partner for freely traded
Host Marriott shares (or the cash equivalent thereof) at any time after one
year from the closing of the merger. In connection with the REIT conversion,
on June 2, 1998, the Operating Partnership filed a Registration Statement on
Form S-4 with the Securities and Exchange Commission. Limited partners will be
able to vote on this Partnership's participation in the merger later this year
through a consent solicitation.
MDAH Supp-58
<PAGE>
HOST MARRIOTT, L.P.
SUPPLEMENT DATED , 1998 FOR PROSPECTUS/CONSENT SOLICITATION STATEMENT
DATED , 1998 FOR MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP
On the terms described in the Prospectus/Consent Solicitation Statement (the
"Consent Solicitation"), dated , 1998, of which this Supplement (the
"Supplement") is a part, Host Marriott Corporation ("Host") has adopted a plan
to restructure its business operations so that it will qualify as a real
estate investment trust ("REIT"). As part of this restructuring (the "REIT
Conversion"), Host and its consolidated subsidiaries will contribute their
full-service hotel properties and certain other businesses and assets to Host
Marriott, L.P. (the "Operating Partnership") in exchange for units of limited
partnership interest in the Operating Partnership ("OP Units") and the
assumption of liabilities. The sole general partner of the Operating
Partnership will be Host Marriott Trust ("Host REIT"), the entity into which
Host will merge as part of the REIT Conversion. Host REIT expects to qualify
as a REIT beginning with its first full taxable year after closing of the REIT
Conversion, which Host REIT currently expects to be the year beginning January
1, 1999.
Following the REIT Conversion and the Blackstone Acquisition, the Operating
Partnership and its subsidiaries initially will own outright, or have
controlling interests in, approximately 120 full-service hotels operating
primarily under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt
brand names (the "Hotels").
As part of the REIT Conversion, the Operating Partnership is proposing to
acquire by merger (the "Mergers") Marriott Hotel Properties Limited
Partnership, a Delaware limited partnership ("MHP" or the "Partnership"), and
up to seven other limited partnerships (the "Partnerships") that own full-
service hotels in which Host or its subsidiaries are general partners. As more
fully described in the Consent Solicitation, limited partners of those
Partnerships that participate in the Mergers will receive either OP Units or,
at their election, unsecured % Callable Notes due December 15, 2005 issued
by the Operating Partnership ("Notes"), in exchange for their partnership
interests in such Partnerships (with respect to the Partnerships, those
limited partners of the Partnerships who are unaffiliated with Host are
referred to herein as the "Limited Partners," and with respect to MHP, the
"MHP Limited Partners").
Beginning one year after the Mergers, Limited Partners who retain OP Units
will have the right to redeem their OP Units at any time and receive, at the
election of Host REIT, either freely tradeable, New York Stock Exchange listed
Common Shares of Host REIT on a one-for-one basis (subject to adjustment) or
cash in an amount equal to the market value of such shares (the "Unit
Redemption Right").
The number of OP Units to be allocated to MHP will be based upon (i) its
Exchange Value (as defined herein) and (ii) the price attributed to an OP Unit
following the Merger, determined as described herein (but in no event greater
than $ per OP Unit). The principal amount of Notes that MHP Limited Partners
may elect to receive in exchange for the OP Units received in the Merger will
be based upon MHP's Note Election Amount (as defined herein). See
"Determination of Exchange Value of MHP and Allocation of OP Units." The
estimated Exchange Value and Note Election Amount set forth herein may
increase or decrease as a result of various adjustments, and will be finally
calculated shortly before the Effective Date. Pursuant to the Merger, MHP
Limited Partners have an estimated Exchange Value of $141,425 per Partnership
Unit and a Note Election Amount of $124,261 per Partnership Unit.
RISK FACTORS
In deciding whether to approve the Merger, MHP Limited Partners should
consider certain risks and other factors. The General Partner believes that
MHP Limited Partners should particularly consider the following, which should
be read in conjunction with the information in the Consent Solicitation under
"Risk Factors" and "Federal Income Tax Consequences:"
. Substantial Benefits to Related Parties. Host REIT and its subsidiaries
will realize substantial benefits from the Mergers and the REIT
Conversion, including savings from a substantial reduction in corporate-
MHP Supp-1
<PAGE>
level income taxes expected as a result of the REIT Conversion. To the
extent that such anticipated benefits of the REIT Conversion are reflected
in the value of Host's common stock prior to the Effective Date, such
benefits will not be shared with the Limited Partners. Because of Host's
significant ownership position in certain Partnerships (including MHP),
the failure of one or more of these Partnerships, including MHP, to
participate in a Merger likely would require that Host contribute some or
all of its ownership interest in the Non-Participating Partnership to a
taxable Non-Controlled Subsidiary, which would materially reduce the
benefit of Host of the REIT Conversion as it applies to that interest.
. Absence of Arm's Length Negotiations. No independent representative was
retained to negotiate on behalf of the MHP Limited Partners or the other
Limited Partners. Although the General Partner has obtained the
Appraisals and the Fairness Opinion from AAA, AAA has not negotiated
with General Partner or Host and has not participated in establishing
the terms of the Mergers. Consequently, the terms and conditions of the
Mergers may have been more favorable to the MHP Limited Partners or the
other Limited Partners if such terms and conditions were the result of
arm's length negotiations.
. Other Conflicts of Interest. The Mergers, the REIT Conversion and the
recommendations of the General Partner involve the following conflicts of
interest because of the relationships among Host, the Operating
Partnership, the General Partners and SLC: (i) the General Partners,
which are all subsidiaries of Host (except for PHLP, in which Host is the
General Partner), must assess whether a Merger is fair and equitable to
the Limited Partners of its Partnership, which involves considerations
for Host and its subsidiaries that are different from those that affect
the Limited Partners, (ii) the terms of the Leases of the Hotels,
including MHP's Hotels, will be determined by Host, which will distribute
the common stock of SLC, the parent of the Lessees, to its shareholders
after such terms have been set and (iii) the terms of the Partnership
Agreement, including provisions which benefit Host REIT, have been
determined by Host. Such conflicts may result in decisions that do not
fully reflect the interests of all Limited Partners, including the MHP
Limited Partners.
. Uncertainties at the Time of Voting Include the Number of OP Units to be
Received. There are several uncertainties at the time the MHP Limited
Partners must vote on the Merger, including (i) the exact Exchange Value
for MHP (which will be adjusted for changes in lender and capital
expenditure reserves, indebtedness, deferred maintenance and other items
prior to the Effective Date), (ii) the price of the OP Units for
purposes of the Merger, which will be determined by reference to the
post-Merger trading prices of Host REIT's Common Shares and which,
together with the Exchange Value, will determine the number of OP Units
the MHP Limited Partners will receive and (iii) the exact principal
amount of the Notes that may be received in exchange for OP Units, which
cannot be known until after the vote on the Merger. For these reasons,
the MHP Limited Partners cannot know at the time they vote on the Merger
these important aspects of the Merger.
. Combined REVPAR for the Operating Partnership's Hotels is Significantly
Less than the REVPAR for MHP's Hotels. The Operating Partnership's pro
forma REVPAR for the first two quarters 1998 is significantly lower than
the REVPAR attributable to MHP's Hotels for the same period.
. Reduced Cash Distributions for MHP Limited Partners. The expected
initial annual cash distributions from the Operating Partnership to the
MHP Limited Partners per Partnership Unit (from $4,015 to $4,417) will
be less than the estimated cash distributions of MHP per Partnership
Unit ($9,500) for 1998.
. Sale of Personal Property May Result in Gain to MHP Limited Partners.
In order to facilitate the participation of MHP in the Merger without
adversely affecting Host REIT's qualification as a REIT, the Operating
Partnership will require, as part of the Merger, that MHP sell a portion
of the personal property associated with its Hotels to a Non-Controlled
Subsidiary. This sale will be a taxable transaction and may (although is
not expected to) result in an allocation of a relatively modest amount
of ordinary recapture income by MHP to MHP Limited Partners. This
income, if any, will be allocated to each MHP Limited Partner in the
same proportion and to the same extent that such MHP Limited Partner was
allocated any deductions directly or indirectly giving rise to the
treatment of such income as recapture income. An MHP Limited Partner who
receives such an allocation of recapture income would not be entitled to
any special distribution from MHP in connection with the sale of
personal property.
MHP Supp-2
<PAGE>
. Price of OP Units Might Be Less than the Fair Market Value of the MHP
Limited Partners' Partnership Interests. The price of an OP Unit, for
purposes of the Mergers and the REIT Conversion, will be equal to the
average closing price on the NYSE of a Host REIT Common Share for the
first 20 trading days after the Effective Date of the Mergers (but in no
event greater than $ per share). It is likely that, over time, the
value of the publicly traded Common Shares of Host REIT (and therefore
the value of the OP Units) will diverge from the deemed value of the OP
Units used for purposes of the Mergers. This could result in the MHP
Limited Partners receiving OP Units with an actual value that is less
than either the price of the OP Units for purposes of the Mergers or the
fair market value of their Partnership Interests.
. Exchange Value May Not Equal Fair Market Value of MHP's Hotels. Each MHP
Limited Partner who retains OP Units will receive consideration with a
deemed value equal to the Exchange Value of such MHP Limited Partner's
Partnership Interest. The determination of the Exchange Value of MHP
involves numerous estimates and assumptions. There is no assurance that
the Exchange Value of MHP will equal the fair market value of the Hotels
and other assets contributed by MHP. See "Determination of Exchange
Value of MHP and Allocation of OP Units."
. Allocation of OP Units to Host REIT is Different from Allocation of OP
Units to Limited Partners. Host REIT will receive in the aggregate a
number of OP Units (including OP Units allocated to the General Partners
of the Partnerships) equal to the number of shares of Host common stock
outstanding on the Effective Date (and, if Host has outstanding shares of
preferred stock at the time of the REIT Conversion, a corresponding
number of preferred partnership interests in the Operating Partnership),
which should fairly represent the market value of Host REIT but may not
be equal to the fair market or net asset value of the Hotels and other
assets that Host will contribute to the Operating Partnership. The
Partnerships will receive OP Units in the Mergers with a deemed value
equal to the Exchange Value of such Partnership. The different methods of
allocating OP Units may result in Limited Partners not receiving the fair
market value of their Partnership Interests and Host REIT receiving a
higher percentage of the interests in the Operating Partnership. See
"Determination of Exchange Values and Allocation of OP Units."
. Inability of MHP Limited Partners to Redeem OP Units for One Year. MHP
Limited Partners who elect to retain OP Units received in the Merger will
be unable to redeem such OP Units for one year following the Merger.
Until then, MHP Limited Partners will bear the risk of illiquidity.
. Value of the Notes Will Be Less than the Exchange Value. At the same
time that he votes on the Merger, each MHP Limited Partner also may
elect to receive, at the time of the Merger in exchange for OP Units, an
unsecured, seven-year Note of the Operating Partnership with a principal
amount equal to the Note Election Amount of his Partnership Interest.
The deemed value of the OP Units to be received by the MHP Limited
Partners will exceed the principal amount of the corresponding Notes
(because the Exchange Value will be higher than the Note Election
Amount) and there is no assurance that the Note an MHP Limited Partner
receives will have a value equal to either (i) the fair market value of
the MHP Limited Partner's share of the Hotels and other assets owned by
MHP or (ii) the principal amount of the Note. There will be no public
market for the Notes. If the Notes are sold, they may sell at prices
substantially below their issuance price. Noteholders are likely to
receive the full principal amount of a Note only if they hold the Note
to maturity, which is December 15, 2005, or if the Operating Partnership
repays the Notes prior to maturity. Because the Notes are unsecured
obligations of the Operating Partnership, they will be effectively
subordinated to all secured debt of the Operating Partnership and all
obligations of both the Participating Partnerships and the Operating
Partnership's other subsidiaries. See "Description of the Notes." As of
June 19, 1998, on a pro forma basis assuming the Full Participation
Scenario, the Operating Partnership would have had aggregate
consolidated debt of approximately $5.1 billion to which the Notes were
effectively subordinated or which rank equally with such Notes.
. Current Host Common Stock Price May Not Necessarily Be Indicative of the
Price of Host REIT Common Shares Following the REIT Conversion. Host's
current stock price is not necessarily indicative of how the market will
value Host REIT Common Shares following the REIT Conversion. The current
stock
MHP Supp-3
<PAGE>
price of Host reflects the current market valuation of Host's current
business and assets (including the SLC common stock and the cash or
securities to be distributed in connection with the REIT Conversion) and
not the business and assets of Host REIT following the REIT Conversion.
. Fundamental Change in Nature of Investment; Potential
Underperformance. The Mergers and the REIT Conversion involve a
fundamental change in the nature of an MHP Limited Partner's investment
from holding an interest in MHP, which was structured as a tax shelter
and tax credit investment, is a finite-life entity, has a fixed
portfolio of two Hotels and distributes the cash flow from the operation
of such Hotels to the MHP Limited Partners, to holding an interest in an
infinite-life, operating real estate company with a portfolio of
approximately 120 Hotels that (i) collects and distributes to its
limited partners rents received from the Lessees (which will bear the
risks and receive the direct benefits of the Hotels' operations), (ii)
has the ability to acquire additional hotels, (iii) is able to reinvest
proceeds from sales or refinancings of existing Hotels in other hotels
and (iv) has a publicly traded general partner. In addition, each MHP
Limited Partner's investment will change from one that allows an MHP
Limited Partner to receive a return of capital in the form of
distributions from any net proceeds of a sale or refinancing of MHP's
assets to an investment in which an MHP Limited Partner who retains OP
Units likely would realize a return of capital only through the exercise
of the Unit Redemption Right. An MHP Limited Partner's share of the
liquidation proceeds, if any, from the sale of MHP's Hotels could be
higher than the amount realized upon exercise of the Unit Redemption
Right (or payments on any Note received by an MHP Limited Partner who
elects to exchange his OP Units for such Note). An investment in the
Operating Partnership may not outperform an investment in MHP. See
"Comparison of Ownership of Partnership Interests, OP Units and Common
Shares."
. Exposure to Market and Economic Conditions of Other Hotels. As a result
of the Mergers, MHP Limited Partners who elect to retain OP Units will
own interests in a much larger enterprise with a broader range of assets
than MHP individually. A material adverse change affecting the Operating
Partnership's assets will affect all Limited Partners, including MHP
Limited Partners, regardless of whether a particular Limited Partner
previously was an investor in such affected assets. MHP owns discrete
assets and the Mergers and the REIT Conversion will significantly
diversify the types and geographic locations of the Hotels in which the
MHP Limited Partners will have interests. As a result, the Hotels owned
by the Operating Partnership may be affected differently by economic and
market conditions than those Hotels previously owned by MHP.
. MHP Limited Partners Have No Cash Appraisal Rights. MHP Limited Partners
who vote against the Merger have no right to receive cash based upon an
appraisal of their Partnership Interests.
. Uncertainties as to the Size and Leverage of the Operating
Partnership. The MHP Limited Partners cannot know at the time they vote
on the Merger the exact size and amount of leverage of the Operating
Partnership. Host is an existing operating company that regularly issues
and repays debt, acquires additional hotels and disposes of existing
hotels. Also, some or all of the Partnerships may elect not to
participate in a Merger. In addition, outside partners in certain
Private Partnerships may not consent to a lease of their partnership's
Hotel(s). In either such case, Host will contribute its interests in
such Partnerships and Private Partnerships to the Operating Partnership,
but the Operating Partnership may, in turn, contribute such interests to
a Non-Controlled Subsidiary, which will be subject to corporate-level
income taxation. Host also may repurchase outstanding securities or
issue new debt or equity securities prior to the consummation of the
Mergers and the REIT Conversion.
. Lack of Control over Hotel Operations. Due to current federal income tax
law restrictions on a REIT's ability to derive revenues directly from
the operation of a hotel, the Operating Partnership will lease virtually
all of its consolidated Hotels to the Lessees, which will operate the
Hotels by continuing to retain the Managers pursuant to the Management
Agreements. The Operating Partnership will not operate the Hotels or
participate in the decisions affecting the daily operations of the
Hotels. The Operating Partnership will have only a limited ability to
require the Lessees or the Managers to operate or manage the Hotels in
any particular manner and no ability to govern any particular aspect of
their day-to-day operation or management. Therefore, the Operating
Partnership will be dependent for its revenue upon the ability of the
Lessees and the Managers to operate and manage the Hotels.
MHP Supp-4
<PAGE>
. Expiration of Leases and Possible Inability to Find Other Lessees. The
Leases will expire seven to ten years after the Effective Date and there
can be no assurance that such Leases will be renewed (or if renewed,
will be renewed on terms as favorable to the Operating Partnership). If
the Leases are not renewed, the Operating Partnership will be required
to find other lessees, which lessees must meet certain requirements set
forth in the Management Agreements. There can be no assurance that
satisfactory lessees could be found or as to the terms and conditions on
which the Operating Partnership would be able to renew the Leases or
enter into new leases with such lessees.
. Requisite Vote of MHP Limited Partners Binds All MHP Limited
Partners. For MHP, approval by a majority of the Partnership Interests
of MHP that are eligible to be voted is required to approve the Merger,
as described in "Voting Procedures--Required Vote and Other Conditions."
Such approval will cause MHP to participate in the Merger and will bind
all MHP Limited Partners, including MHP Limited Partners who voted
against or abstained from voting with respect to the Merger.
. Substantial Indebtedness of the Operating Partnership. The Operating
Partnership will have substantial indebtedness. As of June 19, 1998, on
a pro forma basis assuming the Full Participation Scenario, the
Operating Partnership had outstanding indebtedness totaling
approximately $5.1 billion, which represents a % debt-to-total market
capitalization ratio on a pro forma basis at such date (based upon a
price per Common Share of Host REIT of $ ). The Operating
Partnership's business is capital intensive and it will have significant
capital requirements in the future. The Operating Partnership's leverage
level could affect its ability to (i) obtain financing in the future,
(ii) undertake refinancings on terms and subject to conditions deemed
acceptable by the Operating Partnership, (iii) make distributions to
partners, (iv) pursue its acquisition strategy or (v) compete
effectively or operate successfully under adverse economic conditions.
. No Limitation on Debt. There are no limitations in Host REIT's or the
Operating Partnership's organizational documents which limit the amount
of indebtedness either may incur, although both the Notes and the
Operating Partnership's other debt instruments will contain certain
restrictions on the amount of indebtedness that the Operating
Partnership may incur.
. Rental Revenues from Hotels Subject to Rights of Lenders. In accordance
with the mortgage loan agreements with respect to outstanding
indebtedness of certain Hotel Partnerships, the rental revenues received
by such Hotel Partnerships under certain Leases first will be used to
satisfy the debt service on such outstanding indebtedness with only the
cash flow remaining after debt service being available to satisfy other
obligations of the Hotel Partnership (including paying property taxes
and insurance, funding the required FF&E reserves for the Hotels and
capital improvements and paying debt service with respect to unsecured
debt) and to make distributions to holders of OP Units.
. Ownership Limitations. No person or group may own, actually or
constructively (as determined under the applicable Code provisions), (i)
in excess of 9.8% of the number or value of outstanding Common Shares of
Host REIT or (ii) in excess of 4.9% of the value of the OP Units (other
than Host REIT and The Blackstone Group), subject to waiver or
modification by Host REIT or the Operating Partnership, as the case may
be, in certain limited circumstances.
. Timing of the REIT Conversion. If the REIT Conversion does not occur in
time for Host REIT to elect REIT status effective January 1, 1999, the
effectiveness of Host REIT's election could be delayed to January 1,
2000, which would result in Host REIT continuing to pay corporate-level
income taxes in 1999 and could cause the Blackstone Acquisition not to
be consummated.
. Effect of Subsequent Events upon Recognition of Gain. Even though the
MHP Limited Partners (other than those who elect to receive a Note in
exchange for OP Units) generally are not expected to recognize
significant taxable gain at the time of the Merger, there are a variety
of events and transactions (including the sale of one or more of the
Hotels currently owned by MHP or the reduction of indebtedness securing
one or more of the Hotels) that could cause an MHP Limited Partner to
recognize all or a part of the gain that otherwise has been deferred
through the REIT Conversion. See "Federal Income Tax Consequences
MHP Supp-5
<PAGE>
--Tax Treatment of MHP Limited Partners Who Hold OP Units Following the
Merger." Certain Hotels (including the Blackstone Hotels) will be covered
by agreements with third parties which will restrict the Operating
Partnership's ability to dispose of those properties or refinance their
debt. In addition, if Atlanta Marquis participates in the Mergers, the
Operating Partnership will succeed to an existing agreement that will
restrict its ability to dispose of the Atlanta Marquis Hotel or to
refinance the debt secured by such Hotel without compensating certain
outside partners for the resulting adverse tax consequences. As for the
remaining initial properties (including the Hotels owned by MHP), the
partnership agreement of the Operating Partnership, which is substantially
in the form attached to the Consent Solicitation as Appendix A (the
"Partnership Agreement"), does not impose any restrictions on the
Operating Partnership's ability to dispose of the Hotels or to refinance
debt secured by the Hotels (but the Operating Partnership is obligated to
pay any taxes Host REIT incurs as a result of such transactions). In
addition, the Partnership Agreement provides that Host REIT, as general
partner of the Operating Partnership, is not required to take into account
the tax consequences of the limited partners in deciding whether to cause
the Operating Partnership to undertake specific transactions (but the
Operating Partnership is obligated to pay any taxes that Host REIT incurs
as a result of such transactions) and the limited partners have no right
to approve or disapprove such transactions. See "Description of OP Units--
Sales of Assets."
. Election to Exchange OP Units for Notes. An MHP Limited Partner who
elects to receive a Note in connection with the Merger in exchange for
his OP Units will be treated as having made a taxable disposition of his
Partnership Interest. An MHP Limited Partner who receives a Note may be
eligible to defer a majority of that gain under the "installment sale"
rules. An MHP Limited Partner with a "negative capital account" with
respect to his Partnership Interest who elects to receive a Note will
recognize "phantom income" in that amount at the time of the Merger in
any event. See "Federal Income Tax Consequences--Tax Treatment of MHP
Limited Partners Who Exercise Their Right to Make the Note Election."
. Competition in the Lodging Industry. The profitability of the Hotels is
subject to general economic conditions, the management abilities of the
Managers (including primarily Marriott International), competition, the
desirability of particular locations and other factors relating to the
operation of the Hotels. The full-service segment of the lodging
industry, in which virtually all of the Hotels operate, is highly
competitive, and the Hotels generally operate in geographical markets
that contain numerous competitors. The Hotels' success will be
dependent, in large part, upon their ability to compete in such areas as
access, location, quality of accommodations, room rate structure, the
quality and scope of food and beverage facilities and other services and
amenities. The lodging industry, including the Hotels (and thus the
Operating Partnership), may be adversely affected in the future by (i)
national and regional economic conditions, (ii) changes in travel
patterns, (iii) taxes and government regulations which influence or
determine wages, prices, interest rates, construction procedures and
costs, (iv) the availability of credit and (v) other factors beyond the
control of the Operating Partnership.
. Failure of Host REIT to Qualify as a REIT for Tax Purposes. Taxation of
Host REIT as a corporation if it fails to qualify as a REIT, and Host
REIT's subsequent liability for federal, state and local taxes on its
income and property, would, among other things, have the effect of
reducing cash available for distribution to Host REIT's shareholders and
materially reducing the value of the Common Shares and OP Units.
. Failure of the Operating Partnership to Qualify as a Partnership for Tax
Purposes. Taxation of the Operating Partnership as a corporation if it
fails to qualify as a partnership and the Operating Partnership's
subsequent liability for federal, state and local income taxes, would,
among other things, have the effect of reducing cash available for
distribution to holders of OP Units, would cause Host REIT to fail to
qualify as a REIT for tax purposes and would cause the holders of OP
Units to recognize substantial taxable gain at the time the Operating
Partnership ceases to qualify as a partnership.
. Failure of the Leases to Qualify as Leases. If one or more of the Leases
of the Hotels to the Lessees were to be disregarded for tax purposes (for
example, because a the Lease was determined to lack economic substance),
Host REIT could fail to qualify as a REIT and the Operating Partnership
might be
MHP Supp-6
<PAGE>
treated as a corporation for federal income tax purposes, which would have
a material adverse impact on the MHP Limited Partners and the value of the
OP Units.
. Change in Tax Laws. No assurance can be provided that new legislation,
Treasury Regulations, administrative interpretations or court decisions
will not significantly change the tax laws with respect to Host REIT's
qualification as a REIT or the federal income tax consequences of such
qualification.
. MHP Limited Partners Need to Consult with Their Own Tax Advisors.
Because the specific tax attributes of an MHP Limited Partner and the
facts regarding such MHP Limited Partner's interest in MHP could have a
material impact on the tax consequences to such MHP Limited Partner of
the Merger, the subsequent ownership and disposition of OP Units or Notes
and/or the subsequent ownership and disposition of Common Shares, it is
essential that each MHP Limited Partner consult with his own tax advisors
regarding the application of federal, foreign and state and local tax
laws to such MHP Limited Partner's personal tax situation.
. Effect of Possible Classification as a Publicly Traded Partnership on
Passive Losses. There is a significant possibility that the Operating
Partnership could be classified as a "publicly traded partnership," in
which event the MHP Limited Partners would not be able to use suspended
passive activity losses from other investments (including from MHP) to
offset income from the Operating Partnership. It is estimated that each
MHP Limited Partner who purchased his Partnership Interest at the time of
the original offering of such Interests, has held such Partnership
Interest continuously since that time and whose Partnership Interest has
been his only investment in a passive activity would have a passive
activity loss carryforward as of December 31, 1998.
. Host's Substantial Deferred Tax and Contingent Liabilities. Host will
have substantial deferred tax liabilities that are likely to be
recognized in the next ten years (notwithstanding Host REIT's status as a
REIT), and the IRS could assert substantial additional liabilities for
taxes against Host for taxable years prior to the time Host REIT
qualifies as a REIT. Under the terms of the REIT Conversion and the
Partnership Agreement, the Operating Partnership will be responsible for
paying (or reimbursing Host REIT for the payment of) all such tax
liabilities as well as any other liabilities (including contingent
liabilities and liabilities attributable to litigation that Host REIT may
incur) whether such liabilities are incurred by reason of Host's
activities prior to the REIT Conversion or the activities of Host REIT
subsequent thereto.
Because REITs are not permitted under current federal income tax law to
derive revenues directly from the operation of hotels, the Operating
Partnership will lease the Hotels to lessees (the "Lessees") that will operate
the Hotels under the existing management agreements and pay rent to the
Operating Partnership, as more fully described herein. The Lessees generally
will be indirect controlled subsidiaries of HMC Senior Communities, Inc.
("SLC"), which currently is a wholly owned subsidiary of Host. SLC will become
a separate public company when Host distributes the common stock of SLC and
other considerations to its existing shareholders and the Blackstone Entities
in connection with Host's distribution of its accumulated earnings and profits,
which Host REIT is required to do in order to qualify as a REIT. Shares of Host
REIT and SLC will become separately traded securities and the companies will
operate independently. There will be no overlap between the boards of Host REIT
and SLC. There will be a substantial overlap of shareholders of the two
companies initially, but this likely will diverge over time.
MARRIOTT HOTEL PROPERTIES, INC. (THE "GENERAL PARTNER"), THE GENERAL PARTNER
OF MHP, BELIEVES THAT THE MERGER PROVIDES SUBSTANTIAL BENEFITS AND IS FAIR TO
THE MHP LIMITED PARTNERS AND RECOMMENDS THAT ALL MHP LIMITED PARTNERS VOTE FOR
THE MERGER.
The effects of the Mergers may be different for Limited Partners of the
various Partnerships. This Supplement has been prepared to highlight for MHP
Limited Partners the specific risks, benefits, effects and fairness of the
Merger to them and to provide other information specific to MHP. Supplements
have also been prepared for each of the other Partnerships. This Supplement,
together with the supplements of the other Partnerships (collectively, the
"Supplements"), are part of the Consent Solicitation. Upon receipt of a written
MHP Supp-7
<PAGE>
request by a Limited Partner or his representative so designated in writing,
the General Partner will send a copy of any Supplement without charge. All
requests for a copy of a Supplement should be directed to: Investor Relations,
10400 Fernwood Road, Bethesda, Maryland 20817, telephone number 301-380-2070
(between the hours of 9:00 a.m. and 4:00 p.m., eastern time).
All cross-references refer to the Consent Solicitation unless the context
indicates otherwise. Capitalized terms not defined herein shall have the
meaning set forth in the Consent Solicitation. The information contained
herein, unless otherwise indicated, assumes the REIT Conversion occurs with
all Partnerships participating and no Notes being issued (the "Full
Participation Scenario").
EXPECTED BENEFITS OF THE MERGER
The General Partner believes that participating in the Merger would likely
be beneficial to the MHP Limited Partners for the reasons set forth below.
This information is qualified by and should be read in conjunction with the
information in the Consent Solicitation under "Background and Reasons for the
Mergers and the REIT Conversion--Reasons for the Mergers." These benefits,
which should be viewed as alternatives to continuing the business and
operations of MHP, are expected to include:
. Exchange Value of MHP. MHP Limited Partners who elect to retain OP Units
in the Merger will receive OP Units with an estimated Exchange Value
equal to $141,425 per Partnership Unit.
. Enhanced Liquidity of Investment. The REIT Conversion will offer MHP
Limited Partners significantly enhanced liquidity with respect to their
investments in MHP because, commencing one year following the Effective
Date, MHP Limited Partners who retain OP Units will be able to exercise
their Unit Redemption Right at any time, subject to certain limited
exceptions. Host has approximately 204 million shares of common stock
outstanding and is expected to have a total common equity market
capitalization of approximately $ billion after giving effect to the
estimated $ million earnings and profits distribution (based on
Host's $ closing price per share on the NYSE on , 1998). The
exercise of the Unit Redemption Right, however, generally would result
in recognition of taxable income or gain at that time.
. Public Market Valuation of Assets. The Partnership Units of MHP
currently trade at a discount to the net asset value of MHP's assets. In
contrast, the General Partner believes that by exchanging interests in
MHP, which is a non-traded, finite-life limited partnership with a fixed
portfolio for interests in an infinite-life real estate company focused
primarily on a more diverse and growing full-service hotel portfolio and
providing valuation based upon publicly traded Common Shares of Host
REIT, the MHP Limited Partners will have the opportunity to participate
in the recent trend toward ownership of real estate through a publicly
traded entity, which, in many instances, has resulted in market
valuations of public real estate companies in excess of the estimated
net asset values of those companies. There can be no assurance, however,
that the Common Shares of Host REIT will trade at a premium to the
private market values of the Operating Partnership's assets or that the
relative pricing differential will not change or be eliminated in the
future. Also, the benefit of Host's conversion to a REIT will not be
shared by the MHP Limited Partners if and to the extent that such
benefit is reflected in the market valuation of Host's common stock
prior to the REIT Conversion.
. Regular Quarterly Cash Distributions. The General Partner expects that
the Operating Partnership will make regular quarterly cash distributions
to holders of OP Units. The General Partner expects that while these
distributions will be lower than the estimated cash distributions for
1998 of MHP, the ability to receive distributions quarterly and in
regular amounts would be enhanced. For additional information regarding
historical and estimated future distributions for MHP and the other
Partnerships, see "Background and Reasons for the Mergers and the REIT
Conversion--Reasons for the Mergers."
. Substantial Tax Deferral. The General Partner expects that MHP Limited
Partners who do not elect to receive a Note in exchange for OP Units
generally should be able to obtain the benefits of the Merger while
continuing to defer recognition for federal income tax purposes of at
least a substantial portion, if not all, of the gain with respect to
their Partnership Interests that otherwise would be recognized in the
event of a liquidation of MHP or a sale or other disposition of its
assets in a taxable transaction (although MHP Limited Partners may (but
are not expected to) recognize a relatively modest amount of ordinary
MHP Supp-8
<PAGE>
income as the result of required sales of personal property to a Non-
Controlled Subsidiary in order to facilitate Host REIT's qualification as
a REIT). Thereafter, such MHP Limited Partners generally should be able to
defer at least a substantial portion of such built-in gain until they
elect to exercise their Unit Redemption Right, one or both of the Hotels
currently owned, directly or indirectly, by MHP are sold or otherwise
disposed of in a taxable transaction by the Operating Partnership or the
debt now secured by such Hotels is repaid, prepaid or substantially
reduced. The federal income tax consequences of the Merger are highly
complex and, with respect to each MHP Limited Partner, are dependent upon
many variables, including the particular circumstances of such MHP Limited
Partner. See "Federal Income Tax Consequences--Tax Consequences of the
Merger." Each MHP Limited Partner is urged to consult with his own tax
advisors as to the consequences of the Merger in light of his particular
circumstances.
. Risk Diversification. Participation in the Merger, as well as future
hotel acquisitions by the Operating Partnership, will reduce the
dependence of MHP Limited Partners upon the performance of, and the
exposure to the risks associated with, MHP's Hotels and spread such risk
over a broader and more varied portfolio, including more diverse
geographic locations and multiple brands. See "Business and Properties--
Business Objectives."
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a lower leverage to value ratio than MHP
currently, which has a leverage ratio of 56% (calculated as a percentage
of Appraised Value), resulting in interest and debt service savings and
greater financial stability.
. Growth Potential. The General Partner believes that the MHP Limited
Partners, by owning interests in a publicly traded real estate company
focused primarily on a more diverse and growing luxury and upscale full-
service hotel portfolio, will be able to participate in growth
opportunities that would not otherwise be available to them.
. Greater Access to Capital. With publicly traded equity securities, a
larger base of assets and a substantially greater equity value than MHP
individually, Host REIT expects to have greater access to the capital
necessary to fund the Operating Partnership's operations and to
consummate acquisitions on more attractive terms than would be available
to MHP individually. This greater access to capital should provide
greater financial stability to the Operating Partnership and reduce the
level of risk associated with refinancing existing loans upon maturity,
as compared to MHP individually.
If MHP does not participate in the Merger, its business will continue in its
current manner; however, the Operating Partnership may elect to contribute
some or all of its interest in MHP to a Non-Controlled Subsidiary.
DETERMINATION OF EXCHANGE VALUE OF MHP AND ALLOCATION OF OP UNITS
GENERAL. The Exchange Value of MHP will be equal to the greatest of its
Adjusted Appraised Value, Continuation Value and Liquidation Value, each of
which has been determined as follows:
. Adjusted Appraised Value. The General Partner has retained AAA to
determine the market value of each of the Hotels as of March 1, 1998
(the "Appraised Value"). The "Adjusted Appraised Value" of MHP equals
the Appraised Value of its Hotels, adjusted as of the Final Valuation
Date for lender reserves, capital expenditure reserves, existing
indebtedness (including a "mark to market" adjustment to reflect the
market value of such indebtedness), certain deferred maintenance costs,
deferred management fees and transfer and recordation taxes and fees.
. Continuation Value. The "Continuation Value" of MHP represents AAA's
estimate, as adopted by the General Partner, of the discounted present
value, as of January 1, 1998, of the MHP limited partners' share of
estimated future cash distributions and estimated net sales proceeds
(plus lender reserves), assuming that MHP continues as an operating
business for twelve years and its assets are sold on December 31, 2009
for their then estimated market value.
. Liquidation Value. The "Liquidation Value" of MHP represents the
General Partner's estimate of the net proceeds to MHP limited partners
resulting from the assumed sale as of December 31, 1998 of the
MHP Supp-9
<PAGE>
Hotel(s) of MHP, each at its Adjusted Appraised Value (after eliminating
any "mark to market" adjustment and adding back the deduction for transfer
and recordation taxes and fees, if any, made in deriving the Adjusted
Appraised Value), less (i) estimated liquidation costs, expenses and
contingencies equal to 2.5% of Appraised Value and (ii) prepayment
penalties or defeasance costs, as applicable.
Final determination of the Exchange Value of MHP will be made as of the end
of the four week accounting period ending at least 20 days prior to the
Effective Date (the "Final Valuation Date") and will be equal to the greatest
of Adjusted Appraised Value, Continuation Value and Liquidation Value as of
such date. Adjusted Appraised Value, Continuation Value and Liquidation Value
will be adjusted as of the Final Valuation Date (i) to reflect the amount of
lender and capital expenditure reserves and the amount of deferred management
fees as of such date, (ii) to increase the Adjusted Appraised Value by any
amounts actually expended by MHP after the Initial Valuation Date to perform
deferred maintenance that were previously subtracted in determining the
estimated Adjusted Appraised Value of MHP and (iii) to reflect any changes in
MHP's other reserves, such as for litigation expenses and indemnification
costs and any revised estimates of transfer and recordation taxes and fees.
Appraised Value. MHP's Hotels were appraised as of March 1, 1998 by AAA, an
independent, nationally recognized hotel valuation and financial advisory firm
experienced in the appraisals of lodging properties such as MHP's Hotels. Each
appraisal (an "Appraisal") was reviewed by a Member Appraisal Institute
("MAI") appraiser and certified by such MAI appraiser as having been prepared
in accordance with the requirements of the Standards of Professional Practice
of the Appraisal Institute and the Uniform Standards of Professional Appraisal
Practice of the Appraisal Foundation.
The purpose of each Appraisal is to provide an estimate of the "Market
Value" of the related Hotel. "Market Value" means the most probable price
which a property should bring in a competitive and open market under all
conditions requisite to a fair sale, the buyer and seller each acting
prudently and knowledgeably and assuming the price is not affected by undue
stimuli. Implicit in this definition is the consummation of a sale as of a
specified date and the passing of title from seller to buyer under conditions
whereby: (i) the buyer and seller are equally motivated; (ii) both parties are
well informed or well advised, and each is acting in what he considers his own
best interest; (iii) a reasonable time frame is allowed for exposure in the
open market; (iv) payment is made in terms of cash in U.S. dollars or in terms
of financial arrangements comparable thereto and (v) the price represents the
normal consideration for the property sold unaffected by special or creative
financing or sales concessions granted by anyone associated with the sale. AAA
made site visits at all of MHP's Hotels for purposes of the Appraisals.
In preparing the Appraisals, AAA relied primarily on the income
capitalization method of valuation, and then compared the value estimated by
this method with recent sales of comparable properties, as a check on the
reasonableness of the value determined through the income capitalization
method. AAA employed the following procedures for determining the Appraised
Value of each MHP Hotel:
. Historical 1997 and Projected Year's Earnings. AAA reviewed the
historical 1997 net operating income (i.e., income before interest,
taxes, depreciation and amortization) ("NOI") prior to incentive
management fees and certain capital expenditures for the applicable
Hotel. AAA also prepared a projection of the net operating income prior
to incentive management fees and certain capital expenditures for the
applicable Hotel for the twelve month period ending February 28, 1999
(the "Projected Year"), using historical financial information for each
Hotel, budget information, a survey with the manager of each Hotel
addressing the physical condition of the Hotel, local market conditions
(including business mix, demand generators, future trends and
predictability of business), changes in the competitive environment,
comparison with direct competitors of the Hotel and risk factors
relating to the particular Hotel. The resulting gross margin (ratio of
total revenues to NOI prior to incentive management fees) was checked
against AAA's database of the gross margins for similar hotels for
reasonableness.
. Impact of Incentive Management Fees. AAA estimated a normalized annual
amount of incentive management fees payable under the applicable
management agreement and subtracted this amount from
MHP Supp-10
<PAGE>
the net operating income prior to incentive management fees and certain
capital expenditures for 1997 and the Projected Year.
. Impact of Owner Funded Capital Expenditures. AAA estimated normalized
annual amounts of owner funded capital expenditures (over and above the
FF&E reserve) based in part on projected owner funded capital
expenditures estimated in the Engineering Study. The normalized amounts
were then subtracted from the NOI prior to owner funded capital
expenditures for 1997 and the Projected Year.
. Capitalization of Adjusted NOI. AAA then capitalized the amount
resulting from the foregoing adjustments ("Adjusted NOI") for 1997 and
the Projected Year by dividing such amounts by capitalization rates that
AAA determined to be appropriate. A capitalization rate represents the
relationship between net operating income and sales prices of income
producing property. AAA selected the capitalization rates based upon its
review of current published surveys reflecting the opinions of investors
and participants such as REITs, hotel acquisition/management companies
and pension funds, lenders, brokers and consultants as to current
capitalization rates, and its own database of capitalization rates
reflected in recent transactions, adjusted for factors specific to the
Hotel, such as location, physical condition, reserve policies, local
market volatility and competition, guest mix, renovation influences and
other income characteristics. AAA used separate capitalization rates
that it deemed appropriate to capitalize 1997 historical Adjusted NOI
and estimated Projected Year's Adjusted NOI. AAA then estimated the
value of each Hotel based upon each of the values estimated by
capitalizing 1997 and Projected Year's Adjusted NOI and its professional
judgment. The following table sets forth the effective capitalization
rates for 1997 and Projected Year's Adjusted NOI resulting from AAA's
estimated Appraised Values of MHP's Hotels.
RESULTING EFFECTIVE CAPITALIZATION RATES FOR APPRAISALS OF MHP'S HOTELS
<TABLE>
<CAPTION>
PROJECTED YEAR
1997 (ENDING FEBRUARY 28, 1999)
---- --------------------------
<S> <C>
8.8-9.4% 9.8-10.2%
</TABLE>
APPRAISED VALUES OF MHP'S HOTELS
<TABLE>
<CAPTION>
APPRAISED
VALUE
HOTEL --------------
(IN THOUSANDS)
<S> <C>
Orlando World Center.......... $292,500
Harbor Beach Resort........... 61,761(1)
--------
Total....................... $354,261
========
</TABLE>
- --------
(1) Excludes 49.5% of the $122,300,000 Appraised Value of the Harbor Beach
Resort.
. Comparison with Comparable Sales. AAA checked the Appraised Value of
each Hotel derived by the foregoing procedures against its database of
comparable sale transactions for reasonableness.
In the case of Harbor Beach Resort, which is only partly owned by MHP, the
Appraised Value of such Hotel was reduced proportionately to the amount
attributable to MHP's ownership interest therein (but no adjustment was made to
reflect the effect that the outside interest might have on decisions with
respect to sales, refinancings or other major operational matters). With
respect to MHP's Hotels, one property was encumbered by a ground lease as of
the date of the Appraisals. Accordingly, the Appraised Value of such Hotel has
been decreased to reflect the encumbrance of the ground lease and the interest
of the ground lessor in the operating cash flows of such Hotel. The Appraised
Value assumes all contractual provisions for FF&E reserves are adequate and
have not been reduced to reflect deferred maintenance or environmental
remediation costs with respect to MHP's Hotels (but estimated deferred
maintenance costs have been deducted in estimating the Adjusted Appraised Value
of each of MHP's Hotels). The Appraised Value did not take into account the
costs that might be incurred in selling the Hotels (but estimated costs for
transfer and recordation taxes and fees have been deducted in estimating the
Adjusted Appraised Value of each Hotel).
MHP Supp-11
<PAGE>
The Appraisals are not guarantees of present or future values and no
assurance can be given as to the actual value of MHP's Hotels. The Appraisals
should be read in conjunction with other information, such as, but not limited
to, the audited financial statements of MHP.
The Appraised Value, and the assumptions underlying the projections on which
the Appraised Value is based, are contingent upon a series of future events,
the outcomes of which are not necessarily within the Operating Partnership's
control and cannot be determined at this time. There can be no assurance that
another appraiser would not have arrived at a different result. Some of the
assumptions inevitably will not materialize and unanticipated events and
circumstances will occur subsequent to the date of the Appraisals.
Furthermore, the actual results achieved from MHP's Hotels will vary from the
results projected in the Appraisals and the variations may be material.
Adjusted Appraised Value. The Adjusted Appraised Value of MHP was determined
by totaling the Appraised Values of all of the Hotels of MHP and then making
various adjustments to the aggregate Appraised Value, as described below.
. Lender Reserves. MHP's debt service reserves are required to be held by
third-party lenders. The amount of these lender reserves as of the
Initial Valuation Date was added to the Appraised Values of these
Hotels. A final determination of the lender reserves of MHP will be made
on the Final Valuation Date and any changes in such reserves will be
reflected in the Adjusted Appraised Value.)
. Mortgage and Other Debt. The estimated principal balance and accrued
interest as of the Effective Date (assumed to be December 31, 1998) of
all mortgage and other debt of MHP has been subtracted from the
Appraised Value.
. Mark to Market Adjustments. The third-party loans of the Partnerships
have various interest rates and terms to maturity. In order to reflect
the market value of the third-party loans of each Partnership, the
estimated Adjusted Appraised Value for MHP has been increased to "mark
to market" the interest rate for such loans. This adjustment has been
estimated by comparing the interest cost using the applicable interest
rates on existing third-party loans over their remaining term to the
interest cost using the interest rate that the Operating Partnership
believes it would be able to obtain for unsecured debt in the market as
of the Final Valuation Date (which would have been % per annum based on
a 225 basis point (2.25 percent) spread over the yield on seven-year
U.S. Treasury securities as of , 1998). The mark to market adjustment
for each loan was calculated by determining the difference between the
present values, as of December 31, 1998, of the interest payments over
the remaining term of the loan from January 1, 1999 to maturity using
the actual interest rate as the discount rate as compared to using the
assumed market rate as the discount rate.
. Deferred Maintenance Costs. The estimated cost to complete any deferred
maintenance items identified in the Engineering Study relating to MHP's
Hotels have been subtracted from the Appraised Value. The adjustments for
this item will be reduced at the Final Valuation Date to reflect amounts
expended after the Initial Valuation Date to perform such deferred
maintenance. No adjustments have been made for previously budgeted
capital expenditures or deferred maintenance costs estimated in the
Engineering Study that are reflected in the cash flow projections used
for purposes of estimating Appraised Values.
MHP Supp-12
<PAGE>
The following table sets forth the adjustments to the aggregate Appraised
Values made to derive the estimated Adjusted Appraised Value for MHP as of the
Initial Valuation Date.
CALCULATION OF ESTIMATED ADJUSTED APPRAISED VALUE FOR MHP AS OF THE INITIAL
VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................ $ 354,261(1)
Lender reserves................ 1,800
Mortgage debt.................. (192,137)(1)
Other debt..................... (722)
Mark to market adjustment...... 2,878
Deferred maintenance costs..... (245)
---------
Estimated Adjusted Appraised
Value......................... $ 165,835
=========
Limited partners' share........ $ 140,032
Per Partnership Unit........... $ 140,032
</TABLE>
- --------
(1) Excludes 49.5% of the $122,300,000 Appraised Value of the Harbor Beach
Resort and the $82,266,000 in mortgage debt encumbering the Hotel.
CONTINUATION VALUE. AAA estimated the Continuation Value of MHP using the
following methodology:
. Estimated Future Cash Distributions. AAA prepared estimates of future
partnership cash flow for MHP for the 12-year period from January 1,
1998 through December 31, 2009 based upon the estimated 1998 NOI before
incentive management fees used in the Appraisals and for each subsequent
year applying an assumed annual stabilized growth rate (as shown in the
table below) developed by AAA for this analysis. For each year in the
projection period, AAA estimated the amount of cash available for
distribution to MHP's limited partners after payment of all management
fees, debt service, owner funded capital expenditures based on the
Engineering Study and other partnership expenses and after application
of the applicable partnership agreement provisions. AAA assumed that
MHP's FF&E reserve was adequate and understood that Host determined that
there were no reserve shortfalls or surpluses.
. Refinancing Assumptions. For MHP's debt that matures during the 12-year
period, AAA assumed that the debt would be refinanced with an interest
rate of 7.25% per annum and a 25-year amortization schedule, with
estimated refinancing costs of 2% of the refinanced amount being paid
from operating cash flow.
. Determination of Residual Value. To estimate the residual value of the
MHP limited partners' interest in MHP at the end of the 12-year period,
AAA assumed that the MHP Hotels would be sold as of December 31, 2009 at
their then market value. AAA estimated the market value of each Hotel as
of such date by applying an exit capitalization rate that it deemed
appropriate, using the factors described above in connection with the
"--Appraised Value," which are set forth in the table below, to the
estimated Adjusted NOI for 2009 (estimated as described above). AAA then
subtracted estimated sales costs of 2.0% of the estimated market value,
added lender reserves and subtracted the estimated outstanding principal
balance of debt as of December 31, 2009 and deferred management fees to
arrive at net sales proceeds available for distribution to partners. AAA
then determined what portion of such estimated net sales proceeds would
be distributable to MHP's limited partners under the partnership and
debt agreements.
. Discounting Distributions to Present Value. As a final step, AAA
discounted the estimated future cash distributions to MHP's limited
partners from operations and estimated net sales proceeds to their
present value as of January 1, 1998, using a discount rate of 20% per
annum. AAA believes that this discount rate reflects the return on
investment that investors expect from leveraged investments of this
nature.
MHP Supp-13
<PAGE>
The growth rate and exit capitalization rate used to determine the estimated
Continuation Value for MHP are as set forth below:
GROWTH RATE, EXIT CAPITALIZATION RATE AND ESTIMATED CONTINUATION VALUE FOR MHP
<TABLE>
<CAPTION>
ESTIMATED
CONTINUATION VALUE
GROWTH RATE EXIT CAPITALIZATION RATE (2009) (PER PARTNERSHIP UNIT)
----------- ------------------------------- ----------------------
<S> <C> <C>
3.65%(1) 9.9% $141,425
</TABLE>
- --------
(1) Reflects the average of the stabilized growth rates of Harbor Beach
Resort (3.80% each year) and Orlando World Center (3.50% beginning in
2003 to reflect the effect of the planned expansion of the Hotel).
LIQUIDATION VALUE. The Liquidation Value of MHP was estimated by the General
Partner and represents the estimated value of MHP if all of its assets were
sold as of December 31, 1998. Such value was based upon the Adjusted Appraised
Value of MHP, with the following adjustments: (i) the "mark to market"
adjustment used to estimate the Adjusted Appraised Value was eliminated and
instead prepayment or defeasance costs that would be payable under existing
debt agreements (regardless of whether the debt in fact can be prepaid on
December 31, 1998) were deducted from the Appraised Value; and (ii) the
deduction for transfer and recordation taxes and fees used to estimate the
Adjusted Appraised Value was eliminated and instead an amount equal 2.5% of
the Appraised Value of MHP's Hotels was subtracted from the Appraised Value
for estimated liquidation costs, expenses and contingencies. The General
Partner then determined the portion of the estimated Liquidation Value that
would be distributable to MHP's limited partners under the terms of the
partnership agreement and other contractual arrangements.
The following table sets forth the adjustments made to the Adjusted
Appraised Value to estimate the Liquidation Value of MHP as of the Initial
Valuation Date:
CALCULATION OF ESTIMATED LIQUIDATION VALUE OF MHP AS OF THE INITIAL VALUATION
DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................ $ 354,261(1)
Lender reserves................ 1,800
Mortgage debt.................. (192,137)(1)
Other debt..................... (722)
Prepayment/defeasance costs.... (10,794)
Deferred maintenance costs..... (245)
Sales costs.................... (8,857)
---------
Estimated Liquidation Value.... $ 143,306
=========
Limited partners' share........ $ 124,261
Per Partnership Unit........... $ 124,261
</TABLE>
- --------
(1) Excludes 49.5% of the $122,300,000 Appraised Value of the Harbor Beach
Resort and the $82,266,000 in mortgage debt encumbering the Hotel.
ESTIMATED EXCHANGE VALUE. The following table sets forth the estimated
Exchange Value of MHP (based upon the greatest of its estimated Adjusted
Appraised Value, estimated Continuation Value and estimated Liquidation
Value), the estimated minimum and pro forma number of OP Units to be received
and the estimated Note Election Amount for MHP, all on a per Partnership Unit
basis, as of the Initial Valuation Date. The estimated Exchange Value for MHP
will be received by each MHP Limited Partner retaining OP Units in the Merger.
The estimated Note Election Amount for MHP (which will be received by MHP
Limited Partners
MHP Supp-14
<PAGE>
electing to receive Notes in exchange for OP Units) is equal to the
Liquidation Value for MHP. The estimated values set forth below may increase
or decrease as a result of various adjustments, which will be finally
calculated as of the Final Valuation Date but will not change as a result of
less than all of the Partnerships participating in the Mergers. The actual
number of OP Units to be received by the MHP Limited Partners will be based on
the average closing price on the NYSE of a Host REIT Common Share for the 20
trading days after the Effective Date.
ESTIMATED EXCHANGE VALUE, NUMBER OF OP UNITS AND NOTE ELECTION AMOUNT OF MHP
PER PARTNERSHIP UNIT(1)
<TABLE>
<CAPTION>
ESTIMATED ESTIMATED ESTIMATED ESTIMATED
ADJUSTED ESTIMATED ESTIMATED ESTIMATED MAXIMUM PRO FORMA NOTE
APPRAISED CONTINUATION LIQUIDATION EXCHANGE NUMBER OF NUMBER OF ELECTION
VALUE VALUE VALUE VALUE(2) OP UNITS(3) OP UNITS(4) AMOUNT(5)
--------- ------------ ----------- --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
$140,032 $141,425 $124,261 $141,425 7,071 $124,261
</TABLE>
- --------
(1) A Partnership Unit in MHP represents an original investment of $100,000.
(2) The estimated Exchange Value is equal to the greatest of estimated
Adjusted Appraised Value, estimated Continuation Value and estimated
Liquidation Value.
(3) Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Merger.
(4) Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
(5) The principal amount of Notes is equal to the greater of (i) the
Liquidation Value or (ii) 60% of the Exchange Value (the "Note Election
Amount").
Price of OP Units to Pay Exchange Value to MHP Limited Partners. Each MHP
Limited Partner will receive OP Units with a deemed value equal to the
Exchange Value of such MHP Limited Partner's Partnership Interests. The price
of an OP Unit for this purpose will be equal to the average closing price on
the NYSE of a Host REIT Common Share for the 20 trading days after the
Effective Date of the Mergers (but in no event greater than $ per share).
The closing price per share of Host common stock on the NYSE was $ , on ,
1998.
MHP Limited Partners at the Effective Date of the Merger who retain OP Units
will receive cash distributions from MHP for all of 1998 and, if the Merger
does not occur in 1998, any portion of 1999 prior to the Merger for which
period they do not receive a cash distribution from the Operating Partnership.
Cash distributions will be made by MHP in accordance with its partnership
agreement on or before June 1, 1999 in respect of 1998 operations and, if the
Merger does not occur prior to January 1, 1999, within 90 days after the
Effective Date of the Merger in respect of any 1999 operations. Limited
Partners at the Effective Date of the Merger who receive Notes in exchange for
OP Units will participate in the same distributions from MHP as Limited
Partners who retain OP Units but will not receive any distributions from the
Operating Partnership with respect to periods after the Effective Date of the
Merger.
No fractional OP Units will be issued. Fractional amounts less than or equal
to 0.50 of an OP Unit will be rounded down to the next whole number and
fractional amounts greater than 0.50 will be rounded up to the next whole
number of OP Units.
VALUATION OF THE GENERAL PARTNER'S AND ITS AFFILIATE'S INTERESTS IN MHP AND
ALLOCATION OF OP UNITS TO THE GENERAL PARTNER AND ITS AFFILIATES
The value of the General Partner's interest will be equal to the aggregate
Exchange Value of MHP minus the aggregate Exchange Value of the MHP Limited
Partners' Partnership Interests (giving effect to the applicable distribution
preferences in the MHP partnership agreement). The number of OP Units that
will be received by the General Partner will be equal to the value of its
interest in MHP divided by the same price per OP Unit used to determine the
number of OP Units to be received by the MHP Limited Partners. The total
number of OP Units that will be owned directly or indirectly by Host REIT
(including OP Units owned by the General Partner) will be equal to the number
of outstanding shares of common stock of Host at the Effective Date.
MHP Supp-15
<PAGE>
The following table sets forth the estimated value of the General Partner's
and its affiliate's interests in MHP based upon the estimated aggregate
Exchange Value of the MHP Limited Partners' Partnership Interests as of the
Initial Valuation Date and the minimum and pro forma number of OP Units
estimated to be received by the General Partner and its affiliates in respect
thereof.
ESTIMATED VALUE OF THE GENERAL PARTNER'S AND ITS AFFILIATE'S INTERESTS AND
NUMBER OF OP UNITS
(DOLLARS IN THOUSANDS)
<TABLE>
<S> <C>
Aggregate Exchange Value........................................... $153,385
Limited Partners' share of aggregate Exchange Value................ 141,425
--------
Value of General Partner's interest................................ 11,960
Value of Host's limited partner interest........................... 68,344
--------
Total Host interest................................................ $ 80,304
========
Number of OP Units:
Minimum(1)........................................................
Pro Forma(2)...................................................... 4,015
</TABLE>
- --------
(1)Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Mergers.
(2)Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
CASH DISTRIBUTIONS
Historical Cash Distributions Paid by MHP. The following table sets forth
the distributions paid to MHP Limited Partners (per Partnership Unit) during
the periods indicated. The information below should be read in conjunction
with the information in this Supplement under the caption "Selected Financial
Data."
HISTORICAL CASH DISTRIBUTIONS PAID BY MHP
(PER PARTNERSHIP UNIT)(1)
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
------------------ --------------------------------
1998 1997 1996 1995 1994 1993
------------------ ------ ------ ------ ----- -----
<S> <C> <C> <C> <C> <C> <C>
From net income........... $1,500 $7,700 $4,970 $2,084 $ -- $ --
Representing return of
capital(2)............... -- -- -- -- -- --
------ ------ ------ ------ ----- -----
Total................... $1,500 $7,700 $4,970 $2,084 $ -- $ --
====== ====== ====== ====== ===== =====
</TABLE>
- --------
(1) A Partnership Unit represents a $100,000 original investment in MHP.
(2) Computed as all distributions in excess of distributions from operating
cash flow.
Compensation and Distributions to the General Partner. Under MHP's
partnership agreement, the General Partner does not receive fees or
compensation in connection with managing the affairs of MHP but the General
Partner and its affiliates are reimbursed for certain costs and expenses
incurred on behalf of MHP. In addition, the General Partner is entitled to
distributions related to its interests in MHP. The following information has
been prepared to compare the amount of reimbursements paid and cash
distributions made by MHP to the General Partner and its affiliates to the
amounts that would have been paid if the reimbursement and distribution
structure which will be in effect after the REIT Conversion had been in effect
for the periods presented.
Following the REIT Conversion, Host REIT will be operated as a self-
administered REIT and as a result no reimbursements or other compensation will
be received by the General Partner.
The following table sets forth the reimbursements and distributions paid by
MHP to its General Partner and its affiliates for the last three fiscal years
and the First Two Quarters 1998 ("Historical") and the reimbursements and
distributions that would have been paid to the General Partner and its
affiliates for the last fiscal year and for
MHP Supp-16
<PAGE>
the First Two Quarters 1998 if the REIT Conversion had been in effect, assuming
the Full Participation Scenario ("Pro Forma") and assuming a distribution per
OP Unit of $1.05 per year during such period, which is the midpoint of the
expected distribution range for 1999.
HISTORICAL AND PRO FORMA REIMBURSEMENTS AND DISTRIBUTIONS TO THE GENERAL
PARTNER AND ITS AFFILIATES
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS FISCAL YEAR
1998 1997 1996 1995
----------------- ----------------- ---------- ----------
PRO PRO
HISTORICAL FORMA HISTORICAL FORMA HISTORICAL HISTORICAL
---------- ------ ---------- ------ ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Principal and Interest
Payments on Orlando
Ballroom Loan.......... $ -- $ N/A $2,429 $ N/A $4,604 $3,531
Reimbursements(1)(2).... 271 -- 204 -- 126 129
Distributions(3)........ 740 2,108 3,797 4,216 102 43
------ ------ ------ ------ ------ ------
Total .............. $1,011 $2,108 $6,430 $4,216 $4,832 $3,703
====== ====== ====== ====== ====== ======
</TABLE>
- --------
(1) All expenses will be paid directly by the Operating Partnership,
accordingly, there are no expected reimbursements on a pro forma basis.
(2) In 1997, MHP Acquisition Corporation purchased a controlling interest in
MHP. Distributions to the General Partner were $15,000, $78,000, $50,000
and $21,000 for the First Two Quarters 1998 and the fiscal years ended
December 31, 1997, 1996 and 1995, respectively, and to the Partnership
Units owned by affiliates of the General Partner were $725,000 and
$3,719,000 for the First Two Quarters 1998 and the fiscal year ended
December 31, 1997.
(3) The amount of distributions payable to the General Partner and its
affiliates on a pro forma basis reflect distributions at a rate of $1.05
per annum per OP Unit (which is the midpoint of the expected range of
distributions per OP Unit for 1999) with respect to the estimated number of
OP Units that the General Partner and its affiliates will receive with
respect to its general and limited partner interests in MHP. Such number
does not reflect the aggregate number of OP Units Host will receive in
connection with the REIT Conversion.
CERTAIN INFORMATION REGARDING THE HOTELS OWNED BY MHP
<TABLE>
<CAPTION>
NAME OF HOTEL LOCATION OF HOTEL NUMBER OF ROOMS DATE OPENED
------------- ------------------- --------------- -----------
<S> <C> <C> <C>
Marriott's Orlando World
Center....................... Orlando, FL 1,503 1986
Marriott's Harbor Beach
Resort(1).................... Fort Lauderdale, FL 624 1984
-----
Total....................... 2,127
=====
</TABLE>
- --------
(1) MHP owns a 50.5% interest in Marriott's Harbor Beach Resort.
The table below sets forth certain performance information for MHP's Hotels
for the indicated periods.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
-------------------- -------------------------
1998 1997 1997 1996 1995
--------- --------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Average daily rate............. $ 176.75 $ 167.75 $155.44 $145.33 $139.40
Occupancy...................... 85.0% 87.1% 80.3% 78.7% 79.0%
REVPAR......................... $ 150.24 $ 146.11 $124.82 $114.37 $110.13
% REVPAR change................ 2.8% -- 9.1% 3.9% --
</TABLE>
Marriott's Orlando World Center, Orlando, Florida
The Orlando Hotel is a full-service Marriott hotel located on approximately
190 acres of fee-owned land two miles from Walt Disney World Resort and is
known as Marriott's Orlando World Center. It is located approximately 15 miles
from the Orlando International Airport.
MHP Supp-17
<PAGE>
The Orlando Hotel opened on March 24, 1986. The Orlando Hotel contains 1,503
guest rooms, including 85 suites, in a 27-story building. Designed as part of
the Marriott International network of convention hotels, it has extensive
meeting and convention facilities totaling 200,000 square feet, all on one
level of the hotel, including (i) a 38,675 square foot grand ballroom, (ii)
additional ballroom space of 40,740 square feet which can be subdivided into
meeting rooms and exhibit space, (iii) a 50,960 square foot ballroom and
exhibition hall which was completed in 1990 and (iv) 14 meeting rooms. Hotel
facilities also include nine restaurants and lounges, an 18-hole championship
golf course, eight lighted tennis courts, four pools, a health club, golf and
tennis pro shops, specialty and gift shops, a game room and parking for 2,100
cars. MHP purchased the Orlando Hotel in 1984 for approximately $211 million.
In March 1998, MHP announced its plan to construct a 500-room tower with a new
parking garage at the Orlando Hotel.
Competition. The primary competition for the Orlando Hotel comes from the
following five first-class convention and resort lodging-oriented hotels: (i)
the Sheraton Dolphin Hotel with 1,510 guest rooms and 202,000 square feet of
meeting space, (ii) the Westin Swan with 758 guest rooms and 52,000 square
feet of meeting space, (iii) the Peabody Hotel with 891 guest rooms and 54,000
square feet of meeting space, (iv) the Hyatt Regency Grand Cypress Hotel, with
750 guest rooms and 65,000 square feet of meeting space and (v) the Coronado
Springs Resort, which opened in July 1997, with 1,967 rooms and 99,000 square
feet of meeting space. In addition, other hotels, including hotels owned by
Disney, also compete with the Orlando Hotel. None of these hotels are operated
as part of the Marriott International full-service hotel system. As a major
convention hotel, the Orlando Hotel also competes with similar facilities
throughout the country.
Several new hotel projects are expected to enter the market in the near
future, including hotels by Disney and Loews Corporation. Loews Corporation
has plans to construct two first-class hotels on Universal Studios Florida
property of approximately 800 and 1,300 rooms to be opened by the year 2000.
As a result of the continued expansion of Walt Disney World, the All Star
Resort with 3,840 rooms is going to increase to 5,760 rooms. Additionally, the
Animal Kingdom attraction at Walt Disney World is planning to open a hotel by
January 1999.
Marriott's Harbor Beach Resort, Fort Lauderdale, Florida
The Harbor Beach Hotel is a full-service Marriott hotel located on a 16.5
acre tract of leased beach-front property located in Fort Lauderdale, Florida
and is known as Marriott's Harbor Beach Resort. The Hotel is located
approximately five miles from the Fort Lauderdale/Hollywood International
Airport.
The Harbor Beach Hotel opened in October 1984 with 624 guest rooms,
including 35 suites, in a 15-story building. The Harbor Beach Hotel has
approximately 30,000 square feet of meeting and banquet space, including (i) a
14,900 square foot grand ballroom, (ii) an 8,000 square foot junior ballroom,
(iii) seven meeting rooms and (iv) two boardrooms. Hotel facilities also
include five restaurants, three lounges, a 1,100 foot private ocean beach with
50 private cabanas, an outdoor pool, five tennis courts, a health club, gift
shop, tennis pro shop and parking for 900 cars. The Harbor Beach Partnership,
of which MHP owns 50.5%, purchased the Harbor Beach Hotel in 1982 for
approximately $87 million.
Competition. The primary competition for the Harbor Beach Hotel comes from
the following five first-class hotels: (i) the Hyatt Pier 66 with 388 guest
rooms and 22,000 square feet of meeting space, (ii) the Boca Raton Hotel and
Club with 963 guest rooms and 70,000 square feet of meeting space, (iii) the
Marriott Marco Island Resort and Golf Club with 735 guest rooms and 48,000
square feet of meeting space, (iv) the Sheraton Bal Harbour with 644 guest
rooms and 73,000 square feet of meeting space and (v) the Breakers with 572
guest rooms and 36,000 square feet of meeting space. The Marriott Marco Island
Resort and Golf Club is managed by Marriott International, and other than
limited joint marketing efforts, the Harbor Beach Hotel and the Marriott Marco
Island Resort are direct competitors. Host acquired another competing area
hotel, the Fort Lauderdale Marina Hotel, in January 1994. In addition, other
hotels in the Fort Lauderdale area also compete with the Harbor Beach Hotel;
however, these differ from the Harbor Beach Hotel in terms of size, room
rates, facilities, amenities and services offered, market orientation and/or
location. None of these other hotels are operated as part of the
MHP Supp-18
<PAGE>
Marriott International full-service hotel system. As a major resort facility,
the Harbor Beach Hotel also competes with similar facilities throughout the
country. The Loews Miami Beach hotel with 800 rooms and 85,000 square feet of
meeting space is scheduled to open in October 1998.
Ground Lease. The Harbor Beach Hotel is located on a site that is leased
from an unrelated third party for an initial term expiring November 30, 2080.
The Harbor Beach Partnership has the option to extend the term for an
additional 25 years. The lease provides for annual rental of $1,560,000 for
lease years 1995 through 1999. Thereafter, annual rentals for each succeeding
five-year period increase by an amount equal to 10% of the previous annual
rental. Under the lease, the Harbor Beach Partnership pays all costs,
expenses, taxes and assessments relating to the Harbor Beach Hotel and the
underlying land, including real estate taxes. In the event the ground lessor
decides to sell the leased premises, the Harbor Beach Partnership has a right
of first refusal to purchase the leased premises. Upon expiration or
termination of the lease, title to the Harbor Beach Hotel and all improvements
revert to the ground lessor.
AMENDMENTS TO MHP'S PARTNERSHIP AGREEMENT
In order to allow the Hotels of MHP to be leased to SLC in connection with
the Merger and the REIT Conversion, MHP's partnership agreement must be
amended. Currently, there is no provision in MHP's partnership agreement to
allow MHP's Hotels to be leased. Therefore, Section 5.02B of MHP's partnership
agreement must be amended to add a new paragraph 5.02B(xi) to read as follows:
(xi) lease or consent to the lease, directly or indirectly, in one
transaction or a series of related transactions, any or all of the Hotels.
Other Amendments. Amendments to certain terms and sections of MHP's
partnership agreement would be made in order to (i) reduce to one the number
of appraisals of the fair market value of MHP's Hotel that MHP must provide to
MHP Limited Partners before the General Partners can cause MHP to sell its
assets to the General Partner or an affiliate, (ii) delete certain obsolete
references to entities and agreements that are no longer in existence, (iii)
update MHP's partnership agreement to reflect the passage of time since the
formation of MHP and (iv) make any other amendments to MHP's partnership
agreement deemed necessary or advisable, in the sole discretion of the General
Partner, in connection with the consummation of the Merger and the REIT
Conversion. The General Partner does not believe that these amendments would
affect the rights of the MHP Limited Partners in any material respect nor the
duties and obligations of the General Partner. These changes are included,
along with the other proposed amendments, in the copy of MHP's partnership
agreement, as proposed to be amended, which is attached hereto. The amended
MHP partnership agreement is marked to indicate the revisions made to the
existing MHP partnership agreement and should be read in its entirety. Deleted
provisions are contained in brackets and struck through and added provisions
are in bold type and underlined.
FAIRNESS ANALYSIS AND OPINION
FAIRNESS ANALYSIS
The General Partner believes that the Merger provides substantial benefits
and is fair to the Limited Partners of MHP and recommends that all Limited
Partners of MHP consent to the Merger. The General Partner bases this
recommendation primarily on (i) its view that the expected benefits of the
Merger for the MHP Limited Partners outweigh the risks and potential
detriments of the Merger to the MHP Limited Partners (see "Background and
Reasons for the Mergers and the REIT Conversion--Reasons for the Mergers" and
"Risk Factors"), (ii) its view that the value of the OP Units allocable to the
MHP Limited Partners on the basis of the Exchange Value established for MHP
represents fair consideration for the Partnership Interests held by the MHP
Limited Partners and is fair to the MHP Limited Partners from a financial
point of view and (iii) the Appraisals and Fairness Opinion of AAA.
The Merger is not conditioned upon the consummation of any of the other
Mergers. The General Partner has considered this fact in evaluating the
fairness of the Merger. The General Partner believes that the fairness
MHP Supp-19
<PAGE>
of the Merger will not be materially affected by the presence or absence of
any other individual Partnership or by any particular combination of other
Partnerships and that the Merger will be fair to the MHP Limited Partners,
individually and as a whole, if it is consummated with any combination of
other Participating Partnerships. The General Partner bases this belief
primarily on the fact that the consideration to be paid to the MHP Limited
Partners has been established based upon MHP's Exchange Value, without regard
to any possible combination of other Partnerships.
In reaching the conclusions implicit in the above recommendation, the
General Partner has taken into account the following considerations, placing
the greatest weight on the first two considerations:
. The General Partner has concluded that the Exchange Value for MHP, which is
equal to its Continuation Value, represents fair consideration for the
Partnership Interests of the MHP Limited Partners in the Merger in relation
to MHP. The General Partner also has concluded that the Exchange Value
established for the MHP Limited Partners fairly reflects the value of the
assets held by MHP. In addition, the Fairness Opinion supports these
conclusions.
. MHP Limited Partners will be able to defer recognition of gain until such
time as they choose to realize such gain based on their own personal
circumstances.
. The General Partner has concluded that the potential benefits of the Merger
to the MHP Limited Partners, as described under "Background and Reasons for
the Mergers and the REIT Conversion--Reasons for the Mergers," outweigh the
potential risks and detriments of the Merger for the MHP Limited Partners,
as described in "Risk Factors."
. The Fairness Opinion, in the view of the General Partner, supports the
fairness of the Merger, even though it includes qualifications, limitations
and assumptions relating to its scope and other factors that MHP Limited
Partners should consider carefully. The availability of the Fairness
Opinion is particularly significant in light of the absence of arm's length
negotiations in establishing the terms of the Merger.
. Host will contribute its wholly owned full-service hotel assets,
substantially all of its interests in the Hotel Partnerships and its other
assets (excluding its senior living assets and the cash or securities to be
distributed to its shareholders) to the Operating Partnership in exchange
for (i) a number of OP Units equal to the number of outstanding shares of
common stock of Host, (ii) preferred partnership interests in the Operating
Partnership corresponding to any shares of Host preferred stock outstanding
at the time of the REIT Conversion and (iii) the assumption by the
Operating Partnership of all liabilities of Host (including past and future
tax liabilities), other than liabilities of SLC. Following these
contributions, the Operating Partnership and its subsidiaries will directly
own all of Host's wholly owned hotels and all of Host's interests in the
Hotel Partnerships and Host's other assets. Host will receive OP Units in
respect of its general partner interest in MHP on substantially the same
basis as the Partnership Units held by MHP Limited Partners. Host REIT will
not receive any compensation for its services as general partner to the
Operating Partnership following the REIT Conversion and will benefit from
the operations of the Operating Partnership only to the extent of the
distributions received based upon its percentage interest in the Operating
Partnership to the same extent as the other limited partners. Because Host
REIT will share in the value of the Operating Partnership solely through
distributions and not through any separate compensation structure, the
General Partner believes that this is a factor supporting the fairness of
the Merger to the MHP Limited Partners.
. The General Partner believes that the value of the consideration to be
received by the MHP Limited Partners in the Merger is fair in relation to
the value which would be derived by such Limited Partners under any of the
alternatives described under "Background and Reasons for the Mergers and
the REIT Conversion--Alternatives to the Mergers," especially since the
Exchange Value of MHP is equal to its Continuation Value, which is the
greatest of the Adjusted Appraised Value, the Continuation Value and the
Liquidation Value and the historic prices paid for MHP Partnership Units.
The consideration also is greater than the amounts paid in recent sales of
Partnership Units, including the December 1996 Tender Offer by Host. The
General Partner does not believe that the sale of any of MHP's Hotels and
liquidation of MHP will obtain for MHP Limited Partners
MHP Supp-20
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as much value as the value to be received by such MHP Limited Partners
following the Merger. The General Partner believes that the following
benefits are of the greatest value and importance to the MHP Limited
Partners:
. Enhanced Liquidity. The Merger and the REIT Conversion will offer MHP
Limited Partners significantly enhanced liquidity with respect to their
investments in MHP because, commencing one year following the Effective
Date, MHP Limited Partners who retain OP Units will be able to exercise
their Unit Redemption Right at any time, subject to certain limited
exceptions. Host has approximately 204 million shares of common stock
outstanding and is expected to have a total common equity market
capitalization of approximately $ billion after giving effect to the
estimated $ million earnings and profits distribution (based on Host's
$ closing price per share on the NYSE on , 1998). The exercise of
the Unit Redemption Right, however, generally would result in recognition
of taxable income or gain at that time.
. Risk Diversification. Upon consummation of the REIT Conversion, each MHP
Limited Partner's investment will be converted from an investment in
MHP, which owns two hotels, into an investment in an enterprise that
initially will own or control approximately 120 Hotels and will have a
total market capitalization of approximately $ billion, thereby
reducing the dependence upon the performance of, and the exposure to the
risks associated with, the Hotels currently owned by MHP and spreading
such risk over a broader and more varied portfolio, including more
diverse geographic locations and multiple brands.
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a lower leverage to value ratio than MHP
currently, which has a leverage ratio of 56% (calculated as a percentage
of Appraised Value), resulting in interest and debt service savings and
greater financial stability.
. Regular Quarterly Cash Distributions. The General Partner expects that
the Operating Partnership will make regular quarterly cash distributions
to holders of OP Units. Host expects that these distributions by MHP
would be higher than the estimated cash distributions by the Operating
Partnership for 1998, but nevertheless the ability to receive
distributions quarterly and in regular amounts would be enhanced.
. Substantial Tax Deferral. The General Partner expects that MHP Limited
Partners who do not elect to receive Notes in exchange for OP Units
generally should be able to obtain the benefits of the Merger while
continuing to defer recognition for federal income tax purposes of at
least a substantial portion, if not all, of the gain with respect to
their Partnership Interests that otherwise would be recognized in the
event of a liquidation of MHP or a sale or other disposition of its
assets in a taxable transaction
. The General Partner believes that the economic terms of the leases of the
MHP Hotels are fair and reasonable from the standpoint of the Operating
Partnership.
The General Partner believes that the factors described above, which support
the fairness of the Merger to the MHP Limited Partners, when weighed against
the factors that may be disadvantageous, taken as a whole, indicate that the
Merger is fair to the MHP Limited Partners.
FAIRNESS OPINION
AAA, an independent financial advisory firm with substantial real estate and
partnership transaction experience, was engaged by the General Partner and the
other General Partners to perform the Appraisals and to render the Fairness
Opinion that (i) the Exchange Value and the methodologies and underlying
assumptions used to determine the Exchange Value, the Adjusted Appraised
Value, the Continuation Value and the Liquidation Value of MHP and each other
Partnership (including, without limitation, the assumptions used to determine
the various adjustments to the Appraised Values of the Hotels) are fair and
reasonable, from a financial point of view, to the MHP Limited Partners and
the Limited Partners of each other Partnership and (ii) the methodologies used
to determine the value of an OP Unit and to allocate the equity in the
Operating Partnership to be received by the MHP Limited Partners and the
Limited Partners of each other Partnership are fair and reasonable to the MHP
Limited Partners and the Limited Partners of each other Partnership. The
Fairness Opinion is addressed to each
MHP Supp-21
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Partnership and it may be relied upon by each of the MHP Limited Partners and
the Limited Partners of each of the other Partnerships. The full text of the
Fairness Opinion, which contains a description of the assumptions and
qualifications applicable to the review and analysis by AAA, is set forth in
Appendix B to the Consent Solicitation and should be read in its entirety. The
material assumptions and qualifications to the Fairness Opinion are summarized
below, although this summary does not purport to be a complete description of
the various inquiries and analyses undertaken by AAA in rendering the Fairness
Opinion. Arriving at a fairness opinion is a complex analytical process not
necessarily susceptible to partial analysis or amenable to summary
description. For a more complete description of the assumptions and
qualifications that limit the scope of the Fairness Opinion, see "--
Qualifications to Fairness Opinion" and "--Assumptions" below.
Although the General Partner advised AAA that certain assumptions were
appropriate in its view, the General Partner imposed no conditions or
limitations on the scope of the investigation by AAA or the methods and
procedures to be followed by AAA in rendering the Fairness Opinion. The fees
and expenses of AAA will be treated as a Merger Expense and will be paid by
the Operating Partnership. In addition, the General Partner has agreed to
indemnify AAA against certain liabilities. See "--Compensation and Material
Relationships."
Qualifications to Fairness Opinion. In the Fairness Opinion, AAA
specifically states that it did not: (a) specifically consider other
methodologies for allocation of the OP Units, (b) address or conclude that
other methodologies for allocation of the OP Units to MHP and the other
Partnerships might not have been more favorable to the Limited Partners in
certain of the Partnerships, (c) negotiate with the General Partner, the
General Partners of the other Partnerships or Host, (d) participate in
establishing the terms of the Merger and the other Mergers, (e) provide an
opinion as to the terms and conditions of the Merger and the other Mergers
other than those explicitly stated in the Fairness Opinion, (f) make any
independent review of the capital expenditure estimates set forth in the
Engineering Study or (g) make any estimates of MHP's and each other
Partnership's contingent liabilities. In addition, with respect to the
specific reference to the allocation of the equity interest in the Operating
Partnership to be received by the limited partners of each Partnership, AAA
has assumed that the average closing price on the NYSE of a Host REIT Common
share for the 20 trading days after the Effective Date of the Mergers
represents a fair price.
In connection with preparing the Fairness Opinion, AAA was not engaged to,
and consequently did not, prepare any written report or compendium of its
analysis for internal or external use beyond the analysis set forth in
Appendix B. AAA will not deliver any additional written opinion of the
analysis, other than to update the written opinion if requested by the
Operating Partnership.
Experience of AAA. AAA is the world's largest independent valuation
consulting firm and is regularly and continually engaged in the valuation of
commercial real estate and businesses and their securities in connection with
tender offers, mergers and acquisitions, recapitalizations and
reorganizations, divestitures, employee stock ownership plans, leveraged
buyout plans, private placements, limited partnerships, estate and corporate
matters, other financial advisory matters and other valuation purposes.
AAA was selected because of its experience in the valuation of businesses
and their securities in connection with tender offers, mergers and
acquisitions, recapitalizations and reorganizations, including transactions
involving hotel partnerships. In addition, Host and its affiliates have
previously engaged AAA to provide appraisals and fairness opinions in
connection with other transactions. The General Partner and the other General
Partners considered two other firms for purposes of performing the appraisals
and rendering the Fairness Opinion, and received proposals from each. The
General Partner selected AAA based upon price and experience.
Summary of Materials Considered and Investigation Undertaken. As a basis for
rendering the Fairness Opinion, AAA has made such reviews, studies and
analyses as it deemed necessary and pertinent in order to provide it with a
reasonable basis for the Fairness Opinion, including, but not limited to, the
following: (i) reviewed the transaction documents and SEC reporting and/or
filing documents, including drafts of the Form S-4 for the Mergers; (ii)
provided the Market Value of each Hotel owned by each Partnership in a
separate short form appraisal report and each such report was reviewed and
certified by an MAI appraiser as to its preparation in accordance with the
requirements of the Standards of Professional Practice of the Appraisal
Institute and the Uniform Standards of Professional Appraisal Practice of the
Appraisal Foundation; as part of the Appraisals, AAA reviewed historical
operating statements, 1998 budget and year-to-date results, and other
financial
MHP Supp-22
<PAGE>
information as it deemed necessary as a basis for the Fairness Opinion and the
Appraisals also considered market transactions of similar lodging properties
as appropriate as a basis for the Market Value of each Hotel; (iii) reviewed
the methodologies used by each of the General Partners in their determination
of the Exchange Value of each Partnership, including the nature and amount of
all adjustments to the Appraised Values in determining such Exchange Values;
AAA reviewed and tested for the fairness and reasonableness of all adjustments
as well as for consideration of all adjustments deemed to be appropriate by
AAA; (iv) reviewed the methodologies used by each of the General Partners in
their determination of the value of an OP Unit and the allocation of the
equity interest in the Operating Partnership to be received by the partners of
each Partnership, and AAA reviewed and tested for the fairness and
reasonableness of the methods and measurements made by the General Partners;
(v) reviewed the General Partners' determination of the Liquidation Value of
each Partnership, and AAA reviewed and tested for the fairness and
reasonableness of all adjustments proposed by the General Partners, as well as
for consideration of all adjustments deemed appropriate by AAA; (vi) provided
an estimate of the Continuation Value of each Partnership based upon the
estimated present value of expected benefits to be received by each limited
partner interest as though the Mergers did not occur and each Partnership's
assets were sold within a twelve year period; AAA, as part of its analysis and
review, determined appropriate rates of growth in house profit or net
operating income, as well as reviewed other key variables affecting
partnership cash flows and other economic/financial factors affecting the
Partnerships' expected operations and results; (vii) reviewed the terms of the
ground leases of the Hotels and the partnership agreement of each Partnership;
(viii) reviewed audited and unaudited historical income statements, balance
sheets and statements of sources and uses of funds of each Partnership and
Host and pro forma financial information for Host REIT; (ix) reviewed audited
and unaudited historical operating statements of each Hotel, as well as
current operating statements and budgets; (x) conducted real estate valuation
and financial due diligence with respect to the Partnerships and their
underlying assets, liabilities and equity; (xi) reviewed internal Marriott
International, Host and Partnership financial analyses and other internally
generated data for each Hotel and (xii) discussed all of the foregoing
information, where appropriate, with management of Marriott International,
Host and the Partnerships and their respective employees.
Assumptions. In rendering its opinion, AAA relied, without independent
verification, on the accuracy and completeness in all material respects of
certain relevant publicly available information and information provided to
AAA by Host and the Hotels. AAA assumed that all information furnished by
Host, the Hotels and the Partnerships and their representatives, upon which
AAA relied, presented an accurate description in all material respects of the
current and prospective status of the Hotels and the Partnerships from an
operational and financial point of view. AAA also noted that the Fairness
Opinion was based upon financial, economic, market and other considerations as
they existed and could be evaluated on the date thereof.
Conclusions. AAA concluded that, based upon and subject to its analysis and
assumptions and limiting conditions, and as of the date of the Fairness
Opinion: (i) the Exchange Value and the methodologies used to determine the
Exchange Value, the Adjusted Appraised Value, the Continuation Value and the
Liquidation Value of each Partnership of each Partnership (including, without
limitation, the assumptions used to determine the various adjustments to the
Appraised Values of each of the Hotels) are fair and reasonable, from a
financial point of view, to the MHP Limited Partners and the Limited Partners
of each other Partnership and (ii) the methodologies used to determine the
price of an OP Unit and to allocate the equity interest in the Operating
Partnership to be received by the MHP Limited Partners and the Limited
Partners of each other Partnership are fair and reasonable to the MHP Limited
Partners and the Limited Partners of each other Partnership.
Compensation and Material Relationships. AAA has been paid a fee of $335,000
for its services as described herein, including the Appraisals and preparing
to deliver the Fairness Opinion. In addition, AAA will be reimbursed for all
reasonable out-of-pocket expenses, including legal fees and will be
indemnified against certain liabilities, including certain liabilities under
the securities laws. The fee was negotiated between Host, the General Partners
and AAA. Payment of the fee to AAA is not dependent upon completion of the
Mergers. AAA has been previously engaged by Host and its affiliates to provide
appraisals, fairness opinions and solvency opinions in connection with other
transactions.
MHP Supp-23
<PAGE>
VOTING PROCEDURES
The consent of MHP Limited Partners holding a majority of the outstanding
limited partner interests is required for participation in the Merger. The
General Partner and its affiliate collectively own 48.33% of the outstanding
limited partner interests. The General Partner and its affiliate are required
to vote all of their limited partner interests in MHP in the same manner as
the majority of the other limited partner interests vote so long as consents
of a majority of limited partner interests held by Limited Partners are
returned and not withdrawn prior to the end of the Solicitation Period.
An MHP Limited Partner may mark the Consent Form to vote "FOR," "AGAINST" or
"ABSTAIN" with respect to participation in a Merger by MHP. THE FAILURE OF A
LIMITED PARTNER OF MHP TO RETURN A SIGNED CONSENT FORM WILL NOT BE COUNTED FOR
PURPOSES OF DETERMINING WHETHER A MAJORITY OF MHP LIMITED PARTNER PARTNERSHIP
INTERESTS ARE PRESENT. AN ABSTENTION OF AN MHP LIMITED PARTNER WILL BE COUNTED
FOR PURPOSES OF ESTABLISHING THE NUMBER OF LIMITED PARTNER INTERESTS REQUIRED
TO RECOGNIZE THE VOTE BUT WILL BE EFFECTIVELY COUNTED AS A VOTE "AGAINST" THE
MERGER. LIMITED PARTNERS WHO RETURN A SIGNED CONSENT FORM BUT FAIL TO INDICATE
THEIR APPROVAL OR DISAPPROVAL AS TO ANY MATTER (INCLUDING THE MERGER) WILL BE
DEEMED TO HAVE VOTED TO APPROVE SUCH MATTER. The voting procedures applicable
to MHP Limited Partners are set forth in the Consent Solicitation under the
heading "Voting Procedures--Required Vote and Other Conditions."
As of June 19, 1998, MHP Acquisition Corporation holds 47.3% of the total
number of MHP Partnership Units. No other person owned of record, or to the
Partnership's knowledge owned beneficially, more than 5% of the total number
of MHP Partnership Units.
FEDERAL INCOME TAX CONSEQUENCES
In addition to the federal income tax consequences discussed in the sections
of the Consent Solicitation entitled "Federal Income Tax Consequences" and
"Risk Factors--Federal Income Tax Risks," MHP Limited Partners should read
carefully the following discussion of federal income tax consequences
applicable specifically to the MHP Limited Partners. The information included
in this discussion is based upon various factual assumptions and information
which are believed by the Operating Partnership and the General Partner to be
reliable. However, some of these assumptions inevitably will not materialize,
and unanticipated events and circumstances will occur. Therefore, there likely
will be differences between the information provided herein, including the
numerical data and estimates, and actual results, and the variations may be
material and adverse.
Applicability of Tax Opinions
Hogan & Hartson L.L.P. ("Hogan & Hartson"), counsel to Host REIT, Host and
the Operating Partnership, has provided to Host REIT and the Operating
Partnership an opinion letter (substantially in the form of Appendix C to the
Consent Solicitation) as to certain federal income tax consequences to the
Operating Partnership and the MHP Limited Partners resulting from the Mergers
and the REIT Conversion. The opinion letter is based upon certain assumptions
and certain representations provided by Host REIT, Host, the Operating
Partnership and the General Partners. These representations generally involve
factual matters relating to the organization, ownership and operations
(including the income, assets, businesses, liabilities and properties) of the
Partnerships and Hotels contributed to the Operating Partnership by Host and
the Blackstone Entities prior to the Mergers and the REIT Conversion and of
Host REIT, the Operating Partnership and the Partnerships following the
Mergers and the REIT Conversion. In addition, on the Effective Date, Hogan &
Hartson expects to provide to Host REIT and the Operating Partnership an
opinion letter (substantially in the form of Appendix D to the Consent
Solicitation) as to the qualification and taxation of Host REIT as a REIT
under the Code following the REIT Conversion. The receipt of this opinion is a
condition to the REIT Conversion and each of the Mergers. See "Federal Income
Tax Consequences--Summary of Tax Opinions" in the Consent Solicitation.
MHP Supp-24
<PAGE>
Each opinion provided by Hogan & Hartson in the opinion letter that is
substantially in the form of Appendix C to the Consent Solicitation is
applicable to the MHP Limited Partners.
The opinions already rendered by Hogan & Hartson are based on the Code and
Treasury Regulations in effect on the date hereof, current administrative
interpretations and positions of the IRS and existing court decisions, and the
opinions to be rendered by Hogan & Hartson on the Effective Date will be based
on the same authorities as of the Effective Date. No assurance can be given
that future legislation, Treasury Regulations, administrative interpretations
and court decisions will not significantly change the law or the above
conclusions reached by counsel. In addition, any such change could apply
retroactively to transactions preceding the date of change. Moreover, opinions
of counsel merely represent counsel's best judgment with respect to the
probable outcome on the merits and are not binding on the IRS or the courts.
Accordingly, even if there is no change in applicable law, no assurance can be
provided that such opinions (which do not bind the IRS or the courts) will not
be challenged by the IRS or will be sustained by a court if so challenged.
With the one exception described below (see "--Tax Consequences of the
Merger--Deemed Cash Distribution and Resulting Taxable Gain") and in the
Consent Solicitation under "Federal Income Tax Consequences--Tax Consequences
of the Mergers --IRS Ruling Request Regarding Allocation of Partnership
Liabilities," neither Host REIT, the Operating Partnership nor the General
Partners have requested or plan to request any rulings from the IRS concerning
the tax consequences of the Mergers or the treatment of either the Operating
Partnership or Host REIT subsequent to the REIT Conversion.
Tax Consequences of the Merger
Overview. Hogan & Hartson has provided an opinion to the effect that, except
for any gain attributable to the sale of personal property by MHP to a Non-
Controlled Subsidiary in connection with the REIT Conversion, the Merger will
not result in the recognition of taxable gain or loss at the time of the
Merger to an MHP Limited Partner (i) who does not exercise his Unit Redemption
Right on a date sooner than the date two years after the date of the
consummation of the Merger; (ii) who does not receive a cash distribution (or
a deemed cash distribution resulting from relief from liabilities, including
as a result of any repayment of the Orlando Mortgage or the Harbor Beach
Mortgage) in connection with the Merger or the REIT Conversion in excess of
his aggregate adjusted basis in his MHP Partnership Units at the time of the
Merger; (iii) who does not elect to receive a Note in exchange for his OP
Units in connection with the Merger (the "Note Election"); (iv) who is not
required to recognize gain by reason of the exercise by another MHP Limited
Partner of his right to make the Note Election; and (v) who does not have his
"at risk" amount fall below zero as a result of the Merger or the REIT
Conversion. See "Federal Income Tax Consequences--Summary of Tax Opinions" in
the Consent Solicitation.
With respect to the foregoing exceptions to nonrecognition treatment, the
Operating Partnership and the General Partner believe as follows: (i) an MHP
Limited Partner who acquired his MHP Partnership Units in the original
offering of such Partnership Units and who has held such Partnership Units at
all times since would not be considered to receive, as a result of the Merger,
a distribution (or a deemed cash distribution resulting from relief from
liabilities) that exceeds his aggregate adjusted basis in his MHP Partnership
Units at the time of the Merger, and would not have his "at risk" amount fall
below zero as a result of the Merger, and (ii) a portion of the personal
property associated with both of the Hotels owned by MHP will need to be sold
to a Non-Controlled Subsidiary in connection with the REIT Conversion, which
may (but is not expected to) result in the recognition of a relatively modest
amount of income by the MHP Limited Partners. See "Federal Income Tax
Consequences--Tax Consequences of the Mergers--Overview" in the Consent
Solicitation and "Tax Allocations upon the Sale of Certain Personal Property
Associated with the MHP Hotels" below.
With respect to the effects of an MHP Limited Partner's election to receive
a Note in exchange for his OP Units in connection with the Merger, Hogan &
Hartson is of the opinion that, although the matter is not free from doubt, an
MHP Limited Partner who does not make the Note Election should not be required
to recognize gain by reason of another MHP Limited Partner's exercise of such
right. With respect to the exercise of a Unit Redemption Right, Hogan &
Hartson is of the opinion that it is more likely than not that an MHP Limited
MHP Supp-25
<PAGE>
Partner's exercise of his Unit Redemption Right more than one year after the
date of consummation of the Merger but less than two years after such date
will not cause the Merger itself to be a taxable transaction for the MHP
Limited Partner (or the other MHP Limited Partners). See "Federal Income Tax
Consequences--Summary of Tax Opinions" in the Consent Solicitation. Opinions
of counsel, however, do not bind the IRS or the courts, and no assurances can
be provided that such opinions will not be challenged by the IRS or will be
sustained by a court if so challenged.
Deemed Cash Distribution and Resulting Taxable Gain. With respect to his MHP
Partnership Units, an MHP Limited Partner will receive no actual cash
distribution in connection with the Merger but would be deemed to receive a
cash distribution in connection with the Merger to the extent that his share
of Operating Partnership liabilities immediately after the Merger and the REIT
Conversion is less than his share of MHP liabilities immediately prior to the
Merger. For example, any repayment of the Orlando Mortgage or the Harbor Beach
Mortgage or debt encumbering other Hotels may result in a deemed cash
distribution to the MHP Limited Partners. See "Federal Income Tax
Consequences--Tax Consequences of the Mergers--Relief from Liabilities/Deemed
Cash Distribution" in the Consent Solicitation. Even though the Orlando
Mortgage, the Harbor Beach Mortgage and the debt encumbering other Hotels is
not expected to be repaid or refinanced in connection with the Merger and the
REIT Conversion (except as described in the consent solicitation), an MHP
Limited Partner's share of indebtedness following the Merger and the REIT
Conversion may nonetheless decrease in comparison to the Limited Partner's
estimated aggregate share of MHP indebtedness as of December 31, 1998
(calculated based on the assumption that the Merger did not occur) by reason
of the manner in which the debt allocation rules work when multiple assets
with different levels of leverage are consolidated into a single partnership.
An MHP Limited Partner, however, would recognize taxable gain as a result of
any deemed cash distribution only to the extent that the deemed cash
distribution were to exceed his adjusted tax basis in his MHP Partnership
Units immediately prior to the Merger. As noted above, the Operating
Partnership and the General Partner believe, based upon and subject to the
assumptions and other limitations described below, that an MHP Limited Partner
who acquired his MHP Partnership Units in the original offering of such
Partnership Units and has held the Partnership Units at all times since the
offering will have an adjusted tax basis in excess of the deemed cash
distribution that might occur in connection with the Merger and the REIT
Conversion. Therefore, such an MHP Limited Partner should not recognize gain
due to such deemed cash distribution resulting from the relief from
liabilities in connection with the Merger and the REIT Conversion.
The adjusted tax basis of an MHP Limited Partner who did not acquire his MHP
Partnership Units in the original offering of such Partnership Units or who
has not held his MHP Partnership Units at all times since such offering could
vary materially from that of an MHP Limited Partner who did so. If an MHP
Limited Partner has an adjusted tax basis in his MHP Partnership Units (per
MHP Partnership Unit) that is substantially less than the adjusted tax basis
of an MHP Limited Partner who acquired his MHP Partnership Units in the
original offering of such Partnership Units and has held such Partnership
Units at all times since, he could recognize gain due to any deemed cash
distribution resulting from the relief from liabilities in connection with the
Merger and the REIT Conversion.
The Operating Partnership has no current plan or intention to cause the
prepayment of the Orlando Mortgage or the Harbor Beach Mortgage or, except as
described in the Consent Solicitation, any of the nonrecourse liabilities
encumbering the Hotels owned by the other Partnerships. The Operating
Partnership, however, will have to repay mortgage indebtedness securing the
Hotels owned by the Partnerships at the time such indebtedness matures. There
can be no assurance that at such time the Operating Partnership will be able
to secure nonrecourse mortgage indebtedness secured only by those Hotels in an
amount sufficient to avoid a deemed cash distribution to the former Limited
Partners in certain of those Partnerships, including MHP (although such a
deemed distribution of cash may or may not result in the recognition of
taxable income or gain by the former MHP Limited Partners). Moreover, the
Operating Partnership's current long-term financing strategy is to have as
little debt as possible that is secured by individual Hotels and to have as
much debt as
MHP Supp-26
<PAGE>
possible in the form of unsecured debt, held either by the public or by
institutional investors, which debt may or may not be recourse to Host REIT,
as general partner of the Operating Partnership. In view of these
considerations and the potential adverse consequences to Limited Partners in
certain Partnerships, including the MHP Limited Partners, the Operating
Partnership has requested from the IRS a ruling to the effect that such
unsecured indebtedness of the Operating Partnership that is issued initially
to institutional investors and is not recourse to Host REIT (i) would qualify
as "nonrecourse liabilities" for purposes of Code Section 752, (ii) to the
extent the proceeds thereof are applied to repay existing nonrecourse mortgage
indebtedness secured by one or more Hotels (including the Orlando Mortgage and
the Harbor Beach Mortgage), would be considered to be "secured" by those
Hotels for purposes of allocating the liabilities for tax basis purposes (and
thus would be allocable, at least in substantial part, to the former Limited
Partners in the Partnerships owning those Hotels, including the MHP Limited
Partners), and (iii) would constitute "qualified nonrecourse financing"
secured by such Hotels for purposes of Code Section 465. The IRS has recently
issued a ruling to that effect to another taxpayer, and has indicated to the
Operating Partnership's representatives that it is favorably inclined to issue
that ruling to the Operating Partnership.
Each MHP Limited Partner will gradually begin to recognize income over the
term of his ownership of OP Units (beginning, perhaps, in his first year of
ownership of OP Units) attributable to deemed cash distributions resulting
from the relief from liabilities, as the aggregate principal amount of
nonrecourse indebtedness encumbering (or deemed to encumber) the Hotels
amortizes in accordance with its terms. The Operating Partnership will make
regular quarterly cash distributions to the MHP Limited Partners that may or
may not be sufficient to allow the MHP Limited Partners to pay the federal and
state income tax owed on the income allocated to such Limited Partners by
reason of the amortization of the debt secured by the MHP Hotels.
Section 465(e) Recapture. As discussed in the Consent Solicitation, see
"Federal Income Tax Consequences--Tax Consequences of the Mergers--Section
465(e) Recapture," the "at risk" rules of Section 465 of the Code generally
apply to limit the use of partnership losses by a partner. Under Section
465(e) of the Code, a partner may be required to include in gross income, or
"recapture," losses previously allowed to such partner with respect to his
investment in a partnership if the amount for which the partner is "at risk"
in relation to his investment in the partnership is less than zero at the
close of the taxable year. The "at risk" rules generally do not apply to
losses attributable to real property placed in service prior to January 1,
1987 by the taxpayer or to losses attributable to a partnership in which the
taxpayer acquired his interests before that date (the "grandfather" rule).
Thus, the "at risk" rules have not been applicable to date to those MHP
Limited Partners who acquired their Partnership Units at the time of the
original offering or at any time prior to January 1, 1987 and who have held
those Partnership Units since the date of the acquisition. The MHP Limited
Partners, however, will become subject to the "at risk" rules as a result of
the Merger and their receipt of OP Units in connection therewith (since the OP
Units do not qualify for the "grandfather" rule).
It is possible that the consummation of the Mergers and the REIT Conversion
or the repayment of certain "qualified nonrecourse financing" of the Operating
Partnership, the Hotel Partnerships or the Hotels contributed to the Operating
Partnership by the Blackstone Entities at the time of or following the Mergers
and the REIT Conversion could, singularly or in combination, cause an MHP
Limited Partner's amount at risk in relation to his investment in MHP (and,
after the Mergers, in the Operating Partnership) to be reduced below zero,
resulting in an income inclusion to the Limited Partner under Section 465(e)
of the Code. Currently, a sufficient portion of the current debt of MHP
constitutes "qualified nonrecourse financing" so that the MHP Limited Partners
have positive at risk amounts, and the Operating Partnership expects that most
of the current debt with respect to the other Hotel Partnerships and the
Hotels contributed by the Blackstone Entities that will be assumed by the
Operating Partnership as part of the Mergers and the REIT Conversion should
qualify as "qualified nonrecourse financing." The Operating Partnership and
the General Partner believe, based upon and subject to the assumptions and
other limitations described below, that an MHP Limited Partner who acquired
his MHP Partnership Units in the original offering of such Partnership Units
and has held the Partnership Units at all times since will have a positive at
risk amount immediately following the Mergers and the REIT Conversion.
It is possible, however, that a former MHP Limited Partner's at risk amount
could decline in the future, either because of the allocation of losses from
the Operating Partnership to that former MHP Limited Partner or
MHP Supp-27
<PAGE>
because of cash distributions by the Operating Partnership to that former MHP
Limited Partner in excess of the taxable income allocable to him with respect
to his OP Partnership Units. Moreover, there can be no assurance that debt
incurred by the Operating Partnership in the future to refinance existing debt
would qualify as "qualified nonrecourse financing." If, however, the Operating
Partnership were to obtain the requested ruling from the IRS and were to
refinance existing mortgage indebtedness of the Partnerships (including the
Orlando Mortgage or the Harbor Beach Mortgage) with the type of indebtedness
described in the rulings, such indebtedness should constitute "qualified
nonrecourse financing" for purposes of the "at risk" rules.
Impact of Assumption of MHP Liabilities by the Operating Partnership. As
described in the Consent Solicitation, see "Federal Income Tax Consequences--
Tax Consequences of the Mergers--Disguised Sale Regulations," an MHP Limited
Partner will recognize gain to the extent he is treated as having sold all or
part of his MHP Partnership Interest in a "disguised sale." For purposes of
these rules, certain reductions in a partner's share of partnership
liabilities are treated as a transfer of money or other property from the
partnership to the partner which may give rise to a disguised sale, even if
that reduction would not otherwise result in a taxable deemed cash
distribution in excess of the partner's basis in his partnership interest.
However, if a transfer of property by a partner to a partnership is not
otherwise treated as part of a disguised sale, then any reduction in the
partner's share of "qualified liabilities" also will not be treated as part of
a disguised sale. A "qualified liability" in connection with a transfer of
property to a partnership includes (i) any liability incurred more than two
years prior to the earlier of the transfer of the property or the date the
partner agrees in writing to the transfer, as long as the liability has
encumbered the transferred property throughout the two-year period; (ii) a
liability that was not incurred in anticipation of the transfer of the
property to a partnership, but that was incurred by the partner within the
two-year period prior to the earlier of the date the partner agrees in writing
to transfer the property or the date the partner transfers the property to a
partnership and that has encumbered the transferred property since it was
incurred; (iii) a liability that is traceable under the Treasury Regulations
to capital expenditures with respect to the property; and (iv) a liability
that was incurred in the ordinary course of the trade or business in which
property transferred to the partnership was used or held, but only if all the
assets related to that trade or business are transferred, other than assets
that are not material to a continuation of the trade or business. However, a
recourse liability is not a "qualified liability" unless the amount of the
liability does not exceed the fair market value of the transferred property
(less any other liabilities that are senior in priority and encumber such
property or any allocable liabilities described in (iii) or (iv) above) at the
time of transfer.
The General Partner and the Operating Partnership believe, based upon their
review of the facts and circumstances surrounding each liability, that all
liabilities of MHP fall into one of the four categories of "qualified
liabilities" described in the preceding paragraph. However, the General
Partner estimates that approximately $8.8 million of MHP indebtedness ($8,800
per $100,000 original investment of MHP), as of December 31, 1998, may be
"qualified liabilities" solely by reason of exception (ii) in the preceding
paragraph (i.e., a liability incurred within two years of the Merger but not
in anticipation of the Merger) and, thus, MHP and the MHP Limited Partners
will be required to disclose such indebtedness on a completed IRS Form 8275 or
on a statement attached to their tax returns for the taxable year in which the
Merger occurs. There can be no assurance, however, that the IRS will not
challenge the position of MHP that this indebtedness is a "qualified
liability."
Tax Treatment of MHP Limited Partners Who Hold OP Units Following the Merger
Initial Basis in Units. In general, an MHP Limited Partner will have an
initial tax basis in his OP Units received in the Merger with respect to his
MHP Partnership Units equal to the basis in his MHP Partnership Units at the
time of the Merger, reduced to reflect any deemed cash distributions resulting
from a reduction in his share of MHP liabilities and increased to reflect his
share of other liabilities of the Operating Partnership and any gain required
to be recognized in connection with the Merger and the REIT Conversion
(including income, if any, attributable to the sale of a portion of the
personal property associated with both the MHP Hotels, as described below
under "--Tax Allocations upon the Sale of Certain Personal Property Associated
with the MHP Hotels"). For a discussion of the federal income tax consequences
for an MHP Limited Partner from a reduction
MHP Supp-28
<PAGE>
in basis that may result from the Merger and the REIT Conversion, see "Federal
Income Tax Consequences--Tax Treatment of Limited Partners Who Hold OP Units
Following the Mergers--Initial Tax Basis of OP Units" in the Consent
Solicitation.
Tax Allocations by the Operating Partnership upon a Sale of MHP
Hotels. Pursuant to Section 704(c) of the Code, income, gain, loss and
deduction attributable to appreciated or depreciated property that is
contributed to a partnership must be allocated for federal income tax purposes
in a manner such that the contributor is charged with, or benefits from, the
unrealized gain or unrealized loss associated with the property at the time of
contribution. The amount of such unrealized gain or unrealized loss is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution (referred to as the "Book-Tax
Difference"). The Operating Partnership and the General Partner estimate,
based upon and subject to the assumptions and other limitations described
below, that the Book-Tax Difference for all MHP Limited Partners (but
excluding all of Host's interests) with respect to the MHP Hotels will be
$114,642,148 upon the consummation of the Merger.
If the Operating Partnership were to sell the Orlando World Center and its
interest in the Harbor Beach Hotel, the former partners of MHP (including Host
REIT with respect to Host's indirect interest in MHP) would be specially
allocated by the Operating Partnership an aggregate amount of taxable gain
equal to the aggregate Book-Tax Difference with respect to those MHP Hotels.
The share of such gain allocable to an MHP Limited Partner who acquired his
MHP Partnership Units in the original offering of such Partnership Units and
held such Partnership Units at all times since would be $221,883 per MHP
Partnership Unit. The share of such gain of an MHP Limited Partner who did not
acquire his MHP Partnership Units in the original offering of such Partnership
Units or who has not held his MHP Partnership Units at all times since such
offering could vary materially from this amount. If the Operating Partnership
were to sell one of the MHP Hotels with a Book-Tax Difference, the remaining
Book-Tax Difference at the time the Hotel is sold would be required to be
allocated exclusively to the former MHP Limited Partners and the General
Partner, even though the proceeds of such sale would be allocated
proportionately among all the partners in the Operating Partnership (and would
likely be retained by the Operating Partnership, rather than distributed to
holders of OP Units and Common Shares of Host REIT). The MHP Limited Partners
would not be entitled to any special distributions from the Operating
Partnership in connection with such a sale, and thus would not necessarily
receive cash distributions from the Operating Partnership sufficient to pay
such additional taxes. Although the Partnership Agreement does not impose any
restrictions upon the Operating Partnership preventing it from causing the
sale of either or both of the MHP Hotels at any time following the Merger, the
Operating Partnership does not have current plans to pursue a sale of either
of the MHP Hotels. See "Federal Income Tax Consequences--Tax Treatment of
Limited Partners Who Hold OP Units Following the Mergers--Sale of Individual
Hotels" in the Consent Solicitation.
Tax Allocations upon the Sale of Certain Personal Property Associated with
the MHP Hotels. As discussed in the Consent Solicitation, see "Federal Income
Tax Consequences--Federal Income Taxation of Host REIT Following the REIT
Conversion--Income Tests Applicable to REITs" and "--Taxable Income
Attributable to Sales of Personal Property in Connection with the REIT
Conversion," if the rent attributable to personal property leased in
connection with the lease of each Hotel is greater than 15% of the total rent
received under the lease of such Hotel, the portion of the rent attributable
to the personal property will not constitute qualifying income to Host REIT
(the "15% Personal Property Test"). The Operating Partnership and the General
Partner have determined that the percentage of rent attributable to the
personal property to be leased in connection with the lease of the two MHP
Hotels would not satisfy the 15% Personal Property Test. The 15% Personal
Property Test is a mechanical test that is based not on the relative fair
market value of the assets subject to lease, or the relative fair rental value
of those assets, but, rather, is based on the average relative adjusted tax
bases of the assets subject to the lease. Accordingly, immediately prior to
the Merger, the Operating Partnership will require MHP, if it chooses to
participate in the Merger, to sell to a Non-Controlled Subsidiary a portion of
the personal property associated with the MHP Hotels. This sale, which will be
a taxable transaction, may
MHP Supp-29
<PAGE>
(although is not expected to) result in the recognition by MHP (and the
allocation to the MHP Limited Partners) of a relatively modest amount of
taxable gain to the extent of the difference, if any, between the fair market
value of the personal property at the time of the sale and the adjusted tax
basis of such property at that time. The actual amount of any such gain will
be determinable only at the time of the sale and will be affected by the
specific personal property selected to be sold and the fair market value and
adjusted basis of that personal property. Pursuant to the MHP partnership
agreement, any such taxable gain will be characterized as ordinary recapture
income and will be allocated by MHP to the former MHP Limited Partners in the
same proportions and to the same extent that such Limited Partners were
allocated any deductions directly or indirectly giving rise to the treatment
of such gains as recapture income prior to the Merger. The MHP Limited
Partners would not be entitled to any special distributions from MHP in
connection with such a sale of personal property.
Tax Allocations with Respect to Contributed Hotels Generally. The tax
allocations of depreciation to the MHP Limited Partners may change
significantly as a result of the Mergers and the REIT Conversion for two
reasons. First, as described above, pursuant to Section 704(c) of the Code,
depreciation and deductions attributable to the two MHP Hotels will be
required to be allocated for federal income tax purposes in a manner such that
the MHP Limited Partners are charged with the Book-Tax Difference associated
with the MHP Hotels at the time of the consummation of the Merger.
Consequently, an MHP Limited Partner will be allocated less depreciation with
respect to the MHP Hotels than would be the case if the Mergers had not
occurred and the MHP Limited Partner had continued to hold his MHP Partnership
Units. (On the other hand, a former MHP Limited Partner will be allocated
depreciation with respect to other Hotels acquired by the Operating
Partnership in connection with the Mergers and the REIT Conversion, including
the Hotels owned by the other Hotel Partnerships and the Hotels being
contributed to the Operating Partnership by Host and the Blackstone Entities
in connection with the Mergers and the REIT Conversion.) Second, the Mergers
will cause the technical termination under Section 708(b)(1)(B) of the Code of
MHP and most of the other Hotel Partnerships that participate in the Mergers
and the REIT Conversion. Section 168(i)(7) of the Code provides, in effect,
that when a partnership terminates under Section 708(b)(1)(B) of the Code, the
partnership must begin new depreciation periods for its property. As a result,
the remaining bases of the real estate components of the MHP Hotels and the
Hotels held by the other Hotel Partnerships that terminate will be depreciated
over 39 years, rather than over the remaining current lives of such Hotels
(which range from less than one year to 39 years). See "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--Effect of Mergers on Depreciation" in the Consent Solicitation.
In light of the complexity of the governing rules affecting the calculation
and allocation of depreciation with respect to properties contributed to a
partnership, particularly when a number of those properties are subject to the
separate adjustments required in connection with a technical termination under
Section 708 of the Code, the number of Hotels that the Operating Partnership
will be acquiring in connection with the Mergers and the REIT Conversion, and
the impact on these calculations of other outside events, including equity
offerings by Host or Host REIT and other acquisitions undertaken by Host, Host
REIT or the Operating Partnership prior to or in connection with the REIT
Conversion, the Operating Partnership and the General Partner believe that it
is impossible to predict with any degree of precision the impact that the
Mergers and the REIT Conversion will have on the future depreciation (and,
consequently, the amount of taxable income) allocable to an MHP Limited
Partner.
Impact on Passive Activity Losses of an Investment in a Publicly Traded
Partnership. The passive loss limitation rules generally provide that
individuals, estates, trusts and certain closely held corporations and
personal service corporations can only deduct losses from passive activities
(generally activities in which the taxpayer does not materially participate,
which would include the Operating Partnership for MHP Limited Partners) to the
extent that such losses are not in excess of the taxpayer's income from
passive activities or investments. An MHP Limited Partner would be able to
offset losses from other passive activities against income from the Operating
Partnership that is considered passive income (but not portfolio income) so
long as the Operating Partnership is not treated as a publicly traded
partnership. The Operating Partnership and the General Partner believe,
however, that there is a substantial risk that the Operating Partnership will
be treated as a
MHP Supp-30
<PAGE>
publicly traded partnership for purposes of the passive loss limitation rules.
In this event, any losses or deductions of the Operating Partnership allocable
to an MHP Limited Partner after the Merger could not be used to offset passive
income from other passive activities. Similarly, losses from other passive
activities (including losses attributable to MHP for periods prior to the
Merger) could not be applied to offset income of the Operating Partnership
allocated to an MHP Limited Partner. An MHP Limited Partner, however, would be
able to offset any passive losses from his investment in MHP (or other
investments) against any gain recognized by the MHP Limited Partner as a
result of the Merger. The Operating Partnership and the General Partner
estimate that, as of December 31, 1998, an MHP Limited Partner that purchased
his Partnership Units at the time of the original offering has held those
Partnership Units continuously since that time, and whose Partnership Units
have been his only investment in a passive activity would have a passive
activity loss carryforward of approximately $1,217, on a per Partnership Unit
basis.
State and Local Taxes. MHP Limited Partners holding OP Units will be subject
to state and local taxation in a number of jurisdictions in which the
Operating Partnership directly or indirectly holds real property and would be
required to file periodic tax returns in those jurisdictions. In this regard,
immediately following the Mergers and the REIT Conversion, the Operating
Partnership expects that it will own properties in approximately 28 states
across the United States and the District of Columbia. Currently, MHP owns,
directly and indirectly, only Florida properties. See "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--State and Local Taxes" in the Consent Solicitation.
Assumptions Used in Determining Tax Consequences of the Merger
In preparing the discussion set forth above, the Operating Partnership and
the General Partner made several key assumptions, which are described below.
If any such assumption is not accurate with respect to a particular MHP
Limited Partner, the tax consequences of the Merger to such MHP Limited
Partner could be substantially different from those reflected above.
ACCORDINGLY, EACH MHP LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS
OWN TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH MHP LIMITED PARTNER'S
PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING
IN THE MERGER.
First, with respect to an MHP Limited Partner's basis in his MHP Partnership
Units prior to the Merger, the Operating Partnership and the General Partner
assumed that an MHP Limited Partner acquired his MHP Partnership Units in the
original offering of such Partnership Units and has held such Partnership
Units at all times since the offering (the "Original Limited Partner's
Adjusted Basis"). In general, each MHP Limited Partner had an initial tax
basis in his MHP Partnership Units ("Initial Basis") equal to his cash
investment in MHP (plus his proportionate share of MHP's nonrecourse
liabilities at the time he acquired his MHP Partnership Units). An MHP Limited
Partner's Initial Basis generally has been increased by (a) such Limited
Partner's share of MHP taxable income and (b) any increases in his or her
share of liabilities of MHP. Generally, such Limited Partner's Initial Basis
has been decreased (but not below zero) by (i) his share of MHP cash
distributions, (ii) any decreases in his share of liabilities of MHP, (iii)
his share of losses of MHP and (iv) his share of nondeductible expenditures of
MHP that are not chargeable to capital.
The General Partner has set forth on Appendix E to the Consent Solicitation
for MHP (i) the Original Limited Partner's Adjusted Basis as of December 31,
1997 for each such MHP Limited Partner, and (ii) an estimate of such MHP
Limited Partner's Original Limited Partner's Adjusted Basis as of December 31,
1998 (computed without regard to the Mergers and based upon the assumptions
set forth in Appendix E to the Consent Solicitation). The General Partner also
has set forth on Appendix E to the Consent Solicitation for each MHP Limited
Partner whose adjusted basis in his MHP Partnership Interest is the same as
the Original Limited Partner's Adjusted Basis (i) the MHP liabilities
allocable to such MHP Limited Partner as of December 31, 1997, and (ii) an
estimate of the MHP liabilities allocable to such Limited Partner as of
December 31, 1998 (computed without regard to the Mergers and based upon the
assumptions set forth in Appendix E to the Consent Solicitation).
MHP Supp-31
<PAGE>
The adjusted tax basis of an MHP Limited Partner who did not acquire his MHP
Partnership Units in the original offering of such Partnership Units could
vary materially from that of an MHP Limited Partner who did so for various
reasons. If an MHP Limited Partner has an adjusted tax basis in his MHP
Partnership Units that is less than the Original Limited Partner's Adjusted
Tax Basis, the Merger might result in the receipt by the MHP Limited Partner
of a deemed distribution of cash in excess of his adjusted tax basis in his
MHP Partnership Units, which could result in the recognition of income or
gain.
Second, the Operating Partnership and the General Partner assumed that the
method expected to be used by the Operating Partnership to allocate
liabilities among the partners will be respected for federal income tax
purposes. The Operating Partnership will allocate liabilities associated with
the MHP Hotels as described in "Federal Income Tax Consequences--Tax
Consequences of the Mergers--Relief from Liabilities/Deemed Cash Distribution"
in the Consent Solicitation. If the method used by the Operating Partnership
were not respected for federal income tax purposes and the nonrecourse
liabilities actually allocable to an MHP Limited Partner are less than the
amount assumed by the Operating Partnership and the General Partner, the
Merger might result in the receipt by such MHP Limited Partner of a deemed
distribution of cash that is greater than the deemed distribution of cash
expected to be received by such MHP Limited Partner as described above in "Tax
Consequences of the Merger--Deemed Cash Distribution and Resulting Taxable
Gain." For an MHP Limited Partner who did not acquire his MHP Partnership
Units in the original offering of such Partnership Units or who did not hold
such Partnership Units at all times since, this deemed distribution of cash
could exceed his adjusted tax basis in his MHP Partnership Units, which could
result in the recognition of income or gain.
Finally, the Operating Partnership and the General Partner assumed that the
Merger will be treated for federal income tax purposes as the transfer by the
MHP Limited Partners of their interests in the Partnership to the Operating
Partnership in exchange for OP Units. There can be no assurance, however, that
the IRS will not seek to recharacterize each Merger as either (i) the
liquidation of a Partnership followed by the distribution by the Partnership
of its assets to its partners and the subsequent transfers by such partners of
such assets to the Operating Partnership in exchange for OP Units, or (ii) the
transfer by a Partnership of its assets to the Operating Partnership in
exchange for OP Units (and possibly Notes) and the subsequent distribution of
such OP Units (and possibly Notes) to its partners. If the Merger is
recharacterized in the manner described in (ii) in the preceding sentence, the
tax consequences of the Merger to the MHP Limited Partners likely would be
materially affected.
EACH MHP LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX
ADVISORS TO DETERMINE THE IMPACT OF SUCH MHP LIMITED PARTNER'S PARTICULAR TAX
SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER.
THE TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER TO A PARTICULAR MHP
LIMITED PARTNER COULD VARY SUBSTANTIALLY FROM THE CONSEQUENCES DESCRIBED
ABOVE.
Tax Treatment of MHP Limited Partners Who Exercise Their Right to Make the
Note Election
An MHP Limited Partner who exercises his right to make the Note Election and
receive a Note in connection with the Merger will be treated as having made a
taxable disposition of his OP Units. The amount realized in connection with
such disposition will equal the sum of the "issue price" of the Note (i.e.,
the face amount of the Note, currently estimated as $124,261 per MHP
Partnership Unit) plus the portion of MHP liabilities allocable to the MHP
Limited Partner for federal income tax purposes immediately prior to the
disposition of the OP Units (estimated as $216,322 per MHP Partnership Unit as
of December 31, 1998). To the extent the amount realized exceeds the MHP
Limited Partner's adjusted basis in his MHP Partnership Units, the MHP Limited
Partner will recognize gain. The Operating Partnership and the General Partner
estimate (assuming the MHP Limited Partner acquired his MHP Partnership Units
at the time of the original offering and has held such Partnership Units at
all times since the offering) that the amount of gain that would be recognized
by an MHP Limited Partner who made the Note Election would be approximately
$204,720 per MHP Partnership Unit, as of December 31, 1998. For a discussion
of the federal income tax rates applicable to the net capital gain from the
sale of a capital asset, see "Federal Income Tax Consequences--Tax Treatment
of Limited Partners Who
MHP Supp-32
<PAGE>
Hold OP Units Following the Mergers--Disposition of OP Units by Limited
Partners" in the Consent Solicitation. In this regard, the General Partner
estimates that, as of December 31, 1998, if MHP sold both of its Hotels in a
fully taxable transaction for a net amount, after payment of liabilities,
equal to the Liquidation Value of MHP, the "unrecognized Section 1250 gain"
per MHP Partnership Unit would be $133,537 and the gain subject to tax as
ordinary income under Code Section 1245 per MHP Partnership Unit would be
$10,808. An MHP Limited Partner who makes the Note Election would be able to
treat any per Partnership Unit passive activity loss carryforward with respect
to the activities of MHP, to the extent the sum of such losses exceeds his
passive activity income for 1998, as losses that are not from a passive
activity and, therefore, not subject to the passive activity loss limitation
rules. For purposes of determining the gain recognized by a Limited Partner as
a result of making the Note Election, an original Limited Partner's Adjusted
Basis does not reflect such Limited Partner's share of the syndication costs
incurred by his Partnership at formation. An original MHP Limited Partner's
share of syndication costs was $10,700 per MHP Partnership Unit.
An MHP Limited Partner who elects to receive a Note may be eligible to defer
a majority of that gain under the "installment sale" rules. Those rules,
however, will not permit the MHP Limited Partner to defer all of the gain,
and, to the extent that the face amount of the Note (and any other installment
obligations received by the taxpayer during the year) outstanding at the end
of the taxable year in which the Merger occur exceeds $5,000,000, will require
that the MHP Limited Partner who defers gain pay to the IRS interest on the
resulting tax that has been deferred. The MHP Limited Partner will not be
eligible to defer gain recognized upon the receipt of the Note to the extent
that his share of MHP liabilities at the time of the Merger exceeds his
adjusted tax basis in his MHP Partnership Units immediately prior to the
Merger (that is, to the extent that he has a "negative capital account" for
tax purposes). In addition, the MHP Limited Partner will not be eligible to
defer gain to the extent that such gain would be taxed as ordinary income
under Sections 1245 and 1250 of the Code. Lastly, if an MHP Limited Partner
disposes of the Note, any gain that had been deferred would be recognized in
the year of disposition.
THE SPECIFIC TAX ATTRIBUTES OF A PARTICULAR MHP LIMITED PARTNER COULD HAVE A
MATERIAL IMPACT ON THE TAX CONSEQUENCES OF THE MERGER AND THE SUBSEQUENT
OWNERSHIP AND DISPOSITION OF NOTES. THEREFORE, IT IS ESSENTIAL THAT MHP
LIMITED PARTNERS CONSIDERING ELECTING TO RECEIVE NOTES CONSULT WITH THEIR OWN
TAX ADVISORS WITH REGARD TO THE APPLICATION OF THE FEDERAL INCOME TAX LAWS TO
SUCH MHP LIMITED PARTNERS' RESPECTIVE PERSONAL TAX SITUATIONS, AS WELL AS ANY
TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY STATE, LOCAL OR FOREIGN TAXING
JURISDICTION.
Tax Consequences if MHP Does Not Participate in the Merger
If MHP does not participate in the Merger, the MHP Limited Partners would
not have any tax consequences resulting from the Merger. The consequences of
continued ownership of MHP Partnership Units will be the same as would have
resulted if the Merger had not been proposed.
* * *
The above description is not exhaustive of all possible tax considerations
associated with the Merger and the REIT Conversion. This summary does not
discuss foreign tax considerations, nor does it discuss all of the aspects of
federal income taxation or state and local taxation that may be relevant to
MHP Limited Partners in light of their particular circumstances. EACH MHP
LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX ADVISORS TO
DETERMINE THE IMPACT OF SUCH MHP LIMITED PARTNER'S PARTICULAR TAX SITUATION ON
THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER.
MHP Supp-33
<PAGE>
SELECTED FINANCIAL DATA
The following table presents selected historical financial data derived from
the MHP financial statements for the five most recent fiscal years in the
period ended December 31, 1997 and the unaudited condensed consolidated
financial statements for the First Two Quarters 1998 and First Two Quarters
1997. The following data should be read in conjunction with MHP's financial
statements and the notes thereto, Management's Discussion and Analysis of
Financial Condition and Results of Operations and the other financial
information included elsewhere herein.
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS FISCAL YEAR
---------------- -------------------------------------------
1998 1997 1997 1996 1995 1994 1993
------- ------- ------- ------- ------- ------- -------
(UNAUDITED) (AMOUNTS IN THOUSANDS,
EXCEPT PER PARTNERSHIP UNIT(1))
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................ $47,968 $45,873 $75,211 $71,834 $66,998 $58,474 $61,347
Operating profit........ 30,115 28,733 42,095 42,185 36,053 28,677 23,338
Income before
extraordinary item(2).. 17,818 15,343 19,477 18,449 13,150 7,311 14,748
Net income.............. 17,818 15,343 16,416 18,449 13,150 7,311 14,748
Distributions:
General partner........ 15 14 78 50 21 -- --
Limited partners....... 1,500 1,500 7,706 4,964 2,084 -- --
------- ------- ------- ------- ------- ------- -------
Total.................. 1,515 1,514 7,784 5,014 2,105 -- --
Per Partnership Unit(1):
Net income (loss)...... 17,640 15,190 16,252 18,265 13,018 7,238 14,600
Distributions.......... 1,500 1,500 7,700 4,970 2,084 -- --
Cash provided by
operating activities... 26,062 25,633 31,758 27,632 25,755 20,884 8,857
Cash used in investing
activities............. (5,417) (5,071) (12,840) (8,911) (6,922) (8,241) (3,174)
Cash used in financing
activities............. (2,972) (7,417) (9,831) (20,664) (18,026) (11,956) (14,225)
Increase (decrease) in
cash and cash
equivalents............ 17,673 13,145 9,087 (1,943) 807 687 (8,542)
Ratio of earnings to
fixed charges(3)
(unaudited)............ 2.89x 2.51x 2.00x 1.92x 1.63x 1.32x --
Deficiency of earnings
to fixed charges(3)
(unaudited)............ -- -- -- -- -- -- 4,590
Total assets at book
value.................. 278,264 256,645 261,109 249,441 251,217 254,058 257,620
Cash and cash
equivalents............ 28,367 14,752 10,694 1,607 3,550 2,743 2,056
Total debt(4)........... 240,809 230,727 240,748 235,146 248,659 260,843 271,879
Total liabilities....... 242,113 231,654 241,261 238,272 253,483 267,369 278,242
Partner's capital
(deficit):
Limited partners....... 35,681 24,632 19,541 10,948 (2,353) (13,287) (20,525)
General partner........ 470 359 307 221 87 (24) (97)
Book value per
Partnership Unit
(unaudited)(1)......... 35,681 24,632 19,541 10,948 (2,353) (13,287) (20,525)
Exchange value per
Partnership Unit
(unaudited)(1)......... 141,425 -- -- -- -- -- --
</TABLE>
- --------
(1) A Partnership Unit represents a $100,000 original investment in MHP.
(2) In 1997, the Partnership recognized a $3.1 million extraordinary loss
resulting from the prepayment penalty related to the early extinguishment
of the mortgage debt on the Orlando Hotel and the write-off of related
deferred financing costs.
(3) The ratio of earnings to fixed charges is computed by dividing net income
before interest expense and other fixed charges by total fixed charges,
including interest expense, amortization of debt issuance costs and the
portion of rent expense that is deemed to represent interest. The
deficiency of earnings to fixed charges in 1993 was largely the result of
depreciation and amortization of $14,601,000.
(4) Total debt includes amounts due to Host Marriott of $2,295,000,
$2,294,000, $6,420,000, $9,149,000 and $13,635,000 as of June 20, 1997,
December 31, 1996, 1995, 1994 and 1993, respectively.
MHP Supp-34
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
The chart below summarizes REVPAR, or revenue per available room, the first
two quarters for 1998 and 1997:
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
---------
1998 1997 % INCREASE
---- ---- ----------
<S> <C> <C> <C>
Orlando World Center................................. $139 $136 2%
Harbor Beach......................................... $177 $170 4%
Combined Average..................................... $150 $146 3%
</TABLE>
Total consolidated Partnership revenues for the first two quarters 1998,
increased 5% when compared to the comparable period in 1997. Operating results
for the first two quarters 1998 were strong for both the Orlando Hotel and the
Harbor Beach Hotel (the "Hotels"). REVPAR represents the combination of the
average daily room rate charged and the average daily occupancy achieved and
is a commonly used indicator of hotel performance. On a combined basis, for
the first two quarters 1998, REVPAR increased 3% primarily due to increases in
average room rate. For the first two quarters 1998, the combined average room
rate increased 5% over the comparable period in 1997 to $177 while the
combined average occupancy decreased two percentage points to 85%.
Hotel revenues. For the first two quarters 1998, revenues reported by the
Orlando Hotel increased 7% over the same period of 1997. The strong
performance for the first two quarters 1998 was a result of a 2% increase in
REVPAR to $139. This increase was attributed to a 4% increase in average room
rate to $162 offset by a one percentage point decrease in occupancy to 86%.
The hotel achieved its increase in average room rate as a result of rate
increases across all segments and the hotel's ability to restrict discounted
transient room rates. The decrease in occupancy was primarily due to a
decrease in group roomnights.
Rental income. Rental income for the first two quarters from the Harbor
Beach Hotel remained stable over 1997.
For the first two quarters 1998, REVPAR increased 4% to $177 when compared
to the same period in 1997. This increase was due to a 10% increase in average
room rate to $215 offset by a five percentage point decrease in occupancy to
82%. The improvement in REVPAR was primarily a result of a 16% increase in the
group rate.
Operating costs and expenses. The Partnership's operating costs and expenses
decreased 4% to $17.1 million for the first two quarters 1998 when compared to
the same period in 1997. The principal component of this category is discussed
below:
Depreciation and amortization. Depreciation and amortization for the first
two quarters 1998 increased approximately $0.3 million, or 7% as compared to
1997. The increase is primarily due to the completion of the rooms renovation
project at the Orlando Hotel during fourth quarter 1997.
Operating profit. As a result of changes in revenues and expenses discussed
above, operating profit increased by $1.4 million to $30.1 million over the
same period in 1997.
Interest expense. Interest expense for the first two quarters 1998 decreased
7% as compared to the same period in 1997 due to the refinancing of the
Orlando Hotel's mortgage debt at a lower interest rate in 1997.
Minority interest. Based upon its 50.5% ownership interest, the Partnership
controls the Harbor Beach Partnership and, as a result, the condensed
consolidated financial statements of the Partnership include the accounts of
the Harbor Beach Partnership. Minority interest represents the net income from
the Harbor Beach
MHP Supp-35
<PAGE>
Partnership allocable to the co-general partner. Minority interest in income
decreased from $3.8 million for the first two quarters 1997 to $3.6 million
for the first two quarters 1998 primarily due to a slight decrease in net
income from the Harbor Beach Partnership due to an increase in depreciation
expense.
Net income. For the first two quarters 1998, net income increased $2.5
million to $17.8 million over the same period in 1997. This increase was
primarily due to increases in hotel revenues and rental income and the
decrease in interest expense, as discussed above.
1997 Compared to 1996
Hotel Revenues. Hotel revenues increased approximately $3.1 million, or 6%,
over 1996 as a result of continued growth in corporate group business. REVPAR
at the Orlando Hotel increased 11% over 1996 to $118. This higher rate
resulted from increased demand generated by Disney's 25th Anniversary
celebration and an increase in group roomnights from the association and
international markets. Average occupancy increased by two percentage points to
80%. As a result of the increase in REVPAR, room sales at the Orlando World
Center increased $5.0 million, or 8%, over 1996. Food and beverage sales in
1997 increased $3.6 million, or 7.5%, over 1996 primarily due to an 11%
increase in banquet sales. Food and beverage profit increased $1.1 million, or
6%, over 1996 due to the increase in sales combined with continued emphasis on
cost containment. In 1998, the Orlando World Center expects demand will remain
strong and as a result, 1998 hotel revenues are expected to increase.
Direct operating costs and expenses increased $4.9 million, or 7%, over 1996
due to an increase in certain variable costs related to the increase in room
sales and higher food and beverage costs due to the creation of a special
events department at the Orlando World Center.
Rental Income. Rental income from the Harbor Beach Hotel increased by
approximately $326,000, or 2%, when compared to 1996 as a result of the
Hotel's ability to restrict discounted rates and achieve a higher transient
room rate. The Harbor Beach Hotel experienced an increase in corporate group
demand of almost 5,000 roomnights. REVPAR increased 6% over 1996 due to a 6%
increase in the average room rate to $173. As a result of the increase in
REVPAR, room sales and profit increased 4.5% and 4%, or $1.4 million and $1.1
million, respectively, over 1996.
Indirect hotel operating costs and expenses. Indirect hotel operating costs
and expenses increased by $3.5 million, or 13%, from $29.6 million in 1996 to
$33.1 million in 1997. The principal components of this category are discussed
below.
Depreciation and amortization. Depreciation and amortization increased 9%
from $9.7 million in 1996 to $10.6 million in 1997 primarily due to the
addition of furniture and equipment at the Harbor Beach Hotel in 1996.
Incentive management fees. In accordance with the Orlando World Center
Management Agreement, incentive management fees increased by $1.8 million, or
24%, over 1996 as a result of improved operating results at the Orlando World
Center. Cash flow from operations of the Orlando World Center Hotel was
sufficient to pay all incentive management fees earned by the Manager in 1997
and 1996. Additional incentive management fees of $1.4 million were also
earned by the Manager for the first time in 1997.
Base management fees. In accordance with the Orlando World Center Hotel
Management Agreement, base management fees increased 7%, from $3.6 million in
1996 to $3.8 million in 1997, due to improved total sales at the Orlando World
Center Hotel.
Operating Profit. Operating profit remained stable at $42.1 million due to
the increases in depreciation and amortization and incentive management fees,
as discussed above.
MHP Supp-36
<PAGE>
Interest expense. Interest expense decreased 6% from $5.1 million in 1996 to
$4.7 million in 1997 primarily due to principal payments on the Orlando
Mortgage Debt prior to refinancing of $7.0 million and repayment of the entire
Orlando Ballroom Loan in 1997.
Minority interest in income. Based on its 50.5% ownership interest, the
Partnership controls the Harbor Beach Partnership and as a result, the
accounts of the Harbor Beach Partnership are consolidated in the consolidated
financial statements of the Partnership. Minority interest in income
represents the net income from the Harbor Beach Partnership allocable to the
other general partner in that Partnership. Minority interest in income
decreased 3% in 1997 primarily due to an increase in depreciation expense
partially offset by an increase in rental income from the Harbor Beach Hotel,
as discussed above.
Net income. Net income for 1997 decreased $2.0 million, or 11%, over 1996
primarily due to the $3.1 million extraordinary loss resulting from the
prepayment penalty related to the early extinguishment of the mortgage debt on
the Orlando Hotel and the write-off of deferred financing costs related to
that debt. This loss was partially offset by higher hotel revenues in 1997.
1996 Compared to 1995
Hotel Revenues. Hotel revenues increased approximately $3.3 million, or 7%,
over 1995 as a result of continued growth in corporate group and transient
business. REVPAR at the Orlando World Center increased 2% over 1995 to $106.
This increase was a result of the Hotel's ability to restrict discounted rates
and achieve a higher average room rate. The average room rate increased 4%
from 1995 to $137. This increase was slightly offset by a 1.1 percentage point
decrease in average occupancy to 78%. The first half of a rooms renovation
project was completed during 1996, thus decreasing the availability of rooms
for sale. As a result of the increase in REVPAR, room sales at the Orlando
World Center increased $2.4 million, or 4%, over 1995. Food and beverage sales
in 1996 increased $2.1 million, or 5%, over 1995 primarily due to a 6%
increase in banquet sales. Food and beverage profit increased $1.0 million, or
6%, over 1995 due to the increase in revenues combined with continued emphasis
on cost containment.
Direct hotel operating costs and expenses increased $2.7 million, or 4%,
over 1995 due to an increase in certain variable costs related to the increase
in room sales. The ratio of operating costs to room sales declined in 1996 to
58.0% as compared to 1995 at 58.7%.
Rental Income. Rental income from the Harbor Beach Hotel increased by
approximately $1.6 million, or 8%, when compared to 1995 due to increased
transient demand especially in the leisure segment, the highest average room
rate category. The Harbor Beach Hotel experienced record call volume during
prime season and a significant increase in international travelers. REVPAR
increased 7% over 1995 due to a 5% increase in the average room rate to $164
combined with an increase in average occupancy of 1.9 percentage points to
82%. Despite a 3% decline in group roomnights, transient roomnights increased
13% over 1995. As a result of the increase in REVPAR, room sales and profit
increased 9% and 10%, or $2.6 million and $2.3 million, respectively, over
1995.
Indirect hotel operating costs and expenses. Indirect hotel operating costs
and expenses decreased by $1.3 million, or 4%, from $30.9 million in 1995 to
$29.6 million in 1996. The principal components of this category are discussed
below.
Depreciation and amortization. Depreciation and amortization decreased by
$2.0 million, or 17%, when compared to 1995 due to a portion of the Hotels'
furniture and fixtures becoming fully depreciated in 1995.
Incentive management fees. In accordance with the Orlando World Center
Management Agreement, incentive management fees increased by $0.5 million, or
7%, over 1995 as a result of improved operating results at the Orlando World
Center. Cash flow from operations of the Orlando World Center was sufficient
to pay all incentive management fees earned by the Manager in 1996 and 1995.
MHP Supp-37
<PAGE>
Base management fees. In accordance with the Orlando World Center Management
Agreement, base management fees increased 5%, from $3.4 million in 1995 to
$3.6 million in 1996, due to improved total sales at the Orlando World Center.
Operating Profit. As a result of the changes in revenues and operating costs
and expenses discussed above, operating profit increased by $6.1 million to
$42.2 million, or 59% of revenues, for 1996, from $36.1 million or 54% of
revenues for 1995.
Interest expense. Interest expense increased 1% from $21.9 million in 1995
to $22.0 million in 1996, primarily due to the Orlando Mortgage Debt loan
modification and extension in October 1995. The Orlando Mortgage Debt interest
rate was increased from 7% to 8% in October 1995. The interest rate increase
was offset slightly by principal payments on the Orlando Mortgage Debt of $7.5
million in 1996.
Minority interest in income. Based on its 50.5% ownership interest, the
Partnership controls the Harbor Beach Partnership and as a result, the
accounts of the Harbor Beach Partnership are consolidated in the consolidated
financial statements of the Partnership. Minority interest in income
represents the net income from the Harbor Beach Partnership allocable to the
other general partner in that Partnership. Minority interest in income
increased from $1.7 million in 1995 to $2.6 million in 1996, primarily due to
the increase in rental income from the Harbor Beach Hotel, as discussed above.
Net income. Net income for 1996 increased $5.3 million, or 40%, over 1995
primarily due to higher Hotel revenues and rental income, offset by increased
incentive and base management fees and an increase in minority interest in
income.
CAPITAL RESOURCES AND LIQUIDITY
The Partnership's financing needs have historically been funded through loan
agreements with independent financial institutions, Host Marriott Corporation
("Host Marriott") and its affiliates or Marriott International, Inc. (the
"Manager") and its affiliates. The general partner believes that the
Partnership will have sufficient capital resources and liquidity to continue
to conduct its business in the ordinary course.
Principal Sources and Uses of Cash
The Partnership's principal source of cash is from operations. Its principal
uses of cash are to fund the property improvement funds of the Hotels, to pay
required principal amortization of the mortgage debt and other debt incurred
to fund costs of capital improvements at the Hotels, financing costs and cash
distributions to the partners.
Total consolidated cash provided by operations for the first two quarters
1998 and 1997, was $26.1 million and $25.6 million, respectively. The increase
was primarily due to an increase in hotel revenues and rental income when
compared to the same period in 1997. Total consolidated cash provided by
operations was $31.8 million, $27.6 million and $25.8 million for the years
ended December 31, 1997, 1996 and 1995, respectively.
For the first two quarters 1998 and 1997, cash used in investing activities
was $5.4 million and $5.1 million, respectively, consisting primarily of an
increase in additions to property and equipment. This is primarily due to the
commencement of the Orlando Hotel expansion project in May 1998. Cash used in
investing activities was $12.8 million, $8.9 million and $6.9 million for the
years ended December 31, 1997, 1996, and 1995, respectively. The Partnership's
investing activities consist primarily of contributions to the property
improvement fund of the Hotels of $9.1 million, $8.7 million and $7.7 million
for the years ended December 31, 1997, 1996 and 1995, respectively.
For the first two quarters 1998 and 1997, cash used in financing activities
was $3.0 million and $7.4 million, respectively. The decrease in cash used in
financing activities was primarily the result of a decrease in principal
MHP Supp-38
<PAGE>
repayments on the mortgage debt and the receipt of construction loan advances.
During the first two quarters 1998, the Partnership distributed $1.5 million
to its partners ($1,500 per limited partner unit). This distribution
represented $540 per limited partner unit from 1997 operations and $960 per
limited partner unit related to first quarter 1998 operations. In addition, on
August 4, 1998, the Partnership distributed $8,080,808 ($8,000 per limited
partner unit) from 1998 operations. Cash used in financing activities was $9.8
million, $20.7 million and $18.0 million for the years ended December 31,
1997, 1996 and 1995 respectively. Principal repayments made on the mortgage
debt of the Hotels totaled $8.5 million, $8.9 million and $9.0 million for the
years ended December 31, 1997, 1996 and 1995, respectively. Payment of
financing costs related to the mortgage debt of the Partnership Hotels totaled
$2.0 million, $40,000 and $2.3 million for the years ended December 31, 1997,
1996 and 1995, respectively. Cash distributed to the partners was $7.8
million, $5.0 million and $2.1 million for the years ended December 31, 1997,
1996 and 1995, respectively. Cash distributions paid to minority interest were
$2.0 million, $2.1 million and $1.5 million for the years ended December 31,
1997, 1996 and 1995, respectively.
Pursuant to the refinancing of the Orlando Mortgage Debt, the Partnership
received proceeds of $152.0 million. Of the proceeds, $139.3 million was used
to repay the outstanding principal balance on the Orlando Mortgage Debt and
accrued interest, $2.0 million was used to pay related refinancing costs and
$1.9 million was used to pay prepayment penalties. The remaining $8.8 million
is held by the Partnership as working capital.
During 1997, Marriott International Capital Corporation ("MICC"), a wholly-
owned subsidiary of Marriott International, advanced $3.5 million to the
Orlando World Center to provide financing for the rooms and suites
refurbishment. Principal repayments to Host Marriott related to the Orlando
Ballroom Loan and the Orlando Rooms Renovation Loan totaled $2.3 million, $4.1
million and $2.7 million for the years ended December 31, 1997, 1996 and 1995,
respectively. Principal repayments to MICC related to the Harbor Beach Rooms
Renovation Loan totaled $0.6 million, $0.5 million and $0.5 million for each
of the years ended December 31, 1997, 1996 and 1995.
The General Partner believes that cash from operations will provide adequate
funds for the operational needs of the Partnership and the Harbor Beach
Partnership for the foreseeable future. The interest rates on the refinanced
Orlando Mortgage Debt and the Harbor Beach Mortgage Debt are fixed at 7.48%
and 9.13%, respectively. The Harbor Beach Mortgage Debt matures in the year
2000, at which time the loan-to-value ratios and debt service coverage of the
Harbor Beach Hotel is expected to enhance the Harbor Beach Partnership's
ability to secure replacement financing.
Property Improvement Funds
The Orlando World Center Management Agreement and the Harbor Beach Hotel
Operating Lease provide for the establishment of a property improvement fund
for each Hotel. Pursuant to these agreements, contributions to the funds are
equal to a percentage of total sales of each Hotel and are used to provide for
the funding of routine capital expenditures and the replacement of furniture,
fixtures and equipment. Upon maturity of the Orlando World Center Mortgage
Debt on June 16, 1995, contributions to the Orlando World Center fund
increased from 4% to 5% of total sales. Total contributions to the Orlando
World Center fund were $6.4 million, $6.0 million and $5.1 million for the
years ended December 31, 1997, 1996 and 1995, respectively. Total capital
expenditures at the Orlando World Center were $7.9 million, $8.1 million and
$4.8 million for the years ended December 31, 1997, 1996 and 1995,
respectively. In addition, principal and interest paid to MICC on the Orlando
Rooms Renovation Loan totaled $100,000 in 1997. The balance of the Orlando
World Center fund was $2.9 million as of December 31, 1997.
Contributions to the Harbor Beach Hotel's property improvement fund are
equal to 5% of total hotel sales. Total contributions to the Harbor Beach
Hotel fund were $2.7 million, $2.7 million and $2.6 million for the years
ended December 31, 1997, 1996 and 1995, respectively. Total capital
expenditures at the Harbor Beach Hotel were $2.5 million, $1.6 million and
$1.3 million for the years ended December 31, 1997, 1996 and 1995,
respectively. The balance of the Harbor Beach Hotel fund was $3.2 million as
of December 31, 1997.
MHP Supp-39
<PAGE>
INFLATION
For the three fiscal years ended December 31, 1997 and the First Two
Quarters 1998, the rate of inflation has been relatively low and, accordingly,
has not had a significant impact to the Partnership's revenues and net income.
The manager is generally able to pass through increased costs to customers
through higher room rates. In 1997, the increase in average room rates at the
Hotels exceeded those of direct competitors as well as the general level of
inflation. The amount of the Partnership's interest expense under floating
rate debt for a particular year will be affected by changes in short-term
interest rates.
YEAR 2000 ISSUES
Over the last few years, Host Marriott Corporation, the parent company of
the General Partner, has invested in implementing new accounting systems which
are Year 2000 compliant. Accordingly, the General Partner believes that future
costs associated with Year 2000 issues will be minimal and not material to the
Partnership's financial statements.
However, the Partnership does rely upon accounting software used by the
Manager of its properties to obtain financial information. The General Partner
believes that the manager has begun to implement changes to the property
specific software to ensure the software will function properly in the Year
2000 and does not expect to incur significant costs related to these
modifications.
MHP Supp-40
<PAGE>
FINANCIAL STATEMENTS
MHP Supp-41
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE PARTNERS OF MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP:
We have audited the accompanying consolidated balance sheet of Marriott
Hotel Properties Limited Partnership (a Delaware limited partnership) and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of operations, changes in partners' capital (deficit) and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the General Partner's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. We did not audit the 1995 financial statements
of Lauderdale Beach Association, which statements reflect total assets and
total revenues of 25 percent and 29 percent in 1995, respectively, of the
consolidated totals. Those statements were audited by other auditors whose
report has been furnished to us and our opinion, insofar as it relates to the
amounts included for that entity, is based solely on the report of the other
auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits and the report of other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Marriott Hotel Properties Limited
Partnership and subsidiaries as of December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Washington, D.C.
March 11, 1998
MHP Supp-42
<PAGE>
MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Property and equipment, net............................... $222,216 $222,491
Minority interest......................................... 10,042 10,641
Due from Marriott International, Inc. and affiliates...... 7,912 9,114
Property improvement funds................................ 6,056 3,542
Deferred financing costs, net............................. 2,130 1,787
Loan deposit.............................................. 1,800 --
Prepaid ground rent....................................... 259 259
Cash and cash equivalents................................. 10,694 1,607
-------- --------
$261,109 $249,441
======== ========
LIABILITIES AND PARTNERS' CAPITAL
Mortgage debt............................................. $235,946 $230,959
Notes payable and amounts due to Marriott International,
Inc. and affiliates...................................... 4,987 4,106
Accounts payable and accrued interest..................... 196 802
Note payable and amounts due to Host Marriott
Corporation.............................................. 132 2,405
-------- --------
Total Liabilities................................... 241,261 238,272
-------- --------
PARTNERS' CAPITAL
General Partner
Capital contribution.................................... 1,010 1,010
Capital distributions................................... (590) (512)
Cumulative net losses................................... (113) (277)
-------- --------
307 221
-------- --------
Limited Partners
Capital contributions, net of offering costs of
$10,978................................................ 89,022 89,022
Investor notes receivable............................... -- (47)
Capital distributions................................... (58,324) (50,618)
Cumulative net losses................................... (11,157) (27,409)
-------- --------
19,541 10,948
-------- --------
Total Partners' Capital............................. 19,848 11,169
-------- --------
$261,109 $249,441
======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
MHP Supp-43
<PAGE>
MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
REVENUES
Hotel (Note 3)................................. $ 53,574 $ 50,523 $ 47,251
Rental income (Note 8)......................... 21,637 21,311 19,747
-------- -------- --------
75,211 71,834 66,998
-------- -------- --------
OPERATING COSTS AND EXPENSES
Depreciation and amortization.................. 10,601 9,693 11,739
Incentive management fees to Marriott
International and affiliates.................. 9,308 7,518 7,047
Base management fees to Marriott International
and affiliates................................ 3,846 3,609 3,431
Property taxes................................. 3,336 3,059 3,104
Ground rent, insurance and other............... 6,025 5,770 5,624
-------- -------- --------
33,116 29,649 30,945
-------- -------- --------
Operating Profit................................. 42,095 42,185 36,053
Interest expense (including interest paid to
related parties of $0.3 million, $0.7 million
and $1.0 million in 1997, 1996 and 1995,
respectively)................................... (20,842) (22,007) (21,864)
Interest income.................................. 803 919 679
-------- -------- --------
INCOME BEFORE MINORITY INTEREST AND EXTRAORDINARY
ITEM............................................ 22,056 21,097 14,868
MINORITY INTEREST IN INCOME...................... (2,579) (2,648) (1,718)
-------- -------- --------
INCOME BEFORE EXTRAORDINARY ITEM................. 19,477 18,449 13,150
EXTRAORDINARY ITEM:
Loss on extinguishment of debt................. (3,061) -- --
-------- -------- --------
NET INCOME....................................... $ 16,416 $ 18,449 $ 13,150
======== ======== ========
ALLOCATION OF NET INCOME
General Partner................................ $ 164 $ 184 $ 132
Limited Partners............................... 16,252 18,265 13,018
-------- -------- --------
$ 16,416 $ 18,449 $ 13,150
======== ======== ========
INCOME BEFORE EXTRAORDINARY ITEM PER LIMITED
PARTNER UNIT (1,000 Units)...................... $ 19,282 $ 18,265 $ 13,018
======== ======== ========
NET INCOME PER LIMITED PARTNER UNIT (1,000
Units).......................................... $ 16,252 $ 18,265 $ 13,018
======== ======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
MHP Supp-44
<PAGE>
MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP AND SUBSIDIARIES
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNER PARTNERS TOTAL
------- -------- --------
<S> <C> <C> <C>
Balance, December 31, 1994......................... $(24) $(13,287) $(13,311)
Net income....................................... 132 13,018 13,150
Capital distributions............................ (21) (2,084) (2,105)
---- -------- --------
Balance, December 31, 1995......................... 87 (2,353) (2,266)
Net income....................................... 184 18,265 18,449
Capital distributions............................ (50) (4,964) (5,014)
---- -------- --------
Balance, December 31, 1996......................... 221 10,948 11,169
Net income....................................... 164 16,252 16,416
Investor note payments........................... -- 47 47
Capital distributions............................ (78) (7,706) (7,784)
---- -------- --------
Balance, December 31, 1997......................... $307 $ 19,541 $ 19,848
==== ======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
MHP Supp-45
<PAGE>
MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
--------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income.................................... $ 16,416 $ 18,449 $ 13,150
Extraordinary item............................ 3,061 -- --
--------- -------- --------
Income before extraordinary item.............. 19,477 18,449 13,150
Noncash items:
Depreciation and amortization............... 10,601 9,693 11,739
Minority interest in income................. 2,579 2,648 1,718
Amortization of deferred financing costs as
interest................................... 519 519 1,041
Loss on disposal of property and equipment.. -- 6 48
Changes in operating accounts:
Payment of deferred incentive management
fees....................................... (2,046) (1,474) (1,972)
Due from Marriott International, Inc. ...... 1,202 (1,964) (360)
Accounts payable and accrued interest....... (595) (292) 325
Due to Host Marriott Corporation............ 21 47 62
Prepaid ground rent and other receivables... -- -- 4
--------- -------- --------
Cash provided by operating activities..... 31,758 27,632 25,755
--------- -------- --------
INVESTING ACTIVITIES
Additions to property and equipment........... (10,326) (9,732) (6,123)
Changes in property improvement funds......... (2,514) 821 (1,748)
Withdrawal from capital reserve escrow........ -- -- 949
--------- -------- --------
Cash used in investing activities......... (12,840) (8,911) (6,922)
--------- -------- --------
FINANCING ACTIVITIES
Proceeds from mortgage debt................... 152,000 -- --
Repayments of mortgage debt and capital lease
obligations.................................. (147,013) (8,901) (8,970)
Capital distributions to partners............. (7,777) (5,007) (2,105)
Proceeds from (repayments of) notes payable to
Marriott International, Inc. ................ 2,909 (486) (485)
Repayments to Host Marriott Corporation....... (2,294) (4,126) (2,727)
Payment of financing costs.................... (2,004) (40) (2,254)
Capital distributions to minority interest.... (1,980) (2,104) (1,485)
Payment of prepayment penalty................. (1,919) -- --
Payment of loan deposit....................... (1,800) -- --
Collection of investor notes receivable....... 47 -- --
--------- -------- --------
Cash used in financing activities......... (9,831) (20,664) (18,026)
--------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS.................................... 9,087 (1,943) 807
CASH AND CASH EQUIVALENTS at beginning of year.. 1,607 3,550 2,743
--------- -------- --------
CASH AND CASH EQUIVALENTS at end of year........ $ 10,694 $ 1,607 $ 3,550
========= ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for mortgage and other interest..... $ 20,894 $ 21,390 $ 20,893
========= ======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
MHP Supp-46
<PAGE>
MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
NOTE 1. THE PARTNERSHIP
Description of the Partnership
Marriott Hotel Properties Limited Partnership (the "Partnership"), a
Delaware limited partnership, was formed on August 22, 1984, to acquire,
construct, own and operate the 1,503-room Marriott Orlando World Center Hotel
(the "Orlando World Center"). The Orlando World Center is managed as part of
the Marriott Hotels, Resorts and Suites full-service hotel system by Marriott
International, Inc. (the "Manager" or "Marriott International").
Between November 1, 1985 and November 27, 1985 (the "Closing Date"), 1,000
limited partnership interests (the "Units"), representing a 99% interest in
the Partnership, were sold in a private placement. The limited partners paid
$10,000,000 in cash on the Closing Date with the remainder due in five annual
installments through May 15, 1990. The limited partners' obligations to make
the installment payments were evidenced by promissory notes totaling
$45,350,000 payable to the Partnership and secured by the Units. The general
partner is Hotel Properties Management, Inc. (the "General Partner"), a
wholly-owned subsidiary of Host Marriott Corporation, with a 1% general
partnership interest.
On the Closing Date, the Partnership purchased from affiliates of Host
Marriott (i) a 99% limited partnership interest in the Warner Center Marriott
Hotel Limited Partnership (the "Warner Center Partnership"), which owned the
473-room Warner Center Marriott Hotel (the "Warner Center Hotel") in Los
Angeles, California and (ii) a 49% general partnership interest in, and a loan
receivable of $3,680,000 from, Lauderdale Beach Association (the "Harbor Beach
Partnership"), a general partnership that owns Marriott's 624-room Harbor
Beach Resort (the "Harbor Beach Hotel") in Ft. Lauderdale, Florida. As a
result of certain transactions, the Partnership now owns a 50.5% interest in
the Harbor Beach Partnership. The Harbor Beach Hotel is leased to Marriott
Hotel Services, Inc. (the "Operating Tenant"), a wholly-owned subsidiary of
Marriott International. On November 17, 1993, the lender foreclosed on the
Warner Center Hotel. The foreclosure was followed by the dissolution of the
Warner Center Partnership.
On January 14, 1997, MHP Acquisition Corporation (the "Company"), a wholly-
owned subsidiary of Host Marriott, completed a tender offer for limited
partnership units in the Partnership. The Company purchased 463.75 units for
an aggregate consideration of $37.1 million or $80,000 per unit. Additionally,
in a Partnership vote held in conjunction with the tender offer, the limited
partners approved all of the proposed amendments to the partnership agreement
that were conditions to the tender offer. Subsequent to the tender offer, the
Company purchased an additional 8 units on March 29, 1997 and one unit on June
21, 1997. Combined with its prior ownership position, Host Marriott now
indirectly owns, through affiliates, 48.84% of the Partnership.
Partnership Allocations and Distributions
The Partnership generally allocates net profits and losses, cash available
for distribution and tax credits as follows: (i) first, 1% to the General
Partner and 99% to the limited partners until cumulative distributions of sale
and refinancing proceeds ("Capital Receipts") equal to 50% of capital
contributions have been distributed; (ii) next, 15% to the General Partner and
85% to the limited partners until cumulative distributions of Capital Receipts
equal to all capital contributions have been distributed; and (iii)
thereafter, 30% to the General Partner and 70% to the limited partners.
Capital Receipts not retained by the Partnership will generally be
distributed (i) first, 1% to the General Partner and 99% to the limited
partners until the General Partner and the limited partners (collectively the
"Partners") have received cumulative distributions of Capital Receipts equal
to their capital contributions; and (ii) thereafter, 30% to the General
Partner and 70% to the limited partners.
MHP Supp-47
<PAGE>
Gains are generally allocated (i) first, to Partners with negative capital
accounts, (ii) next, in amounts necessary to bring each Partner's capital
account balance equal to their invested capital, defined as the excess of
paid-in capital contributions over cumulative distributions of Capital
Receipts, and (iii) thereafter, 30% to the General Partner and 70% to the
limited partners.
Upon the sale of substantially all of the assets, gains and sales proceeds
will be distributed based on a specific allocation, as stated in the
partnership agreement, in order to provide the limited partners (if proceeds
are sufficient) a 15% cumulative return, as defined, to the extent not
previously received from cash distributions.
For financial reporting purposes, net losses of the Partnership are
allocated 1% to the General Partner and 99% to the limited partners.
The Harbor Beach Partnership generally allocates profits and losses, cash
distributions, gains and losses, and Capital Receipts in the ratio of
ownership interests.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting
The Partnership's records are maintained on the accrual basis of accounting
and its fiscal year coincides with the calendar year.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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 from those estimates.
Working Capital and Supplies
Pursuant to the terms of the management agreement discussed in Note 8, the
Partnership is required to provide the Manager with working capital and
supplies to meet the operating needs of the Orlando World Center. The Manager
converts cash advanced by the Partnership into other forms of working capital
consisting primarily of operating cash, inventories, and trade receivables and
payables which are maintained and controlled by the Manager. Upon the
termination of the management agreement, the Manager is required to convert
working capital and supplies into cash and return it to the Partnership. As a
result of these conditions, the individual components of working capital and
supplies controlled by the Manager are not reflected in the accompanying
consolidated balance sheet. As of December 31, 1997 and 1996, $4,707,000 has
been advanced to the Manager for working capital and supplies which is
included in "Due from Marriott International, Inc." on the accompanying
consolidated balance sheet. The supplies advanced to the Manager are recorded
at their estimated net realizable value. As of December 31, 1997 and 1996,
accumulated amortization related to the revaluation of these supplies totaled
$762,000.
Revenues and Expenses
Hotel Revenues represents house profit from the Orlando World Center since
the Partnership has delegated substantially all of the operating decisions
related to the generation of house profit of the Orlando World Center to the
Manager. House profit reflects hotel operating results which flow to the
Partnership as property owner and represents gross hotel sales less property-
level expenses, excluding depreciation and amortization, base and incentive
management fees, real and personal property taxes, ground and equipment rent,
insurance and certain other costs, which are disclosed separately in the
consolidated statement of operations (see Note 3).
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to
MHP Supp-48
<PAGE>
Physician Practice Management Entities and Certain Other Entities with
Contractual Management Arrangements." EITF 97-2 addresses the circumstances in
which a management entity may include the revenues and expenses of a managed
entity in its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding the property-level revenues and operating expenses of the Hotels
from its consolidated statements of operations (see Note 3). If the
Partnership concludes that EITF 97-2 should be applied to the Hotels, it would
include operating results of those managed operations in its consolidated
financial statements. Application of EITF 97-2 to consolidated financial
statements as of and for the year ended December 31, 1997, would have
increased both revenues and operating expenses by approximately $74.6 million
and would have had no impact on operating profit or net income.
Principles of Consolidation
The consolidated financial statements for the years ended December 31, 1997,
1996 and 1995 include the accounts of the Partnership and the Harbor Beach
Partnership (collectively the "Partnerships"). The 49.5% general partnership
interest in the Harbor Beach Partnership owned by an unrelated party is
reported as minority interest. All significant intercompany balances and
transactions have been eliminated.
Property and Equipment
Property and equipment is recorded at cost. Depreciation and amortization
are computed using the straight-line method over the following estimated
useful lives of the assets, less a 10% estimated residual value on the
original building cost and land improvements related to the Orlando World
Center:
<TABLE>
<S> <C>
Land improvements............................................. 40 to 50 years
Building and improvements..................................... 40 to 50 years
Leasehold improvements........................................ 40 years
Furniture and equipment....................................... 3 to 10 years
</TABLE>
All property and equipment is pledged as security for the mortgage debt
described in Note 6.
The Partnership and the Harbor Beach Partnership assess the impairment of
their real estate properties based on whether estimated future undiscounted
cash flow from such properties on an individual hotel basis will be less than
their net book value. If a property is impaired, its basis is adjusted to fair
market value.
Deferred Financing Costs
Prior to 1997, deferred financing costs consisted of costs incurred in
connection with the October 31, 1995 refinancing of the Orlando Mortgage Debt,
described in Note 6. Deferred financing costs associated with this refinancing
totaled $2,316,000. On December 31, 1997, the Partnership refinanced the
Orlando Mortgage Debt and incurred financing costs of $2,004,000. The deferred
financing costs are amortized over the period of the debt using the straight-
line method which approximates the effective interest rate method. The net
deferred financing costs associated with the 1995 refinancing of $1,142,000
were amortized on December 31, 1997 and are reflected as part of the
extraordinary loss on the consolidated statement of operations. Deferred
financing costs associated with the restructuring of the Harbor Beach Mortgage
Debt (see Note 6) amounted to $350,000. Accumulated amortization of deferred
financing costs was $224,000 and $879,000 at December 31, 1997 and 1996,
respectively.
Cash and Cash Equivalents
The Partnership considers all highly liquid investments with a maturity of
three months or less at date of purchase to be cash equivalents.
MHP Supp-49
<PAGE>
Income Taxes
Provision for Federal and state income taxes has not been made in the
accompanying financial statements since the Partnership does not pay income
taxes, but rather allocates its profits and losses to the individual partners.
Significant differences exist between the net income for financial reporting
purposes and the net income reported in the Partnership's tax return. These
differences are due primarily to the use, for income tax purposes, of
accelerated depreciation methods, shorter depreciable lives of the assets,
differences in the timing of the recognition of base and incentive management
fee expense and the expensing of certain costs incurred during construction
which have been capitalized in the accompanying financial statements. As a
result of these differences, the excess of the tax basis in net Partnership
liabilities over the net liabilities reported in the accompanying financial
statements amounted to $109,961,000 and $100,739,000 as of December 31, 1997
and 1996, respectively.
Statement of Financial Accounting Standards
In 1996, the Partnership adopted Statement of Financial Accounting Standards
("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." Adoption of SFAS No. 121 has not had an
effect on the consolidated financial statements.
NOTE 3. HOTEL REVENUES
Hotel Revenues consist of hotel operating results for the Orlando World
Center for the three years ended December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
HOTEL SALES
Rooms............................................. $64,277 $59,289 $56,881
Food and beverage................................. 51,424 47,852 45,708
Other............................................. 12,517 13,157 11,762
------- ------- -------
128,218 120,298 114,351
------- ------- -------
HOTEL EXPENSES
Departmental Direct Costs
Rooms........................................... 12,801 12,201 11,665
Food and beverage............................... 32,391 29,968 28,784
Other hotel operating expenses.................... 29,452 27,606 26,651
------- ------- -------
74,644 69,775 67,100
------- ------- -------
HOTEL REVENUES...................................... $53,574 $50,523 $47,251
======= ======= =======
</TABLE>
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Land and improvements.................................. $ 31,074 $ 31,074
Building and improvements.............................. 152,560 152,361
Leasehold improvements................................. 82,871 80,841
Furniture and equipment................................ 77,943 69,846
--------- ---------
344,448 334,122
Less accumulated depreciation.......................... (122,232) (111,631)
--------- ---------
$ 222,216 $ 222,491
========= =========
</TABLE>
MHP Supp-50
<PAGE>
NOTE 5. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments are shown below. The fair
values of financial instruments not included in this table are estimated to be
equal to their carrying amounts (in thousands):
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997 AS OF DECEMBER 31, 1996
------------------------ ------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- ------------ ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Mortgage debt.................. $ 235,946 $ 237,725 $ 230,959 $ 233,468
Note payable due to Host
Marriott Corporation.......... -- -- 2,294 2,294
Incentive management fees
payable to
Marriott International, Inc. .. -- -- 2,046 2,046
Notes payable due to Marriott
International, Inc. .......... 4,802 4,748 1,893 1,847
</TABLE>
The estimated fair value of mortgage debt is based on the expected future
debt service payments discounted at estimated market rates. Notes payable due
to Host Marriott Corporation and Marriott International, Inc. and incentive
management fees payable to Marriott International, Inc. are valued based on
the expected future payments from operating cash flow discounted at risk-
adjusted rates.
NOTE 6. DEBT
The Partnerships have entered into various longterm loan agreements to
provide nonrecourse mortgage financing for the Hotels. Combined mortgage debt
maturities, at December 31, 1997 are (in thousands):
<TABLE>
<S> <C>
1998................................................................ $ 2,965
1999................................................................ 3,346
2000................................................................ 82,049
2001................................................................ 1,748
2002................................................................ 1,884
Thereafter.......................................................... 143,954
--------
$235,946
========
</TABLE>
Orlando Mortgage
On January 12, 1993 (the "Closing Date"), the General Partner refinanced the
Orlando World Center mortgage debt (the "Orlando Mortgage Debt"). On the
Closing Date, the Partnership paid $29.3 million to the lender which was
applied as follows: $12.0 million to the outstanding principal balance, $13.5
million to interest due through the Closing Date and $3.8 million to financing
costs. The Orlando Mortgage Debt carried a fixed rate of interest of 6.705%
and required semi-annual principal amortization totaling $22 million through
its maturity on June 16, 1995 (the "Maturity Date").
On the Maturity Date, the lender granted the Partnership a forbearance on
the loan extending it from June 16, 1995 through October 31, 1995. The
Partnership paid interest monthly in arrears at a floating rate equal to the
applicable Federal Funds rate plus 225 basis points. During the forbearance
period, the weighted average interest rate was 7.94%. On October 31, 1995, the
Partnership successfully completed a modification and extension of the Orlando
Mortgage Debt. The mortgage debt carried a fixed rate of interest of 8.44% and
required semi-annual amortization of principal. The loan was due to mature on
June 16, 2000 with unamortized principal of $127.0 million due at that time.
No debt service guarantee was provided. As of December 31, 1997 and December
31, 1996, the outstanding principal balance was $138,479,000 and $145,479,000,
respectively. The outstanding principal balance was repaid on December 31,
1997 with proceeds from the refinancing discussed below.
MHP Supp-51
<PAGE>
On October 31, 1997, the General Partner executed a commitment letter with
two new lenders to refinance the Orlando World Center's mortgage debt. The new
loan provides a total borrowing capacity of $240 million.
On December 31, 1997, the Partnership completed the refinancing of the
mortgage debt. The new lenders provided $152 million to pay the outstanding
balance on the existing mortgage and accrued interest of $139.3 million,
related financing costs of $2.0 million, a prepayment penalty of $1.9 million
that has been reflected as part of the extraordinary loss on the accompanying
consolidated statement of operations and the remaining $8.8 million is part of
the Partnership's working capital. The loan requires monthly payments of
interest at a fixed rate of 7.48% and principal based on a 30-year
amortization schedule. The loan matures on January 1, 2008.
The remaining balance of $88 million is available for the construction costs
associated with a 500-room expansion at the Orlando World Center. In
connection with the executed commitment letter, the Partnership advanced $2.4
million to the lender as a good faith deposit. Upon completion of the $152
million portion of the loan, the lender returned $600,000 of this deposit. The
remaining $1.8 million will be returned to the Partnership upon completion of
construction. The General Partner is currently working with the lender to
finalize the documents related to this construction loan.
The refinanced mortgage debt is secured by the Orlando World Center, the
land on which the Orlando World Center and golf course are located and an
assignment of certain operating agreements.
Harbor Beach Mortgage
The original Harbor Beach loan agreement provided $86.6 million for
construction of the Harbor Beach Hotel. On June 30, 1986, this debt was
refinanced with a major insurance company. The $92 million replacement loan
(the "Harbor Beach Mortgage Debt") bore interest at a fixed rate of 9.375% and
required payments of interest only through July 1988 and monthly payments of
principal and interest in the amount of $765,000 thereafter until maturity on
July 1, 1993. Upon maturity, the lender granted the Harbor Beach Partnership a
forbearance of the loan for a fee of $165,000. Under the forbearance
agreement, the Harbor Beach Partnership continued to pay the lender through
March 29, 1994, payments of principal and interest in accordance with the
terms of the Harbor Beach Mortgage Debt.
On March 29, 1994 (the "Closing Date"), the Harbor Beach Partnership
completed the restructuring of the Harbor Beach Mortgage Debt. The
restructured mortgage debt carries a fixed rate of interest of 9.125% (the
"Contract Interest Rate") and is payable monthly in arrears. Interest only at
the Contract Interest Rate was due and payable for the first twelve payments
through and including April 1, 1995. For the period from the Closing Date
through April 1, 1995, the difference between the interest only payment and
$772,600 (the "Payment Amount") was contributed to an escrow account with the
lender to fund capital improvements at the Harbor Beach Hotel. The Payment
Amount represents the amount necessary to amortize the outstanding principal
balance, as of the Closing Date, over a 22-year effective amortization period.
The loan matures on May 1, 2000. The restructured mortgage debt is
collateralized by all property and assets of the Harbor Beach Hotel. No debt
service guarantee was provided. As of December 31, 1997 and 1996, the
outstanding principal balance was $83,946,000 and $85,480,000, respectively.
Orlando Ballroom Loan
During 1990, Host Marriott agreed to provide interim financing of up to $14
million to fund the construction of a new ballroom and exhibition hall at the
Orlando World Center. Construction was completed in February 1990. On December
31, 1990, the interim financing was converted to a permanent loan from Host
Marriott with $13.2 million advanced. Interest only, at the Bankers Trust
Company prime rate, was payable from the Partnership's cash flow after debt
service. On June 16, 1992, in conjunction with the refinancing of the Orlando
Mortgage Debt, the Orlando ballroom loan was converted from a term loan to a
revolving line of credit with a floating interest rate equal to the Bankers
Trust Company prime rate. As of December 31, 1996, the outstanding principal
balance was $2,294,000. The remaining outstanding principal balance was paid
in full on June 24, 1997.
MHP Supp-52
<PAGE>
The weighted average effective interest rate for the period from January 1,
1997 through June 24, 1997 and for the years ended December 31, 1996 and 1995
was 8.4%, 8.3% and 8.8%, respectively (rate as of June 24, 1997 and December
31, 1996 was 8.5% and 8.3%, respectively).
Orlando Rooms Renovation Loan
During 1997, the Partnership entered into a loan agreement (the "Orlando
Rooms Renovation Loan") with Marriott International Capital Corporation
("MICC"), a wholly-owned subsidiary of Marriott International, in conjunction
with a rooms and suites refurbishment at the Orlando World Center. The loan
provided financing of $3.5 million. The loan requires payments of principal
and interest to be paid from the Orlando World Center property improvement
fund. This unsecured loan carries a fixed interest rate of 9% and matures on
June 16, 1999. The outstanding principal balance was $3,472,000 on December
31, 1997.
Harbor Beach Rooms Renovation Loan
On July 21, 1994, the Harbor Beach Partnership entered into a loan agreement
with MICC in conjunction with a rooms and suites refurbishment at the Harbor
Beach Hotel. The loan provided financing of up to $2.8 million, plus accrued
interest through December 31, 1994, to fund costs in excess of funds available
in the Harbor Beach Partnership's property improvement fund. This unsecured
loan carries a fixed rate of interest of 8%. Accrued interest totaling $64,000
was rolled into the principal balance at December 31, 1994. Payments of
principal and interest based upon a five-year amortization period commenced in
January 1995. Under the terms of the loan, the debt service payments are
included as a deduction in determining the fees paid to the Operating Tenant,
as described in Note 8. As of December 31, 1997 and 1996, the outstanding
principal balance was $1,330,000 and $1,893,000, respectively. Interest earned
by MICC was $128,000, $171,000 and $211,000 in 1997, 1996 and 1995,
respectively.
NOTE 7. LEASES
The Harbor Beach Partnership, through an assignment of a lease on January
15, 1982, acquired all rights to a 99-year lease with a 25-year renewal option
for the land on which the Harbor Beach Hotel is located. On April 28, 1993,
the lessor sold its rights under the lease to an unrelated party. A provision
under the sale of the lease provided for the early refund to the Harbor Beach
Partnership of the remaining $1,250,000 balance of an initial $2,500,000
security deposit paid to the lessor and a $500,000 payment to facilitate the
modification of the lease.
Lease payments are made quarterly in advance in accordance with a lease year
that operates from December 1 through November 30. The annual rental is
$1,560,000 for lease years 1995 through 1999. After lease year 1999, annual
rentals for each succeeding five-year period increase by an amount equal to
10% of the previous annual rental.
Minimum annual rentals during the term of the ground lease are (in
thousands):
<TABLE>
<CAPTION>
YEAR
----
<S> <C>
1998............................................................... $ 1,560
1999............................................................... 1,573
2000............................................................... 1,716
2001............................................................... 1,716
2002............................................................... 1,716
Thereafter......................................................... 311,043
--------
Total Minimum Lease Payments....................................... $319,324
========
</TABLE>
MHP Supp-53
<PAGE>
NOTE 8. MANAGEMENT AND OPERATING LEASE AGREEMENTS
The Partnership has entered into a long-term management agreement with the
Manager, and the Harbor Beach Partnership has entered into a long-term
operating lease with the Operating Tenant. The Hotels are operated as part of
the Marriott Hotels, Resorts and Suites full-service hotel system. Significant
provisions under the agreements are as follows:
Orlando World Center. The management agreement provides for an initial term
of 25 years, commencing with the opening of the Orlando World Center (March
24, 1986), and five 10-year renewals at the Manager's option. The Manager is
paid a base management fee of 3% of gross hotel sales and is also entitled to
an incentive management fee equal to 20% of operating profit, as defined, and
an additional incentive management fee equal to 30% of the following amount:
(i) 80% of operating profit in each fiscal year less (ii) the greater of (a)
$25,000,000 or (b) debt service plus $7,000,000. Payment of the incentive
management fee is subordinate to debt service and retention of specified
amounts of operating profit by the Partnership. Unpaid incentive management
fees are deferred without interest and are payable from future operating cash
flow, as defined, but are due upon termination of the management agreement
only if the termination is the result of a default by the Partnership. Unpaid
incentive management fees as of December 31, 1996 were $2,046,000 which were
paid in 1997. Therefore, there were no unpaid incentive management fees as of
December 31, 1997. In addition, based on higher cash flow from the Orlando
Hotel, the Manager earned additional incentive management fees in 1997 which
were paid during the year.
Under the management agreement, the Manager is required to furnish the
Orlando World Center with certain services ("Chain Services") which are
generally provided on a central or regional basis to all hotels in the
Marriott full-service hotel system. Chain Services include central training,
advertising and promotion, a national reservation system, computerized payroll
and accounting services, and such additional services as needed which may be
more efficiently performed on a centralized basis. Costs and expenses incurred
in providing such services are allocated among all domestic full-service
hotels managed, owned or leased by Marriott International or its subsidiaries.
In addition, the Hotel participates in Marriott International's Marriott
Rewards Program ("MRP"). This program was formerly known as the Honored Guest
Awards Program ("HGA"). The cost of this program is charged to all hotels in
the Marriott hotel system based upon the MRP sales at each hotel. The total
amount of Chain Services and MRP costs allocated to the Orlando World Center
was $3,149,000, $3,588,000, and $3,336,000 for the years ended December 31,
1997, 1996 and 1995, respectively.
Harbor Beach Hotel. The operating lease provides for an initial 36-year term
commencing with the opening of the Harbor Beach Hotel (October 29, 1984), with
options to renew for six successive 10-year periods based on certain defined
conditions. The annual rental paid to the Harbor Beach Partnership includes
the following:
. basic rental: annual rental payable under the land lease and insurance
costs
. percentage rental: determined by multiplying the applicable percentage
set annually by the Harbor Beach Partnership by revenues
. performance rental: first $9,720,000 of operating profit of the Harbor
Beach Hotel, as defined
. additional performance rental: 50% of operating profit of the Harbor
Beach Hotel, as defined, in excess of $9,720,000
. contingent rental: up to 50% of operating profit of the Harbor Beach
Hotel, as defined, in excess of $9,720,000 if the aggregate annual
rental is otherwise insufficient to cover debt service.
Pursuant to the terms of the Harbor Beach rooms renovation loan (see Note
6), the annual performance rental is adjusted upward by the annual debt
service required under the loan. For the five-year period beginning with 1995
and ending in 1999, annual performance rental is increased by $696,557 to
$10,416,557. Subsequent to year-end 1999, performance rental will return to
$9,720,000.
MHP Supp-54
<PAGE>
Percentage rental is intended to cover the cost of utilities, repairs and
maintenance, and the required contribution to the property improvement fund
(5% of sales) and is therefore adjusted annually in order to equal the actual
applicable costs. Any payments of contingent rental reduce future payments of
additional performance rental (subject to limitations) in subsequent years. No
contingent rental has been accrued as of December 31, 1997 and 1996.
Rental income under the Harbor Beach Partnership operating lease for the
three years ended December 31, 1997 was (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Basic Rental........................................ $ 1,712 $ 1,694 $ 1,616
Percentage Rental................................... 6,284 6,240 5,921
Performance Rental.................................. 10,417 10,417 10,417
Additional Performance Rental....................... 3,224 2,960 1,793
------- ------- -------
$21,637 $21,311 $19,747
======= ======= =======
</TABLE>
Cost and accumulated depreciation of the rental property were $103,110,000
and $41,299,000 at December 31, 1997, and $100,647,000 and $37,279,000,
respectively, at December 31, 1996.
Property Improvement Funds
The management agreement and the operating lease provide for the
establishment of a property improvement fund for each of the Hotels.
Contributions to the property improvement funds are equal to five percent of
gross sales of each hotel. Contributions to the fund for the Orlando World
Center totaled $6,411,000 and $6,015,000 for the years ended December 31, 1997
and 1996, respectively. Contributions to the fund for the Harbor Beach Hotel
totaled $2,730,000 and $2,729,000 for the years ended December 31, 1997 and
1996, respectively.
NOTE 9. COMPARATIVE LEASED HOTEL OPERATING RESULTS
The Harbor Beach Hotel is a leased property whose income to the Partnership
is included in the consolidated statement of operations as rental income. The
following is a comparative summary of hotel operating results for the Harbor
Beach Hotel for the three years ended December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
HOTEL SALES
Rooms............................................. $32,322 $30,939 $28,384
Food and beverage................................. 20,668 20,764 19,366
Other............................................. 5,089 5,016 4,857
------- ------- -------
58,079 56,719 52,607
------- ------- -------
HOTEL EXPENSES
Departmental Direct Costs
Rooms........................................... 5,882 5,566 5,332
Food and beverage............................... 12,937 12,664 12,140
Other hotel operating expenses.................... 22,395 22,151 21,219
------- ------- -------
41,214 40,381 38,691
------- ------- -------
HOTEL REVENUES...................................... $16,865 $16,338 $13,916
======= ======= =======
</TABLE>
MHP Supp-55
<PAGE>
MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
FIRST TWO QUARTERS
--------------------
1998 1997
--------- ---------
<S> <C> <C>
REVENUES
Hotel................................................... $ 32,957 $ 30,867
Rental income........................................... 15,011 15,006
--------- ---------
47,968 45,873
--------- ---------
OPERATING COSTS AND EXPENSES
Incentive management fees............................... 6,328 6,187
Depreciation and amortization........................... 4,892 4,561
Base management fees.................................... 2,095 2,024
Ground rent, property taxes and other................... 4,538 4,368
--------- ---------
17,853 17,140
--------- ---------
OPERATING PROFIT.......................................... 30,115 28,733
Interest expense........................................ (9,199) (9,893)
Other revenue........................................... 505 285
--------- ---------
INCOME BEFORE MINORITY INTEREST........................... 21,421 19,125
MINORITY INTEREST IN INCOME............................... (3,603) (3,782)
--------- ---------
NET INCOME................................................ $ 17,818 $ 15,343
========= =========
ALLOCATION OF NET INCOME
General Partner......................................... $ 178 $ 153
Limited Partners........................................ 17,640 15,190
--------- ---------
$ 17,818 $ 15,343
========= =========
NET INCOME PER LIMITED PARTNER UNIT (1,000 Units)......... $ 17,640 $ 15,190
========= =========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
MHP Supp-56
<PAGE>
MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 19, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Property and equipment, net........................... $220,939 $222,216
Due from Marriott International, Inc. and affiliates.. 9,012 7,912
Minority interest..................................... 7,924 10,042
Other assets.......................................... 12,022 10,245
Cash and cash equivalents............................. 28,367 10,694
-------- --------
$278,264 $261,109
======== ========
LIABILITIES AND PARTNERS' CAPITAL
LIABILITIES
Mortgage debt....................................... $237,183 $235,946
Notes payable and amounts due to Marriott Interna-
tional, Inc. and affiliates........................ 3,780 4,987
Accounts payable and accrued interest............... 1,129 196
Amounts due to Host Marriott Corporation............ 21 132
-------- --------
Total Liabilities................................. 242,113 241,261
-------- --------
PARTNERS' CAPITAL
General Partner..................................... 470 307
Limited Partners.................................... 35,681 19,541
-------- --------
Total Partners' Capital........................... 36,151 19,848
-------- --------
$278,264 $261,109
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
MHP Supp-57
<PAGE>
MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO QUARTERS
--------------------
1998 1997
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net income............................................. $ 17,818 $ 15,343
Noncash items.......................................... 8,614 8,582
Changes in operating accounts.......................... (370) 1,708
--------- ---------
Cash provided by operating activities................ 26,062 25,633
--------- ---------
INVESTING ACTIVITIES
Additions to property and equipment.................... (3,615) (1,481)
Changes in property improvement funds.................. (1,802) (3,590)
--------- ---------
Cash used in investing activities.................... (5,417) (5,071)
--------- ---------
FINANCING ACTIVITIES
Construction loan advances............................. 2,492 --
Principal repayments of mortgage debt.................. (1,255) (4,122)
Capital distributions to partners...................... (1,515) (1,514)
Capital distributions to minority interest............. (1,485) (1,485)
Repayments to Marriott International, Inc. and affili-
ates.................................................. (1,175) (296)
Payment of financing costs............................. (34) --
--------- ---------
Cash used in financing activities.................... (2,972) (7,417)
--------- ---------
INCREASE IN CASH AND CASH EQUIVALENTS.................... 17,673 13,145
CASH AND CASH EQUIVALENTS at beginning of period......... 10,694 1,607
--------- ---------
CASH AND CASH EQUIVALENTS at end of period............... $ 28,367 $ 14,752
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for mortgage and other interest.............. $ 8,112 $ 9,660
========= =========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
MHP Supp-58
<PAGE>
MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying condensed consolidated financial statements have been
prepared by Marriott Hotel Properties Limited Partnership (the "Partnership")
without audit. Certain information and footnote disclosures normally included
in financial statements presented in accordance with generally accepted
accounting principles have been condensed or omitted from the accompanying
statements. The Partnership believes the disclosures made are adequate to make
the information presented not misleading. However, the condensed consolidated
financial statements should be read in conjunction with the Partnership's
financial statements and notes thereto included in the Partnership's Form 10-K
for the year ended December 31, 1997.
In the opinion of the Partnership, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments (which include only
normal recurring adjustments) necessary to present fairly the financial
position of the Partnership as of June 19, 1998, the results of operations and
cash flows for the first two quarters 1998 and 1997. Interim results are not
necessarily indicative of fiscal year performance because of seasonal and
short-term variations.
The Partnership owns Marriott's Orlando World Center (the "Orlando Hotel")
and a 50.5% interest in a partnership owning Marriott's Harbor Beach Resort
(the "Harbor Beach Partnership"), whose financial statements are consolidated
herein. The remaining 49.5% general partnership interest in the Harbor Beach
Partnership is reported as minority interest. All significant intercompany
balances and transactions have been eliminated.
For financial reporting purposes, net income and net losses of the
Partnership are allocated 99% to the limited partners and 1% to the general
partner. Significant differences exist between the net income and net losses
for financial reporting purposes and the net income and net losses reported
for Federal income tax purposes. These differences are due primarily to the
use, for income tax purposes, of accelerated depreciation methods, shorter
depreciable lives of the assets, differences in the timing of the recognition
of management fee expense and the deduction of certain costs incurred during
construction which have been capitalized in the accompanying condensed
consolidated financial statements.
2. Certain reclassifications were made to the prior year financial
statements to conform to the 1998 presentation.
3. Hotel revenues represent house profit from the Orlando Hotel since the
Partnership has delegated substantially all of the operating decisions related
to the generation of house profit of the Orlando Hotel to Marriott
International, Inc. (the "Manager"). House profit reflects hotel operating
results which flow to the Partnership as property owner and represents gross
hotel sales less property-level expenses, excluding depreciation and
amortization, base and incentive management fees, property taxes and certain
other costs, which are disclosed separately in the condensed consolidated
statement of operations.
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding property-level revenues and operating expenses of the Hotels from
its statements of operations. If the Partnership concludes that EITF 97-2
should be applied to the Hotels, it would include operating results of this
managed operation in its financial statements. Application of EITF 97-2 to
financial statements as of and for the first two quarters 1998 would have
MHP Supp-59
<PAGE>
MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
increased both revenues and operating costs and expenses by approximately
$36.9 million and would have had no impact on net income.
Hotel revenues consist of hotel operating results for the Orlando Hotel for
1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
---------------
1998 1997
------- -------
<S> <C> <C>
HOTEL SALES
Rooms..................................................... $35,167 $34,365
Food and beverage......................................... 28,201 26,476
Other..................................................... 6,480 6,614
------- -------
69,848 67,455
------- -------
HOTEL EXPENSES
Departmental Direct Costs
Rooms................................................... 6,392 6,477
Food and beverage....................................... 16,820 16,025
Other hotel operating expenses............................ 13,679 14,086
------- -------
36,891 36,588
------- -------
HOTEL REVENUES.............................................. $32,957 $30,867
======= =======
</TABLE>
4. Rental income under the Harbor Beach Partnership operating lease for the
first two quarters was (in thousands):
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
---------------
1998 1997
------- -------
<S> <C> <C>
Basic rental................................................ $ 806 $ 771
Percentage rental........................................... 3,279 3,513
Performance rental.......................................... 10,417 10,417
Additional performance rental............................... 509 305
------- -------
RENTAL INCOME............................................... $15,011 $15,006
======= =======
</TABLE>
5. On April 15, 1998, the Partnership successfully completed the financing
for the expansion of the Orlando World Center (the "Construction Loan"). The
lender is obligated to provide up to $88 million to fund costs related to the
construction of a 500-room tower, new parking garage, expansion of the
existing JW's Steakhouse restaurant, redesign of the existing golf course and
construction of 15,000 square feet of additional meeting space. During the
construction period, the Partnership is required to make monthly payments of
principal and interest at the fixed interest rate of 7.48% with such interest
payments funded by the Construction Loan. Principal payments will be funded by
hotel operations. Upon completion of the expansion, the Partnership will be
required to pay principal and interest at the fixed interest rate of 7.48%
amortized over the remaining term of the Construction Loan. The Construction
Loan matures on January 1, 2008. As of June 19, 1998, the Partnership has
received Construction Loan advances of $2.5 million which were used to pay
construction costs.
6. On April 17, 1998, Host Marriott, parent company of the General Partner
of the Partnership, announced that its Board of Directors authorized Host
Marriott to reorganize its business operations to qualify as a real estate
investment trust ("REIT") to become effective as of January 1, 1999. As part
of the REIT conversion, Host
MHP Supp-60
<PAGE>
MARRIOTT HOTEL PROPERTIES LIMITED PARTNERSHIP AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Marriott formed a new operating partnership (the "Operating Partnership"), and
limited partners in certain Host Marriott full-service hotel partnerships and
joint ventures, including the Partnership, are expected to be given an
opportunity to receive, on a tax-deferred basis, Operating Partnership units
in the new Operating Partnership in exchange for their current limited
partnership interests. The Operating Partnership units would be redeemable by
the limited partner for freely traded Host Marriott shares (or the cash
equivalent thereof) at any time after one year from the closing of the merger.
In connection with the REIT conversion, on June 2, 1998, the Operating
Partnership filed a Registration Statement on Form S-4 with the Securities and
Exchange Commission. Limited partners will be able to vote on this
Partnership's participation in the merger later this year through a consent
solicitation.
MHP Supp-61
<PAGE>
HOST MARRIOTT, L.P.
SUPPLEMENT DATED , 1998 FOR
PROSPECTUS/CONSENT SOLICITATION STATEMENT DATED , 1998 FOR
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
On the terms described in the Prospectus/Consent Solicitation Statement (the
"Consent Solicitation"), dated , 1998, of which this Supplement (the
"Supplement") is a part, Host Marriott Corporation ("Host") has adopted a plan
to restructure its business operations so that it will qualify as a real
estate investment trust ("REIT"). As part of this restructuring (the "REIT
Conversion"), Host and its consolidated subsidiaries will contribute their
full-service hotel properties and certain other businesses and assets to Host
Marriott, L.P. (the "Operating Partnership") in exchange for units of limited
partnership interest in the Operating Partnership ("OP Units") and the
assumption of liabilities. The sole general partner of the Operating
Partnership will be Host Marriott Trust ("Host REIT"), the entity into which
Host will merge as part of the REIT Conversion. Host REIT expects to qualify
as a REIT beginning with its first full taxable year after closing of the REIT
Conversion, which Host REIT currently expects to be the year beginning January
1, 1999.
Following the REIT Conversion and the Blackstone Acquisition (defined
below), the Operating Partnership and its subsidiaries initially will own
outright, or have controlling interests in, approximately 120 full-service
hotels operating primarily under the Marriott, Ritz-Carlton, Four Seasons,
Swissotel and Hyatt brand names (the "Hotels").
As part of the REIT Conversion, the Operating Partnership is proposing to
acquire by merger (the "Mergers") Marriott Hotel Properties II Limited
Partnership, a Delaware limited partnership ("MHP2" or the "Partnership"), and
up to seven other limited partnerships (the "Partnerships") that own full-
service hotels in which Host or its subsidiaries are general partners. As more
fully described in the Consent Solicitation, limited partners of those
Partnerships that participate in the Mergers will receive either OP Units or,
at their election, unsecured % Callable Notes due December 15, 2005 issued by
the Operating Partnership ("Notes"), in exchange for their partnership
interests in such Partnerships (with respect to the Partnerships, those
limited partners of the Partnerships who are unaffiliated with Host are
referred to herein as the "Limited Partners", and with respect to MHP2, the
"MHP2 Limited Partners").
Beginning one year after the Mergers, Limited Partners who return OP Units
will have the right to redeem their OP Units at any time and receive, at the
election of Host REIT, either freely tradeable New York Stock Exchange listed
Common Shares of Host REIT on a one-for-one basis (subject to adjustment) or
cash in an amount equal to the market value of such shares (the "Unit
Redemption Right").
The number of OP Units to be allocated to MHP2 will be based upon (i) its
Exchange Value (as defined herein) and (ii) the price attributed to an OP Unit
following the Merger, determined as described herein (but in no event greater
than $ per OP Unit). The principal amount of Notes that MHP2 Limited
Partners may elect to receive in exchange for the OP Units received in the
Merger will be based upon MHP2's Note Election Amount (as defined herein). See
"Determination of Exchange Value of MHP2 and Allocation of OP Units." The
estimated Exchange Value and Note Election Amount set forth herein may
increase or decrease as a result of various adjustments, and will be finally
calculated shortly before the Effective Date. Pursuant to the Merger, MHP2
Limited Partners have an estimated Exchange Value of $237,334 per Partnership
Unit and a Note Election Amount of $205,140 per Partnership Unit.
RISK FACTORS
In deciding whether to approve the Merger, MHP2 Limited Partners should
consider certain risks and other factors. The General Partner believes that
MHP2 Limited Partners should particularly consider the following, which should
be read in conjunction with the information in the Consent Solicitation under
"Risk Factors" and "Federal Income Tax Consequences:"
. Substantial Benefits to Related Parties. Host REIT and its subsidiaries
will realize substantial benefits from the Mergers and the REIT
Conversion, including savings from a substantial reduction in corporate-
level income taxes expected as a result of the REIT Conversion. To the
extent that the
MHP2 Supp-1
<PAGE>
anticipated benefits of the REIT Conversion are reflected in the value
of Host's common stock before the Effective Date, such benefits will not
be shared with the Limited Partners. Because of Host's significant
ownership position in certain Partnerships (including MHP2), the failure
of one or more of these Partnerships, including MHP2, to participate in
a Merger likely would require that Host contribute some or all of its
ownership interest in the Non-Participating Partnership to a taxable
Non-Controlled Subsidiary, which would materially reduce the benefit to
Host of the REIT Conversion as it applies to that interest.
. Absence of Arm's Length Negotiations. No independent representative was
retained to negotiate on behalf of the MHP2 Limited Partners or the
other Limited Partners. Although the General Partner has obtained the
Appraisals and the Fairness Opinion from AAA, AAA has not negotiated
with the General Partner or Host and has not participated in
establishing the terms of the Mergers. Consequently, the terms and
conditions of the Mergers may have been more favorable to the MHP2
Limited Partners or the other Limited Partners if such terms and
conditions were the result of arm's length negotiations.
. Other Conflicts of Interest. The Mergers, the REIT Conversion and the
recommendations of the General Partner involve the following conflicts
of interest because of the relationships among Host, the Operating
Partnership, the General Partners and SLC: (i) the General Partners,
which are all subsidiaries of Host (except for PHLP, in which Host is
the General Partner), must assess whether a Merger is fair and equitable
to the Limited Partners of its Partnership, which involves
considerations for Host and its subsidiaries that are different from
those that affect the Limited Partners, (ii) the terms of the Leases of
the Hotels, including the MHP2 Hotels, will be determined by Host, which
will distribute the common stock of SLC, the parent of the Lessees, to
its shareholders after such terms have been set and (iii) the terms of
the Partnership Agreement, including provisions which benefit Host REIT,
have been determined by Host. Such conflicts may result in decisions
that do not fully reflect the interests of all Limited Partners,
including the MHP2 Limited Partners.
. Exchange Value May Not Equal Fair Market Value of MHP2's Hotels. Each
MHP2 Limited Partner who retains OP Units will receive consideration
with a deemed value equal to the Exchange Value of such MHP2 Limited
Partner's Partnership Interest. The determination of the Exchange Value
of MHP2 involves numerous estimates and assumptions. There is no
assurance that the Exchange Value of MHP2 will equal the fair market
value of the Hotels and other assets contributed by MHP2. See
"Determination of Exchange Value of MHP2 and Allocation of OP Units."
. Allocation of OP Units to Host REIT is Different from Allocation of OP
Units to Limited Partners. Host REIT will receive in the aggregate a
number of OP Units (including OP Units allocated to the General Partners
of the Partnerships) equal to the number of shares of Host common stock
outstanding on the Effective Date (and, if Host has outstanding shares
of preferred stock at the time of the REIT Conversion, a corresponding
number of preferred partnership interests in the Operating Partnership),
which should fairly represent the market value of Host REIT but may not
be equal to the fair market or net asset value of the Hotels and other
assets that Host will contribute to the Operating Partnership. The
Partnerships will receive OP Units in the Mergers with a deemed value
equal to the Exchange Value of such Partnership. The different methods
of allocating OP Units may result in Limited Partners not receiving the
fair market value of their Partnership Interests and Host REIT receiving
a higher percentage of the interests in the Operating Partnership. See
"Determination of Exchange Values and Allocation of OP Units."
. Price of OP Units Might Be Less than the Fair Market Value of the MHP2
Limited Partners' Partnership Interests. The price of an OP Unit, for
purposes of the Mergers and the REIT Conversion, will be equal to the
average closing price on the NYSE of a Host REIT Common Share for the
first 20 trading days after the Effective Date of the Mergers (but in no
event greater than $ per share). It is likely that, over time, the
value of the publicly traded Common Shares of Host REIT (and therefore
the value of the OP Units) will diverge from the deemed value of the OP
Units used for purposes of the Mergers. This could result in the MHP2
Limited Partners receiving OP Units with an actual value that is less
than either the price of the OP Units for purposes of the Mergers or the
fair market value of their Partnership Interests.
MHP2 Supp-2
<PAGE>
. Reduced Cash Distributions for MHP2 Limited Partners. The expected
initial annual cash distributions of the Operating Partnership to the
MHP2 Limited Partners per Partnership Unit (from $5,968 to $6,565) will
be less than the estimated cash distributions of MHP2 per Partnership
Unit ($21,564) for 1998.
. Uncertainties at the Time of Voting Include the Number of OP Units to be
Received. There are several uncertainties at the time the MHP2 Limited
Partners must vote on the Merger, including (i) the exact Exchange Value
for MHP2 (which will be adjusted for changes in lender and capital
expenditure reserves, indebtedness, deferred maintenance and other items
prior to the Effective Date), (ii) the price of the OP Units for
purposes of the Merger, which will be determined by reference to the
post-Merger trading prices of Host REIT's Common Shares and which,
together with the Exchange Value, will determine the number of OP Units
the MHP2 Limited Partners will receive and (iii) the exact principal
amount of the Notes that may be received in exchange for OP Units, which
cannot be known until after the vote on the Merger. For these reasons,
the MHP2 Limited Partners cannot know at the time they vote on the
Merger these important aspects of the Merger.
. Combined REVPAR for the Operating Partnership's Hotels is Significantly
Less than the REVPAR for MHP2's Hotels. The Operating Partnership's pro
forma REVPAR for the first Two Quarters 1998 is significantly lower than
the REVPAR attributable to MHP2's Hotels for the same period.
. Inability of MHP2 Limited Partners to Redeem OP Units for One Year. MHP2
Limited Partners who elect to retain OP Units received in the Merger
will be unable to redeem such OP Units for one year following the
Merger. Until then, MHP2 Limited Partners will bear the risk of
illiquidity.
. Value of the Notes Will Be Less than the Exchange Value. At the same
time that he votes on the Merger, each MHP2 Limited Partner also may
elect to receive, at the time of the Merger in exchange for OP Units, an
unsecured, seven-year Note of the Operating Partnership with a principal
amount equal to the Note Election Amount of his Partnership Interest.
The deemed value of the OP Units to be received by the MHP2 Limited
Partners will exceed the principal amount of the corresponding Notes
(because the Exchange Value will be higher than the Note Election
Amount) and there is no assurance that the Note an MHP2 Limited Partner
receives will have a value equal to either (i) the fair market value of
the MHP2 Limited Partner's share of the Hotels and other assets owned by
MHP2 or (ii) the principal amount of the Note. There will be no public
market for the Notes. If the Notes are sold, they may sell at prices
substantially below their issuance price. Noteholders are likely to
receive the full principal amount of a Note only if they hold the Note
to maturity, which is December 15, 2005, or if the Operating Partnership
repays the Notes prior to maturity. Because the Notes are unsecured
obligations of the Operating Partnership, they will be effectively
subordinated to all secured debt of the Operating Partnership and all
obligations of both the Participating Partnerships and the Operating
Partnership's other subsidiaries. See "Description of the Notes." As of
June 19, 1998, on a pro forma basis assuming the Full Participation
Scenario, the Operating Partnership would have had aggregate
consolidated debt of approximately $5.1 billion to which the Notes were
effectively subordinated or which rank equally with such Notes.
. Current Host Common Stock Price May Not Necessarily Be Indicative of the
Price of Host REIT Common Shares Following the REIT Conversion. Host's
current stock price is not necessarily indicative of how the market will
value Host REIT Common Shares following the REIT Conversion. The current
stock price of Host reflects the current market valuation of Host's
current business and assets (including the SLC common stock and the cash
or securities to be distributed in connection with the REIT Conversion)
and not the business and assets of Host REIT following the REIT
Conversion.
. Fundamental Change in Nature of Investment; Potential
Underperformance. The Merger and the REIT Conversion involve a
fundamental change in the nature of an MHP2 Limited Partner's investment
from holding an interest in MHP2, which was originally structured as a
tax-sheltered cash
flow investment (effective through 1997), is a finite-life entity, has a
fixed portfolio of four Hotels and distributes the cash flow from the
operation of such Hotels to the MHP2 Limited Partners, to holding
MHP2 Supp-3
<PAGE>
an interest in an infinite-life, operating real estate company with a
portfolio of approximately 120 Hotels that (i) collects and distributes
to its limited partners rents received from the Lessees (which will bear
the risks and receive the direct benefits of the Hotels' operations),
(ii) has the ability to acquire additional hotels, (iii) is able to
reinvest proceeds from sales or refinancings of existing Hotels in other
hotels and (iv) has a publicly traded general partner. In addition, each
MHP2 Limited Partner's investment will change from one that allows an
MHP2 Limited Partner to receive a return of capital in the form of
distributions from any net proceeds of a sale or refinancing of MHP2's
assets to an investment in which an MHP2 Limited Partner who retains OP
Units likely would realize a return of capital only through the exercise
of the Unit Redemption Right. An MHP2 Limited Partner's share of the
liquidation proceeds, if any, from the sale of an MHP2 Hotel or Hotels
could be higher than the amount realized upon exercise of the Unit
Redemption Right (or payments on any Note received by an MHP2 Limited
Partner who elects to exchange his OP Units for such Note). An
investment in the Operating Partnership may not outperform an investment
in MHP2. See "Comparison of Ownership of Partnership Interests, OP Units
and Common Shares."
. Exposure to Market and Economic Conditions of Other Hotels. As a result
of the Mergers, MHP2 Limited Partners who elect to retain OP Units will
own interests in a much larger enterprise with a broader range of assets
than MHP2 individually. A material adverse change affecting the
Operating Partnership's assets will affect all Limited Partners,
including MHP2 Limited Partners, regardless of whether a particular
Limited Partner previously was an investor in such affected assets. MHP2
owns discrete assets and the Mergers and the REIT Conversion will
significantly diversify the types and geographic locations of the Hotels
in which the MHP2 Limited Partners will have interests. As a result, the
Hotels owned by the Operating Partnership may be affected differently by
economic and market conditions than those Hotels previously owned by
MHP2.
. MHP2 Limited Partners Have No Cash Appraisal Rights. MHP2 Limited
Partners who vote against the Merger have no right to receive cash based
upon an appraisal of their Partnership Interests.
. Uncertainties as to the Size and Leverage of the Operating
Partnership. The MHP2 Limited Partners cannot know at the time they vote
on the Merger the exact size and amount of leverage of the Operating
Partnership. Host is an existing operating company that regularly issues
and repays debt, acquires additional hotels and disposes of existing
hotels. Also, some or all of the Partnerships may elect not to
participate in a Merger. In addition, outside partners in certain
Private Partnerships may not consent to a lease of their partnership's
Hotel(s). In either such case, Host will contribute its interests in
such Partnerships and Private Partnerships to the Operating Partnership,
but the Operating Partnership may, in turn, contribute such interests to
a Non-Controlled Subsidiary, which will be subject to corporate-level
income taxation. Host also may repurchase outstanding securities or
issue new debt or equity securities prior to the consummation of the
Mergers and the REIT Conversion.
. Lack of Control over Hotel Operations. Due to current federal income tax
law restrictions on a REIT's ability to derive revenues directly from
the operation of a hotel, the Operating Partnership will lease virtually
all of its consolidated Hotels to the Lessees, which will operate the
Hotels by continuing to retain the Managers pursuant to the Management
Agreements. The Operating Partnership will not operate the Hotels or
participate in the decisions affecting the daily operations of the
Hotels. The Operating Partnership will have only a limited ability to
require the Lessees or the Managers to operate or manage the Hotels in
any particular manner and no ability to govern any particular aspect of
their day-to-day operation or management. Therefore, the Operating
Partnership will be dependent for its revenue upon the ability of the
Lessees and the Managers to operate and manage the Hotels.
. Expiration of Leases and Possible Inability to Find Other Lessees. The
Leases will expire seven to ten years after the Effective Date and there
can be no assurance that such Leases will be renewed (or if renewed,
will be renewed on terms as favorable to the Operating Partnership). If
the Leases are not renewed, the Operating Partnership will be required
to find other lessees, which lessees must meet certain requirements set
forth in the Management Agreements. There can be no assurance that
satisfactory lessees could be found or as to the terms and conditions on
which the Operating Partnership would be able to renew the Leases or
enter into new leases with such lessees.
MHP2 Supp-4
<PAGE>
. Requisite Vote of MHP2 Limited Partners Binds All MHP2 Limited
Partners. For MHP2, approval by a majority of the Partnership Interests
of MHP2 that are eligible to be voted is required to approve the Merger,
as described in "Voting Procedures--Required Vote and Other Conditions."
Such approval will cause MHP2 to participate in the Merger and will bind
all MHP2 Limited Partners, including MHP2 Limited Partners who voted
against or abstained from voting with respect to the Merger.
. Substantial Indebtedness of the Operating Partnership. The Operating
Partnership will have substantial indebtedness. As of June 19, 1998, on
a pro forma basis assuming the Full Participation Scenario, the
Operating Partnership had outstanding indebtedness totaling
approximately $5.1 billion, which represents a % debt-to-total market
capitalization ratio on a pro forma basis at such date (based upon a
price per Common Share of Host REIT of $ ). The Operating
Partnership's business is capital intensive and it will have significant
capital requirements in the future. The Operating Partnership's leverage
level could affect its ability to (i) obtain financing in the future,
(ii) undertake refinancings on terms and subject to conditions deemed
acceptable by the Operating Partnership, (iii) make distributions to
partners, (iv) pursue its acquisition strategy or (v) compete
effectively or operate successfully under adverse economic conditions.
. No Limitation on Debt. There are no limitations in Host REIT's or the
Operating Partnership's organizational documents which limit the amount
of indebtedness either may incur, although both the Notes and the
Operating Partnership's other debt instruments will contain certain
restrictions on the amount of indebtedness that the Operating
Partnership may incur.
. Rental Revenues from Hotels Subject to Rights of Lenders. In accordance
with the mortgage loan agreements with respect to outstanding
indebtedness of certain Hotel Partnerships, the rental revenues received
by such Hotel Partnerships under certain Leases first will be used to
satisfy the debt service on such outstanding indebtedness with only the
cash flow remaining after debt service being available to satisfy other
obligations of the Hotel Partnership (including paying property taxes
and insurance, funding the required FF&E reserves for the Hotels and
capital improvements and paying debt service with respect to unsecured
debt) and to make distributions to holders of OP Units.
. Ownership Limitations. No person or group may own, actually or
constructively (as determined under the applicable Code provisions), (i)
in excess of 9.8% of the number or value of outstanding Common Shares of
Host REIT or (ii) in excess of 4.9% of the value of the OP Units (other
than Host REIT and The Blackstone Group), subject to waiver or
modification by Host REIT or the Operating Partnership, as the case may
be, in certain limited circumstances.
. Timing of the REIT Conversion. If the REIT Conversion does not occur in
time for Host REIT to elect REIT status effective January 1, 1999, the
effectiveness of Host REIT's election could be delayed to January 1,
2000, which would result in Host REIT continuing to pay corporate-level
income taxes in 1999 and could cause the Blackstone Acquisition not to
be consummated.
. Effect of Subsequent Events upon Recognition of Gain. Even though the
MHP2 Limited Partners (other than those who elect to receive a Note in
exchange for OP Units) generally are not expected to recognize
significant taxable gain at the time of the Merger, there are a variety
of events and transactions (including the sale of one or more of the
Hotels currently owned by MHP2 or the reduction of indebtedness securing
one or more of the Hotels) that could cause an MHP2 Limited Partner to
recognize all or a part of the gain that otherwise has been deferred
through the REIT Conversion. See "Federal Income Tax Consequences--Tax
Treatment of MHP2 Limited Partners Who Hold OP Units Following the
Merger." Certain Hotels (including the Blackstone Hotels) will be
covered by agreements with third parties which will restrict the
Operating Partnership's ability to dispose of those properties or
refinance their debt. In addition, if Atlanta Marquis participates in
the Mergers, the Operating Partnership will succeed to an existing
agreement that will restrict its ability to dispose of the Atlanta
Marquis Hotel or to refinance the debt secured by such Hotel without
compensating certain outside partners for the resulting adverse tax
consequences. As for the remaining initial properties (including the
Hotels owned by MHP2), the partnership agreement of the Operating
Partnership, which
MHP2 Supp-5
<PAGE>
is substantially in the form attached to the Consent Solicitation as
Appendix A (the "Partnership Agreement"), does not impose any
restrictions on the Operating Partnership's ability to dispose of the
Hotels or to refinance debt secured by the Hotels (but the Operating
Partnership is obligated to pay any taxes Host REIT incurs as a result
of such transactions). In addition, the Partnership Agreement provides
that Host REIT, as general partner of the Operating Partnership, is not
required to take into account the tax consequences of the limited
partners in deciding whether to cause the Operating Partnership to
undertake specific transactions (but the Operating Partnership is
obligated to pay any taxes that Host REIT incurs as a result of such
transactions) and the limited partners have no right to approve or
disapprove such transactions. See "Description of OP Units--Sales of
Assets."
. Election to Exchange OP Units for Notes. An MHP2 Limited Partner who
elects to receive a Note in connection with the Merger in exchange for
his OP Units will be treated as having made a taxable disposition of his
Partnership Interest. An MHP2 Limited Partner who receives a Note may be
eligible to defer at least a portion of that gain under the "installment
sale" rules. See "Federal Income Tax Consequences--Tax Treatment of MHP2
Limited Partners Who Exercise Their Right to Make the Note Election."
. Competition in the Lodging Industry. The profitability of the Hotels is
subject to general economic conditions, the management abilities of the
Managers (including primarily Marriott International), competition, the
desirability of particular locations and other factors relating to the
operation of the Hotels. The full-service segment of the lodging
industry, in which virtually all of the Hotels operate, is highly
competitive, and the Hotels generally operate in geographical markets
that contain numerous competitors. The Hotels' success will be
dependent, in large part, upon their ability to compete in such areas as
access, location, quality of accommodations, room rate structure, the
quality and scope of food and beverage facilities and other services and
amenities. The lodging industry, including the Hotels (and thus the
Operating Partnership), may be adversely affected in the future by (i)
national and regional economic conditions, (ii) changes in travel
patterns, (iii) taxes and government regulations which influence or
determine wages, prices, interest rates, construction procedures and
costs, (iv) the availability of credit and (v) other factors beyond the
control of the Operating Partnership.
. Failure of Host REIT to Qualify as a REIT for Tax Purposes. Taxation of
Host REIT as a corporation if it fails to qualify as a REIT, and Host
REIT's subsequent liability for federal, state and local taxes on its
income and property, would, among other things, have the effect of
reducing cash available for distribution to Host REIT's shareholders and
materially reducing the value of the Common Shares and OP Units.
. Failure of the Operating Partnership to Qualify as a Partnership for Tax
Purposes. Taxation of the Operating Partnership as a corporation if it
fails to qualify as a partnership and the Operating Partnership's
subsequent liability for federal, state and local income taxes would,
among other things, have the effect of reducing cash available for
distribution to holders of OP Units, would cause Host REIT to fail to
qualify as a REIT for tax purposes and would cause the holders of OP
Units to recognize substantial taxable gain at the time the Operating
Partnership ceases to qualify as a partnership.
. Failure of the Leases to Qualify as Leases. If the leases of the Hotels
to the Lessee were to be disregarded for tax purposes (for example,
because a Lease was determined to lack economic substance), Host REIT
could fail to qualify as a REIT and the Operating Partnership might be
treated as a corporation for federal income tax purposes, which would
have a material adverse impact on the MHP2 Limited Partners and the
value of the OP Units.
. Change in Tax Laws. No assurance can be provided that new legislation,
Treasury Regulations, administrative interpretations or court decisions
will not significantly change the tax laws with respect to Host REIT's
qualification as a REIT or the federal income tax consequences of such
qualification.
. MHP2 Limited Partners Need to Consult with Their Own Tax Advisors.
Because the specific tax attributes of an MHP2 Limited Partner and the
facts regarding such MHP2 Limited Partner's interest in MHP2 could have
a material impact on the tax consequences to such MHP2 Limited Partner
of the Merger, the subsequent ownership and disposition of OP Units or
Notes and/or the subsequent
MHP2 Supp-6
<PAGE>
ownership and disposition of Common Shares, it is essential that each
MHP2 Limited Partner consult with his own tax advisors regarding the
application of federal, foreign and state and local tax laws to such
MHP2 Limited Partner's personal tax situation.
. Effect of Possible Classification as a Publicly Traded Partnership on
Passive Losses. There is a significant possibility that the Operating
Partnership could be classified as a "publicly traded partnership," in
which event the MHP2 Limited Partners would not be able to use suspended
passive activity losses from other investments to offset income from the
Operating Partnership.
. Host's Substantial Deferred Tax and Contingent Liabilities. Host will
have substantial deferred tax liabilities that are likely to be
recognized in the next ten years (notwithstanding Host REIT's status as
a REIT), and the IRS could assert substantial additional liabilities for
taxes against Host for taxable years prior to the time Host REIT
qualifies as a REIT. Under the terms of the REIT Conversion and the
Partnership Agreement, the Operating Partnership will be responsible for
paying (or reimbursing Host REIT for the payment of) all such tax
liabilities as well as any other liabilities (including contingent
liabilities and liabilities attributable to litigation that Host REIT
may incur) whether such liabilities are incurred by reason of Host's
activities prior to the REIT Conversion or the activities of Host REIT
subsequent thereto.
Because REITs are not permitted under current federal income tax law to
derive revenues directly from the operation of hotels, the Operating
Partnership will lease the Hotels to lessees (the "Lessees") that will operate
the Hotels under the existing management agreements and pay rent to the
Operating Partnership, as more fully described herein. The Lessees generally
will be indirect controlled subsidiaries of HMC Senior Communities, Inc.
("SLC"), which currently is a wholly owned subsidiary of Host. SLC will become
a separate public company when Host distributes the common stock of SLC and
other consideration to its existing shareholders and the Blackstone Entities
in connection with Host's distribution of its accumulated earnings and
profits, which Host REIT is required to do in order to qualify as a REIT.
Shares of Host REIT and SLC will become separately traded securities and the
companies will operate independently. There will be no overlap between the
boards of Host REIT and SLC. There will be a substantial overlap of
shareholders of the two companies initially, but this likely will diverge over
time.
MARRIOTT MHP TWO CORPORATION (THE "GENERAL PARTNER"), THE GENERAL PARTNER OF
MHP2, BELIEVES THAT THE MERGER PROVIDES SUBSTANTIAL BENEFITS AND IS FAIR TO
THE MHP2 LIMITED PARTNERS AND RECOMMENDS THAT ALL MHP2 LIMITED PARTNERS VOTE
FOR THE MERGER.
The effects of the Mergers may be different for Limited Partners of the
various Partnerships. This Supplement has been prepared to highlight for MHP2
Limited Partners the specific risks, benefits, effects and fairness of the
Merger to them and to provide other information specific to MHP2. Supplements
have also been prepared for each of the other Partnerships. This Supplement,
together with the supplements of the other Partnerships (collectively, the
"Supplements"), are part of the Consent Solicitation. Upon receipt of a
written request by a Limited Partner or his representative so designated in
writing, the General Partner will send a copy of any Supplement without
charge. All requests for a copy of a Supplement should be directed to:
Investor Relations, 10400 Fernwood Road, Bethesda, Maryland 20817, telephone
number 301-380-2070 (between the hours of 9:00 a.m. and 4:00 p.m., eastern
time).
All cross-references refer to the Consent Solicitation unless the context
indicates otherwise. Capitalized terms not defined herein shall have the
meaning set forth in the Consent Solicitation. The information contained
herein, unless otherwise indicated, assumes the REIT Conversion occurs with
all Partnerships participating and no Notes being issued (the "Full
Participation Scenario").
EXPECTED BENEFITS OF THE MERGER
The General Partner believes that participating in the Merger would likely
be beneficial to the MHP2 Limited Partners for the reasons set forth below.
This information is qualified by and should be read in conjunction with the
information in the Consent Solicitation under "Background and Reasons for the
Mergers and the REIT Conversion--Reasons for the Mergers." These benefits,
which should be viewed as alternatives to continuing the business and
operations of MHP2, are expected to include:
MHP2 Supp-7
<PAGE>
. Exchange Value of MHP2. MHP2 Limited Partners who elect to retain OP
Units in the Merger will receive OP Units with an estimated Exchange
Value equal to $237,334 per Partnership Unit.
. Enhanced Liquidity of Investment. The REIT Conversion will offer MHP2
Limited Partners significantly enhanced liquidity with respect to their
investments in MHP2 because, commencing one year following the Effective
Date, MHP2 Limited Partners who retain OP Units will be able to exercise
their Unit Redemption Right at any time, subject to certain limited
exceptions. Host has approximately 204 million shares of common stock
outstanding and is expected to have a total common equity market
capitalization of approximately $ billion after giving effect to the
estimated $ million earnings and profits distribution (based on
Host's $ closing price per share on the NYSE on , 1998). The
exercise of the Unit Redemption Right, however, generally would result
in recognition of taxable income or gain at that time.
. Public Market Valuation of Assets. The Partnership Units of MHP2
currently trade at a discount to the net asset value of MHP2's assets.
In contrast, the General Partner believes that by exchanging interests
in MHP2, which is a non-traded, finite-life limited partnership with a
fixed portfolio for interests in an infinite-life real estate company
focused primarily on a more diverse and growing full-service hotel
portfolio and providing valuation based upon publicly traded Common
Shares of Host REIT, the MHP2 Limited Partners will have the opportunity
to participate in the recent trend toward ownership of real estate
through a publicly traded entity, which, in many instances, has resulted
in market valuations of public real estate companies in excess of the
estimated net asset values of those companies. There can be no
assurance, however, that the Common Shares of Host REIT will trade at a
premium to the private market values of the Operating Partnership's
assets or that the relative pricing differential will not change or be
eliminated in the future. Also, the benefit of Host's conversion to a
REIT will not be shared by the MHP2 Limited Partners if and to the
extent that such benefit is reflected in the market valuation of Host's
common stock prior to the REIT Conversion.
. Regular Quarterly Cash Distributions. The General Partner expects that
the Operating Partnership will make regular quarterly cash distributions
to holders of OP Units. The General Partner expects that while these
distributions will be lower than the estimated cash distributions for
1998 of MHP2, the ability to receive distributions quarterly and in
regular amounts would be enhanced. For additional information regarding
historical and estimated future distributions for MHP2 and the other
Partnerships, see "Background and Reasons for the Mergers and the REIT
Conversion--Reasons for the Mergers."
. Substantial Tax Deferral. The General Partner expects that MHP2 Limited
Partners who do not elect to receive a Note in exchange for OP Units
generally should be able to obtain the benefits of the Merger while
continuing to defer recognition for federal income tax purposes of at
least a substantial portion, if not all, of the gain with respect to
their Partnership Interests that otherwise would be recognized in the
event of a liquidation of MHP2 or a sale or other disposition of its
assets in a taxable transaction. Thereafter, such MHP2 Limited Partners
generally should be able to defer at least a substantial portion of such
built-in gain until they elect to exercise their Unit Redemption Right
or one or more of the Hotels currently owned, directly or indirectly, by
MHP2 are sold or otherwise disposed of in a taxable transaction by the
Operating Partnership or the debt now secured by such Hotels is repaid,
prepaid or substantially reduced. The federal income tax consequences of
the Merger are highly complex and, with respect to each MHP2 Limited
Partner, are dependent upon many variables, including the particular
circumstances of such MHP2 Limited Partner. See "Federal Income Tax
Consequences--Tax Consequences of the Merger." Each MHP2 Limited Partner
is urged to consult with his own tax advisors as to the consequences of
the Merger in light of his particular circumstances.
. Risk Diversification. Participation in the Merger, as well as future
hotel acquisitions by the Operating Partnership, will reduce the
dependence of MHP2 Limited Partners upon the performance of, and the
exposure to the risks associated with, MHP2's Hotels and spread such
risk over a broader and more varied portfolio, including more diverse
geographic locations and multiple brands. See "Business and Properties--
Business Objectives."
MHP2 Supp-8
<PAGE>
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a lower leverage to value ratio than
MHP2 currently, which has a leverage ratio of 56% (calculated as a
percentage of Appraised Value), resulting in interest and debt service
savings and greater financial stability.
. Growth Potential. The General Partner believes that the MHP2 Limited
Partners, by owning interests in a publicly traded real estate company
focused primarily on a more diverse and growing upscale and luxury full-
service hotel portfolio, will be able to participate in growth
opportunities that would not otherwise be available to them.
. Greater Access to Capital. With publicly traded equity securities, a
larger base of assets and a substantially greater equity value than MHP2
has individually, Host REIT expects to have greater access to the
capital necessary to fund the Operating Partnership's operations and to
consummate acquisitions on more attractive terms than would be available
to MHP2 individually. This greater access to capital should provide
greater financial stability to the Operating Partnership and reduce the
level of risk associated with refinancing existing loans upon maturity,
as compared to MHP2 individually.
If MHP2 does not participate in the Merger, its business will continue in
its current manner; however, the Operating Partnership may elect to contribute
some or all of its interest in MHP to a Non-Controlled Subsidiary.
DETERMINATION OF EXCHANGE VALUE OF MHP2 AND ALLOCATION OF OP UNITS
GENERAL. The Exchange Value of MHP2 will be equal to the greatest of its
Adjusted Appraised Value, Continuation Value and Liquidation Value, each of
which has been determined as follows:
. Adjusted Appraised Value. The General Partner has retained AAA to
determine the market value of each of the Hotels as of March 1, 1998
(the "Appraised Value"). The "Adjusted Appraised Value" of MHP2 equals
the Appraised Value of its Hotels, adjusted as of the Final Valuation
Date for lender reserves, capital expenditure reserves, existing
indebtedness (including a "mark to market" adjustment to reflect the
market value of such indebtedness), certain deferred maintenance costs,
deferred management fees and transfer and recordation taxes and fees.
. Continuation Value. The "Continuation Value" of MHP2 represents AAA's
estimate, as adopted by the General Partner, of the discounted present
value, as of January 1, 1998, of the MHP2 limited partners' share of
estimated future cash distributions and estimated net sales proceeds
(plus lender reserves), assuming that MHP2 continues as an operating
business for twelve years and its assets are sold on December 31, 2009
for their then estimated market value.
. Liquidation Value. The "Liquidation Value" of MHP2 represents the
General Partner's estimate of the net proceeds to MHP2 limited partners
resulting from the assumed sale as of December 31, 1998 of the Hotels of
MHP2 each at its Adjusted Appraised Value (after eliminating any "mark
to market" adjustment and adding back the deduction for transfer and
recordation taxes and fees, if any, made in deriving the Adjusted
Appraised Value), less (i) estimated liquidation costs, expenses and
contingencies equal to 2.5% of Appraised Value and (ii) prepayment
penalties or defeasance costs, as applicable.
Final determination of the Exchange Value of MHP2 will be made as of the end
of the four week accounting period ending at least 20 days prior to the
Effective Date (the "Final Valuation Date") and will be equal to the greatest
of Adjusted Appraised Value, Continuation Value and Liquidation Value as of
such date. Adjusted Appraised Value, Continuation Value and Liquidation Value
will be adjusted as of the Final Valuation Date (i) to reflect the amount of
lender and capital expenditure reserves and the amount of deferred management
fees as of such date, (ii) to increase the Adjusted Appraised Value by any
amounts actually expended by MHP2 after the Initial Valuation Date to perform
deferred maintenance that were previously subtracted in determining the
estimated Adjusted Appraised Value of MHP2 and (iii) to reflect any changes in
MHP2's other reserves, such as for litigation expenses and indemnification
costs and any revised estimates of transfer and recordation taxes and fees.
MHP2 Supp-9
<PAGE>
APPRAISED VALUE. MHP2's Hotels were appraised as of March 1, 1998 by AAA, an
independent, nationally recognized hotel valuation and financial advisory firm
experienced in the appraisals of lodging properties such as MHP2 's Hotels.
Each appraisal (an "Appraisal") was reviewed by a Member Appraisal Institute
("MAI") appraiser and certified by such MAI appraiser as having been prepared
in accordance with the requirements of the Standards of Professional Practice
of the Appraisal Institute and the Uniform Standards of Professional Appraisal
Practice of the Appraisal Foundation.
The purpose of each Appraisal is to provide an estimate of the "Market
Value" of the related Hotel. "Market Value" means the most probable price
which a property should bring in a competitive and open market under all
conditions requisite to a fair sale, the buyer and seller each acting
prudently and knowledgeably and assuming the price is not affected by undue
stimuli. Implicit in this definition is the consummation of a sale as of a
specified date and the passing of title from seller to buyer under conditions
whereby: (i) the buyer and seller are equally motivated; (ii) both parties are
well informed or well advised, and each is acting in what he considers his own
best interest; (iii) a reasonable time frame is allowed for exposure in the
open market; (iv) payment is made in terms of cash in U.S. dollars or in terms
of financial arrangements comparable thereto and (v) the price represents the
normal consideration for the property sold unaffected by special or creative
financing or sales concessions granted by anyone associated with the sale. AAA
made site visits at all of MHP2's Hotels for purposes of the Appraisals.
In preparing the Appraisals, AAA relied primarily on the income
capitalization method of valuation, and then compared the value estimated by
this method with recent sales of comparable properties, as a check on the
reasonableness of the value determined through the income capitalization
method. AAA employed the following procedures for determining the Appraised
Value of each MHP2 Hotel:
. Historical 1997 and Projected Year's Earnings. AAA reviewed the
historical 1997 net operating income (i.e., income before interest,
taxes, depreciation and amortization) ("NOI") prior to incentive
management fees and certain capital expenditures for the applicable
Hotel. AAA also prepared a projection of the net operating income prior
to incentive management fees and certain capital expenditures for the
applicable Hotel for the twelve month period ending February 28, 1999
(the "Projected Year"), using historical financial information for each
Hotel, budget information, a survey with the manager of each Hotel
addressing the physical condition of the Hotel, local market conditions
(including business mix, demand generators, future trends and
predictability of business), changes in the competitive environment,
comparison with direct competitors of the Hotel and risk factors
relating to the particular Hotel. The resulting gross margin (ratio of
total revenues to NOI prior to incentive management fees) was checked
against AAA's database of the gross margins for similar hotels for
reasonableness.
. Impact of Incentive Management Fees. AAA estimated a normalized annual
amount of incentive management fees payable under the applicable
management agreement and subtracted this amount from the net operating
income prior to incentive management fees and certain capital
expenditures for 1997 and the Projected Year.
. Impact of Owner Funded Capital Expenditures. AAA estimated normalized
annual amounts of owner funded capital expenditures (over and above the
FF&E reserve) based in part on projected owner funded capital
expenditures estimated in the Engineering Study. The normalized amounts
were then subtracted from the NOI prior to owner funded capital
expenditures for 1997 and the Projected Year.
. Capitalization of Adjusted NOI. AAA then capitalized the amount
resulting from the foregoing adjustments ("Adjusted NOI") for 1997 and
the Projected Year by dividing such amounts by capitalization rates that
AAA determined to be appropriate. A capitalization rate represents the
relationship between net operating income and sales prices of income
producing property. AAA selected the capitalization rates based upon its
review of current published surveys reflecting the opinions of investors
and participants such as REITs, hotel acquisition/management companies
and pension funds, lenders, brokers and consultants as to current
capitalization rates, and its own database of capitalization rates
reflected in recent transactions, adjusted for factors specific to the
Hotel, such as
MHP2 Supp-10
<PAGE>
location, physical condition, reserve policies, local market volatility
and competition, guest mix, renovation influences and other income
characteristics. AAA used separate capitalization rates that it deemed
appropriate to capitalize 1997 historical Adjusted NOI and estimated
Projected Year's Adjusted NOI. AAA then estimated the value of each
Hotel based upon each of the values estimated by capitalizing 1997 and
Projected Year's Adjusted NOI and its professional judgment. The
following table sets forth the effective capitalization rates for 1997
and Projected Year's Adjusted NOI resulting from AAA's estimated
Appraised Values of MHP2's Hotels.
RESULTING EFFECTIVE CAPITALIZATION RATES FOR APPRAISALS OF MHP2'S HOTELS
<TABLE>
<CAPTION>
PROJECTED YEAR
1997 (ENDING FEBRUARY 28, 1999)
---- --------------------------
<S> <C>
9.1-9.6% 9.7-11.6%
</TABLE>
APPRAISED VALUES OF MHP2'S HOTELS
<TABLE>
<CAPTION>
HOTEL APPRAISED VALUES
----- ----------------
(IN THOUSANDS)
<S> <C>
Marriott Rivercenter Hotel.............................. 180,600
New Orleans Marriott Hotel.............................. $184,300
San Ramon Marriott Hotel................................ 35,300
Santa Clara Marriott Hotel.............................. 63,100(1)
--------
Total................................................. $463,300
========
</TABLE>
- --------
(1) Excludes 50% of the $126,200,000 Appraised Value of the Santa Clara
Marriott Hotel.
. Comparison with Comparable Sales. AAA checked the Appraised Value of
each Hotel derived by the foregoing procedures against its database of
comparable sale transactions for reasonableness.
In the case of the Santa Clara Marriott Hotel, which is only partly owned by
MHP2, the Appraised Value of the Hotel was reduced proportionately to the
amount attributable to MHP2's ownership interest therein (but no adjustment
was made to reflect the effect that the outside interest might have on
decisions with respect to sales, refinancings or other major operational
matters). With respect to MHP2's Hotels, three properties were encumbered by a
ground lease as of the date of the Appraisals. Accordingly, the Appraised
Values of such Hotels have been decreased to reflect the encumbrance of the
ground lease and the interest of the ground lessor in the operating cash flows
of the Hotels. The Appraised Value assumes all contractual provisions for FF&E
reserves are adequate and have not been reduced to reflect deferred
maintenance or environmental remediation costs with respect to MHP2's Hotels
(but estimated deferred maintenance costs have been deducted in estimating the
Adjusted Appraised Value of each of MHP2's Hotels). The Appraised Value did
not take into account the costs that might be incurred in selling the Hotels
(but estimated costs for transfer and recordation taxes and fees have been
deducted in estimating the Adjusted Appraised Value of each Hotel).
The Appraisals are not guarantees of present or future values and no
assurance can be given as to the actual value of MHP2's Hotels. The Appraisals
should be read in conjunction with other information, such as, but not limited
to, the audited financial statements of MHP2.
The Appraised Value, and the assumptions underlying the projections on which
the Appraised Value is based, are contingent upon a series of future events,
the outcomes of which are not necessarily within the Operating Partnership's
control and cannot be determined at this time. There can be no assurance that
another appraiser would not have arrived at a different result. Some of the
assumptions inevitably will not materialize and unanticipated events and
circumstances will occur subsequent to the date of the Appraisals.
Furthermore, the
MHP2 Supp-11
<PAGE>
actual results achieved from MHP2's Hotels will vary from the results
projected in the Appraisals and the variations may be material.
ADJUSTED APPRAISED VALUE. The Adjusted Appraised Value of MHP2 was
determined by totaling the Appraised Values of all of the Hotels of MHP2 and
then making various adjustments to the aggregate Appraised Value, as described
below.
. Lender Reserves. MHP2's debt service reserves are required to be held by
third-party lenders. The amount of these lender reserves as of the
Initial Valuation Date was added to the Appraised Values of these
Hotels. A final determination of the lender reserves of MHP2 will be
made on the Final Valuation Date and any changes in such reserves will
be reflected in the Adjusted Appraised Value.
. Mortgage and Other Debt. The estimated principal balance and accrued
interest as of the Effective Date (assumed to be December 31, 1998) of
all mortgage and other debt of MHP2 has been subtracted from the
Appraised Value.
. Mark to Market Adjustments. The third-party loans of the Partnerships
have various interest rates and terms to maturity. In order to reflect
the market value of the third-party loans of MHP2, the estimated
Adjusted Appraised Value for MHP2 has been decreased to "mark to market"
the interest rate for such loans. This adjustment has been estimated by
comparing the interest cost using the applicable interest rates on
existing third-party loans over their remaining term to the interest
cost using the interest rate that the Operating Partnership believes it
would be able to obtain for unsecured debt in the market as of the Final
Valuation Date (which would have been % per annum based on a 225 basis
point (2.25 percent) spread over the yield on seven-year U.S. Treasury
securities as of , 1998). The mark to market adjustment for each
loan was calculated by determining the difference between the present
values, as of December 31, 1998, of the interest payments over the
remaining term of the loan from January 1, 1999 to maturity using the
actual interest rate as the discount rate as compared to using the
assumed market rate as the discount rate.
. Deferred Management Fees. The amount of deferred management fees
(management fees earned by the manager pursuant to the management
agreement and not paid currently) estimated to be payable under the
Management Agreements of MHP2 as of December 31, 1998 have been
subtracted from the Appraised Value. The amount of such deferred
management fees will be recalculated as of the Final Valuation Date.
. Deferred Maintenance Costs. The estimated cost to complete any deferred
maintenance items identified in the Engineering Study relating to the
MHP2 Hotels have been subtracted from the Appraised Value. The
adjustments for this item will be reduced at the Final Valuation Date to
reflect amounts expended after the Initial Valuation Date to perform
such deferred maintenance. No adjustments have been made for previously
budgeted capital expenditures or deferred maintenance costs estimated in
the Engineering Study that are reflected in the cash flow projections
used for purposes of estimating Appraised Values.
MHP2 Supp-12
<PAGE>
The following table sets forth the adjustments to the aggregate Appraised
Values of MHP2's Hotels made to derive the estimated Adjusted Appraised Value
for MHP2 as of the Initial Valuation Date.
CALCULATION OF ESTIMATED ADJUSTED APPRAISED VALUE FOR MHP2
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value.............................................. $463,300 (1)
Lender reserves.............................................. 6,800
Mortgage debt................................................ (259,945)(1)
Mark to market adjustment.................................... (2,154)
Deferred management fees..................................... (3,184)
Deferred maintenance costs................................... (1,673)
--------
Estimated Adjusted Appraised Value........................... $203,144
========
Limited partners' share...................................... $176,814
Per Partnership Unit......................................... $237,334
</TABLE>
- --------
(1) Excludes 50% of the $126,200,000 Appraised Value of the Santa Clara
Marriott Hotel but includes 100% of the $42,500,000 in mortgage debt
encumbering the Hotel for which MHP2 is responsible.
CONTINUATION VALUE. AAA estimated the Continuation Value of MHP2 using the
following methodology:
. Estimated Future Cash Distributions. AAA prepared estimates of future
partnership cash flow for MHP2 for the 12-year period from January 1,
1998 through December 31, 2009 based upon the estimated 1998 NOI before
incentive management fees used in the Appraisals and for each subsequent
year applying an assumed annual stabilized growth rate (as shown in the
table below) developed by AAA for this analysis. For each year in the
projection period, AAA estimated the amount of cash available for
distribution to MHP2's limited partners after payment of all management
fees, debt service, owner funded capital expenditures based on the
Engineering Study and other partnership expenses and after application
of the applicable partnership agreement provisions. AAA assumed that
MHP2's FF&E reserve was adequate and understood that Host determined
that there were no reserve shortfalls or surpluses.
. Refinancing Assumptions. For debt that matures during the 12-year
period, AAA assumed that the debt would be refinanced with interest
rates ranging from 7.25% to 8.60% per annum and a 20- to 25-year
amortization schedule, with estimated refinancing costs of 2% of the
refinanced amount being paid from operating cash flow.
. Determination of Residual Value. To estimate the residual value of the
MHP2 limited partners' interest in MHP2 at the end of the 12-year
period, AAA assumed that the MHP2 Hotels would be sold as of December
31, 2009 at their then market value. AAA estimated the market value of
each Hotel as of such date by applying an exit capitalization rate that
it deemed appropriate, using the factors described above in connection
with the "--Appraised Value," which are set forth in the table below, to
the estimated Adjusted NOI for 2009 (estimated as described above). AAA
then subtracted estimated sales costs of 2.0% of the estimated market
value, added lender reserves and subtracted the estimated outstanding
principal balance of debt as of December 31, 2009 and deferred
management fees to arrive at net sales proceeds available for
distribution to partners. AAA then determined what portion of such
estimated net sales proceeds would be distributable to MHP2's limited
partners under the partnership and debt agreements.
. Discounting Distributions to Present Value. As a final step, AAA
discounted the estimated future cash distributions to MHP2 's limited
partners from operations and estimated net sales proceeds to their
present value as of January 1, 1998, using a discount rate of 20% per
annum. AAA believes that this discount rate reflects the return on
investment that investors expect from leveraged investments of this
nature.
MHP2 Supp-13
<PAGE>
The growth rate and exit capitalization rate used to determine the estimated
Continuation Value for MHP2 are as set forth below:
GROWTH RATE, EXIT CAPITALIZATION RATE
AND ESTIMATED CONTINUATION VALUE FOR MHP2
<TABLE>
<CAPTION>
ESTIMATED
EXIT CAPITALIZATION CONTINUATION VALUE
GROWTH RATE RATE (2009) (PER PARTNERSHIP UNIT)
----------- ------------------- ----------------------
<S> <C> <C>
3.4% 10.4% $212,032
</TABLE>
LIQUIDATION VALUE. The Liquidation Value of MHP2 was estimated by the
General Partner and represents the estimated value of MHP2 if all of its
assets were sold as of December 31, 1998. Such value was based upon the
Adjusted Appraised Value of MHP2, with the following adjustments: (i) the
"mark to market" adjustment used to estimate the Adjusted Appraised Value was
eliminated and instead prepayment or defeasance costs that would be payable
under existing debt agreements (regardless of whether the debt in fact can be
prepaid on December 31, 1998) were deducted from the Appraised Value; and (ii)
the deduction for transfer and recordation taxes and fees used to estimate the
Adjusted Appraised Value was eliminated and instead an amount equal 2.5% of
the Appraised Value of MHP2's Hotels was subtracted from the Appraised Value
for estimated liquidation costs, expenses and contingencies. The General
Partner then determined the portion of the estimated Liquidation Value that
would be distributable to MHP2's limited partners under the terms of the
partnership agreement and other contractual arrangements.
The following table sets forth the adjustments made to the Adjusted
Appraised Value to estimate the Liquidation Value of MHP2 as of the Initial
Valuation Date:
CALCULATION OF ESTIMATED LIQUIDATION VALUE OF MHP2
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value........................................ $ 463,300(1)
Lender reserves........................................ 6,800
Mortgage debt.......................................... (259,945)(1)
Prepayment/defeasance costs............................ (20,551)
Deferred management fees............................... (3,184)
Deferred maintenance costs............................. (1,673)
Sales costs............................................ (11,583)
---------
Estimated Liquidation Value............................ $ 173,164
=========
Limited partners' share................................ $ 152,829
Per Partnership Unit................................... $ 205,140
</TABLE>
- --------
(1) Excludes 50% of the $126,200,000 Appraised Value of the Santa Clara
Marriott Hotel but includes 100% of the $42,500,000 in mortgage debt
encumbering the Hotel for which MHP2 is responsible.
ESTIMATED EXCHANGE VALUE. The following table sets forth the estimated
Exchange Value of MHP2 (based upon the greatest of its estimated Adjusted
Appraised Value, estimated Continuation Value and estimated Liquidation
Value), the estimated minimum and pro forma number of OP Units to be received
and the estimated Note Election Amount for MHP2, all on a per Partnership Unit
basis as of the Initial Valuation Date. The estimated Exchange Value for MHP2
will be received by each MPH2 Limited Partner retaining OP Units in the
Merger. The estimated Note Election Amount for MHP2 (which will be received by
MHP2 Limited Partners electing to receive Notes in exchange for OP Units) is
equal to the Liquidation Value for MHP2. The estimated values set forth below
may increase or decrease as a result of various adjustments, which will be
finally calculated as of the Final Valuation Date but will not change as a
result of less than all of the Partnerships
MHP2 Supp-14
<PAGE>
participating in the Mergers. The actual number of OP Units to be received by
the MHP2 Limited Partners will be based on the average closing price on the
NYSE of a Host REIT Common Share for the 20 trading days after the Effective
Date.
ESTIMATED EXCHANGE VALUE,
NUMBER OF OP UNITS AND NOTE ELECTION AMOUNT
OF MHP2
PER PARTNERSHIP UNIT(1)
<TABLE>
<CAPTION>
ESTIMATED ESTIMATED ESTIMATED ESTIMATED
ADJUSTED ESTIMATED ESTIMATED ESTIMATED MINIMUM PRO FORMA NOTE
APPRAISED CONTINUATION LIQUIDATION EXCHANGE NUMBER OF NUMBER OF ELECTION
VALUE VALUE VALUE VALUE(2) OP UNITS(3) OP UNITS(4) AMOUNT(5)
--------- ------------ ----------- --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
$237,334 $212,032 $205,140 $237,334 11,867 $205,140
</TABLE>
- --------
(1) A Partnership Unit in MHP2 represents an original investment of $100,000.
(2) The estimated Exchange Value is equal to the greatest of estimated
Adjusted Appraised Value, estimated Continuation Value and estimated
Liquidation Value.
(3) Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Merger.
(4) Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
(5) The principal amount of Notes is equal to the greater of (i) the
Liquidation Value or (ii) 60% of the Exchange Value (the "Note Election
Amount").
Price of OP Units to Pay Exchange Value to MHP2 Limited Partners. Each MHP2
Limited Partner will receive OP Units with a deemed value equal to the
Exchange Value of such MHP2 Limited Partner's Partnership Interests. The price
of an OP Unit for this purpose will be equal to the average closing price on
the NYSE of a Host REIT Common Share for the 20 trading days after the
Effective Date of the Merger (but in no event greater than $ per share). The
closing price per share of Host common stock on the NYSE was $ , on ,
1998.
MHP2 Limited Partners who retain OP Units will receive cash distributions
from MHP2 for all of 1998 and, if the Merger does not occur in 1998, any
portion of 1999 prior to the Merger for which period they do not receive a
cash distribution from the Operating Partnership. Cash distributions will be
made by MHP2 in accordance with its partnership agreement on or before June 1,
1999 in respect of 1998 operations and, if the Merger does not occur prior to
January 1, 1999, within 90 days after the Effective Date of the Merger in
respect of any 1999 operations. MHP2 Limited Partners at the Effective Date of
the Merger who receive Notes in exchange for OP Units will participate in the
same distributions from MHP2 as MHP2 Limited Partners who retain OP Units but
will not receive any distributions from the Operating Partnership with respect
to periods after the Effective Date of the Merger.
No fractional OP Units will be issued. Fractional amounts less than or equal
to 0.50 of an OP Unit will be rounded down to the next whole number and
fractional amounts greater than 0.50 will be rounded up to the next whole
number of OP Units.
VALUATION OF THE GENERAL PARTNER'S INTEREST IN MHP2 AND ALLOCATION OF OP UNITS
TO THE GENERAL PARTNER
The value of the General Partner's interest will be equal to the aggregate
Exchange Value of MHP2 minus the aggregate Exchange Value of the MHP2 Limited
Partners' Partnership Interests (giving effect to the applicable distribution
preferences in the MHP2 partnership agreement). The number of OP Units that
will be received by the General Partner will be equal to the value of its
interest in MHP2 divided by the same price per OP Unit used to determine the
number of OP Units to be received by the MHP2 Limited Partners. The total
number of OP Units that will be owned directly or indirectly by Host REIT
(including OP Units owned by the General Partner) will be equal to the number
of outstanding shares of common stock of Host at the Effective Date.
MHP2 Supp-15
<PAGE>
The following table sets forth the estimated value of the General Partner's
and its affiliates interest in MHP2 based upon the estimated aggregate
Exchange Value of the MHP2 Limited Partners' Partnership Interests as of the
Initial Valuation Date and the minimum and pro forma number of OP Units
estimated to be received by the General Partner and its affiliate in respect
thereof.
ESTIMATED VALUE OF THE GENERAL PARTNER'S AND ITS AFFILIATE'S INTERESTS AND
NUMBER OF OP UNITS
(DOLLARS IN THOUSANDS)
<TABLE>
<S> <C>
Aggregate Exchange Value.............................................. $203,144
Limited partners' share of aggregate Exchange Value................... 176,814
--------
Value of General Partner's interest................................... $ 26,330
Value of Host's limited partner interest.............................. 93,035
--------
Total Host interest................................................... $119,365
========
Number of OP Units:
Minimum(1)..........................................................
Pro Forma(2)........................................................ 5,968
</TABLE>
- --------
(1)Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Mergers.
(2)Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
CASH DISTRIBUTIONS
Historical Cash Distributions Paid by MHP2. The following table sets forth
the distributions paid to MHP2 Limited Partners (per Partnership Unit) during
the periods indicated. The information below should be read in conjunction
with the information in this Supplement under the caption "Selected Financial
Data."
HISTORICAL CASH DISTRIBUTIONS PAID BY MHP2
(PER PARTNERSHIP UNIT)( 1)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS FISCAL YEAR
--------- ---------------------------------------
1998 1997 1996 1995 1994 1993
--------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
From net income............. $14,864 $25,006 $24,616 $15,000 $15,077 $15,583
Representing return of
capital(2)................. -- -- -- -- -- --
Distribution of excess
General Partner reserve.... -- 4,873 -- -- -- --
------- ------- ------- ------- ------- -------
Total..................... $14,864 $29,879 $24,616 $15,000 $15,077 $15,583
======= ======= ======= ======= ======= =======
</TABLE>
- --------
(1) A Partnership Unit represents a $100,000 original investment in MHP2.
(2) Computed as all distributions in excess of distributions from operating
cash flow.
Compensation and Distributions to the General Partner. Under MHP2's
partnership agreement, the General Partner does not receive fees or
compensation in connection with managing the affairs of MHP2 but the General
Partner and its affiliates are reimbursed for certain costs and expenses
incurred on behalf of MHP2. The following information has been prepared to
compare the amount of reimbursements paid and cash distributions made by MHP2
to the General Partner and its affiliates to the amounts that would have been
paid if the reimbursement and distribution structure which will be in effect
after the REIT Conversion had been in effect for the periods presented.
Following the REIT Conversion, Host REIT will be operated as a self-
administered REIT and as a result no reimbursements or other compensation will
be received by the General Partner.
MHP2 Supp-16
<PAGE>
The following table sets forth the reimbursements and distributions paid by
MHP2 to its General Partner and its affiliates for the last three fiscal years
and the First Two Quarters 1998 ("Historical") and the reimbursements and
distributions that would have been paid to the General Partner for the last
fiscal year and the First Two Quarters 1998 if the REIT Conversion had been in
effect, assuming the Full Participation Scenario ("Pro Forma") and assuming a
distribution per OP Unit of $1.05 per year during such period, which is the
midpoint of the expected distribution range for 1999.
HISTORICAL AND PRO FORMA REIMBURSEMENTS AND DISTRIBUTIONS
TO THE GENERAL PARTNER AND ITS AFFILIATES
(IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL YEAR
FIRST TWO QUARTERS ------------------------------------------
1998 1997 1996 1995
-------------------- -------------------- ---------- ----------
HISTORICAL PRO FORMA HISTORICAL PRO FORMA HISTORICAL HISTORICAL
---------- --------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Reimbursements(1)....... $ 158 $ -- $ 351 $ -- $ 225 $ 89
Distributions(2)(3)..... 5,953 3,134 11,788 6,267 8,047 187
------ ------ ------- ------ ------ ----
Total................. $6,111 $3,134 $12,139 $6,267 $8,272 $276
====== ====== ======= ====== ====== ====
</TABLE>
- --------
(1) All expenses will be paid directly by the Operating Partnership,
accordingly, there are no expected reimbursements on a pro forma basis.
(2) The amount of distributions payable to the General Partner and its
affiliates on a pro forma basis reflect distributions at a rate of $1.05
per annum per OP Unit (which is the midpoint of the expected range of
distributions per OP Unit for 1999) with respect to the estimated number
of OP Units that the General Partner and its affiliates will receive with
respect to its general and limited partner interests in MHP2. Such number
does not reflect the aggregate number of OP Units Host will receive in
connection with the REIT Conversion.
(3) In 1996, MHP2 Acquisition Corp. purchased a controlling interest in MHP2.
Distributions to the General Partner were $112,000, $225,000, $185,000 and
$113,000 for the first two quarters 1998 and the fiscal years ended
December 31, 1997, 1996 and 1995, respectively and to the Partnership
Units owned by Host were $5,841,000, $11,563,000, $7,862,000 and $74,000
for the first two quarters 1998 and the fiscal years ended December 31,
1997, 1996 and 1995, respectively.
CERTAIN INFORMATION REGARDING THE HOTELS OWNED BY MHP2
<TABLE>
<CAPTION>
NAME OF HOTEL LOCATION OF HOTEL NUMBER OF ROOMS DATE OPENED
------------- ----------------- --------------- -----------
<S> <C> <C> <C>
Marriott Rivercenter Hotel... San Antonio, TX 999 1988
New Orleans Marriott Hotel... New Orleans, LA 1,290 1972
San Ramon Marriott Hotel..... San Ramon, CA 368 1989
Santa Clara Marriott
Hotel(1).................... Santa Clara, CA 754 1976
-----
TOTAL...................... 3,411
=====
</TABLE>
- --------
(1) MHP2 owns a 50% limited partner interest in the partnership that owns the
Santa Clara Marriott Hotel and Host owns the remaining 50% interest.
The table below sets forth certain performance information for MHP2's Hotels
for the indicated periods.
<TABLE>
<CAPTION>
FIRST
TWO QUARTERS FISCAL YEAR
---------------- -------------------------
1998 1997 1997 1996 1995
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Average daily rate.............. $152.56 $137.85 $133.75 $122.08 $115.53
Occupancy....................... 80.4% 83.3% 80.7% 81.1% 80.6%
REVPAR.......................... $122.66 $114.83 $107.94 $ 99.01 $ 93.12
% REVPAR change................. 7.0% 8.0% 9.0% 6.3% --
</TABLE>
Marriott Rivercenter Hotel, San Antonio, Texas
The San Antonio Hotel is a full-service Marriott hotel located in downtown
San Antonio on a leased parcel of land of approximately 2.7 acres. The Hotel
is situated on the San Antonio Riverwalk and is located one block
MHP2 Supp-17
<PAGE>
from the San Antonio Convention Center and the Alamo. It is located
approximately seven miles from the San Antonio International Airport.
The Hotel opened in October 1988. The Hotel contains 999 guest rooms,
including 86 suites and 40 concierge-level guest rooms, in a 38-story
building. Designed as part of the Marriott International network of convention
hotels, it has extensive meeting and convention facilities, totaling 58,300
square feet, including (i) a 40,000 square foot grand ballroom and (ii) 36
meeting rooms. Hotel facilities also include two restaurants, two lounges, a
health club, an indoor/outdoor pool, a gift shop and a 650-space underground
parking garage.
Capital Improvements. The Hotel is scheduled to complete a refurbishment,
which will include the replacement of the carpeting, bedspreads, upholstery,
drapes and other similar items ("Softgoods") and also the dressers, chairs,
beds and other furniture ("Casegoods") of all of its guest rooms at an
estimated cost of $12.5 million in 2000 and 2001.
Competition. The primary competition for the Hotel comes from the following
two first-class hotels in downtown San Antonio: (i) the Hyatt Regency and (ii)
the Hilton Palacio del Rio Hotel. These two competitors contain an aggregate
of approximately 1,100 rooms and 50,300 square feet of meeting space. The San
Antonio Marriott Riverwalk Hotel, which opened in 1980 and is managed by
Marriott International, is located across the street from the San Antonio
Hotel. Currently, the marketing and sales groups work together and the two
management teams are currently exploring the possibility of working more
closely together to maximize efficiencies. The San Antonio Marriott Riverwalk
Hotel and another area hotel, the Plaza San Antonio Hotel are both owned by
Host Marriott. In addition, other hotels in the San Antonio area also compete
with the San Antonio Hotel; however, these differ from the San Antonio Hotel
in terms of size, room rates, facilities, amenities and services offered,
market orientation and/or location. None of these other hotels are operated as
part of the Marriott International full-service hotel system.
In February 1997, the Residence Inn Alamo Plaza opened with 220 rooms. In
August of 1997, the Adams Mark Hotel opened on the Riverwalk with 410 rooms
and 25,000 square feet of meeting space. Both hotels are in the San Antonio
Hotel's immediate market area and it is expected that the San Antonio Hotel
will compete directly with the Adams Mark Hotel for transient business. The
downtown San Antonio market has experienced a total room increase of 780 rooms
in 1997, of which the only full-service property is the Adams Mark Hotel. In
addition, the demand in this market is at a level that has created interest by
a number of parties in expanding existing properties and/or developing new
full-service hotels. Construction is underway on the expansion of the San
Antonio Convention Center which will bring its size to 500,000 square feet,
thus ranking it as the 12th largest convention center in the country. It is
likely that the expansion to the Convention Center will create demand for
additional hotel rooms in the San Antonio market. While it is difficult to
predict the ultimate outcome of this proposal, it is likely that hotel rooms
will be added to the market and, therefore, increase the San Antonio Hotel's
competition.
Ground Lease. The San Antonio Hotel is located on a site that is leased from
an unrelated third party for an initial term expiring December 31, 2013. To
facilitate the refinancing, the Partnership exercised its option to extend the
land lease for an additional 20-year period. Therefore, the term of the San
Antonio land lease expires on December 31, 2033. The Partnership has the
option to extend the term for up to three successive terms of ten years each.
The lease provides for annual rental during the term of the lease equal to the
greater of $700,000 or 3.5% of annual gross room sales.
New Orleans Marriott Hotel, New Orleans, Louisiana
The New Orleans Hotel is a full-service Marriott hotel located on
approximately 1.88 acres of fee-owned land in the central business district in
downtown New Orleans on the western boundary of the famous French Quarter. The
Hotel is situated on Canal Street, the primary commercial route through the
downtown area. It is located approximately 12 miles from the New Orleans
International Airport.
The Hotel, which opened in July 1972, currently contains 1,290 guest rooms,
including 54 suites and 48 concierge-level guest rooms. The Hotel is comprised
of the original 42-story River Tower and the 20-story
MHP2 Supp-18
<PAGE>
Quarter Tower. Designed as part of the Marriott International network of
convention hotels, it has extensive meeting and convention facilities,
totaling 80,000 square feet, including (i) a 27,100 square foot grand
ballroom, which is the largest hotel ballroom in New Orleans, (ii) a 10,400
square foot junior ballroom and (iii) 25 meeting rooms. Hotel facilities also
include three restaurants, three lounges, a health club, an outdoor pool, a
business center, a gift shop and a 475-space parking garage.
Capital Improvements. The Hotel had 924 guest rooms when it originally
opened in 1972. A 400-room expansion was completed in 1979. The Hotel
underwent an $11.4 million renovation in 1988 which included reconfiguring
certain guest rooms, including 54 suites and 48 concierge-level guest rooms.
The completion of these two projects resulted in the 1,290 guest room count
that the Hotel currently contains. The Hotel has recently undergone a combined
renovation of Softgoods and Casegoods complete refurbishment of all of its
guest rooms at an estimated cost of $13.0 million. In addition, the Hotel
recently completed a lobby and restaurant renovation at a cost of $2.1
million.
Competition. The primary competition for the New Orleans Hotel comes from
the following three first-class convention oriented hotels in the central
business district of New Orleans: (i) the Sheraton New Orleans Hotel, (ii) the
Hyatt Regency New Orleans Hotel and (iii) the New Orleans Hilton Riverside and
Towers Hotel. These three competitors contain an aggregate of approximately
3,900 rooms and 254,000 square feet of meeting space. In addition, other
hotels in the New Orleans area also compete with the New Orleans Hotel;
however, these differ from the New Orleans Hotel in terms of size, room rates,
facilities, amenities and services offered, market orientation and/or
location. None of these other hotels are operated as part of the Marriott
International full-service hotel system. As a major convention facility, the
New Orleans Hotel also competes with similar facilities throughout the
country.
A number of smaller hotel products entered the market in 1997 adding a total
of 1,225 rooms and an additional 724 rooms are expected to be completed in
1998. None of these products are direct competitors of the New Orleans Hotel
and no new direct competitors are expected to open in New Orleans in the near-
term. However, the overall increase in room supply will affect the Hotel in
periods of weak demand.
San Ramon Marriott Hotel, San Ramon, California
The San Ramon Hotel is a full-service Marriott hotel located within the
Bishop Ranch Business Park in San Ramon, California approximately 40 miles
east of San Francisco and approximately 20 miles east of Oakland. The Hotel is
located on a leased parcel of land of approximately 11.8 acres. It is located
approximately 18 miles from the Oakland International Airport and 35 miles
from the San Francisco International Airport.
The Hotel opened in June 1989 and contains 368 guest rooms, including six
suites and 72 concierge-level guest rooms, in a six-story building. The Hotel
has approximately 16,300 square feet of meeting and banquet space, including
(i) a 10,000 square foot main ballroom, (ii) a 5,000 square foot junior
ballroom and (iii) six meeting rooms. Hotel facilities also include a
restaurant, a lounge, a heated outdoor pool, an exercise room, a sundry shop
and outdoor parking for over 560 cars.
Capital Improvements. In January 1997, the Hotel completed a $1.2 million
Softgoods renovation project. In addition, during 1997, the Hotel completed a
combined Softgoods and Casegoods refurbishment of its six suites.
Competition. The primary competition for the San Ramon Hotel comes from the
following three hotels: (i) the Pleasanton Hilton Inn, (ii) the Four Points
Hotel by Sheraton and (iii) the Marriott Residence Inn San Ramon. These three
competitors contain an aggregate of approximately 600 rooms and 21,000 square
feet of meeting space. In addition, other hotels in the San Ramon area also
compete with the San Ramon Hotel;
MHP2 Supp-19
<PAGE>
however, these differ from the San Ramon Hotel in terms of size, room rates,
facilities, amenities and services offered, market orientation and/or
location. None of these other hotels are operated as part of the Marriott
International full-service hotel system. In 1997, 225 limited service rooms
were added to the market and another 640 are expected by June 1998. No new
full-service competition is expected to open in the San Ramon area in the
near-term.
Ground Lease. The San Ramon Hotel is located on a site that is leased from
an unrelated third party for an initial term expiring in May 2014. To
facilitate the refinancing, the Partnership exercised its option to extend the
land lease for an additional 20-year period. Therefore, the current term of
the San Ramon land lease expires in May 2034. The Partnership has the option
to extend the term for up to three successive terms of ten years each. The
lease provides for annual rental during the term of the lease equal to the
greater of $350,000 or 3% of annual gross sales. The minimum rent of $350,000
may be adjusted upward beginning in June 1995, and every fifth year
thereafter, to an amount equal to 75% of the average rent paid during the
three years immediately preceding the applicable five-year period. No such
adjustment was necessary in June 1995.
Santa Clara Marriott Hotel, Santa Clara, California
The Santa Clara Hotel is a full-service Marriott hotel located in Santa
Clara, California on two leased parcels of land, totaling approximately 21.9
acres. The Hotel is situated in the center of "Silicon Valley," approximately
one mile from the Santa Clara Convention Center. It is located approximately
four miles from the San Jose International Airport and 36 miles from the San
Francisco International Airport.
The Hotel opened in June 1976. The Hotel contains 754 guest rooms, including
25 suites and 76 concierge-level guest rooms. The Hotel consists of two towers
(one 13 stories and one 10 stories) and a series of two- and three-story
buildings, all of which are interconnected. The Hotel has approximately 24,000
square feet of meeting and banquet space, which includes three separate
ballrooms, with a total of 20,200 square feet, and six meeting rooms. Hotel
facilities also include two restaurants, two lounges, an indoor/outdoor pool,
an exercise room, a game room, a gift shop and outdoor parking for over 1,200
cars.
Capital Improvements. In 1998, the Hotel is scheduled to complete a
Softgoods renovation of 202 rooms at an approximate cost of $1.8 million and a
combined Softgoods and Casegoods refurbishment of 264 rooms at an approximate
cost of $2.2 million.
Competition. The primary competition for the Santa Clara Hotel comes from
the following three hotels: (i) the Westin Santa Clara Hotel, (ii) the
Doubletree San Jose and (iii) the Embassy Suites Santa Clara Hotel. These
three competitors contain an aggregate of approximately 1,300 rooms and 46,000
square feet of meeting space. In addition, other hotels in the Santa Clara
area also compete with the Santa Clara Hotel; however, these differ from the
Santa Clara Hotel in terms of size, room rates, facilities, amenities and
services offered, market orientation and/or location. None of these other
hotels are operated as part of the Marriott International full-service hotel
system. No new competition is expected to open in the Santa Clara area in the
near-term.
LEGAL PROCEEDINGS
Two groups of limited partners of Marriott Hotel Properties II Limited
Partnerships ("MHP2"), are each asserting putative class claims in a lawsuit,
filed on April 24, 1996, Leonard Rosenblum, as Trustee of the Sylvia Bernie
Rosenblum Trust et al. v. Marriott MHP Two Corporation, et al., Case No. 96-
8377-CIV-HURLEY, and, on December 18, 1997, Mackenzie Patterson Special Fund
2, L.P. et al. v. Marriott MHP Two Corporation, et al., Case No. 97-8989-CIV-
HURLEY, respectively, against Host and certain of its affiliates alleging that
the defendants violated their fiduciary duties and engaged in fraud and
coercion in connection with a tender offer for MHP2 units. The plaintiffs
sought certification as a class action to enjoin the tender offer and damages.
The Rosenblum plaintiffs filed a fifth amended complaint and the defendants
filed a motion to dismiss and the case has been remanded to state court. The
Mackenzie Patterson plaintiffs filed a response to the judge's order to show
cause why the complaint should not be dismissed and the defendants responded
to the plaintiffs' filing and the case has been dismissed.
MHP2 Supp-20
<PAGE>
AMENDMENTS TO MHP2'S PARTNERSHIP AGREEMENT
In order to allow the Hotels of MHP2 to be leased to SLC in connection with
the Merger and the REIT Conversion, MHP2's partnership agreement must be
amended. Currently, there is no provision in MHP2's partnership agreement to
allow MHP2's Hotels to be leased. Therefore, Section 5.02B of MHP2's
partnership agreement must be amended to add a new paragraph 5.02B(xiii) to
read as follows:
(xiii) lease or consent to the lease, directly or indirectly, in one
transaction or a series of related transactions of any or all of the
Hotels.
Other Amendments. Amendments to certain terms and sections of MHP2's
partnership agreement would be made in order to (i) reduce to one the number
of appraisals of the fair market value of MHP2's Hotels that MHP2 must provide
to the MHP2 Limited Partners before the General Partner can cause MHP2 to sell
assets to the General Partner or an affiliate, (ii) delete certain obsolete
references to entities and agreements that are no longer in existence, (iii)
update MHP2's partnership agreement to reflect the passage of time since the
formation of MHP2 and (iv) make any other amendments to MHP2's partnership
agreement deemed necessary or advisable, in the sole discretion of the General
Partner, in connection with the consummation of the Merger and the REIT
Conversion. The General Partner does not believe that these amendments would
affect the rights of the MHP2 Limited Partners in any material respect nor the
duties and obligations of the General Partner. These changes are included,
along with the other proposed amendments, in the copy of MHP2's partnership
agreement, as proposed to be amended, which is attached hereto. The amended
MHP2 partnership agreement is marked to indicate the revisions made to the
existing MHP2 partnership agreement and should be read in its entirety.
Deleted provisions are contained in brackets and struck through and added
provisions are in bold type and underlined.
FAIRNESS ANALYSIS AND OPINION
FAIRNESS ANALYSIS
The General Partner believes that the Merger provides substantial benefits
and is fair to the Limited Partners of MHP2 and recommends that all Limited
Partners of MHP2 consent to the Merger. The General Partner bases this
recommendation primarily on (i) its view that the expected benefits of the
Merger for the MHP2 Limited Partners outweigh the risks and potential
detriments of the Merger to the MHP2 Limited Partners (see "Background and
Reasons for the Mergers and the REIT Conversion Reasons for the Mergers" and
"Risk Factors"), (ii) its view that the value of the OP Units allocable to the
MHP2 Limited Partners on the basis of the Exchange Value established for MHP2
represents fair consideration for the Partnership Interests held by the MHP2
Limited Partners and is fair to the MHP2 Limited Partners from a financial
point of view and (iii) the Appraisals and Fairness Opinion of AAA.
The Merger is not conditioned upon the consummation of any of the other
Mergers. The General Partner has considered this fact in evaluating the
fairness of the Merger. The General Partner believes that the fairness of the
Merger will not be materially affected by the presence or absence of any other
individual Partnership or by any particular combination of other Partnerships
and that the Merger will be fair to the MHP2 Limited Partners, individually
and as a whole, if it is consummated with any combination of other
Participating Partnerships. The General Partner bases this belief primarily on
the fact that the consideration to be paid to the MHP2 Limited Partners has
been established based upon MHP2's Exchange Value, without regard to any
possible combination of other Partnerships.
In reaching the conclusions implicit in the above recommendation, the
General Partner has taken into account the following considerations, placing
the greatest weight on the first two considerations:
. The General Partner has concluded that the Exchange Value for MHP2,
which is equal to its Adjusted Appraised Value, represents fair
consideration for the Partnership Interests of the MHP2 Limited Partners
in the Merger in relation to MHP2. The General Partner also has
concluded that the Exchange Value established for the MHP2 Limited
Partners fairly reflects the value of the assets held by MHP2. In
addition, the Fairness Opinion supports these conclusions.
. MHP2 Limited Partners will be able to defer recognition of gain until
such time as they choose to realize such gain based on their own
personal circumstances.
MHP2 Supp-21
<PAGE>
. The General Partner has concluded that the potential benefits of the
Merger to the MHP2 Limited Partners, as described under "Background and
Reasons for the Mergers and the REIT Conversion--Reasons for the
Mergers," outweigh the potential risks and detriments of the Merger for
the MHP2 Limited Partners, as described in "Risk Factors."
. The Fairness Opinion, in the view of the General Partner, supports the
fairness of the Merger, even though it includes qualifications,
limitations and assumptions relating to its scope and other factors that
MHP2 Limited Partners should consider carefully. The availability of the
Fairness Opinion is particularly significant in light of the absence of
arm's length negotiations in establishing the terms of the Merger.
. Host will contribute its wholly owned full-service hotel assets,
substantially all of its interests in the Hotel Partnerships and its
other assets (excluding its senior living assets and cash or securities
to be distributed to shareholders) to the Operating Partnership in
exchange for (i) a number of OP Units equal to the number of outstanding
shares of common stock of Host, (ii) preferred partnership interests in
the Operating Partnership corresponding to any shares of Host preferred
stock outstanding at the time of the REIT Conversion and (iii) the
assumption by the Operating Partnership of all liabilities of Host
(including past and future tax liabilities), other than liabilities of
SLC. Following these contributions, the Operating Partnership and its
subsidiaries will directly own all of Host's wholly owned hotels and all
of Host's interests in the Hotel Partnerships and Host's other assets.
Host will receive OP Units in respect of its general partner interest in
MHP2 on substantially the same basis as the Partnership Units held by
MHP2 Limited Partners. Host REIT will not receive any compensation for
its services as general partner to the Operating Partnership following
the REIT Conversion and will benefit from the operations of the
Operating Partnership only to the extent of the distributions received
based upon its percentage interest in the Operating Partnership to the
same extent as the other limited partners. Because Host REIT will share
in the value of the Operating Partnership solely through distributions
and not through any separate compensation structure, the General Partner
believes that this is a factor supporting the fairness of the Merger to
the MHP2 Limited Partners.
. The General Partner believes that the value of the consideration to be
received by the MHP2 Limited Partners in the Merger is fair in relation
to the value which would be derived by such Limited Partners under any
of the alternatives described under "Background and Reasons for the
Mergers and the REIT Conversion--Alternatives to the Mergers,"
especially since the Exchange Value of MHP2 is equal to its Adjusted
Appraised Value, which is the greatest of the three values--the Adjusted
Appraised Value, the Continuation Value and the Liquidation Value and
the historic prices paid for Partnership Units. The consideration to be
received by MHP2 Limited Partners in the Merger also is greater than the
amounts paid in recent sales of MHP2 Partnership Units, including the
June 1996 tender offer by Host. The General Partner does not believe
that the sale of any of MHP2's Hotels and liquidation of MHP2 will
obtain for MHP2 Limited Partners as much value as the value to be
received by such MHP2 Limited Partners following the Merger. The General
Partner believes that the following benefits are of the greatest value
and importance to the MHP2 Limited Partners:
. Enhanced Liquidity. The Merger and the REIT Conversion will offer
MHP2 Limited Partners significantly enhanced liquidity with respect
to their investment in MHP2 because, commencing one year following
the Effective Date, MHP2 Limited Partners who retain OP Units will
be able to exercise their Unit Redemption Right at any time, subject
to certain limited exceptions. Host has approximately 204 million
shares of common stock outstanding and is expected to have a total
common equity market capitalization of approximately $ billion
after giving effect to the estimated $ million earnings and profits
distribution (based on Host's $ closing price per share on the NYSE
on , 1998). The exercise of the Unit Redemption Right, however,
generally would result in recognition of taxable income or gain at
that time.
. Risk Diversification. Upon consummation of the REIT Conversion, each
MHP2 Limited Partner's investment will be converted from an
investment in MHP2, which owns four hotels into an investment in an
enterprise that initially will own or control approximately 120
Hotels and will have a total market capitalization of approximately
$ billion, thereby reducing the dependence
MHP2 Supp-22
<PAGE>
upon the performance of, and the exposure to the risks associated
with, any particular Hotel or group of Hotels currently owned by an
individual Partnership and spreading such risk over a broader and
more varied portfolio, including more diverse geographic locations
and multiple brands.
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a lower leverage to value ratio than
MHP2 currently, which has a leverage ratio of 56% (calculated as a
percentage of Appraised Value), resulting in interest and debt
service savings and greater financial stability.
. Regular Quarterly Cash Distributions. The General Partner expects
that the Operating Partnership will make regular quarterly cash
distributions to holders of OP Units. Host expects that distributions
by MHP2 would be higher than the estimated cash distributions by the
Operating Partnership for 1998, but the ability to receive
distributions quarterly and in regular amounts would be enhanced.
. Substantial Tax Deferral. The General Partner expects that MHP2
Limited Partners who do not elect to receive Notes in exchange for OP
Units generally should be able to obtain the benefits of the Merger
while continuing to defer recognition for federal income tax purposes
of at least a substantial portion, if not all, of the gain with
respect to their Partnership Interests that otherwise would be
recognized in the event of a liquidation of MHP2 or a sale or other
disposition of its assets in a taxable transaction.
. The General Partner believes that the economic terms of the leases of
the MHP2 Hotels are fair and reasonable from the standpoint of the
Operating Partnership.
The General Partner believes that the factors described above, which support
the fairness of the Merger to the MHP2 Limited Partners, when weighed against
the factors that may be disadvantageous, taken as a whole, indicate that the
Merger is fair to the MHP2 Limited Partners.
FAIRNESS OPINION
AAA, an independent financial advisory firm with substantial real estate and
partnership transaction experience, was engaged by the General Partner and the
other General Partners to perform the Appraisals and to render the Fairness
Opinion that (i) the Exchange Value and the methodologies and underlying
assumptions used to determine the Exchange Value, the Adjusted Appraised
Value, the Continuation Value and the Liquidation Value of MHP2 and each other
Partnership (including, without limitation, the assumptions used to determine
the various adjustments to the Appraised Values of the Hotels) are fair and
reasonable, from a financial point of view, to the MHP2 Limited Partners and
the Limited Partners of each other Partnership and (ii) the methodologies used
to determine the value of an OP Unit and to allocate the equity in the
Operating Partnership to be received by the MHP2 Limited Partners and the
Limited Partners of each other Partnership are fair and reasonable to the MHP2
Limited Partners and the Limited Partners of each other Partnership. The
Fairness Opinion is addressed to each Partnership and it may be relied upon by
each of the MHP2 Limited Partners and the Limited Partners of the other
Partnerships. The full text of the Fairness Opinion, which contains a
description of the assumptions and qualifications applicable to the review and
analysis by AAA, is set forth in Appendix B to the Consent Solicitation and
should be read in its entirety. The material assumptions and qualifications to
the Fairness Opinion are summarized below, although this summary does not
purport to be a complete description of the various inquiries and analyses
undertaken by AAA in rendering the Fairness Opinion. Arriving at a fairness
opinion is a complex analytical process not necessarily susceptible to partial
analysis or amenable to summary description. For a more complete description
of the assumptions and Qualifications that limit the scope of the Fairness
Opinion, see "--Qualifications to Fairness Opinion" and "--Assumptions" below.
Although the General Partner advised AAA that certain assumptions were
appropriate in its view, the General Partner imposed no conditions or
limitations on the scope of the investigation by AAA or the methods and
procedures to be followed by AAA in rendering the Fairness Opinion. The fees
and expenses of AAA will
MHP2 Supp-23
<PAGE>
be treated as a Merger Expense and will be paid by the Operating Partnership.
In addition, the General Partner has agreed to indemnify AAA against certain
liabilities. See "--Compensation and Material Relationships."
Qualifications to Fairness Opinion. In the Fairness Opinion, AAA
specifically states that it did not: (a) specifically consider other
methodologies for allocation of the OP Units, (b) address or conclude that
other methodologies for allocation of the OP Units to MHP2 and the other
Partnerships might not have been more favorable to the Limited Partners in
certain of the Partnerships, (c) negotiate with the General Partner, the
General Partners of the other Partnerships or Host, (d) participate in
establishing the terms of the Merger and the other Mergers, (e) provide an
opinion as to the terms and conditions of the Merger and the other Mergers
other than those explicitly stated in the Fairness Opinion, (f) make any
independent review of the capital expenditure estimates set forth in the
Engineering Study or (g) make any estimates of MHP2's and each other
Partnership's contingent liabilities. In addition, with respect to the
specific reference to the allocation of the equity interest in the Operating
Partnership to be received by the limited partners of each Partnership, AAA
has assumed that the average closing price on the NYSE of a Host REIT Common
Share for the 20 trading days after the Effective Date of the Mergers
represents a fair price.
In connection with preparing the Fairness Opinion, AAA was not engaged to,
and consequently did not, prepare any written report or compendium of its
analysis for internal or external use beyond the analysis set forth in
Appendix B. AAA will not deliver any additional written opinion of the
analysis, other than to update the written opinion if requested by the
Operating Partnership.
Experience of AAA. AAA is the world's largest independent valuation
consulting firm and is regularly and continually engaged in the valuation of
commercial real estate and businesses and their securities in connection with
tender offers, mergers and acquisitions, recapitalizations and
reorganizations, divestitures, employee stock ownership plans, leveraged
buyout plans, private placements, limited partnerships, estate and corporate
matters, other financial advisory matters and other valuation purposes.
AAA was selected because of its experience in the valuation of businesses
and their securities in connection with tender offers, mergers and
acquisitions, recapitalizations and reorganizations, including transactions
involving hotel partnerships. In addition, Host and its affiliates have
previously engaged AAA to provide appraisals and fairness opinions in
connection with other transactions. The General Partner and the other General
Partners considered two other firms for purposes of performing the appraisals
and rendering the Fairness Opinion and received proposals from each. The
General Partner selected AAA based upon price and experience.
Summary of Materials Considered and Investigation Undertaken. As a basis for
rendering the Fairness Opinion, AAA has made such reviews, studies and
analyses as it deemed necessary and pertinent in order to provide it with a
reasonable basis for the Fairness Opinion, including, but not limited to, the
following: (i) reviewed the transaction documents and SEC reporting and/or
filing documents, including drafts of the Form S-4 for the Mergers; (ii)
provided the Market Value of each Hotel owned by each Partnership in a
separate short form appraisal report and each such report was reviewed and
certified by an MAI appraiser as to its preparation in accordance with the
requirements of the Standards of Professional Practice of the Appraisal
Institute and the Uniform Standards of Professional Appraisal Practice of the
Appraisal Foundation; as part of the Appraisals, AAA reviewed historical
operating statements, 1998 budget and year-to-date results, and other
financial information as it deemed necessary as a basis for the Fairness
Opinion and the Appraisals also considered market transactions of similar
lodging properties as appropriate as a basis for the Market Value of each
Hotel; (iii) reviewed the methodologies used by each of the General Partners
in their determination of the Exchange Value of each Partnership, including
the nature and amount of all adjustments to the Appraised Values in
determining such Exchange Values; AAA reviewed and tested for the fairness and
reasonableness of all adjustments as well as for consideration of all
adjustments deemed to be appropriate by AAA; (iv) reviewed the methodologies
used by each of the General Partners in their determination of the value of an
OP Unit and the allocation of the equity interest in the Operating Partnership
to be received by the partners of each Partnership, and AAA reviewed and
tested for the fairness and reasonableness of the methods and measurements
made by the General Partners; (v) reviewed the General Partners' determination
of the Liquidation Value of each Partnership, and AAA reviewed and tested for
the fairness and reasonableness of all adjustments proposed by
MHP2 Supp-24
<PAGE>
the General Partners, as well as for consideration of all adjustments deemed
appropriate by AAA; (vi) provided an estimate of the Continuation Value of
each Partnership based upon the estimated present value of expected benefits
to be received by each limited partner interest as though the Mergers did not
occur and each Partnership's assets were sold within a twelve year period;
AAA, as part of its analysis and review, determined appropriate rates of
growth in house profit or net operating income, as well as reviewed other key
variables affecting partnership cash flows and other economic/financial
factors affecting the Partnerships' expected operations and results; (vii)
reviewed the terms of the ground leases of the Hotels and the partnership
agreement of each Partnership; (viii) reviewed audited and unaudited
historical income statements, balance sheets and statements of sources and
uses of funds of each Partnership and Host and pro forma financial information
for Host REIT; (ix) reviewed audited and unaudited historical operating
statements of each Hotel, as well as current operating statements and budgets;
(x) conducted real estate valuation and financial due diligence with respect
to the Partnerships and their underlying assets, liabilities and equity; (xi)
reviewed internal Marriott International, Host and Partnership financial
analyses and other internally generated data for each Hotel and (xii)
discussed all of the foregoing information, where appropriate, with management
of Marriott International, Host and the Partnerships and their respective
employees.
Assumptions. In rendering its opinion, AAA relied, without independent
verification, on the accuracy and completeness in all material respects of
certain relevant publicly available information and information provided to
AAA by Host and the Hotels. AAA assumed that all information furnished by
Host, the Hotels and the Partnerships and their representatives, upon which
AAA relied, presented an accurate description in all material respects of the
current and prospective status of the Hotels and the Partnerships from an
operational and financial point of view. AAA also noted that the Fairness
Opinion was based upon financial, economic, market and other considerations as
they existed and could be evaluated on the date thereof.
Conclusions. AAA concluded that, based upon and subject to its analysis and
assumptions and limiting conditions, and as of the date of the Fairness
Opinion: (i) the Exchange Value and the methodologies used to determine the
Exchange Value, the Adjusted Appraised Value, the Continuation Value and the
Liquidation Value of each Partnership (including, without limitation, the
assumptions used to determine the various adjustments to the Appraised Values
of each of the Hotels) are fair and reasonable, from a financial point of
view, to the MHP2 Limited Partners and the Limited Partners of each other
Partnership and (ii) the methodologies used to determine the value of an OP
Unit and to allocate the equity interest in the Operating Partnership to be
received by the MHP2 Limited Partners and the Limited Partners of each other
Partnership are fair and reasonable to the MHP2 Limited Partners and the
Limited Partners of each other Partnership.
Compensation and Material Relationships. AAA has been paid a fee of $335,000
for its services as described herein, including the Appraisals and preparing
to deliver the Fairness Opinion. In addition, AAA will be reimbursed for all
reasonable out-of-pocket expenses, including legal fees and will be
indemnified against certain liabilities, including certain liabilities under
the securities laws. The fee was negotiated between Host, the General Partners
and AAA. Payment of the fee to AAA is not dependent upon completion of the
Mergers. AAA has been previously engaged by Host and its affiliates to provide
appraisals, fairness opinions and solvency opinions in connection with other
transactions.
VOTING PROCEDURES
The consent of MHP2 Limited Partners holding more than 50% of the
outstanding limited partner interests in MHP2 is required for participation in
the Merger. The General Partner and its affiliate collectively own 52.7% of
the outstanding limited partner interests. The General Partner and its
affiliates are required to vote their limited partner interests in MHP2 in the
same manner as the majority of limited partner interests other than those
limited partner interests held by the General Partner and its affiliates
actually voted (so long as a majority of the outside Limited partners are
present for purposes of a vote by submitted ballets or otherwise.
As of June 19, 1998, no other person of record, or the Partnership's
knowledge owns beneficially, more than 5% of the total number of limited
Partnership Units.
MHP2 Supp-25
<PAGE>
An MHP2 Limited Partner may mark the Consent Form to vote "FOR," "AGAINST"
or "ABSTAIN" with respect to participation in a Merger by MHP2. THE FAILURE OF
A LIMITED PARTNER OF MHP2 TO RETURN A SIGNED CONSENT FORM WILL NOT BE COUNTED
FOR PURPOSES OF DETERMINING WHETHER A MAJORITY OF MHP2 LIMITED PARTNER
PARTNERSHIP INTERESTS ARE PRESENT, WHILE AN ABSTENTION WILL HAVE THE SAME
EFFECT AS IF SUCH LIMITED PARTNER HAD VOTED HIS PARTNERSHIP INTERESTS
"AGAINST" THE MERGER. LIMITED PARTNERS WHO RETURN A SIGNED CONSENT FORM BUT
FAIL TO INDICATE THEIR APPROVAL OR DISAPPROVAL AS TO ANY MATTER (INCLUDING THE
MERGER) WILL BE DEEMED TO HAVE VOTED TO APPROVE SUCH MATTER. The voting
procedures applicable to MHP2 Limited Partners are set forth in the Consent
Solicitation under the heading "Voting Procedures--Required Vote and Other
Conditions."
FEDERAL INCOME TAX CONSEQUENCES
In addition to the federal income tax consequences discussed in the sections
of the Consent Solicitation entitled "Federal Income Tax Consequences" and
"Risk Factors--Federal Income Tax Risks," MHP2 Limited Partners should read
carefully the following discussion of federal income tax consequences
applicable specifically to the MHP2 Limited Partners. The information included
in this discussion is based upon various factual assumptions and information
which are believed by the Operating Partnership and the General Partner to be
reliable. However, some of these assumptions inevitably will not materialize,
and unanticipated events and circumstances will occur. Therefore, there likely
will be differences between the information provided herein, including the
numerical data and estimates, and actual results, and the variations may be
material and adverse.
Applicability of Tax Opinions
Hogan & Hartson L.L.P. ("Hogan & Hartson"), counsel to Host REIT, Host, and
the Operating Partnership, has provided to Host REIT and the Operating
Partnership an opinion letter (substantially in the form of Appendix C to the
Consent Solicitation) as to certain federal income tax consequences to the
Operating Partnership and the MHP2 Limited Partners resulting from the Mergers
and the REIT Conversion. The opinion letter is based upon certain assumptions
and certain representations provided by Host REIT, Host, the Operating
Partnership and the General Partners. These representations generally involve
factual matters relating to the organization, ownership and operations
(including the income, assets, businesses, liabilities and properties) of the
Partnerships and Hotels contributed to the Operating Partnership by Host and
the Blackstone Entities prior to the Mergers and the REIT Conversion and of
Host REIT, the Operating Partnership and the Partnerships following the
Mergers and the REIT Conversion. In addition, on the Effective Date, Hogan &
Hartson expects to provide to Host REIT and the Operating Partnership an
opinion letter (substantially in the form of Appendix D to the Consent
Solicitation) as to the qualification and taxation of Host REIT as a REIT
under the Code following the REIT Conversion. The receipt of this opinion
letter is a condition to the REIT Conversion and each of the Mergers. See
"Federal Income Tax Consequences--Summary of Tax Opinions" in the Consent
Solicitation.
Each opinion provided by Hogan & Hartson in the opinion letter that is
substantially in the form of Appendix C to the Consent Solicitation is
applicable to the MHP2 Limited Partners.
The opinions already rendered by Hogan & Hartson are based on the Code and
Treasury Regulations in effect on the date hereof, current administrative
interpretations and positions of the IRS and existing court decisions, and the
opinions to be rendered by Hogan & Hartson on the Effective Date will be based
on the same authorities as of the Effective Date. No assurance can be given
that future legislation, Treasury Regulations, administrative interpretations
and court decisions will not significantly change the law or the above
conclusions reached by counsel. In addition, any such change could apply
retroactively to transactions preceding the date of change. Moreover, opinions
of counsel merely represent counsel's best judgment with respect to the
probable outcome on the merits and are not binding on the IRS or the courts.
Accordingly, even if there is no change in applicable law, no assurance can be
provided that such opinions (which do not bind the IRS or the courts) will not
be challenged by the IRS or will be sustained by a court if so challenged.
With the one exception described below (see "--Tax Consequences of the
Merger--Deemed Cash Distribution and Resulting Taxable Gain") and in the
Consent Solicitation under "Federal Income Tax Consequences--Tax Consequences
of the Mergers-- IRS Ruling Request Regarding Allocation of Partnership
Liabilities," neither Host REIT, the Operating Partnership
MHP2 Supp-26
<PAGE>
nor the General Partners have requested or plan to request any rulings from
the IRS concerning the tax consequences of the Merger or the treatment of
either the Operating Partnership or Host REIT subsequent to the REIT
Conversion.
Tax Consequences of the Merger
Overview. Hogan & Hartson has provided an opinion to the effect that the
Merger will not result in the recognition of taxable gain or loss at the time
of the Merger to an MHP2 Limited Partner (i) who does not exercise his Unit
Redemption Right on a date sooner than the date two years after the date of
the consummation of the Merger; (ii) who does not receive a cash distribution
(or a deemed cash distribution resulting from relief from liabilities,
including as a result of any prepayment of the MHP2 Mortgage Debt or the Santa
Clara Mortgage Debt) in connection with the Merger or the REIT Conversion in
excess of his aggregate adjusted basis in his MHP2 Partnership Units at the
time of the Merger; (iii) who does not elect to receive a Note in exchange for
his OP Units in connection with the Merger (the "Note Election"); (iv) who is
not required to recognize gain by reason of the exercise by another MHP2
Limited Partner of his right to make the Note Election (which, in counsel's
opinion, described below, should not be the result of such election) and (v)
who does not have his "at risk" amount fall below zero as a result of the
Merger or the REIT Conversion. See "Federal Income Tax Consequences--Summary
of Tax Opinions" in the Consent Solicitation.
With respect to the foregoing exceptions to nonrecognition treatment, the
Operating Partnership and the General Partner believe as follows: (i) an MHP2
Limited Partner who acquired his MHP2 Partnership Units in the original
offering of such Partnership Units and who has held such Partnership Units at
all times since would not be considered to receive, as a result of the Merger,
a distribution (or a deemed cash distribution resulting from relief from
liabilities) that exceeds his aggregate adjusted basis in his MHP2 Partnership
Units at the time of the Merger, and would not have his "at risk" amount fall
below zero as a result of the Merger, even if all of the MHP2 Mortgage Debt
and Santa Clara Mortgage Debt were to be repaid in connection with the Merger
or the REIT Conversion, and (ii) none of the personal property owned by MHP2
will need to be sold to a Non-Controlled Subsidiary in connection with the
REIT Conversion. See "Federal Income Tax Consequences--Tax Consequences of the
Mergers--Overview" in the Consent Solicitation.
With respect to the effects of an MHP2 Limited Partner's election to receive
a Note in exchange for his OP Units in connection with the Merger, Hogan &
Hartson is of the opinion that although the matter is not free from doubt, an
MHP2 Limited Partner who does not make the Note Election should not be
required to recognize gain by reason of another MHP2 Limited Partner's
exercise of such right. With respect to the exercise of a Unit Redemption
Right, Hogan & Hartson is of the opinion that it is more likely than not that
an MHP2 Limited Partner's exercise of his Unit Redemption Right more than one
year after the date of consummation of the Merger but less than two years
after such date will not cause the Merger itself to be a taxable transaction
for the MHP2 Limited Partner (or the other MHP2 Limited Partners). See
"Federal Income Tax Consequences--Summary of Tax Opinions" in the Consent
Solicitation. Opinions of counsel, however, do not bind the IRS or the courts,
and no assurances can be provided that such opinions will not be challenged by
the IRS or will be sustained by a court if so challenged.
Deemed Cash Distribution and Resulting Taxable Gain. With respect to his
MHP2 Partnership Units, an MHP2 Limited Partner will receive no actual cash
distribution in connection with the Merger but would be deemed to receive a
cash distribution in connection with the Merger to the extent that his share
of Operating Partnership liabilities immediately after the Merger and the REIT
Conversion is less than his share of MHP2 liabilities immediately prior to the
Merger. For example, any prepayment of the MHP2 Mortgage Debt or the Santa
Clara Mortgage Debt or debt encumbering other Hotels may result in a deemed
cash distribution to the MHP2 Limited Partners. See "Federal Income Tax
Consequences--Tax Consequences of the Mergers--Relief from Liabilities/Deemed
Cash Distribution" in the Consent Solicitation. Even though the MHP2 Mortgage
Debt, the Santa Clara Mortgage Debt and the debt encumbering other Hotels is
not expected to be repaid or refinanced in connection with the Mergers and the
REIT Conversion (except as described in the Consent Solicitation), an MHP2
Limited Partner's share of indebtedness following the Merger and the REIT
Conversion may nonetheless decrease in comparison to the Limited Partner's
estimated aggregate share of MHP2 indebtedness as of
MHP2 Supp-27
<PAGE>
December 31, 1998 (calculated based on the assumption that the Mergers did not
occur) by reason of the manner in which the debt allocation rules work when
multiple assets with different levels of leverage are consolidated into a
single partnership.
An MHP2 Limited Partner, however, would recognize taxable gain as a result
of any deemed cash distribution discussed in the previous paragraph only to
the extent that the deemed cash distribution were to exceed his adjusted tax
basis in his MHP2 Partnership Units immediately prior to the Merger. As noted
above, the Operating Partnership and the General Partner believe, based upon
and subject to the assumptions and other limitations described below, that an
MHP2 Limited Partner who acquired his MHP2 Partnership Units in the original
offering of such Partnership Units and has held the Partnership Units at all
times since the offering will have an adjusted tax basis in excess of the
deemed cash distribution that might occur in connection with the Merger and
the REIT Conversion, even if all of the MHP2 Mortgage Debt and the Santa Clara
Mortgage Debt were to be repaid in connection with the Merger and the REIT
Conversion, and the MHP2 Limited Partner were to have no share of any
Operating Partnership indebtedness following the Merger and the REIT
Conversion. Therefore, such an MHP2 Limited Partner should not recognize gain
due to such deemed cash distribution resulting from the relief from
liabilities in connection with the Merger and the REIT Conversion.
The adjusted tax basis of an MHP2 Limited Partner who did not acquire his
MHP2 Partnership Units in the original offering of such Partnership Units or
who has not held his MHP2 Partnership Units at all times since such offering
could vary materially from that of an MHP2 Limited Partner who did so. If an
MHP2 Limited Partner has an adjusted tax basis in his MHP2 Partnership Units
(per MHP2 Partnership Unit) that is substantially less than the adjusted tax
basis of an MHP2 Limited Partner who acquired his MHP2 Partnership Units in
the original offering of such Partnership Units and has held such Partnership
Units at all times since, he could recognize gain due to any deemed cash
distribution resulting from the relief from liabilities in connection with the
Merger and the REIT Conversion.
The Operating Partnership has no current plan or intention to cause the
prepayment of the MHP2 Mortgage Debt or the Santa Clara Mortgage Debt or,
except as described in the Consent Solicitation, any of the nonrecourse
liabilities encumbering the Hotels owned by the other Partnerships. The
Operating Partnership, however, will have to repay mortgage indebtedness
securing the Hotels owned by the Partnerships at the time such indebtedness
matures. There can be no assurance that at such time the Operating Partnership
will be able to secure nonrecourse mortgage indebtedness secured only by those
Hotels in an amount sufficient to avoid a deemed cash distribution to the
former Limited Partners in certain of those Partnerships, including MHP2
(although such a deemed distribution of cash may or may not result in the
recognition of taxable income or gain by the former MHP2 Limited Partners).
Moreover, the Operating Partnership's current long-term financing strategy is
to have as little debt as possible that is secured by individual Hotels and to
have as much debt as possible in the form of unsecured debt, held either by
the public or by institutional investors, which debt may or may not be
recourse to Host REIT, as general partner of the Operating Partnership. In
view of these considerations and the potential adverse consequences to Limited
Partners in certain Partnerships, the Operating Partnership has requested from
the IRS a ruling to the effect that such unsecured indebtedness of the
Operating Partnership that is issued initially to institutional investors and
is not recourse to Host REIT (i) would qualify as "nonrecourse liabilities"
for purposes of Code Section 752, (ii) to the extent the proceeds thereof are
applied to repay existing nonrecourse mortgage indebtedness secured by one or
more Hotels (including the MHP2 Mortgage Debt or the Santa Clara Mortgage
Debt), would be considered to be "secured" by these Hotels for purposes of
allocating the liabilities for tax basis purposes (and thus would be
allocable, at least in substantial part, to the former Limited Partners in the
Partnerships owning those Hotels, including the MHP2 Limited Partners), and
(iii) would constitute "qualified nonrecourse financing" secured by such
Hotels for purposes of Code Section 465. The IRS has recently issued a ruling
to that effect to another taxpayer, and has indicated to the Operating
Partnership's representatives that it is favorably inclined to issue that
ruling to the Operating Partnership.
Section 465(e) Recapture. As discussed in the Consent Solicitation, see
"Federal Income Tax Consequences--Tax Consequences of the Mergers--Section
465(e) Recapture," the "at risk" rules of Section 465 of the Code generally
apply to limit the use of partnership losses by a partner. Under Section
465(e)
MHP2 Supp-28
<PAGE>
of the Code, a partner would be required to include in gross income, or
"recapture," losses previously allowed to such partner with respect to his
investment in a partnership if the amount for which the partner is "at risk"
in relation to his investment in the partnership is less than zero at the
close of the taxable year.
It is possible that the consummation of the Mergers and the REIT Conversion
or the repayment of certain "qualified nonrecourse financing" of the Operating
Partnership, the Hotel Partnerships or the Hotels contributed to the Operating
Partnership by the Blackstone Entities at the time of or following the Merger
and the REIT Conversion could, singularly or in combination, cause an MHP2
Limited Partner's amount at risk in relation to his investment in MHP2 (and,
after the Mergers, in the Operating Partnership) to be reduced below zero,
resulting in an income inclusion to the Limited Partner under Section 465(e)
of the Code. Currently, all of the current debt of MHP2 constitutes "qualified
nonrecourse financing" and the Operating Partnership expects that most of the
current debt with respect to the other Hotel Partnerships and the Hotels
contributed by the Blackstone Entities that will be assumed by the Operating
Partnership as part of the Mergers and the REIT Conversion should qualify as
"qualified nonrecourse financing." The Operating Partnership and the General
Partner believe, based upon and subject to the assumptions and other
limitations described below, that an MHP2 Limited Partner who acquired his
MHP2 Partnership Units in the original offering of such Partnership Units and
has held the Partnership Units at all times since will have a positive at risk
amount immediately following the Mergers and the REIT Conversion, even if all
of the MHP2 Mortgage Debt and the Santa Clara Mortgage Debt were to be repaid
in connection with the Mergers and the REIT Conversion and the MHP2 Limited
Partners were to have no share of any other "qualified nonrecourse financing"
following the Mergers and the REIT Conversion.
It is possible, however, that a former MHP2 Limited Partner's at risk amount
could decline in the future, either because of the allocation of losses from
the Operating Partnership to that former MHP2 Limited Partner or because of
cash distributions by the Operating Partnership to that former MHP2 Limited
Partner in excess of the taxable income allocable to him with respect to his
OP Units. In that event, it may be necessary for the former MHP2 Limited
Partner to have a share of "qualified nonrecourse financing" from the
Operating Partnership in order to avoid recognizing income by reason of his at
risk amount falling below zero. Moreover, there can be no assurance that debt
incurred by the Operating Partnership in the future to refinance the MHP2
Mortgage Debt, the Santa Clara Mortgage or outstanding mortgage debt of the
other Hotel Partnerships or the Hotels contributed by the Blackstone Entities
will qualify as "qualified nonrecourse financing." If, however, the Operating
Partnership were to obtain the requested ruling from the IRS and were to
refinance existing mortgage indebtedness of the Partnerships with the type of
indebtedness described in the ruling, such indebtedness should constitute
"qualified nonrecourse financing" for purposes of the "at risk" rules.
Impact of Assumption of MHP2 Liabilities by the Operating Partnership. As
described in the Consent Solicitation, see "Federal Income Tax Consequences--
Tax Consequences of the Mergers--Disguised Sale Regulations," an MHP2 Limited
Partner will recognize gain to the extent he is treated as having sold all or
part of his MHP2 Partnership Interest in a "disguised sale." For purposes of
these rules, certain reductions in a partner's share of partnership
liabilities are treated as a transfer of money or other property from the
partnership to the partner which may give rise to a disguised sale, even if
that reduction would not otherwise result in a taxable deemed cash
distribution in excess of the partner's basis in his partnership interest.
However, if a transfer of property by a partner to a partnership is not
otherwise treated as part of a disguised sale, then any reduction in the
partner's share of "qualified liabilities" also will not be treated as part of
a disguised sale. A "qualified liability" in connection with a transfer of
property to a partnership includes (i) any liability incurred more than two
years prior to the earlier of the transfer of the property or the date the
partner agrees in writing to the transfer, as long as the liability has
encumbered the transferred property throughout the two-year period; (ii) a
liability that was not incurred in anticipation of the transfer of the
property to a partnership, but that was incurred by the partner within the
two-year period prior to the earlier of the date the partner agrees in writing
to transfer the property or the date the partner transfers the property to a
partnership and that has encumbered the transferred property since it was
incurred; (iii) a liability that is traceable under the Treasury Regulations
to capital expenditures with respect to the property; and (iv) a liability
that was incurred in the ordinary course of the trade or business in which
property transferred to the partnership was used or held, but only if all the
assets related to
MHP2 Supp-29
<PAGE>
that trade or business are transferred, other than assets that are not
material to a continuation of the trade or business. However, a recourse
liability is not a "qualified liability" unless the amount of the liability
does not exceed the fair market value of the transferred property (less any
other liabilities that are senior in priority and encumber such property or
any allocable liabilities described in (iii) or (iv), above) at the time of
transfer.
The General Partner and the Operating Partnership believe, based upon their
review of the facts and circumstances surrounding each liability, that all
liabilities of MHP2 fall into one of the four categories of "qualified
liabilities" described above and, accordingly, that the mere assumption by the
Operating Partnership of the outstanding liabilities of MHP2 will not give
rise to a "disguised sale" by any of the MHP2 Limited Partners.
Tax Treatment of MHP2 Limited Partners Who Hold OP Units Following the Merger
Initial Basis in Units. In general, an MHP2 Limited Partner will have an
initial tax basis in his OP Units received in the Merger with respect to his
MHP2 Partnership Units equal to the basis in his MHP2 Partnership Units at the
time of the Merger, reduced to reflect any deemed cash distributions resulting
from a reduction in his share of MHP2 liabilities and increased to reflect his
share of other liabilities of the Operating Partnership and any gain required
to be recognized in connection with the Merger and the REIT Conversion. For a
discussion of the federal income tax consequences for an MHP2 Limited Partner
from a reduction in basis that may result from the Merger and the REIT
Conversion, see "Federal Income Tax Consequences--Tax Treatment of Limited
Partners Who Hold OP Units Following the Mergers--Initial Tax Basis of OP
Units" in the Consent Solicitation.
Tax Allocations by the Operating Partnership upon a Sale of MHP2
Hotels. Pursuant to Section 704(c) of the Code, income, gain, loss and
deduction attributable to appreciated or depreciated property that is
contributed to a partnership must be allocated for federal income tax purposes
in a manner such that the contributor is charged with, or benefits from, the
unrealized gain or unrealized loss associated with the property at the time of
contribution. The amount of such unrealized gain or unrealized loss is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution (referred to as the "Book-Tax
Difference"). The Operating Partnership and the General Partner estimate,
based upon and subject to the assumptions and other limitations described
below, that the Book-Tax Difference for all MHP2 Limited Partners (but
excluding all of Host's interests) with respect to the MHP2 Hotels will be
$65,219,051 upon the consummation of the Merger.
If the Operating Partnership were to sell all of the MHP2 Hotels, the former
partners of MHP2 (including Host REIT with respect to Host's interest in MHP2
held through the General Partner) would be specially allocated by the
Operating Partnership an aggregate amount of taxable gain equal to the
aggregate Book-Tax Difference with respect to the MHP2 Hotels. The share of
such gain allocable to an MHP2 Limited Partner who acquired his MHP2
Partnership Units in the original offering of such Partnership Units and held
such Partnership Units at all times since would be $183,556 per MHP2
Partnership Unit if such Partnership Unit were acquired for cash, and $182,646
if such Partnership Unit were acquired pursuant to the installment purchase
plan. The share of such gain of an MHP2 Limited Partner who did not acquire
his MHP2 Partnership Units in the original offering of such Partnership Units
or who has not held his MHP2 Partnership Units at all times since such
offering could vary materially from this amount. If the Operating Partnership
were to sell an MHP2 Hotel with a Book-Tax Difference, the remaining Book-Tax
Difference at the time the Hotel is sold would be required to be allocated
exclusively to the former MHP2 Limited Partners and the General Partner, even
though the proceeds of such sale would be allocated proportionately among all
the partners in the Operating Partnership (and would likely be retained by the
Operating Partnership, rather than distributed to holders of OP Units and
Common Shares of Host REIT). The MHP2 Limited Partners would not be entitled
to any special distributions from the Operating Partnership in connection with
such a sale, and thus would not necessarily receive cash distributions from
the Operating Partnership sufficient to pay such additional taxes. Although
the Partnership Agreement does not impose any restrictions upon the Operating
Partnership
MHP2 Supp-30
<PAGE>
preventing it from causing the sale of any or all of the MHP2 Hotels at any
time following the Mergers, the Operating Partnership does not have current
plans to pursue a sale of any of the MHP2 Hotels. See "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--Sale of Individual Hotels" in the Consent Solicitation.
Tax Allocations with Respect to Contributed Hotels Generally. The tax
allocations of depreciation to the MHP2 Limited Partners may change
significantly as a result of the Mergers and the REIT Conversion for two
reasons. First, as described above, pursuant to Section 704(c) of the Code,
depreciation and deductions attributable to the MHP2 Hotels will be required
to be allocated for federal income tax purposes in a manner such that the MHP2
Limited Partners are charged with the Book-Tax Difference associated with the
MHP2 Hotels at the time of the consummation of the Merger. Consequently, an
MHP2 Limited Partner will be allocated less depreciation with respect to the
MHP2 Hotels than would be the case if the Mergers had not occurred and the
MHP2 Limited Partner had continued to hold his MHP2 Partnership Units. (On the
other hand, a former MHP2 Limited Partner will be allocated depreciation with
respect to other Hotels acquired by the Operating Partnership in connection
with the Mergers and the REIT Conversion, including the Hotels owned by the
other Hotel Partnerships and the Hotels being contributed to the Operating
Partnership by Host and the Blackstone Entities in connection with the Mergers
and the REIT Conversion.) Second, the Mergers will cause the technical
termination under Section 708(b)(1)(B) of the Code of MHP2 and most of the
other Hotel Partnerships that participate in the Merger. Section 168(i)(7) of
the Code provides, in effect, that when a partnership terminates under Section
708(b)(1)(B) of the Code, the partnership must begin new depreciation periods
for his property. As a result, the remaining bases of the real estate
components of the MHP2 Hotels and the Hotels held by the other Hotel
Partnerships that terminate will be depreciated over 39 years, rather than
over the remaining current lives of such Hotels (which range from less than
one year to 39 years). See "Federal Income Tax Consequences--Tax Treatment of
Limited Partners Who Hold OP Units Following the Mergers--Effect of Mergers on
Depreciation" in the Consent Solicitation. The impact of the technical
termination on the amount of depreciation attributable to the MHP2 Hotels will
not be as significant as the impact on other Hotels, however, as MHP2 recently
experienced a similar technical termination in June of 1996.
In light of the complexity of the governing rules affecting the calculation
and allocation of depreciation with respect to properties contributed to a
partnership, particularly when a number of those properties are subject to the
separate adjustments required in connection with a technical termination under
Section 708 of the Code, the number of Hotels that the Operating Partnership
will be acquiring in connection with the Mergers and the REIT Conversion, and
the impact on these calculations of other outside events, including equity
offerings by Host or Host REIT and other acquisitions undertaken by Host, Host
REIT or the Operating Partnership prior to or in connection with the REIT
Conversion, the Operating Partnership and the General Partner believe that it
is impossible to predict with any degree of precision the impact that the
Mergers and the REIT Conversion will have on the future depreciation (and,
consequently, the amount of taxable income) allocable to an MHP2 Limited
Partner.
Impact on Passive Activity Losses of an Investment in a Publicly Traded
Partnership. The passive loss limitation rules generally provide that
individuals, estates, trusts and certain closely held corporations and
personal service corporations can only deduct losses from passive activities
(generally activities in which the taxpayer does not materially participate,
which would include the Operating Partnership for MHP2 Limited Partners) to
the extent that such losses are not in excess of the taxpayer's income from
passive activities or investments. An MHP2 Limited Partner would be able to
offset losses from other passive activities against income from the Operating
Partnership that is considered passive income (but not portfolio income) so
long as the Operating Partnership is not treated as a publicly traded
partnership. The Operating Partnership and the General Partner believe,
however, that there is a substantial risk that the Operating Partnership will
be treated as a publicly traded partnership for purposes of the passive loss
limitation rules. In this event, any losses or deductions of the Operating
Partnership allocable to an MHP2 Limited Partner after the Merger could not be
used to offset passive income from other passive activities. Similarly, losses
from other passive activities could not be applied to offset income of the
Operating Partnership allocated to an MHP2 Limited Partner. An MHP2
MHP2 Supp-31
<PAGE>
Limited Partner, however, would be able to offset any passive losses from his
investments against any gain recognized by the MHP2 Limited Partner as a
result of the Merger.
State and Local Taxes. MHP2 Limited Partners holding Partnership Units will
be subject to state and local taxation in a number of jurisdictions in which
the Operating Partnership directly or indirectly holds real property and would
be required to file periodic tax returns in those jurisdictions. In this
regard, immediately following the Mergers and the REIT Conversion, the
Operating Partnership expects that it will own properties in approximately 28
states across the United States and the District of Columbia. Currently, MHP2
owns, directly and indirectly, properties in only three states. See "Federal
Income Tax Consequences--Tax Treatment of Limited Partners Who Hold OP Units
Following the Mergers--State and Local Taxes" in the Consent Solicitation.
Assumptions Used in Determining Tax Consequences of the Merger
In preparing the discussion set forth above, the Operating Partnership and
the General Partner made several key assumptions, which are described below.
If any such assumption is not accurate with respect to a particular MHP2
Limited Partner, the tax consequences of the Merger to such MHP2 Limited
Partner could be substantially different from those reflected above.
ACCORDINGLY, EACH MHP2 LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS
OWN TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH MHP2 LIMITED PARTNER'S
PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING
IN THE MERGER.
First, with respect to an MHP2 Limited Partner's basis in his MHP2
Partnership Units prior to the Merger, the Operating Partnership and the
General Partner assumed that an MHP2 Limited Partner acquired his MHP2
Partnership Units in the original offering of such Partnership Units and has
held such Partnership Units at all times since the offering (the "Original
Limited Partner's Adjusted Basis"). In general, each MHP2 Limited Partner had
an initial tax basis in his MHP2 Partnership Units ("Initial Basis") equal to
his cash investment in MHP2 (plus his proportionate share of the partnership's
nonrecourse liabilities at the time he acquired his MHP2 Partnership Units).
An MHP2 Limited Partner's Initial Basis generally has been increased by (a)
such Limited Partner's share of MHP2 taxable income and (b) any increases in
his share of liabilities of MHP2. Generally, such Limited Partner's Initial
Basis has been decreased (but not below zero) by (i) his share of MHP2 cash
distributions, (ii) any decreases in his share of liabilities of MHP2, (iii)
his share of losses of MHP2 and (iv) his share of nondeductible expenditures
of MHP2 that are not chargeable to capital.
The General Partner has set forth on Appendix E to the Consent Solicitation
for MHP2 (i) the Original Limited Partner's Adjusted Basis as of December 31,
1997 for each such MHP2 Limited Partner, and (ii) an estimate of such MHP2
Limited Partner's Original Limited Partner's Adjusted Basis as of December 31,
1998 (computed without regard to the Mergers and based upon the assumptions
set forth in Appendix E to the Consent Solicitation). The General Partner also
has set forth on Appendix E to the Consent Solicitation for each MHP2 Limited
Partner whose adjusted basis in his MHP2 Partnership Interest is the same as
the Original Limited Partner's Adjusted Basis (i) the MHP2 liabilities
allocable to such MHP2 Limited Partner as of December 31, 1997, and (ii) an
estimate of the MHP2 liabilities allocable to such Limited Partner as of
December 31, 1998 (computed without regard to the Mergers and based upon the
assumptions set forth in Appendix E to the Consent Solicitation). Each of
these estimates is shown separately for those MHP2 Limited Partners who
acquired their Partnership Units at the time of the original offering pursuant
to an installment purchase plan.
The adjusted tax basis of an MHP2 Limited Partner who did not acquire his
MHP2 Partnership Units in the original offering of such Partnership Units
could vary materially from that of an MHP2 Limited Partner who did so for
various reasons. If an MHP2 Limited Partner has an adjusted tax basis in his
MHP2 Partnership Units that is less than the Original Limited Partner's
Adjusted Tax Basis, the Merger might result in the receipt by the MHP2 Limited
Partner of a deemed distribution of cash in excess of his adjusted tax basis
in his MHP2 Partnership Units, which could result in the recognition of income
or gain.
MHP2 Supp-32
<PAGE>
Finally, the Operating Partnership and the General Partner assumed that the
Merger will be treated for federal income tax purposes as the transfer by the
MHP2 Limited Partners of their interests in the Partnership to the Operating
Partnership in exchange for OP Units. There can be no assurance, however, that
the IRS will not seek to recharacterize each Merger as either (i) the
liquidation of a Partnership followed by the distribution by the Partnership
of its assets to its partners and the subsequent transfers by such partners of
such assets to the Operating Partnership in exchange for OP Units, or (ii) the
transfer by a Partnership of its assets to the Operating Partnership in
exchange for OP Units (and possibly Notes) and the subsequent distribution of
such OP Units (and possibly Notes) to its partners. If the Merger is
recharacterized in the manner described in (ii) in the preceding sentence, the
tax consequences of the Merger to the MHP2 Limited Partners likely would be
materially affected.
EACH MHP2 LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX
ADVISORS TO DETERMINE THE IMPACT OF SUCH MHP2 LIMITED PARTNER'S PARTICULAR TAX
SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER.
THE TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER TO A PARTICULAR MHP2
LIMITED PARTNER COULD VARY SUBSTANTIALLY FROM THE CONSEQUENCES DESCRIBED
ABOVE.
Tax Treatment of MHP2 Limited Partners Who Exercise Their Right to Make the
Note Election
An MHP2 Limited Partner who exercises his right to make the Note Election
and receive a Note in connection with the Merger will be treated as having
made a taxable disposition of his OP Units. The amount realized in connection
with such disposition will equal the sum of the "issue price" of the Notes
(i.e., the face amount of the Note, currently estimated as $205,140 per MHP2
Partnership Unit) plus the portion of the MHP2 liabilities allocable to the
MHP2 Limited Partner for federal income tax purposes immediately prior to the
disposition of the MHP2 OP Units (estimated as $257,539 per MHP2 Partnership
Unit as of December 31, 1998). To the extent the amount realized exceeds the
MHP2 Limited Partner's adjusted basis in his MHP2 Partnership Units, the MHP2
Limited Partner will recognize gain. The Operating Partnership and the General
Partner estimate (assuming the MHP2 Limited Partner acquired his MHP2
Partnership Units at the time of the original offering and has held such
Partnership Units at all times since the offering) that the amount of gain
that would be recognized by an MHP2 Limited Partner who made the Note Election
would be approximately $151,362 per MHP2 Partnership Unit, as of December 31,
1998 if such Partnership Unit were acquired for cash, and $150,452 per MHP2
Partnership Unit if such Partnership were acquired pursuant to the installment
purchase plan. For a discussion of the federal income tax rates applicable to
the net capital gain from the sale of a capital asset, see "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--Disposition of OP Units by Limited Partners" in the Consent
Solicitation. In this regard, the General Partner estimates that, as of
December 31, 1998, if MHP2 sold all of its Hotels in a fully taxable
transaction for a net amount, after payment of liabilities, equal to the
Liquidation Value of MHP2, the "unrecognized Section 1250 gain" per MHP2
Partnership Unit would be $70,652 if such Partnership Unit were acquired for
cash, and $70,652 per MHP2 Partnership Unit if such Partnership were acquired
pursuant to the installment purchase plan. The gain subject to tax as ordinary
income under Code Section 1245 per MHP2 Partnership Unit would be $3,269 if
such Partnership Unit were acquired for cash, and $3,269 per MHP2 Partnership
Unit if such Partnership were acquired pursuant to the installment purchase
plan. An MHP2 Limited Partner who makes the Note Election would be able to
treat any per Partnership Unit passive activity loss carryforward with respect
to the activities of MHP2, to the extent the sum of such losses exceeds his
passive activity income for 1998, as losses that are not from a passive
activity and, therefore, not subject to the passive activity loss limitation
rules. For purposes of determining the gain recognized by a Limited Partner as
a result of making the Note Election, an Original Limited Partner's Adjusted
Basis does not reflect such Limited Partner's share of the syndication costs
incurred by his Partnership at formation. An original MHP2 Limited Partner's
share of syndication costs was $11,310 per MHP2 Partnership Unit.
An MHP2 Limited Partner who elects to receive a Note may be eligible to
defer at least a portion of that gain under the "installment sale" rules.
Those rules, however, will not permit the MHP2 Limited Partner to
MHP2 Supp-33
<PAGE>
defer all of the gain, and, to the extent that the face amount of the Note
(and any other installment obligations received by the taxpayer during the
year) outstanding at the end of the taxable year in which the Merger occur
exceeds $5,000,000, will require that the MHP2 Limited Partner who defers gain
pay to the IRS interest on the resulting tax that has been deferred. The MHP2
Limited Partner will not be eligible to defer gain recognized upon the receipt
of the Note to the extent that his share of MHP2 liabilities at the time of
the Merger exceeds his adjusted tax basis in his MHP2 Partnership Units
immediately prior to the Merger (that is, to the extent that he has a
"negative capital account" for tax purposes). In addition, the MHP2 Limited
Partner will not be eligible to defer gain to the extent that such gain would
be taxed as ordinary income under Section 1245 and 1250 of the Code. Lastly,
if an MHP2 Limited Partner disposes of his Note, any gain that had been
deferred would be recognized in the year of disposition.
THE SPECIFIC TAX ATTRIBUTES OF A PARTICULAR MHP2 LIMITED PARTNER COULD HAVE
A MATERIAL IMPACT ON THE TAX CONSEQUENCES OF THE MERGER AND THE SUBSEQUENT
OWNERSHIP AND DISPOSITION OF NOTES. THEREFORE, IT IS ESSENTIAL THAT MHP2
LIMITED PARTNERS CONSIDERING ELECTING TO RECEIVE NOTES CONSULT WITH THEIR OWN
TAX ADVISORS WITH REGARD TO THE APPLICATION OF THE FEDERAL INCOME TAX LAWS TO
SUCH MHP2 LIMITED PARTNERS' RESPECTIVE PERSONAL TAX SITUATIONS, AS WELL AS ANY
TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY STATE, LOCAL OR FOREIGN TAXING
JURISDICTION.
Tax Consequences if MHP2 Does Not Participate in the Merger
If MHP2 does not participate in the Merger, the MHP2 Limited Partners would
not have any tax consequences resulting from the Merger. The consequences of
continued ownership of MHP2 Partnership Units will be the same as would have
resulted if the Merger had not been proposed.
* * *
The above description is not exhaustive of all possible tax considerations
associated with the Merger and the REIT Conversion. This summary does not
discuss foreign tax considerations, nor does it discuss all of the aspects of
federal income taxation or state and local taxation that may be relevant to
MHP2 Limited Partners in light of their particular circumstances. EACH MHP2
LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX ADVISORS TO
DETERMINE THE IMPACT OF SUCH MHP2 LIMITED PARTNER'S PARTICULAR TAX SITUATION
ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER.
MHP2 Supp-34
<PAGE>
SELECTED FINANCIAL DATA
The following table presents selected historical financial data derived from
the audited financial statements for the five most recent fiscal years in the
period ended December 31, 1997 and the unaudited condensed financial
statements for the First Two Quarters 1998 and the First Two Quarters 1997.
The following data should be read in conjunction with audited financial
statements and the notes thereto, Management's Discussion and Analysis of
Financial Condition and Results of Operations and the other financial
information included elsewhere herein.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
-------------------- ----------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- ---------- ---------- ---------- ---------- ----------
(UNAUDITED) (AMOUNTS IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT)(1)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................ $ 37,946 $ 36,584 $ 69,014 $ 66,292 $ 64,002 $ 58,703 $ 57,003
Operating profit........ 18,894 18,609 31,782 30,280 28,579 25,929 24,581
Net income.............. 12,756 11,851 17,014 14,811 13,045 8,428 6,869
Distributions:
General partner....... 112 99 225 185 113 113 117
Limited partners...... 11,074 9,776 22,260 18,339 11,175 11,232 11,609
--------- --------- ---------- ---------- ---------- ---------- ----------
Total............... 11,186 9,875 22,485 18,524 11,288 11,345 11,726
Per Partnership Unit:(1)
Net income............ 16,952 15,748 22,609 19,682 17,336 11,200 9,128
Distributions......... 14,864 13,123 29,879 24,616 15,000 15,077 15,583
Cash provided by 14,130 17,484 29,979 28,664 27,008 20,895 22,688
operating activities...
Cash used in investing
activities............. (4,622) (3,704) (8,034) (5,722) (11,883) (7,925) (5,024)
Cash used in financing
activities............. (11,971) (12,048) (27,954) (28,171) (11,288) (11,345) (11,695)
(Decrease) increase in
cash and cash
equivalents............ (2,463) 1,732 (6,009) (5,229) 3,837 1,625 5,969
Ratio of earnings to
fixed charges
(unaudited)(2)......... 2.19x 2.09x 1.72x 1.66x 1.50x 1.40x 1.33x
Total assets at book
value.................. 245,957 255,053 249,418 251,740 254,113 250,461 254,184
Cash and cash
equivalents............ 7,900 18,104 10,363 16,372 21,601 17,764 16,139
Total debt.............. 219,644 222,500 221,814 222,500 222,500 222,500 222,500
Total liabilities....... 233,250 236,469 238,281 235,132 233,792 231,897 232,703
Partner's capital:
Limited partners...... 12,435 18,253 10,881 16,297 19,973 18,233 21,121
General partner....... 272 331 256 311 348 331 360
Book value per
Partnership Unit
(unaudited)(1)......... 16,691 24,501 14,605 21,875 26,809 24,474 28,350
Exchange value per
Partnership Unit
(unaudited)(1)......... 237,334 -- -- -- -- -- --
</TABLE>
- --------
(1) A Partnership Unit represents a $100,000 original investment in MHP2.
(2) The ratio of earnings to fixed charges is computed by dividing net income
before interest expense and other fixed charges by total fixed charges,
including interest expense, amortization of debt issuance costs and the
portion of rent expense that is deemed to represent interest.
MHP2 Supp-35
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
First Two Quarters 1998 Compared to First Two Quarters 1997
REVPAR, or revenue per available room, represents the combination of the
average daily room rate charged and the average daily occupancy achieved and
is a commonly used indicator of hotel performance. The following charts
summarize REVPAR and the percentage change from the prior year for each
Partnership Hotel for the first two quarters 1998 and 1997:
<TABLE>
<CAPTION>
FIRST TWO QUARTERS
-------------------------------
1998 1997
--------------- ---------------
REVPAR % CHANGE REVPAR % CHANGE
------ -------- ------ --------
<S> <C> <C> <C> <C>
San Antonio..................................... $136 8% $126 5%
New Orleans..................................... 109 -- 109 5%
San Ramon....................................... 105 15% 91 12%
Santa Clara..................................... 138 14% 121 24%
---- --- ---- ---
Combined Average................................ $123 8% $114 8%
==== === ==== ===
</TABLE>
Revenues. Partnership revenues for the first two quarters 1998 increased by
4% when compared to 1997 results. The increase in overall revenues is
primarily due to a 5% increase in total room sales. For the first two quarters
1998, REVPAR increased 8% as a result of a 11% increase in the combined
average room rate over the same period last year to approximately $153 from
$137 partially offset by a two percentage point decline in combined average
occupancy.
The MARRIOTT RIVERCENTER IN SAN ANTONIO reported a 10%, or $1.7 million,
increase in revenues for the first two quarters 1998 compared to the same
period in 1997. This increase is primarily due to a 9% increase in room
revenues to $22.8 million. Room revenues increased due to an 8% increase in
REVPAR to $136, resulting from a 7% increase in the average room rate to
approximately $154 combined with a slight increase in average occupancy. The
increase in the average room rate is primarily due to more emphasis being
placed on higher-rated transient business versus group business. Hotel
management has accomplished the increase in revenues by monitoring the number
of special corporate accounts and by replacing this business with higher-rated
transient business. The Hotel has begun a major renovation of its ballroom
which will position it to compete more effectively for banquet business in the
future.
Revenues at the NEW ORLEANS MARRIOTT HOTEL decreased 6%, or $990,000, for
first two quarters 1998 when compared to the same period in 1997. The decrease
is primarily due to a 9% decrease in food and beverage revenues and an
increase in other Hotel operating costs. For the first two quarters 1998,
average room rate increased by 6% as compared to the same period in 1997 due
to rate increases in both group and transient room rates. Average occupancy
for the first two quarters 1998 declined by five percentage points to 75%
primarily due to city wide convention group traffic being down significantly
during the first two quarters 1998. Additionally, the rooms renovation project
contributed to the shortfall by creating a lack of room availability. The
lobby and restaurant renovations have now been completed, and the rooms
renovation was completed over the July 4th weekend. In a continuing effort to
replace lost roomnights due to the major conventions rotating to other cities
in 1998, Hotel management is targeting small groups which will also enable
them to increase the average room rate.
Revenues for the first two quarters 1998 at the SAN RAMON MARRIOTT HOTEL
increased 21%, or $637,000 when compared to the same period in 1997. The
increase is due to a 19%, or $820,000, increase in room revenues. Room
revenues increased due to a significant increase in REVPAR. REVPAR increased
15% when compared to 1997 which was attributable to a 21% increase in the
average room rate to approximately $131, while average occupancy fell by four
percentage points to the low-80's. The increase in the average room rate is
MHP2 Supp-36
<PAGE>
due to Hotel management's continued success in increasing the corporate rate.
Room margins continue to maintain a 2% premium over the same period in 1997
due to an increase in room rates and cost efficiencies. In addition, sales
promotion efforts instituted an Events Booking Center to capture more of the
group business market.
The SANTA CLARA MARRIOTT HOTEL reported a 22%, or $2.2 million, increase for
the first two quarters 1998 revenues when compared to the same period in 1997.
The increase is primarily due to a 14% increase in room revenues and a 14%
increase in food and beverage revenues. Room revenues increased due to a 19%
increase in the average room rate to approximately $172, deriving a 14%
increase in REVPAR, while average occupancy decreased four percentage points
to the low-80's. The overall increase in the average room rate is supported by
an increase in regular corporate rates. Hotel management is striving to
improve occupancy by offering special corporate rates and pursuing room
contracts with local technology companies. Food and beverage revenues
increased primarily due to heavier utilization of the catering facilities by
existing groups, the implementation of a new service charge for meeting room
rental, and effective menu pricing in the Hotel's restaurant. A major rooms
renovation is planned for the Hotel this year with work scheduled to commence
in November and conclude in early 1999.
Operating Costs and Expenses. For the first two quarters 1998, operating
costs and expenses increased by $1.1 million to $19.1 million over the same
period in 1997. Operating costs and expenses increased primarily due to
increases in depreciation expense and property taxes expense.
Operating Profit. For the first two quarters 1998, operating profit
increased $285,000 to $18.9 million primarily due to an increase in revenues
which was partially offset by the increase in operating costs and expenses
discussed above.
Interest Expense. Interest expense decreased slightly for the first two
quarters 1998 compared to the same period in 1997 due to principal
amortization of the Partnership's Mortgage Debt during the first two quarters
1998
Equity in Income of Santa Clara Partnership. For the first two quarters
1998, equity in income of the Santa Clara Partnership increased by $744,000 to
$1.9 million primarily due to improved hotel operations at the Santa Clara
Hotel combined with a slight decrease in interest expense on the Santa Clara
Mortgage Debt.
Net Income. For the first two quarters 1998, net income increased by
$905,000 to $12.8 million. This increase primarily resulted from an increase
in operating profit and in equity in income of the Santa Clara Partnership.
1997 Compared to 1996
Revenues. For 1997, Partnership revenues increased to $69.0 million in 1997
from $66.3 million in 1996 due to significant increases in revenues at the San
Antonio and San Ramon Hotels. REVPAR increased 7% as a result of an 8%
increase in the combined average room rate to $132 while the combined average
occupancy remained stable at 81%. Net income for 1997 increased 15% to $17.0
million from $14.8 million in 1996. The Partnership's equity in income of the
Santa Clara Partnership increased $1.4 million in 1997 when compared to 1996
due to improved operations at the Santa Clara Hotel.
Individual hotel operating results are discussed below:
Marriott Rivercenter in San Antonio
The Marriott Rivercenter in San Antonio reported an 8%, or $2.4 million,
increase in revenues during 1997. This increase in revenues was primarily due
to an 8% increase in REVPAR to approximately $120 coupled with a 12%, or
$789,000, increase in food and beverage revenues. REVPAR increased due to a 7%
increase in the average room rate to approximately $140 combined with a 1.2
percentage point increase in average occupancy
MHP2 Supp-37
<PAGE>
to the mid-80's. The increase in the average room rate was due to an increase
in the transient average rate. Because demand has remained strong in the group
business segment, Hotel management has been able to hold out for premium rates
in the transient business segment. Group roomnights increased 6%, or 12,600
roomnights, when compared to the prior year primarily due to the major
conventions rotating back into San Antonio this year. Food and beverage
revenues increased primarily due to an increase in banquet sales as a result
of a shift in customer mix to corporate business. Although faced with the
challenge of increased competition with the openings of the Adams Mark Hotel
and the Residence Inn Alamo Plaza, Hotel management is optimistic that 1998
will be another strong year for the Hotel.
Santa Clara Marriott Hotel
The Partnership's Northern California Hotels both reported significant
increases in revenues during 1997. The Santa Clara Marriott Hotel reported a
25%, or $4.4 million, increase in revenues during 1997 when compared to 1996
results. The increase in revenues is primarily due to a 23% increase in REVPAR
to $118 as the average room rate increased 24% to approximately $147 with
average occupancy remaining stable in the low-80's. The increase in the
average room rate is the result of strong transient demand throughout the
market which has allowed the Hotel to maximize room rates in both the
transient and group business segments. Transient roomnights increased by
approximately 9,000 roomnights, a 6% increase when compared to the prior year.
Hotel management is optimistic that demand in the Silicon Valley region will
remain high throughout 1998. With no new full-service competition expected in
the coming year, Hotel management will continue its strategies of maximizing
rates and effectively managing their customer mix.
San Ramon Marriott
The San Ramon Marriott reported a 12% increase in revenues, or $706,000, for
1997 when compared to 1996. This increase was due to a 14% increase in REVPAR
to $92 as the average room rate increased 15% to approximately $111 partially
offset by a slight decrease in average occupancy to the low-80's. The increase
in the average room rate was achieved primarily as a result of an increase in
the corporate rate. In 1997, 225 limited service rooms were added to the
market and another 640 are expected to be added by June 1998. However, a
number of companies are filling the existing office space in the area and the
space currently under construction is already substantially committed. Hotel
management is optimistic that 1998 will be another successful year.
New Orleans Marriott Hotel
The New Orleans Marriott Hotel reported a slight decrease in revenues in
1997 when compared to 1996 results due to a 2%, or $904,000, decrease in room
revenues which was significantly offset by a 20%, or $783,000, increase in
food and beverage revenues. REVPAR remained stable at $97 due to a 2% increase
in the average room rate to approximately $127 partially offset by a 1.3
percentage point decrease in average occupancy to the mid-70's. The increase
in the average room rate is due to growth in the group business segment. While
group roomnights were down 8,300 roomnights in 1997 when compared to 1996, the
group mix shifted to higher-rated association business. The decrease in
average occupancy is due to the lack of city-wide groups over the summer
months. This cycle generally repeats itself every three years as it is
affected by the tradition of the conventions, which meet in different cities
on an alternating basis. Food and beverage revenues increased when compared to
the prior year primarily as a result of Super Bowl XXXI taking place in New
Orleans in January 1997. This event generated significant catering and audio
visual revenues. In addition, food and beverage revenues increased due to the
shift in customer mix to association business which more heavily utilized the
catering facilities. The Hotel is currently undergoing a complete rooms
refurbishment at an approximate cost of $13.0 million which is scheduled to be
completed in July 1998.
Operating Costs and Expenses: In 1997, operating costs and expenses
increased $1.2 million to $37.2 million primarily due to an increase in ground
rent, insurance and other. In 1997, ground rent, insurance and other increased
to $1.8 million in 1997 from $893,000 in 1996 primarily due to a loss on the
retirement of assets as a significant number of assets were retired at the New
Orleans Hotel in conjunction with the refurbishment of
MHP2 Supp-38
<PAGE>
the guest rooms, an increase in general and administrative expenses and an
increase in ground rent expense associated with improved hotel operations. As
a percentage of revenues, operating costs and expenses represented 54% of
revenues for 1997 and 1996.
Operating Profit: In 1997, operating profit increased $1.5 million to $31.8
million primarily due to the changes in revenues and operating costs and
expenses discussed above. As a percentage of total revenues, operating profit
represented 46% in 1997 and 1996.
Equity in Income of Santa Clara Partnership: In 1997, equity in income of
the Santa Clara Partnership increased to $2.0 million in 1997 from $665,000 in
1996 primarily due to improved hotel operations at the Santa Clara Hotel,
while interest expense increased only slightly from year to year on the Santa
Clara Mortgage Debt.
Net Income: In 1997, net income increased to $17.0 million in 1997 from
$14.8 million in 1996 primarily due to improved Hotel revenues and an increase
in equity in income of the Santa Clara Partnership.
1996 Compared to 1995
Revenues. For 1996, Partnership revenues increased from $64.0 million in
1995 to $66.3 million in 1996 due to a 4% increase in REVPAR. REVPAR increased
primarily due to a 5% increase in the combined average room rate to $123 while
the combined average occupancy remained stable at 81%. Net income for 1996
increased 14% to $14.8 million from $13.0 million in 1995. Interest expense
increased slightly due to refinancing expenses incurred with the extension of
the Original Mortgage Debt which are reflected as interest expense in the
accompanying statement of operations. The Partnership's equity in income of
the Santa Clara Partnership increased $546,000 in 1996 when compared to 1995
due to improved operations at the Santa Clara Hotel.
Individual hotel operating results are discussed below:
New Orleans Marriott
The New Orleans Marriott reported a 4% increase in revenues during 1996. The
increase was due to a 3% increase in REVPAR partially offset by a 3% decrease
in food and beverage revenues. REVPAR increased due to a 4% increase in
average room rate to approximately $125 while average occupancy remained
stable in the high-70's. The decline in food and beverage revenues was
primarily due to decreases in banquet sales.
Marriott Rivercenter in San Antonio
The Marriott Rivercenter in San Antonio reported a slight increase in
revenues during 1996 due to a 2% increase in REVPAR. REVPAR increased due to a
2% increase in average room rate to approximately $130 partially offset by a
1.0 percentage point decrease in average occupancy to the mid-80's.
San Ramon Marriott Hotel
Revenues at the Northern California Hotels increased significantly in 1996
when compared to 1995 results. The San Ramon Marriott Hotel reported a 15%
increase in revenues primarily due to an 11% increase in REVPAR. REVPAR
increased primarily due to an 8% increase in average room rate to
approximately $95 combined with a 1.8 percentage point increase in average
occupancy to the mid-80s.
Santa Clara Marriott Hotel
The Santa Clara Marriott Hotel reported a 19% increase in revenues in 1996.
This increase in revenues was primarily due to an 18% increase in REVPAR as
average room rate increased 14% to approximately $120 combined with a 2.8
percentage point increase in average occupancy to the low-80's.
Operating Costs and Expenses: In 1996, operating costs and expenses
increased $589,000 to $36.0 million. As a percentage of revenues, operating
costs and expenses represented 54% of revenues for 1996 and 55% for 1995.
MHP2 Supp-39
<PAGE>
Operating Profit: In 1996, operating profit increased $1.7 million to $30.3
million primarily due to the changes in revenues and operating costs and
expenses discussed above. As a percentage of total revenues, operating profit
represented 46% in 1997 and 45% in 1996.
Interest Expense: In 1996, interest expense increased to $18.3 million from
$17.8 million in 1995, primarily due to the inclusion financing costs incurred
in obtaining the extension of Original Mortgage Debt in March 1996 which were
included as interest expense in 1996.
Equity in Income of Santa Clara Partnership: In 1996, equity in income of
Santa Clara Partnership increased to $665,000 from $119,000 in 1995, primarily
due to improved hotel operations at the Santa Clara Hotel while interest
expense increased only slightly from year to year on the Santa Clara Mortgage
Debt.
Net Income: In 1996, net income increased to $14.8 million from $13.0
million in 1995, primarily due to improved Hotel revenues and an increase in
equity in income of the Santa Clara Partnership.
CAPITAL RESOURCES AND LIQUIDITY
The Partnership's financing needs have historically been funded through loan
agreements with independent financial institutions. The General Partner
believes that the Partnership will have sufficient capital resources and
liquidity to continue to conduct its operations in the ordinary course of
business.
Mortgage Debt
The Partnership is financed with mortgage debt of $222.5 million which is
nonrecourse to the Partnership and is secured by first mortgages on the
Hotels, as well as a pledge of its limited partner interest in the Santa Clara
Partnership. The mortgage debt bears interest at a fixed rate of 8.22% for an
11-year term expiring October 11, 2007. During the first loan year (October
1996 through September 1997), the mortgage debt required payments of interest
only. Subsequently, principal amortization based upon a 20-year amortization
schedule began. As a result of the required principal amortization, at the end
of the 11-year term, the mortgage debt's principal balance outstanding will
have been reduced $64.4 million. Partnership debt service was $19.2 million
for 1997 and will be $22.6 million annually thereafter until the end of the
11-year term.
The General Partner expects cash flow from the Partnership's Hotels and the
Santa Clara Hotel will be sufficient to provide for the Partnership's and the
Santa Clara Partnership's debt service.
Principal Sources and Uses of Cash
The Partnership's principal source of cash is from operations and
distributions from the Santa Clara Partnership. Its principal uses of cash are
to pay debt service on the Partnership's Mortgage Debt, to fund the property
improvement funds of the Hotels, to establish reserves required by the lender
and to make cash distributions to the partners. Additionally, in 1996, the
Partnership received cash from the General Partner Reserve and, in 1996 and
1997, utilized cash to pay financing costs incurred in connection with the
refinancing of the Partnership's Mortgage Debt and the Santa Clara Mortgage
Debt.
Total cash provided from operations was $30.0 million, $28.7 million and
$27.0 million for the years ended December 31, 1997, 1996 and 1995,
respectively. The General Partner Reserve provided total cash of $25.7 million
for the year ended December 31, 1996. Debt service paid on the Partnership's
Mortgage Debt was $19.2 million, $17.2 million and $17.3 million for the years
ended December 31, 1997, 1996 and 1995, respectively. Total cash provided by
operating activities was $14.1 million and $17.5 million for the first two
quarters 1998 and 1997, respectively. This decrease was due to a change in
operating accounts partially offset by an increase in net income.
Cash used in investing activities increased to $8.0 million in 1997 from
$5.7 million in 1996 primarily due to an increase in property and equipment
expenditures at the New Orleans Hotel associated with the rooms
MHP2 Supp-40
<PAGE>
refurbishment. Investing activities for the three years ended December 31,
1997, included the following activities. Distributions from the Santa Clara
Partnership were $2.4 million, $781,000 and $1.4 million for the years ended
December 31, 1997, 1996 and 1995, respectively. Contributions to the property
improvement funds of the Hotels were $8.2 million, $6.6 million and $6.3
million for the years ended December 31, 1997, 1996 and 1995, respectively.
Contributions to the Santa Clara Partnership property improvement fund were
$2.4 million, $2.0 million and $1.8 million for 1997, 1996 and 1995,
respectively. Cash used in investing activities increased to $4.6 million for
the first two quarters 1998 from $3.7 million for the first two quarters 1997.
Property and equipment expenditures have increased to $2.9 million as compared
to $2.8 million over the same period last year, and the net change in the
property improvement funds of the Hotels was $2.5 million and $1.9 million for
the first two quarters 1998 and 1997, respectively. Contributions to the
property improvement funds of the Hotels were $4.2 million and $4.1 million
for the first two quarters 1998 and 1997, respectively.
Cash used in financing activities decreased slightly to $28.0 million in
1997 from $28.2 million in 1996. Financing activities for the three years
ended December 31, 1997, included the following activities. The various
reserves required by the lender pursuant to the terms of the Partnership's
Mortgage Debt and the Santa Clara Mortgage Debt totaled $6.9 million and $12.8
million for the years ended December 31, 1997 and 1996, respectively. The
change in the reserve accounts includes the $6.9 million deposited into the
reserve accounts for the payment of insurance premiums and real estate taxes
as well as $854,000 of interest earned on the lender reserves reduced by $2.7
million of accrued real estates tax liabilities and $239,000 of capital
expenditure reimbursements. Cash distributed to the partners was $22.5
million, $18.5 million and $11.3 million for the years ended December 31,
1997, 1996 and 1995, respectively. Financing costs related to the refinancing
of the Partnership's Mortgage Debt and the Santa Clara Mortgage Debt totaled
$34,000 and $6.0 million for the years ended December 31, 1997 and 1996,
respectively. There were no financing costs paid in 1995. Cash used in
financing activities were $12.0 million for the first two quarters 1998 and
1997. A net increase in restricted lender reserves was partially offset by
cash utilized to make principal payments of $2.2 million on the Partnership's
Mortgage Debt. Additionally, capital distributions increased to $11.2 million
from $9.9 million for the first two quarters 1998 and 1997, respectively.
The General Partner believes that cash from Hotel operations and the
reserves established in conjunction with the refinancing will continue to meet
the short and long-term operational capital needs of the Partnership. In
August 1998, the Partnership will make a cash distribution of $6,700 per
limited partner unit from second quarter 1998 operating cash flow bringing
total distributions year to date from 1998 operating cash flow to $11,700 per
limited partner unit.
The Partnership is required to maintain the Hotels and the Santa Clara Hotel
in good condition. Under each of the Partnership Hotels and the Santa Clara
Hotel management agreements, the Partnership is required to make annual
contributions to the property improvement funds which provide funding for
replacement of furniture, fixtures and equipment. The General Partner believes
the property improvement funds, as adjusted in the case of the New Orleans
Hotel, and the capital reserves established in conjunction with the
refinancing will be adequate for the future capital repairs and replacement
needs of the Hotels and the Santa Clara Hotel. As previously reported, the
escrow contribution percentage for the New Orleans Marriott Hotel increased
from 5% to 7% in late 1997 and will continue at 7% through 1998 to allow for
adequate funding of the total rooms refurbishment of its guest rooms. This
project was completed in July 1998, and during the refurbishment, the Hotel
replaced the carpeting, bedspreads, upholstery, drapes and other similar items
as well as the dressers, chairs, beds and other furniture in the guest rooms.
The General Partner believes that cash from Hotel operations and the
reserves established in conjunction with the refinancing will continue to meet
the short and long-term operational needs of the Partnership. Including the
final 1997 distribution made in April 1998 of $9,864 per limited partner unit,
the Partnership distributed $26,621 per limited partner unit from 1997
operating cash flow. This represents a 26.6% annual return on invested
capital. In addition, in May 1998, the Partnership made a cash distribution of
$5,000 per limited partner unit from the First Quarter 1998 operating cash
flow. Prospectively, the Partnership expects to increase
MHP2 Supp-41
<PAGE>
distribution frequency from its historic bi-annual distributions if operating
results and forecasts indicate it is warranted. In addition, the General
Partner believes the property improvement funds, as adjusted in the case of
the New Orleans Hotel, and the capital reserves established in conjunction
with the refinancing will be adequate for the future capital repairs and
replacement needs of the Hotels.
INFLATION
The rate of inflation has been relatively low since the inception of the
Partnership and accordingly, has not had a significant impact on operating
results. However, the Hotels and the Santa Clara's room rates and occupancy
are inflation sensitive. The Manager is generally able to pass through
increased costs to customers through higher room rates. In 1997, the increase
in average room rates at the San Antonio, San Ramon and Santa Clara Hotels
exceeded those of direct competitors as well as the general level of
inflation. As stated above, the Mortgage Debt bears a fixed interest rate,
thereby eliminating exposure to the impact of future increases in interest
rates.
YEAR 2000 ISSUES
Over the last few years, Host Marriott, the parent company of the General
Partner, has invested in implementing new accounting systems which are Year
2000 compliant. Accordingly, the General Partner believes that future costs
associated with Year 2000 issues will be minimal and not material to the
Partnership's financial statements.
However, the Partnership does rely upon accounting software used by MHS, the
Manager of its properties to obtain financial information. The General Partner
believes that the manager has begun to implement changes to the property
specific software to ensure the software will function properly in the Year
2000 and does not expect to incur significant costs related to these
modifications.
MHP2 Supp-42
<PAGE>
FINANCIAL STATEMENTS
MHP2 Supp-43
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE PARTNERS OF MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP:
We have audited the accompanying balance sheet of Marriott Hotel Properties
II Limited Partnership (a Delaware limited partnership) as of December 31,
1997 and 1996, and the related statements of operations, changes in partners'
capital and cash flows for each of the three years in the period ended
December 31, 1997. These financial statements are the responsibility of the
General Partner's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Marriott Hotel Properties
II Limited Partnership as of December 31, 1997 and 1996, and the results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
Arthur Andersen LLP
Washington, D.C.
March 18, 1998
MHP2 Supp-44
<PAGE>
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
ASSETS
Property and equipment, net............................... $ 197,512 $ 198,826
Due from Marriott Hotel Services, Inc..................... 7,063 7,447
Deferred financing and organization costs, net............ 5,663 5,932
Other assets.............................................. 8,510 10,348
Restricted cash reserves.................................. 20,307 12,815
Cash and cash equivalents................................. 10,363 16,372
--------- ---------
$ 249,418 $ 251,740
========= =========
LIABILITIES AND PARTNERS' CAPITAL
LIABILITIES
Mortgage debt........................................... $ 221,814 $ 222,500
Investment in Santa Clara Partnership................... 8,737 8,360
Due to Marriott Hotel Services, Inc..................... 3,567 2,882
Accounts payable and accrued expenses................... 4,163 1,390
--------- ---------
Total Liabilities..................................... 238,281 235,132
========= =========
PARTNERS' CAPITAL
General Partner
Capital contribution, net of offering costs of $22...... 731 731
Capital distributions................................... (1,036) (811)
Cumulative net income................................... 561 391
--------- ---------
256 311
--------- ---------
Limited Partners
Capital contribution, net of offering costs of $8,426... 64,689 64,689
Capital distributions................................... (109,378) (87,118)
Cumulative net income................................... 55,570 38,726
--------- ---------
10,881 16,297
--------- ---------
Total Partners' Capital............................... 11,137 16,608
--------- ---------
$ 249,418 $ 251,740
========= =========
</TABLE>
See Notes to financial statements.
MHP2 Supp-45
<PAGE>
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
REVENUES (Note 3)............................... $ 69,014 $ 66,292 $ 64,002
-------- -------- --------
OPERATING COSTS AND EXPENSES
Depreciation and amortization................. 13,087 13,456 13,364
Incentive management fees..................... 9,925 9,813 9,412
Property taxes................................ 5,712 5,208 5,526
Base management fees.......................... 4,649 4,471 4,281
Ground rent, insurance and other.............. 3,859 3,064 2,840
-------- -------- --------
37,232 36,012 35,423
======== ======== ========
OPERATING PROFIT................................ 31,782 30,280 28,579
Interest expense.............................. (18,841) (18,305) (17,803)
Interest income............................... 2,047 2,171 2,150
-------- -------- --------
INCOME BEFORE EQUITY IN INCOME OF SANTA CLARA
PARTNERSHIP.................................... 14,988 14,146 12,926
-------- -------- --------
EQUITY IN INCOME OF SANTA CLARA PARTNERSHIP..... 2,026 665 119
-------- -------- --------
NET INCOME...................................... $ 17,014 $ 14,811 $ 13,045
-------- -------- --------
ALLOCATION OF NET INCOME
General Partner............................... $ 170 $ 148 $ 130
Limited Partners.............................. 16,844 14,663 12,915
-------- -------- --------
$ 17,014 $ 14,811 $ 13,045
======== ======== ========
NET INCOME PER LIMITED PARTNER UNIT (745
Units)......................................... $ 22,609 $ 19,682 $ 17,336
======== ======== ========
</TABLE>
See Notes to financial statements.
MHP2 Supp-46
<PAGE>
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNER PARTNERS TOTAL
------- -------- --------
<S> <C> <C> <C>
Balance, December 31, 1994.......................... $ 331 $ 18,233 $ 18,564
Capital distributions............................. (113) (11,175) (11,288)
Net income........................................ 130 12,915 13,045
----- -------- --------
Balance, December 31, 1995.......................... 348 19,973 20,321
Capital distributions............................. (185) (18,339) (18,524)
Net income........................................ 148 14,663 14,811
----- -------- --------
Balance, December 31, 1996.......................... 311 16,297 16,608
Capital distributions............................. (225) (22,260) (22,485)
Net income........................................ 170 16,844 17,014
----- -------- --------
Balance, December 31, 1997.......................... $ 256 $ 10,881 $ 11,137
===== ======== ========
</TABLE>
See Notes to financial statements.
MHP2 Supp-47
<PAGE>
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- --------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income.................................... $ 17,014 $ 14,811 $ 13,045
Noncash items:
Depreciation and amortization............... 13,087 13,456 13,364
Deferred incentive management fees.......... 161 414 461
Equity in income of Santa Clara
Partnership................................ (2,026) (665) (119)
Amortization of deferred financing costs as
interest................................... 303 206 489
Loss on retirement of assets................ 473 27 10
Changes in operating accounts:
Due from Marriott Hotel Services, Inc....... 384 (172) (426)
Accounts payable and accrued expenses....... 30 957 61
Other assets................................ 29 (223) --
Due to Marriott Hotel Services, Inc......... 524 (147) 123
-------- --------- --------
Cash provided by operating activities..... 29,979 28,664 27,008
-------- --------- --------
INVESTING ACTIVITIES
Additions to property and equipment, net...... (12,250) (8,300) (5,566)
Distributions from Santa Clara Partnership.... 2,403 781 1,370
Change in property improvement funds.......... 1,813 1,797 (1,341)
Additions to restricted cash reserve.......... -- -- (6,346)
-------- --------- --------
Cash used in investing activities......... (8,034) (5,722) (11,883)
-------- --------- --------
FINANCING ACTIVITIES
Capital distributions......................... (22,485) (18,524) (11,288)
Additions to restricted lender reserves, net.. (4,749) (12,815) --
Principal payments on mortgage debt........... (686) -- --
Payment of financing costs.................... (34) (6,025) --
Proceeds from mortgage loan................... -- 222,500 --
Repayment of mortgage debt.................... -- (213,307) --
-------- --------- --------
Cash used in financing activities......... (27,954) (28,171) (11,288)
-------- --------- --------
(DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS.................................... (6,009) (5,229) 3,837
CASH AND CASH EQUIVALENTS at beginning of year.. 16,372 21,601 17,764
-------- --------- --------
CASH AND CASH EQUIVALENTS at end of year........ $ 10,363 $ 16,372 $ 21,601
======== ========= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for mortgage interest............... $ 18,541 $ 17,173 $ 17,267
======== ========= ========
</TABLE>
See Notes to financial statements.
MHP2 Supp-48
<PAGE>
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
NOTE 1. THE PARTNERSHIP
Description of the Partnership
Marriott Hotel Properties II Limited Partnership (the "Partnership"), a
Delaware limited partnership, was formed to acquire and operate (i) the 1,290-
room New Orleans Marriott Hotel and underlying land in New Orleans, Louisiana
(the "New Orleans Hotel"); (ii) the 999-room Marriott Rivercenter Hotel in San
Antonio, Texas (the "San Antonio Hotel"); (iii) the 368-room Bishop Ranch
Marriott Hotel in San Ramon, California (the "San Ramon Hotel");
(collectively, the "Hotels") and (iv) a 50% limited partner interest in the
Santa Clara Marriott Hotel Limited Partnership (the "Santa Clara
Partnership"), a Delaware limited partnership, which owns the 754-room Santa
Clara Marriott Hotel in Santa Clara, California (the "Santa Clara Hotel"). The
remaining 50% interest in the Santa Clara Partnership is owned by Marriott MHP
Two Corporation (the "General Partner") with a 1% interest, and HMH
Properties, Inc., a wholly-owned indirect subsidiary of Host Marriott
Corporation ("Host Marriott") with a 49% limited partner interest.
The sole general partner of the Partnership, with a 1% interest, is MHP Two
Corporation, a wholly-owned subsidiary of Host Marriott. The General Partner
made a capital contribution of $752,525 for its 1% general partner interest.
On March 20, 1989 (the "Partnership Closing Date"), 745 limited partner
interests (the "Units"), representing a 99% interest in the Partnership, were
sold in a private placement. The offering price per Unit was $100,000, payable
in three annual installments through June 1, 1991 (the "Investor Notes"), or
as an alternative, $89,247 in cash on the Partnership Closing Date as full
payment of the subscription price. On the Partnership Closing Date, the
Partnership executed purchase agreements (the "Purchase Agreements") with Host
Marriott to acquire the Hotels and the 50% limited partner interest in the
Santa Clara Partnership for $319.5 million. Of the total purchase price,
$222.5 million was paid from proceeds of the mortgage loan (the "Original
Mortgage Debt"), $43.4 million was evidenced by a promissory note payable to
Host Marriott (the "Deferred Purchase Note"), $43.5 million was paid from a
cash distribution by the Santa Clara Partnership and the remainder from the
initial payment on the sale of the Units. The principal outstanding on the
Deferred Purchase Note was fully repaid in 1991 with the proceeds of the
Investor Notes.
The New Orleans and San Antonio Hotels and the limited partner interest in
the Santa Clara Partnership were conveyed to the Partnership on the
Partnership Closing Date and the San Ramon Hotel was conveyed to the
Partnership upon completion of its construction on May 31, 1989. The Hotels
and the Santa Clara Hotel are managed by Marriott International, Inc. under
long-term management agreements. In conjunction with the refinancing of the
Partnership's Mortgage Debt described in Note 7, Marriott International, Inc.
assigned all of its interests in the management agreements to Marriott Hotel
Services, Inc. (the "Manager"), a wholly-owned subsidiary of Marriott
International, Inc. ("Marriott International").
On June 13, 1996, MHPII Acquisition Corp. (the "Company"), a wholly-owned
subsidiary of Host Marriott, completed a tender offer for the limited
partnership Units in the Partnership. The Company purchased 377 Units for an
aggregate consideration of $56,550,000 or $150,000 per Unit. Subsequent to the
tender offer, the Company purchased an additional ten Units in the
Partnership. As a result of these transactions, the Company became the
majority limited partner in the Partnership, owning 387 Units. In 1997, the
Company acquired an additional Unit bringing its total ownership to 388 Units,
or approximately 52% of the total Units outstanding. Additionally, in a
Partnership vote held in conjunction with the tender offer, the limited
partners approved certain amendments to the Partnership Agreement that were
conditions to the tender offer. The amendments: (i) revised the provisions
limiting the voting rights of the General Partner and its affiliates to permit
the General Partner and its affiliates (including the Company) to have full
voting rights with respect to all Units currently held by the General Partner
or acquired by its affiliates except on matters where the General Partner or
its affiliates have an actual economic interest other than as a Limited
Partner or General Partner (an "Interested Transaction") and
MHP2 Supp-49
<PAGE>
(ii) modified the voting provisions with respect to Interested Transactions to
permit action to be taken if approved by limited partners holding a majority
of the outstanding Units, with all Units held by the General Partner and its
affiliates being voted in the same manner as a majority of the Units actually
voted by limited partners other than the General Partner and its affiliates.
As a result of the approval of this and the other minor amendments, the
Partnership Agreement was amended and restated effective June 14, 1996.
Partnership Allocations and Distributions
Pursuant to the terms of the Partnership Agreement, Partnership allocations,
for Federal income tax purposes, and distributions are generally made as
follows:
a. Cash available for distribution is distributed for each fiscal year
semi-annually as follows: (i) 100% to the limited partners until the
limited partners have received with respect to such fiscal year a non-
cumulative 10% preferred distribution on their Invested Capital, as
defined; (ii) 100% to the General Partner until the General Partner has
received an amount equal to 1/99th of the amount distributed to the limited
partners; (iii) 1% to the General Partner and 99% to the limited partners
until such time as the limited partners have received the 15% Preferred
Distribution, as defined, plus $50,000 per Unit, payable only from Capital
Receipts, as defined, to the extent available after the payment of the 15%
Preferred Distribution; and (iv) thereafter, 20% to the General Partner and
80% to the limited partners.
b. Refinancing and sales proceeds ("Capital Receipts") available for
distribution to the partners will be distributed as follows: (i) 1% to the
General Partner and 99% to the limited partners until the limited partners
have received cumulative distributions from Capital Receipts equal to the
15% Preferred Distribution plus $100,000 per Unit; and (ii) 20% to the
General Partner and 80% to the limited partners.
c. Net profits generally will be allocated to the partners in proportion
to the distributions of cash available for distribution.
d. Net losses generally will be allocated 75% to the General Partner and
25% to the limited partners.
e. Gains recognized by the Partnership will be allocated in the following
order of priority: (i) to all partners up to the amount necessary to bring
the limited partners' capital account balances to an amount equal to the
limited partners' 15% Preferred Distribution plus the limited partners'
Invested Capital and to bring the General Partner's capital account balance
to an amount equal to 1/99th of the capital account balance of the limited
partners; and (ii) 20% to the General Partner and 80% to the limited
partners.
For financial reporting purposes, profits and losses are generally allocated
among the partners based on their stated interests in cash available for
distribution.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting
The Partnership records are maintained on the accrual basis of accounting
and its fiscal year coincides with the calendar year.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Revenues and Expenses
Hotel revenues represent house profit of the Partnership's Hotels since the
Partnership has delegated substantially all of the operating decisions related
to the generation of house profit of the Hotels to the Manager.
MHP2 Supp-50
<PAGE>
House profit reflects hotel operating results which flow to the Partnership as
property owner and represents gross hotel sales less property-level expenses,
excluding depreciation and amortization, base and incentive management fees,
property taxes, ground rent, insurance and other costs, which are disclosed
separately in the statement of operations.
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding the property-level revenues and operating expenses of its Hotels
from its statement of operations (see Note 3). If the Partnership concludes
that EITF 97-2 should be applied to its Hotels, it would include operating
results of those managed operations in its financial statements. Application
of EITF 97-2 to financial statements as of and for the year ended December 31,
1997 would have increased both revenues and operating expenses by
approximately $85,949,000 and would have had no impact on net income.
Property and Equipment
Property and equipment is recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives as follows:
<TABLE>
<S> <C>
Land improvements.......................................... 40 years
Building and improvements.................................. 30 to 40 years
Leasehold improvements..................................... 40 years
Furniture and equipment.................................... 3 to 10 years
</TABLE>
All property and equipment is pledged as security against the Mortgage Debt
described in Note 7.
The Partnership assesses impairment of its real estate properties based on
whether estimated undiscounted future cash flows from such properties on an
individual hotel basis will be less than their net book value. If a property
is impaired, its basis is adjusted to fair market value.
Deferred Financing and Organization Costs
Deferred financing and organization costs consist of loan fees and legal and
accounting costs incurred in connection with obtaining Partnership financing
and the formation of the Partnership. Deferred financing costs totaling
$3,280,000 were fully amortized at March 21, 1996. Additional financing costs
of $34,000 and $6,025,000 were incurred in 1997 and 1996, respectively, in
connection with the refinancing of the Partnership's mortgage loan. Financing
costs are amortized using the straight-line method, which approximates the
effective interest method, over the 20 year loan term. At December 31, 1997
and 1996, accumulated amortization of deferred financing and organization
costs totaled $396,000 and $92,000, respectively.
Restricted Cash Reserve
In 1994, a restricted cash reserve consisting of funds generated in excess
of an annual 17.5% return on partners' invested capital, as defined, was
established in an escrow account maintained by the lender. Through October of
1995, deposits were made in conjunction with the bi-annual distributions to
the limited partners. At the time the mortgage debt matured on March 21, 1996,
the Partnership applied the balance in the reserve as of December 31, 1995,
$9,193,000, to the principal balance of the mortgage loan as a condition to
the extension of the loan agreement.
On September 23, 1996, the General Partner refinanced the Partnership's
mortgage debt. On this date, the Partnership was required to establish certain
reserves which are held by an agent of the lender including:
. $7.0 million Owner Funded Capital Expenditure Reserve--The funds will be
expended for various renewals, replacements and site improvements that
are the Partnership's obligation pursuant to the management agreement. A
majority of these projects were completed in 1997 utilizing escrow funds
and the General Partner will be seeking reimbursement of these funds
during 1998.
MHP2 Supp-51
<PAGE>
. $1.1 million Capital Expenditure Reserve--The funds will be expended for
Americans with Disabilities Act of 1990 modifications and environmental
remediation projects identified during the course of the appraisals and
environmental studies undertaken in conjunction with the refinancing. A
majority of these projects were completed in 1997 utilizing escrow funds
and the General Partner will be seeking reimbursement of these funds
during 1998.
. $4.5 million Debt Service Reserve--Based upon current forecasts, it is
expected that cash from operations will be sufficient for the required
payment terms of the Mortgage Debt. However, due to seasonality of the
four hotels' operations, the timing of debt service payments and the
lender's desire for additional security, the Partnership was required to
establish a debt service reserve for both the Partnership Mortgage Debt
and the Santa Clara Partnership mortgage debt totaling two months of
debt service.
. $155,000 Ground Rent Reserve--This reserve is equal to one month of
ground rent.
These reserves were funded by using $12.2 million from the General Partner
Reserve and $634,000 from the Partnership and the Santa Clara Partnership
property improvement funds.
The loan agreement also requires that the Partnership deposit into the
Capital Expenditure Reserve $1.0 million in December of each calendar year
commencing in December 1997 until a total of $5.0 million has been deposited
to be used for air conditioning system maintenance at the New Orleans Hotel.
In addition, the loan agreement requires that should the long-term senior
unsecured debt of Marriott International be downgraded by Standard and Poors
Rating Services from an A- to a BBB+, additional reserves would need to be
established by the Partnership. In March 1997, Marriott International acquired
the Renaissance Hotel Group N.V., adding greater geographic diversity and
growth potential to its lodging portfolio. The assumption of additional debt
associated with this transaction resulted in a single downgrade of Marriott
International's long-term senior unsecured debt effective April 1, 1997.
Accordingly, at that time, the Partnership transferred $1.3 million from the
Manager's existing tax and insurance reserve account and $465,000 from
Partnership cash to the lender to establish a separate escrow account for the
payment of the next succeeding insurance premiums and real estate taxes for
the Hotels and the Santa Clara Hotel. In the future, the Partnership will make
deposits to the reserve account each period and the insurance premiums and
real estate taxes will continue to be paid by the lender until such time as
Marriott International's debt is upgraded to A-. In addition, the Partnership
was required to deposit an additional month's debt service for both the
Partnership and the Santa Clara Partnership into the Debt Service Reserve
account totaling $2.3 million. The money to fund these reserves had been set
aside by the General Partner prior to the distribution of the excess of the
General Partner reserve made to the partners in April 1997. The tax and
insurance reserves and the Debt Service Reserve are included in restricted
cash reserves and the resulting tax and insurance liability is included in
accounts payable and accrued expenses in the accompanying balance sheet.
Cash and Cash Equivalents
The Partnership considers all highly liquid investments with a maturity of
three months or less at date of purchase to be cash equivalents.
Investment in Santa Clara Partnership
The Partnership's earnings from the Santa Clara Partnership are recorded
based on the equity method of accounting. Equity in earnings from the Santa
Clara Partnership includes 100% of the interest expense related to the debt
incurred by the Santa Clara Partnership, the proceeds of which were
distributed to the Partnership. The $28.4 million excess of the purchase price
of the Santa Clara Partnership interest over the Partnership's proportionate
share of the net book value of the assets acquired is being amortized over the
related remaining lives of those assets. Amortization is included in Equity in
Income of Santa Clara Partnership in the accompanying statement of operations.
At December 31, 1997 and 1996, accumulated amortization of the excess purchase
price of the Santa Clara Partnership investment was $11,917,000 and
$11,006,000, respectively.
MHP2 Supp-52
<PAGE>
Pursuant to the terms of the Santa Clara partnership agreement, the
Partnership has an obligation to make capital contributions to fund certain
debt service shortfalls to the extent debt service is greater than 50% of cash
flow available before debt service (the "Debt Service Advances"). No
contributions were made in 1997 and 1996. Any outstanding Debt Service
Advances, together with accrued interest, would have been repayable prior to
certain distributions and would have been due, in any event, ten years after
the date of each advance. There have been no Debt Service Advances since
inception of the Santa Clara Partnership.
Interest Rate Swap Agreements
As of December 31, 1995, the Partnership was a party to an interest rate
swap agreement to reduce the Partnership's exposure to floating interest
rates. The Partnership accounted for the swap arrangement as a hedge of an
obligation to pay floating rates of interest and accordingly, recorded
interest expense based upon its payment obligation at a fixed rate. This
agreement terminated at the initial maturity of the Partnership's mortgage
loan on March 21, 1996.
Income Taxes
Provision for Federal and state income taxes has not been made in the
accompanying financial statements since the Partnership does not pay income
taxes but rather allocates its profits and losses to the individual partners.
Significant differences exist between the net income for financial reporting
purposes and the net income as reported in the Partnership's tax return. These
differences are due primarily to the use, for income tax purposes, of
accelerated depreciation methods and shorter depreciable lives of the assets
and differences in the timing of recognition of incentive management fee
expense. As a result of these differences, the deficit of the net assets
reported in the accompanying financial statements over the tax basis in net
Partnership assets is $85.9 million and $87.9 million as of December 31, 1997
and 1996, respectively. Following the Company's acquisition of limited partner
interests in the Partnership in 1996, the Partnership underwent a termination
and constructive liquidation for tax purposes. All partners were then deemed
to recontribute their assets to a newly reconstituted partnership. Upon
recontribution the Partnership recorded the fixed assets at their fair market
value for tax reporting purposes, as represented by the Company's purchase
price for limited partner units resulting in a significant change in the 1996
tax basis when compared to the prior year.
Statement of Financial Accounting Standards
In the First Quarter of 1996, the Partnership adopted Statement of Financial
Accounting Standards ("SFAS") No. 121 "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of." Adoption of SFAS
No. 121 did not have an effect on its financial statements.
Reclassifications
Certain reclassifications were made to the prior year's financial statements
to conform to the 1997 presentation.
MHP2 Supp-53
<PAGE>
NOTE 3. REVENUES
Partnership revenues consist of the Hotels' operating results for the three
years ended December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------- ------- -------
<S> <C> <C> <C>
HOTEL SALES
Rooms............................................ $101,603 $98,436 $93,292
Food and beverage................................ 44,877 42,427 42,198
Other............................................ 8,483 8,171 7,215
-------- ------- -------
154,963 149,034 142,705
======== ======= =======
HOTEL EXPENSES
Departmental direct costs
Rooms.......................................... 19,676 18,878 18,416
Food and beverage.............................. 31,439 30,496 28,975
Other hotel operating expenses................. 34,834 33,368 31,312
-------- ------- -------
85,949 82,742 78,703
-------- ------- -------
REVENUES........................................... $ 69,014 $66,292 $64,002
======== ======= =======
</TABLE>
NOTE 4. PROPERTY AND IMPROVEMENTS
Property and equipment consists of the following as of December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Land and improvements.................................... $ 17,091 $ 17,091
Building and improvements................................ 107,826 105,382
Leasehold improvements................................... 118,978 111,197
Furniture and equipment.................................. 51,848 61,206
-------- --------
295,743 294,876
Less accumulated depreciation............................ (98,231) (96,050)
-------- --------
$197,512 $198,826
======== ========
</TABLE>
NOTE 5. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments are shown below. The fair
values of financial instruments not included in this table are estimated to be
equal to their carrying amounts.
<TABLE>
<CAPTION>
AS OF AS OF
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------ ------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- --------- -------- ---------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C>
Mortgage debt............................ $221,814 $230,700 $222,500 $222,500
Incentive management fees due to Marriott
Hotel
Services, Inc........................... 2,739 800 2,578 170
</TABLE>
The 1996 and 1997 estimated fair value of the mortgage debt obligation is
based on the expected future debt service payments discounted at risk adjusted
rates. Incentive management fees due are valued based on the expected future
payments from operating cash flow discounted at risk adjusted rates.
MHP2 Supp-54
<PAGE>
NOTE 6. SANTA CLARA PARTNERSHIP
Summarized financial information for the Santa Clara Partnership consists of
the following as of December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
BALANCE SHEET
Property and equipment..................................... $28,688 $30,144
Due from Marriott International, Inc....................... 2,059 2,170
Property improvement fund.................................. 2,619 1,230
Cash and cash equivalents.................................. 3,177 1,933
------- -------
Total Assets........................................... $36,543 $35,477
======= =======
Mortgage debt.............................................. $43,366 $43,500
Due to Marriott International, Inc......................... 970 749
Accounts payable and accrued expenses...................... 482 522
Partners' Deficit.......................................... (8,275) (9,294)
------- -------
Total Liabilities and Partners' Deficit................ $36,543 $35,477
======= =======
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS
REVENUES................................... $ 21,709 $ 17,347 $ 14,516
OPERATING COSTS AND EXPENSES
Depreciation and amortization............ 3,013 2,927 2,765
Interest................................. 3,625 3,318 3,063
Incentive management fees................ 3,401 2,652 2,175
Base management fees..................... 1,420 1,224 1,079
Property taxes........................... 470 499 508
Ground rent, insurance and other......... 281 264 201
---------- ---------- ----------
12,210 10,884 9,791
---------- ---------- ----------
NET INCOME................................. $ 9,499 $ 6,463 $ 4,725
========== ========== ==========
</TABLE>
NOTE 7. MORTGAGE DEBT
As of December 31, 1995, the Partnership's debt consisted of a $222.5
million mortgage loan (the "Original Mortgage Debt"). The Original Mortgage
Debt was nonrecourse to the Partnership and was secured by a first mortgage on
each of the Hotels including the grant of a security interest in the
Partnership's furniture, fixtures and equipment, contracts and other
intangibles and an assignment of the Partnership's rights under the Management
and Purchase Agreements.
At the option of the Partnership, the Original Mortgage Debt loan agreement
provided for interest rate options which were tied to a Eurodollar rate, an
adjusted CD rate or the fluctuating corporate base rate. For Eurodollar or CD
elections, the Partnership paid the applicable rate plus an increment equal to
0.9 percentage points. In April 1992, the Partnership entered into an interest
rate swap agreement for the entire loan amount with the primary lender to
effectively fix the interest rate on the Original Mortgage Debt at 7.8% per
annum from May 1992 through loan maturity. The Partnership's obligations under
the swap agreement were secured by a pledge of collateral by the General
Partner. The weighted average interest rate on the Original Mortgage Debt for
the year ended December 31, 1995 was 7.8%. The interest rate swap agreement
expired on March 21, 1996.
MHP2 Supp-55
<PAGE>
On March 21, 1996, the Original Mortgage Debt and the Santa Clara mortgage
debt matured, at which time the lender granted the Partnership an extension of
the two loans for an additional six months until replacement financing could
be finalized with another lender. Under the terms of the extension, interest
accrued at the London interbank offered rate ("LIBOR") plus 1.875 percentage
points for the first three months and accrued at LIBOR plus 2.25 percentage
points for the second three months. No principal amortization was required
during the extension period. However, under the terms of the extension, the
Partnership applied the $9.2 million accumulated in the primary lender reserve
account to pay down the principal balance of the Original Mortgage Debt to
$213.3 million and deposited $19.1 million into the primary lender reserve
account. The primary lender reserve account was established in 1994 to provide
funds for a principal paydown on the Original Mortgage Debt at maturity. The
$19.1 million deposit represented the balance ($16.8 million) from the
unrestricted reserve account included in cash in the accompanying balance
sheet as of December 31, 1995, previously established by the General Partner
in 1992 (the "General Partner Reserve") and cash flow from the Partnership for
the first two accounting periods of 1996 ($2.3 million). During the extension
period, the Partnership also was required to deposit into the primary lender
reserve account all cash flow from the Hotels plus all of the Partnership's
cash flow from the Santa Clara Partnership, net of (i) $500,000 per accounting
period, (ii) debt service and (iii) current incentive management fees paid.
The $500,000 per accounting period was deposited into a separate expense
reserve account which was used by the Partnership to fund administrative
expenses and refinancing costs, any owner funded capital expenditures, as well
as the Partnership's share of any such costs incurred by the Santa Clara
Partnership during the six month extension period.
On September 23, 1996 (the "Closing Date"), the General Partner refinanced
the Partnership's Original Mortgage Debt, as well as the $43.5 million
mortgage debt of the Santa Clara Partnership. A total of $266.0 million was
borrowed from a new third party lender, $222.5 million of which is recorded on
the Partnership's financial statements (the "Mortgage Debt"). The
Partnership's Mortgage Debt is nonrecourse to the Partnership and is secured
by first mortgages on the Hotels, as well as a pledge of its limited partner
interest in the Santa Clara Partnership. The two loans are cross-defaulted.
The debt bears interest at a fixed rate of 8.22% for an 11-year term expiring
October 11, 2007, requires payments of interest only during the first loan
year (October 1996 through September 1997). Subsequently, principal
amortization based upon a 20-year amortization schedule beginning with the
second loan year. The mortgage debt balance was $221.8 million as of December
31, 1997. The weighted average interest rate on the Mortgage Debt for the
years ended December 31, 1997 and 1996 was 8.2% and 7.7%, respectively. On the
Closing Date, the Partnership was required to establish certain reserves. In
addition, a new reserve was established in 1997 and additional amounts were
deposited into the existing reserves. All reserves are discussed in Note 2.
The required principal payments of the Mortgage Debt at December 31, 1997
are as follows (in thousands):
<TABLE>
<S> <C>
1998................................................................ $ 4,379
1999................................................................ 4,759
2000................................................................ 5,119
2001................................................................ 5,614
2002................................................................ 6,100
Thereafter.......................................................... 195,843
--------
$221,814
========
</TABLE>
NOTE 8. LAND LEASES
The San Antonio and San Ramon Hotels are located on sites with ground leases
from unrelated third parties. The initial lease terms expire in 2013 and 2014,
respectively. To facilitate the refinancing, the Partnership exercised its
option to extend the land leases of both properties for an additional twenty-
year period. Therefore, the current terms of the San Antonio and San Ramon
land leases expire in 2033 and 2034, respectively. The Partnership is
obligated to pay annual rent equal to the greater of a minimum rent or a
percentage rent and has the option to extend the terms for up to three
successive ten-year terms each. Ground rent on the San Antonio
MHP2 Supp-56
<PAGE>
Hotel is equal to the greater of $700,000 or 3.5% of annual gross room sales.
Ground rent on the San Ramon Hotel is equal to the greater of $350,000 or 3%
of annual gross sales for the first five years, after which minimum rent was
adjusted upward every five years, beginning in 1989, to an amount equal to 75%
of the average rent paid during the three years immediately preceding the
applicable five-year period. No such adjustment was necessary at that time.
Ground rent expense for the San Antonio and San Ramon Hotels totaled
$2,122,000, $1,982,000 and $1,879,000, for the years ended December 31, 1997,
1996 and 1995, respectively.
Future minimum annual rental commitments for all land leases entered into by
the Partnership, as described above, are as follows (in thousands):
<TABLE>
<CAPTION>
FISCAL YEAR LAND LEASES
----------- -----------
<S> <C>
1998............................................................. $ 1,050
1999............................................................. 1,050
2000............................................................. 1,050
2001............................................................. 1,050
2002............................................................. 1,050
Thereafter....................................................... 32,900
-------
Total Minimum Lease Payments................................... $38,150
=======
</TABLE>
NOTE 9. MANAGEMENT AGREEMENTS
The Partnership entered into long-term hotel management agreements (the
"Management Agreements") with the Manager to manage the Hotels as part of the
Marriott International, Inc. full service hotel system. The Management
Agreement for each Hotel has an initial term expiring on December 31, 2008. To
facilitate the refinancing, the Manager exercised its option to renew the
Management Agreements for each Hotel for an additional 10-year term.
Therefore, the current terms of the Management Agreements for each Hotel
expire on December 31, 2018. This, as well as the assignment of the Management
Agreements described in Note 1, and other minor changes were documented in an
amendment to each of the Management Agreements. The Manager has the option to
renew the Management Agreements for up to three additional 10-year terms. The
Manager also manages the Santa Clara Hotel on behalf of the Santa Clara
Partnership. The Manager is paid a base management fee equal to 3% of gross
hotel sales. Base management fees paid in 1997, 1996 and 1995 were $4,649,000,
$4,471,000 and $4,281,000, respectively.
In addition, the Manager is entitled to an incentive management fee equal to
20% of each Hotel's Operating Profit, as defined. The incentive management fee
with respect to each Hotel is payable only out of 55% of each Hotel's
Operating Profit after the Partnership's payment or retention for such fiscal
year of the following: (i) the Ground Rent, if any, with respect to such
Hotel; (ii) the Qualifying Debt Service, as defined, with respect to such
Hotel; (iii) such Hotel's Pro-Rata Share of Total Mortgage Debt Service
Shortfall, as defined, if any, with respect to all Hotels; and (iv) the
Partnership's non-cumulative 10% Priority Return on the Adjusted Contributed
Capital, as defined, with respect to such Hotel.
Unpaid incentive management fees are accrued without interest and are paid
from cash flow available for incentive management fees following payment of
any then current incentive management fees. Incentive management fees earned
for the years ended December 31, 1997, 1996 and 1995 were $9,925,000,
$9,813,000 and $9,412,000, respectively. Deferred incentive management fees
for the years ended December 31, 1997 and 1996 were $2,739,000 and $2,578,000,
respectively, and are included in Due to Marriott Hotel Services, Inc. in the
accompanying balance sheet.
Pursuant to the Management Agreements, the Manager is required to furnish
the Hotels with certain services ("Chain Services") which are generally
provided on a central or regional basis to all hotels in the Manager's full-
service hotel system. Chain Services include central training, advertising and
promotion, a national reservations system, computerized payroll and accounting
services and such additional services as needed which
MHP2 Supp-57
<PAGE>
may be more efficiently performed on a centralized basis. Costs and expenses
incurred in providing such services are allocated among all domestic full-
service hotels managed, owned or leased by the Manager or its subsidiaries. In
addition, the Hotels also participate in the Manager's Marriott Rewards
Program ("MRP"). This program succeeded the Manager's Honored Guest Awards
Program. The cost of this program is charged to all hotels in the Manager's
hotel system based upon the MRP sales at each hotel. The total amount of Chain
Services and MRP costs charged to the Partnership for the years ended December
31, 1997, 1996 and 1995 were $5,593,000, $5,433,000 and $5,151,000,
respectively, and are included in Revenues (as defined in Note 3) in the
accompanying statement of operations.
The Management Agreements provide for the establishment of a property
improvement fund for each Hotel to cover the cost of certain non-routine
repairs and maintenance to the Hotels which are normally capitalized and the
cost of replacements and renewals to the Hotels' property and improvements.
Contributions to the property improvement fund are based on a percentage of
gross sales. Contributions to the property improvement fund for the San
Antonio Hotel are 4% in 1991 through 1998 and 5% thereafter. Contributions to
the property improvement fund for the San Ramon Hotel are 4% in 1994 through
1998 and 5% thereafter. Contributions to the property improvement fund for the
New Orleans Hotel are 5% each year; however, the contribution percentage was
increased to 7% for 1997 and 1998. Commencing with fiscal year 2003, the
Manager shall have the right, but not the obligation, to increase the amount
it transfers into the fund to any amount greater than 5% but not exceeding 6%
of gross sales. Total contributions to the property improvement fund for the
years ended December 31, 1997, 1996 and 1995 were $8,193,000, $6,622,000 and
$6,342,000, respectively.
Pursuant to the terms of the Management Agreements, the Partnership is
required to provide the Manager with working capital and supplies to meet the
operating needs of the Hotels. The Manager converts cash advanced by the
Partnership into other forms of working capital consisting primarily of
operating cash, inventories, and trade receivables and payables which are
maintained and controlled by the Manager. Upon termination of any of the
Management Agreements, the working capital and supplies of the related Hotel
will be returned to the Partnership. The individual components of working
capital and supplies controlled by the Manager are not reflected in the
Partnership's balance sheet. As of December 31, 1997 and 1996, $6,633,000 has
been advanced to the Manager for working capital and supplies which is
included in Due from Marriott Hotel Services, Inc. in the accompanying balance
sheet. The supplies advanced to the Manager are recorded at their estimated
net realizable value.
Each of the Management Agreements also provides that the Partnership may
terminate any of the Management Agreements and remove the Manager if, during
any three consecutive fiscal years after fiscal year 1992, with respect to any
Hotel, the sum of the operating profit before real and personal property
taxes, fails to equal or exceed 8% of the sum of the original cost of the
Hotel plus certain additional hotel investments by the Partnership. The
Manager may, however, prevent termination by paying to the Partnership such
amounts as are necessary to achieve the above performance standards.
MHP2 Supp-58
<PAGE>
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
CONDENSED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
----------------
1998 1997
------- -------
<S> <C> <C>
REVENUES..................................................... $37,946 $36,584
------- -------
OPERATING COSTS AND EXPENSES
Depreciation............................................... 6,285 6,042
Incentive management fees.................................. 5,550 5,410
Property taxes............................................. 3,178 2,760
Base management fees....................................... 2,390 2,303
Ground rent................................................ 1,090 993
Insurance and other........................................ 559 467
------- -------
19,052 17,975
------- -------
OPERATING PROFIT............................................. 18,894 18,609
Interest expense........................................... (8,708) (8,827)
Interest income............................................ 714 957
------- -------
INCOME BEFORE EQUITY IN INCOME OF SANTA CLARA PARTNERSHIP.... 10,900 10,739
------- -------
EQUITY IN INCOME OF SANTA CLARA PARTNERSHIP.................. 1,856 1,112
------- -------
NET INCOME................................................... $12,756 $11,851
======= =======
ALLOCATION OF NET INCOME
General Partner............................................ $ 127 $ 119
Limited Partners........................................... 12,629 11,732
------- -------
$12,756 $11,851
======= =======
NET INCOME PER LIMITED PARTNER UNIT
(745 Units)................................................. $16,952 $15,748
======= =======
</TABLE>
See Notes to Condensed Financial Statements.
MHP2 Supp-59
<PAGE>
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
CONDENSED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 19, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Property and equipment, net............................ $194,173 $197,512
Due from Marriott Hotel Services, Inc.................. 10,208 7,063
Other assets........................................... 11,031 8,510
Deferred financing costs, net.......................... 5,523 5,663
Restricted cash reserves............................... 17,122 20,307
Cash and cash equivalents.............................. 7,900 10,363
--------- ---------
$245,957 $249,418
========= =========
LIABILITIES AND PARTNERS' CAPITAL
LIABILITIES
Mortgage debt........................................ $ 219,644 $ 221,814
Investment in Santa Clara Partnership................ 7,726 8,737
Due to Marriott International, Inc................... 4,203 3,567
Accounts payable and accrued expenses................ 1,677 4,163
--------- ---------
Total Liabilities.................................. 233,250 238,281
--------- ---------
PARTNERS' CAPITAL
General Partner...................................... 272 256
Limited Partners..................................... 12,435 10,881
--------- ---------
Total Partners' Capital............................ 12,707 11,137
--------- ---------
$245,957 $249,418
========= =========
</TABLE>
See Notes to Condensed Financial Statements.
MHP2 Supp-60
<PAGE>
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
CONDENSED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
------------------
1998 1997
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES
Net income................................................ $ 12,756 $ 11,851
Noncash items............................................. 4,647 5,087
Change in operating accounts.............................. (3,273) 546
-------- --------
Cash provided by operating activities................... 14,130 17,484
-------- --------
INVESTING ACTIVITIES
Additions to property and equipment, net.................. (2,946) (2,764)
Change in property improvement fund....................... (2,521) (1,922)
Distributions from Santa Clara Partnership................ 845 982
-------- --------
Cash used in investing activities....................... (4,622) (3,704)
-------- --------
FINANCING ACTIVITIES
Capital distributions to partners......................... (11,186) (9,875)
Repayment of mortgage debt................................ (2,170) --
Change in restricted lender reserves, net................. 1,385 (2,139)
Payment of financing costs................................ -- (34)
-------- --------
Cash used in financing activities....................... (11,971) (12,048)
-------- --------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS............ (2,463) 1,732
CASH AND CASH EQUIVALENTS at beginning of period............ 10,363 16,372
-------- --------
CASH AND CASH EQUIVALENTS at end of period.................. $ 7,900 $ 18,104
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for mortgage interest........................... $ 9,181 $ 9,246
======== ========
</TABLE>
See Notes to Condensed Financial Statements.
MHP2 Supp-61
<PAGE>
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying condensed financial statements have been prepared by
Marriott Hotel Properties II Limited Partnership (the "Partnership") without
audit. Certain information and footnote disclosures normally included in
financial statements presented in accordance with generally accepted
accounting principles have been condensed or omitted from the accompanying
statements. The Partnership believes the disclosures made are adequate to make
the information presented not misleading. However, the condensed financial
statements should be read in conjunction with the Partnership's financial
statements and notes thereto included in the Partnership's Form 10-K for the
fiscal year ended December 31, 1997.
In the opinion of the Partnership, the accompanying condensed unaudited
financial statements reflect all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position of
the Partnership as of June 19, 1998; the results of operations and cash flows
for the first two quarters 1998 and 1997. Interim results are not necessarily
indicative of fiscal year performance because of seasonal and short-term
variations.
For financial reporting purposes, net income of the Partnership is allocated
99% to the limited partners and 1% to the General Partner. Significant
differences exist between the net income for financial reporting purposes and
the net income reported for Federal income tax purposes. These differences are
due primarily to the use for income tax purposes of accelerated depreciation
methods and shorter depreciable lives of assets and differences in the timing
of recognition of incentive management fee expense.
2. The Partnership owns the New Orleans, San Antonio Rivercenter and San
Ramon Marriott Hotels (the "Hotels"). In addition, the Partnership owns a 50%
limited partnership interest in the Santa Clara Marriott Hotel Limited
Partnership (the "Santa Clara Partnership") which owns the Santa Clara
Marriott Hotel (the "Santa Clara Hotel"). The sole general partner of the
Partnership and the Santa Clara Partnership, with a 1% interest in each, is
Marriott MHP Two Corporation (the "General Partner"), a wholly-owned
subsidiary of Host Marriott Corporation ("Host Marriott"). The remaining 49%
interest in the Santa Clara Partnership is owned by HMH Properties, Inc., a
wholly-owned subsidiary of Host Marriott. The Partnership's income from the
Santa Clara Partnership is reported as Equity in Income of the Santa Clara
Partnership. In arriving at Equity in Income from the Santa Clara Partnership,
the Partnership is allocated 100% of the interest expense related to the debt
incurred to purchase the Santa Clara Partnership interest. Summarized
financial information for the Santa Clara Partnership is presented in Note 5.
3. Certain reclassifications were made to the prior year condensed financial
statements to conform to the current year presentation.
4. Hotel revenues represent house profit of the Partnership's Hotels since
the Partnership has delegated substantially all of the operating decisions
related to the generation of house profit of the Hotels to Marriott Hotel
Services, Inc. (the "Manager"). House profit reflects hotel operating results
which flow to the Partnership as property owner and represents gross hotel
sales less property-level expenses, excluding depreciation and amortization,
base and incentive management fees, property taxes, ground rent, insurance and
certain other costs, which are disclosed separately in the condensed statement
of operations
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
MHP2 Supp-62
<PAGE>
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED)
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding property-level revenues and operating expenses of the Hotels from
its statements of operations. If the Partnership concludes that EITF 97-2
should be applied to the Hotels, it would include operating results of this
managed operation in its financial statements. Application of EITF 97-2 to
financial statements as of and for the first two quarters 1998, would have
increased both revenues and operating costs and expenses by approximately
$41.7 million and would have had no impact on net income.
Partnership revenues generated by the Hotels for 1998 and 1997, consist of
(in thousands):
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
-----------------
1998 1997
-------- --------
<S> <C> <C>
HOTEL SALES
Rooms...................................................... $ 52,920 $ 50,384
Food and beverage.......................................... 22,223 22,072
Other...................................................... 4,514 4,320
-------- --------
79,657 76,776
-------- --------
HOTEL EXPENSES
Departmental direct costs
Rooms...................................................... 9,499 9,151
Food and beverage.......................................... 15,315 14,952
Other hotel operating expenses............................. 16,897 16,089
-------- --------
41,711 40,192
-------- --------
HOTEL REVENUES............................................... $ 37,946 $ 36,584
======== ========
</TABLE>
5. Summarized financial information for the Santa Clara Partnership for 1998
and 1997, is as follows (in thousands):
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
------------------
1998 1997
-------- --------
(UNAUDITED)
<S> <C> <C>
CONDENSED STATEMENT OF OPERATIONS
REVENUES.................................................... $ 12,490 $ 10,247
-------- --------
OPERATING COSTS AND EXPENSES
Incentive management fees................................. 2,008 1,610
Depreciation and amortization............................. 1,424 1,134
Base management fees...................................... 760 668
Property taxes............................................ 245 244
Ground rent, insurance and other.......................... 257 230
-------- --------
4,694 3,886
-------- --------
OPERATING PROFIT............................................ 7,796 6,361
Interest expense.......................................... (1,675) (1,699)
Interest income........................................... 107 102
-------- --------
NET INCOME.................................................. $ 6,228 $ 4,764
======== ========
</TABLE>
MHP2 Supp-63
<PAGE>
MARRIOTT HOTEL PROPERTIES II LIMITED PARTNERSHIP
NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
JUNE 19, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
CONDENSED BALANCE SHEET
Property and equipment, net.......................... $ 27,623 $ 28,688
Property Improvement Fund............................ 3,554 2,619
Due from Marriott Hotel Services, Inc................ 2,649 2,059
Cash and cash equivalents............................ 4,949 3,177
-------- --------
Total Assets....................................... $ 38,775 $ 36,543
======== ========
Mortgage debt........................................ $ 42,942 $ 43,366
Due to Marriott Hotel Services, Inc.................. 475 970
Accounts payable and accrued expenses................ 322 482
Partners' deficit.................................... (4,964) (8,275)
-------- --------
Total Liabilities and Partners' Deficit............ $ 38,775 $ 36,543
======== ========
</TABLE>
6. As previously reported, Host Marriott, parent company of the General
Partner of the Partnership, announced on April 17, 1998, that its Board of
Directors authorized Host Marriott to reorganize its business operations to
qualify as a real estate investment trust ("REIT") to become effective as of
January 1, 1999. As part of the REIT conversion, Host Marriott formed a new
operating partnership (the "Operating Partnership"), and limited partners in
certain Host Marriott full-service hotel partnerships and joint ventures,
including the Marriott Hotel Properties II Limited Partnership, are expected
to be given an opportunity to receive, on a tax-deferred basis, Operating
Partnership units in the Operating Partnership in exchange for their current
limited partnership interests. The Operating Partnership units would be
redeemable by the limited partner for freely traded Host Marriott shares (or
the cash equivalent thereof) at any time after one year from the closing of
the merger. In connection with the REIT conversion, the Operating Partnership
filed a Registration Statement on Form S-4 with the Securities and Exchange
Commission on June 2, 1998. Limited partners will be able to vote on this
Partnership's participation in the merger later this year through a consent
solicitation.
MHP2 Supp-64
<PAGE>
HOST MARRIOTT, L.P.
SUPPLEMENT DATED , 1998 FOR
PROSPECTUS/CONSENT SOLICITATION STATEMENT DATED , 1998 FOR
POTOMAC HOTEL LIMITED PARTNERSHIP
On the terms described in the Prospectus/Consent Solicitation Statement (the
"Consent Solicitation"), dated , 1998, of which this Supplement (the
"Supplement") is a part, Host Marriott Corporation, a Delaware corporation
("Host"), has adopted a plan to restructure its business operations so that it
will qualify as a real estate investment trust ("REIT"). As part of this
restructuring (the "REIT Conversion"), Host and its consolidated subsidiaries
will contribute their full-service hotel properties and certain other
businesses and assets to Host Marriott, L.P. (the "Operating Partnership") in
exchange for units of limited partnership interest in the Operating
Partnership ("OP Units") and the assumption of liabilities. The sole general
partner of the Operating Partnership will be Host Marriott Trust ("Host
REIT"), the entity into which Host will merge as part of the REIT Conversion.
Host REIT expects to qualify as a REIT beginning with its first full taxable
year after closing of the REIT Conversion, which Host REIT currently expects
to be the year beginning January 1, 1999.
Following the REIT Conversion and the Blackstone Acquisition (defined
below), the Operating Partnership and its subsidiaries initially will own
outright, or have controlling interests in, approximately 120 full-service
hotels operating primarily under the Marriott, Ritz-Carlton, Four Seasons,
Swissotel and Hyatt brand names (the "Hotels").
As part of the REIT Conversion, the Operating Partnership is proposing to
acquire by merger (the "Mergers") Potomac Hotel Limited Partnership, a
Delaware limited partnership ("PHLP" or the "Partnership"), and up to seven
other limited partnerships (the "Partnerships") that own full-service hotels
in which Host or its subsidiaries are general partners. As more fully
described in the Consent Solicitation, limited partners of those Partnerships
that participate in the Mergers will receive either OP Units or, at their
election, unsecured % Callable Notes due December 15, 2005 issued by the
Operating Partnership ("Notes"), in exchange for their partnership interests
in such Partnerships (with respect to the Partnerships, those limited partners
who are unaffiliated with Host are referred to herein as the "Limited
Partners," and with respect to PHLP, the "PHLP Limited Partners").
Beginning one year after the Mergers, Limited Partners who retain OP Units
will have the right to redeem their OP Units at any time and receive, at the
election of Host REIT, either freely tradeable, New York Stock Exchange listed
Common Shares of Host REIT on a one-for-one basis (subject to adjustment) or
cash in an amount equal to the market value of such shares (the "Unit
Redemption Right").
The number of OP Units to be allocated to PHLP will be based upon (i) its
Exchange Value (as defined herein) and (ii) the price attributed to an OP Unit
following the Merger, determined as described herein (but in no event greater
than $ per OP Unit). The principal amount of the Notes that PHLP Limited
Partners may elect to receive in exchange for the OP Units received in the
Merger will be based upon PHLP's Note Election Amount (as defined herein). See
"Determination of Exchange Value of PHLP and Allocation of OP Units." The
estimated Exchange Value and Note Election Amount set forth herein may
increase or decrease as a result of various adjustments, and will be finally
calculated shortly before the Effective Date. Pursuant to the Merger, PHLP
Limited Partners have an estimated Exchange Value of $5,040 per Partnership
Unit and a Note Election Amount of $3,024 per Partnership Unit.
RISK FACTORS
In deciding whether to approve the Merger, PHLP Limited Partners should
consider certain risks and other factors. The General Partner believes that
PHLP Limited Partners should particularly consider the following, which should
be read in conjunction with the information in the Consent Solicitation under
"Risk Factors" and "Federal Income Tax Consequences:"
. Substantial Benefits to Related Parties. Host REIT and its subsidiaries
will realize substantial benefits from the Mergers and the REIT
Conversion, including savings from a substantial reduction in corporate-
level income taxes expected as a result of the REIT Conversion. To the
extent that such anticipated benefits of the REIT Conversion are
reflected in the value of Host's common stock prior to the Effective
Date, such benefits will not be shared with the Limited Partners.
Because of Host's
PHLP Supp-1
<PAGE>
significant ownership position in certain Partnerships, the failure of
one or more of these Partnerships to participate in a Merger likely
would require that Host contribute some or all of its ownership interest
in the Non-Participating Partnership to a taxable Non-Controlled
Subsidiary, which would materially reduce the benefit to Host of the
REIT Conversion as it applies to that interest.
. Absence of Arm's Length Negotiations. No independent representative was
retained to negotiate on behalf of the PHLP Limited Partners or the
other Limited Partners. Although the General Partner has obtained the
Appraisals and the Fairness Opinion from AAA, AAA has not negotiated
with the General Partner and has not participated in establishing the
terms of the Mergers. Consequently, the terms and conditions of the
Mergers may have been more favorable to the PHLP Limited Partners or the
other Limited Partners if such terms and conditions were the result of
arm's length negotiations.
. Other Conflicts of Interest. The Mergers, the REIT Conversion and the
recommendations of the General Partner involve the following conflicts
of interest because of the relationships among Host, the Operating
Partnership, the General Partners and SLC: (i) the General Partners,
which are all subsidiaries of Host (except for PHLP, in which Host is
the General Partner), must assess whether a Merger is fair and equitable
to the Limited Partners of its Partnership, which involves
considerations for Host and its subsidiaries that are different from
those that affect the Limited Partners, (ii) the terms of the Leases of
the Hotels, including PHLP's Hotels, will be determined by Host, which
will distribute the common stock of SLC, the parent of the Lessees, to
its shareholders after such terms have been set and (iii) the terms of
the Partnership Agreement, including provisions which benefit Host REIT,
have been determined by Host. Such conflicts may result in decisions
that do not fully reflect the interests of all Limited Partners,
including the PHLP Limited Partners.
. Uncertainties at the Time of Voting Include the Number of OP Units to be
Received. There are several uncertainties at the time the PHLP Limited
Partners must vote on the Merger, including (i) the exact Exchange Value
for PHLP (which will be adjusted for changes in lender and capital
expenditure reserves, indebtedness, deferred maintenance and other items
prior to the Effective Date), (ii) the price of the OP Units for
purposes of the Merger, which will be determined by reference to the
post-Merger trading prices of Host REIT's Common Shares and which,
together with the Exchange Value, will determine the number of OP Units
the PHLP Limited Partners will receive and (iii) the exact principal
amount of the Notes that may be received in exchange for OP Units, which
cannot be known until after the vote on the Merger. For these reasons,
the PHLP Limited Partners cannot know at the time they vote on the
Merger these important aspects of the Merger.
. Sale of Personal Property May Result in Gain to PHLP Limited
Partners. In order to facilitate the participation of PHLP in the Merger
without adversely affecting Host REIT's qualification as a REIT, the
Operating Partnership will require, as part of the Merger, that PHLP
sell a portion of the personal property associated with its Hotels to a
Non-Controlled Subsidiary. This sale will be a taxable transaction and
may (although it is not expected to) result in an allocation of a
relatively modest amount of ordinary recapture income by PHLP to PHLP
Limited Partners. This income, if any, will be allocated to each PHLP
Limited Partner in the same proportion and to the same extent that such
PHLP Limited Partner was allocated any deductions directly or indirectly
giving rise to the treatment of such income as recapture income. A PHLP
Limited Partner who receives such an allocation of recapture income
would not be entitled to any special distribution from PHLP in
connection with the sale of personal property.
. Exchange Value May Not Equal Fair Market Value of PHLP's Hotels. Each
PHLP Limited Partner who retains OP Units will receive consideration
with a deemed value equal to the Exchange Value of such PHLP Limited
Partner's Partnership Interest. The determination of the Exchange Value
of PHLP involves numerous estimates and assumptions. There is no
assurance that the Exchange Value of PHLP will equal the fair market
value of the Hotels and other assets contributed by PHLP. See
"Determination of Exchange Value of PHLP and Allocation of OP Units."
. Allocation of OP Units to Host REIT is Different from Allocation of OP
Units to Limited Partners. Host REIT will receive in the aggregate a
number of OP Units (including OP Units
PHLP Supp-2
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allocated to the General Partners of the Partnerships) equal to the
number of shares of Host common stock outstanding on the Effective Date
(and, if Host has outstanding shares of preferred stock at the time of
the REIT Conversion, a corresponding number of preferred partnership
interests in the Operating Partnership), which should fairly represent
the market value of Host REIT but may not be equal to the fair market or
net asset value of the Hotels and other assets that Host will contribute
to the Operating Partnership. The Partnerships will receive OP Units in
the Mergers with a deemed value equal to the Exchange Value of such
Partnership. The different methods of allocating OP Units may result in
Limited Partners not receiving the fair market value of their
Partnership Interests and Host REIT receiving a higher percentage of the
interests in the Operating Partnership. See "Determination of Exchange
Values and Allocation of OP Units."
. Price of OP Units Might Be Less than the Fair Market Value of the PHLP
Limited Partners' Partnership Interests. The price of an OP Unit, for
purposes of the Mergers and the REIT Conversion, will be equal to the
average closing price on the NYSE of a Host REIT Common Share for the
first 20 trading days after the Effective Date of the Mergers (but in no
event greater than $ per share). It is likely that, over time, the
value of the publicly traded Common Shares of Host REIT (and therefore
the value of the OP Units) will diverge from the deemed value of the OP
Units used for purposes of the Mergers. This could result in the PHLP
Limited Partners receiving OP Units with an actual value that is less
than either the price of the OP Units for purposes of the Mergers or the
fair market value of their Partnership Interests.
. Inability of PHLP Limited Partners to Redeem OP Units for One Year. PHLP
Limited Partners who elect to retain OP Units received in the Merger
will be unable to redeem such OP Units for one year following the
Merger. Until then, PHLP Limited Partners will bear the risk of
illiquidity.
. Value of the Notes Will Be Less than the Exchange Value. At the same
time that he votes on the Merger, each PHLP Limited Partner can also
elect to receive, in exchange for OP Units, an unsecured, seven-year
Note of the Operating Partnership with a principal amount equal to the
Note Election Amount of his Partnership Interest. The deemed value of
the OP Units to be received by the PHLP Limited Partners will exceed the
principal amount of the corresponding Notes (because the Exchange Value
will be higher than the Note Election Amount) and there is no assurance
that the Note a PHLP Limited Partner receives will have a value equal to
either (i) the fair market value of the PHLP Limited Partner's share of
the Hotels and other assets owned by PHLP or (ii) the principal amount
of the Note. There will be no public market for the Notes. If the Notes
are sold, they may sell at prices substantially below their issuance
price. Noteholders are likely to receive the full face amount of a Note
only if they hold the Note to maturity, which is December 15, 2005, or
if the Operating Partnership repays the Notes prior to maturity. Because
the Notes are unsecured obligations of the Operating Partnership, they
will be effectively subordinated to all secured debt of the Operating
Partnership and all obligations of both the Participating Partnerships
and the Operating Partnership's other subsidiaries. See "Description of
the Notes." As of June 19, 1998, on a pro forma basis assuming the Full
Participation Scenario, the Operating Partnership would have had
aggregate consolidated debt of approximately $5.1 billion to which the
Notes were effectively subordinated or which rank equally with such
Notes.
. Current Host Common Stock Price May Not Necessarily Be Indicative of the
Price of Host REIT Common Shares Following the REIT Conversion. Host's
current stock price is not necessarily indicative of how the market will
value Host REIT Common Shares following the REIT Conversion. The current
stock price of Host reflects the current market valuation of Host's
current business and assets (including the SLC common stock and the cash
or securities to be distributed in connection with the REIT Conversion)
and not the business and assets of Host REIT following the REIT
Conversion.
. Fundamental Change in Nature of Investment; Potential
Underperformance. The Mergers and the REIT Conversion involve a
fundamental change in the nature of a PHLP Limited Partner's investment
from holding an interest in PHLP, which was structured as a tax shelter
investment, is a finite-life entity, has a fixed portfolio of eight
Hotels and has never distributed cash flow from the operation of such
Hotels to its Limited Partners, to holding an interest in an infinite-
life, operating real estate company with a portfolio of approximately
120 Hotels that (i) collects and distributes to its limited
PHLP Supp-3
<PAGE>
partners rents received from the Lessees (which will bear the risks and
receive the direct benefits of the Hotels' operations), (ii) has the
ability to acquire additional hotels, (iii) is able to reinvest proceeds
from sales or refinancings of existing Hotels in other hotels and (iv)
has a publicly traded general partner. In addition, each PHLP Limited
Partner's investment will change from one that allows a PHLP Limited
Partner to receive a return of capital in the form of distributions from
any net proceeds of a sale or refinancing of PHLP's assets to an
investment in which a PHLP Limited Partner who retains OP Units likely
would realize a return of capital only through the exercise of the Unit
Redemption Right. A PHLP Limited Partner's share of the liquidation
proceeds, if any, from the sale of PHLP's Hotels could be higher than
the amount realized upon exercise of the Unit Redemption Right (or
payments on any Note received by a PHLP Limited Partner who elects to
exchange his OP Units for such Note). An investment in the Operating
Partnership may not outperform an investment in PHLP. See "Comparison of
Ownership of Partnership Interests, OP Units and Common Shares."
. Exposure to Market and Economic Conditions of Other Hotels. As a result
of the Merger, PHLP Limited Partners who elect to retain OP Units will
own interests in a much larger enterprise with a broader range of assets
than PHLP individually. A material adverse change affecting the
Operating Partnership's assets will affect all Limited Partners,
including PHLP Limited Partners, regardless of whether a particular
Limited Partner previously was an investor in such affected assets. PHLP
owns discrete assets and the Mergers and the REIT Conversion will
significantly diversify the types and geographic locations of the Hotels
in which the PHLP Limited Partners will have interests. As a result, the
Hotels owned by the Operating Partnership may be affected differently by
economic and market conditions than those Hotels owned by PHLP.
. PHLP Limited Partners Have No Cash Appraisal Rights. PHLP Limited
Partners who vote against the Merger have no right to receive cash based
upon an appraisal of their Partnership Interests.
. Uncertainties as to the Size and Leverage of the Operating
Partnership. The PHLP Limited Partners cannot know at the time they vote
on the Merger the exact size and amount of leverage of the Operating
Partnership. Host is an existing operating company that regularly issues
and repays debt, acquires additional hotels and disposes of existing
hotels. Also, some or all of the Partnerships may elect not to
participate in a Merger. In addition, outside partners in certain
Private Partnerships may not consent to a lease of their partnership's
Hotel(s). In either such case, Host will contribute its interests in
such Partnerships and Private Partnerships to the Operating Partnership,
but the Operating Partnership may, in turn, contribute such interests to
a Non-Controlled Subsidiary, which will be subject to corporate-level
income taxation. Host also may repurchase outstanding securities or
issue new debt or equity securities prior to the consummation of the
Mergers and the REIT Conversion.
. Lack of Control over Hotel Operations. Due to current federal income tax
law restrictions on a REIT's ability to derive revenues directly from
the operation of a hotel, the Operating Partnership will lease virtually
all of its consolidated Hotels to the Lessees, which will operate the
Hotels by continuing to retain the Managers pursuant to the Management
Agreements. The Operating Partnership will not operate the Hotels or
participate in the decisions affecting the daily operations of the
Hotels. The Operating Partnership will have only a limited ability to
require the Lessees or the Managers to operate or manage the Hotels in
any particular manner and no ability to govern any particular aspect of
their day-to-day operation or management. Therefore, the Operating
Partnership will be dependent for its revenue upon the ability of the
Lessees and the Managers to operate and manage the Hotels.
. Expiration of Leases and Possible Inability to Find Other Lessees. The
Leases will expire seven to ten years after the Effective Date and there
can be no assurance that such Leases will be renewed (or if renewed,
will be renewed on terms as favorable to the Operating Partnership). If
the Leases are not renewed, the Operating Partnership will be required
to find other lessees, which lessees must meet certain requirements set
forth in the Management Agreements. There can be no assurance that
satisfactory lessees could be found or as to the terms and conditions on
which the Operating Partnership would be able to renew the Leases or
enter into new leases with such lessees.
PHLP Supp-4
<PAGE>
. Requisite Vote of PHLP Limited Partners Binds All PHLP Limited
Partners. For PHLP, approval by a majority of the Partnership Interests
that are eligible to be voted is required to approve the Merger, as
described in "Voting Procedures--Required Vote and Other Conditions."
Such approval will cause PHLP to participate in the Merger and will bind
all PHLP Limited Partners, including PHLP Limited Partners who voted
against or abstained from voting with respect to the Merger.
. Substantial Indebtedness of the Operating Partnership. The Operating
Partnership will have substantial indebtedness. As of June 19, 1998, on
a pro forma basis assuming the Full Participation Scenario, the
Operating Partnership had outstanding indebtedness totaling
approximately $5.1 billion, which represents a % debt-to-total market
capitalization ratio on a pro forma basis at such date (based upon a
price per Common Share of Host REIT of $ ). The Operating
Partnership's business is capital intensive and it will have significant
capital requirements in the future. The Operating Partnership's leverage
level could affect its ability to (i) obtain financing in the future,
(ii) undertake refinancings on terms and subject to conditions deemed
acceptable by the Operating Partnership, (iii) make distributions to
partners, (iv) pursue its acquisition strategy or (v) compete
effectively or operate successfully under adverse economic conditions.
. No Limitation on Debt. There are no limitations in Host REIT's or the
Operating Partnership's organizational documents which limit the amount
of indebtedness either may incur, although both the Notes and the
Operating Partnership's other debt instruments will contain certain
restrictions on the amount of indebtedness that the Operating
Partnership may incur.
. Rental Revenues from Hotels Subject to Rights of Lenders. In accordance
with the mortgage loan agreements with respect to outstanding
indebtedness of certain Hotel Partnerships, the rental revenues received
by such Hotel Partnerships under certain Leases first will be used to
satisfy the debt service on such outstanding indebtedness with only the
cash flow remaining after debt service being available to satisfy other
obligations of the Hotel Partnership (including paying property taxes
and insurance, funding the required FF&E reserves for the Hotels and
capital improvements and paying debt service with respect to unsecured
debt) and to make distributions to holders of OP Units.
. Ownership Limitations. No person or group may own, actually or
constructively (as determined under the applicable Code provisions), (i)
in excess of 9.8% of the number or value of outstanding Common Shares of
Host REIT or (ii) in excess of 4.9% of the value of the OP Units (other
than Host REIT and The Blackstone Group), subject to waiver or
modification by Host REIT or the Operating Partnership, as the case may
be, in certain limited circumstances.
. Timing of the REIT Conversion. If the REIT Conversion does not occur in
time for Host REIT to elect REIT status effective January 1, 1999, the
effectiveness of Host REIT's election could be delayed to January 1,
2000, which would result in Host REIT continuing to pay corporate-level
income taxes in 1999 and could cause the Blackstone Acquisition not to
be consummated.
. Effect of Subsequent Events upon Recognition of Gain. Even though the
PHLP Limited Partners (other than those who elect to receive a Note in
exchange for OP Units) generally are not expected to recognize
significant taxable gain at the time of the Merger, there are a variety
of events and transactions (including the sale of one or more of the
Hotels currently owned by PHLP or the reduction of indebtedness securing
one or more of the Hotels) that could cause a PHLP Limited Partner to
recognize all or a part of the gain that otherwise has been deferred
through the REIT Conversion. In this regard, the refinancing of the
existing debt secured by PHLP's Hotels (the "Mitsui Bank Debt"), which
matures in December 1998 but which may be extended through December
1999, could result, depending upon the circumstances, in the recognition
of significant taxable gain by PHLP Limited Partners. See "Federal
Income Tax Consequences--Tax Treatment of PHLP Limited Partners Who Hold
OP Units Following the Merger." Certain Hotels (including the Blackstone
Hotels) will be covered by agreements with third parties which will
restrict the Operating Partnership's ability to dispose of those
properties or refinance their debt. In addition, if Atlanta Marquis
participates in the Merger, the Operating Partnership will succeed to an
existing agreement that will restrict its ability to disposes of the
Atlanta Marquis Hotel or to refinance the debt secured by such Hotel
without compensating certain outside partners for the resulting adverse
tax consequences. As for the remaining
PHLP Supp-5
<PAGE>
initial properties (including the Hotels owned by PHLP), the partnership
agreement of the Operating Partnership, which is substantially in the
form attached to the Consent Solicitation as Appendix A (the
"Partnership Agreement"), does not impose any restrictions on the
Operating Partnership's ability to dispose of the Hotels or to refinance
debt secured by the Hotels (but the Operating Partnership is obligated
to pay any taxes Host REIT incurs as a result of such transactions). In
addition, the Partnership Agreement provides that Host REIT, as general
partner of the Operating Partnership, is not required to take into
account the tax consequences of the limited partners in deciding whether
to cause the Operating Partnership to undertake specific transactions
(but the Operating Partnership is obligated to pay any taxes that Host
REIT incurs as a result of such transactions) and the limited partners
have no right to approve or disapprove such transactions. See
"Description of OP Units--Sales of Assets."
. Election to Exchange OP Units for Notes. A PHLP Limited Partner who
elects to receive a Note in connection with the Merger in exchange for
his OP Units will be treated as having made a taxable disposition of his
Partnership Interest. A PHLP Limited Partner who receives a Note may be
eligible to defer only a small portion, but not all, of that gain under
the "installment sale" rules. A PHLP Limited Partner with a "negative
capital account" with respect to his Partnership Interest who elects to
receive a Note will recognize "phantom income" in that amount at the
time of the Merger in any event. See "Federal Income Tax Consequences--
Tax Treatment of PHLP Limited Partners Who Exercise Their Right to Make
the Note Election."
. Competition in the Lodging Industry. The profitability of the Hotels is
subject to general economic conditions, the management abilities of the
Managers (including primarily Marriott International), competition, the
desirability of particular locations and other factors relating to the
operation of the Hotels. The full-service segment of the lodging
industry, in which virtually all of the Hotels operate, is highly
competitive, and the Hotels generally operate in geographical markets
that contain numerous competitors. The Hotels' success will be
dependent, in large part, upon their ability to compete in such areas as
access, location, quality of accommodations, room rate structure, the
quality and scope of food and beverage facilities and other services and
amenities. The lodging industry, including the Hotels (and thus the
Operating Partnership), may be adversely affected in the future by (i)
national and regional economic conditions, (ii) changes in travel
patterns, (iii) taxes and government regulations which influence or
determine wages, prices, interest rates, construction procedures and
costs, (iv) the availability of credit and (v) other factors beyond the
control of the Operating Partnership.
. Failure of Host REIT to Qualify as a REIT for Tax Purposes. Taxation of
Host REIT as a corporation if it fails to qualify as a REIT, and Host
REIT's subsequent liability for federal, state and local taxes on its
income and property, would, among other things, have the effect of
reducing cash available for distribution to Host REIT's shareholders and
materially reducing the value of the Common Shares and OP Units.
. Failure of the Operating Partnership to Qualify as a Partnership for Tax
Purposes. Taxation of the Operating Partnership as a corporation if it
fails to qualify as a partnership and the Operating Partnership's
subsequent liability for federal, state and local income taxes would,
among other things, have the effect of reducing cash available for
distribution to holders of OP Units, would cause Host REIT to fail to
qualify as a REIT for tax purposes and would cause the holders of OP
Units to recognize substantial taxable gain at the time the Operating
Partnership ceases to qualify as a partnership.
. Failure of the Leases to Qualify as Leases. If one or more of the Leases
of the Hotels to the Lessees were to be disregarded for tax purposes
(for example, because a Lease was determined to lack economic
substance), Host REIT could fail to qualify as a REIT and the Operating
Partnership might be treated as a corporation for federal income tax
purposes, which would have a material adverse impact on the PHLP Limited
Partners and the value of the OP Units.
. Change in Tax Laws. No assurance can be provided that new legislation,
Treasury Regulations, administrative interpretations or court decisions
will not significantly change the tax laws with respect to Host REIT's
qualification as a REIT or the federal income tax consequences of such
qualification.
PHLP Supp-6
<PAGE>
. PHLP Limited Partners Need to Consult with Their Own Tax Advisors.
Because the specific tax attributes of a PHLP Limited Partner and the
facts regarding such PHLP Limited Partner's interest in PHLP could have
a material impact on the tax consequences to such PHLP Limited Partner
of the Merger, the subsequent ownership and disposition of OP Units or
Notes and/or the subsequent ownership and disposition of Common Shares,
it is essential that each PHLP Limited Partner consult with his own tax
advisors regarding the application of federal, foreign and state and
local tax laws to such PHLP Limited Partner's personal tax situation.
. Effect of Possible Classification as a Publicly Traded Partnership on
Passive Losses. There is a significant possibility that the Operating
Partnership could be classified as a "publicly traded partnership," in
which event the PHLP Limited Partners would not be able to use suspended
passive activity losses from other investments to offset income from the
Operating Partnership.
. Host's Substantial Deferred Tax and Contingent Liabilities. Host will
have substantial deferred tax liabilities that are likely to be
recognized in the next ten years (notwithstanding Host REIT's status as
a REIT), and the IRS could assert substantial additional liabilities for
taxes against Host for taxable years prior to the time Host REIT
qualifies as a REIT. Under the terms of the REIT Conversion and the
Partnership Agreement, the Operating Partnership will be responsible for
paying (or reimbursing Host REIT for the payment of) all such tax
liabilities as well as any other liabilities (including contingent
liabilities and liabilities attributable to litigation that Host REIT
may incur) whether such liabilities are incurred by reason of Host's
activities prior to the REIT Conversion or the activities of Host REIT
subsequent thereto.
Because REITs are not permitted under current federal income tax law to
derive revenues directly from the operation of hotels, the Operating
Partnership will lease the Hotels to lessees (the "Lessees") that will operate
the Hotels under the existing management agreements and pay rent to the
Operating Partnership, as more fully described herein. The Lessees generally
will be indirect controlled subsidiaries of HMC Senior Communities, Inc.
("SLC"), which currently is a wholly owned subsidiary of Host. SLC will become
a separate public company when Host distributes the common stock of SLC and
other consideration to its existing shareholders and the Blackstone Entities
in connection with Host's distribution of its accumulated earnings and
profits, which Host REIT is required to do in order to qualify as a REIT.
Shares of Host REIT and SLC will become separately traded securities and the
companies will operate independently. There will be no overlap between the
boards of Host REIT and SLC. There will be a substantial overlap of
shareholders of the two companies initially, but this likely will diverge over
time.
HOST MARRIOTT CORPORATION (THE "GENERAL PARTNER"), THE GENERAL PARTNER OF
PHLP, BELIEVES THAT THE MERGER PROVIDES SUBSTANTIAL BENEFITS AND IS FAIR TO
THE PHLP LIMITED PARTNERS AND RECOMMENDS THAT ALL PHLP LIMITED PARTNERS VOTE
FOR THE MERGER. THE GENERAL PARTNER ALSO RECOMMENDS THAT PHLP LIMITED PARTNERS
DO NOT ELECT TO RECEIVE NOTES AS SUCH ELECTION MAY RESULT IN A SUBSTANTIAL
TAXABLE GAIN.
The effects of the Mergers may be different for Limited Partners of the
various Partnerships. This Supplement has been prepared to highlight for PHLP
Limited Partners the specific risks, benefits, effects and fairness of the
Merger to them and to provide other information specific to PHLP. Supplements
have also been prepared for each of the other Partnerships. This Supplement,
together with the supplements of the other Partnerships (collectively, the
"Supplements"), are part of the Consent Solicitation. Upon receipt of a
written request by a Limited Partner or his representative so designated in
writing, the General Partner will send a copy of any Supplement without
charge. All requests for a copy of a Supplement should be directed to:
Investors Relations, 10400 Fernwood Road, Bethesda, Maryland 20817, telephone
number 301-380-2070 (between the hours of 9:00 a.m. and 4:00 p.m., eastern
time).
All cross-references refer to the Consent Solicitation unless the context
indicates otherwise. Capitalized terms not defined herein shall have the
meaning set forth in the Consent Solicitation. The information contained
herein, unless otherwise indicated, assumes the REIT Conversion occurs with
all Partnerships participating and no Notes being issued (the "Full
Participation Scenario").
PHLP Supp-7
<PAGE>
EXPECTED BENEFITS OF THE MERGER
The General Partner believes that participating in the Merger would likely
be beneficial to the PHLP Limited Partners for the reasons set forth below.
This information is qualified by and should be read in conjunction with the
information in the Consent Solicitation under "Background and Reasons for the
Mergers and the REIT Conversion--Reasons for the Mergers." These benefits,
which should be viewed as alternatives to continuing the business and
operations of PHLP, are expected to include:
. Exchange Value of PHLP. PHLP Limited Partners who elect to retain OP
Units in the Merger will receive OP Units with an estimated Exchange
Value equal to $5,040 per Partnership Unit.
. Enhanced Liquidity of Investment. The REIT Conversion will offer PHLP
Limited Partners significantly enhanced liquidity with respect to their
investments in PHLP because, commencing one year following the Effective
Date, PHLP Limited Partners who retain OP Units will be able to exercise
their Unit Redemption Right at any time, subject to certain limited
exceptions. Host has approximately 204 million shares of common stock
outstanding and is expected to have a total common equity market
capitalization of approximately $ billion after giving effect to the
estimated $ million earnings and profits distribution (based on
Host's $ closing price per share on the NYSE on , 1998). The
exercise of the Unit Redemption Right, however, generally would result
in recognition of taxable income or gain at that time.
. Public Market Valuation of Assets. Trading has been extremely limited in
the Partnership Units of PHLP. In contrast, the General Partner believes
that by exchanging interests in PHLP, which is a non-traded, finite-life
limited partnership with a fixed portfolio for interests in an infinite-
life real estate company focused primarily on a more diverse and growing
full-service hotel portfolio and providing valuation based upon publicly
traded Common Shares of Host REIT, the PHLP Limited Partners will have
the opportunity to participate in the recent trend toward ownership of
real estate through a publicly traded entity, which, in many instances,
has resulted in market valuations of public real estate companies in
excess of the estimated net asset values of those companies. There can
be no assurance, however, that the Common Shares of Host REIT will trade
at a premium to the private market values of the Operating Partnership's
assets or that the relative pricing differential will not change or be
eliminated in the future. Also, the benefit of Host's conversion to a
REIT will not be shared by the PHLP Limited Partners if and to the
extent that such benefit is reflected in the market valuation of Host's
common stock prior to the REIT Conversion.
. Regular Quarterly Cash Distributions. The General Partner expects that
the Operating Partnership will make regular quarterly cash distributions
to holders of OP Units. PHLP has never distributed cash to its Limited
Partners, thus the ability of the PHLP Limited Partners to receive
quarterly and regular distributions would be enhanced. For additional
information regarding historical and estimated future distributions for
PHLP and the other Partnerships, see "Background and Reasons for the
Mergers and the REIT Conversion--Reasons for the Mergers."
. Substantial Tax Deferral. The General Partner expects that PHLP Limited
Partners who do not elect to receive a Note in exchange for OP Units
generally should be able to obtain the benefits of the Merger while
continuing to defer recognition for federal income tax purposes of at
least a substantial portion, if not all, of the gain with respect to
their Partnership Interests that otherwise would be recognized in the
event of a liquidation of PHLP or a sale or other disposition of its
assets in a taxable transaction (although PHLP Limited Partners may
(although are not expected to) recognize a relatively modest amount of
ordinary income as the result of required sales of personal property to
a Non-Controlled Subsidiary in order to facilitate Host REIT's
qualification as a REIT). Thereafter, such PHLP Limited Partners
generally should be able to defer at least a substantial portion of such
built-in gain until they elect to exercise their Unit Redemption Right
or one or more of the Hotels currently owned by PHLP are sold or
otherwise disposed of in a taxable transaction by the Operating
Partnership or the Mitsui Bank Debt now secured by such Hotels is
repaid, prepaid or substantially reduced. The federal income tax
consequences of the Merger are highly complex and, with respect to each
PHLP Limited Partner, are dependent upon many variables, including the
particular circumstances of such PHLP Limited
PHLP Supp-8
<PAGE>
Partner. See "Federal Income Tax Consequences--Tax Consequences of the
Merger." Each PHLP Limited Partner is urged to consult with his own tax
advisors as to the consequences of the Merger in light of his particular
circumstances.
. Enhanced Ability of Operating Partnership to Refinance the Mitsui Bank
Debt. The Mitsui Bank Debt of $172.7 million as of December 31, 1997,
must be refinanced no later than December 1999. There is no assurance,
however, that such refinancing, either by PHLP on a standalone basis or
the Operating Partnership following the Merger, will not require that
PHLP Limited Partners recognize at least a substantial portion of the
taxable gain that otherwise has been deferred through the Merger. In
connection with an IRS ruling that the Operating Partnership has
requested, see "Federal Income Tax Consequences--Tax Consequences of the
Merger--Deemed Cash Distribution and Resulting Taxable Gain," it is
expected that the former PHLP Limited Partners will reduce the amount of
"phantom income" they are allocated, thereby reducing their taxable
gains. There can be no assurance, however, that the Operating
Partnership will receive the ruling and, if received, the exact impact
it will have on an individual PHLP Limited Partner.
. Risk Diversification. Participation in the Merger, as well as future
hotel acquisitions by the Operating Partnership, will reduce the
dependence of PHLP Limited Partners upon the performance of, and the
exposure to the risks associated with, its Hotels and spread such risk
over a broader and more varied portfolio, including more diverse
geographic locations and multiple brands. See "Business and Properties--
Business Objectives."
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a significantly lower leverage to value
ratio than PHLP currently, which has outstanding debt balances in excess
of the Appraised Values of its Hotels, resulting in significant interest
and debt service savings and greater financial stability. In addition,
the Mitsui Bank Debt currently matures in December 1998 with the right
to extend the maturity to December 1999. There can be no assurance,
however, that PHLP can either extend the debt maturity beyond December
1999 or refinance such debt on favorable terms in the absence of the
Merger or the Operating Partnership could extend or refinance such debt
if the Merger is consummated. The Operating Partnership and the General
Partner believe, however, that PHLP will face greater difficulties in
finding a satisfactory replacement for such debt than the Operating
Partnership, given the Operating Partnership's larger size, greater
diversity of assets and extent of its relationship with lenders.
. Growth Potential. The General Partner believes that the PHLP Limited
Partners, by owning interests in a publicly traded real estate company
focused primarily on a more diverse and growing luxury and upscale full-
service hotel portfolio, will be able to participate in growth
opportunities that would not otherwise be available to them.
. Greater Access to Capital. With publicly traded equity securities, a
larger base of assets and a substantially greater equity value than PHLP
individually, Host REIT expects to have greater access to the capital
necessary to fund the Operating Partnership's operations and to
consummate acquisitions on more attractive terms than would be available
to PHLP individually. This greater access to capital should provide
greater financial stability to the Operating Partnership and reduce the
level of risk associated with refinancing existing loans upon maturity,
as compared to PHLP individually.
If PHLP does not participate in the Merger, its business will continue in
the same manner; however, the Operating Partnership may elect to contribute
some or all of its interest in PHLP to a Non-Controlled Subsidiary.
DETERMINATION OF EXCHANGE VALUE OF PHLP AND ALLOCATION OF OP UNITS
GENERAL. The Exchange Value of PHLP will be equal to the greatest of its
Adjusted Appraised Value, Continuation Value and Liquidation Value, each of
which has been determined as follows:
. Adjusted Appraised Value. The General Partner has retained AAA to
determine the market value of each of the Hotels as of March 1, 1998
(the "Appraised Value"). The "Adjusted Appraised Value"
PHLP Supp-9
<PAGE>
of PHLP equals the Appraised Value of its Hotels, adjusted as of the
Final Valuation Date for lender reserves, capital expenditure reserves,
existing indebtedness (including a "mark to market" adjustment to
reflect the market value of such indebtedness), certain deferred
maintenance costs, deferred management fees and transfer and recordation
taxes and fees.
. Continuation Value. The "Continuation Value" of PHLP represents AAA's
estimate, as adopted by the General Partner, of the discounted present
value, as of January 1, 1998, of the PHLP limited partners' share of
estimated future cash distributions and estimated net sales proceeds
(plus lender reserves), assuming that PHLP continues as an operating
business for twelve years and its assets are sold on December 31, 2009
for their then estimated market value.
. Liquidation Value. The "Liquidation Value" of PHLP represents the
General Partner's estimate of the net proceeds to PHLP limited partners
resulting from the assumed sale as of December 31, 1998 of the Hotels of
PHLP, each at its Adjusted Appraised Value (after eliminating any "mark
to market" adjustment and adding back the deduction for transfer and
recordation taxes and fees, if any, made in deriving the Adjusted
Appraised Value), less (i) estimated liquidation costs, expenses and
contingencies equal to 2.5% of Appraised Value and (ii) prepayment
penalties or defeasance costs, as applicable.
Final determination of the Exchange Value of PHLP will be made as of the end
of the four week accounting period ending at least 20 days prior to the
Effective Date (the "Final Valuation Date") and will be equal to the greatest
of Adjusted Appraised Value, Continuation Value and Liquidation Value as of
such date. Adjusted Appraised Value, Continuation Value and Liquidation Value
will be adjusted as of the Final Valuation Date(i) to reflect the amount of
lender and capital expenditure reserves and the amount of deferred management
fees as of such date, (ii) to increase the Adjusted Appraised Value by any
amounts actually expended by PHLP after the Initial Valuation Date to perform
deferred maintenance that were previously subtracted in determining the
estimated Adjusted Appraised Value of PHLP and (iii) to reflect any changes in
PHLP's other reserves, such as for litigation expenses and indemnification
costs and any revised estimates of transfer and recordation taxes and fees.
APPRAISED VALUE. PHLP's Hotels were appraised as of March 1, 1998 by AAA, an
independent, nationally recognized hotel valuation and financial advisory firm
experienced in the appraisals of lodging properties such as PHLP's Hotels.
Each appraisal (an "Appraisal") was reviewed by a Member Appraisal Institute
("MAI") appraiser and certified by such MAI appraiser as having been prepared
in accordance with the requirements of the Standards of Professional Practice
of the Appraisal Institute and the Uniform Standards of Professional Appraisal
Practice of the Appraisal Foundation.
The purpose of each Appraisal is to provide an estimate of the "Market
Value" of the related Hotel. "Market Value" means the most probable price
which a property should bring in a competitive and open market under all
conditions requisite to a fair sale, the buyer and seller each acting
prudently and knowledgeably and assuming the price is not affected by undue
stimuli. Implicit in this definition is the consummation of a sale as of a
specified date and the passing of title from seller to buyer under conditions
whereby: (i) the buyer and seller are equally motivated; (ii) both parties are
well informed or well advised, and each is acting in what he considers his own
best interest; (iii) a reasonable time frame is allowed for exposure in the
open market; (iv) payment is made in terms of cash in U.S. dollars or in terms
of financial arrangements comparable thereto and (v) the price represents the
normal consideration for the property sold unaffected by special or creative
financing or sales concessions granted by anyone associated with the sale. AAA
made site visits at all but one of PHLP's Hotels for purposes of the
Appraisals.
In preparing the Appraisals, AAA relied primarily on the income
capitalization method of valuation, and then compared the value estimated by
this method with recent sales of comparable properties, as a check on the
reasonableness of the value determined through the income capitalization
method. AAA employed the following procedures for determining the Appraised
Value of PHLP's Hotels:
. Historical 1997 and Projected Year's Earnings. AAA reviewed the
historical 1997 net operating income (i.e., income before interest,
taxes, depreciation and amortization) ("NOI") prior to incentive
PHLP Supp-10
<PAGE>
management fees and certain capital expenditures for each Hotel. AAA
also prepared a projection of the net operating income prior to
incentive management fees and certain capital expenditures for each
Hotel for the twelve month period ending February 28, 1999 (the
"Projected Year"), using historical financial information for each
Hotel, budget information, a survey with the manager of each Hotel
addressing the physical condition of each Hotel, local market conditions
(including business mix, demand generators, future trends and
predictability of business), changes in the competitive environment,
comparison with direct competitors of the Hotel and risk factors
relating to each Hotel. The resulting gross margin (ratio of total
revenues to NOI prior to incentive management fees) was checked against
AAA's database of the gross margins for similar hotels for
reasonableness.
. Impact of Incentive Management Fees. AAA estimated a normalized annual
amount of incentive management fees payable under the applicable
management agreement and subtracted this amount from the net operating
income prior to incentive management fees and certain capital
expenditures for 1997 and the Projected Year.
. Impact of Owner Funded Capital Expenditures. AAA estimated normalized
annual amounts of owner funded capital expenditures (over and above the
FF&E reserve) based in part on projected owner funded capital
expenditures estimated in the Engineering Study. The normalized amounts
were then subtracted from the NOI prior to owner funded capital
expenditures for 1997 and the Projected Year.
. Capitalization of Adjusted NOI. AAA then capitalized the amount
resulting from the foregoing adjustments ("Adjusted NOI") for 1997 and
the Projected Year by dividing such amounts by capitalization rates that
AAA determined to be appropriate. A capitalization rate represents the
relationship between net operating income and sales prices of income
producing property. AAA selected the capitalization rates based upon its
review of current published surveys reflecting the opinions of investors
and participants such as REITs, hotel acquisition/management companies
and pension funds, lenders, brokers and consultants as to current
capitalization rates, and its own database of capitalization rates
reflected in recent transactions, adjusted for factors specific to the
Hotel, such as location, physical condition, reserve policies, local
market volatility and competition, guest mix, renovation influences and
other income characteristics. AAA used separate capitalization rates
that it deemed appropriate to capitalize 1997 historical Adjusted NOI
and estimated Projected Year's Adjusted NOI. AAA then estimated the
value of each Hotel based upon each of the values estimated by
capitalizing 1997 and Projected Year's Adjusted NOI and its professional
judgment. The following table sets forth the effective capitalization
rates for 1997 and Projected Year's Adjusted NOI resulting from AAA's
estimated Appraised Values of PHLP's Hotels.
RESULTING EFFECTIVE CAPITALIZATION RATES FOR APPRAISALS OF PHLP'S HOTELS
<TABLE>
<CAPTION>
PROJECTED YEAR
1997 (ENDING FEBRUARY 28, 1999)
---- --------------------------
<S> <C>
9.2-9.8% 9.7-10.6%
</TABLE>
APPRAISED VALUES OF PHLP'S HOTELS
<TABLE>
<CAPTION>
APPRAISED
HOTEL VALUE
----- --------------
(IN THOUSANDS)
<S> <C>
Albuquerque Marriott Hotel.................................. $ 21,600
Greensboro High Point Marriott Hotel........................ 27,800
Houston Marriott Medical Center Hotel....................... 26,300
Marriott Mountain Shadows Resort............................ 38,600
Miami Biscayne Bay Hotel.................................... 38,500
Raleigh Marriott Hotel...................................... 28,000
Seattle Sea-Tac Airport Marriott Hotel...................... 63,600
Tampa Westshore Marriott Hotel.............................. 21,400
--------
Total..................................................... $265,800
========
</TABLE>
PHLP Supp-11
<PAGE>
. Comparison with Comparable Sales. AAA checked the Appraised Value of
each Hotel derived by the foregoing procedures against its database of
comparable sale transactions for reasonableness.
With respect to PHLP's Hotels, five properties were encumbered by ground
leases as of the date of the Appraisals. Accordingly, the Appraised Values of
such Hotels have been decreased to reflect the encumbrance of the ground
leases and the interests of the ground lessors in the operating cash flows of
such Hotels. The Appraised Value assumes all contractual provisions for FF&E
reserves are adequate and have not been reduced to reflect deferred
maintenance or environmental remediation costs with respect to PHLP's Hotels
(but estimated deferred maintenance costs have been deducted in estimating the
Adjusted Appraised Value of each of PHLP's Hotels). The Appraised Value did
not take into account the costs that might be incurred in selling the Hotels
(but estimated costs for transfer and recordation taxes and fees have been
deducted in estimating the Adjusted Appraised Value of the Hotels).
The Appraisals are not guarantees of present or future values and no
assurance can be given as to the actual value of PHLP's Hotels. The Appraisals
should be read in conjunction with other information, such as, but not limited
to, the audited financial statements of PHLP.
The Appraised Value, and the assumptions underlying the projections on which
the Appraised Value are based, are contingent upon a series of future events,
the outcomes of which are not necessarily within the Operating Partnership's
control and cannot be determined at this time. There can be no assurance that
another appraiser would not have arrived at a different result. Some of the
assumptions inevitably will not materialize and unanticipated events and
circumstances will occur subsequent to the date of the Appraisals.
Furthermore, the actual results achieved from PHLP's Hotels will vary from the
results projected in the Appraisals and the variations may be material.
ADJUSTED APPRAISED VALUE. The Adjusted Appraised Value of PHLP was
determined by totaling the Appraised Values of all of the Hotels of PHLP and
then making various adjustments to the aggregate Appraised Value, as described
below.
. Mortgage and Other Debt. The estimated principal balance and accrued
interest as of the Effective Date (assumed to be December 31, 1998) of
all mortgage and other debt of PHLP has been subtracted from the
Appraised Value.
. Deferred Management Fees. The amount of deferred management fees
(management fees earned by the manager pursuant to the Management
Agreement and not paid currently) estimated to be payable under the
Management Agreements of PHLP as of December 31, 1998 have been
subtracted from the Appraised Value. The amount of such deferred
management fees will be recalculated as of the Final Valuation Date.
. Deferred Maintenance Costs. The estimated cost to complete any deferred
maintenance items identified in the Engineering Study relating to PHLP's
Hotels have been subtracted from the Appraised Value. The adjustments
for this item will be reduced at the Final Valuation Date to reflect
amounts expended after the Initial Valuation Date to perform such
deferred maintenance. No adjustments have been made for previously
budgeted capital expenditures or deferred maintenance costs estimated in
the Engineering Study that are reflected in the cash flow projections
used for purposes of estimating Appraised Values.
. Transfer and Recordation Taxes and Fees. The estimated transfer and
recordation taxes and fees required to be paid by PHLP in connection
with the Merger have been subtracted from the Appraised Value. The
actual transfer and recordation taxes and fees will be paid by the
Operating Partnership as part of the Merger Expenses.
PHLP Supp-12
<PAGE>
The following table sets forth the adjustments to the aggregate Appraised
Values made to derive the estimated Adjusted Appraised Value for PHLP as of
the Initial Valuation Date.
CALCULATION OF ESTIMATED ADJUSTED APPRAISED VALUE FOR PHLP
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................................................. $ 265,800
Mortgage debt................................................... (161,136)
Other debt...................................................... (128,102)
Deferred management fees........................................ (34,151)
Deferred maintenance costs...................................... (5,212)
Transfer taxes.................................................. (814)
---------
Estimated Adjusted Appraised Value.............................. $ 0
=========
Limited partners' share......................................... $ 0
Per Partnership Unit............................................ $ 0
</TABLE>
CONTINUATION VALUE. AAA estimated the Continuation Value of PHLP using the
following methodology:
. Estimated Future Cash Distributions. AAA prepared estimates of future
partnership cash flow for PHLP for the 12-year period from January 1,
1998 through December 31, 2009 based upon the estimated 1998 NOI before
incentive management fees used in the Appraisals and for each subsequent
year applying an assumed annual stabilized growth rate (as shown in the
table below) developed by AAA for this analysis. For each year in the
projection period, AAA estimated the amount of cash available for
distribution to PHLP's limited partners after payment of all management
fees, debt service, owner funded capital expenditures based on the
Engineering Study and other partnership expenses and after application
of the applicable partnership agreement provisions. AAA assumed that
PHLP's FF&E reserve was adequate and understood that Host determined
that there were no reserve shortfalls or surpluses.
. Refinancing Assumptions. For debt that matures during the 12-year
period, AAA assumed that the first mortgage debt of PHLP would be
refinanced with interest rate of 8.0% per annum and a 25-year
amortization schedule and the second mortgage debt would be refinanced
with an 8.5% interest rate per annum and a 25-year amortization
schedule, with estimated refinancing costs of 2% of the refinanced
amount being added to the principal balance of the loan, since cash flow
of PHLP was estimated to be insufficient to pay such costs.
. Determination of Residual Value. To estimate the residual value of the
PHLP limited partners' interest in PHLP at the end of the 12-year
period, AAA assumed that the PHLP Hotels would be sold as of December
31, 2009 at their then market value. AAA estimated the market value of
each Hotel as of such date by applying an exit capitalization rate that
it deemed appropriate, using the factors described above in connection
with the "--Appraised Value," which are set forth in the table below, to
the estimated Adjusted NOI for 2009 (estimated as described above). AAA
then subtracted estimated sales costs of 2.0% of the estimated market
value, added lender reserves and subtracted the estimated outstanding
principal balance of debt as of December 31, 2009 and deferred
management fees to arrive at net sales proceeds available for
distribution to PHLP partners. AAA then determined what portion of such
estimated net sales proceeds would be distributable to PHLP's limited
partners under the partnership and debt agreements.
. Discounting Distributions to Present Value. As a final step, AAA
discounted the estimated future cash distributions to PHLP's limited
partners from operations and estimated net sales proceeds to their
present value as of January 1, 1998, using a discount rate of 20% per
annum. AAA believes that this discount rate reflects the return on
investment that investors expect from leveraged investments of this
nature.
PHLP Supp-13
<PAGE>
The growth rate and exit capitalization rate used to determine the estimated
Continuation Value for PHLP are as set forth below:
GROWTH RATE, EXIT CAPITALIZATION RATE
AND ESTIMATED CONTINUATION VALUE FOR PHLP
<TABLE>
<CAPTION>
ESTIMATED
CONTINUATION VALUE
GROWTH RATE EXIT CAPITALIZATION RATE (2009) (PER PARTNERSHIP UNIT)
----------- ------------------------------- ----------------------
<S> <C> <C>
3.6% 10.1% $5,040
</TABLE>
LIQUIDATION VALUE. The Liquidation Value of PHLP was estimated by the
General Partner and represents the estimated value of PHLP if all of its
assets were sold as of December 31, 1998. Such value was based upon the
Adjusted Appraised Value of PHLP, with the following adjustments: (i) the
"mark to market" adjustment used to estimate the Adjusted Appraised Value was
eliminated and instead prepayment or defeasance costs that would be payable
under existing debt agreements (regardless of whether the debt in fact can be
prepaid on December 31, 1998) were deducted from the Appraised Value; and (ii)
the deduction for transfer and recordation taxes and fees used to estimate the
Adjusted Appraised Value was eliminated and instead an amount equal 2.5% of
the Appraised Value of PHLP's Hotels was subtracted from the Appraised Value
for estimated liquidation costs, expenses and contingencies. The General
Partner then determined the portion of the estimated Liquidation Value that
would be distributable to PHLP's limited partners under the terms of the
partnership agreement and other contractual arrangements.
The following table sets forth the adjustments made to the Adjusted
Appraised Value to estimate the Liquidation Value of PHLP as of the Initial
Valuation Date:
CALCULATION OF ESTIMATED LIQUIDATION VALUE OF PHLP
AS OF THE INITIAL VALUATION DATE
(IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNT)
<TABLE>
<S> <C>
Appraised Value................................................. $ 265,800
Mortgage debt................................................... (161,136)
Other debt...................................................... (128,102)
Deferred management fees........................................ (34,151)
Deferred maintenance costs...................................... (5,212)
Sales costs..................................................... (6,645)
---------
Estimated Liquidation Value..................................... $ 0
=========
Limited partners' share......................................... $ 0
Per Partnership Unit............................................ $ 0
</TABLE>
ESTIMATED EXCHANGE VALUE. The following table sets forth the estimated
Exchange Value of PHLP (based upon the greatest of its estimated Adjusted
Appraised Value, estimated Continuation Value and estimated Liquidation
Value), the estimated minimum and pro forma number of OP Units to be received
and the estimated Note Election Amount for PHLP, all on a per Partnership Unit
basis as of the Initial Valuation Date. The estimated Exchange Value for PHLP
will be received by each PHLP Limited Partner retaining OP Units in the
Merger. The estimated Note Election Amount for PHLP (which will be received by
PHLP Limited Partners electing to receive Notes in exchange for OP Units) is
equal to 60% of the estimated Exchange Value for PHLP. The estimated values
set forth below may increase or decrease as a result of various adjustments,
which will be finally calculated as of the Final Valuation Date but will not
change as a result of less than all of the Partnerships participating in the
Mergers. The actual number of OP Units to be received by the PHLP Limited
Partners will be based on the average closing price on the NYSE of a Host REIT
Common Share for the 20 trading days after the Effective Date.
PHLP Supp-14
<PAGE>
ESTIMATED EXCHANGE VALUE, NUMBER OF OP UNITS AND NOTE ELECTION AMOUNT OF PHLP
PER PARTNERSHIP UNIT(1)
<TABLE>
<CAPTION>
ESTIMATED ESTIMATED
ESTIMATED ESTIMATED ESTIMATED ESTIMATED MINIMUM PRO FORMA ESTIMATED
ADJUSTED APPRAISED CONTINUATION LIQUIDATION EXCHANGE NUMBER OF NUMBER OF NOTE ELECTION
VALUE VALUE VALUE VALUE(2) OP UNITS(3) OP UNITS(4) AMOUNT(5)
------------------ ------------ ----------- --------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
$0 $5,040 $0 $5,040 252 $3,024
</TABLE>
- --------
(1) A Partnership Unit in PHLP represents an original investment of $10,000.
(2) The estimated Exchange Value is equal to the greatest of estimated
Adjusted Appraised Value, estimated Continuation Value and estimated
Liquidation Value.
(3) Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Merger.
(4) Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
(5) The principal amount of Notes is equal to the greater of (i) the
Liquidation Value or (ii) 60% of the Exchange Value (the "Note Election
Amount").
Price of OP Units to Pay Exchange Value to PHLP Limited Partners. Each PHLP
Limited Partner will receive OP Units with a deemed value equal to the
Exchange Value of such PHLP Limited Partner's Partnership Interests. The price
of an OP Unit for this purpose will be equal to the average closing price on
the NYSE of a Host REIT Common Share for the 20 trading days after the
Effective Date of the Mergers (but in no event greater than $ per share).
The closing price per share of Host common stock on the NYSE was $ on
, 1998.
PHLP Limited Partners at the Effective Date of the Merger who retain OP
Units will receive cash distributions from PHLP for all of 1998 and, if the
Merger does not occur in 1998, any portion of 1999 prior to the Merger for
which period they do not receive a cash distribution from the Operating
Partnership. Cash distributions will be made by PHLP in accordance with its
partnership agreement on or before June 1, 1999 in respect of 1998 operations
and, if the Merger does not occur prior to January 1, 1999, within 90 days
after the Effective Date of the Merger in respect of any 1999 operations. PHLP
Limited Partners at the Effective Date of the Merger who receive Notes in
exchange for OP Units will participate in the same distributions from PHLP as
Limited Partners who retain OP Units but will not receive any distributions
from the Operating Partnership with respect to periods after the Effective
Date of the Merger.
No fractional OP Units will be issued. Fractional amounts less than or equal
to 0.50 of an OP Unit will be rounded down to the next whole number and
fractional amounts greater than 0.50 will be rounded up to the next whole
number of OP Units.
VALUATION OF THE GENERAL PARTNER'S INTEREST IN PHLP AND ALLOCATION OF OP UNITS
TO THE GENERAL PARTNER
The value of the General Partner's interest will be equal to the aggregate
Exchange Value of PHLP minus the aggregate Exchange Value of the PHLP Limited
Partners' Partnership Interests (giving effect to the applicable distribution
preferences in the PHLP partnership agreement). The number of OP Units that
will be received by the General Partner will be equal to the value of its
interest in PHLP divided by the same price per OP Unit used to determine the
number of OP Units to be received by the PHLP Limited Partners. The total
number of OP Units that will be owned directly or indirectly by Host REIT
(including OP Units owned by the General Partner) will be equal to the number
of outstanding shares of common stock of Host at the Effective Date.
PHLP Supp-15
<PAGE>
The following table sets forth the estimated value of the General Partner's
interest in PHLP based upon the estimated aggregate Exchange Value of the PHLP
Limited Partners' Partnership Interests as of the Initial Valuation Date and
the minimum and pro forma number of OP Units estimated to be received by the
General Partner in respect thereof.
ESTIMATED VALUE OF THE GENERAL PARTNER'S INTEREST AND NUMBER OF OP UNITS
(DOLLARS IN THOUSANDS)
<TABLE>
<S> <C>
Aggregate Exchange Value............................................... $12,096
Limited partners' share of aggregate Exchange Value.................... 9,072
-------
Value of General Partner's interest.................................... $ 3,024
Value of Host's limited partner interest............................... 5
-------
Total Host interest.................................................... $ 3,029
=======
Number of OP Units:
Minimum(1)...........................................................
Pro Forma(2)......................................................... 151
</TABLE>
- --------
(1) Assumes the price of an OP Unit is $ , which is the maximum price for
purposes of the Mergers.
(2) Assumes the price of an OP Unit is $20.00, which is the price used for
purposes of the pro forma financial statements.
CASH DISTRIBUTIONS
Historical Cash Distributions Paid by PHLP. PHLP has never paid any cash
distributions to its Limited Partners.
Compensation and Distributions to the General Partner. Under PHLP's
partnership agreement, the General Partner does not receive fees or
compensation in connection with managing the affairs of PHLP but the General
Partner and its affiliates are reimbursed for certain costs and expenses
incurred on behalf of PHLP. In addition, the General Partner is entitled to
distributions related to its interests in PHLP. The following information has
been prepared to compare the amount of reimbursements paid and cash
distributions made by PHLP to the General Partner and its affiliates to the
amounts that would have been paid if the reimbursement and distribution
structure which will be in effect after the REIT Conversion had been in effect
for the periods presented.
Following the REIT Conversion, Host REIT will be operated as a self-
administered REIT and as a result no reimbursements or other compensation will
be received by the General Partner.
PHLP Supp-16
<PAGE>
The following table sets forth the reimbursements and distributions paid by
PHLP to the General Partner for the last three fiscal years and the First Two
Quarters 1998 ("Historical") and the reimbursements and distributions that
would have been paid to the General Partner for the last fiscal year and the
First Two Quarters 1998 if the REIT Conversion had been in effect, assuming
the Full Participation Scenario ("Pro Forma") and assuming a distribution per
OP Unit of $1.05 per year during such period, which is the midpoint of the
expected distribution range for 1999.
HISTORICAL AND PRO FORMA
REIMBURSEMENTS AND DISTRIBUTIONS TO THE GENERAL PARTNER
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR FISCAL YEAR
1998 1997 1996 1995
-------------------- -------------------- ---------- ----------
HISTORICAL PRO FORMA HISTORICAL PRO FORMA HISTORICAL HISTORICAL
---------- --------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Principal and interest
payments on loans...... $6,798 $-- $ 9,845 $ -- $9,358 $11,820
Reimbursements(1)....... 132 -- 259 -- 218 88
Distributions(2)........ 0 80 0 159 0 0
------ --- ------- ---- ------ -------
Total................. $6,930 $80 $10,104 $159 $9,576 $11,908
====== === ======= ==== ====== =======
</TABLE>
- --------
(1) All expenses will be paid directly by the Operating Partnership,
accordingly, there are no expected reimbursements on a pro forma basis.
(2) The amount of distribution payable to the General Partner on a pro forma
basis reflect distributions at a rate of $1.05 per annum per OP Unit
(which is the midpoint of the expected range of distributions per OP Unit
for 1999) with respect to the estimated number of OP Units that the
General Partner will receive with respect to its general and limited
partner interests in PHLP. Such number does not reflect the aggregate
number of OP Units Host will receive in connection with the REIT
Conversion.
CERTAIN INFORMATION REGARDING THE HOTELS OWNED BY PHLP
<TABLE>
<CAPTION>
NUMBER OF DATE
NAME OF HOTEL LOCATION OF HOTEL ROOMS OPENED
- ------------- ----------------- --------- ------
<S> <C> <C> <C>
Albuquerque Marriott Hotel Albuquerque, NM 411 1982
Greensboro-High Point Marriott Hotel Greensboro, NC 299 1983
Houston Marriott Medical Center Hotel Houston, TX 386 1984
Marriott Mountain Shadows Resort Scottsdale, AZ 337 1959
Miami Biscayne Bay Hotel Miami, FL 605 1983
Raleigh Marriott Hotel Raleigh, NC 375 1982
Seattle Sea-Tac Airport Marriott Hotel Seattle, WA 459 1981
Tampa Westshore Marriott Hotel Tampa, FL 310 1981
-----
TOTAL 3,182
=====
</TABLE>
The table below sets forth certain performance information for PHLP's Hotels
for the indicated periods.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
-------------------- ------------------------
1998 1997 1997 1996 1995(1)
--------- --------- ------- ------ -------
<S> <C> <C> <C> <C> <C>
Average daily rate.............. $ 117.81 $ 110.15 $105.40 $95.98 $94.86
Occupancy....................... 81.1% 82.2% 78.5% 79.4% 79%
REVPAR.......................... $ 95.54 $ 90.54 $ 82.74 $76.21 $74.94
% REVPAR change................. 5.5% -- 8.6% 1.7% --
</TABLE>
- --------
(1) 1995 information includes statistics on one Dallas hotel which was sold on
August 22, 1995. The % REVPAR change for 1995 is not shown as the Point
Clear and Tampa Hotels were foreclosed upon and the Tampa and Raleigh
Hotels were subsequently purchased in 1994 making 1994 and 1995
information incomparable.
PHLP Supp-17
<PAGE>
Albuquerque Marriott Hotel, Albuquerque, New Mexico
The Albuquerque Marriott Hotel is located on a leased parcel of land of
approximately six acres in the northeastern suburbs of Albuquerque in a
residential, office and commercial development called Uptown.
The Hotel, which opened in July 1982, consists of a 16-story guest room
tower. The facilities include 411 guest rooms, two restaurants, one lobby bar
and cocktail service in the lobby. There is approximately 13,800 square feet
of space for conventions and banquets. Parking is provided for approximately
500 cars. In addition, the Hotel offers an indoor/outdoor pool, hydrotherapy
pool, sauna, health club and gift shop.
Competition. Studies indicate that currently six hotels with approximately
1,800 rooms directly compete with the Albuquerque Marriott Hotel in the
Albuquerque market.
Ground Lease. The Hotel site is subject to a ground lease with an initial
term expiring in July 2032 and with three renewal options of 10 years each.
The ground lease provides for annual rent equal to the greater of (i) 3.5% of
annual gross room sales or (ii) $155,000 for the first 10 years and $165,000
thereafter during the initial term of the lease. For periods subsequent to the
initial term of the lease, annual rent will equal the greatest of (i) 3.5% of
annual gross room sales, (ii) $165,000 or (iii) 10% of the fair market value
of the land, determined in each case as of each renewal date of the lease.
Greensboro-High Point Marriott Hotel, Greensboro, North Carolina
The Greensboro-High Point Marriott Hotel is located on approximately 15
acres of leased land on the grounds of the Greensboro-High Point Regional
Airport which serves the cities of Greensboro, High Point and Winston-Salem.
The Hotel, which opened in June 1983, is a six-story tower containing 299
guest rooms including a concierge floor, two restaurants, a lounge and
approximately 9,000 square feet of space for banquets and conventions. Parking
for 500 cars is provided. In addition, the Hotel has two lighted tennis
courts, an indoor/outdoor pool with a 1,200-square foot deck for banquet
functions, a hydrotherapy pool, a gift shop and a health club.
Competition. Studies indicate that currently three hotels containing
approximately 1,500 rooms directly compete with the Greensboro-High Point
Marriott Hotel in the Greensboro market.
Ground Lease. The Hotel site is subject to a ground lease from the
Greensboro-High Point Airport Authority with an initial term expiring in June
2008 and with an option to extend for an additional 15 years. Additional
renewal options totaling 20 years are available if the Hotel is expanded to
500 rooms. The lease calls for an annual rent equal to the greater of (i)
2.25% of the annual gross room sales plus 2% of the annual gross alcoholic
beverage sales plus 1% of the annual gross food sales or (ii) $127,000.
During the first extended term, the percentage rental for the annual gross
room sales will be increased to 3% and, if on the first day of the extended
term the Hotel contains fewer than 400 rooms, the percentage rentals for
alcoholic beverage and food sales will increase to 2.5% and 1.25%,
respectively.
Houston Marriott Medical Center Hotel, Houston, Texas
The Houston Marriott Medical Center Hotel is located in the Texas Medical
Center in Houston, Texas, on a leased site of 23,670 square feet, and is
situated directly opposite the main building of the Methodist Hospital and
adjoins the Scurlock Towers which houses the Total Health Care Center of
Methodist Hospital and approximately 200 doctors' offices.
The Hotel, which opened in August 1984, includes 386 guest rooms, two
concierge floors, two restaurants and a lounge. There is approximately 8,500
square feet of space with facilities for conventions and banquets.
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Parking is available for approximately 380 cars in an adjacent parking
structure. Additional facilities within the Hotel include an indoor pool, a
hydrotherapy pool, a gift shop and a health club.
Competition. Studies indicate that currently six hotels containing
approximately 1,600 rooms directly compete with the Houston Marriott Medical
Center Hotel in the Houston market.
Ground Lease. The land on which the Hotel is located is subject to a ground
lease with an initial term expiring in August 2009 with five 10-year renewal
options. The lease provides for annual rental equal to the greater of (i)
$160,000 or (ii) 3% of the first $15 million of annual gross room sales plus
3.25% of annual gross room sales in excess of $15 million.
Marriott's Mountain Shadows Resort, Scottsdale, Arizona
The Mountain Shadows Resort Hotel is located on approximately 25 acres of
fee-owned land in Scottsdale, approximately ten miles north of the Phoenix Sky
Harbor International Airport. Host Marriott owns land adjacent to the site, on
which an 18-hole executive-style golf course is located.
Mountain Shadows opened in 1959 and was acquired by PHLP in 1982. A major
renovation program was completed in 1983. The Hotel contains 337 guest rooms
as well as three pools, two hydrotherapy pools, eight lighted tennis courts
and a fitness center. Hotel guests have full privileges at the Mountain
Shadows Golf Club which offers an 18-hole executive-style golf course. In
addition, guests of the Hotel have access to the Camelback Inn Country Club
owned by Marriott International (which is approximately two miles from the
Hotel and offers two 18-hole championship golf courses) and the Camelback Inn
spa located on the Camelback Inn resort grounds. Dining facilities at the
Hotel include a family restaurant, a specialty seafood restaurant and an
outdoor terrace. The Hotel's restaurants can accommodate seating for 430. In
addition, the Mountain Shadows Golf Club offers a restaurant/snack bar, bar
and patio area. The Hotel has more than 15,000 square feet of space for
conventions and banquets. Parking is available for approximately 740 cars.
Competition. Studies indicate that currently five hotels containing
approximately 1,500 rooms directly compete with Marriott's Mountain Shadows
Resort in the Scottsdale market.
Miami Biscayne Bay Hotel, Miami, Florida
The Miami Biscayne Bay Hotel is located on a leased parcel of land of
approximately 1.9 acres plus space and facilities in an adjacent building in a
residential and commercial project located on Biscayne Bay in downtown Miami.
The Hotel, which opened in December 1983, is a 31-story tower which has 605
guest rooms, one restaurant, an indoor lounge and cocktail service in the
lobby. Approximately 14,000 square feet of space with facilities for
conventions and banquets is available. Parking is provided for 288 cars. In
addition, the Hotel has an outdoor pool, a recreation deck, a game room, a
gift shop and a health club.
Competition. Studies indicate that currently five hotels containing
approximately 2,500 rooms directly compete with the Miami Biscayne Bay Hotel
in the Miami market.
Ground Lease. The Hotel site is subject to a ground lease with an initial
term expiring in December 2008, with renewal options for five successive 10-
year periods. The lease calls for annual rental of the greater of (i) $1.0
million or (ii) 4% of annual gross room sales plus 3% of annual gross food and
beverage sales.
Raleigh Marriott Hotel, Raleigh, North Carolina
The Raleigh Marriott Hotel is located on approximately ten acres of fee-
owned land at the entrance to Crabtree Valley Mall in northwest Raleigh. The
Raleigh-Durham Airport and the Research Triangle Park are located 10 and 17
miles west of the site, respectively. Downtown Raleigh is two miles east of
the site.
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The Hotel, which opened in March 1982, includes 375 guest rooms, one
restaurant, a cocktail lounge and approximately 8,300 square feet of space for
conventions and banquets. Parking for approximately 571 cars is provided. In
addition, the Hotel offers an indoor/outdoor pool, a concierge lounge, sauna
and hydrotherapy facilities, a health club and a gift shop.
Competition. Studies indicate that currently three hotels with approximately
900 rooms directly compete with the Raleigh Marriott Hotel in the Raleigh
market.
Seattle Marriott Hotel Sea-Tac Airport, Seattle, Washington
The Seattle Marriott Hotel is located on nine acres of fee-owned land near
the entrance to the Seattle-Tacoma International Airport. The Hotel is
approximately ten miles from downtown Seattle and approximately three miles
from Interstate 5, the major north-south route through Washington.
The Hotel, which opened in January 1981, consists of a nine-story tower and
three five-story wings surrounding a landscaped atrium. The facilities include
459 guest rooms, a restaurant, an atrium cocktail service bar, three ballrooms
totaling 18,500 square feet and meeting and conference rooms. In addition, the
Hotel has two hydrotherapy pools, a health club, a sauna, an indoor pool, a
gift shop, a game room and parking for 550 cars.
Competition. Studies indicate that currently four hotels containing
approximately 1,500 rooms directly compete with the Seattle Marriott Hotel
Sea-Tac Airport in the Seattle market.
Tampa Westshore Hotel, Tampa, Florida
The Tampa Westshore Hotel is located on a leased parcel of land of
approximately seven acres in a major office development just off I-75 on North
Westshore Boulevard. The Hotel is approximately two miles from the Tampa
International Airport and five miles from downtown Tampa.
The Hotel, which opened in July 1981, consists of a 13-story hotel tower, a
one-and-one-half story lobby and meeting space. The facilities include 310
guest rooms, a restaurant, a sports bar, a concierge lounge and approximately
8,400 square feet of space for conventions and banquets. Parking for more than
400 cars is provided. In addition, the Hotel has an indoor/outdoor pool, a
hydrotherapy pool, a health club, a game room and a gift shop.
Competition. Studies indicate that currently 11 hotels containing
approximately 3,200 rooms directly compete with the Tampa Westshore Hotel in
the Tampa market.
Ground Lease. The Hotel is subject to a ground lease with an initial term
expiring in July 2006 with five 10-year renewal options. The lease provides
for a percentage rent equal to the greater of (i) 3% of gross room sales plus
1% of gross food sales plus 1% of gross alcoholic beverage sales or (ii)
$96,000 per year.
LEGAL PROCEEDINGS
PHLP. On July 15, 1998, one limited partner in PHLP filed a class action
lawsuit styled Michael C. deBerardinis v. Host Marriott Corporation, Civil
Action No. WMN 98-2263, in the United States District Court for the District
of Maryland. The plaintiff alleges that Host misled the limited partners in
order to induce them into approving the sale of one of the Partnership's
hotels, violated the securities regulations by issuing a false and misleading
consent solicitation and breached fiduciary duties and the partnership
agreement. The complaint seeks unspecified damages. Host has not yet been
served with the complaint but intends to vigorously defend against the claims
asserted in the lawsuit.
AMENDMENTS TO PHLP'S PARTNERSHIP AGREEMENT
In order to allow the Hotels of PHLP to be leased to SLC in connection with
the Merger and the REIT Conversion, PHLP's partnership agreement must be
amended. Currently, there is no provision in PHLP's
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partnership agreement to allow PHLP's Hotels to be leased. Therefore, Section
5.02B of PHLP's partnership agreement must be amended to amend and restate
paragraph 5.02B(ii) to read as follows:
(vi) sell, lease or otherwise dispose of (or consent to the sale, lease
or other disposition of), directly or indirectly, in one transaction or a
series of related transactions any or all of the Hotels.
Other Amendments. Amendments to certain terms and sections of PHLP's
partnership agreement would be made in order to (i) delete certain obsolete
references to entities and agreements that are no longer in existence, (ii)
update PHLP's partnership agreement to reflect the passage of time since the
formation of PHLP and (iii) make any other amendments to PHLP's partnership
agreement deemed necessary or advisable, in the sole discretion of the General
Partner, in connection with the consummation of the Merger and the REIT
Conversion. The General Partner does not believe that these amendments would
affect the rights of the PHLP Limited Partners in any material respect nor the
duties and obligations of the General Partner. These changes are included,
along with the other proposed amendments, in the copy of PHLP's partnership
agreement, as proposed to be amended, which is attached hereto. The amended
PHLP partnership agreement is marked to indicate the revisions made to the
existing PHLP partnership agreement and should be read in its entirety.
Deleted provisions are contained in brackets and struck through and added
provisions are in bold type and underlined.
FAIRNESS ANALYSIS AND OPINION
FAIRNESS ANALYSIS
The General Partner believes that the Merger provides substantial benefits
and is fair to the Limited Partners of PHLP and recommends that all Limited
Partners of PHLP consent to the Merger. The General Partner bases this
recommendation primarily on (i) its view that the expected benefits of the
Merger for the PHLP Limited Partners outweigh the risks and potential
detriments of the Merger to the PHLP Limited Partners (see "Background and
Reasons for the Mergers and the REIT Conversion--Reasons for the Mergers" and
"Risk Factors"), (ii) its view that the value of the OP Units allocable to the
PHLP Limited Partners on the basis of the Exchange Value established for PHLP
represents fair consideration for the Partnership Interests held by the PHLP
Limited Partners and is fair to the PHLP Limited Partners from a financial
point of view and (iii) the Appraisals and Fairness Opinion of AAA.
The Merger is not conditioned upon the consummation of any of the other
Mergers. The General Partner has considered this fact in evaluating the
fairness of the Merger. The General Partner believes that the fairness of the
Merger will not be materially affected by the presence or absence of any other
individual Partnership or by any particular combination of other Partnerships
and that the Merger will be fair to the PHLP Limited Partners, individually
and as a whole, if it is consummated with any combination of other
Participating Partnerships. The General Partner bases this belief primarily on
the fact that the consideration to be paid to the PHLP Limited Partners has
been established based upon PHLP's Exchange Value, without regard to any
possible combination of other Partnerships.
In reaching the conclusions implicit in the above recommendation, the
General Partner has taken into account the following considerations, placing
the greatest weight on the first two considerations:
. The General Partner has concluded that the Exchange Value for PHLP, which
is equal to its Continuation Value, represents fair consideration for the
Partnership Interests of the PHLP Limited Partners in the Merger in
relation to PHLP. The General Partner also has concluded that the
Exchange Value established for the PHLP Limited Partners fairly reflects
the value of the assets held by PHLP. In addition, the Fairness Opinion
supports these conclusions.
. PHLP Limited Partners will be able to defer recognition of gain until
such time as they choose to realize such gain based on their personal
circumstances.
. The General Partner has concluded that the potential benefits of the
Merger to the PHLP Limited Partners, as described under "Background and
Reasons for the Mergers and the REIT Conversion--Reasons for
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the Mergers," outweigh the potential risks and detriments of the Merger
for the PHLP Limited Partners, as described in "Risk Factors."
. The Fairness Opinion, in the view of the General Partner, supports the
fairness of the Merger, even though it includes qualifications,
limitations and assumptions relating to its scope and other factors that
PHLP Limited Partners should consider carefully. The availability of the
Fairness Opinion is particularly significant in light of the absence of
arm's length negotiations in establishing the terms of the Merger.
. Host will contribute its wholly owned full-service hotel assets,
substantially all of its interests in the Hotel Partnerships and its
other assets (excluding its senior living assets and the cash or
securities to be distributed to its shareholders) to the Operating
Partnership in exchange for (i) a number of OP Units equal to the number
of outstanding shares of common stock of Host, (ii) preferred partnership
interests in the Operating Partnership corresponding to any shares of
Host preferred stock outstanding at the time of the REIT Conversion and
(iii) the assumption by the Operating Partnership of all liabilities of
Host (including past and future tax liabilities) other than liabilities
of SLC. Following these contributions, the Operating Partnership and its
subsidiaries will directly own all of Host's wholly owned hotels and all
of Host's interests in the Hotel Partnerships and Host's other assets.
Host will receive OP Units in respect of its general partner interests in
PHLP on substantially the same basis as the Partnership Units held by
Limited Partners. Host REIT will not receive any compensation for its
services as general partner to the Operating Partnership following the
REIT Conversion and will benefit from the operations of the Operating
Partnership only to the extent of the distributions received based upon
its percentage interest in the Operating Partnership to the same extent
as the other limited partners. Because Host REIT will share in the value
of the Operating Partnership solely through distributions and not through
any separate compensation structure, the General Partner believes that
this is a factor supporting the fairness of the Merger to the PHLP
Limited Partners.
. The General Partner believes that the value of the consideration to be
received by the PHLP Limited Partners in the Merger is fair in relation
to the value which would be derived by such Limited Partners under any of
the alternatives described under "Background and Reasons for the Mergers
and the REIT Conversion--Alternatives to the Mergers," especially since
the Exchange Value of PHLP is equal to its Continuation Value, which is
the greatest of the Adjusted Appraised Value, the Continuation Value and
the Liquidation Value and the historic prices paid for PHLP Partnership
Units. The General Partner does not believe that the sale of any of
PHLP's Hotels and liquidation of PHLP will obtain for PHLP Limited
Partners as much value as the value to be received by such PHLP Limited
Partners following the Merger. In addition, while the Continuation Values
of certain of the Partnerships, including PHLP, are higher than the
Adjusted Appraised Values of such Partnerships, the General Partner
believes that the Merger provides substantial benefits to PHLP Limited
Partners, including those benefits described under "Background and
Reasons for the Mergers and the REIT Conversion--Reasons for the
Mergers," especially enhanced liquidity and regular quarterly cash
distributions. The General Partner believes that the following benefits
are of the greatest value and importance to the PHLP Limited Partners:
. Enhanced Liquidity. The Merger and the REIT Conversion will offer
PHLP Limited Partners significantly enhanced liquidity with respect
to their investments in PHLP because, commencing one year following
the Effective Date, PHLP Limited Partners who retain OP Units will be
able to exercise their Unit Redemption Right at any time, subject to
certain limited exceptions. Host has approximately 204 million shares
of common stock outstanding and is expected to have a total common
equity market capitalization of approximately $ billion after
giving effect to the estimated $ million earnings and profits
distribution (based on Host's $ closing price per share on the NYSE
on , 1998). The exercise of the Unit Redemption Right, however,
generally would result in recognition of taxable income or gain at
that time.
. Risk Diversification. Upon consummation of the REIT Conversion, each
PHLP Limited Partner's investment will be converted from an
investment in PHLP, which owns eight hotels, into an investment in an
enterprise that initially will own or control approximately 120
Hotels and will have a total market capitalization of approximately
$ billion, thereby reducing the dependence upon the performance of,
and the exposure to the risks associated with, any particular Hotel
or group of
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Hotels currently owned by PHLP and spreading such risk over a broader
and more varied portfolio, including more diverse geographic locations
and multiple brands.
. Reduction in Leverage and Interest Costs. It is expected that the
Operating Partnership will have a significantly lower leverage to
value ratio than PHLP currently, which has outstanding debt balances
in excess of the Appraised Values of its Hotels, resulting in
significant interest and debt service savings and greater financial
stability.
. Regular Quarterly Cash Distributions. The General Partner expects
that the Operating Partnership will make regular quarterly cash
distributions to holders of OP Units. Host expects that these
distributions will be higher than the estimated cash distributions
for 1998 for PHLP and, in any event, the ability to receive
distributions quarterly and in regular amounts would be enhanced.
. Substantial Tax Deferral. The General Partner expects that PHLP
Limited Partners who do not elect to receive Notes in exchange for OP
Units generally should be able to obtain the benefits of the Merger
while continuing to defer recognition for federal income tax purposes
of at least a substantial portion, if not all, of the gain with
respect to their Partnership Interests that otherwise would be
recognized in the event of a liquidation of PHLP or a sale or other
disposition of its assets in a taxable transaction (although PHLP
Limited Partners may (although are not expected to) recognize a
relatively modest amount of ordinary income as the result of required
sales of personal property by PHLP to a Non-Controlled Subsidiary in
order to facilitate Host REIT's qualification as a REIT).
The General Partner believes that the factors described above, which support
the fairness of the Merger to the PHLP Limited Partners, when weighed against
the factors that may be disadvantageous, taken as a whole, indicate that the
Merger is fair to the PHLP Limited Partners.
FAIRNESS OPINION
AAA, an independent financial advisory firm with substantial real estate and
partnership transaction experience, was engaged by the General Partner and the
other General Partners to perform the Appraisals and to render the Fairness
Opinion that (i) the Exchange Value and the methodologies and underlying
assumptions used to determine the Exchange Value, the Adjusted Appraised Value,
the Continuation Value and the Liquidation Value of PHLP and each other
Partnership (including, without limitation, the assumptions used to determine
the various adjustments to the Appraised Values of the Hotels,) are fair and
reasonable, from a financial point of view, to the PHLP Limited Partners and
the Limited Partners of each other Partnership and (ii) the methodologies used
to determine the value of an OP Unit and to allocate the equity in the
Operating Partnership to be received by the PHLP Limited Partners and the
Limited Partners of each other Partnership are fair and reasonable to the PHLP
Limited Partners and the Limited Partners of each other Partnership. The
Fairness Opinion is addressed to each Partnership and it may be relied upon by
each of the PHLP Limited Partners and the Limited Partners of each of the other
Partnerships. The full text of the Fairness Opinion, which contains a
description of the assumptions and qualifications applicable to the review and
analysis by AAA, is set forth in Appendix B to the Consent Solicitation and
should be read in its entirety. The material assumptions and qualifications to
the Fairness Opinion are summarized below, although this summary does not
purport to be a complete description of the various inquiries and analyses
undertaken by AAA in rendering the Fairness Opinion. Arriving at a fairness
opinion is a complex analytical process not necessarily susceptible to partial
analysis or amenable to summary description. For a more complete description of
the assumptions and qualifications that limit the scope of the Fairness
Opinion, see "--Qualifications to Fairness Opinion" and "--Assumptions" below.
Although the General Partner advised AAA that certain assumptions were
appropriate in its view, the General Partner imposed no conditions or
limitations on the scope of the investigation by AAA or the methods and
procedures to be followed by AAA in rendering the Fairness Opinion. The fees
and expenses of AAA will be treated as a Merger Expense and will be paid by the
Operating Partnership. In addition, the General Partner has agreed to indemnify
AAA against certain liabilities. See "--Compensation and Material
Relationships."
PHLP Supp-23
<PAGE>
Qualifications to Fairness Opinion. In the Fairness Opinion, AAA
specifically states that it did not: (a) specifically consider other
methodologies for allocation of the OP Units, (b) address or conclude that
other methodologies for allocation of the OP Units to PHLP and the other
Partnerships might not have been more favorable to the Limited Partners in
certain of the Partnerships, (c) negotiate with the General Partner, the
General Partners of other Partnerships or Host, (d) participate in
establishing the terms of the Merger and the other Mergers, (e) provide an
opinion as to the terms and conditions of the Merger and the other Mergers
other than those explicitly stated in the Fairness Opinion, (f) make any
independent review of the capital expenditure estimates set forth in the
Engineering Study or (g) make any estimates of PHLP's and each other
Partnership's contingent liabilities. In addition, with respect to the
specific reference to the allocation of the equity interest in the Operating
Partnership to be received by the limited partners of each Partnership, AAA
has assumed that the average closing price on the NYSE of a Host REIT Common
Share for the 20 trading days after the Effective Date of the Mergers
represents a fair price.
In connection with preparing the Fairness Opinion, AAA was not engaged to,
and consequently did not, prepare any written report or compendium of its
analysis for internal or external use beyond the analysis set forth in
Appendix B. AAA will not deliver any additional written opinion of the
analysis, other than to update the written opinion if requested by the
Operating Partnership.
Experience of AAA. AAA is the world's largest independent valuation
consulting firm and is regularly and continually engaged in the valuation of
commercial real estate and businesses and their securities in connection with
tender offers, mergers and acquisitions, recapitalizations and
reorganizations, divestitures, employee stock ownership plans, leveraged
buyout plans, private placements, limited partnerships, estate and corporate
matters, other financial advisory matters and other valuation purposes.
AAA was selected because of its experience in the valuation of businesses
and their securities in connection with tender offers, mergers and
acquisitions, recapitalizations and reorganizations, including transactions
involving hotel partnerships. In addition, Host and its affiliates have
previously engaged AAA to provide appraisals and fairness opinions in
connection with other transactions. The General Partner and the other General
Partners considered two other firms for purposes of performing the appraisals
and rendering the Fairness Opinion and received proposals from each. The
General Partners Selected AAA based upon price and experience.
Summary of Materials Considered and Investigation Undertaken. As a basis for
rendering the Fairness Opinion, AAA has made such reviews, studies and
analyses as it deemed necessary and pertinent in order to provide it with a
reasonable basis for the Fairness Opinion, including, but not limited to, the
following: (i) reviewed the transaction documents and SEC reporting and/or
filing documents, including drafts of the Form S-4 for the Mergers; (ii)
provided the Market Value of each Hotel owned by each Partnership in a
separate short form appraisal report and each such report was reviewed and
certified by an MAI appraiser as to its preparation in accordance with the
requirements of the Standards of Professional Practice of the Appraisal
Institute and the Uniform Standards of Professional Appraisal Practice of the
Appraisal Foundation; as part of the Appraisals, AAA reviewed historical
operating statements, 1998 budget and year-to-date results, and other
financial information as it deemed necessary as a basis for the Fairness
Opinion and the Appraisals also considered market transactions of similar
lodging properties as appropriate as a basis for the Market Value of each
Hotel; (iii) reviewed the methodologies used by each of the General Partners
in their determination of the Exchange Value of each Partnership, including
the nature and amount of all adjustments to the Appraised Values in
determining such Exchange Values; AAA reviewed and tested for the fairness and
reasonableness of all adjustments as well as for consideration of all
adjustments deemed to be appropriate by AAA; (iv) reviewed the methodologies
used by each of the General Partners in their determination of the value of an
OP Unit and the allocation of the equity interest in the Operating Partnership
to be received by the limited partners of each Partnership, and AAA reviewed
and tested for the fairness and reasonableness of the methods and measurements
made by the General Partners; (v) reviewed the General Partners' determination
of the Liquidation Value of each Partnership, and AAA reviewed and tested for
the fairness and reasonableness of all adjustments proposed by the General
Partners, as well as for consideration of all adjustments deemed appropriate
by AAA; (vi) provided an estimate of the Continuation Value of each
Partnership based upon the estimated present value of expected
PHLP Supp-24
<PAGE>
benefits to be received by each limited partner interest as though the Mergers
did not occur and each Partnership's assets were sold within a twelve year
period; AAA, as part of its analysis and review, determined appropriate rates
of growth in house profit or net operating income, as well as reviewed other
key variables affecting partnership cash flows and other economic/financial
factors affecting the Partnerships' expected operations and results; (vii)
reviewed the terms of the ground leases of the Hotels and the partnership
agreement of each Partnership; (viii) reviewed audited and unaudited
historical income statements, balance sheets and statements of sources and
uses of funds of each Partnership and Host and pro forma financial information
for Host REIT; (ix) reviewed audited and unaudited historical operating
statements of each Hotel, as well as current operating statements and budgets;
(x) conducted real estate valuation and financial due diligence with respect
to the Partnerships and their underlying assets, liabilities and equity; (xi)
reviewed internal Marriott International, Host and Partnership financial
analyses and other internally generated data for each Hotel; and (xii)
discussed all of the foregoing information, where appropriate, with management
of Marriott International, Host and the Partnerships and their respective
employees.
Assumptions. In rendering its opinion, AAA relied, without independent
verification, on the accuracy and completeness in all material respects of
certain relevant publicly available information and information provided to
AAA by Host and the Hotels. AAA assumed that all information furnished by
Host, the Hotels and the Partnerships and their representatives, upon which
AAA relied, presented an accurate description in all material respects of the
current and prospective status of the Hotels and the Partnerships from an
operational and financial point of view. AAA also noted that the Fairness
Opinion was based upon financial, economic, market and other considerations as
they existed and could be evaluated on the date thereof.
Conclusions. AAA concluded that, based upon and subject to its analysis and
assumptions and limiting conditions, and as of the date of the Fairness
Opinion: (i) the Exchange Value and methodologies used to determine the
Exchange Value, the Adjusted Appraised Value, the Continuation Value and the
Liquidation Value of each Partnership (including, without limitation, the
assumptions used to determine the various adjustments to the Appraised Values
of each of the Hotels,) are fair and reasonable, from a financial point of
view, to the PHLP Limited Partners and the Limited Partners of each other
Partnership and (ii) the methodologies used to determine the value of an OP
Unit and to allocate the equity interest in the Operating Partnership to be
received by the PHLP Limited Partners and the Limited Partners of each other
Partnership are fair and reasonable to the PHLP Limited Partners and the
Limited Partners of each other Partnership.
Compensation and Material Relationships. AAA has been paid a fee of $335,000
for its services as described herein, including the Appraisals and preparing
to deliver the Fairness Opinion. In addition, AAA will be reimbursed for all
reasonable out-of-pocket expenses, including legal fees and will be
indemnified against certain liabilities, including certain liabilities under
the securities laws. The fee was negotiated between Host, the General Partners
and AAA. Payment of the fee to AAA is not dependent upon completion of the
Mergers. AAA has been previously engaged by Host and its affiliates to provide
appraisals, fairness opinions and solvency opinions in connection with other
transactions.
VOTING PROCEDURES
The consent of PHLP Limited Partners holding more than 50% of the
outstanding limited partner interests is required for participation in the
Merger. The General Partner holds 0.06% of the outstanding limited partner
interests. The General Partner intends to vote its limited partner interests
FOR the Merger.
A PHLP Limited Partner may mark the Consent Form to vote "FOR," "AGAINST" or
"ABSTAIN" with respect to participation in the Merger by PHLP. THE FAILURE OF
A PHLP LIMITED PARTNER TO VOTE OR AN ABSTENTION WILL HAVE THE SAME EFFECT AS
IF SUCH LIMITED PARTNER HAD VOTED HIS PARTNERSHIP INTERESTS "AGAINST" THE
MERGER. LIMITED PARTNERS WHO RETURN A SIGNED CONSENT FORM BUT FAIL TO INDICATE
THEIR APPROVAL OR DISAPPROVAL AS TO ANY MATTER (INCLUDING THE MERGER) WILL BE
DEEMED TO HAVE VOTED TO APPROVE SUCH MATTER. The voting procedures applicable
to PHLP Limited Partners are set forth in the Consent Solicitation under the
heading "Voting Procedures--Required Vote and Other Conditions."
As of June 19, 1998, no person owned of record, or to the Partnership's
knowledge owns beneficially, more than 5% of the total number of PHLP
Partnership Units.
PHLP Supp-25
<PAGE>
FEDERAL INCOME TAX CONSEQUENCES
In addition to the federal income tax consequences discussed in the sections
of the Consent Solicitation entitled "Federal Income Tax Consequences" and
"Risk Factors--Federal Income Tax Risks," PHLP Limited Partners should read
carefully the following discussion of federal income tax consequences
applicable specifically to the PHLP Limited Partners. The information included
in this discussion is based upon various factual assumptions and information
which are believed by the Operating Partnership and the General Partner to be
reliable. However, some of these assumptions inevitably will not materialize
and unanticipated events and circumstances will occur. Therefore, there likely
will be differences between the information provided herein, including the
numerical data and estimates, and actual results and the variations may be
material and adverse.
Applicability of Tax Opinions
Hogan & Hartson L.L.P. ("Hogan & Hartson"), counsel to Host REIT, Host and
the Operating Partnership, has provided to Host REIT and the Operating
Partnership an opinion letter (substantially in the form of Appendix C to the
Consent Solicitation) as to certain federal income tax consequences to the
Operating Partnership and the PHLP Limited Partners resulting from the Mergers
and the REIT Conversion. The opinion letter is based upon certain assumptions
and certain representations provided by Host REIT, Host, the Operating
Partnership and the General Partners. These representations generally involve
factual matters relating to the organization, ownership and operations
(including the income, assets, businesses, liabilities and properties) of the
Partnerships and Hotels contributed to the Operating Partnership by Host and
the Blackstone Entities prior to the Mergers and the REIT Conversion and of
Host REIT, the Operating Partnership and the Partnerships following the
Mergers and the REIT Conversion. In addition, on the Effective Date, Hogan &
Hartson expects to provide to Host REIT and the Operating Partnership an
opinion letter (substantially in the form of Appendix D to the Consent
Solicitation) as to the qualification and taxation of Host REIT as a REIT
under the Code following the REIT Conversion. The receipt of this opinion
letter is a condition to the REIT Conversion and each of the Mergers. See
"Federal Income Tax Considerations--Summary of Tax Opinions" in the Consent
Solicitation.
Each opinion provided by Hogan & Hartson in the opinion letter that is
substantially in the form of Appendix C to the Consent Solicitation is
applicable to the PHLP Limited Partners.
The opinions already rendered by Hogan & Hartson are based on the Code and
Treasury Regulations in effect on the date hereof, current administrative
interpretations and positions of the IRS and existing court decisions, and the
opinions to be rendered by Hogan & Hartson on the Effective Date will be based
on the same authorities as of the Effective Date. No assurance can be given
that future legislation, Treasury Regulations, administrative interpretations
and court decisions will not significantly change the law or the above
conclusions reached by counsel. In addition, any such change could apply
retroactively to transactions preceding the date of change. Moreover, opinions
of counsel merely represent counsel's best judgment with respect to the
probable outcome on the merits and are not binding on the IRS or the courts.
Accordingly, even if there is no change in applicable law, no assurance can be
provided that such opinions (which do not bind the IRS or the courts) will not
be challenged by the IRS or will be sustained by a court if so challenged.
With the one exception described below (see "--Tax Consequences of the
Merger--Deemed Cash Distribution and Resulting Taxable Gain") and in the
Consent Solicitation under "Federal Income Tax Consequences--Tax Consequences
of the Mergers --IRS Ruling Request Regarding Allocation of Partnership
Liabilities," neither Host REIT, the Operating Partnership nor the General
Partners have requested or plan to request any rulings from the IRS concerning
the tax consequences of the Mergers or the treatment of either the Operating
Partnership or Host REIT subsequent to the REIT Conversion.
Tax Consequences of the Merger
Overview. Hogan & Hartson has provided an opinion to the effect that, except
for any gain attributable to the sale of personal property by PHLP to a Non-
Controlled Subsidiary in connection with the REIT Conversion, the Merger will
not result in the recognition of taxable gain or loss at the time of the
Merger to a PHLP Limited
PHLP Supp-26
<PAGE>
Partner (i) who does not exercise his Unit Redemption Right on a date sooner
than the date two years after the date of the consummation of the Merger; (ii)
who does not receive a cash distribution (or a deemed cash distribution
resulting from relief from liabilities, including as a result of any repayment
of the Mitsui Bank Debt) in connection with the Merger or the REIT Conversion
in excess of his aggregate adjusted basis in his PHLP Partnership Units at the
time of the Merger; (iii) who does not elect to receive a Note in exchange for
his OP Units in connection with the Merger (the "Note Election"); (iv) who is
not required to recognize gain by reason of the exercise by another PHLP
Limited Partner of his right to make the Note Election (which, in counsel's
opinion, described below, should not be the result of such election); and (v)
who does not have his "at risk" amount fall below zero as a result of the
Merger or the REIT Conversion. See "Federal Income Tax Consequences--Summary
of Tax Opinions" in the Consent Solicitation.
With respect to the foregoing exceptions to nonrecognition treatment, the
Operating Partnership and the General Partner believe as follows: (i) a PHLP
Limited Partner who acquired his PHLP Partnership Units in the original
offering of such Partnership Units and who has held such Partnership Units at
all times since would not be considered to receive, as a result of the Merger,
a distribution (or a deemed cash distribution resulting from relief from
liabilities) that exceeds his aggregate adjusted basis in his PHLP Partnership
Units at the time of the Merger, and would not have his "at risk" amount fall
below zero as a result of the Merger, and (ii) a portion of the personal
property associated with six of the eight Hotels owned by PHLP will need to be
sold to a Non-Controlled Subsidiary in connection with the REIT Conversion,
which may (but is not expected to) result in the recognition of a relatively
modest amount of income by the PHLP Limited Partners. See "Federal Income Tax
Consequences--Tax Consequences of the Mergers--Overview" in the Consent
Solicitation and "Tax Allocations upon the Sale of Certain Personal Property
Associated with the PHLP Hotels" below.
With respect to the effects of a PHLP Limited Partner's election to receive
a Note in exchange for his OP Units in connection with the Merger, Hogan &
Hartson is of the opinion that, although the matter is not free from doubt, a
PHLP Limited Partner who does not make the Note Election should not be
required to recognize gain by reason of another PHLP Limited Partner's
exercise of such right. With respect to the exercise of a Unit Redemption
Right, Hogan & Hartson is of the opinion that it is more likely than not that
a PHLP Limited Partner's exercise of his Unit Redemption Right more than one
year after the date of consummation of the Merger but less than two years
after such date will not cause the Merger itself to be a taxable transaction
for the PHLP Limited Partner (or the other PHLP Limited Partners). See
"Federal Income Tax Consequences--Summary of Tax Opinions" in the Consent
Solicitation. Opinions of counsel, however, do not bind the IRS or the courts,
and no assurances can be provided that such opinions will not be challenged by
the IRS or will be sustained by a court if so challenged.
Deemed Cash Distribution and Resulting Taxable Gain. With respect to his
PHLP Partnership Units, a PHLP Limited Partner will receive no actual cash
distribution in connection with the Merger but would be deemed to receive a
cash distribution in connection with the Merger to the extent that his share
of Operating Partnership liabilities immediately after the Merger and the REIT
Conversion is less than his share of PHLP liabilities immediately prior to the
Merger. For example, any repayment of the Mitsui Bank Debt or debt encumbering
other Hotels may result in a deemed cash distribution to the PHLP Limited
Partners. See "Federal Income Tax Considerations--Tax Consequences of the
Mergers--Relief from Liabilities/Deemed Cash Distribution" in the Consent
Solicitation. Even if the Mitsui Bank Debt or debt encumbering other Hotels is
not repaid or refinanced in connection with the Mergers and the REIT
Conversion, a PHLP Limited Partner's share of indebtedness following the
Mergers and the REIT Conversion may decrease in comparison to the Limited
Partner's estimated aggregate share of PHLP indebtedness as of December 31,
1998 (calculated based on the assumption that the Mergers did not occur) by
reason of the manner in which the debt allocation rules work when multiple
assets with different levels of leverage are consolidated into a single
partnership. However, the prepayment of indebtedness owed by PHLP to the
General Partner or its affiliates in connection with the Merger will not
result in a deemed cash distribution to the PHLP Limited Partners.
A PHLP Limited Partner, however, would recognize taxable gain as a result of
any deemed cash distribution only to the extent that the deemed cash
distribution were to exceed his adjusted tax basis in his PHLP Partnership
PHLP Supp-27
<PAGE>
Units immediately prior to the Merger. As noted above, the Operating
Partnership and the General Partner believe, based upon and subject to the
assumptions and other limitations described below, that a PHLP Limited Partner
who acquired his PHLP Partnership Units in the original offering of such
Partnership Units and has held the Partnership Units at all times since the
offering will have an adjusted tax basis in excess of the deemed cash
distribution that might occur in connection with the Merger and the REIT
Conversion. Therefore, such a PHLP Limited Partner should not recognize gain
due to such deemed cash distribution resulting from the relief from
liabilities in connection with the Merger and the REIT Conversion.
The adjusted tax basis of a PHLP Limited Partner who did not acquire his
PHLP Partnership Units in the original offering of such Partnership Units or
who has not held his PHLP Partnership Units at all times since such offering
could vary materially from that of a PHLP Limited Partner who did so. If a
PHLP Limited Partner has an adjusted tax basis in his PHLP Partnership Units
(per PHLP Partnership Unit) that is substantially less than the adjusted tax
basis of a PHLP Limited Partner who acquired his PHLP Partnership Units in the
original offering of such Partnership Units and has held such Partnership
Units at all times since, he could recognize gain due to any deemed cash
distribution resulting from the relief from liabilities in connection with the
Merger and the REIT Conversion.
The Mitsui Bank Debt matures on December 22, 1999. There can be no assurance
that either PHLP or the Operating Partnership could refinance the Mitsui Bank
Debt at maturity with mortgage indebtedness secured only by the PHLP Hotels
that would qualify as nonrecourse liabilities allocable to the PHLP Limited
Partners for purposes of determining their adjusted tax basis in their
partnership interests (either in PHLP or in the Operating Partnership
following the Merger). The Operating Partnership and the General Partner
believe, however, that PHLP will face the same, if not greater, difficulties
with regard to obtaining such refinancing if PHLP does not participate in the
Merger and that the Operating Partnership, given the magnitude and diversity
of its assets and the extent of its relationships with lenders, may be in a
better position than PHLP to obtain satisfactory replacement financing.
Moreover, the Operating Partnership's current long-term financing strategy is
to have as little debt as possible that is secured by individual Hotels and to
have as much debt as possible in the form of unsecured debt, held either by
the public or by institutional investors, which debt may or may not be
recourse to Host REIT, as general partner of the Operating Partnership. In
view of these considerations and the potential adverse consequences to Limited
Partners in certain Partnerships, including the PHLP Limited Partners, the
Operating Partnership has requested from the IRS a ruling to the effect that
such unsecured indebtedness of the Operating Partnership that is issued
initially to institutional investors and is not recourse to Host REIT (i)
would qualify as "nonrecourse liabilities" for purposes of Code Section 752,
(ii) to the extent the proceeds thereof are applied to repay existing
nonrecourse mortgage indebtedness secured by one or more Hotels (including the
Mitsui Bank Debt), would be considered to be "secured" by those Hotels for
purposes of allocating the liabilities for tax basis purposes (and thus would
be allocable, at least in substantial part, to the former Limited Partners in
the Partnerships owning those Hotels, including the PHLP Limited Partners),
and (iii) would constitute "qualified nonrecourse financing" secured by such
Hotels for purposes of Code Section 465. The IRS has recently issued a ruling
to that effect to another taxpayer, and has indicated to the Operating
Partnership's representatives that it is favorably inclined to issue that
ruling to the Operating Partnership.
Each PHLP Limited Partner will gradually begin to recognize income over the
term of his ownership of OP Units (beginning, perhaps, in his first year of
ownership of OP Units) attributable to deemed cash distributions resulting
from the relief from liabilities, as the aggregate principal amount of
nonrecourse indebtedness encumbering (or deemed to encumber) the Hotels
amortizes in accordance with its terms. The Operating Partnership will make
regular quarterly cash distributions to the PHLP Limited Partners that may or
may not be sufficient to allow the PHLP Limited Partners to pay the federal
and state income tax owed on the income allocated to such Limited Partners by
reason of the amortization of the debt secured by the PHLP Hotels.
Even if PHLP does not participate in the Merger, the General Partner has
estimated that the PHLP Limited Partners will be required to recognize in
taxable year 1998 income of approximately $5,000 per PHLP
PHLP Supp-28
<PAGE>
Partnership Unit, as of December 31, 1998, resulting, in part, from the
amortization of the Mitsui Bank Debt and the General Partner expects that PHLP
will not make cash distributions to the Limited Partners sufficient to pay
such additional taxes.
Section 465(e) Recapture. As discussed in the Consent Solicitation, see
"Federal Income Tax Consequences--Tax Consequences of the Mergers--Section
465(e) Recapture," the "at risk" rules of Section 465 of the Code generally
apply to limit the use of partnership losses by a partner. Under Section
465(e) of the Code, a partner may be required to include in gross income, or
"recapture," losses previously allowed to such partner with respect to his
investment in a partnership if the amount for which the partner is "at risk"
in relation to his investment in the partnership is less than zero at the
close of the taxable year. The "at risk" rules generally do not apply to
losses attributable to real property placed in service prior to January 1,
1987 by the taxpayer or to losses attributable to a partnership in which the
taxpayer acquired his interests before that date (the "grandfather" rule).
Thus, the "at risk" rules have not been applicable to date to those PHLP
Limited Partners who acquired their Partnership Units at the time of the
original offering in July of 1982 or at any time prior to January 1, 1987, and
who have held those Partnership Units since the date of the acquisition. The
PHLP Limited Partners, however, will become subject to the "at risk" rules as
a result of the Merger and their receipt of OP Units in connection therewith
(since the OP Units do not qualify for the "grandfather" rule).
It is possible that the consummation of the Mergers and the REIT Conversion
or the repayment of certain "qualified nonrecourse financing" of the Operating
Partnership, the Hotel Partnerships or the Hotels contributed to the Operating
Partnership by the Blackstone Entities at the time of or following the Merger
and the REIT Conversion could, singularly or in combination, cause a PHLP
Limited Partner's amount at risk in relation to his investment in PHLP (and,
after the Mergers, in the Operating Partnership) to be reduced below zero,
resulting in an income inclusion to the Limited Partner under Section 465(e)
of the Code. Currently, a sufficient portion of the current debt of PHLP
constitutes "qualified nonrecourse financing" so that the PHLP Limited
Partners have positive at risk amounts, and the Operating Partnership expects
that most of the current debt with respect to the other Hotel Partnerships and
the Hotels contributed by the Blackstone Entities that will be assumed by the
Operating Partnership as part of the Mergers and the REIT Conversion should
qualify as "qualified nonrecourse financing." The Operating Partnership and
the General Partner believe, based upon and subject to the assumptions and
other limitations described below, that a PHLP Limited Partner who acquired
his PHLP Partnership Units in the original offering of such Partnership Units
and has held the Partnership Units at all times since will have a positive at
risk amount immediately following the Merger and the REIT Conversion.
It is possible, however, that a former PHLP Limited Partner's at risk amount
could decline in the future, either because of the allocation of losses from
the Operating Partnership to that former PHLP Limited Partner or because of
cash distributions by the Operating Partnership to that former PHLP Limited
Partner in excess of the taxable income allocable to him with respect to his
OP Units. Moreover, there can be no assurance that debt incurred by the
Operating Partnership in the future to refinance the Mitsui Bank Debt or
outstanding mortgage debt of the other Hotel Partnerships or the Hotels
contributed by the Blackstone Entities will qualify as "qualified nonrecourse
financing." If, however, the Operating Partnership were to obtain the
requested ruling from the IRS and were to refinance existing mortgage
indebtedness of the Partnerships with the type of indebtedness described in
the ruling, such indebtedness should constitute "qualified nonrecourse
financing" for purposes of the "at risk" rules.
Impact of Assumption of PHLP Liabilities by the Operating Partnership. As
described in the Consent Solicitation, see "Federal Income Tax Consequences--
Tax Consequences of the Mergers--Disguised Sale Regulations," a PHLP Limited
Partner will recognize gain to the extent he is treated as having sold all or
part of his PHLP Partnership Interest in a "disguised sale." For purposes of
these rules, certain reductions in a partner's share of partnership
liabilities are treated as a transfer of money or other property from the
partnership to the partner which may give rise to a disguised sale, even if
that reduction would not otherwise result in a taxable deemed cash
distribution in excess of the partner's basis in his partnership interest.
However, if a transfer of property by a partner to a partnership is not
otherwise treated as part of a disguised sale, then any reduction in
PHLP Supp-29
<PAGE>
the partner's share of "qualified liabilities" also will not be treated as
part of a disguised sale. A "qualified liability" in connection with a
transfer of property to a partnership includes (i) any liability incurred more
than two years prior to the earlier of the transfer of the property or the
date the partner agrees in writing to the transfer, as long as the liability
has encumbered the transferred property throughout the two-year period; (ii) a
liability that was not incurred in anticipation of the transfer of the
property to a partnership, but that was incurred by the partner within the
two-year period prior to the earlier of the date the partner agrees in writing
to transfer the property or the date the partner transfers the property to a
partnership and that has encumbered the transferred property since it was
incurred; (iii) a liability that is traceable under the Treasury Regulations
to capital expenditures with respect to the property; and (iv) a liability
that was incurred in the ordinary course of the trade or business in which
property transferred to the partnership was used or held, but only if all the
assets related to that trade or business are transferred, other than assets
that are not material to a continuation of the trade or business. However, a
recourse liability is not a "qualified liability" unless the amount of the
liability does not exceed the fair market value of the transferred property
(less any other liabilities that are senior in priority and encumber such
property or any allocable liabilities described in (iii) or (iv), above) at
the time of transfer.
The General Partner and the Operating Partnership believe, based upon their
review of the facts and circumstances surrounding each liability, that all
liabilities of PHLP fall into one of the four categories of "qualified
liabilities" described above and, accordingly, that the mere assumption by the
Operating Partnership of the outstanding liabilities of PHLP will not give
rise to a "disguised sale" by any of the PHLP Limited Partners.
Tax Treatment of PHLP Limited Partners Who Hold OP Units Following the Merger
Initial Basis in Units. In general, a PHLP Limited Partner will have an
initial tax basis in his OP Units received in the Merger with respect to his
PHLP Partnership Units equal to the basis in his PHLP Partnership Units at the
time of the Merger, reduced to reflect any deemed cash distributions resulting
from a reduction in his share of PHLP liabilities and increased to reflect his
share of other liabilities of the Operating Partnership and any gain required
to be recognized in connection with the Merger and the REIT Conversion
(including income, if any, attributable to the sale of a portion of the
personal property associated with the six PHLP Hotels, as described below
under "--Tax Allocations upon the Sale of Certain Personal Property Associated
with the PHLP Hotels"). For a discussion of the federal income tax
consequences for a PHLP Limited Partner from a reduction in basis that may
result from the Merger and the REIT Conversion, see "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--Initial Tax Basis of OP Units" in the Consent Solicitation.
Tax Allocations by the Operating Partnership upon a Sale of PHLP
Hotels. Pursuant to Section 704(c) of the Code, income, gain, loss and
deduction attributable to appreciated or depreciated property that is
contributed to a partnership must be allocated for federal income tax purposes
in a manner such that the contributor is charged with, or benefits from, the
unrealized gain or unrealized loss associated with the property at the time of
contribution. The amount of such unrealized gain or unrealized loss is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution (referred to as the "Book-Tax
Difference"). The Operating Partnership and the General Partner estimate,
based upon and subject to the assumptions and other limitations described
below, that the Book-Tax Difference for all PHLP Limited Partners (but
excluding all of Host's Interests) with respect to the PHLP Hotels will be
$100,606,432 upon the consummation of the Merger.
If the Operating Partnership were to sell all of the PHLP Hotels, the former
partners of PHLP (including Host REIT with respect to Host's interest in PHLP)
would be specially allocated by the Operating Partnership an aggregate amount
of taxable gain equal to the aggregate Book-Tax Difference with respect to the
PHLP Hotels. The share of such gain allocable to a PHLP Limited Partner who
acquired his PHLP Partnership Units in the original offering of such
Partnership Units and held such Partnership Units at all times since would be
$55,892 per PHLP Partnership Unit. The share of such gain of a PHLP Limited
Partner who did not acquire his PHLP Partnership Units in the original
offering of such Partnership Units or who has not held his PHLP
PHLP Supp-30
<PAGE>
Partnership Units at all times since such offering could vary materially from
this amount. If the Operating Partnership were to sell a PHLP Hotel with a
Book-Tax Difference, the remaining Book-Tax Difference at the time the Hotel
is sold would be required to be allocated exclusively to the former PHLP
Limited Partners and the General Partner, even though the proceeds of such
sale would be allocated proportionately among all the partners in the
Operating Partnership (and would likely be retained by the Operating
Partnership, rather than distributed to holders of OP Units and Common Shares
of Host REIT). The PHLP Limited Partners would not be entitled to any special
distributions from the Operating Partnership in connection with such a sale,
and thus would not necessarily receive cash distributions from the Operating
Partnership sufficient to pay such additional taxes. Although the Partnership
Agreement does not impose any restrictions upon the Operating Partnership
preventing it from causing the sale of any or all of the PHLP Hotels at any
time following the Merger, the Operating Partnership does not have current
plans to pursue a sale of any of the PHLP Hotels. See "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--Sale of Individual Hotels" in the Consent Solicitation.
Tax Allocations upon the Sale of Certain Personal Property Associated with
the PHLP Hotels. As discussed in the Consent Solicitation, see "Federal Income
Tax Consequences--Federal Income Taxation of Host REIT Following the REIT
Conversion--Income Tests Applicable to REITs" and "--Taxable Income
Attributable to Sales of Personal Property in Connection with the REIT
Conversion," if the rent attributable to personal property leased in
connection with the lease of each Hotel is greater than 15% of the total rent
received under the lease of such Hotel, the portion of the rent attributable
to the personal property will not constitute qualifying income to Host REIT
(the "15% Personal Property Test"). The Operating Partnership and the General
Partner have determined that the percentage of rent attributable to the
personal property to be leased in connection with the lease of the six PHLP
Hotels (other than the Tampa and Raleigh Hotels) would not satisfy the 15%
Personal Property Test. The 15% Personal Property Test is a mechanical test
that is based not on the relative fair market value of the assets subject to
lease, or the relative fair rental value of those assets, but, rather, is
based on the average relative adjusted tax bases of the assets subject to the
lease. Accordingly, immediately prior to the Merger, the Operating Partnership
will require PHLP, if it chooses to participate in the Merger, to sell to a
Non-Controlled Subsidiary a portion of the personal property associated with
those six PHLP Hotels. This sale, which will be a taxable transaction, may
(although is not expected to) result in the recognition by PHLP (and the
allocation to the PHLP Limited Partners) of a relatively modest amount of
taxable gain to the extent of the difference, if any, between the fair market
value of the personal property at the time of the sale and the adjusted tax
basis of such property at that time. The actual amount of any such gain will
be determinable only at the time of the sale and will be affected by the
specific personal property selected to be sold and the fair market value and
adjusted basis of that personal property. Pursuant to the PHLP partnership
agreement, any such taxable gain will be characterized as ordinary recapture
income and will be allocated by PHLP to the former PHLP Limited Partners in
the same proportions and to the same extent that such Limited Partners were
allocated any deductions directly or indirectly giving rise to the treatment
of such gains as recapture income prior to the Merger. The PHLP Limited
Partners would not be entitled to any special distributions from PHLP in
connection with such a sale of personal property.
Tax Allocations with Respect to Contributed Hotels Generally. The tax
allocations of depreciation to the PHLP Limited Partners may change
significantly as a result of the Mergers and the REIT Conversion for two
reasons. First, as described above, pursuant to Section 704(c) of the Code,
depreciation and deductions attributable to the PHLP Hotels will be required
to be allocated for federal income tax purposes in a manner such that the PHLP
Limited Partners are charged with the Book-Tax Difference associated with the
PHLP Hotels at the time of the consummation of the Merger. Consequently, a
PHLP Limited Partner will be allocated less depreciation with respect to the
PHLP Hotels than would be the case if the Mergers had not occurred and the
PHLP Limited Partner had continued to hold his PHLP Partnership Units. (On the
other hand, a former PHLP Limited Partner will be allocated depreciation with
respect to other Hotels acquired by the Operating Partnership in connection
with the Mergers and the REIT Conversion, including the Hotels owned by the
other Hotel Partnerships and the Hotels being contributed to the Operating
Partnership by Host and the Blackstone Entities
PHLP Supp-31
<PAGE>
in connection with the Merger and the REIT Conversion.) Second, the Mergers
will cause the technical termination under Section 708(b)(1)(B) of the Code of
PHLP and most of the other Hotel Partnerships that participate in the Mergers
and the REIT Conversion. Section 168(i)(7) of the Code provides, in effect,
that when a partnership terminates under Section 708(b)(1)(B) of the Code, the
partnership must begin new depreciation periods for its property. As a result,
the remaining bases of the real estate components of the PHLP Hotels and the
Hotels held by the other Hotel Partnerships that terminate will be depreciated
over 39 years, rather than over the remaining current lives of such Hotels
(which range from less than one year to 39 years). See "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--Effect of Mergers on Depreciation" in the Consent Solicitation.
In light of the complexity of the governing rules affecting the calculation
and allocation of depreciation with respect to properties contributed to a
partnership, particularly when a number of those properties are subject to the
separate adjustments required in connection with a technical termination under
Section 708 of the Code, the number of Hotels that the Operating Partnership
will be acquiring in connection with the Mergers and the REIT Conversion, and
the impact on these calculations of other outside events, including equity
offerings by Host or Host REIT and other acquisitions undertaken by Host, Host
REIT or the Operating Partnership prior to or in connection with the REIT
Conversion, the Operating Partnership and the General Partner believe that it
is impossible to predict with any degree of precision the impact that the
Mergers and the REIT Conversion will have on the future depreciation (and,
consequently, the amount of taxable income) allocable to a PHLP Limited
Partner.
Impact on Passive Activity Losses of an Investment in a Publicly Traded
Partnership. The passive loss limitation rules generally provide that
individuals, estates, trusts and certain closely held corporations and
personal service corporations can only deduct losses from passive activities
(generally activities in which the taxpayer does not materially participate,
which would include the Operating Partnership for PHLP Limited Partners) to
the extent that such losses are not in excess of the taxpayer's income from
passive activities or investments. A PHLP Limited Partner would be able to
offset losses from other passive activities against income from the Operating
Partnership that is considered passive income (but not portfolio income) so
long as the Operating Partnership is not treated as a publicly traded
partnership. The Operating Partnership and the General Partner believe,
however, that there is a substantial risk that the Operating Partnership will
be treated as a publicly traded partnership for purposes of the passive loss
limitation rules. In this event, any losses or deductions of the Operating
Partnership allocable to a PHLP Limited Partner after the Merger could not be
used to offset passive income from other passive activities. Similarly, losses
from other passive activities could not be applied to offset income of the
Operating Partnership allocated to a PHLP Limited Partner. A PHLP Limited
Partner, however, would be able to offset any passive losses from his other
investments against any gain recognized by the PHLP Limited Partner as a
result of the Merger.
State and Local Taxes. PHLP Limited Partners holding OP Units will be
subject to state and local taxation in a number of jurisdictions in which the
Operating Partnership directly or indirectly holds real property and would be
required to file periodic tax returns in those jurisdictions. In this regard,
immediately following the Mergers and the REIT Conversion, the Operating
Partnership expects that it will own properties in approximately 28 states
across the United States and the District of Columbia. Currently, PHLP owns,
directly and indirectly, properties in only six states. See "Federal Income
Tax Consequences--Tax Treatment of Limited Partners Who Hold OP Units
Following the Mergers--State and Local Taxes" in the Consent Solicitation.
Assumptions Used in Determining Tax Consequences of the Merger
In preparing the discussion set forth above, the Operating Partnership and
the General Partner made several key assumptions, which are described below.
If any such assumption is not accurate with respect to a particular PHLP
Limited Partner, the tax consequences of the Merger to such PHLP Limited
Partner could be substantially different from those reflected above.
ACCORDINGLY, EACH PHLP LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS
OWN TAX ADVISORS TO DETERMINE THE IMPACT OF SUCH
PHLP Supp-32
<PAGE>
PHLP LIMITED PARTNER'S PARTICULAR TAX SITUATION ON THE ANTICIPATED TAX
CONSEQUENCES OF PARTICIPATING IN THE MERGER.
First, with respect to a PHLP Limited Partner's basis in his PHLP
Partnership Units prior to the Merger, the Operating Partnership and the
General Partner assumed that a PHLP Limited Partner acquired his PHLP
Partnership Units in the original offering of such Partnership Units and has
held such Partnership Units at all times since the offering (the "Original
Limited Partner's Adjusted Basis"). In general, each PHLP Limited Partner had
an initial tax basis in his PHLP Partnership Units ("Initial Basis") equal to
his cash investment in PHLP (plus his proportionate share of PHLP's
nonrecourse liabilities at the time he acquired his PHLP Partnership Units). A
PHLP Limited Partner's Initial Basis generally has been increased by (a) such
Limited Partner's share of PHLP taxable income and (b) any increases in his
share of liabilities of PHLP. Generally, such Limited Partner's Initial Basis
has been decreased (but not below zero) by (i) his share of PHLP cash
distributions, (ii) any decreases in his share of liabilities of PHLP, (iii)
his share of losses of PHLP and (iv) his share of nondeductible expenditures
of PHLP that are not chargeable to capital.
The General Partner has set forth on Appendix E to the Consent Solicitation
for PHLP (i) the Original Limited Partner's Adjusted Basis as of December 31,
1997 for each such PHLP Limited Partner and (ii) an estimate of such PHLP
Limited Partner's Original Limited Partner's Adjusted Basis as of December 31,
1998 (computed without regard to the Mergers and based upon the assumptions
set forth in Appendix E to the Consent Solicitation). The General Partner also
has set forth on Appendix E to the Consent Solicitation for each PHLP Limited
Partner whose adjusted basis in his PHLP Partnership Interest is the same as
the Original Limited Partner's Adjusted Basis (a) the PHLP liabilities
allocable to such PHLP Limited Partner as of December 31, 1997 and (b) an
estimate of the PHLP liabilities allocable to such Limited Partner as of
December 31, 1998 (computed without regard to the Mergers and based upon the
assumptions set forth in Appendix E to the Consent Solicitation).
The adjusted tax basis of a PHLP Limited Partner who did not acquire his
PHLP Partnership Units in the original offering of such Partnership Units
could vary materially from that of a PHLP Limited Partner who did so for
various reasons. If a PHLP Limited Partner has an adjusted tax basis in his
PHLP Partnership Units that is less than the Original Limited Partner's
Adjusted Tax Basis, the Merger might result in the receipt by the PHLP Limited
Partner of a deemed distribution of cash in excess of his adjusted tax basis
in his PHLP Partnership Units, which could result in the recognition of income
or gain.
Second, the Operating Partnership and the General Partner assumed that the
method expected to be used by the Operating Partnership to allocate
liabilities among the partners will be respected for federal income tax
purposes. The Operating Partnership will allocate liabilities associated with
the PHLP Hotels as described in "Federal Income Tax Consequences--Tax
Consequences of the Mergers--Relief from Liabilities/Deemed Cash Distribution"
in the Consent Solicitation. If the method used by the Operating Partnership
were not respected for federal income tax purposes and the nonrecourse
liabilities actually allocable to a PHLP Limited Partner are less than the
amount assumed by the Operating Partnership and the General Partner, the
Merger might result in the receipt by such PHLP Limited Partner of a deemed
distribution of cash that is greater than the deemed distribution of cash
expected to be received by such PHLP Limited Partner as described above in
"Tax Consequences of the Merger--Deemed Cash Distribution and Resulting
Taxable Gain." For a PHLP Limited Partner who did not acquire his PHLP
Partnership Units in the original offering of such Partnership Units or who
did not hold such Partnership Units at all times since, this deemed
distribution of cash could exceed his adjusted tax basis in his PHLP
Partnership Units, which could result in the recognition of income or gain.
Finally, the Operating Partnership and the General Partner assumed that the
Merger will be treated for federal income tax purposes as the transfer by the
PHLP Limited Partners of their interests in the Partnership to the Operating
Partnership in exchange for OP Units. There can be no assurance, however, that
the IRS will not seek to recharacterize each Merger as either (i) the
liquidation of a Partnership followed by the distribution by the Partnership
of its assets to its partners and the subsequent transfers by such partners of
such assets to the
PHLP Supp-33
<PAGE>
Operating Partnership in exchange for OP Units or (ii) the transfer by a
Partnership of its assets to the Operating Partnership in exchange for OP
Units (and possibly Notes) and the subsequent distribution of such OP Units
(and possibly Notes) to its partners. If the Merger is recharacterized in the
manner described in (ii) in the preceding sentence, the tax consequences of
the Merger to the PHLP Limited Partners likely would be materially affected.
EACH PHLP LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX
ADVISORS TO DETERMINE THE IMPACT OF SUCH PHLP LIMITED PARTNER'S PARTICULAR TAX
SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER.
THE TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER TO A PARTICULAR PHLP
LIMITED PARTNER COULD VARY SUBSTANTIALLY FROM THE CONSEQUENCES DESCRIBED
ABOVE.
Tax Treatment of PHLP Limited Partners Who Exercise their Right to Make the
Note Election
A PHLP Limited Partner who exercises his right to make the Note Election and
receive a Note in connection with the Merger will be treated as having made a
taxable disposition of his OP Units. The amount realized in connection with
such disposition will equal the sum of the "issue price" of the Note (i.e.,
the face amount of the Note, currently estimated as $3,024 per PHLP
Partnership Unit) plus the portion of PHLP liabilities allocable to the PHLP
Limited Partner for federal income tax purposes immediately prior to the
disposition of the OP Units (estimated as $71,861 per PHLP Partnership Unit as
of December 31, 1998). To the extent the amount realized exceeds the PHLP
Limited Partner's adjusted basis in his PHLP Partnership Units, the PHLP
Limited Partner will recognize gain. The Operating Partnership and the General
Partner estimate (assuming the PHLP Limited Partner acquired his PHLP
Partnership Units at the time of the original offering and has held such
Partnership Units at all times since the offering) that the amount of gain
that would be recognized by a PHLP Limited Partner who made the Note Election
would be approximately $53,876 per PHLP Partnership Unit, as of December 31,
1998. For a discussion of the federal income tax rates applicable to the net
capital gain from the sale of a capital asset, see "Federal Income Tax
Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following
the Mergers--Disposition of OP Units by Limited Partners" in the Consent
Solicitation. In this regard, the General Partner estimates that, as of
December 31, 1998, if PHLP sold all of its Hotels in a fully taxable
transaction for a net amount, after payment of liabilities, determined by
reference to the Note Election Amount of PHLP, the "unrecognized Section 1250
gain" per PHLP Partnership Unit would be $52,023 and the gain subject to tax
as ordinary income under Code Section 1245 per PHLP Partnership Unit would be
$1,853. A PHLP Limited Partner who makes the Note Election would be able to
treat any per Partnership Unit passive activity loss carryforward with respect
to the activities of PHLP, to the extent the sum of such losses exceeds his
passive activity income for 1998, as losses that are not from a passive
activity and, therefore, not subject to the passive activity loss limitation
rules.
A PHLP Limited Partner who elects to receive a Note may be eligible to defer
only a small portion of that gain under the "installment sale" rules. To the
extent that the face amount of the Note (and any other installment obligations
received by the taxpayer during the year) outstanding at the end of the
taxable year in which the Merger occurs exceeds $5,000,000, the "installment
sale" rules will require that the PHLP Limited Partner who defers gain pay to
the IRS interest on the resulting tax that has been deferred. The PHLP Limited
Partner will not be eligible to defer gain recognized upon the receipt of the
Note to the extent that his share of PHLP liabilities at the time of the
Merger exceeds his adjusted tax basis in his PHLP Partnership Units
immediately prior to the Merger (that is, to the extent that he has a
"negative capital account" for tax purposes). In addition, the PHLP Limited
Partner will not be eligible to defer gain to the extent that such gain would
be taxed as ordinary income under Sections 1245 and 1250 of the Code. Lastly,
if a PHLP Limited Partner disposes of his Note, any gain that had been
deferred would be recognized in the year of disposition.
PHLP Supp-34
<PAGE>
THE SPECIFIC TAX ATTRIBUTES OF A PARTICULAR PHLP LIMITED PARTNER COULD HAVE
A MATERIAL IMPACT ON THE TAX CONSEQUENCES OF THE MERGER AND THE SUBSEQUENT
OWNERSHIP AND DISPOSITION OF NOTES. THEREFORE, IT IS ESSENTIAL THAT PHLP
LIMITED PARTNERS CONSIDERING ELECTING TO RECEIVE NOTES CONSULT WITH THEIR OWN
TAX ADVISORS WITH REGARD TO THE APPLICATION OF THE FEDERAL INCOME TAX LAWS TO
SUCH PHLP LIMITED PARTNERS' RESPECTIVE PERSONAL TAX SITUATIONS, AS WELL AS ANY
TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY STATE, LOCAL, OR FOREIGN TAXING
JURISDICTION.
Tax Consequences if PHLP Does Not Participate in the Merger
If PHLP does not participate in the Merger, the PHLP Limited Partners would
not have any tax consequences resulting from the Merger. The consequences of
continued ownership of PHLP Partnership Units will be the same as would have
resulted if the Merger had not been proposed.
* * *
The above description is not exhaustive of all possible tax considerations
associated with the Merger and the REIT Conversion. This summary does not
discuss foreign tax considerations, nor does it discuss all of the aspects of
federal income taxation or state and local taxation that may be relevant to
PHLP Limited Partners in light of their particular circumstances. EACH PHLP
LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX ADVISORS TO
DETERMINE THE IMPACT OF SUCH PHLP LIMITED PARTNER'S PARTICULAR TAX SITUATION
ON THE ANTICIPATED TAX CONSEQUENCES OF PARTICIPATING IN THE MERGER.
PHLP Supp-35
<PAGE>
SELECTED FINANCIAL DATA
The following table presents selected historical financial data derived from
the audited financial statements for the five most recent fiscal years in the
period ended December 31, 1997 and the unaudited condensed financial
statements for the First Two Quarters 1998 and First Two Quarters 1997. The
following data should be read in conjunction with the financial statements and
the notes thereto, Management's Discussion and Analysis of Financial Condition
and Results of Operations and the other financial information included
elsewhere herein.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS FISCAL YEAR
-------------------- ----------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- ---------- ---------- ---------- ---------- ----------
(UNAUDITED) (AMOUNTS IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT(1))
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................ $ 29,480 $ 28,048 $ 50,323 $ 45,853 $ 50,598 $ 43,777 $ 45,994
Operating profit........ 14,077 14,350 21,056 21,898 23,442 9,863 10,593
Income (loss) before
extraordinary item(2).. 2,429 3,188 (2,825) (1,841) 20,045 (22,741) (21,729)
Net income (loss)....... 2,429 3,188 (2,825) (1,841) 166,348 24,427 (4,581)
Distributions
General partner........ -- -- -- -- -- -- --
Limited partners....... -- -- -- -- -- -- --
Per Partnership Unit:
Net income (loss)...... 1,336 1,753 (1,554) (1,013) 88,187 8,601 (2,519)
Distributions.......... -- -- -- -- -- -- --
Cash provided by
operating activities... 17,962 18,043 20,886 19,384 14,812 3,480 5,764
Cash used in (provided
by) investing
activities............. (4,082) (4,195) (7,754) (10,249) 37,237 (36,472) --
Cash used in (provided
by) financing
activities............. (16,473) (18,102) (15,178) (10,046) (53,793) 37,156 (4,372)
Increase (decrease) in
cash and cash
equivalents............ (2,593) (4,254) (2,046) (911) (1,744) 4,164 1,392
Ratio of earnings to
fixed charges
(unaudited)(3)......... 1.20x 1.27x -- -- -- -- --
Deficiency of earnings
to fixed charges
(unaudited)(3)......... -- -- 2,825 1,841 4,541 22,741 21,729
Total assets at book
value.................. 185,666 188,608 178,224 179,867 176,521 196,061 203,251
Cash and cash
equivalents............ 589 974 3,182 5,228 6,139 7,883 3,719
Total debt(4)........... 292,998 299,940 298,442 304,564 308,519 359,186 401,829
Total liabilities....... 330,359 329,717 325,346 324,164 318,977 506,865 538,482
Partners' deficit:
Limited partners....... (109,876) (106,327) (112,280) (109,483) (107,660) (266,396) (281,878)
General partner........ (34,817) (34,782) (34,842) (34,814) (34,796) (44,408) (53,353)
Book Value per
Partnership Unit
(unaudited)(1)......... (61,042) (59,071) (62,378) (60,824) (59,811) (147,998) (156,599)
Exchange Value per
Partnership Unit
(unaudited)(1)......... 5,040 -- -- -- -- -- --
</TABLE>
- --------
(1) A Partnership Unit represents a $10,000 original investment in PHLP.
(2) In 1995, an extraordinary gain of $46,303,000 was recognized as a result
of the forgiveness of deferred base and incentive management fees in
connection with the bank loan restructuring. In 1994 and 1993, $47,168,000
and $17,148,000 respectively, of gains on early debt extinguishment
resulting from the foreclosure of the S&L Hotels were recognized as
extraordinary items.
(3) The ratio of earnings to fixed charges is computed by dividing net income
before interest expense and other fixed charges by total fixed charges,
including interest expense, amortization of debt issuance costs and the
portion of rent expense that is deemed to represent interest. The
deficiency of earnings to fixed charges is largely the result of
depreciation and amortization of $8,430,000, $5,473,000, $5,912,000,
$7,219,000, and $6,859,000 for the fiscal years 1997, 1996, 1995, 1994,
and 1993, respectively.
(4) Total debt includes amounts due to Host of $123,819,000, $121,952,000,
$125,475,000, $124,348,000, $122,176,000, $114,186,000 and $79,983,000 as
of June 19, 1998, June 20, 1997 and December 31, 1997, 1996 and 1995,
respectively.
PHLP Supp-36
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
First Two Quarters 1998 Compared to First Two Quarters 1997
Hotel Revenues: Hotel revenues increased 5% to 29.5 million for the first
two quarters 1998, when compared to the same period in 1997. The increases in
revenues are primarily due to the increases in REVPAR at seven of the eight
Hotels for the first two quarters 1998. REVPAR, or revenue per available room,
represents the combination of the average daily room rate charged and the
average daily occupancy achieved and is a commonly used indicator of hotel
performance. For the first two quarters 1998, the combined average room rate
increased 7% to $118, while the combined average occupancy decreased one
percentage point to 81%, when compared to the same period in 1997.
Operating Costs and Expenses: Operating costs and expenses increased 12% to
$15.4 million for the first two quarters 1998, when compared to the same
period in 1997. The principal components of this category are:
Management Fees: Incentive management fees, base management fees, and
ground rent are calculated generally as a percentage of Hotel sales or
Hotel revenues. The increases in these expenses for the first two quarters
1998 were directly related to the increases in Hotel sales and Hotel
revenues for the first two quarters 1998.
Depreciation: Depreciation expense increased in the first two quarters of
1998 due to property and equipment additions as well as a change in the
estimated useful lives of certain assets.
Operating Profit: Operating profit decreased 2% to $14.1 million for the
first two quarters 1998, when compared to the same period in 1997. The
decrease in operating profit for the first two quarters 1998 was attributable
to the increase in operating costs and expenses which was partially offset by
the increase in revenues.
Interest Expense: Interest expense increased 4% to $11.9 million for the
first two quarters 1998, when compared to the same period in 1997. The
weighted average interest rate on the Bank Loan was 8.3% for the first two
quarters 1998, as compared to 7.4% for the comparable period in 1997.
Net Income: Net income decreased 24% to $2.4 million for the first two
quarters 1998, when compared to the same period in 1997 due to the increases
in operating costs and expenses and interest expense.
Individual hotel operating results are discussed below:
For the first two quarters 1998 revenues at the MOUNTAIN SHADOWS RESORT
decreased 2% to $5.3 million when compared to the same period of 1997 due to
the decline in food and beverage revenues. In the upcoming months the Hotel
plans to increase its marketing efforts by distributing a newsletter in the
fall and circulating mailers during the holiday season.
Revenues for the TAMPA WESTSHORE HOTEL increased 4% to $2.9 million for the
first two quarters 1998, due to a 9% increase in room sales which was offset
by a 3% decrease in food and beverage sales. REVPAR improved 8% to $106 due to
an increase of 12% in the average room rate to $128 which was offset by a four
percentage point decrease in average occupancy when compared to the first two
quarters 1997. The slight decrease in average occupancy is related to the
customer's sensitivity to increases in average room rates. The Hotel recently
completed the renovation of the Champions lounge and has installed new health
club equipment for the guests. The Hotel is also utilizing focus groups in
order to continue to increase guest satisfaction and employing aggressive
pricing strategies in order to gain group business.
For the first two quarters 1998, revenues at the MIAMI BISCAYNE BAY HOTEL
increased 9% to $6.1 million when compared to the same period in 1997. This
increase was due to a 6% increase in REVPAR to $100 coupled
PHLP Supp-37
<PAGE>
with a 15% increase in food and beverage revenues due to strong catering
sales. The Hotel added two new airline contracts and started to focus on the
Latin American markets to increase it occupancy for the remainder of 1998.
For the first two quarters 1998 revenues at the SEATTLE SEA-TAC HOTEL
increased 17% to $4.8 million when compared to the same period in 1997. REVPAR
increased 10% to $96 due to a four percentage point increase in average
occupancy to 80% and a 6% increase in the average room rate to $120.
Additionally, for the first two quarters 1998 food and beverage revenues
increased 22% to $1.4 million. During 1998, the Hotel implemented revenue-
maximizing strategies, such as requiring large groups to purchase one catered
meal per day, and recent renovations at the Yukon Landing Restaurant and
Snoqualmie Ballroom have helped increase restaurant and banquet business.
During 1998, the Hotel obtained business from several new groups and also
experienced greater success with weekend promotions resulting in increased
revenues.
The GREENSBORO HOTEL experienced a 9% increase in revenues for the first two
quarters 1998 to $2.4 million over the same period in 1997 due to increased
room revenues and food and beverage revenues. Room revenues at the Hotel
increased 6% to $3.4 million when compared to the same period in 1997 due to a
7% increase in REVPAR to $89. The increase in REVPAR was due to a 7% increase
in the average room rate to $111 with average occupancy remaining stable at
80%. Food and beverage revenues increased 38% to $518,000 over the same period
of 1997 due to the significant increases in the Hotel's catering business.
Revenues at the HOUSTON MEDICAL CENTER HOTEL increased 18% to $3.3 million
for the first two quarters 1998 when compared to the same period in 1997. The
Hotel increased its sales 7% while reducing its direct operating expenses by
2%. The increase in sales was due to a 10% increase in REVPAR to $88 which was
attributable to a 14% increase in the average room rate to $109 offset by a
two percentage point decline in average occupancy to 81%. Direct operating
expenses decreased as the Hotel used stricter cost containment measures in its
food and beverage department. In order to address the decline in average
occupancy for the first two quarters 1998, the Hotel is planning several new
promotions. These promotions include using amusement park affiliations to
garner weekend and Labor Day business and using local media to obtain weekend
restaurant business. The Hotel is undergoing a rooms renovation that will
replace the bedspreads, drapery, upholstery, carpet and furniture in all the
guest rooms.
The RALEIGH CRABTREE VALLEY HOTEL reported a 4% increase in revenues for the
first two quarters 1998 to $2.7 million due to a 5% increase in REVPAR to $84.
The average room rate increased 6% to $102 while average occupancy decreased
one percentage point to 82% when compared to same period of last year. The
Hotel increased its corporate room rate by $10 in 1998, which primarily led to
the increase in the average room rate. In order to better serve its guests,
the Hotel opened a business center in May 1998. To improve the Hotel's average
occupancy, the Hotel is continuing its partnership with the North Carolina
State University as the preferred hotel of Wolfpack sporting events.
Revenues for the first two quarters of 1998 at the ALBUQUERQUE HOTEL
decreased 20% to $2 million due to a 7% decrease in REVPAR to $68 and a 36%
decline in food and beverage revenues when compared to the same period in
1997. The decrease in REVPAR was due to a 5% decrease in the average room rate
to $91 and a one percentage point decrease in occupancy to 75%. The Hotel is
trying to increase business on weekends through the "Can't Beat Friday"
discounted rate promotion. In order to increase food and beverage sales, a
director of catering was hired, and a restaurant and bar renovation is planned
for early 1999.
PHLP Supp-38
<PAGE>
The following chart summarizes REVPAR, or revenues per available room, and
the percentage change in REVPAR from the prior year for each Hotel owned by
the Partnership as of the end of the Second Quarter 1998. The percentage
change in REVPAR for the Raleigh and Tampa Hotels from 1994 to 1995 is not
shown because these Hotels were not owned by the Partnership for the entire
year in 1994.
<TABLE>
<CAPTION>
FIRST TWO QUARTERS 1998 1997 1996 1995
----------------------- --------------- --------------- ---------------
REVPAR % CHANGE REVPAR % CHANGE REVPAR % CHANGE REVPAR % CHANGE
------------ ------------ ------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mountain Shadows........ $ 139 2% $105 6% $99 5% $94 7%
Seattle................. 96 10 91 11 82 4 79 11
Tampa Westshore......... 106 8 87 9 80 10 73 N/A
Greensboro.............. 89 7 80 7 75 (1) 76 7
Miami Biscayne Bay...... 100 6 80 13 71 1 70 9
Raleigh Crabtree
Valley................. 84 5 76 6 72 9 66 N/A
Houston Medical Center.. 88 10 75 12 67 5 64 2
Albuquerque............. 68 (7) 70 1 69 3 67 0
</TABLE>
1997 COMPARED TO 1996
Mountain Shadows
The Mountain Shadows Resort's revenues increased 10% to $6.8 million in 1997
when compared to 1996 due primarily to a 6% increase in REVPAR to $105. The
increase in REVPAR was due to an 11% increase in the average room rate to $138
offset by a four percentage point decrease in average occupancy to 76%. The
increase in the average room rate was attributable to the increases in the
Hotel's corporate rate by $15 to $151 and in the group rates by $9 to $135.
The decrease in average occupancy was related to unexpected group
cancellations during the second quarter of 1997. In 1997, the Hotel combined
its sales center with two other Marriott properties in the Scottsdale region
which improved its sales and marketing efficiency. Additionally during 1997,
the Hotel completed a renovation of its Cactus Flower Restaurant and its
Shells Seafood Restaurant. In early 1998, the Hotel replaced the carpet in the
ballroom.
Seattle
The Seattle Marriott Hotel reported an increase in revenues of 14% to $9.7
million for 1997 when compared to the prior year due to an 11% increase in
REVPAR to $91. The increase in REVPAR was due to a $12 increase in the average
room rate to $117. The Hotel's average occupancy remained stable at 78%. The
increase in average room rate is the result of the Hotel's ability to increase
room rates with little to no price resistance due to the strong transient
demand in the Seattle area. The Hotel's food and beverage revenues increased
$365,000 or 17% to $2.5 million when compared to 1996. This increase is
attributable to the increase in catering sales. The Hotel completed
renovations of its Snoqualmie Ballroom and Yukon Restaurant in February 1998.
In addition, the Hotel will be adding coffee makers, reading chairs, and
ergonomic workstations to its guest rooms in 1998. The current outlook for the
Seattle area remains strong due to continued growth of large companies such as
Boeing and Microsoft in the region.
Tampa Westshore
The Tampa Marriott Westshore Hotel experienced a 2% increase in revenues to
$4.6 million in 1997 as compared to 1996. REVPAR increased 9% to $87 in 1997
due to an $8 increase in the average room rate to $108 coupled with a two
percentage point increase in average occupancy to 81%. Rooms revenues
increased 7%, or $500,000, in 1997 when compared to 1996. This increase was
partially offset by an increase in repairs and maintenance expense related to
the air conditioning system. In 1998, the Hotel plans to replace the cooling
tower related to the air conditioning system. In early 1997, the Hotel
completed the third phase of the rooms renovation project that replaced the
furniture in approximately 108 guest rooms. All the guest rooms now feature
new furniture. During the summer of 1998, the Hotel plans to replace the guest
room carpet, draperies, and bedspreads. These improvements will enable the
Hotel to compete more effectively in the Tampa market in the future.
PHLP Supp-39
<PAGE>
Greensboro
In 1997, the Greensboro Hotel's revenues increased 4% to $4.7 million when
compared to 1996. REVPAR increased 7% to $80 due to increases in the average
room rate of $3 to $101 and in average occupancy of three percentage points to
79%. The increase in occupancy was primarily due to the addition of 2,000 new
contract roomnights. During 1997, the Hotel filled an open Director of
Marketing position that has helped increase revenues at the Hotel, especially
revenue from group and contract sales. In early 1997 the Hotel renovated the
restaurant, and in 1998 the Hotel will replace fixtures and tiles in all its
guest bathrooms. The Partnership expects the Greensboro market to continue to
improve in 1998 due to the increased popularity of the North Carolina
furniture market.
Miami Biscayne Bay
Miami Biscayne Bay Hotel revenues for 1997 increased an impressive 18% to
$9.1 million when compared to 1996 due primarily to increased rooms revenues.
REVPAR for 1997 increased 13% to $80 when compared to 1996 due to a $10
increase in average room rate to $97 and a one percentage point increase in
average occupancy to 83%. In 1997, the Hotel reduced its lower-rated airline
contract roomnights by approximately 19,000 roomnights and replaced a majority
of these roomnights with higher-rated corporate roomnights. During 1997, the
Hotel sold 64% corporate-rated rooms and 36% group and contract-rated rooms as
compared to 1996 when the Hotel sold 55% corporate-rated rooms and 45% group
and contract-rated rooms. During 1997, the Hotel replaced the furniture in its
guest rooms. During the summer of 1998, the Hotel plans to renovate the lobby,
restaurant and lounges.
Raleigh
In 1997, revenues increased 4% to $5.2 million for the Raleigh Hotel as
compared to 1996. REVPAR increased 6% to $76 due to a 7% increase in the
average room rate to $94. Average occupancy declined slightly to 81%. The
increase in average room rate was due to a $10 increase in the corporate rate
in 1997 to $119 as well as increases in some of the Hotel's special corporate
rates. During 1997, the Hotel began projects to expand its restaurant and to
convert its lounge to additional meeting space. These projects will be
completed in early 1998. Additionally, the Hotel plans to replace its ballroom
carpeting and create a Hotel business center in 1998. The Hotel currently is
marketing to local universities to attract weekend business during the fall
sports season.
Houston Medical Center
Revenues for the Houston Medical Center Hotel increased an impressive 20% to
$5.4 million in 1997 when compared to 1996. REVPAR increased 12% to $75 due to
a 12% increase in average room rate to $97 and a one percentage point increase
in average occupancy to 78%. The Hotel increased its corporate room rate by
$20 to $149 in 1997. Rooms revenues increased 13% due to the increase in the
average room rate. In 1998, the Hotel plans to complete a rooms renovation
that will replace the bedspreads, drapery, upholstery, carpet, and furniture
in all its guest rooms. This renovation will enable the Hotel to have a more
competitive product, and the General Partner anticipates that it will allow
the Hotel to increase its average room rate further in the future.
Albuquerque
Although REVPAR increased $1 to $70, revenues for the Albuquerque Hotel
decreased slightly in 1997 to $4.8 million when compared to the prior year.
The increase in REVPAR was due to the 13% increase in average room rate to $97
offset significantly by the eight percentage point decrease in average
occupancy to 72%. The decrease in revenues was due to the increase in salaries
and wages expenses related to the addition of a director of group sales and
the increase in sales promotion costs. These costs were necessary to address
the declining average occupancy. During 1998, the Hotel plans to replace a
major portion of the roof on the building and renovate the Allies American
Grille restaurant.
PHLP Supp-40
<PAGE>
1997 COMPARED TO 1996 COMBINED RESULTS OF OPERATIONS
Hotel Revenues: Hotel revenues increased 10% to $50.3 million in 1997
primarily due to an increase in REVPAR at each of the Partnership's Hotels in
1997 when compared to 1996.
Hotel Sales: Hotel sales increased 5% to $150.5 million in 1997 due to
increased rooms sales in 1997. The combined average room rate increased 10% to
$105 while combined average occupancy remained stable at 79%.
Direct Hotel Expenses: Direct hotel expenses increased 3% to $100.2 million
in 1997. The increase in direct hotel expenses is due to higher variable costs
related to the increase in hotel sales. However, direct hotel expenses as a
percentage of hotel sales decreased to 67% in 1997 from 68% in 1996.
Depreciation: Depreciation increased in 1997 due to property and equipment
additions, and the change in the estimated useful lives of certain assets.
Management Fees: Incentive and base management fees increased 12% to $8.4
million and 5% to $4.5 million, respectively, in 1997 due to the corresponding
increase in hotel sales.
Net Loss: Net loss increased 53% to $2.8 million in 1997. The increase in
net loss primarily is attributable to increased depreciation expense on the
Partnership's property and equipment and an increase in management fees in
1997 as compared to 1996.
1996 COMPARED TO 1995
Mountain Shadows
REVPAR for 1996 increased 5% to $99. This increase was due to a 3% increase
in the average room rate to $124 combined with a two percentage point increase
in occupancy to 80%. Hotel revenues for 1996 increased 4% to $6.2 million. The
increase in average room rate and hotel revenues is due to the Hotel's
successful efforts in shifting business from lower rated group business to
higher transient rates. The Hotel's marketing promotions include a newsletter
to 3,000 past customers as well as newspaper advertising in key cities such as
Los Angeles, Chicago and New York.
Seattle
Hotel revenues increased 7% to $8.5 million in 1996 when compared to the
prior year due to an increase in REVPAR of 4% to $82. The increase in REVPAR
was due to a $6 increase in average room rate to $105 partially offset by a
one percentage point decrease in occupancy to 78%. The increase in the average
room rate is the result of the strong transient demand in the growing Seattle
economy. The local economy is tied to the global aerospace industry as well as
the availability of raw timber products. Current projections for each of these
industries are strong and indicate steady growth and reliability.
Tampa Westshore
The Tampa Westshore Hotel experienced a 10% increase in REVPAR to $80 for
1996 as compared to 1995. This increase was due to a 6% increase in the
average room rate to $100 coupled with a two percentage point increase in
average occupancy to 79%. The increase in average room rate is attributable to
strong market demand and the successful efforts of Hotel management in
restricting discounted corporate rates. An increase in transient business
contributed to the increase in average occupancy. In early 1997, the Hotel
completed the third phase of a rooms renovation project which replaced the
furniture in approximately 108 guest rooms. All 311 guest rooms now have new
furniture which will enable the Hotel to compete more effectively in the Tampa
market.
PHLP Supp-41
<PAGE>
Greensboro
For 1996, REVPAR decreased slightly to $75 when compared to 1995. The
average room rate increased 6% to $98; however, this increase was offset by a
six percentage point decline in average occupancy to 76% as a result of new
competition in the Greensboro area. Hotel revenues decreased 5% to $4.5
million primarily due to the decline in occupancy. In 1996, the Hotel facade
was painted, and in early 1997 a renovation of the restaurant was completed.
Miami Biscayne Bay
REVPAR for 1996 increased slightly to $71 when compared to 1995 due to a
four and one-half percentage point increase in average occupancy to 82%
partially offset by a 3% decrease in the average room rate to $87. The
increase in average occupancy was due to the addition of a new contract with
United Airlines for 13,000 room nights in 1996. Hotel revenues decreased 7% to
$7.7 million primarily due a decrease in catering profits as a result of
business associated with the 1995 Superbowl not recurring in 1996. During
1996, the Hotel installed new carpet in the ballrooms and in selected
corridors. During 1997, the remaining corridors will receive new carpet, and
285 rooms will undergo a redo which will include new carpet and mattresses.
Raleigh
In 1996, REVPAR increased 9% to $72, due to a 9% increase in average room
rate to $88 while the average occupancy remained stable at 82%. The increase
in average room rate was due to a $10 increase in the corporate rate in 1996.
Hotel revenues increased 16% to $5 million primarily due to the increase in
average room rates. During 1996, the Hotel completed a rooms renovation which
replaced the furniture in 375 guest rooms.
Houston Medical Center
REVPAR for 1996 increased 5% to $67 when compared to 1995 due to the 2%
increase in average room rate to $87 and a two percentage point increase in
average occupancy to 77%. Hotel revenues increased 10% to $4.5 million in
1996. These increases were due to strong demand in the medical markets,
increased business due to city wide conventions and success in shifting lower
rated business to higher corporate rates.
Albuquerque
Hotel revenues for 1996 increased slightly to $5.0 million when compared to
the prior year primarily due a 3% increase in REVPAR to $69. The increase in
REVPAR is primarily due to a one and one-half percentage point increase in
average occupancy to 80% as a result of increased transient demand in the
Albuquerque market. The average room rate remained stable at $86. The Hotel is
focusing its marketing efforts on increasing weekend group business. During
1997, the Hotel will complete a renovation of its meeting rooms.
1996 COMPARED TO 1995 COMBINED RESULTS OF OPERATIONS
Hotel Revenues: Hotel revenues decreased 9% to $45.9 million in 1996
primarily due to the sale of the Dallas Hotel in 1995. For the eight hotels
which were owned by the Partnership continuously throughout 1996 and 1995
(Albuquerque, Greensboro, Houston, Miami Biscayne Bay, Mountain Shadows,
Raleigh, Seattle, and Tampa (the "Combined Hotels")), Combined Hotel revenues
increased 4% in 1996 due to an increase in Combined Hotel sales.
Hotel Sales: Hotel sales decreased 6% to $143.3 million in 1996 due to the
sale of the Dallas Hotel in 1995. Combined Hotel sales increased 5% in 1996
through a 1% increase in the Combined Hotel average room rate to $96 and a
slight increase in the Combined Hotel average occupancy to 79%.
Direct Hotel Expenses: Direct hotel expenses decreased 5% to $97.5 million
in 1996 due to the sale of the Dallas Hotel. Combined direct hotel expenses
increased 5% in 1996. The increase in Combined direct hotel
PHLP Supp-42
<PAGE>
expenses is due to an increase in variable costs related to the increase in
Combined Hotel sales. Furthermore, direct hotel expenses as a percentage of
Hotel sales increased to 68% in 1996 from 67% in 1995.
Management Fees: Incentive and base management fees decreased 14% to $7.5
million and 6% to $4.3 million, respectively, in 1996 due to a corresponding
decrease in hotel sales.
Property Taxes: Property taxes decreased 25% to $3.1 million in 1996 due to
the sale of the Dallas Hotel in 1995.
Interest Expense: Interest expense decreased 16% to $24.6 million in 1996
due to lower principal balances in 1996 and a lower average interest rate on
the Bank Loan in 1996.
Net Income: Net income decreased 109% to a net loss of $1.8 million in 1996.
The decrease is due to the recognition of the gain on the sale of the Dallas
Hotel of $24.6 million and the gain on forgiveness of deferred fees of $146.3
million in 1995.
CAPITAL RESOURCES AND LIQUIDITY
The Partnership's financing needs have historically been funded through loan
agreements with independent financial institutions, Host Marriott Corporation
("Host Marriott") and its affiliates or Marriott International, Inc.
("Marriott International") and its affiliates. The general partner believes
that the Partnership will have sufficient capital resources and liquidity to
continue to conduct its business in the ordinary course.
Principal Sources and Uses of Cash
The Partnership reported a decrease in cash and cash equivalents of $2.6
million during the first two quarters 1998. This decrease was due to the use
of cash for investing and financing activities partially offset by cash
provided by operating activities. The Partnership reported a decrease in cash
and cash equivalents of $2.0 million for 1997. This decrease was due to the
use of cash for investing and financing activities partially offset by cash
provided by operating activities.
The Partnership's principal source of cash is cash from operations. Total
cash provided by operations remained steady at $18.0 million, for the twenty-
four weeks ended June 19, 1998, when compared to the first two quarters 1997.
Total cash provided by operations increased $1.5 million, to $20.9 million,
for 1997 due to improved Hotel operating results. Total cash provided by
operations was $19.4 million and $14.8 million for 1996 and 1995,
respectively.
The Partnership's principal uses of cash are to (i) pay for capital
expenditures and to fund the property improvement funds, (ii) make deposits to
restricted cash accounts, (iii) pay debt service on the Partnership's mortgage
debt, and (iv) pay amounts owed to Host Marriott and Marriott International.
Cash used in investing activities was $4.1 million for the first two
quarters 1998, and $4.2 million for the first two quarters 1997. Cash used in
investing activities for the first two quarters 1998, included capital
expenditures of $3.4 million primarily related to furniture, fixtures, and
equipment renewals and replacements at the Hotels. Cash used in investing
activities decreased to $7.8 million in 1997 from $10.2 million in 1996. Cash
used in investing activities included cash paid for FF&E of $7.3 million in
1997 compared to $9.9 million in 1996. Cash used in investing activities was
$10.2 million in 1996, and cash provided by investing activities was $37.2
million in 1995 due to proceeds received from the gain on the sale of the
Dallas Hotel.
Cash used in financing activities was $16.5 million and $18.1 million for
the first two quarters 1998 and 1997, respectively. Cash used in financing
activities for the first two quarters 1998, included repayments to Host
Marriott and affiliates of $4.6 million and repayments on the Partnership's
mortgage debt of $3.8 million. Cash used in financing activities increased to
$15.2 million in 1997 from $10.0 million in 1996. Cash used in financing
activities for 1997 included repayments on the Partnership's mortgage debt of
$7.2 million, repayments to Host
PHLP Supp-43
<PAGE>
Marriott and affiliates of $6.1 million, and net deposits to restricted cash
accounts of $1.8 million. Cash used in financing activities was $10.0 million
and $53.8 million in 1996 and 1995, respectively. In 1995, the Partnership
repaid $59 million on its mortgage on the Bank Hotels primarily from proceeds
from the sale of the Dallas Hotel and from a $10 million advance from Host
Marriott under the Bank Guaranty.
No cash was distributed to the partners during the First Two Quarters 1998,
or the First Two Quarters 1997. No cash was distributed to the Partners for
the years ended December 31, 1997, 1996 and 1995. Since all cash flow from the
Partnership's hotels is utilized to pay Partnership obligations, no cash is
expected to be available for distribution to the partners for the foreseeable
future.
Capital Expenditures
It is anticipated that shortfalls in the property improvement fund for the
six hotels financed with the Bank Loan, as defined below, will occur in 1999.
The General Partner is currently working with the Manager and the lender to
resolve the expected shortfalls.
Debt
The Partnership's financing needs are funded through loan agreements with
(i) The Mitsui Trust and Banking Company (the "Bank Lender"), (ii) Host
Marriott and its affiliates, and (iii) Marriott International and its
affiliates.
Total Partnership interest expense increased 4% to $11.9 million for the
first two quarters 1998, when compared to the same period in 1997 primarily
due to increased interest expense on the mortgage loan (the "Bank Loan"). The
weighted average interest rate on the Bank Loan was 8.3% for the first two
quarters 1998, as compared to 7.4% for the comparable period in 1997.
On June 22, 1998, the Partnership made the required Bank Loan principal
payment of $3.0 million. Thus, as of June 22, 1998, the Bank Loan principal
balance is $165.9 million.
The Bank Loan was scheduled to mature on December 22, 1998; however, an
additional one-year extension was available. As required under the Bank Loan,
the Partnership provided notice of its intent to extend the loan along with
adequate debt service coverage tests to extend the Bank Loan maturity to
December 22, 1999.
Pursuant to the terms of the restated Bank Loan, operating profit, as
defined, and the subordinated portion of the base management fee in excess of
debt service for the six hotels financed with the Bank Loan must be held in a
collateral account with the lender. After the end of each fiscal year, excess
cash remaining in the collateral account is applied to repay Bank Loan
principal, advances under the $26 million debt service guaranty (the "Bank
Guaranty") provided by Host Marriott and, depending upon the unadvanced
balance of the Bank Guaranty, deferred base management fees to Marriott
International. As a result, on February 23, 1998, the Partnership repaid $3.8
million in principal on the Bank Loan, $2.2 million to Host Marriott on the
Bank Guaranty, and $1.5 million to Marriott International for deferred base
management fees using amounts in the collateral account. As of June 19, 1998,
the balance of the Bank Loan was $168.9 million, $21.6 million was available
under the Bank Guaranty, and deferred base management fees payable to Marriott
International were $2.4 million.
In connection with the restructuring of the Bank Loan, Host Marriott agreed
to provide an additional guaranty (the "Interest Guaranty") for $12 million to
cover any shortfalls in the payment of interest after application of all cash
flow available for debt service. Advances with respect to interest will be
made first under the Interest Guaranty and then under the Bank Guaranty or an
equivalent "backup" guaranty provided by Marriott International. No amounts
have been advanced under the Interest Guaranty. Additionally, in early 1998,
in accordance with the terms of the Interest Guaranty, the amount available
was reduced from $8 million to $4 million.
PHLP Supp-44
<PAGE>
Host Marriott advanced funds (the "Host FF&E Loans") to the Partnership from
1991 through 1994 for the purchase of FF&E. The loans are secured by payments
from Marriott International under leases from the Partnership for FF&E
replacements. On February 9, 1998, Marriott International repaid $1.5 million
of principal to the Partnership on these leases, and the Partnership
subsequently repaid $1.4 million of principal to Host Marriott on the Host
FF&E Loans. Therefore, as of June 19, 1998, the balance of the Host FF&E Loans
was $1.5 million.
INFLATION
For the three fiscal years ended December 31, 1997, the rate of inflation
has been relatively low and, accordingly, has not had a significant impact on
the Partnership's revenues and net losses before extraordinary items. However,
the Hotel's room rates and occupancy levels are sensitive to inflation, and
the amount of the Partnership's interest expense under floating rate debt for
a particular year will be affected by changes in short-term interest rates.
YEAR 2000 ISSUES
Over the last few years, Host Marriott Corporation, the parent company of
the General Partner, has invested in implementing new accounting systems which
are Year 2000 compliant. Accordingly, the General Partner believes that future
costs associated with Year 2000 issues will be minimal and not material to the
Partnership's financial statements.
However, the Partnership does rely upon accounting software used by MHSI,
the Manager of its properties to obtain financial information. The General
Partner believes that the manager has begun to implement changes to the
property specific software to ensure the software will function properly in
the Year 2000 and does not expect to incur significant costs related to these
modifications.
PHLP Supp-45
<PAGE>
FINANCIAL STATEMENTS
PHLP Supp-46
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE PARTNERS OF POTOMAC HOTEL LIMITED PARTNERSHIP:
We have audited the accompanying balance sheet of Potomac Hotel Limited
Partnership, a Delaware limited partnership, (the "Partnership") as of
December 31, 1997 and 1996, and the related statements of operations, changes
in partners' deficit and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements referred to below are the
responsibility of the General Partner's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Potomac Hotel Limited
Partnership as of December 31, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting
principles.
Arthur Andersen LLP
Washington, D.C.,
March 4, 1998
PHLP Supp-47
<PAGE>
POTOMAC HOTEL LIMITED PARTNERSHIP
BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
ASSETS
Property and equipment, net.............................. $ 154,253 $ 155,412
Due from Marriott International, Inc. and affiliates..... 10,173 10,870
Restricted cash.......................................... 6,351 4,507
Property improvement funds............................... 3,792 3,141
Deferred financing costs, net............................ 473 709
Cash and cash equivalents................................ 3,182 5,228
--------- ---------
$ 178,224 $ 179,867
========= =========
LIABILITIES AND PARTNERS' DEFICIT
LIABILITIES
Mortgage debt.......................................... $ 172,667 $ 179,837
Due to Host Marriott Corporation and affiliates........ 125,549 124,370
Incentive and base management fees due to Marriott
International, Inc.................................... 25,868 17,172
Due to Marriott International, Inc. and affiliates..... 398 1,956
Accrued interest and other liabilities................. 864 829
--------- ---------
Total Liabilities.................................. 325,346 324,164
--------- ---------
PARTNERS' DEFICIT
General Partner
Capital contribution................................. 172,093 172,093
Cumulative net losses................................ (20,408) (20,380)
Cumulative withdrawals............................... (186,527) (186,527)
--------- ---------
(34,842) (34,814)
--------- ---------
Limited Partners
Capital contributions, net of offering costs......... 15,600 15,600
Cumulative net losses................................ (127,880) (125,083)
--------- ---------
(112,280) (109,483)
--------- ---------
Total Partners' Deficit............................ (147,122) (144,297)
--------- ---------
$ 178,224 $ 179,867
========= =========
</TABLE>
See Notes to Financial Statements.
PHLP Supp-48
<PAGE>
POTOMAC HOTEL LIMITED PARTNERSHIP
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
REVENUES
Hotel (Note 3)................................ $ 50,323 $ 45,853 $ 50,598
-------- -------- --------
OPERATING COSTS AND EXPENSES
Depreciation.................................. 8,430 5,473 5,912
Incentive management fee...................... 8,408 7,477 8,651
Base management fee........................... 4,515 4,300 4,597
Property taxes................................ 3,071 3,081 4,082
Ground rent, insurance and other.............. 4,843 3,624 3,914
-------- -------- --------
29,267 23,955 27,156
-------- -------- --------
OPERATING PROFIT................................ 21,056 21,898 23,442
Interest expense.............................. (24,596) (24,582) (29,431)
Other revenue................................. 715 843 1,448
Gain on sale of Dallas Hotel.................. -- -- 24,586
-------- -------- --------
NET (LOSS) INCOME BEFORE EXTRAORDINARY ITEM..... (2,825) (1,841) 20,045
EXTRAORDINARY ITEM
Gain on forgiveness of deferred fees.......... -- -- 146,303
-------- -------- --------
NET (LOSS) INCOME............................... $ (2,825) $ (1,841) $166,348
======== ======== ========
ALLOCATION OF NET (LOSS) INCOME
General Partner............................... $ (28) $ (18) $ 7,612
Limited Partners.............................. (2,797) (1,823) 158,736
-------- -------- --------
$ (2,825) $ (1,841) $166,348
======== ======== ========
NET (LOSS) INCOME BEFORE EXTRAORDINARY ITEM PER
LIMITED PARTNER UNIT (1,800 UNITS)............. $ (1,554) $ (1,013) $ 7,720
======== ======== ========
NET (LOSS) INCOME PER LIMITED PARTNER UNIT
(1,800 UNITS).................................. $ (1,554) $ (1,013) $ 88,187
======== ======== ========
</TABLE>
See Notes to Financial Statements.
PHLP Supp-49
<PAGE>
POTOMAC HOTEL LIMITED PARTNERSHIP
STATEMENTS OF CHANGES IN PARTNERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNER PARTNERS TOTAL
-------- --------- ---------
<S> <C> <C> <C>
Balance, December 31, 1994..................... $(44,408) $(266,396) $(310,804)
Net income................................... 7,612 158,736 166,348
Capital contribution from forgiveness of
debt........................................ 2,000 -- 2,000
-------- --------- ---------
Balance, December 31, 1995..................... (34,796) (107,660) (142,456)
Net loss..................................... (18) (1,823) (1,841)
-------- --------- ---------
Balance, December 31, 1996..................... (34,814) (109,483) (144,297)
Net loss..................................... (28) (2,797) (2,825)
-------- --------- ---------
Balance, December 31, 1997..................... $(34,842) $(112,280) $(147,122)
======== ========= =========
</TABLE>
See Notes to Financial Statements.
PHLP Supp-50
<PAGE>
POTOMAC HOTEL LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net (loss) income................................. $(2,825) $(1,841) $166,348
Extraordinary item................................ -- -- 146,303
------- ------- --------
Net (loss) income before extraordinary item....... (2,825) (1,841) 20,045
Noncash items:
Deferred incentive and base management fees...... 8,696 7,737 9,435
Depreciation..................................... 8,430 5,473 5,912
Interest on amounts due to Host Marriott
Corporation and affiliates...................... 7,084 6,892 6,235
Amortization of financing costs as interest...... 236 237 310
Loss on disposition of property and equipment.... -- 136 103
Interest on amounts due to an affiliate of
Marriott International, Inc..................... -- 29 --
Gain on sale of the Dallas Hotel................. -- -- (24,586)
Changes in operating accounts:
Due from/to Marriott International, Inc. and
affiliates...................................... (985) 541 (2,719)
Accrued interest and other liabilities........... 250 180 77
------- ------- --------
Cash provided by operating activities........... 20,886 19,384 14,812
------- ------- --------
INVESTING ACTIVITIES
Additions to property and equipment, net.......... (7,271) (9,924) (4,976)
Change in property improvement funds.............. (651) (63) (2,590)
Working capital received from (funded to) Marriott
International, Inc. and affiliates, net.......... 168 (262) 400
Net proceeds from sale of the Dallas Hotel........ -- -- 44,403
------- ------- --------
Cash (used in) provided by investing activities.. (7,754) (10,249) 37,237
------- ------- --------
FINANCING ACTIVITIES
Principal repayments on mortgage debt............. (7,170) (6,163) (59,000)
(Repayments to) advances from Host Marriott
Corporation and affiliates, net.................. (6,120) (4,670) 3,319
Change in restricted cash......................... (1,844) (1,559) (2,948)
(Repayments to) advances from affiliates of
Marriott International, Inc...................... (44) (37) 350
Collection of amounts due from Marriott
International, Inc............................... -- 2,383 5,755
Payment of financing costs........................ -- -- (1,112)
Increase in amounts due from Marriott
International, Inc............................... -- -- (157)
------- ------- --------
Cash used in financing activities................ (15,178) (10,046) (53,793)
------- ------- --------
DECREASE IN CASH AND CASH EQUIVALENTS.............. (2,046) (911) (1,744)
CASH AND CASH EQUIVALENTS at beginning of year..... 5,228 6,139 7,883
------- ------- --------
CASH AND CASH EQUIVALENTS at end of year........... $ 3,182 $ 5,228 $ 6,139
======= ======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for mortgage and other interest......... $17,046 $17,528 $ 22,555
======= ======= ========
NONCASH FINANCING ACTIVITIES:
Forgiveness of obligations due to General Partner
accounted for as a capital contribution........... $ -- $ -- $ 2,000
======= ======= ========
</TABLE>
See Notes to Financial Statements.
PHLP Supp-51
<PAGE>
POTOMAC HOTEL LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
NOTE 1. THE PARTNERSHIP
Description of the Partnership
Potomac Hotel Limited Partnership (the "Partnership") was formed in Delaware
on December 17, 1981, to acquire, develop, own, and operate up to 11 Hotels
(the "Hotels"). On July 16, 1982, 1,800 limited partnership interests
("Units") were sold pursuant to a public offering at $10,000 per unit. The
Partnership commenced operations on July 17, 1982. The Hotels are operated as
part of the Marriott full-service hotel system and are managed by Marriott
International, Inc. ("Marriott International") or Marriott Hotel Services,
Inc. ("MHSI"), which is a subsidiary of Marriott International, (collectively
the "Managers"). The sole general partner of the Partnership is Host Marriott
Corporation ("Host Marriott" or the "General Partner").
The General Partner contributed five existing hotels (including one
undergoing substantial renovation), three hotels under construction, and sites
for three hotels planned to be developed to the Partnership in exchange for
$186,527,000 and a 1% General Partner interest. These funds were borrowed by
the Partnership under a loan agreement (see Note 6). The Partnership completed
the development and construction of its final hotel during 1984. On January
31, 1986, the Partnership sold its 307-room Denver West Hotel to Host Marriott
in accordance with provisions of the loan agreement and the partnership
agreement. As discussed in Note 6, foreclosures on the Raleigh, Tampa, and
Point Clear Hotels occurred in 1993 and 1994. In 1994, the Partnership
repurchased the Raleigh and Tampa Hotels using proceeds from two loans
advanced by a subsidiary of Host Marriott. On August 22, 1995, the Partnership
sold its Dallas Hotel to a wholly-owned subsidiary of Host Marriott and used
the proceeds to repay a portion of its mortgage debt in connection with the
restructuring of the Bank Loan, as described in Note 6. As of December 31,
1997, the Partnership owned and operated eight hotels located in the following
cities: Albuquerque, New Mexico; Greensboro, North Carolina; Houston, Texas;
Miami, Florida; Raleigh, North Carolina; Scottsdale, Arizona; Seattle,
Washington; and Tampa, Florida.
Partnership Allocations and Distributions
The partnership agreement provides for the distribution of cash and the
allocation, for tax purposes, of operating income, gains and losses, and
deductions and credits among the partners. Except for all cash proceeds
attributable to the replacement of furniture, fixtures and equipment ("FF&E")
as well as depreciation and interest on indebtedness (all of which are
specially allocated to the General Partner by the partnership agreement),
profits and losses are allocated between the partners as follows:
<TABLE>
<CAPTION>
PROFITS LOSSES
------- ------
<S> <C> <C>
General Partner............................................ 25% 1%
Limited Partners........................................... 75% 99%
</TABLE>
Any future distributions of cash will be made in the same percentages that
profits and losses are allocated.
Gains (for financial statement purposes) from the sale or other disposition
of Partnership property are allocated (i) first, to the partners with negative
capital accounts in proportion to their capital investment balances and (ii)
thereafter 25% to the General Partner and 75% to the limited partners.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting
The Partnership records are maintained on the accrual basis of accounting,
and its fiscal year coincides with the calendar year.
PHLP Supp-52
<PAGE>
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures 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 from those estimates.
Working Capital and Supplies
Pursuant to the terms of the Partnership's management agreements discussed
in Note 8, the Partnership is required to provide the Managers with working
capital and supplies to meet the operating needs of the Hotels. The Managers
convert cash advanced by the Partnership into other forms of working capital
consisting primarily of operating cash, inventories, and trade receivables and
payables which are maintained and controlled by the Managers. Upon the
termination of the agreements, it is expected that the working capital and
supplies will be converted into cash and returned to the Partnership or
transferred to a subsequent owner or operator for consideration. As a result
of these conditions, the individual components of working capital and supplies
controlled by the Managers are not reflected in the accompanying balance
sheet.
Revenues and Expenses
Hotel revenues represent house profit of the Partnership's Hotels since the
Partnership has delegated substantially all of the operating decisions related
to the generation of house profit of the Hotels to the Managers. House profit
reflects hotel operating results which flow to the Partnership as property
owner and represents gross hotel sales less property-level expenses, excluding
depreciation, base and incentive management fees, property taxes, ground rent,
insurance, and certain other costs, which are disclosed separately in the
statement of operations.
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding the property-level revenues and operating expenses of the Hotels
from its statements of operations. If the Partnership concludes that EITF 97-2
should be applied to the Hotels, it would include operating results of those
managed operations in its financial statements. Application of EITF 97-2 to
financial statements as of and for the year ended December 31, 1997, would
have increased both revenues and operating expenses by approximately $100.2
million and would have had no impact on the net loss.
Property and Equipment
Property and equipment is recorded at the cost incurred directly by the
Partnership or at the cost incurred by the General Partner in the case of
those assets contributed by the General Partner. Depreciation is computed
using the straight-line method over the estimated useful lives of the assets
as follows:
<TABLE>
<S> <C>
Buildings and improvements..................................... 40 years
Leasehold improvements......................................... 40 years
Furniture and equipment........................................ 4-10 years
</TABLE>
The Partnership assesses impairment of its real estate properties based on
whether estimated undiscounted future cash flows from such properties will be
less than their net book value. If a property is impaired, its basis is
adjusted to fair market value.
PHLP Supp-53
<PAGE>
Deferred Financing Costs
Deferred financing costs consist of legal and accounting fees and other
costs incurred in connection with obtaining Partnership financing. Financing
costs are amortized using the straight-line method, which approximates the
effective interest rate method, over the life of the mortgage debt. As of
December 31, 1997 and 1996, deferred financing costs totaled $1,256,000.
Accumulated amortization of deferred financing costs as of December 31, 1997
and 1996, was $783,000 and $547,000, respectively.
Cash and Cash Equivalents
The Partnership considers all highly liquid investments with a maturity of
three months or less at date of purchase to be cash equivalents.
Income Taxes
Provision for federal and state income taxes has not been made in the
accompanying financial statements because the Partnership does not pay income
taxes but, rather, allocates profits and losses to the individual partners.
Significant differences exist between the net income or loss for financial
reporting purposes and the net income or loss as reported in the Partnership's
tax return. These differences are due primarily to the use for tax purposes of
differing useful lives and accelerated depreciation methods for assets,
differing bases in contributed capital, and differing timings of the
recognition of management fee expenses. As a result of these differences, the
excess of the net liabilities reported on a tax basis over the net liabilities
reported in the accompanying financial statements was $36 million as of
December 31, 1997, and $46 million as of December 31, 1996.
Statement of Financial Accounting Standards
In 1996, the Partnership adopted Statement of Financial Accounting Standards
("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of." Adoption of SFAS No. 121 did not have an
effect on its financial statements.
Reclassifications
Certain reclassifications were made to the prior years financial statements
to conform to the current year presentation.
NOTE 3. REVENUES
Hotel revenues consist of the following hotel operating results for the
three years ended December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
HOTEL SALES
Rooms.......................................... $ 95,761 $ 89,916 $ 94,654
Food and beverage.............................. 43,385 42,111 46,605
Other.......................................... 11,348 11,315 11,977
-------- -------- --------
150,494 143,342 153,236
-------- -------- --------
HOTEL EXPENSES
Departmental direct costs
Rooms........................................ 23,556 22,619 23,443
Food and beverage............................ 33,231 32,863 35,569
Other hotel operating expenses................. 43,384 42,007 43,626
-------- -------- --------
100,171 97,489 102,638
-------- -------- --------
HOTEL REVENUES................................... $ 50,323 $ 45,853 $ 50,598
======== ======== ========
</TABLE>
PHLP Supp-54
<PAGE>
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Land..................................................... $ 10,444 $ 10,444
Building and improvements................................ 194,661 191,449
Furniture and equipment.................................. 26,758 22,699
-------- --------
231,863 224,592
Less accumulated depreciation............................ (77,610) (69,180)
-------- --------
$154,253 $155,412
======== ========
</TABLE>
NOTE 5. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments are shown below. The fair
values of financial instruments not included in this table are estimated to be
equal to their carrying amounts.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997 AS OF DECEMBER 31, 1996
------------------------ ------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- ------------ ----------- ------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C>
DEBT AND OTHER LIABILITIES
Mortgage debt............. $ 172,667 $ 173,474 $ 179,837 $ 177,695
Due to Host Marriott
Corporation and
affiliates............... 122,356 40,803 118,280 41,313
Due to Marriott
International, Inc. and
affiliates............... 26,168 3,208 17,515 2,086
</TABLE>
The estimated fair value of mortgage debt is based on the expected future
debt service payments, discounted at estimated market rates adjusted for the
presence of debt service guaranties. "Due to Host Marriott Corporation and
affiliates" and "Due to Marriott International, Inc. and affiliates" are
valued based on the expected future payments from operating cash flow
discounted at risk adjusted rates.
NOTE 6. DEBT
Host Marriott Guaranty
The Partnership originally entered into a loan agreement dated January 14,
1982, (the "Original Loan") which funded up to $348 million to finance the
acquisition and development of the Hotels. In connection with the Original
Loan, the General Partner agreed to advance up to $42.6 million to cover debt
service shortfalls (the "Host Marriott Guaranty"). The General Partner
advanced a total of $33.4 million under the Host Marriott Guaranty. The
Partnership repaid $22.3 million and $5 million from the proceeds of the S&L
Loan and the Bank Loan, respectively, as defined below. Therefore, as of
December 31, 1997, $6.1 million plus accrued interest was outstanding related
to the Host Marriott Guaranty.
Savings and Loan Association Loan
On February 28, 1985, the Partnership borrowed $103 million (the "S&L Loan")
from a savings and loan association (the "S&L Lender") to refinance the loans
on three of its hotels located in Raleigh, North Carolina; Tampa, Florida; and
Point Clear, Alabama (the "S&L Hotels") and to repay a portion of the Host
Marriott Guaranty ($22.3 million). The S&L Loan, with an original maturity of
March 1, 2000, bore interest at 2.75% over the monthly average rate on six-
month Treasury Bills (subject to a 9% floor and a 16% ceiling). For the years
1989 through 1992, the S&L Lender, the Manager, and the General Partner agreed
to several modifications including (i) reductions in the interest rate, (ii)
reductions in the base management fees paid to the Manager, (iii) increases in
the debt service guaranty provided by Host Marriott (the "S&L Guaranty"), and
(iv) Host Marriott's subordination of cash flow generated from the Host
Marriott owned 66-room addition to the Raleigh Hotel.
PHLP Supp-55
<PAGE>
Bank Loan
On December 22, 1987, the Partnership borrowed $245 million (the "Bank
Loan") from The Mitsui Trust and Banking Company (the "Bank Lender") to repay
the outstanding indebtedness on seven of its Hotels (the "Bank Hotels"), a
portion of the Host Marriott Guaranty ($5.0 million), and related transaction
costs. The Bank Loan bore interest at an effective fixed rate of 10.37% and
required monthly interest payments with the entire principal balance due at
maturity.
The Bank Loan was secured by first priority liens on the Bank Hotels and all
related assets, including working capital and supplies advanced to the Manager
for each Bank Hotel. The Bank Loan established a priority for distributions of
cash from operations, prohibited the Partnership from creating any other liens
on the Bank Hotels, and restricted the Partnership from incurring certain
other indebtedness. The Bank Loan was non-recourse to the Partnership and its
partners, but was supported by a $26 million Host Marriott guaranty (the "Bank
Guaranty") and an equivalent Marriott International "backup" guaranty (to be
funded only if Host Marriott did not fund its guaranty).
The Bank Loan matured on December 22, 1994, with a principal balance of $245
million, and was not repaid at that time because the Partnership had
insufficient funds to do so. On December 22, 1994, the Partnership entered
into a forbearance agreement with the Bank Lender under which the Bank Lender
agreed not to exercise its rights and remedies for nonpayment of the Bank Loan
on the maturity date until February 24, 1995. The forbearance agreement was
subsequently extended until August 22, 1995, to allow the Partnership time to
solicit the consent of its limited partners regarding the sale of the Dallas
Hotel to a subsidiary of the General Partner in connection with the
restructuring of the Bank Loan. In exchange for the Bank Lender's agreement to
forbear, the Partnership made monthly interest payments at the one-month
London Interbank Offered Rate ("LIBOR") rate plus two percentage points for
the period December 22, 1994, through June 21, 1995, and at the one-month
LIBOR rate plus two-and-one-quarter percentage points for the period June 22,
1995, through August 21, 1995.
Restructured Bank Loan
On August 22, 1995, the General Partner and the Bank Lender successfully
completed the restructuring and extension of the Bank Loan. The principal
terms of the restructured Bank Loan are as follows: (i) the General Partner
advanced $10 million under the Bank Guaranty, which was used to pay down
principal on the Bank Loan (advances under the Bank Guaranty bear interest at
an annual rate equal to the prime rate, as announced by Bankers Trust
Company); (ii) the Partnership used $44 million of proceeds from the sale of
the Dallas Hotel to repay principal on the Bank Loan; (iii) the maturity of
the Bank Loan was extended to December 22, 1997, with two additional one-year
extensions available if certain debt service coverage tests are met; (iv)
semi-annual payments of interest at the six-month LIBOR rate plus 1.5
percentage points and annual payments of principal of $5 million during the
first three years of the restructured loan and $6 million during any extension
periods; (v) the General Partner's liability under the Bank Guaranty remained
at $26 million (subject to a credit for the advance of $10 million described
in (i) above); (vi) Marriott International continued its "backup" guaranty (
the "Marriott International Backup Guaranty"), under which Marriott
International agreed to advance any amounts not advanced by Host Marriott
under the Bank Guaranty; (vii) Host Marriott (but not Marriott International)
agreed to an additional guaranty (the "Interest Guaranty") for $12 million to
cover any shortfalls in the payment of interest after application of all cash
flow available for debt service (advances in respect to interest will be made
first under the Interest Guaranty then under the Bank Guaranty or the Marriott
International Backup Guaranty); (viii) the Interest Guaranty is to be reduced
each year by $4 million less any Interest Guaranty advances as of the date
such reduction is to occur and the Interest Guaranty will be increased by $4
million for each extension period, if applicable (the remaining liability
under the Bank Guaranty and the Marriott International Backup Guaranty in any
event must at least be equal to the scheduled amortization payments due during
the extension periods); (ix) all Partnership cash relating to the Bank Hotels
(including the Bank Hotels property improvement fund and the subordinated base
management fees) collateralize the Bank Loan; (x) the Bank Lender was paid a
fee of $573,000 for the successful restructuring of the Bank Loan; and (xi)
the Bank
PHLP Supp-56
<PAGE>
Lender required Marriott International to terminate the management agreement
related to the Bank Hotels (the "Marriott International Management Agreement")
and to forgive the deferred balances of base and incentive management fees
outstanding as of December 31, 1994. The Partnership recorded an extraordinary
gain of $146.3 million in 1995 to recognize the gain which resulted from the
forgiveness of the deferred fees. In addition, the Bank Lender required a
portion of the base management fee equal to 1% of gross Bank Hotel sales and a
portion of the property improvement fund contribution equal to 1% of gross
Bank Hotel sales to be subordinated to the payment of debt service.
The Bank Loan was scheduled to mature on December 22, 1997; however, two
one-year extensions were available. As required under the Bank Loan, on June
19, 1997, the Partnership provided notice to the lender of its intent to
extend the loan along with a debt service coverage ratio calculation with a
required ratio greater than 1.2 and successfully extended the Bank Loan
maturity to December 22, 1998. An additional one-year extension is available
under the Bank Loan, and in order to extend the loan to December 22, 1999, the
Partnership must provide notice of its intent to extend the loan along with
adequate debt service coverage tests to the lender by June 22, 1998. Based on
current debt service coverage tests, the Partnership expects to be able to
exercise the additional one-year extension of the loan upon its maturity on
December 22, 1998.
Pursuant to the terms of the restated Bank Loan, operating profit, as
defined, and the subordinated portion of the base management fee from the Bank
Hotels in excess of debt service must be held in a collateral account with the
Bank Lender. After the end of each fiscal year, excess cash remaining in the
collateral account is applied as follows: (i) 50% to repay Bank Loan principal
and (ii) 50% to pay principal and interest on advances under the Bank
Guaranty, until the unadvanced portion of the Bank Guaranty is replenished to
a balance of $20.0 million. Thereafter, excess cash in the collateral account
is applied as follows: (i) 50% to repay Bank Loan principal, (ii) 25% to pay
principal and interest on advances under the Bank Guaranty, and (iii) 25% to
repay deferred base management fees to Marriott International.
As of December 31, 1997 and 1996, the principal balance of the Bank Loan was
$172.7 million and $179.8 million, respectively. As of December 31, 1997 and
1996, $8.5 million and $10.0 million including accrued interest, respectively,
was outstanding pursuant to the Bank Guaranty. On February 23, 1998, in
accordance with the cash flow priorities described in the preceding paragraph,
the Partnership repaid $3.8 million in principal on the Bank Loan, $2.2
million to Host Marriott on the Bank Guaranty, and $1.5 million to Marriott
International for deferred base management fees using amounts in the
collateral account. Therefore, as of February 23, 1998, the balance on the
Bank Loan was $168.9 million, $21.6 million was available under the Bank
Guaranty, and deferred base management fees payable to Marriott International
were $2.1 million. The weighted average interest rate on the Bank Loan was
7.46% for 1997, 7.26% for 1996, and 7.89% for 1995. At December 31, 1997, the
interest rate on the Bank Loan was 8.25%. The weighted average interest rate
on the Bank Guaranty was 8.44% for 1997, 8.27% for 1996, and 8.85% for 1995.
At December 31, 1997, the interest rate on the Bank Guaranty was 8.50%.
No amounts were advanced under the Interest Guaranty during 1997.
Additionally on December 22, 1997, in accordance with the terms of the
Interest Guaranty, the amount available was increased from $4 million to $8
million, and in early 1998, the amount available was reduced to $4 million.
Raleigh and Tampa Loans
The Partnership repurchased the Raleigh Hotel and the Tampa Hotel on May 20,
1994, and July 11, 1994, respectively, with funding provided by non-recourse
loans to the Partnership from a wholly-owned subsidiary of Host Marriott.
The non-recourse loan for the Raleigh Hotel totaled $19.4 million to cover
the $18.7 million purchase price and closing costs. Under the terms of the
loan, $14.0 million of principal ("Raleigh Note A") bears interest at a fixed
rate of 10% and requires quarterly payments of interest and principal, based
on a 25-year amortization schedule, with a balloon payment due at maturity on
May 20, 2001. The remaining principal of $5.4 million
PHLP Supp-57
<PAGE>
("Raleigh Note B") bears interest at a fixed rate of 11.5% and matures on May
20, 2006. Cash flow from the Raleigh Hotel is used to pay debt service in the
following order of priority: (i) interest on Raleigh Note A, (ii) principal on
Raleigh Note A, and (iii) interest on Raleigh Note B. The remaining cash flow
is used to pay principal on Raleigh Note B. If cash flow is insufficient to
pay interest on Raleigh Note B, the unpaid interest rolls into the Raleigh
Note B principal balance annually. As of December 31, 1997 and 1996, the
Raleigh Note A principal balance was $13.5 million, and the Raleigh Note B
principal balance was $3.8 million and $4.8 million, respectively.
The non-recourse loan for the Tampa Hotel totaled $16.3 million to cover the
$15.7 million purchase price and closing costs. Under the terms of the loan,
$10.0 million of principal ("Tampa Note A") bears interest at a fixed rate of
10% and requires quarterly payments of interest and principal, based on a 25-
year amortization schedule, with a balloon payment due at maturity on July 11,
2001. The remaining principal of $6.3 million ("Tampa Note B") bears interest
at a fixed rate of 11.5% and matures on July 11, 2006. Cash flow from the
Tampa Hotel is used to pay debt service in the following order of priority:
(i) interest on Tampa Note A, (ii) principal on Tampa Note A, and (iii)
interest on Tampa Note B. The remaining cash flow is used to pay principal on
Tampa Note B. If cash flow is insufficient to pay interest on Tampa Note B,
the unpaid interest rolls into the Tampa Note B principal balance annually. As
of December 31, 1997 and 1996, the Tampa Note A principal balance was $9.7
million, and the Tampa Note B principal balance was $5.4 million and $6.1
million, respectively.
Both of the Raleigh and Tampa loans are secured by a first priority lien on
the building; land (the Partnership's leasehold interest in the case of the
Tampa Hotel); furniture, fixtures and equipment; and working capital and
supplies advanced to the Manager.
As of December 31, 1997, required principal payments related to the Raleigh
and Tampa Loans are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR
----
<S> <C>
1998.............................................................. $ 325
1999.............................................................. 357
2000.............................................................. 393
2001.............................................................. 22,125
2002.............................................................. --
Thereafter........................................................ 9,200
-------
$32,400
=======
</TABLE>
Furniture, Fixtures and Equipment Loans
Prior to December 22, 1994, the Bank Loan and Marriott International
Management Agreement, as defined in Note 8, required the Partnership to
deposit funds in an escrow account (based on a percentage, ranging from 1% to
5%, of Bank Hotel sales) to be used to replace FF&E at the Bank Hotels.
Additionally, the Bank Loan required the General Partner to fund up to $30
million of these reserves, if necessary (the "FF&E Guaranty"). The Marriott
International Management Agreement contained a similar reserve requirement for
the S&L Hotels.
Host Marriott advanced funds (the "Host FF&E Loans") for the purchase of
FF&E for the Bank Hotels from 1991 through 1994 pursuant to the FF&E Guaranty
and also provided loans for the purchase of FF&E at the S&L Hotels for 1991
and 1992. The Host FF&E Loans bear interest at the prime rate and are to be
repaid in annual installments over six years. As of December 31, 1997 and
1996, $2.9 million and $5.2 million was outstanding under the Host FF&E Loans.
The weighted average interest rate was 8.44% for 1997, 8.27% for 1996 and
8.85% for 1995. At December 31, 1997, the interest rate was 8.50%.
PHLP Supp-58
<PAGE>
As of December 31, 1997, required principal payments related to the Host
FF&E Loans are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR AMOUNT
---- ------
<S> <C>
1998............................................................... $2,600
1999............................................................... 300
------
$2,900
======
</TABLE>
Subsequent to year-end, the Partnership repaid $1.4 million of principal to
Host Marriott on the Host FF&E Loans, thereby reducing the balance on the Host
FF&E Loans to $1.5 million.
These loans are non-recourse to the Partnership and its partners and are
secured by payments from Marriott International under the FF&E Leases, as
defined in Note 8. Interest expense on these loans is offset by lease payments
received under the Marriott International FF&E Leases. As of December 31, 1997
and 1996, Marriott International owed $2.9 million plus accrued interest to
the Partnership pursuant to these agreements with the final installment due on
December 31, 1999. Subsequent to year-end, Marriott International repaid $1.5
million of principal to the Partnership on the Marriott International FF&E
Leases.
Since 1995 the Bank Hotels' FF&E funding requirements have been met through
contributions to a property improvement fund for the combined Bank Hotels.
Since its acquisition date in 1994, the FF&E funding requirements for the
Tampa Hotel have been met through the establishment of a property improvement
fund for the Hotel. However, the Raleigh Hotel required additional funds, as
described below. See Note 8 for further details on the property improvement
funds.
Raleigh Hotel Furniture, Fixtures and Equipment Loans
In 1995, Host Marriott and MHSI each provided an unsecured loan to the
Partnership in the amount of $350,000 ("Raleigh $350,000 FF&E Loans") to fund
costs of a softgoods rooms renovation at the Raleigh Hotel in excess of
amounts available in the Hotel's property improvement fund. Each Raleigh
$350,000 FF&E Loan was fully advanced to the Partnership by January 24, 1995.
The Raleigh $350,000 FF&E Loans bear interest at the prime rate. Payments on
the loans are made each accounting period from a portion of the property
improvement fund contribution equal to 1% of gross Hotel sales and are applied
first to interest and then to principal. The Raleigh $350,000 FF&E Loans are
due and payable on the earlier of the termination of the Raleigh management
agreement or December 31, 2005. Interest accrued in 1995 was added to the
principal balance of each of the loans. As of December 31, 1997 and 1996,
$298,000 and $342,000, respectively, was due on each of the Raleigh $350,000
FF&E Loans. The weighted average interest rate was 8.44% for 1997, 8.27% for
1996, and 8.85% for 1995. At December 31, 1997, the interest rate on the
Raleigh $350,000 FF&E Loans was 8.50%.
In 1996, Host Marriott provided another unsecured loan to the Partnership in
the amount of $700,000 ("Raleigh $700,000 FF&E Loan") to fund costs of a
casegoods rooms renovation at the Raleigh Hotel in excess of the amounts
available in the Hotel's property improvement fund. The Raleigh $700,000 FF&E
Loan was fully advanced to the Partnership by December 9, 1996. The Raleigh
$700,000 FF&E Loan bears interest at the prime rate plus 0.5%. Payments on the
loan are made each accounting period from a portion of the property
improvement fund contribution equal to 1% of gross Hotel sales and are applied
first to interest and then to principal. The Raleigh $700,000 FF&E Loan is due
and payable on the earlier of the termination of the Raleigh management
agreement or December 31, 2003. As of December 31, 1997 and 1996, $571,000 and
$658,000, respectively, was due on the Raleigh $700,000 FF&E Loan. The
weighted average interest rate was 8.94% for 1997 and 8.75% for 1996. At
December 31, 1997, the interest rate was 9.00%.
Other Loans
As of December 31, 1997, the Partnership also owed Host Marriott $88.8
million including accrued interest, as follows: (i) $64.4 million related to
the original Host Marriott Guaranty and the S&L Guaranty; (ii) $8.5
PHLP Supp-59
<PAGE>
million related to the Bank Guaranty; (iii) $5.4 million related to working
capital advances; (iv) $8.9 million for capital improvements at the Point
Clear, Alabama Hotel; and (v) $1.6 million from Host Marriott's subordination
of cash flow from the 66-room Raleigh addition. All of the above-mentioned
advances bear interest at the prime rate as announced by Bankers Trust Company
with a weighted average interest rate of 8.44% for 1997, 8.27% for 1996, and
8.85% for 1995. At December 31, 1997, the interest rate was 8.50%.
All Partnership indebtedness, including the Bank Loan, guaranty advances,
other General Partner loans, and deferred base and incentive management fees,
which is outstanding upon dissolution of the Partnership must be repaid before
any cash distributions can be made to the partners.
NOTE 7. LEASES
The Partnership's five ground leases have lease terms expiring in 2006
(Tampa), 2008 (Greensboro and Miami), 2009 (Houston), and 2032 (Albuquerque)
and contain one or more renewal options that allow the Partnership to extend
the leases from 15 to 50 additional years. The leases generally provide for
minimum base rentals as well as additional ground rentals which are calculated
as a percentage of sales in excess of minimum base rentals. Total ground
rental expense for the three years ended December 31 consisted of (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Minimum rentals..................................... $1,548 $1,548 $1,548
Additional rentals based on sales................... 719 706 664
------ ------ ------
$2,267 $2,254 $2,212
====== ====== ======
</TABLE>
Minimum rentals for the five Hotels operating under noncancelable leases for
real estate for future years (exclusive of percentage rentals) are as follows
(in thousands):
<TABLE>
<CAPTION>
MINIMUM
YEAR RENTAL
---- -------
<S> <C>
1998............................................................. $ 1,548
1999............................................................. 1,548
2000............................................................. 1,548
2001............................................................. 1,548
2002............................................................. 1,548
Thereafter....................................................... 13,216
-------
Total minimum lease payments..................................... $20,956
=======
</TABLE>
NOTE 8. MANAGEMENT AGREEMENTS
Marriott International Management Agreement
On July 16, 1982, the Partnership entered into a management agreement with
Marriott International (the "Marriott International Management Agreement") to
manage and operate the Hotels for a term of 25 years from the opening of each
Hotel with renewal terms, at the option of Marriott International, of up to an
additional 50 years. The Marriott International Management Agreement provided
for payment of base management fees equal to a percentage of sales ranging
from 7% to 8% depending on the length of time the Hotel had been open as well
as incentive management fees equal to a percentage of hotel operating profit,
as defined, ranging from 20% to 90% depending on the level of returns from
operating profit paid to the Partnership. In connection with obtaining the
Bank Loan, the Marriott International Management Agreement was amended on
December 22, 1987, with respect to the Bank Hotels to provide for the payment
of base management fees only after payment of debt service on the Bank Loan.
If funds available after debt service were insufficient to pay all base
management fees related to the Bank Hotels, the fees were deferred without
interest and payable in future years. The Partnership and the S&L Lender also
modified the Marriott International Management Agreement with respect to the
S&L Hotels, providing for reductions in the base management fees for 1989
through 1993. As of December 31, 1994,
PHLP Supp-60
<PAGE>
the balance of deferred base management fees was $47.5 million. Payment of the
incentive management fees was dependent upon the availability of cash flow
after debt service, and incentive management fees were payable only after
repayment of certain debt service guaranty advances and certain priority
returns to the Partnership expressed as a percentage of limited partner
invested equity. Through December 31, 1994, no incentive management fees had
been paid since inception. As of December 31, 1994, deferred incentive
management fees were $98.8 million. In connection with the Bank Loan
restructuring in 1995, the Marriott International Management Agreement was
terminated and the deferred balances of base and incentive management fees
outstanding as of December 31, 1994, were forgiven. The Partnership recorded
an extraordinary gain of $146.3 million in 1995 to recognize the gain which
resulted from the forgiveness of the deferred fees.
Until the termination of the Marriott International Management Agreement,
Marriott International entered into leases (the "FF&E Leases") from the
Partnership for all FF&E replacements for terms of up to six years. Lease
payments represent an amount approximately equal to the principal
amortization, interest, and fees associated with indebtedness incurred by the
Partnership to finance the replacements and any sales and use taxes, personal
property taxes, insurance premiums, and additional costs incurred by the
Partnership in connection with the acquisition and use of such replacements.
As of December 31, 1997 and 1996, Marriott International was obligated to pay
$2.9 million and $5.2 million, respectively, to the Partnership under these
agreements.
Bank Hotels Management Agreement
Effective December 31, 1994, in connection with the Bank Loan restructuring,
the Partnership entered into a new management agreement (the "Bank Hotels
Management Agreement") with Marriott International. This agreement provides
for an initial term of 25 years from the opening date, as specified in the
agreement, of each Bank Hotel with renewal terms at the option of Marriott
International of up to an additional 50 years. The Bank Hotels Management
Agreement provides Marriott International with a base management fee of 3% of
gross Bank Hotel sales. In accordance with the restructured Bank Loan, a
portion of the base management fee equal to 1% of gross Bank Hotel sales (the
"Subordinated Base Management Fee") is subordinate to the payment of debt
service on the Bank Loan and repayment of certain advances under the Bank
Guaranty. As a result, the Subordinated Base Management Fee is set aside in a
collateral account to be made available for the payment of (i) debt service on
the Bank Loan, (ii) debt service on the Bank Guaranty, and (iii) depending
upon the balance of the Bank Guaranty, deferred base management fees. Any
unpaid base management fees are deferred without interest and are payable in
future years. As of December 31, 1997 and 1996, deferred base management fees
were $3.6 million and $2.4 million, respectively. On February 23, 1998, the
Partnership repaid $1.5 million to Marriott International for deferred base
management fees. Therefore, as of February 23, 1998, deferred base management
fees were $2.1 million.
The Manager will continue to earn incentive management fees equal to 20% of
hotel operating profit, as defined, and additional incentive management fees,
after certain returns to the Partnership, ranging from 10% to 70% of hotel
operating profit depending upon the level of returns achieved by the
Partnership. Payment of incentive management fees will continue to be fully
subordinated to the payment of debt service and to the replenishment of all
guaranties. As of December 31, 1997 and 1996, deferred incentive management
fees were $22.2 million and $14.8 million, respectively.
The Bank Hotels Management Agreement also requires the Partnership to
maintain a property improvement fund (the "Bank Hotels Property Improvement
Fund") to ensure that the physical condition and product quality of the Bank
Hotels are maintained. Contributions to the Bank Hotels Property Improvement
Fund are equal to 5% of gross Bank Hotel sales.
On February 24, 1995, the Partnership, the Bank Lender, and Marriott
International entered into a cash collateral agreement with terms effective
January 1, 1995, whereby all Partnership cash relating to the Bank Hotels
(including the Bank Hotels Property Improvement Fund and the Subordinated Base
Management Fees) was pledged as collateral for the Bank Loan. Pursuant to the
cash collateral agreement, a portion of the Bank Hotels Property Improvement
Fund contribution equal to 4% of gross Bank Hotel sales is to be deposited
into an
PHLP Supp-61
<PAGE>
escrow account for the FF&E needs of the Bank Hotels. This escrow balance as
of December 31, 1997 and 1996, was $2.8 million and $2.4 million,
respectively. The remaining portion of the Bank Hotels Property Improvement
Fund contribution equal to 1% of gross Bank Hotel sales is to be deposited
into a restricted cash account which is subordinated to the payment of current
debt service on the Bank Loan. Any balance remaining in the restricted cash
account at the end of each year, after payment of debt service, will be
released from any restrictions. As of December 31, 1997 and 1996, the balance
in the restricted cash account was $1.1 million. The balance in the fund was
not required for 1997 or 1996 debt service and was transferred to the Bank
Hotels Property Improvement Fund in early 1998 and 1997, respectively.
Raleigh and Tampa Management Agreements
Upon the Partnership's reacquisition of the Raleigh and Tampa Hotels, the
Partnership entered into new management agreements (the "MHSI Agreements")
with MHSI for each of the Hotels. These agreements provide for payments to
MHSI as follows: (i) a base management fee equal to 3% of gross Hotel sales
and (ii) an incentive management fee equal to 20% of operating profit, as
defined. The MHSI Agreements provide for an initial term expiring on December
31, 2009. MHSI may renew each agreement at its option, for up to two
successive eight-year terms. The Partnership may terminate the Raleigh or
Tampa management agreement after June 18, 1999, and July 16, 1999,
respectively, if specified minimum operating results for each Hotel are not
achieved. However, MHSI can prevent termination by waiving its base management
fee with respect to each Hotel for a two-year period.
The MHSI Agreements provide for a priority return to the Partnership equal
to 10.75% of the owner's investment, plus ground rent in the case of the Tampa
Hotel. As of December 31, 1997, the Raleigh and Tampa owner's investment was
$19.6 million and $16.8 million, respectively. The MHSI Agreement for Raleigh
provides for a portion of the base management fee payable to MHSI equal to 1%
of gross Hotel sales to be subordinated to the first 10% of the 10.75%
priority return for five years from the effective date of the Raleigh
agreement. Any unpaid base management fees will accrue and are payable from
any excess operating profit; however, any deferred base management fees
remaining on June 18, 1999, will be waived. As of December 31, 1997 and 1996,
no base management fees were deferred under the Raleigh management agreement.
Incentive management fees are payable from 40% of available cash flow, as
defined. Any unpaid incentive management fees for the Raleigh and Tampa Hotels
are waived annually. In 1997, incentive management fees paid for the Raleigh
and Tampa Hotels were $567,000 and $350,000, respectively. In 1996, incentive
management fees paid for the Raleigh and Tampa Hotels were $574,000 and
$315,000, respectively.
Each MHSI Agreement provides for the establishment of a property improvement
fund ("Property Improvement Fund") for each Hotel. Contributions to the
Property Improvement Fund equal 5% of gross Hotel sales from each Hotel.
However, effective August 1996, MHSI and the Partnership agreed to increase
the contribution from 5% to 7% for the Raleigh Hotel until an additional
$300,000 was deposited to cover the cost of certain renovations. This increase
was in effect until the fourth quarter of 1997. In addition, a portion of the
contribution for the Raleigh Hotel equal to 2% of gross Hotel sales is used to
pay interest and principal on the Raleigh $350,000 FF&E Loans and the Raleigh
$700,000 FF&E Loan. As of December 31, 1997, the balances of the Raleigh and
Tampa Property Improvement Funds were $727,000 and $232,000, respectively. As
of December 31, 1996, the balances of the Raleigh and Tampa Property
Improvement Funds were $678,000 and $67,000, respectively.
General
Pursuant to the terms of the management agreements, the Managers are
required to furnish the Hotels with certain services ("Chain Services") which
generally are provided on a central or regional basis to all hotels in the
Marriott hotel system. Chain Services include central training, advertising
and promotion, a national reservation system, computerized payroll and
accounting services, and such additional services, as needed, which may be
performed more efficiently on a centralized basis. Costs and expenses incurred
in providing such services
PHLP Supp-62
<PAGE>
are allocated among all domestic hotels managed, owned, or leased by Marriott
International or its subsidiaries. In addition, the Hotels also participate in
Marriott International's Marriott Rewards Program ("MRP"). This program was
formerly called the Honored Guest Awards Program. The cost of this program is
charged to all hotels in the Marriott hotel system based on the MRP sales at
each hotel. The total amount of Chain Services and MRP costs charged to the
Partnership was $7.3 million in 1997, $7.1 million in 1996, and $7.6 million
in 1995.
Pursuant to the terms of the management agreements, the Partnership is
required to provide the Managers with working capital and supplies to meet the
operating needs of the Hotels. In 1995, in conjunction with the sale of the
Dallas Hotel, $946,000 was reimbursed by the Dallas Hotel to the Partnership.
These funds were used to pay interest and principal on working capital
advances from Host Marriott. Additionally during 1995, Marriott International
returned $400,000 in working capital to the Partnership. During 1996, the
Partnership advanced $262,000 to Marriott International for working capital.
During 1997, $168,000 in working capital was returned to the Partnership.
Therefore, as of December 31, 1997 and 1996, $5.1 million and $5.3 million,
respectively, has been advanced to the Managers for working capital and
supplies for the Hotels.
NOTE 9. RELATED PARTY TRANSACTIONS
A 66-guest room addition to the Raleigh Hotel was completed and opened on
July 18, 1987. The $3.4 million addition was operated as part of the Raleigh
Hotel but was owned by Host Marriott. Host Marriott subordinated its receipt
of cash flow generated from the Host Marriott-owned Raleigh addition (the
"Addition Deferral") to the payment of debt service on the S&L Loan for the
years 1991 through 1993. The Addition Deferral bears interest at the prime
rate. The weighted average interest rate was 8.44% for 1997, 8.27% for 1996,
and 8.85% for 1995. The balance of the Addition Deferral including accrued
interest at December 31, 1997 and 1996, was $1.6 and $1.5 million,
respectively. Except for the balance of $1.6 million, the Partnership's rights
and obligations under the Addition Deferral arrangement terminated with the
Raleigh Hotel foreclosure. Additionally, the 66-room addition was purchased by
the Partnership when the Raleigh Hotel was repurchased during 1994.
On June 28, 1995, the Partnership assigned its right of first refusal to
purchase the Point Clear Hotel to a subsidiary of Host Marriott, which
subsequently purchased the Hotel. In exchange, Host Marriott agreed to forgive
$2 million of accrued interest on certain advances to the Partnership, which
has been accounted for as a capital contribution by the General Partner.
On August 22, 1995, the Partnership sold the Dallas Hotel to a subsidiary of
Host Marriott. The proceeds from the sale of the Dallas Hotel were used to
repay $44 million of the Bank Loan.
PHLP Supp-63
<PAGE>
POTOMAC HOTEL LIMITED PARTNERSHIP
CONDENSED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
------------------
1998 1997
-------- --------
<S> <C> <C>
REVENUES
Hotel revenues............................................ $ 29,480 $ 28,048
-------- --------
OPERATING COSTS AND EXPENSES
Incentive management fees................................. 5,548 5,195
Depreciation.............................................. 3,891 2,526
Base management fees...................................... 2,370 2,257
Property taxes............................................ 1,625 1,602
Ground rent, insurance and other.......................... 1,969 2,118
-------- --------
15,403 13,698
-------- --------
OPERATING PROFIT............................................ 14,077 14,350
Interest expense.......................................... (11,905) (11,490)
Other revenues............................................ 257 328
-------- --------
NET INCOME.................................................. $ 2,429 $ 3,188
======== ========
ALLOCATION OF NET INCOME
General Partner........................................... $ 25 $ 32
Limited Partners.......................................... 2,404 3,156
-------- --------
$ 2,429 $ 3,188
======== ========
NET INCOME PER LIMITED PARTNER UNIT (1,800 Units)........... $ 1,336 $ 1,753
======== ========
</TABLE>
See Notes to Condensed Financial Statements.
PHLP Supp-64
<PAGE>
POTOMAC HOTEL LIMITED PARTNERSHIP
CONDENSED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 19, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Property and equipment, net........................... $ 153,748 $ 154,253
Due from Marriott International, Inc. and affiliates.. 10,602 10,173
Other assets.......................................... 4,834 4,265
Restricted cash....................................... 15,893 6,351
Cash and cash equivalents............................. 589 3,182
--------- ---------
$ 185,666 $ 178,224
========= =========
LIABILITIES AND PARTNERS' DEFICIT
LIABILITIES
Mortgage debt....................................... $ 168,909 $ 172,667
Due to Host Marriott Corporation and affiliates..... 123,819 125,549
Incentive and base management fees due to Marriott
International, Inc. ............................... 29,793 25,868
Due to Marriott International, Inc. and affiliates.. 368 398
Accrued interest and other liabilities.............. 7,470 864
--------- ---------
Total Liabilities................................. 330,359 325,346
--------- ---------
PARTNERS' DEFICIT
General Partner..................................... (34,817) (34,842)
Limited Partners.................................... (109,876) (112,280)
--------- ---------
Total Partners' Deficit........................... (144,693) (147,122)
--------- ---------
$ 185,666 $ 178,224
========= =========
</TABLE>
See Notes to Condensed Financial Statements.
PHLP Supp-65
<PAGE>
POTOMAC HOTEL LIMITED PARTNERSHIP
CONDENSED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
------------------
1998 1997
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES
Net income............................................... $ 2,429 $ 3,188
Noncash items............................................ 11,251 9,457
Changes in operating accounts............................ 4,282 5,398
-------- --------
Cash provided by operating activities.................. 17,962 18,043
-------- --------
INVESTING ACTIVITIES
Additions to property and equipment...................... (3,404) (3,358)
Change in property improvement funds..................... (678) (1,005)
Working capital received from Marriott International,
Inc. and affiliates, net................................ -- 168
-------- --------
Cash used in investing activities...................... (4,082) (4,195)
-------- --------
FINANCING ACTIVITIES
Change in restricted cash................................ (9,542) (10,490)
Repayments to Host Marriott Corporation and affiliates,
net..................................................... (4,649) (5,419)
Principal repayments on mortgage debt.................... (3,758) (2,171)
Repayments to affiliates of Marriott International,
Inc..................................................... (28) (22)
Collection of amounts due from Marriott International,
Inc..................................................... 1,504 --
-------- --------
Cash used in financing activities...................... (16,473) (18,102)
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS...................... (2,593) (4,254)
CASH AND CASH EQUIVALENTS at beginning of period........... 3,182 5,228
-------- --------
CASH AND CASH EQUIVALENTS at end of period................. $ 589 $ 974
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for mortgage and other interest................ $ 2,162 $ 2,080
======== ========
</TABLE>
See Notes to Condensed Financial Statements.
PHLP Supp-66
<PAGE>
POTOMAC HOTEL LIMITED PARTNERSHIP
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying condensed financial statements have been prepared by
Potomac Hotel Limited Partnership (the "Partnership") without audit. Certain
information and footnote disclosures normally included in financial statements
presented in accordance with generally accepted accounting principles have
been condensed or omitted from the accompanying statements. The Partnership
believes the disclosures made are adequate to make the information presented
not misleading. However, the condensed financial statements should be read in
conjunction with the Partnership's financial statements and notes thereto
included in the Partnership's Form 10-K for the fiscal year ended December 31,
1997.
In the opinion of the Partnership, the accompanying unaudited condensed
financial statements reflect all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position of
the Partnership as of June 19, 1998; the results of operations and cash flows
for the first two quarters 1998 and 1997. Interim results are not necessarily
indicative of fiscal year performance because of seasonal and short-term
variations.
For financial reporting purposes, the Partnership's net income is allocated
99% to the limited partners and 1% to Host Marriott Corporation ("Host
Marriott" or "General Partner"). Significant differences exist between the net
income for financial reporting purposes and the net income for Federal income
tax reporting purposes. These differences are due primarily to the use for tax
purposes of differing useful lives and accelerated depreciation methods,
differing tax bases in contributed capital, and differing timings in the
recognition of management fee expense.
2. Certain reclassifications were made to the prior quarter financial
statements to conform to the current quarter presentation.
3. Hotel revenues represent house profit of the Partnership's hotels since
the Partnership has delegated substantially all of the operating decisions
related to the generation of house profit of the hotels to the manager. House
profit reflects hotel operating results which flow to the Partnership as
property owner and represents gross hotel sales less property-level expenses,
excluding depreciation, base and incentive management fees, property taxes,
ground rent, insurance, and certain other costs, which are disclosed
separately in the condensed statement of operations.
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Partnership is assessing the impact of EITF 97-2 on its policy of
excluding property-level revenues and operating expenses of the Hotels from
its condensed statements of operations. If the Partnership concludes that EITF
97-2 should be applied to the Hotels, it would include operating results of
this managed operation in its condensed financial statements. Application of
EITF 97-2 to the condensed financial statements as of and for the first two
quarters 1998, would have increased both revenues and operating expenses by
approximately $49.5 million, respectively, and would have had no impact on net
income.
PHLP Supp-67
<PAGE>
POTOMAC HOTEL LIMITED PARTNERSHIP
NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED)
Hotel revenues consist of the following hotel operating results (in
thousands):
<TABLE>
<CAPTION>
FIRST TWO
QUARTERS
-----------------
1998 1997
-------- --------
<S> <C> <C>
HOTEL SALES
Rooms...................................................... $ 51,015 $ 48,339
Food and beverage.......................................... 22,137 21,190
Other...................................................... 5,841 5,704
-------- --------
78,993 75,233
-------- --------
HOTEL EXPENSES
Departmental Direct Costs
Rooms.................................................... 11,780 11,098
Food and beverage........................................ 16,292 15,840
Other hotel operating expenses............................. 21,441 20,247
-------- --------
49,513 47,185
-------- --------
HOTEL REVENUES............................................... $ 29,480 $ 28,048
======== ========
</TABLE>
4. Host Marriott, the General Partner of the Partnership, announced on April
17, 1998, that its Board of Directors has authorized the company to reorganize
its business operations to qualify as a real estate investment trust ("REIT")
to become effective as of January 1, 1999. As part of the REIT conversion,
Host Marriott expects to form a new operating partnership (the "Operating
Partnership") and limited partners in certain Host Marriott full-service hotel
partnerships and joint ventures, including the Partnership, are expected to be
given an opportunity to receive, on a tax-deferred basis, Operating
Partnership units in the Operating Partnership in exchange for their current
limited partnership interests. The Operating Partnership units would be
redeemable by the limited partner for freely traded Host Marriott shares (or
the cash equivalent thereof) at any time after one year from the closing of
the merger. In connection with the REIT conversion, the Operating Partnership
filed a Registration Statement on Form S-4 with the Securities and Exchange
Commission on June 2, 1998. Limited partners will be able to vote on this
Partnership's participation in the merger later this year through a consent
solicitation.
PHLP Supp-68
<PAGE>
PART II. INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF TRUSTEES AND OFFICERS.
The Declaration of Trust of Host REIT authorizes it, to the maximum extent
permitted by Maryland law, to obligate itself to indemnify and to pay or
reimburse reasonable expenses in advance of final disposition of a proceeding
to (a) any present or former trustee or officer or (b) any individual who,
while a trustee of Host REIT and at the request of Host REIT, serves or has
served another real estate investment trust, corporation, partnership, joint
venture, trust, employee benefit plan or any other enterprise from and against
any claim or liability to which such person may become subject or which such
person may incur by reason of his or her status as a present or former Trustee
or officer of Host REIT. The Bylaws of Host REIT obligate it, to the maximum
extent permitted by Maryland law, to indemnify and to pay or reimburse
reasonable expenses in advance of final disposition of a proceeding to (a) any
present or former trustee or officer who is made party to the proceeding by
reason of his service in that capacity or (b) any individual who, while a
trustee or officer of Host REIT and at the request of Host REIT, serves or has
served another real estate investment trust, corporation, partnership, joint
venture, trust, employee benefit plan or any other enterprise as a trustee,
director, officer or partner of such real estate investment trust,
corporation, partnership, joint venture, trust, employee benefit plan or other
enterprise and who is made a party to the proceeding by reason of his service
in that capacity, against any claim or liability to which he may become
subject by reason of such status. The Declaration of Trust and Bylaws also
permit Host REIT to indemnify and advance expenses to any person who served as
a predecessor of Host REIT in any of the capacities described above and to any
employee or agent of Host REIT or a predecessor of Host REIT. The Bylaws
require Host REIT to indemnify a trustee or officer who has been successful,
on the merits or otherwise, in the defense of any proceeding to which he is
made a party by reason of his service in that capacity.
The Maryland REIT Law permits a Maryland real estate investment trust to
indemnify and advance expenses to its trustees, officers, employees and agents
to the same extent as permitted by the MGCL for trustees and officers of
Maryland corporations. Host REIT will indemnify its present and former
trustees and officers, among others, against judgments, penalties, fines,
settlements and reasonable expenses actually incurred by them in connection
with any proceeding to which they may be made a party by reason of their
service in those or other capacities unless it is established that (a) the act
or omission of the trustee or officer was material to the matter giving rise
to the proceeding and (i) was committed in bad faith or (ii) was the result of
active and deliberate dishonesty, (b) the trustee or officer actually received
an improper personal benefit in money, property or services or (c) in the case
of any criminal proceeding, the trustee or officer had reasonable cause to
believe that the act or omission was unlawful. However, under Maryland law,
Host REIT may not indemnify for an adverse judgment in a suit by or in the
right of the corporation. The Bylaws of Host REIT require it, as a condition
to advancing expenses, to obtain (a) a written affirmation by the trustee or
officer of his good faith belief that he has met the standard of conduct
necessary for indemnification by Host REIT as authorized by the Bylaws and (b)
a written statement by or on his behalf to repay the amount paid or reimbursed
by Host REIT if it shall ultimately be determined that the standard of conduct
was not met.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FINANCIAL STATEMENT SCHEDULES
Report of Independent Public Accountants on Financial Statement Sched-
ules.................................................................... S-1
Schedule III--Real Estate and Accumulated Depreciation................... S-2
</TABLE>
II-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBITS
--------
<C> <S>
2.1** --Form of Agreement and Plan of Merger between the Partnerships and
the Merger Partnerships
3.1* --Form of Amended and Restated Agreement of Limited Partnership of
Host Marriott, L.P.
3.2* --Amended and Restated Agreement of Limited Partnership dated
December 31, 1997 of Atlanta Marriott Marquis II Limited Partnership
(incorporated by reference to Exhibit 2.a. of Atlanta Marquis
Limited Partnership's Form 10-K for the year ended December 31,
1997)
3.3* --Amended and Restated Agreement of Limited Partnership dated June
12, 1989, of Mutual Benefit Chicago Marriott Suite Hotel Partners,
L.P. (incorporated by reference to Exhibit 3.1 of Mutual Benefit
Chicago Marriott Suite Hotel Partners, L.P.'s Form 10 filed June 12,
1998)
3.4* --Second Amended and Restated Agreement of Limited Partnership dated
September 26, 1997 of Desert Springs Marriott Limited Partnership
(incorporated by reference to Exhibit 3.2 of Desert Springs Limited
Partnership's Form 10-Q for the quarter ended September 30, 1997)
3.5* --Second Amended and Restated Agreement of Limited Partnership dated
April 3, 1997 of Hanover Marriott Limited Partnership (incorporated
by reference to Exhibit 3(a) of Hanover Marriott Limited
Partnership's Form 10 filed June 12, 1998)
3.6* --Amended and Restated Agreement of Limited Partnership dated
February 7, 1990 of Marriott Diversified American Hotels, L.P.
(incorporated by reference to Exhibit 3(a) of Marriott Diversified
American Hotels, L.P.'s Form 10 filed June 12, 1998)
3.7* --Amended and Restated Agreement of Limited Partnership dated
November 27, 1985 of Marriott Hotel Properties Limited Partnership
(incorporated by reference to Exhibit 3.1 of Marriott Hotel
Properties Limited Partnership's Form 10 dated September 29, 1986)
3.8* --Amended and Restated Agreement of Limited Partnership dated June
14, 1996 of Marriott Hotel Properties II Limited Partnership
(incorporated by reference to Exhibit 3.1 of Marriott Hotel
Properties II Limited Partnership's Form 10-K for the year ended
December 31, 1996)
3.9* --Amended and Restated Agreement of Limited Partnership dated July
16, 1982 of Potomac Hotel Limited Partnership (incorporated by
reference to Exhibit 3 of Potomac Hotel Limited Partnership's Form
10-K for the year ended December 31, 1994)
3.10* --Certificate of Incorporation dated April 15, 1998 of HMC Real
Estate Corporation, the general partner of Host Marriott, L.P.
3.11* --Bylaws dated April 15, 1998 of HMC Real Estate Corporation, the
general partner of Host Marriott, L.P.
4.1** --Form of Indenture between Host Marriott, L.P. and [Indenture
Trustee]
4.2** --Form of Note
5.1** --Opinion of Hogan & Hartson L.L.P. regarding legality of the
securities being registered
8.1** --Opinion of Hogan & Hartson L.L.P. regarding certain tax matters
10.1** --Form of Management Agreement
10.2** --Form of Lease
12.1* --Computation of Ratios of Earnings to Fixed Charges
21.1** --List of Subsidiaries of Host Marriott, L.P.
23.1** --Consent of Hogan & Hartson L.L.P. (included in Exhibit 5.1)
23.2 --Consent of Arthur Andersen LLP
23.3 --Consent of American Appraisal Associates, Inc.
25.1** --Statement of Eligibility and Qualification of [Trustee] [bound
separately]
99.1* --Appraisal of Houston Marriott Medical Center Hotel by American
Appraisal Associates, Inc. dated March 1, 1998
99.2* --Appraisal of Seattle Marriott Hotel, Sea-Tac by American Appraisal
Associates, Inc. dated March 1, 1998
99.3* --Appraisal of Marriott's Desert Springs Resort & Spa by American
Appraisal Associates, Inc. dated March 1, 1998
99.4* --Appraisal of Raleigh Marriott Crabtree Valley by American Appraisal
Associates, Inc. dated March 1, 1998
99.5* --Appraisal of Atlanta Marriott Marquis by American Appraisal
Associates, Inc. dated March 1, 1998
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBITS
--------
<C> <S>
99.6* --Appraisal of Greensboro-High Point Marriott by American Appraisal
Associates, Inc. dated March 1, 1998
99.7* --Appraisal of San Ramon Marriott at Bishop Ranch by American
Appraisal Associates, Inc. dated March 1, 1998
99.8* --Appraisal of Marriott Rivercenter by American Appraisal Associates,
Inc. dated March 1, 1998
99.9* --Appraisal of New Orleans Marriott Hotel by American Appraisal
Associates, Inc. dated March 1, 1998
99.10* --Appraisal of Santa Clara Marriott by American Appraisal Associates,
Inc. dated March 1, 1998
99.11* --Appraisal of Fairview Park Marriott by American Appraisal
Associates, Inc. dated March 1, 1998
99.12* --Appraisal of Detroit Marriott Livonia Hotel by American Appraisal
Associates, Inc. dated March 1, 1998
99.13* --Appraisal of Biscayne Bay Marriott Hotel & Marina by American
Appraisal Associates, Inc. dated March 1, 1998
99.14* --Appraisal of Marriott's Mountain Shadow Resort & Golf Club by
American Appraisal Associates, Inc. dated March 1, 1998
99.15* --Appraisal of Southfield Marriott Hotel by American Appraisal
Associates, Inc. dated March 1, 1998
99.16* --Appraisal of Marriott At Research Triangle Park by American
Appraisal Associates, Inc. dated March 1, 1998
99.17* --Appraisal of Tampa Marriott Westshore by American Appraisal
Associates, Inc. dated March 1, 1998
99.18* --Appraisal of Albuquerque Marriott by American Appraisal Associates,
Inc. dated March 1, 1998
99.19* --Appraisal of Fullerton Marriott Hotel by American Appraisal
Associates, Inc. dated March 1, 1998
99.20* --Appraisal of Dayton Marriott by American Appraisal Associates, Inc.
dated March 1, 1998
99.21* --Appraisal of Marriott's Harbor Beach Resort by American Appraisal
Associates, Inc. dated March 1, 1998
99.22* --Appraisal of Marriott's Orlando World Center by American Appraisal
Associates, Inc. dated March 1, 1998
99.23* --Appraisal of Chicago Marriott Suites O'Hare by American Appraisal
Associates, Inc. dated March 1, 1998
99.24* --Appraisal of Hanover Marriott Hotel by American Appraisal
Associates, Inc. dated March 1, 1998
99.25** --Fairness Opinion dated , 1998 of American Appraisal Associates,
Inc.
</TABLE>
- --------
* Previously filed.
** To be filed by amendment.
ITEM 22. UNDERTAKINGS.
The undersigned registrant hereby undertakes as follows: that prior to any
public reoffering of the securities registered hereunder through use of a
prospectus which is part of this registration statement, by any person or
party who is deemed to be an underwriter within the meaning of Rule 145(c),
the issuer undertakes that such reoffering prospectus will contain the
information called for by the applicable registration form with respect to
reofferings by persons who may be deemed underwriters, in addition to the
information called for by the other Items of the applicable form.
The registrant undertakes that every prospectus (i) that is filed pursuant
to the immediately preceding paragraph or (ii) that purports to meet the
requirements of section 10(a)(3) of the Act and is used in connection with an
offering of securities subject to Rule 415, will be filed as a part of an
amendment to the registration statement and will not be used until such
amendment is effective, and that, for purposes of determining any liability
under the Securities Act of 1933, as amended, each such post-effective
amendment shall be deemed a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended, may be permitted to trustees, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or
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otherwise, the registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the registrant of expenses incurred or paid by a trustee, officer
or controlling person of the registrant in the successful defense of any
action, suit or proceeding) is asserted by such trustee, officer or
controlling person in connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication
of such issue.
The undersigned registrant hereby undertakes to file an application for the
purpose of determining the eligibility of the trustee to act under subsection
(a) of Section 310 of the Trust Indenture Act in accordance with the rules and
regulations prescribed by the Commission under Section 305(b)(2) of the Trust
Indenture Act.
The undersigned registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Items 4, 10(b), 11 or 13 of this Form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This includes information contained in documents
filed subsequent to the effective date of the registration statement through
the date of responding to the request.
The undersigned registrant hereby undertakes to supply by means of a post-
effective amendment all information concerning a transaction, and the company
being acquired involved therein, that was not the subject of and included in
the registration statement when it became effective.
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SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT, THE REGISTRANT HAS DULY
CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF BETHESDA, STATE OF
MARYLAND, ON AUGUST 10, 1998.
Host Marriott, L.P.
By: HMC Real Estate Corporation,
---------------------------------
AS GENERAL PARTNER OF HOST
MARRIOTT, L.P.
By: /s/ Robert E. Parsons, Jr.
---------------------------------
NAME: ROBERT E. PARSONS, JR.
TITLE: PRESIDENT AND DIRECTOR
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C>
/s/ Robert E. Parsons, Jr. President and
- ------------------------------------- Director (Chief August 10, 1998
ROBERT E. PARSONS, JR. Executive Officer
and Chief Financial
Officer)
/s/ Donald D. Olinger Vice President
- ------------------------------------- (Chief Accounting August 10, 1998
DONALD D. OLINGER Officer)
/s/ Christopher G. Townsend Vice President and
- ------------------------------------- Director August 10, 1998
CHRISTOPHER G. TOWNSEND
</TABLE>
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<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
reports and to all references to our firm included in or made a part of this
registration statement.
Arthur Andersen LLP
Washington, D.C.
August 7, 1998
1
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EXHIBIT 23.3
CONSENT OF APPRAISER
We hereby consent to the references made to us, our appraisals and/or
fairness opinion by Host Marriott, L.P. in the Prospectus/Consent Solicitation
Statement constituting a part of this Registration Statement on Form S-4. In
addition we consent to the filing of our appraisal reports and fairness
opinion referred to therein as exhibits to the Registration Statement. In
giving such consent, we do not thereby admit that we come within the category
of persons whose consent is required under Section 7 of the Securities Act of
1933, as amended, or the rules and regulations of the Securities and Exchange
Commission thereunder.
American Appraisal Associates, Inc.
/s/ Ronald M. Georgen
By __________________________________
Ronald M. Georgen
President
Milwaukee, Wisconsin
August 7 , 1998
