SUNSTONE HOTEL INVESTORS INC, 424B4, 1996-08-08

SUNSTONE HOTEL INVESTORS INC
424B4, 1996-08-08
REAL ESTATE INVESTMENT TRUSTS

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This filing is made pursuant
to Rule 424(b)(4) under
the Securities Act of
1933 in connection with
Registration No. 333-07685

4,000,000 SHARES

LOGO
COMMON STOCK

Sunstone Hotel Investors, Inc. (the "Company") is a self-administered real
estate investment trust that, through Sunstone Hotel Investors, L.P. (the
"Partnership"), owns mid-price and upscale hotels in the western United States.
The hotels operate or will operate under nationally recognized franchises,
including Courtyard by Marriott(R), Doubletree(R), Hampton Inn(R), Holiday
Inn(R), Holiday Inn(R) Hotel & Suites, Holiday Inn Express(SM), Holiday Inn
Select(SM), Comfort Suites(R) and Residence Inn(R). The Company recently
acquired one hotel and intends to acquire two additional hotels (collectively,
the "Acquisition Hotels") concurrently with the closing of this offering (the
"Offering"). Following such acquisitions, the Company will own 20 hotels with an
aggregate of 2,612 rooms in seven states, including Arizona (1 hotel),
California (5), Colorado (6), New Mexico (1), Oregon (2), Utah (2) and
Washington (3).

The net proceeds to the Company from the Offering will be approximately
$36.8 million, $24.2 million of which will be used to fund the purchase of the
Acquisition Hotels, and the balance to repay borrowings outstanding under the
Company's line of credit. The Company's Articles of Incorporation limit its
consolidated indebtedness to 50% of the Company's investment in hotel
properties, at cost. Upon the closing of the Offering, the Company's
consolidated indebtedness will be approximately 16.3% of its investment in hotel
properties, at cost.

All of the shares of Common Stock offered hereby are being sold by the
Company. The Common Stock is listed on the New York Stock Exchange ("NYSE")
under the symbol "SSI." On August 7, 1996, the last reported sales price per
share of the Company's Common Stock on the NYSE was $10.00. Since its initial
public offering of Common Stock in August 1995, the Company has paid regular
quarterly dividends representing an annual distribution of $0.92 per share.

SEE "RISK FACTORS" HEREIN FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD
BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY.
------------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

THE ATTORNEY GENERAL OF THE STATE OF NEW YORK HAS NOT PASSED ON OR ENDORSED THE
MERITS OF THE OFFERING. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL.

<TABLE>
<S> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
Price to Underwriting Proceeds to
Public Discount(1) Company(2)
- -------------------------------------------------------------------------------------------------------
Per Share........................................ $10.00 $0.60 $9.40
Total(3)......................................... $40,000,000 $2,400,000 $37,600,000
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
</TABLE>

(1) See "Underwriting" for information concerning indemnification of the
Underwriters and other matters.

(2) Before deducting expenses payable by the Company, estimated at $800,000. See
"Use of Proceeds."

(3) The Company has granted the Underwriters a 30-day option to purchase up to
additional 600,000 shares of Common Stock solely to cover over-allotments,
if any, at the Price to Public less the Underwriting Discount. If the
Underwriters exercise this option in full, the Price to Public will total
$46,000,000, the Underwriting Discount will total $2,760,000, and the
Proceeds to Company will total $43,240,000. See "Underwriting."

The shares of Common Stock are offered by the Underwriters named herein,
when, as and if delivered to and accepted by the Underwriters and subject to
their right to reject any order in whole or in part. It is expected that
delivery of the certificates representing the shares of Common Stock will be
made against payment therefor at the office of Montgomery Securities on or about
August 13, 1996.

------------------------

MONTGOMERY SECURITIES

BEAR, STEARNS & CO. INC.
EVEREN SECURITIES, INC.
RAYMOND JAMES & ASSOCIATES, INC.

August 7, 1996

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[COLOR PHOTOS OF HOTELS AND MAP]
<PAGE> 3

AVAILABLE INFORMATION

The Company is subject to the information requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files, reports, proxy statements and other information filed by the
Company can be inspected and copied at the public reference facilities
maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549, and at regional offices of the Commission located
at 7 World Trade Center, 13th Floor, New York, New York 10048 and Citicorp Corp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511.
Copies of such material can be obtained by mail from the Public Reference
Section of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549 at
prescribed rates. The Commission also maintains a web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Commission, including the Company,
and the address is http://www.sec.gov.

The Company has filed with the Commission, 450 Fifth Street, N.W.,
Washington D.C. 20549, a Registration Statement on Form S-11 under the
Securities Act of 1933, as amended (the "Securities Act"), and the rules and
regulations promulgated thereunder, with respect to the Common Stock offered
pursuant to this Prospectus. This Prospectus, which is part of the Registration
Statement, does not contain all of the information set forth in the Registration
Statement and the exhibits. For further information concerning the Company and
the Common Stock offered hereby, reference is made to the Registration Statement
and the exhibits and schedules filed therewith, which may be examined without
charge at, or copies obtained upon payment of prescribed fees from, the
Commission and its regional offices at the locations listed above. Any
statements contained herein concerning the provisions of any document are not
necessarily complete, and, in each instance, reference is made to the copy of
such document filed as an exhibit to the Registration Statement or otherwise
filed with the Commission. Each such statement is qualified in its entirety by
such reference.

IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY OVERALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE OR OTHERWISE. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. DURING THIS
OFFERING, CERTAIN PERSONS AFFILIATED WITH PERSONS PARTICIPATING IN THE
DISTRIBUTION MAY ENGAGE IN TRANSACTIONS FOR THEIR OWN ACCOUNTS OR FOR THE
ACCOUNTS OF OTHERS IN THE COMMON STOCK PURSUANT TO EXEMPTIONS FROM RULE 10B-6
AND 10B-7 UNDER THE EXCHANGE ACT. SEE "UNDERWRITING."
------------------------

THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT AND SECTION 21E OF THE EXCHANGE ACT. SUCH
STATEMENTS RELATE TO FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE
COMPANY, AND PROSPECTIVE INVESTORS ARE CAUTIONED THAT THE COMPANY'S ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THOSE SET FORTH IN THE FORWARD-LOOKING
STATEMENTS. PROSPECTIVE INVESTORS SHOULD SPECIFICALLY CONSIDER THE VARIOUS
FACTORS IDENTIFIED IN THIS PROSPECTUS WHICH COULD CAUSE ACTUAL RESULTS TO
DIFFER, INCLUDING THOSE DISCUSSED IN THE SECTION ENTITLED "RISK FACTORS."

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TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUMMARY......................... 1
The Company.............................. 1
The Hotels............................... 3
The Lodging Industry..................... 5
Recent Developments...................... 6
Second Quarter 1996 Financial
Highlights............................. 9
Risk Factors............................. 10
Distribution Policy...................... 10
REIT Structure........................... 10
Tax Status............................... 11
The Offering............................. 11
Summary Financial Data................... 12
RISK FACTORS............................... 14
The Company's Inability to Effectively
Manage Growth.......................... 14
Conflicts of Interest Between the Company
and Certain Officers and Directors..... 14
Lack of Control Over Operations of the
Hotels................................. 15
Renovation and Redevelopment Risks....... 15
Risk that Pending Acquisitions Will
Not Close.............................. 15
Multi-Property Acquisition Risks......... 16
Hawthorn Suites Development Risks........ 16
Competition for Acquisitions............. 16
Development Risks........................ 17
Substantial Reliance on Mr. Alter........ 17
Total Dependence on the Lessee and
Payments under the Percentage Leases... 17
Distribution of Substantially All of Cash
Available for Distribution;
Distributions Include Return of
Capital................................ 18
Hotel Industry Risks..................... 18
Real Estate Investment Risks............. 19
Risks of Increases in Operating Costs and
Capital Expenditures................... 21
Dependence on Acquisitions to Increase
Cash Available for Distribution........ 21
Risks of Leverage........................ 21
Risks of Operating Hotels Under Franchise
Agreements............................. 21
Tax Risks................................ 22
Ability of Board of Directors to Change
Certain Policies....................... 23
Common Stock Price Fluctuations and
Trading Volume......................... 23
Adverse Effect of Shares Available for
Future Issuance and Sale on Market
Price of Common Stock.................. 24
Limitation on Acquisition and Change of
Control................................ 24

<CAPTION>
PAGE
----
<S> <C>
THE COMPANY................................ 26
USE OF PROCEEDS............................ 27
PRICE RANGE OF COMMON STOCK
AND DISTRIBUTIONS........................ 28
CAPITALIZATION............................. 29
SELECTED FINANCIAL INFORMATION............. 30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS............................... 34
Overview................................. 34
Pro Forma Results of Operations of the
Company................................ 34
Pro Forma Results of Operations of the
Lessee................................. 35
Seasonality and Diversification.......... 36
Actual Results of Operations of
the Company............................ 37
Pro Forma Liquidity and Capital
Resources.............................. 37
Inflation................................ 38
BUSINESS AND PROPERTIES.................... 39
The Lodging Industry..................... 39
Overview of the Company.................. 40
Growth Strategy.......................... 40
Description of Franchises................ 45
Description of the Hotels................ 47
Operating Performance of the Hotels...... 51
The Percentage Leases.................... 54
The Management Agreement................. 59
Franchise Agreements..................... 59
Operating Practices...................... 61
Employees................................ 61
Environmental Matters.................... 61
Competition.............................. 62
Depreciation............................. 62
Legal Proceedings........................ 63
POLICIES AND OBJECTIVES WITH RESPECT TO
CERTAIN ACTIVITIES....................... 63
Investment Policies...................... 63
Financing................................ 64
Conflict of Interest Policies............ 64
Policies With Respect to Other
Activities............................. 66
Working Capital Reserves................. 66
MANAGEMENT................................. 67
Directors and Executive Officers......... 67
Audit Committee.......................... 68
Compensation Committee................... 69
Executive Compensation................... 69
</TABLE>

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<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Compensation of Directors................ 71
Alter Employment Agreement............... 71
Biederman Employment Agreement........... 71
1994 Stock Incentive Plan................ 71
The Directors Plan....................... 74
Limitation of Liability and
Indemnification........................ 75
Certain Events With Respect to Mr. Alter
and Mr. Biederman...................... 76
Strategic Consultant..................... 76
CERTAIN TRANSACTIONS....................... 77
Minimizing the Risks of Potential
Conflicts of Interest.................. 77
Initial Capitalization................... 77
Percentage Leases........................ 77
Acquisition of the Sunstone Initial
Hotels................................. 77
Management Agreement..................... 78
Employment Agreements.................... 78
Third Party Pledge Agreement............. 78
Unit Purchase Agreement.................. 78
Purchase of Courtyard by
Marriott-Riverside, California Hotel... 78
Purchase of Residence Inn-Highlands
Ranch, Colorado Hotel.................. 79
Personnel and Office Sharing Arrangement
and Certain Reimbursements............. 79
Indemnification Agreements............... 79
THE LESSEE................................. 80
General.................................. 80
Management............................... 80
1996 Stock Appreciation Rights Plan...... 81
THE MANAGEMENT COMPANY..................... 83
General.................................. 83
The Management Agreement................. 83
PRINCIPAL STOCKHOLDERS..................... 84
DESCRIPTION OF CAPITAL STOCK............... 85
General.................................. 85
Common Stock............................. 85
Preferred Stock.......................... 86
Classification or Reclassification of
Common Stock or Preferred Stock........ 86
Restrictions on Ownership................ 86
CERTAIN PROVISIONS OF MARYLAND LAW AND OF
THE COMPANY'S ARTICLES OF INCORPORATION
AND BYLAWS............................... 89
Classification of the Board of
Directors.............................. 89
Removal of Directors..................... 89

<CAPTION>
PAGE
----
<S> <C>
Limitation of Liability and
Indemnification........................ 89
Business Combinations.................... 90
Control Share Acquisitions............... 91
Amendments to the Company's Articles of
Incorporation and Bylaws............... 91
Dissolution of the Company............... 92
Operations............................... 92
Anti-Takeover Effect of Certain
Provisions of Maryland Law and of the
Company's Articles of Incorporation
and Bylaws............................. 92
Other Matters............................ 92
SHARES AVAILABLE FOR FUTURE SALE........... 92
PARTNERSHIP AGREEMENT...................... 93
Management............................... 93
Transferability of Interests............. 93
Capital Contribution..................... 94
Redemption Rights........................ 94
Registration Rights...................... 95
Operations............................... 95
Distributions............................ 95
Allocations.............................. 95
Term..................................... 95
Tax Matters.............................. 95
FEDERAL INCOME TAX CONSIDERATIONS.......... 96
Summary of Tax Opinions.................. 96
Taxation of the Company.................. 97
Requirements for Qualification........... 98
Failure to Qualify....................... 106
Taxation of Taxable U.S. Stockholders.... 106
Taxation of Stockholders on the
Disposition of the Common Stock........ 107
Capital Gains and Losses................. 107
Information Reporting Requirements and
Backup Withholding..................... 107
Taxation of Tax-Exempt Stockholders...... 107
Taxation of Non-U.S. Stockholders........ 108
Other Tax Consequences................... 109
Tax Aspects of the Partnership........... 109
UNDERWRITING............................... 114
EXPERTS.................................... 115
REPORTS TO STOCKHOLDERS.................... 115
LEGAL MATTERS.............................. 115
ADDITIONAL INFORMATION..................... 116
GLOSSARY OF SIGNIFICANT TERMS.............. 117
INDEX OF FINANCIAL STATEMENTS.............. F-1
</TABLE>

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PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and financial statements and the notes thereto appearing elsewhere
in this Prospectus. Unless the context otherwise indicates, all references
herein to the "Company" include Sunstone Hotel Investors, Inc. and the
Partnership, Sunstone Hotel Investors, L.P. Except as otherwise noted, all the
information in this Prospectus assumes no exercise of the Underwriters'
over-allotment option. The offering of 4,000,000 shares of Common Stock pursuant
to this Prospectus is referred to as the "Offering." As used herein, the terms
"upscale" and "mid-price", respectively, mean the segments of the lodging
industry classified as such by Smith Travel Research in its industry reports
that consist of hotels with average daily room rates (total revenues divided by
the total number of rooms occupied) between the 70th and 85th percentile and the
40th and 70th percentile, respectively, of the average daily room rates of all
hotels in the markets in which the Company's hotels operate. See "Glossary of
Significant Terms" for the definitions of certain additional terms used in this
Prospectus.

THE COMPANY

The Company is a self-administered real estate investment trust ("REIT")
that, through Sunstone Hotel Investors, L.P. (the "Partnership"), owns mid-price
and upscale hotels in the western United States. The hotels operate or will
operate under nationally recognized franchises, including Courtyard by Marriott,
Doubletree Hotel, Hampton Inn, Holiday Inn, Holiday Inn Hotel & Suites, Holiday
Inn Express, Holiday Inn Select, Comfort Suites and Residence Inn. The Company
owns 18 hotels, eight of which were acquired subsequent to the Company's initial
public offering (the "IPO") in August 1995. The Company recently acquired one of
the 18 hotels and intends to acquire two additional hotels concurrently with the
closing of the Offering (collectively, the "Acquisition Hotels"). Following such
acquisitions, the Company will own 20 hotels with an aggregate of 2,612 rooms in
seven states, including Arizona (1 hotel), California (5), Colorado (6), New
Mexico (1), Utah (2), Oregon (2), and Washington (3), and will have doubled the
number of hotels in its portfolio in the 12 months since the IPO. The 17 hotels
owned prior to June 1, 1996 are referred to as the "Current Hotels," and
together with the three Acquisition Hotels are referred to as the "Hotels."

In addition to significantly expanding its hotel portfolio, the Company has
generated internal revenue growth by renovating or redeveloping many of the
Current Hotels, and improving their management and marketing programs. As a
REIT, the Company derives revenues from its hotels through leases (the
"Percentage Leases") between the Partnership, as landlord, and Sunstone Hotel
Properties, Inc. (the "Lessee") which provide for rent payments based
principally on a percentage of room revenues at the hotels. Revenue per
available room ("REVPAR") for the seven Current Hotels that were owned by the
Company or its predecessor for the entire first quarter of 1995 and 1996 and
were not undergoing redevelopment or significant renovation during such periods
increased 5.5%, from $39.82 to $42.03. REVPAR for all of the Current Hotels and
the Acquisition Hotels during such periods increased 1.6%, from $38.22 to
$38.82. The Company believes that its recently completed and future
redevelopment and renovation activities, as well as improvements in management
and marketing, will continue to fuel REVPAR growth at its hotels, thereby
increasing revenue to the Company.

The Company's growth strategy is to enhance stockholder value by increasing
Cash Available for Distribution per share to the holders of its Common Stock by:

- Acquiring underperforming hotels located primarily in the western United
States that are, or can be redeveloped and repositioned into, nationally
franchised mid-price and upscale hotels, with an increasing emphasis on
multi-property acquisitions;

- Enhancing the operating performance of hotels owned or acquired by the
Company through selective renovation, redevelopment and rebranding, and
improved management and marketing;

- Developing Hawthorn Suites, a national chain of upscale extended-stay
hotels, through property conversions or new construction in several major
urban markets on the West Coast pursuant to a proposed master development
agreement with U.S. Franchise Systems, Inc.; and

1
<PAGE> 7

- Selectively developing new mid-price and upscale hotels in markets where
room demand and other competitive factors justify new construction.

The Company believes that there will continue to be substantial
acquisition, redevelopment, renovation and repositioning opportunities in the
near future in the mid-price and upscale hotel markets in the western United
States. The Company believes these opportunities will result from the aging of a
significant portion of the nation's hotel supply and the recent imposition of
capital expenditure and other modernization requirements by certain national
hotel franchisors on the owners of franchised hotels, many of which are small
independent hotel companies or private hotel owners that may be unwilling or
unable to satisfy such requirements.

Since its IPO in August 1995, the Company has:

- Acquired six of the Current Hotels for purchase prices aggregating $19.3
million, including a portfolio of four hotels in Washington and Oregon;

- Acquired and substantially completed construction of a 78-room Residence
Inn for approximately $5.0 million, which is expected to open during the
third quarter of 1996;

- Acquired one of the Acquisition Hotels, and contracted to acquire the
other two Acquisition Hotels, for purchase prices aggregating $24.2
million, and with the Acquisition Hotels will have increased the number
of rooms in its portfolio by 96.7% to 2,612;

- Completed $1.2 million in renovations to two of the Current Hotels and
$4.4 million of redevelopment to two of the Current Hotels, and commenced
redevelopment budgeted at $5.5 million to four of the Current Hotels;

- Entered into a letter of intent with U.S. Franchise Systems, Inc.
expected to result in a master development agreement to franchise
extended-stay Hawthorn Suites in several major urban markets on the West
Coast;

- Entered into a letter of intent to acquire a 166-room full-service
convention hotel for $8.4 million upon completion of construction by an
unaffiliated developer, which is expected to occur in 1997;

- Increased availability under the Line of Credit from $30 million to $50
million; and

- Added two project managers and benefitted from the addition of a Chief
Financial Officer, an asset manager and other management personnel to the
Lessee.

2
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THE HOTELS

Strong Franchise Brands

Consistent with its strategy to own hotels with nationally recognized
franchise affiliations, upon the closing of the Offering, the Company will own
hotels with the following brands:

<TABLE>
<CAPTION>
NUMBER OF NUMBER PERCENTAGE OF
HOTELS OF ROOMS TOTAL ROOMS
--------- -------- -------------
<S> <C> <C> <C>
CURRENT HOTELS
Courtyard by Marriott..................................... 2 279 10.7%
Doubletree Hotel.......................................... 1 213 8.2
Hampton Inn(1)............................................ 7 939 35.9
Holiday Inn brands(2)(3).................................. 6 599 22.9
Residence Inn(4).......................................... 1 78 3.0
ACQUISITION HOTELS
Comfort Suites............................................ 1 165 6.3
Holiday Inn Hotel & Suites(5)............................. 1 151 5.8
Holiday Inn Select(6)..................................... 1 188 7.2
-- ----- -----
20 2,612 100.0%
== ===== =====
</TABLE>

- ---------------
(1) The Company has received a franchise license from Promus Hotels, Inc.
("Hampton") for a Hampton Inn for the Cypress Inn-Clackamas, Oregon hotel,
subject to the completion of certain renovations and improvements, which the
Company estimates will be completed during the third quarter of 1996.

(2) These brands include Holiday Inn (2 hotels), Holiday Inn Express (2) and
Holiday Inn Hotel & Suites (2).

(3) The Company has received franchise licenses from Holiday Inns Franchising,
Inc. ("Holiday Inn") for (i) a Holiday Inn Hotel & Suites for the Cypress
Inn-Kent (Seattle), Washington hotel, (ii) a Holiday Inn Express for the
Cypress Inn-Portland, Oregon and Cypress Inn-Poulsbo, Washington hotels and
(iii) a Holiday Inn Hotel & Suites for the Holiday Inn-Craig, Colorado
hotel, subject in each instance to the completion of certain renovations and
improvements, which the Company estimates will be completed during the third
quarter of 1996 (except for the Holiday Inn-Craig, Colorado hotel, which the
Company estimates will be completed during the first quarter of 1997).

(4) The Company has received a franchise license from Marriott International,
Inc. ("Marriott") for a Residence Inn for the Highlands Ranch (Denver),
Colorado hotel, subject to the completion of construction, which the Company
estimates will be completed during the third quarter of 1996.

(5) This hotel is currently operated under another national franchise, but the
Company has received from Holiday Inn a Holiday Inn Hotel & Suites franchise
license for the hotel, subject to the acquisition of the hotel and the
completion of certain renovations and improvements, which the Company
estimates will be completed during the fourth quarter of 1996.

(6) The Company has received from Holiday Inn a Holiday Inn Select franchise
license for the Holiday Inn-Renton (Seattle), Washington hotel, subject to
the completion of certain renovations and improvements, which the Company
estimates will be completed during the fourth quarter of 1996.

For a description of the accommodations, services and amenities generally
offered by each franchise system, see "Business and Properties."

3
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Operational Data

The following table sets forth certain unaudited pro forma operational data
on a hotel-by-hotel basis, including Percentage Rent payments to the Company
from the Lessee.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
--------------------------------------------------------------
REVENUE
YEAR NO. AVERAGE PER
YEAR RENOVATED/ OF ROOM PRO FORMA DAILY AVAILABLE
OPENED REDEVELOPED ROOMS REVENUE RENT(1) OCCUPANCY(2) RATE ROOM(3)
------ ----------- ----- ------------ ----------- ------------ ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CURRENT HOTELS
Courtyard by Marriott:
Fresno, California............. 1989 1994 116 $1,784,403 $ 768,590 72.5% $58.11 $42.13
Riverside, California.......... 1988 1994 163 1,510,480 524,250 52.9 48.04 25.41
----- ---------- ----------- ---- ------ ------
Subtotal/weighted average.... 279 3,294,883 1,292,840 61.0 53.01 32.34
----- ---------- ----------- ---- ------ ------
Doubletree Hotel:
Santa Fe, New Mexico........... 1985 1996 213 2,904,098 1,108,599 51.8 72.14 37.37
----- ---------- ----------- ---- ------ ------
Inn:
Mesa, Arizona.................. 1987 118 2,103,230 980,574 82.3 59.35 48.85
Arcadia, California............ 1989 131 1,866,039 896,010 64.2 60.78 39.02
Oakland, California............ 1986 1996 152 2,178,429 593,410 85.0 47.13 40.06
Denver, Colorado............... 1986 152 2,771,499 1,412,344 80.2 62.32 49.98
Pueblo, Colorado............... 1986 112 2,050,358 993,912 87.4 57.38 50.15
Silverthorne, Colorado......... 1976 1996 160 2,380,277 980,809 58.6 69.57 40.77
Clackamas (Portland),
Oregon(4).................... 1986 1996 114 976,469 464,312 48.9 47.95 23.45
----- ---------- ----------- ---- ------ ------
Subtotal/weighted average.... 939 14,326,301 6,321,371 72.4 57.75 41.81
----- ---------- ----------- ---- ------ ------
Holiday Inn:
Steamboat Springs, Colorado.... 1974 1996 82 1,408,569 504,593 66.3 70.94 47.03
Provo, Utah.................... 1972 1994 78 1,222,237 536,023 78.5 54.67 42.92
----- ---------- ----------- ---- ------ ------
Subtotal/weighted average.... 160 2,630,806 1,040,616 72.3 62.32 45.06
----- ---------- ----------- ---- ------ ------
Holiday Inn Hotel & Suites:
Craig, Colorado(4)............. 1981 1992 169 1,632,494 646,100 55.7 47.54 26.48
Kent (Seattle),
Washington(4)................ 1987 1996 122 1,386,483 641,062 52.3 59.58 31.16
----- ---------- ----------- ---- ------ ------
Subtotal/weighted average.... 291 3,018,977 1,287,162 54.2 52.40 28.40
----- ---------- ----------- ---- ------ ------
Holiday Inn Express:
Portland, Oregon(4)............ 1986 1996 85 983,719 372,309 63.5 49.89 31.68
Poulsbo, Washington(4)......... 1986 1996 63 755,818 343,022 62.1 52.90 32.85
----- ---------- ----------- ---- ------ ------
Subtotal/weighted average.... 148 1,739,537 715,331 62.9 51.16 32.18
----- ---------- ----------- ---- ------ ------
Residence Inn:
Highlands Ranch (Denver),
Colorado(5).................. 1996 78 N/A N/A N/A N/A N/A
----- ---------- ----------- ---- ------ ------
Total/weighted average........... 2,108 27,914,602 11,765,919 65.4 57.64 37.70
----- ---------- ----------- ---- ------ ------
ACQUISITION HOTELS
Comfort Suites:
South San Francisco,
California................... 1985 165 3,204,950 1,272,963 83.3 63.91 53.24
Holiday Inn Hotel & Suites:
Price, Utah(6)................. 1984 151 1,553,590 714,696 69.0 40.85 28.19
Holiday Inn Select:
Renton (Seattle),
Washington(7)................ 1968 1994 188 2,914,026 1,266,454 74.3 57.18 42.48
----- ---------- ----------- ---- ------ ------
Total/weighted average........... 2,612 $35,587,168 $15,020,032 67.4% $57.08 $38.47
===== =========== =========== ==== ====== ======
</TABLE>

- ---------------
(1) Represents rents to be paid by the Lessee to the Company calculated on a pro
forma basis by applying the rent provisions in the Percentage Leases, using
historical revenues and related expenses of the Hotels as if they were owned
as of January 1, 1995. For pro forma and historical revenues and related
expenses associated with the operation of the Lessee, the Company and the
Hotels, see "Selected Financial Information" and the financial statements
elsewhere in this Prospectus.

4
<PAGE> 10

(2) The occupancy rates for certain of the Current Hotels reflect the Company's
strategy of acquiring underperforming hotels to be redeveloped, renovated
and/or rebranded.

(3) Revenue per available room is determined by dividing room revenues by
available rooms for the applicable period.

(4) This hotel is currently undergoing redevelopment or renovation in order to
satisfy the franchise license requirements for the brand under which the
hotel is listed in the left-hand column. The Company estimates redevelopment
or renovation will be completed during the third quarter of 1996, except for
the Holiday Inn-Craig, Colorado hotel which the Company estimates will be
completed during the first quarter of 1997. The Hampton Inn-Clackamas,
Oregon, Holiday Inn Hotel & Suites-Kent, Washington, Holiday Inn
Express-Portland, Oregon, and the Holiday Inn Express-Poulsbo, Washington
hotels were operated during 1995 under the independent Cypress Inns brand
and the figures are reported for that brand.

(5) This hotel is currently under construction, which the Company estimates will
be completed during the third quarter of 1996. The Company has received from
Marriott a Residence Inn franchise license for this hotel, subject to the
completion of construction.

(6) This hotel is currently operated under another national franchise, but the
Company has received from Holiday Inn a Holiday Inn Hotel & Suites franchise
license for the hotel, subject to the acquisition of the hotel and the
completion of certain renovations and improvements, which the Company
estimates will be completed during the fourth quarter of 1996.

(7) Renovations to date were made in 1994 by the prior owner. The Company is
obligated to renovate the hotel following the Offering in order to satisfy
the conditions of Holiday Inn for a Holiday Inn Select franchise license.
The Company estimates that such renovations will be completed during the
fourth quarter of 1996.

THE LODGING INDUSTRY

The fundamentals of the lodging industry have improved significantly in
each year since 1991. The industry as a whole generated record earnings in 1995,
with industry-wide pre-tax profits of $8.5 billion. This was up 55% from $5.5
billion in pre-tax profits in 1994, and represented the industry's third
consecutive year of profitability. Coopers & Lybrand Hospitality Directions,
January 1996 ("Hospitality Directions") projects that industry pre-tax profits
will reach $14.7 billion in 1998.

The industry's profitability has been fueled by four consecutive years in
which the growth in demand for hotel rooms has exceeded the growth in room
supply. Industry-wide growth in room demand exceeded the growth in total room
supply by 2.0%, 2.6%, 2.8% and 1.4% in 1992, 1993, 1994 and 1995, respectively.
This trend has continued in the first quarter of 1996, with demand growth
eclipsing supply growth by 1.2%, despite harsh winter weather conditions
affecting many markets.

This sustained, favorable relationship between demand growth and supply
growth has enabled the industry to increase REVPAR every year since 1991. REVPAR
for the industry as a whole grew 2.4%, 5.7%, 6.9% and 5.6% in 1992, 1993, 1994
and 1995, respectively, and increased 7.4% in the first quarter of 1996 compared
to the first quarter of 1995. Hospitality Directions forecasts industry-wide
REVPAR gains averaging 5% annually in the period 1996 through 1998.

The fundamentals are similarly favorable in the mid-price segment in which
the majority of the Company's hotels operate. Demand for mid-price rooms grew at
3.8% in 1995, while the supply of new mid-price rooms increased only 2.4%.
Carrying this trend forward, demand for mid-price rooms grew at the same 3.8%
rate during the 12 months ended March 31, 1996, compared to a 2.6% increase in
mid-price room supply in the same period.

REVPAR at mid-price hotels grew 5.3% in 1995, and increased 6.4% in the 12
months ended March 31, 1996, compared to the 12 months ended March 31, 1995.
Hospitality Directions forecasts that the mid-price segment will achieve REVPAR
gains averaging 4.9% annually in the period 1996 through 1998.

5
<PAGE> 11

The upscale segment of the industry, which represents a growing number of
the Company's hotels, is expected to achieve strong results in the near-term due
to limited growth in the supply of new upscale rooms. Demand growth should
exceed the rate of new upscale room supply by an average of 0.6% annually during
the 1996 through 1998 period, according to Hospitality Directions, translating
into an average 5.7% annual increase in REVPAR for the upscale segment for the
same 1996 through 1998 period.

The Company believes near-term supply growth will be limited in the upscale
segment due to (i) the continued availability of upscale hotel acquisition
opportunities in most markets at prices below replacement cost, (ii) the high
relative cost of construction of upscale hotels, (iii) more limited financing
available for upscale hotel construction, and (iv) long construction lead times
for upscale hotels.

Unless otherwise noted, all statistics in this Prospectus relating to the
lodging industry generally (other than Company statistics) are from, or have
been derived from, information published or provided by Smith Travel Research,
an independent industry research organization. Smith Travel Research has not
provided any form of consultation, advice or counsel regarding any aspect of the
Offering, and Smith Travel Research is in no way associated with the Offering.

RECENT DEVELOPMENTS

Completed and Pending Acquisitions

The following table sets forth certain information with respect to the
Company's hotel acquisitions, including those acquired in the IPO and
thereafter.

<TABLE>
<CAPTION>
HOTELS ROOMS
---------------------- ----------------------
NUMBER OF CUMULATIVE NUMBER OF CUMULATIVE
DATE ACQUIRED PROPERTIES HOTELS TOTAL ROOMS TOTAL
- --------------------- -------------------------------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
August 1995 (IPO) Initial Hotels 10 10 1,331(2) 1,331
December 1995 Hampton Inn, Oakland, California 1 11 152 1,483
December 1995(1) Residence Inn, Highlands Ranch 1 12 78 1,561
(Denver), Colorado
February 1996 Cypress Inn Hotels: 4 16 384 1,945
Holiday Inn Express, Poulsbo,
Washington
Holiday Inn Express, Portland,
Oregon
Holiday Inn Hotel & Suites,
Kent (Seattle),
Washington
Hampton Inn, Clackamas
(Portland), Oregon
April 1996 Courtyard by Marriott, 1 17 163 2,108
Riverside, California
June 1996 Holiday Inn Select, Renton, 1 18 188 2,296
Washington
August 1996 (est.) Comfort Suites, South San 1 19 165 2,461
Francisco, California
Holiday Inn Hotel & Suites, 1 20 151 2,612
Price, Utah(3)
</TABLE>

See the table on page 3 for the status of franchise licenses.
- ---------------
(1) The Company acquired the land on this date. The hotel is currently under
construction and is expected to be completed by the end of the third quarter
of 1996.

(2) The total number of rooms at the time of the IPO was 1,328. In connection
with the redevelopment of the Doubletree-Santa Fe, New Mexico hotel, three
rooms were added.

(3) This hotel is currently operated under another national franchise, but the
Company has received from Holiday Inn a Holiday Inn Hotel & Suites franchise
license for the hotel, subject to the acquisition of the hotel and the
completion of certain renovations and improvements, which the Company
estimates will be completed during the fourth quarter of 1996.

6
<PAGE> 12

The Company acquired six hotels in the Cypress Inn portfolio purchase in
February 1996 for approximately $15 million. The six hotels were sold as a
package by a lender following a mortgage loan default by the owner/borrower. In
May 1996, the Company sold two of the hotels without adverse tax consequences
because they did not satisfy the Company's investment criteria. The Company has
commenced redevelopment budgeted at $5.5 million to the four remaining hotels
(collectively, the "Cypress Inn Hotels"), which it expects to complete during
the third quarter of 1996. See "Redevelopment and Renovation" immediately below
and "Business and Properties -- Growth Strategy -- Redevelopment and Renovation"
elsewhere in this Prospectus. The Company believes that after taking into
account the purchase price and redevelopment expenses for the four retained
Cypress Inn Hotels, the total cost to the Company for these hotels will be below
replacement cost.

The Company acquired one of the Acquisition Hotels, a 188-room Holiday Inn
in Renton, Washington, on June 28, 1996 for approximately $8.2 million,
including acquisition costs. The Company intends to acquire the other two
Acquisition Hotels concurrently with the closing of the Offering for cash
purchase prices aggregating approximately $16.0 million, including estimated
closing costs. These hotels include a 165-room Comfort Suites in South San
Francisco, California, and a 151-room hotel in Price, Utah which is currently
operated under another national franchise, but has been approved to operate as a
Holiday Inn Hotel & Suites subject to the completion of certain renovations and
improvements, which the Company expects will be completed during the fourth
quarter of 1996. The purchase agreements for these two hotels contain customary
closing and other conditions. The Company has not completed its physical,
economic or environmental due diligence investigation of these hotels, and there
can be no assurance that the Company will close these acquisitions. See "Risk
Factors -- Risk that Pending Acquisitions Will Not Close."

Development of Residence Inn

The Company is currently developing a 78-room Residence Inn hotel in
Highlands Ranch (Denver), Colorado. Highlands Ranch is a rapidly growing
22,000-acre master planned community with a limited number of sites designated
for hotel development. The Company believes that this extended-stay hotel will
appeal to families relocating to the community and business travelers visiting
the business parks in the community. The Company expects to complete the $5.0
million project during the third quarter of 1996. The site includes sufficient
land to add 42 rooms if and when market conditions justify an expansion. There
can be no assurance, however, that this development will be completed on time or
within budget. See "Risk Factors -- Development Risks."

Redevelopment and Renovation

Since the IPO, the Company has completed $4.4 million in redevelopment to
two of the Current Hotels, and has commenced redevelopment budgeted at $5.5
million on the four recently acquired Cypress Inn Hotels, which the Company
estimates will be completed during the third quarter of 1996. This redevelopment
will enable the Company to rebrand these hotels as a Holiday Inn Hotel & Suites
hotel, two Holiday Inn Express hotels and a Hampton Inn hotel, which the Company
believes will allow it to significantly increase REVPAR at each hotel. The two
Current Hotels which were redeveloped included the Best Western-Santa Fe, New
Mexico hotel ($2.6 million), which was transformed from a mid-price hotel into a
full-service, upscale Doubletree Hotel, and the Holiday Inn-Steamboat Springs,
Colorado hotel ($1.8 million), at which major exterior, guestroom, common area
and restaurant improvements were made. The restaurant improvements at the
Holiday Inn-Steamboat Springs hotel enabled the Company to lease the restaurant
to a regional restaurant operator, which the Company believes will provide
increased lease revenue from the hotel.

Since the IPO, the Company also completed $1.2 million in renovations to
two of the Current Hotels. These included the Hampton Inn-Oakland, California
hotel ($1 million) and the Hampton Inn-Silverthorne, Colorado hotel ($0.2
million). At the Hampton Inn-Oakland, California hotel improvements were made to
the exterior, the guest rooms and bathrooms, as well as to the lobby and meeting
spaces. At the Hampton Inn-Silverthorne, Colorado hotel improvements were made
to the exterior, the guest rooms and to meeting spaces. In addition,
improvements were made to the restaurant at the Hampton Inn-Silverthorne,
enabling the Company to lease the restaurant to a regional restaurant operator,
which the Company believes will provide increased lease revenue from the hotel.
Renovations to the lobby of the hotel will also be made and are scheduled to be
completed during the fourth quarter of 1996.

7
<PAGE> 13

For a general discussion of the Company's renovation and redevelopment
strategy and specific information on the renovation and redevelopment work
completed or to be completed at each Hotel, see "Business and
Properties -- Growth Strategy -- Internal Growth Strategy -- Redevelopment and
Renovation." There can be no assurance that renovation or redevelopment work
will be completed on time or within budget. See "Risk Factors -- Renovation and
Redevelopment Risk."

The Company believes that after taking into account the purchase price of
each Hotel in its portfolio and the cost of redeveloping or renovating it, the
total cost to the Company for each Hotel is 30% to 40% below its replacement
cost.

Hawthorn Suites Master Development Agreement

The Company recently entered into a letter of intent with U.S. Franchise
Systems, Inc. ("USFS") which is expected to lead to a master development
agreement to franchise extended-stay Hawthorn Suites hotels in several major
urban markets in California, Oregon and Washington, including San Diego, San
Francisco, San Jose, Portland, Seattle and certain areas of Los Angeles. Under
the proposed arrangement the Company would have the first right to develop
Hawthorn Suites in its selected submarkets, provided it meets certain deadlines
for acquiring hotel sites and applying for franchise licenses. Development may
consist of conversions of existing properties or new construction and may be
performed by the Company, or by unaffiliated developers (and thus allow the
Company to minimize development risks). It is intended that USFS will be
required to help the Company identify hotel sites, provide architectural plans
and development oversight and assist in marketing the hotels. For a more
detailed description of the intended agreement regarding Hawthorn Suites, see
"Business and Properties -- Growth Strategy -- External Growth Strategy." The
Hawthorn Suites arrangement is only in the letter of intent stage, and there is
no assurance that the Company will enter into a definitive agreement regarding
it, or, that such agreement would contain the terms described herein. See "Risk
Factors -- Hawthorn Suites Development Risks" and "-- Development Risks."

Hawthorn Suites are upscale extended-stay hotels competing primarily with
Residence Inns and Homewood Suites. The franchise rights to this brand were
recently acquired by USFS, a hotel franchise company founded by Michael Leven,
the former President of Holiday Inn. The Company believes USFS intends to grow
the Hawthorn Suites brand into a leading national hotel chain from its current
base of 17 Hawthorn Suites hotels. The Company believes the arrangement with
USFS will give it a significant advantage in the growing extended-stay market in
the western United States.

Letter of Intent to Acquire Newly Developed Convention Center Hotel

In June 1996, the Company entered into a letter of intent with Mortensen
Development Corporation, a major developer of hotels in the United States, to
acquire a 166-room hotel to be developed in Pueblo, Colorado (the "Pueblo
Convention Hotel") for approximately $8.4 million. The Company's acquisition
will be subject to the completion of construction and opening of the hotel, and
certain additional conditions to be set forth in a definitive purchase
agreement. The Company anticipates that the development will commence by the
fourth quarter of 1996 and the hotel will open by the end of the third quarter
of 1997. The Company intends to brand the hotel as a Doubletree Hotel and to
lease the restaurant to a national or regional restaurant company. The project
is being coordinated by the Company and the developer with the local government,
which will develop and own the nearby Pueblo Convention Center. Because of
certain financial assistance being provided to the developer by the local
government, the cost per room to the Company for the Pueblo Convention Hotel is
anticipated to be less than the cost to develop a comparable hotel. There can be
no assurance, however, that a definitive development and purchase agreement will
be executed or that the Pueblo Convention Hotel will be constructed or that the
Company will consummate the acquisition. See "Risk Factors -- Development
Risks." The financial and statistical information set forth in this Prospectus
does not include information for the Pueblo Convention Hotel.

Line of Credit and Term Loan

In June of 1996, the Company's lender, Bank One, Arizona, N.A., increased
the availability of borrowings under the Company's revolving line of credit (the
"Line of Credit") from $30 million to $50 million. At the same time, the bank
reduced the interest rate from LIBOR plus 2.75% to LIBOR plus
8
<PAGE> 14

2.25%, with further reductions to LIBOR plus 1.90% after the Company closes the
Offering, and LIBOR plus 1.75% if the Company satisfies certain other financial
conditions. The Company will use a portion of the proceeds of the Offering to
repay borrowings outstanding under the Line of Credit. Borrowings under the Line
of Credit are subject to the provision in the Articles of Incorporation which
limits the Company's consolidated indebtedness to 50% of its investment in hotel
properties, at cost. After proceeds of this Offering are used to acquire the
Acquisition Hotels and repay borrowings under the Line of Credit, the balance
due under the Line of Credit will be approximately $15.2 million and the
Company's consolidated indebtedness will be approximately 16.3% of its
investment in hotel properties, at cost.

In addition to increasing available borrowings under the Line of Credit,
the Company recently applied to a life insurance company for a $9.0 million
10-year fixed-rate term loan (the "Term Loan"), which will be secured by two of
the Current Hotels. The Term Loan is expected to close in the fourth quarter of
1996. The Company intends to use the proceeds of the Term Loan to further repay
borrowings under the Line of Credit. There can be no assurance that the Company
will consummate the Term Loan.

For further information regarding the Company's indebtedness and use of
debt financing, see "Risk Factors -- Risks of Leverage," "Policies and
Objectives with Respect to Certain Activities -- Financing" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Pro
Forma Liquidity and Capital Resources."

Additions to Management; Strategic Consulting

The Company added two project managers with extensive construction industry
experience to supervise hotel renovation and redevelopment. The Company has also
entered into a preliminary agreement with Geller & Co., a leading hotel industry
consulting firm, to provide strategic advice in connection with future
acquisitions and alliances with hotel franchisors. Laurence Geller, the
principal of Geller & Co., has extensive experience and contacts in the hotel
industry, which the Company believes will help strengthen its strategic
relationships and provide additional growth opportunities. Under the consulting
arrangement, Geller & Co.'s fees will be paid only in shares of Common Stock and
options to acquire Common Stock. See "Business and Properties -- Growth
Strategy" and "Management -- Strategic Consultant."

The Lessee has also added a number of key management personnel to oversee
the operation of the Company's hotels. Kenneth J. Biehl, who served as Vice
President and Corporate Controller of Starwood Lodging Corporation, has joined
the Lessee as Chief Financial Officer. The Lessee has also added an asset
manager, a director of human resources and three regional general managers. The
Lessee has also adopted a stock appreciation rights plan tied to the price of
the Company's Common Stock in order to help further align the interests of the
Lessee's employees with those of the Company's stockholders, and intends to
issue 162,400 stock appreciation rights to 98 of the Lessee's employees. See
"The Lessee -- Management."

SECOND QUARTER 1996 FINANCIAL HIGHLIGHTS

Comparing actual results for the second quarter of 1996 to pro forma
results for the second quarter of 1995, funds from operations ("FFO") increased
16.7%, from $1.8 million to $2.1 million, despite the fact that six Hotels were
undergoing redevelopment or renovation during the quarter. On a per share basis,
FFO increased to $0.27 from $0.23, and Percentage Lease revenue increased 42.9%,
from $2.1 million to $3.0 million, from the second quarter of 1996 as compared
to the corresponding period in 1995. Net income increased 2.0%, from $869,000 to
$886,000, and net income per share was unchanged at $0.14, for the second
quarter of 1996 as compared to the corresponding period in 1995. Actual results
for 1996 include the results of the ten Hotels acquired by the Company in
connection with its IPO in August 1995, plus the six Hotels subsequently
acquired (other than the Holiday Inn-Renton, Washington hotel acquired on June
28, 1996 and the Residence Inn-Highlands Ranch, Colorado hotel which is under
construction). Pro forma results for 1995 include the results of the ten Hotels
acquired by the Company in connection with the IPO.

The increase in FFO was fueled by REVPAR growth. REVPAR for the eight
Current Hotels that were owned by the Company or its predecessor for the entire
second quarter of 1995 and 1996 increased 8.0%, from $38.83 to $41.92, during
such periods. With respect to the ten Current Hotels not undergoing
redevelopment

9
<PAGE> 15

or renovation (i.e., all hotels except the Doubletree-Sante Fe, New Mexico
hotel, the Hampton Inn-Oakland, California hotel, and the four Cypress Inn
hotels located in Washington and Oregon), REVPAR rose 8.5% from the second
quarter of 1996 as compared to the corresponding period in 1995, from $36.83 to
$39.96. At the beginning of the second quarter of 1996, the Company completed
its renovation of the Holiday Inn-Steamboat Springs, Colorado hotel. In
addition, redevelopment work is expected to be completed early in the third
quarter of 1996 at the four Cypress Inn hotels, which are undergoing significant
interior and exterior renovations and are being rebranded under national
franchises, including Hampton Inn, Holiday Inn Hotel & Suites and Holiday Inn
Express. REVPAR for the six Current Hotels undergoing redevelopment or
renovation (not including the Residence Inn-Highlands Ranch, Colorado hotel
which was under construction) decreased 8.1%, from $34.20 to $31.43, for the
second quarter of 1996 as compared to the corresponding period in 1995. However,
such renovations are expected to generate increased revenue at these hotels
beginning in the fourth quarter of 1996.

RISK FACTORS

AN INVESTMENT IN THE COMMON STOCK INVOLVES VARIOUS RISKS, AND INVESTORS
SHOULD CAREFULLY CONSIDER THE MATTERS DISCUSSED UNDER "RISK FACTORS."

DISTRIBUTION POLICY

For the period from August 16, 1995 (the closing date of the IPO) through
March 31, 1996, the Company paid quarterly dividends at the rate of $0.23 per
share per quarter (corresponding to $0.92 per share per year). The Company
declared a dividend on July 16, 1996 of $0.23 per share for the second quarter
of 1996 with a record date of August 1, 1996. Therefore, purchasers of Common
Stock in the Offering will not receive this dividend. The Company's
distributions with respect to 1995 included an approximate 15% return of
capital. Given the dynamic nature of the Company's acquisition strategy and the
extent to which any future acquisitions may alter this calculation, no
assurances can be given regarding what percent of future dividends will
constitute return of capital for federal income tax purposes. While future
distributions paid by the Company will be at the discretion of the Board of
Directors and will depend on the actual cash flow of the Company, its financial
condition, capital requirements, the annual distribution requirements under the
REIT provisions of the Internal Revenue Code of 1986, as amended (the "Code"),
and such other factors as the directors of the Company deem relevant, it is the
present intention of the Company to pay regular quarterly dividends of at least
the current dividend rate for the immediate future. See "Prospectus
Summary -- Tax Status," "Partnership Agreement -- Distributions" and "Price
Range of Common Stock and Distributions." In the future the Company may
implement a dividend reinvestment program under which holders of Common Stock
may elect automatically to reinvest dividends and make additional investments in
shares of Common Stock. If a dividend reinvestment and stock purchase program is
implemented, the Company may, from time to time, repurchase Common Stock in the
open market for purposes of fulfilling its obligations under this program, or
may elect to issue additional shares of Common Stock.

REIT STRUCTURE

In order for the Company to qualify as a REIT under federal income tax law,
neither the Company nor the Partnership can operate hotels. The Partnership
leases the Current Hotels and will lease the Acquisition Hotels and intends to
lease any other hotels acquired in the future to the Lessee pursuant to
Percentage Leases between the Partnership and the Lessee, each with an initial
term of ten years. The Lessee will pay the franchise fees, management fees and
certain other operating expenses of the Hotels. The Lessee is owned by Robert A.
Alter, Chairman and President of the Company, and Charles L. Biederman, director
and Executive Vice President of the Company. The Current Hotels are, and the
Acquisition Hotels will be, managed by Sunstone Hotel Management, Inc. (the
"Management Company") pursuant to a management agreement between the Lessee and
the Management Company (the "Management Agreement") for a fee equal to 2% of
gross revenues of the Hotels. The Management Company is owned by Mr. Alter.

In order to minimize conflicts of interest inherent in the legal structure
required to maintain the Company's status as a REIT, Mr. Alter and Mr. Biederman
have entered into a pledge agreement (the "Third

10
<PAGE> 16

Party Pledge Agreement") that requires each of them to pledge ownership units in
the Partnership ("Units") to the Company to secure the Lessee's obligations
under the Percentage Lease applicable to each hotel now leased or acquired in
the future and leased to the Lessee in an amount equal to four months' initial
base rent for the Company's hotels. Mr. Alter and Mr. Biederman have also
entered into a unit purchase agreement with the Company and the Lessee (the
"Unit Purchase Agreement"), that requires that the Lessee's income (net of
shareholder tax liability) be used to either accumulate reserves to pay rent
under the Percentage Leases or to purchase Units from the Partnership at the
then current price of the Common Stock. The Percentage Leases also contain
cross-default provisions permitting the Company to terminate one or more of the
Percentage Leases at its election, subject to certain conditions, upon a default
by Mr. Alter or Mr. Biederman under the Unit Purchase Agreement or any other
agreement with the Company. Further, the Management Company has agreed not to
collect any payments from the Lessee after receiving notice of an event of
default under a Percentage Lease. Mr. Alter has personally guaranteed the
Lessee's obligation to return any amounts received by the Management Company in
violation of this agreement.

TAX STATUS

The Company will elect to be taxed as a REIT under Sections 856-860 of the
Code, commencing with its taxable year ended December 31, 1995. If the Company
qualifies for taxation as a REIT, then under current federal income tax laws the
Company generally will not be taxed at the corporate level to the extent it
currently distributes at least 95% of its net taxable income to its
stockholders. Even if the Company qualifies for taxation as a REIT, the Company
may be subject to certain federal, state and local taxes on its income and
property and to federal income and excise tax on its undistributed income.
Failure to qualify as a REIT will render the Company subject to federal income
tax (including any applicable minimum tax) on its taxable income at regular
corporate rates and distributions to the holders of Common Shares in any such
year will not be deductible by the Company. Although the Company does not intend
to request a ruling from the Internal Revenue Service (the "Service") as to its
REIT status, the Company has obtained the opinion of its legal counsel, Brobeck,
Phleger & Harrison LLP, that the Company qualifies as a REIT, which opinion is
based on certain assumptions and representations and is not binding on the
Service or any court. In connection with the Company's election to be taxed as a
REIT, the Company's Certificate of Incorporation imposes restrictions on the
transfer of shares of Common Stock. The Company has adopted the calendar year as
its taxable year. See "Risk Factors -- Tax Risks" and "-- Ownership Limitation,"
"Federal Income Tax Considerations -- Taxation of the Company" and "Description
of Capital Stock -- Certificate of Incorporation and Bylaw
Provisions -- Restrictions on Transfer."

THE OFFERING

<TABLE>
<S> <C>
Shares of Common Stock offered by the Company...... 4,000,000 shares
Shares of Common Stock and Units to be outstanding
after the Offering............................... 11,782,300 shares and Units(1)
Use of Proceeds.................................... To fund the purchase of the Acquisition
Hotels and to repay borrowings
outstanding under the Line of Credit.
NYSE symbol(2)..................................... SSI
</TABLE>

- ---------------
(1) Includes 1,458,800 shares issuable at the option of the Company upon
redemption of the Units by Limited Partners and 9,000 shares of restricted
Common Stock owned by certain officers and directors of the Company.
Excludes shares of Common Stock issuable upon exercise of options issued or
to be issued pursuant to the Company's 1994 Plan and the Directors Plan and
upon redemption of Units which are issuable upon exercise of outstanding
warrants issued to Messrs. Alter, Biederman and Enever and MYPC Partners
("MYPC"), an affiliate of Montgomery Securities, one of the Representatives.
See "Management -- Compensation of Directors," "Management -- 1994 Stock
Incentive Plan," "Management -- The Directors Plan" and "Underwriting."

(2) The Company's Common Stock has been listed on the NYSE since July 23, 1996.
Prior to that date, the stock was listed for quotation on the Nasdaq
National Market under the symbol "SSHI."

11
<PAGE> 17

SUMMARY FINANCIAL DATA

The following tables set forth summary historical and pro forma operating
and financial data for the Company and the Lessee. Such data should be read in
conjunction with the financial statements and notes thereto contained elsewhere
in this Prospectus. The pro forma operating and other data for the Company and
the Lessee is presented as if the acquisition of the Acquisition Hotels, and the
closing of the IPO and the Offering had occurred as of the beginning of the
periods presented and therefore incorporates certain assumptions that are
included in the Notes to the Unaudited Pro Forma Consolidated Statements of
Income included elsewhere in this Prospectus. The pro forma balance sheet data
is presented as if the acquisition of the Acquisition Hotels, the closing of the
Offering and the application of the proceeds of the Offering had occurred on
March 31, 1996.

SUNSTONE HOTEL INVESTORS, INC.

SUMMARY HISTORICAL AND PRO FORMA OPERATING AND FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
PRO FORMA(1)
HISTORICAL ---------------------------------------------------------------------------
------------------------

PERIOD FROM
AUGUST 16,
1995 THREE YEAR ENDED THREE MONTHS ENDED
(INCEPTION) MONTHS DECEMBER 31, 1995 MARCH 31, 1995
THROUGH ENDED ------------------------------- -------------------------------
DECEMBER 31, MARCH 31, CURRENT ACQUISITION THE CURRENT ACQUISITION THE
1995 1996 HOTELS HOTELS HOTELS HOTELS HOTELS HOTELS
------------ --------- ------- ----------- ------- ------- ----------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Percentage Lease
revenue(2)................ $ 3,013 $ 3,190 $11,766 $ 3,254 $15,020 $ 3,288 $ 580 $ 3,868
Net income.................. 1,181 1,337 4,673 684 5,357 1,592 (41) 1,551
Net income per Common Share
outstanding............... $ 0.19 $ 0.21 $ 0.52 $ 0.15
Weighted average number of
shares of Common Stock and
Common Stock equivalents
outstanding............... 6,322 6,322 10,322 10,322
OTHER DATA:
Lessee room revenue......... $ 7,060 $ 6,786 $27,914 $ 7,673 $35,587 $ 7,248 $ 1,468 $ 8,716
Funds From Operations(3).... 2,592 2,479 8,627 2,822 11,449 2,584 465 3,049
Cash Available for
Distribution(4)........... 2,296 2,193 7,455 2,515 9,970 2,281 406 2,687
Cash provided by operating
activities................ 2,291 1,348
Cash used in investing
activities................ (32,899) (17,999 )
Cash provided by (used in)
financing activities...... 35,824 11,836
Occupancy................... 60.1% 63.7 % 67.4% 65.3%
ADR......................... $ 58.27 $ 63.51 $ 57.08 $ 58.50
REVPAR...................... $ 35.02 $ 40.46 $ 38.47 $ 38.22

<TABLE>
<CAPTION>
AT MARCH 31, 1996
-----------------------------
PRO FORMA
ACTUAL AS ADJUSTED(1)(5)
------- -----------------
<S> <C> <C>
BALANCE SHEET DATA:
Investment in Hotels at cost...................................................................... $67,076 $ 98,076
Total assets...................................................................................... 71,044 104,894
Total long-term debt.............................................................................. 22,000 18,175
Minority interest in Partnership.................................................................. 8,722 10,585
Total shareholders' equity........................................................................ 38,632 74,444
</TABLE>

Notes located on subsequent page.

12
<PAGE> 18

- ---------------

(1) The pro forma information does not purport to represent what the Company's
or the Lessee's financial position or results of operations actually would
have been if the Company had, in fact, owned and leased to the Lessee the
Current Hotels and the Acquisition Hotels at the beginning of the periods
indicated, or to project the Company's or the Lessee's results of operations
for any future period.

(2) With respect to the pro forma information, Rent from the Lessee to the
Company is calculated on a pro forma basis by applying the Rent provisions
of the Percentage Leases to the historical room and other revenue of the
Hotels as if the beginning of the periods were the beginning of the lease
year and assumes the Company owned and leased the Current Hotels and the
Acquisition Hotels throughout the periods presented.

(3) With respect to the presentation of Funds From Operations, management
elected early adoption of the "new definition" as recommended in the March
1995 NAREIT White Paper on Funds From Operations beginning January 1, 1995.
Management and industry analysts generally consider Funds From Operations to
be one measure of the financial performance of an equity REIT that provides
a relevant basis for comparison among REITs and it is presented to assist
investors in analyzing the performance of the Company. "Funds From
Operations" ("FFO") is defined as income before minority interest (computed
in accordance with generally accepted accounting principles), excluding
gains (losses) from debt restructuring and sales of property and real estate
related depreciation and amortization (excluding amortization of financing
costs). FFO does not represent cash generated from operating activities in
accordance with generally accepted accounting principles and is not
necessarily indicative of cash available to fund cash needs. FFO should not
be considered an alternative to net income as an indication of the Company's
financial performance or as an alternative to cash flows from operating
activities as a measure of liquidity.

(4) Cash Available for Distribution is computed by subtracting from FFO the sum
of (a) 4% of room revenues, which the Company is obligated by the Percentage
Leases to make available to the Lessee for the periodic refurbishment and
replacement of furniture, fixture and equipment at the Hotels, and (b)
amounts required to repay principal amortization on long-term debt.

(5) Pro forma balance sheet data reflects the sale of 4,000,000 shares of Common
Stock and the application of the net proceeds as set forth in "Use of
Proceeds."

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<PAGE> 19

RISK FACTORS

In evaluating the Company's business, prospective investors should
carefully consider the following factors in addition to the other information
contained in this Prospectus.

THE COMPANY'S INABILITY TO EFFECTIVELY MANAGE GROWTH

The Company's success is in large part dependent upon the ability of the
Lessee to effectively operate all of the Hotels, as well as any additional
hotels in which the Company invests. The Lessee's capacity to operate additional
hotels under Percentage Leases with current staffing levels and office locations
will diminish as additional hotels are added to the Company's portfolio,
particularly in the context of hotel portfolio acquisitions. Such growth will
require the Lessee to hire and manage more staff, or to open more offices or to
operate in different locations than it has had in the past. There can be no
assurance the Lessee will effectively operate the Hotels. In the event the
Lessee fails to effectively operate the Hotels, the Company's internal growth
strategy and acquisition strategy would be more difficult to achieve and,
therefore, Cash Available for Distribution could be adversely affected.

CONFLICTS OF INTEREST BETWEEN THE COMPANY AND CERTAIN OFFICERS AND DIRECTORS

Because of Mr. Alter's and Mr. Biederman's ownership in and positions with
the Company and the Lessee and Mr. Alter's ownership of the Management Company,
there are inherent conflicts of interest between the Lessee and the Company in
the leasing, acquisition, disposition, operation and management of the Company's
hotels. Accordingly, the interests of stockholders may not have been, and in the
future may not be, reflected fully in all decisions made or actions taken by the
officers and directors of the Company. See "The Company" and "Policies and
Objectives with Respect to Certain Activities -- Conflict of Interest Policies."

No Arm's-Length Bargaining on Percentage Leases, Management Agreement,
Employment Agreements, or Acquisition Agreements

The terms of the Percentage Leases, the Management Agreement, the Alter
Employment Agreement, the Biederman Employment Agreement, and the acquisition
agreements pursuant to which the Company acquired the Sunstone Initial Hotels in
connection with the IPO were not negotiated on an arm's-length basis. In the
event revenues from the Company's hotels increase significantly over prior
periods and operating expenses with respect thereto are less than historical or
projected operating expenses, the Lessee could disproportionately benefit. In
the event incremental expenses exceed incremental increases in revenues,
conflicts of interest may arise between the Lessee and the Company. See "Certain
Transactions -- Percentage Leases" and "Policies and Objectives with Respect to
Certain Activities -- Conflict of Interest Policies -- Provisions of the
Employment Agreements and Development by Mr. Alter and Mr. Biederman." The
Company will not own any interest in the Lessee. Because Mr. Alter and Mr.
Biederman are the stockholders of the Lessee and Mr. Alter is the sole
stockholder of the Management Company, and each of them are officers of the
Company, there is a conflict of interest with respect to the enforcement and
termination of the Percentage Leases. Because of these conflicts, Mr. Alter's
and Mr. Biederman's decisions relating to the Company's enforcement of its
rights under the Percentage Leases may not solely reflect the interests of the
stockholders. See "The Lessee" and "The Management Company."

Conflicts Relating to Sunstone Initial Hotels

In connection with the IPO, the Company acquired the Sunstone Initial
Hotels from the affiliates of Messrs. Alter, Biederman and Enever (the "Sunstone
Affiliates"). The Sunstone Initial Hotels had a negative book value of $7.5
million. This resulted in Mr. Alter having approximately $3.5 million and Mr.
Biederman approximately $3.7 million in unrealized gain on the sale of their
interests in the Sunstone Initial Hotels, which was carried over into the
Partnership's basis in such hotels and reflected in their tax basis in the
Partnership. Such unrealized gain is specially allocated to Mr. Alter and Mr.
Biederman pursuant to the Partnership Agreement and, consequently, any sale of
such Sunstone Initial Hotels by the Partnership may

14
<PAGE> 20

cause adverse tax consequences to them and the Sunstone Affiliates. Therefore,
the interests of the Company, Mr. Alter and Mr. Biederman and the Sunstone
Affiliates could be different in connection with the sale of a Sunstone Initial
Hotel. In addition, the reduction of mortgage indebtedness by the Partnership at
any time below the amount of approximately $8.4 million would create adverse tax
consequences to Mr. Alter and Mr. Biederman and certain Sunstone Affiliates.
These conflicts may result in decisions relating to the sale of the Sunstone
Initial Hotels and/or the incurrence or repayment of indebtedness which do not
reflect solely the interests of the stockholders.

Conflicts Relating to Sale of Hotels Subject to Percentage Leases

The Company will generally be required under the Percentage Leases to pay a
lease termination fee to the Lessee if the Company elects to sell a hotel and
not replace it with another hotel. Where applicable, the termination fee is
equal to the net income of the Lessee for such hotel for the prior twelve month
period. The payment of a termination fee to the Lessee, which is owned by Mr.
Alter and Mr. Biederman, may result in decisions regarding the sale of a hotel
which do not reflect solely the interests of the Company. See "Certain
Transactions -- Percentage Leases."

Conflicts of Interest Relating to Acquisition Strategy

Because of Mr. Alter's ownership interest in the Lessee and the Management
Company, there may be a conflict of interest in the decisions to acquire
additional hotels which disproportionately benefit the operations of the Lessee
and the Management Company at the expense of the Company.

LACK OF CONTROL OVER OPERATIONS OF THE HOTELS

Certain tax rules relating to the qualification of a REIT prohibit the
Company from operating hotels. Therefore, the Company enters into Percentage
Leases with the Lessee, and the Lessee operates the hotels and pays Rent to the
Company based, in large part, on the revenues from the hotels. The Lessee
controls the daily operations of the hotels under the Percentage Leases, which
have non-cancelable initial terms of ten years. Although Mr. Alter and Mr.
Biederman are the sole stockholders of the Lessee, neither the Company nor the
Partnership has the authority to require the Lessee to operate the hotels in a
particular manner, or to govern any particular aspect of their operation (e.g.,
setting room rates), except as set forth in the Percentage Leases. Thus, even if
the Company's management believes the Lessee is operating the hotels
inefficiently or in a manner that does not result in a maximization of Rent to
the Company under the Percentage Leases and, therefore, negatively affects Cash
Available for Distribution, the Company may not require the Lessee to change its
method of operation. The Company is limited to seeking redress only if the
Lessee violates the terms of the Percentage Leases, in which case the Company's
primary remedy is to terminate one or more of the Percentage Leases and seek to
recover damages from the Lessee pursuant to the applicable Percentage Lease or
to enforce its remedies under the Third Party Pledge Agreement. See "Business
and Properties -- The Percentage Leases," and "Certain Transactions -- Third
Party Pledge Agreement."

RENOVATION AND REDEVELOPMENT RISKS

The Company faces risks arising from its strategy of acquiring hotels in
need of substantial renovation or redevelopment, particularly the risk that the
cost or time to complete the renovation or redevelopment will exceed the
budgeted amount. Such delays or cost overruns may arise from shortages of
materials or skilled labor, a change in the scope of the original project, the
need to comply with building code or other legal requirements, the discovery of
structural or other latent problems with a property once construction has
commenced and other risks inherent in the construction process. Delays or cost
overruns in connection with renovations or redevelopments could have a material
adverse effect on Cash Available for Distribution.

RISK THAT PENDING ACQUISITIONS WILL NOT CLOSE

The Company intends to acquire the Comfort Inn-South San Francisco,
California, and the Price, Utah, Acquisition Hotels concurrently with the
closing of the Offering. The Company has not, however, finalized its

15
<PAGE> 21

physical, environmental and economic analysis of these properties and,
therefore, could decide not to acquire such properties based on such analysis.
If the Company does not complete the acquisition of these two Acquisition
Hotels, for whatever reason, then following the closing of the Offering
approximately $16.0 million of the net proceeds of the Offering will have no
specific designated use. In such event, there can be no assurance that the
Company would be able to locate additional available acquisitions which meet the
Company's investment criteria and the Company's Cash Available for Distribution
would be adversely affected.

MULTI-PROPERTY ACQUISITION RISKS

Since the IPO, the Company has increasingly emphasized and intends to
continue to emphasize acquisitions of multiple hotels in a single transaction in
order to reduce acquisition expenses per hotel and enable the Company to more
rapidly expand its hotel portfolio. Multiple-property acquisitions are, however,
more complex than single-property acquisitions and the risk that a
multiple-property acquisition will not close may be greater than in a
single-hotel acquisition. In addition, the Company's costs for a portfolio
acquisition that does not close are generally greater than for an individual
property. If the Company fails to close hotel acquisitions, its ability to
increase Cash Available for Distribution will be limited. See "Risk Factors --
Dependence on Acquisitions to Increase Cash Available for Distribution." Another
risk associated with multiple-property acquisitions is that a seller may require
that a group of hotels be purchased as a package, even though one or more of the
hotels in the package does not meet the Company's investment criteria. In such
cases, the Company may purchase the group of hotels with the intent to re-sell
those which do not meet its criteria. This occurred in the first quarter of 1996
with the acquisition of the six Cypress Inn Hotels in Oregon and Washington, two
of which were re-sold by the Company within three months of the acquisition. In
such circumstances, however, there is no assurance as to how quickly the Company
could sell such hotels or the price at which they could be sold. Such hotels
might reduce Cash Available for Distribution if they operate at a loss during
the time the Company holds them for sale or if the Company sells them at a loss.
In addition, any gains on the sale of such hotels within four years of the date
of acquisition would be subject to a 100% tax.

HAWTHORN SUITES DEVELOPMENT RISKS

The Company intends to enter into a five-year master development agreement
with USFS to permit the Company to own properties operated under the Hawthorn
Suites brand. Pursuant to the letter of intent, executed in June 1996, the
Company will have the right to obtain franchise licenses in several major urban
markets on the West Coast. Under the proposed arrangement, certain development
rights will expire if the Company does not exercise them during each year of the
five-year term. This timetable may cause the Company to overcommit to building
and owning Hawthorn Suites at the expense of other growth opportunities. USFS
has received the required governmental approvals in Oregon and Washington to
issue a franchise license for the Hawthorn Suite brand, but has not yet received
such approval in California. While USFS anticipates obtaining such approval in
California in the near future, there can be no assurance that USFS will obtain
it in a timely fashion or at all. Further, as a relatively unproven franchisor
the Company's focus on this brand subjects it to greater risks than a more
diversified approach.

COMPETITION FOR ACQUISITIONS

There will be competition for investment opportunities in mid-price and
upscale hotels from entities organized for purposes substantially similar to the
Company's objectives as well as other purchasers of hotels. The Company is
competing for such hotel investment opportunities with entities which have
substantially greater financial resources than the Company or better
relationships with franchisors, sellers or lenders. These entities may also
generally be able to accept more risk than the Company prudently can manage.
Competition may generally reduce the number of suitable hotel investment
opportunities offered to the Company and increase the bargaining power of
property owners seeking to sell. See "Business and Properties -- Competition."

16
<PAGE> 22

DEVELOPMENT RISKS

The Company is currently developing a 78-room Residence Inn in Highlands
Ranch (Denver), Colorado, which it estimates will be completed during the third
quarter of 1996, and has entered into a letter of intent to purchase a 166-room
hotel in Pueblo, Colorado, upon completion of construction by an unaffiliated
developer, which is expected to commence in the fourth quarter of 1996 and be
completed in the third quarter of 1997. In addition, under the proposed master
development agreement with USFS, the Company may develop extended-stay Hawthorn
Suites hotels in a number of major urban markets on the West Coast markets, or
may purchase extended-stay Hawthorn Suites hotels from unaffiliated developers
after they have been completed. The Company also intends to look for additional
opportunities to develop upscale and mid-price hotels in markets where room
supply and other competitive factors justify new construction. See "Business and
Properties -- Growth Strategy -- External Growth Strategy." New project
development is subject to a number of risks, including risks of construction
delays or cost overruns that may increase project costs, and new project
commencement risks such as receipt of zoning, occupancy and other required
governmental permits and authorizations and the incurrence of development costs
in connection with projects that are not completed. There can be no assurances
that the Highlands Ranch or Pueblo projects, any Hawthorn Suites projects or any
other future development projects will be completed in a timely manner or within
budget. Additional risks of development projects include the risks associated
with effectively marketing a hotel in order to ramp-up occupancy after the hotel
has been opened at projected room rates. Any failure to complete a development
project in a timely manner and within budget or to ramp-up occupancy after
completion of the project could have a material adverse effect on Cash Available
for Distribution.

SUBSTANTIAL RELIANCE ON MR. ALTER

The Company places substantial reliance on the hotel industry knowledge and
experience and the continued services of Robert A. Alter, the Company's Chairman
of the Board of Directors, President, Chief Financial Officer and Secretary. The
Company's future success and its ability to manage future growth depends in
large part upon the efforts of Mr. Alter and on the Company's ability to attract
and retain other highly qualified personnel. Competition for such personnel is
intense and there can be no assurance that the Company will be successful in
attracting and retaining such personnel. The loss of Mr. Alter's services or the
Company's inability to attract and retain highly qualified personnel may
adversely affect the operations of the Company and the Cash Available for
Distribution. See "Management -- Alter Employment Agreement."

TOTAL DEPENDENCE ON THE LESSEE AND PAYMENTS UNDER THE PERCENTAGE LEASES

The Company selected the Lessee without consideration of other lessees
because it believes that Mr. Alter and Mr. Biederman, who own the Lessee, will
be better able to direct the continuation of the management practices developed
by the Sunstone Affiliates who owned a number of the Current Hotels prior to the
IPO than would other lessees unfamiliar with these practices. The Lessee was
also selected because Mr. Alter and Mr. Biederman own significant Units in the
Partnership and options to acquire Common Stock of the Company, and therefore
have an incentive to cause the Lessee to maximize Rents that other lessees would
not have. The Company's primary source of revenue is Rent payments under the
Percentage Leases. Consequently, the Company relies entirely on the Lessee to
effectively operate the Company's hotels in a manner which generates sufficient
cash flow to enable the Lessee to timely make the Rent payments under the
applicable Percentage Leases. Ineffective operation of the hotels may result in
the Lessee being unable to pay Rent at the higher tier level necessary for the
Company to fund distributions to stockholders because payment of Base Rent alone
is insufficient for such purposes. In addition, the Lessee may determine that
maximizing revenue at the hotels is not in the best economic interest of the
Lessee and therefore the Lessee may not pursue operating strategies that would
solely be in the best interest of the Company. Finally, if the Lessee is unable
to generate an operating profit at the hotels, there is a greater risk that the
Lessee will default on its obligations under the Percentage Leases. In that
event, distributions to stockholders would be adversely affected. On a pro forma
basis for the year ended December 31, 1995, the Lessee incurred a net loss of
$373,000.

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<PAGE> 23

Limited Guarantees and Security for the Performance of the Lessee's Obligations
under the Percentage Leases

Pursuant to the Third Party Pledge Agreement, the obligations of the Lessee
under the Percentage Lease for each hotel now owned or acquired in the future by
the Company and leased to the Lessee are secured with a pledge by Mr. Alter and
Mr. Biederman, the stockholders of the Lessee, of Units in the Partnership equal
in value to four months of initial Base Rent for each hotel. The obligations of
the Lessee under the Percentage Leases are not secured by any additional
security deposits or guarantees by third parties. Other than working capital to
operate the hotels, the Lessee will have only nominal assets in addition to its
rights and benefits under the Percentage Leases. As a result, the Lessee will
likely have insufficient assets to satisfy any claims the Company may have
against the Lessee if the Lessee defaults under the Percentage Leases.
Consequently, a material default under a Percentage Lease would have a material
adverse effect on Cash Available for Distribution. See "The Lessee," and
"Certain Transactions -- Third Party Pledge Agreement."

Insufficiency of Base Rent to Make Current Distributions

The receipt by the Company of Base Rent payments under the Percentage
Leases will not, by itself, provide the cash flow necessary to enable the
Company to continue to make such distributions at the current level. The Company
is therefore dependent on the receipt of Percentage Rent from the Lessee in
order to fund the proposed distributions at the current level. In the event that
all or a portion of such Percentage Rent is not received by the Company, the
Company may not be able to make such distributions to its stockholders. There
can be no assurance that the Company will receive Percentage Rent from the
Lessee or that the Lessee will be able to pay Base Rent as required by the
Percentage Leases.

DISTRIBUTION OF SUBSTANTIALLY ALL OF CASH AVAILABLE FOR DISTRIBUTION;
DISTRIBUTIONS INCLUDE RETURN OF CAPITAL

Consistent with the Company's practice of acquiring properties in need of
renovation or redevelopment, the Company's estimated annual distribution to
stockholders is approximately 109% of the Company's estimated pro forma Cash
Available for Distribution for the year ended December 31, 1995. See "Price
Range of Common Stock and Dividends." If the Company has distributed all or
substantially all of its Cash Available for Distribution, it will have retained
little or no cash from the Rent payments under the Percentage Leases. In that
event, expenditures for additional acquisitions or future capital improvements
would have to be funded from borrowings under the Line of Credit or other
lending facilities not yet obtained, or from proceeds from the sale of assets
(including the hotels) or equity securities. In addition, the Company estimates
that approximately 15% of the estimated annual distribution will constitute a
return of capital rather than a distribution of retained earnings. Consequently,
there is a risk that the initial distribution rate has been set too high and may
not be sustainable.

HOTEL INDUSTRY RISKS

Operating Risks

The Company's hotels are subject to all operating risks common to the hotel
industry. The hotel industry has experienced volatility in the past, as have the
Company's hotels (other than the Highlands Ranch (Denver) Residence Inn hotel,
which has not been completed). There can be no assurance that volatility will
not occur in the future. Hotel industry risks include, among other things,
competition from other hotels; over-building in the hotel industry which has
adversely affected occupancy, ADR and REVPAR; increases in operating costs due
to inflation and other factors, which may not necessarily be offset by increased
room rates; dependence on business and commercial travelers and tourism; strikes
and other labor disturbances of hotel employees for hotels owned by the Company;
increases in energy costs and other expenses of travel; and adverse effects of
general and local economic conditions. These factors could decrease room
revenues of the hotels and adversely affect the Lessee's ability to make
payments of Rent under the Percentage Leases to the Company, including payments
at the higher tier Percentage Rent levels, and therefore, reduce Cash Available
for Distribution.

18
<PAGE> 24

Seasonality of Hotel Business and the Hotels

The hotel industry is seasonal in nature. Generally, revenues for the
Company's hotels are greater in the first and third quarters than in the second
and fourth quarters. This seasonality can be expected to cause quarterly
fluctuations in the Company's Percentage Lease revenues, which, therefore, may
be insufficient to provide all of the Cash Available for Distribution necessary
to pay dividends on the Common Stock in a given quarter.

Concentration of Investments in California and Colorado

Eleven of the 20 Hotels are located in California and Colorado. See
"Business and Properties." The concentration of the Company's investments in
California and Colorado could result in adverse events or conditions which
affect those areas in particular, natural disasters and economic recessions,
having a more significant negative effect on the operations of the combined
Hotels, and ultimately Cash Available for Distribution, than if the Hotels were
more geographically diverse.

Limited Diversification of Hotels; Emphasis on Holiday Inn and Hampton Inn
Hotels

The Company intends to operate eight of the Hotels under Holiday Inn brands
and seven under the Hampton Inn brand. In its growth strategy, the Company
intends to continue to emphasize the acquisition or development of hotels which
can be operated under franchises similar to those of the Hotels. Therefore, the
Company will be subject to risks inherent in concentrating investments in any
franchise brand, in particular the Holiday Inn and Hampton Inn brands, such as a
reduction in business following any adverse publicity related to the brand,
which could have an adverse effect on Rent under the Percentage Leases and Cash
Available for Distribution.

Competition for Guests

The hotel industry is highly competitive. The Company's hotels will compete
with other existing and new hotels in their geographic markets. Many of the
Company's competitors have substantially greater marketing and financial
resources than the Company and the Lessee, which may negatively impact the
Company's growth strategy and consequently the Cash Available for Distribution.
See "Business and Properties -- Competition."

Investment Concentration in Single Industry

The Company's current strategy is to acquire additional hotels. The Company
will not seek to invest in assets selected to reduce the risks associated with
an investment in the hotel industry and will be subject to risks inherent in
concentrating investments in a single industry. Therefore, the adverse effect on
the Rents under the Percentage Leases and Cash Available for Distribution
resulting from a downturn in the hotel industry will be more pronounced than if
the Company had diversified its investments outside of the hotel industry. See
"Business and Properties -- The Lodging Industry."

REAL ESTATE INVESTMENT RISKS

General Risks of Investing in Real Estate

The Company's hotels will be subject to varying degrees of risk generally
incident to the ownership of real property. The underlying value of the hotels
and the Company's income and ability to make distributions to its stockholders
are dependent upon the ability of the Lessee to operate the Company's hotels in
a manner sufficient to maintain or increase room revenues and to generate
sufficient revenue in excess of operating expenses to make Rent payments to the
Company as required by the Percentage Leases. Income from the hotels may be
adversely affected by changes in national economic conditions, changes in local
market conditions due to changes in general or local economic conditions and
neighborhood characteristics, competition from other hotels, changes in interest
rates and in the availability, cost and terms of mortgage funds, the impact of
present or future environmental legislation and compliance with environmental
laws, the

19
<PAGE> 25

ongoing need for capital improvements, particularly in older structures, changes
in real estate tax rates and other operating expenses, changes in governmental
rules and fiscal policies, civil unrest, acts of God, including earthquakes,
hurricanes and other natural disasters (which may result in uninsured losses),
acts of war, changes in zoning laws, and other factors which are beyond the
control of the Company.

Illiquidity of Real Estate

Real estate investments are relatively illiquid. The ability of the Company
to vary its portfolio in response to changes in economic and other conditions
will be limited. No assurance can be given that the market value of any of the
Company's hotels will not decrease in the future. In addition, there can be no
assurance that the Company will be able to dispose of a hotel when it finds
disposition advantageous or necessary or that the sale price of any hotel will
recoup or exceed the amount of the Company's investment.

Uninsured and Underinsured Losses

There are certain types of losses, generally of a catastrophic nature, such
as earthquakes, floods and hurricanes, that may be uninsurable or not
economically insurable. The Board of Directors will use its discretion in
determining amounts, coverage limits and deductibility provisions of insurance,
including title insurance with respect to the Company's hotels, with a view to
maintaining appropriate insurance coverage on the Company's investments at a
reasonable cost and on suitable terms. This may result in insurance coverage
that, in the event of a substantial loss, would not be sufficient to pay the
full current market value or current replacement cost of the Company's lost
investment. Inflation, changes in building codes and ordinances, environmental
considerations, and other factors also might make it infeasible to use insurance
proceeds to replace a damaged or destroyed hotel.

Environmental Matters

Operating costs at the Company's hotels may be affected by the obligation
to pay for the cost of complying with existing environmental laws, ordinances
and regulations, as well as the cost of compliance with future legislation.
Under various federal, state and local environmental laws, ordinances and
regulations, a current or previous owner or operator of real property may be
liable for the costs of removal or remediation of petroleum and hazardous
substances on, under or in such property. Such laws may impose liability without
fault or knowledge by the owner or operator. The cost of complying with
environmental laws could materially adversely affect Cash Available for
Distribution. See "Business and Properties -- Environmental Matters."

Compliance with Americans with Disabilities Act and other Changes in
Governmental Rules and Regulations

Under the Americans with Disabilities Act of 1990 (the "ADA"), all public
accommodations are required to meet certain federal requirements related to
access and use by disabled persons. A determination that the Company is not in
compliance with the ADA could result in imposition of fines or an award of
damages to private litigants. In addition, changes in governmental rules and
regulations or enforcement policies affecting the use and operation of the
Company's hotels, including changes to building codes and fire and life-safety
codes, may occur. If the Company were required to make substantial modifications
at the hotels to comply with the ADA or other changes in governmental rules and
regulations, the Company's Cash Available for Distribution could be adversely
affected.

Fluctuations in Property Taxes and Casualty Insurance Premiums

Each of the Company's hotels is subject to real property taxes. The real
property taxes on hotels in which the Company invests may increase or decrease
as property tax rates change and as properties are assessed or reassessed by
taxing authorities. Each of the Company's hotels will be covered by casualty
insurance. Like real property tax rates, insurance rates may increase or
decrease depending on the claims experience at the hotels and as the replacement
value of the hotels increases or decreases. The Company is obligated under the
Percentage Leases to pay for real property taxes and insurance.

20
<PAGE> 26

RISKS OF INCREASES IN OPERATING COSTS AND CAPITAL EXPENDITURES

Hotels in general, including the Company's hotels, have an ongoing need for
renovations and other capital improvements, particularly in older structures,
including periodic replacement of furniture, fixtures and equipment. Under the
terms of the Percentage Leases, the Company is obligated to pay the cost of
certain capital expenditures at its hotels and to pay for furniture, fixtures
and equipment. The ability of the Company to fund these and other capital
expenditures and periodic replacement of furniture, fixtures and equipment will
depend in part on the financial performance of the Lessee and the hotels. If
these expenses exceed the Company's estimate, the additional expenses could have
an adverse effect on Cash Available for Distribution. Any inability or failure
to fund these expenditures could have a material adverse effect on occupancy
rates, ADRs and REVPAR and may constitute a breach under the Franchise
Agreements for the applicable hotels.

DEPENDENCE ON ACQUISITIONS TO INCREASE CASH AVAILABLE FOR DISTRIBUTION

The Company's success in implementing its growth plan will depend
significantly on the Company's ability to acquire additional hotels at
attractive prices. After the ramp up of certain of the Hotels which were
recently redeveloped or renovated and repositioned or which are expected to be
redeveloped or renovated and repositioned in the near future, internal growth in
ADR and occupancy for the Hotels is not expected to provide as much growth in
Cash Available for Distribution as will acquisition of additional hotels.
However, since the Company intends to borrow funds to purchase, redevelop or
renovate and reposition hotels, the Company will be subject to the risks
associated with increased indebtedness, such as paying debt service even if cash
flow from such additional hotels is not sufficient to pay it or cost overruns in
redeveloping or renovating such additional hotels. See "Risk Factors -- Risks of
Leverage" and "-- Renovation and Redevelopment Risks."

RISKS OF LEVERAGE

Under the Company's Articles of Incorporation, the Board of Directors has
the discretion to permit the Company to incur debt in an amount not to exceed
50% of its investment in hotel properties, at cost (the "Debt Limitation"). The
Line of Credit provides for borrowings of up to $50 million to implement the
Company's growth strategy and for other corporate purposes. The Line of Credit
is secured by mortgages on certain of the Hotels and may be secured by
additional hotels acquired by the Company in the future. Subject to the Debt
Limitation, the Company may borrow additional amounts from the same or other
lenders in the future, or may issue corporate debt securities in public or
private offerings. Certain of such additional borrowings may be secured by
hotels owned by the Company. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Pro Forma Liquidity and Capital
Resources" and "Policies and Objectives with Respect to Certain
Activities -- Financing."

To the extent the Company incurs debt, the debt service requirements may
reduce Cash Available for Distribution. Variable rate debt, such as the Line of
Credit, will result in higher debt service requirements, if interest rates
increase, which may decrease Cash Available for Distribution. There can be no
assurance that the Company, upon the incurrence of debt, will be able to meet
its debt service obligations and, to the extent that it cannot, the Company
risks the loss of some or all of its assets, including its hotels, to
foreclosure, which could result in a financial loss to the Company. Adverse
economic conditions could result in higher interest rates on variable rate debt,
including borrowings under the Line of Credit, could decrease Cash Available for
Distribution and increase the risk of loss upon a sale or from a foreclosure.

RISKS OF OPERATING HOTELS UNDER FRANCHISE AGREEMENTS

The Franchise Agreements or commitments to enter into Franchise Agreements
for eight of the Hotels condition the issuance of the license upon the
completion of certain redevelopment or renovation work in accordance with the
franchisor's standards. If the Company fails to satisfy such conditions, the
franchisor would not be required to issue the license. Such an occurrence could
have a material adverse effect on the results of operation of the affected Hotel
and thus reduce Percentage Rent payable by the Lessee for such Hotel.

21
<PAGE> 27

The continuation of the existing Franchise Agreements is, and any Franchise
Agreement entered into in the future will be, subject to specified operating
standards and other terms and conditions. Franchisors periodically inspect their
licensed hotels to confirm adherence to their operating standards. The failure
of the Company or the Lessee to maintain such standards respecting the Company's
hotels or to adhere to such other requirements of the applicable Franchise
Agreement could result in the loss or cancellation of the Franchise Agreement.
It is possible that a franchisor could condition the continuation of a Franchise
Agreement on the completion of capital improvements which the Board of Directors
determines are too expensive or otherwise not economically feasible in light of
general economic conditions or the operating results or prospects of the
affected hotel. In that event, the Board of Directors may elect to allow the
Lessee to permit the Franchise Agreement to lapse or be terminated. The
Courtyard by Marriott Franchise Agreements prohibit termination without the
franchisor's consent. Pursuant to an agreement among the franchisor, the Company
and the Lessee, the Company could be required to continue to cause the Courtyard
by Marriott hotels in Fresno and Riverside, California to be operated as a
Courtyard by Marriott. The loss of a Franchise Agreement could have a material
adverse effect upon the operations or the underlying value of the hotel covered
by the Franchise Agreement because of the loss of associated name recognition,
marketing support and centralized reservation systems provided by the
franchisor. See "Business and Properties -- Franchise Agreements."

TAX RISKS

Failure to Qualify as a REIT

The Company intends to operate so as to qualify as a REIT for federal
income tax purposes. If the Company were to fail to qualify as a REIT in any
taxable year, the Company would not be allowed a deduction for distributions to
stockholders in computing its taxable income and would be subject to federal
income tax (including any applicable minimum tax) on its taxable income at
regular corporate rates. Unless entitled to relief under certain Code
provisions, the Company also would be disqualified from treatment as a REIT for
the four taxable years following the year during which qualification was lost.
As a result, Cash Available for Distribution would be reduced for each of the
years involved. Although the Company currently intends to operate in a manner
designed to qualify as a REIT, it is possible that future economic, market,
legal, tax or other considerations may cause the Board of Directors, with the
consent of two-thirds of the stockholders, to revoke the REIT election. See
"Federal Income Tax Considerations."

Adverse Effect of REIT Minimum Distribution Requirements

In order to qualify as a REIT, the Company generally will be required each
year to distribute to its stockholders at least 95% of its net taxable income
(excluding any net capital gain). In addition, the Company will be subject to a
4.0% nondeductible excise tax on the amount, if any, by which certain
distributions paid by it with respect to any calendar year are less than the sum
of (i) 85% of its ordinary income, (ii) 95% of its capital gain net income for
that year and (iii) 100% of its undistributed taxable income from prior years.

The Company intends to make distributions to its stockholders to comply
with the 95% distribution requirement and to avoid the nondeductible excise tax.
The Company's income will consist primarily of its share of the income of the
Partnership, and its Cash Available for Distribution will consist primarily of
its share of cash distributions from the Partnership. Differences in timing
between the recognition of taxable income and the receipt of Cash Available for
Distribution due to the seasonality of the hospitality industry could require
the Company through the Partnership, to borrow funds on a short-term basis under
the Company's borrowing arrangements (to the extent, if at all, permitted by the
lender) to meet the 95% distribution requirement and to avoid the nondeductible
excise tax. For federal income tax purposes, distributions paid to stockholders
may consist of ordinary income, capital gains, nontaxable return of capital, or
a combination thereof. The Company will provide its stockholders with an annual
statement as to its designation of the taxability of distributions. The
requirement to distribute a substantial portion of the Company's net taxable
income could cause the Company to distribute amounts that would otherwise be
spent on future acquisitions, unanticipated capital expenditures or repayment of
debt, which would require the Company to borrow or sell assets to fund the costs
of such items.

22
<PAGE> 28

Distributions by the Partnership will be determined by the Board of
Directors, in the Company's capacity as the general partner of the Partnership,
and will be dependent on a number of factors, including the amount of the
Partnership's distributable cash, the Partnership's financial condition, any
decision by the Board of Directors to reinvest funds rather than to distribute
such funds, the Partnership's capital expenditures, the annual distribution
requirements under the REIT provisions of the Code and such other factors as the
Board of Directors deems relevant. See "Federal Income Tax
Considerations -- Requirements for Qualification -- Distribution Requirements."

Failure of the Partnership to be Classified as a Partnership for Federal Income
Tax Purposes;
Impact on REIT Status

If the Service were to challenge successfully the tax status of the
Partnership as a partnership for federal income tax purposes, the Partnership
would be taxable as a corporation. In such event, since the Company's ownership
interest in the Partnership constitutes more than 10% of the Partnership's
voting securities and exceeds 5% of the value of the Company's assets, the
Company would cease to qualify as a REIT. The imposition of corporate income tax
on the Company and the Partnership would substantially reduce the amount of Cash
Available for Distribution. See "Federal Income Tax Considerations -- Tax
Aspects of the Partnership."

Anti-Abuse Regulations

The United States Treasury Department recently issued regulations which
authorize the Service, in certain "abusive" transactions involving partnerships,
to disregard the form of the transaction and recast it for federal tax purposes
as the Service deems appropriate (the "Anti-Abuse Regulations"). The Anti-Abuse
Regulations would apply where a partnership is formed or utilized in connection
with a transaction (or series of related transactions) with a principal purpose
of substantially reducing the present value of the partners' aggregate federal
tax liability in a manner inconsistent with the intent of the partnership
provisions of the Code. See "Federal Income Tax Considerations -- Requirements
for Qualification -- Anti-Abuse Regulations."

ABILITY OF BOARD OF DIRECTORS TO CHANGE CERTAIN POLICIES

The major policies of the Company, including its policies with respect to
acquisitions, financing, executive compensation, growth, operations, debt
capitalization and distributions, are determined by the Board of Directors. The
Board of Directors may amend or revise these or other policies from time to time
without a vote of the holders of the Common Stock. Such amended or revised
policies may not achieve anticipated objectives which may have an adverse effect
on Cash Available for Distribution. The Company cannot change the provision of
its Articles of Incorporation limiting indebtedness to the Debt Limitation or
its policy of seeking to maintain its qualification as a REIT without the
approval of the holders of two-thirds of the outstanding voting shares. See
"Policies and Objectives with Respect to Certain Activities."

COMMON STOCK PRICE FLUCTUATIONS AND TRADING VOLUME

A number of factors may adversely influence the price of the Company's
Common Stock in public trading markets, many of which are beyond the control of
the Company. In particular, an increase in market interests rates will result in
higher yields on other financial instruments and may lead purchasers of Common
Stock to demand a higher annual distribution rate on the price paid for the
Common Stock, which could adversely affect the market price of the Common Stock.
Although the Common Stock is listed on the NYSE, the daily trading volume of
shares of stock or beneficial interests in REIT's in general and the Common
Stock in particular may be lower than the trading volume of securities of
certain other industries. As a result, investors in the Company who desire to
liquidate substantial holdings at a single point in time may find that they are
unable to dispose of such shares in the market without causing a substantial
decline in the market value of such shares.

23
<PAGE> 29

ADVERSE EFFECT OF SHARES AVAILABLE FOR FUTURE ISSUANCE AND SALE ON MARKET PRICE
OF COMMON STOCK

The Company's Articles of Incorporation authorize the Board of Directors to
issue up to 60,000,000 shares of capital stock, consisting of 50,000,000 shares
of Common Stock and 10,000,000 shares of Preferred Stock. Upon the closing of
the Offering, the Board of Directors will be able to reclassify and issue an
aggregate of approximately 39,676,500 unissued or unreserved shares of Common
Stock and to classify and issue all 10,000,000 unissued shares of Preferred
Stock. The Company's acquisition strategy depends in part on access to
additional capital through sales and issuances of equity securities. The market
price of the Common Stock may be adversely affected by the availability for
future sale and issuance of such unissued and unreserved shares of Common Stock
and Preferred Stock.

In addition, the market price of the Common Stock may also be adversely
affected by the availability for future sale and issuance of approximately
1,458,800 shares of Common Stock that could be issued upon the redemption of
Units of the Partnership. The Company is required under the Partnership
Agreement to file a Registration Statement on Form S-3 to give the limited
partners of the Partnership the ability to sell shares of Common Stock issued
upon redemption of Units. See "Shares Available for Future Sale."

LIMITATION ON ACQUISITION AND CHANGE OF CONTROL

Staggered Board

The Board of Directors of the Company has three classes. The terms of the
Company's initial directors will expire in 1997, 1998 and 1999, respectively.
Directors for each class will be elected for a three-year term upon the
expiration of that class' term. The staggered terms of directors may delay,
deter or prevent a change of control of the Company or other transaction, which
could involve holders of Common Stock receiving a premium for their shares of
Common Stock over the prevailing market price or which might otherwise be in
such holders' interest. See "Management -- Directors and Executive Officers."

Authority to Reclassify and Issue Common Stock and to Classify and Issue
Preferred Stock

As discussed above, the Company's Articles of Incorporation authorize the
Board of Directors to reclassify and issue any unissued shares of Common Stock
and to classify and issue up to 10,000,000 shares of Preferred Stock and to
establish the preferences and other terms of any shares issued. See "Description
of Capital Stock -- Preferred Stock." Although the Company has no current
intention to reclassify and issue any unissued shares of Common Stock or to
classify and issue shares of Preferred Stock in the foreseeable future, the
issuance of such reclassified shares of Common Stock or classified shares of
Preferred Stock could have the effect of delaying, deferring or preventing a
change of control of the Company even if a change of control were in the
interests of the stockholders. No shares of Preferred Stock will be issued or
outstanding as of the closing of the Offering.

Maryland Anti-Takeover Statutes

As a Maryland corporation, the Company is subject to various provisions of
Maryland law, which impose certain restrictions and require certain procedures
with respect to certain takeover offers and business combinations, including,
but not limited to, combinations with interested holders and share purchases by
certain holders. These provisions could have the effect of delaying, deferring
or preventing a change of control of the Company, even if a change of control
were in the best interests of the stockholders. These provisions are described
in "Certain Provisions of Maryland Law and of the Company's Articles of
Incorporation and Bylaws -- Business Combinations," "-- Control Share
Acquisitions" and "-- Anti-Takeover Effect of Certain Provisions of Maryland Law
and of the Articles of Incorporation and Bylaws."

24
<PAGE> 30

Ownership Limit

In order for the Company to maintain its qualification as a REIT, not more
than 50% in value of its outstanding shares may be owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities). Furthermore, if any stockholder or group of stockholders of
the Lessee owns, actually or constructively, 10% or more of the shares of
beneficial interest of the Company, the Lessee could become a related-party
tenant of the Partnership, which would result in loss of REIT status for the
Company. For the purpose of preserving the Company's REIT qualification, the
Company's Articles of Incorporation prohibit direct or indirect ownership of
more than 9.8% of the outstanding shares of Common Stock or the outstanding
shares of the Preferred Stock of the Company (the "Ownership Limit"). Generally,
the shares of beneficial interest owned by affiliated owners will be aggregated
for purposes of the Ownership Limit. The Ownership Limit could have the effect
of delaying, deferring or preventing a takeover or other transaction in which
holders of some, or a majority, of shares of Common Stock might receive a
premium for their shares of Common Stock over the then prevailing market price
or which such holders might believe to be otherwise in their best interests. See
"Description of Capital Stock -- Restrictions on Ownership" and "Federal Income
Tax Considerations -- Requirements for Qualification."

25
<PAGE> 31

THE COMPANY

The Company was incorporated in Maryland in August 1994 and is a
self-administered REIT. The Company's IPO occurred in August 1995. The Company
is the sole general partner of the Partnership and, after contributing all of
the net proceeds of the Offering to the Partnership, will own an approximately
87.6% general and limited partnership interest in the Partnership. The
Partnership owns the 17 Current Hotels and one of the Acquisition Hotels, and
intends to acquire the other two Acquisition Hotels concurrently with the
closing of the Offering.

In order to qualify as a REIT, neither the Company nor the Partnership can
operate hotels. The Partnership therefore leases the Current Hotels, and will
lease the Acquisition Hotels, to the Lessee, which is owned by Mr. Alter and Mr.
Biederman, pursuant to Percentage Leases designed to allow the Company to
participate in revenue growth by providing that between approximately 60% to 65%
of room revenues in excess of specified amounts, 5% of the Lessee's food and
beverage revenues, 100% of any sublease and concession rentals and certain other
net revenues in excess of Base Rent will be paid to the Partnership as
Percentage Rent. See "Business and Properties -- The Percentage Leases." The
Current Hotels are, and Acquisition Hotels will be, managed by the Management
Company, which is owned by Mr. Alter, for a fee equal to 2% of gross revenues of
the Hotels. See "The Management Company." The Company intends that any other
hotels acquired by it will be leased to the Lessee and managed by the Management
Company on terms substantially similar to those described above, although the
provisions may be altered depending on the purchase price paid, economic
conditions and other factors deemed relevant at the time.

The Company has taken steps to mitigate the potential for conflicts of
interest which result from the relationship between the Company and Mr. Alter
and Mr. Biederman. See "Certain Transactions."

The Company's executive offices are located at 115 Calle de Industrias,
Suite 201, San Clemente, California 92672 and its telephone number is (714)
361-3900.

Following the Offering, the structure and relationship among the Company,
the Partnership, the Lessee, the Management Company and the Hotels will be as
follows:
[GRAPH]
26
<PAGE> 32

USE OF PROCEEDS

The net proceeds to the Company from the Offering are estimated to be
approximately $36.8 million (approximately $42.4 million if the Underwriters'
over-allotment option is fully exercised). The Company will contribute the net
proceeds of the Offering to the Partnership and, after such contribution of the
net proceeds, will own approximately 87.6% interest in the Partnership (88.2% if
the over-allotment option is fully exercised). The Partnership will use the net
proceeds as follows: (i) approximately $20.8 million to repay outstanding
borrowings under the Line of Credit, $8.2 million of which was borrowed to
acquire one of the three Acquisition Hotels; and (ii) approximately $16.0
million to purchase the other two Acquisition Hotels concurrently with the
closing of the Offering. After the Offering, the Company will have approximately
$15.2 million of borrowings outstanding under the Line of Credit, approximately
$9.0 million of which it intends to repay with proceeds of the 10-year fixed
rate Term Loan when it closes, which is expected to occur in the fourth quarter
of 1996.

The Line of Credit currently bears interest at a rate of LIBOR plus 2.25%.
Upon the closing of the Offering, the interest rate on the Line of Credit will
decrease to LIBOR plus 1.90% (and upon satisfaction of certain other financial
conditions, LIBOR plus 1.75%). The Line of Credit has been utilized by the
Company to fund acquisitions and renovations of certain Hotels and for working
capital. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Pro Forma Liquidity and Capital Resources."

Pending the use of proceeds referenced above, the net proceeds will be
invested in interest-bearing, short-term investment grade securities or money
market accounts, which are consistent with the Company's intention to qualify
for taxation as a REIT. Such investments may include, for example, government
and government agency securities, certificates of deposit and interest-bearing
bank deposits.

27
<PAGE> 33

PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

The Company's Common Stock commenced trading on the NYSE on July 23, 1996
under the symbol "SSI." From the time of the Company's IPO (August 16, 1995)
through July 22, 1996 the stock was listed for quotation on the Nasdaq National
Market under the symbol "SSHI." The following table sets forth, for the periods
indicated, the high and low closing sales price information for the Common Stock
as reported on the Nasdaq National Market composite tape, as well as cash
distributions paid or anticipated to be paid per share of Common Stock for the
applicable periods.

<TABLE>
<CAPTION>
PER SHARE CASH
HIGH LOW DISTRIBUTION
------- ------ --------------
<S> <C> <C> <C>
1995
Third Quarter (from August 16, 1995)....................... $ 9.625 $8.875 $0.115(1)
Fourth Quarter............................................. $10.375 $8.250 $0.230
1996
First Quarter.............................................. $11.375 $9.875 $0.230
Second Quarter............................................. $11.250 $9.938 $0.230(2)
</TABLE>

- ---------------
(1) Represents the pro rata portion (for the period from August 16, 1995 to
September 30, 1995) of a quarterly distribution of $0.230.

(2) The Company declared this dividend on July 16, 1996, with a record date of
August 1, 1996.

On August 7, 1996, the last reported sale price of the Common Stock on the
NYSE was $10.00 per share. As of June 17, 1996, the Company had 34 shareholders
of record and the Company believes that as of the same date the Company had
approximately 1,786 beneficial owners of its Common Stock.

Although the declaration of distributions is within the discretion of the
Board of Directors and depends on the Company's results of operations, Cash
Available for Distribution, the financial condition of the Company, tax
considerations (including those related to REITs) and other factors considered
important by the Board of Directors, the Company's policy is to make regular
quarterly distributions to its shareholders. The Company's ability to make
distributions will depend on the receipt of distributions from the Partnership.
The Company intends to cause the Partnership to distribute to its partners
substantially all of the Partnership's Cash Available for Distribution. The
Partnership's primary source of revenue is rent payments under the Percentage
Leases for the Hotels. The Company must rely on the operation of its hotels to
generate sufficient cash flow to permit the Lessee to meet its rent obligations
under the Percentage Leases. The Lessee has only nominal assets and had a pro
forma operating loss of $373,000 for the year ended December 31, 1995. However,
its obligations under the Percentage Leases are secured by a blanket lien on
substantially all of its assets and a pledge of 258,311 Units by Mr. Alter and
Mr. Biederman pursuant to the Third Party Pledge Agreement, with a value on the
date pledged equal to four months of initial Base Rent under each of the
Percentage Leases. See "Certain Transactions -- Unit Pledge Agreement." See
"Business and Properties -- The Percentage Leases."

Under the federal income tax provisions affecting REITs, the Company must
distribute at least 95% of its taxable income in order to avoid taxation as a
regular corporation. Moreover, the Company must distribute at least 85% of its
ordinary income and 95% of its capital gain net income to avoid certain excise
taxes applicable to REITs. Under certain circumstances, the Company may be
required to make distributions in excess of Cash Available for Distribution in
order to meet such distribution requirements. In such event, the Company would
seek to borrow the amount of the deficiency or sell assets to obtain the cash
necessary to make distributions to retain its qualification as a REIT for
federal income tax purposes. See "Federal Income Tax Considerations -- Taxation
of the Company."

In the future the Company may implement a dividend reinvestment program
under which holders of Common Stock may elect automatically to reinvest
dividends and make additional investments in shares of Common Stock. If a
dividend reinvestment and stock purchase program is implemented, the Company
may, from time to time, repurchase Common Stock in the open market for purposes
of fulfilling its obligations under the program, or may elect to issue
additional shares of Common Stock.

28
<PAGE> 34

CAPITALIZATION

The following table sets forth the pro forma capitalization of the Company
as of March 31, 1996, as adjusted to give effect to the sale on such date by the
Company of the shares of Common Stock offered in the Offering and the use of the
net proceeds therefrom as described under "Use of Proceeds."

<TABLE>
<CAPTION>
MARCH 31, 1996
--------------------
PRO
FORMA
AS
ACTUAL ADJUSTED
------- --------
(IN THOUSANDS)
<S> <C> <C>
Long-term debt.......................................................... $22,000 $ 18,175
------- -------
Minority interest....................................................... 8,722 10,585
------- -------
Stockholders' equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized, no
shares issued and outstanding...................................... -- --
Common stock, $.01 par value, 50,000,000 shares authorized; 6,322,000
shares issued and outstanding, 10,322,000 shares issued and
outstanding, as adjusted(1)........................................ 63 103
Additional paid-in capital............................................ 37,432 73,204
Retained earnings..................................................... 1,137 1,137
------- -------
Total stockholders' equity............................................ 38,632 74,444
------- -------
Total capitalization............................................... $69,354 $103,204
======= =======
</TABLE>

- ---------------
(1) Excludes 1,458,800 shares issuable upon redemption of Units of the
Partnership outstanding prior to the Offering. See
"Management -- Compensation of Directors," "Management -- 1994 Stock
Incentive Plan," "Management -- The Directors Plan" and "Underwriting."

29
<PAGE> 35

SELECTED FINANCIAL INFORMATION

The following tables set forth selected historical and pro forma operating
and financial data for the Company, the Lessee and the Sunstone Initial Hotels.

With respect to the Company, the following tables set forth (i) selected
historical operating and other financial data for the period August 16, 1995
(inception) through December 31, 1995 and the three months ended March 31, 1996,
(ii) selected historical balance sheet data as of March 31, 1996, (iii) selected
pro forma operating and other financial data for the year ended December 31,
1995, and the three months ended March 31, 1995 and 1996, and (iv) selected pro
forma balance sheet data as of March 31, 1996.

With respect to the Lessee, the following tables set forth (i) selected
historical financial data for the period August 16, 1995 (inception) through
December 31, 1995 and the three months ended March 31, 1996 and (ii) selected
pro forma financial information for the year ended December 31, 1995 and the
three months ended March 31, 1995 and 1996.

With respect to the Sunstone Initial Hotels, the following tables set forth
selected combined historical financial data for each of the years in the
five-year period ended December 31, 1994 and the period from January 1, 1995 to
August 15, 1995.

The selected historical financial data for the Company and the Lessee for
the period August 16, 1995 (inception) through December 31, 1995 has been
derived from the historical financial statements of the Company and the Lessee,
respectively, audited by Coopers & Lybrand L.L.P., independent accountants,
whose reports with respect thereto are included elsewhere in this Prospectus.

Under rules of the Securities and Exchange Commission, the Sunstone Initial
Hotels may be deemed to be a predecessor of the Company. The selected financial
data for the Sunstone Initial Hotels for each of the years in the two-year
period ended December 31, 1994 and the period from January 1, 1995 to August 15,
1995 was derived from the historical financial statements of the Sunstone
Initial Hotels audited by Coopers & Lybrand L.L.P., independent accountants,
whose reports with respect thereto are included elsewhere in this Prospectus.

The selected historical operating and financial data for the Company and
the Lessee for the three months ended March 31, 1996 were derived from unaudited
internal statements of operations of the Company and the Lessee, respectively.
In the opinion of the respective managements, the unaudited interim financial
information includes all adjustments (consisting only of normal recurring
adjustments) necessary to present fairly the information set forth therein. Due
to the seasonality of the hotel business, the results for the interim periods
are not necessarily indicative of the results of a full year.

The pro forma operating and other financial data is presented as if the
acquisition of the Hotels and the closing of the IPO and the Offering had
occurred as of the beginning of the periods presented and, therefore,
incorporates certain assumptions that are included in the notes to the pro forma
financial statements included elsewhere in this Prospectus. The pro forma
balance sheet data of the Company is presented as if the acquisition of the
Acquisition Hotels and the closing of the Offering had occurred on March 31,
1996. The pro forma information does not purport to represent what the Company's
financial position or results of operations or the Lessee's results of operation
actually would have been had such transactions, in fact, occurred on such date
or at the beginning of the periods indicated, or to project the Company or the
Lessee's financial position or results of operations at any future date or for
any future period.

The following selected financial information should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and all of the financial statements and notes thereto contained in
this Prospectus.

30
<PAGE> 36

SUNSTONE HOTEL INVESTORS, INC.

SELECTED HISTORICAL AND PRO FORMA OPERATING AND FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
HISTORICAL
----------------------- PRO FORMA (1)
PERIOD FROM -----------------------------------------------------------------
AUGUST 16,
1995 THREE YEAR ENDED THREE MONTHS ENDED
(INCEPTION) MONTHS DECEMBER 31, 1995 MARCH 31, 1995
THROUGH ENDED ------------------------------- -------------------------------
DECEMBER 31, MARCH 31, CURRENT ACQUISITION THE CURRENT ACQUISITION THE
1995 1996 HOTELS HOTELS HOTELS HOTELS HOTELS HOTELS
------------ --------- ------- ----------- ------- ------- ----------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Revenue:
Lease revenue(2).................. $ 3,013 $ 3,190 $11,766 $ 3,254 $15,020 $3,288 $ 580 $ 3,868
Interest income................... 47 19 47 47
-------- -------- ------- ------- ------- ------- ------- -------
3,060 3,209 11,813 3,254 15,067 3,288 580 3,868
-------- -------- ------- ------- ------- ------- ------- -------
EXPENSES:
Real estate related
depreciation.................... 968 849 3,282 2,048 5,330 765 512 1,277
Interest expense and amortization
of financing costs.............. 47 324 1,510 1,510 364 364
Real estate and personal property
taxes and insurance............. 312 253 1,301 432 1,733 236 115 351
General and administrative........ 109 153 375 375 104 104
-------- -------- ------- ------- ------- ------- ------- -------
1,436 1,579 6,468 2,480 8,948 1,469 627 2,096
-------- -------- ------- ------- ------- ------- ------- -------
Income before minority interest
and extraordinary item.......... 1,624 1,630 5,345 774 6,119 1,819 (47) 1,772
Minority interest................. 284 293 672 90 762 227 (6) 221
-------- -------- ------- ------- ------- ------- ------- -------
Income before extraordinary
item............................ 1,340 1,337 4,673 684 5,357 1,592 (41) 1,551
Extraordinary item due to early
extinguishment debt (net of
$34,000 minority interest)...... 159
-------- -------- ------- ------- ------- ------- ------- -------
Net income.......................... $ 1,181 $ 1,337 $ 4,673 $ 684 $ 5,357 $1,592 $ (41) $ 1,551
======== ======== ======= ======= ======= ======= ======= =======
Net income per share................ $ 0.19 $ 0.21 $ 0.52 $ 0.15
======== ======== ======= =======
Weighted average number of shares of
Common Stock and Common Stock
equivalents outstanding........... 6,322 6,322 10,322 10,322
Other Data:
Lessee room revenue................. $ 7,060 $ 6,786 $27,914 $ 7,673 $35,587 7,248 1,468 8,716
Funds From Operations(3)............ 2,592 2,479 8,627 2,822 11,449 2,584 465 3,049
Cash Available for
Distribution(4)................... 2,296 2,193 7,455 2,515 9,970 2,281 406 2,687
Cash provided by operating
activities........................ 2,291 1,348
Cash used in investing activities... (32,899) (17,999)
Cash provided by (used in) financing
activities........................ 35,824 11,836
Occupancy........................... 60.1% 63.7% 67.4% 65.3%
ADR................................. $ 58.27 $ 63.51 $ 57.08 $ 58.50
REVPAR.............................. $ 35.02 $ 40.46 $ 38.47 $ 38.22

<CAPTION>
PRO FORMA(1)
-------------------------------
THREE MONTHS ENDED
MARCH 31, 1996
-------------------------------
CURRENT ACQUISITION THE
HOTELS HOTELS HOTELS
------- ----------- -------
<S> <C> <C> <C>
OPERATING DATA:
Revenue:
Lease revenue(2).................. $3,417 $ 643 $ 4,060
Interest income................... 19 19
------- ------- -------
3,436 643 4,079
------- ------- -------
EXPENSES:
Real estate related
depreciation.................... 876 512 1,388
Interest expense and amortization
of financing costs.............. 364 364
Real estate and personal property
taxes and insurance............. 274 116 390
General and administrative........ 153 153
------- ------- -------
1,667 628 2,295
------- ------- -------
Income before minority interest
and extraordinary item.......... 1,769 15 1,784
Minority interest................. 220 2 222
------- ------- -------
Income before extraordinary
item............................ 1,549 13 1,562
Extraordinary item due to early
extinguishment debt (net of
$34,000 minority interest)......
------- ------- -------
Net income.......................... $1,549 $ 13 $ 1,562
======= ======= =======
Net income per share................ $ 0.15
=======
Weighted average number of shares of
Common Stock and Common Stock
equivalents outstanding........... 10,322
Other Data:
Lessee room revenue................. $7,207 $ 1,746 $ 8,953
Funds From Operations(3)............ 2,645 527 3,172
Cash Available for
Distribution(4)................... 2,342 457 2,799
Cash provided by operating
activities........................
Cash used in investing activities...
Cash provided by (used in) financing
activities........................
Occupancy........................... 63.1%
ADR................................. $ 61.54
REVPAR.............................. $ 38.82
</TABLE>

- ---------------
Notes follow "Sunstone Initial Hotels" table.

31
<PAGE> 37

LESSEE

SELECTED HISTORICAL AND PRO FORMA FINANCIAL DATA
(IN THOUSANDS)

<TABLE>
<CAPTION>
HISTORICAL
----------------------- PRO FORMA(1)
PERIOD FROM ---------------------------------------------------------------------------------------------
AUGUST 16,
1995 THREE YEAR ENDED THREE MONTHS ENDED THREE MONTHS ENDED
(INCEPTION) MONTHS DECEMBER 31, 1995 MARCH 31, 1995 MARCH 31, 1996
THROUGH ENDED ----------------------------- ----------------------------- -----------------------------
DECEMBER 31, MARCH 31, CURRENT ACQUISITION THE CURRENT ACQUISITION THE CURRENT ACQUISITION THE
1995 1996 HOTELS HOTELS HOTELS HOTELS HOTELS HOTELS HOTELS HOTELS HOTELS
------------ --------- ------- ----------- ------- ------- ----------- ------- ------- ----------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Operating
Data:
Room
revenue... $7,060 $6,786 $27,914 $ 7,673 $35,587 $7,248 $1,468 $ 8,716 $7,207 $1,746 $ 8,953
Other
revenue... 865 550 3,221 2,452 5,673 837 554 1,391 635 513 1,148
------ ------ ------- ------- ------- ------ ------ ------- ------ ------ -------
Total
revenue... 7,925 7,336 31,135 10,125 41,260 8,085 2,022 10,107 7,842 2,259 10,101
Hotel
operating
expenses... 5,658 4,165 19,583 7,030 26,613 4,660 1,677 6,337 4,525 1,708 6,233
------ ------ ------- ------- ------- ------ ------ ------- ------ ------ -------
Income
before
overhead
expenses
and
Percentage
Lease
payments... 2,267 3,171 11,552 3,095 14,647 3,425 345 3,770 3,317 551 3,868
Percentage
Lease
payments... 3,013 3,190 11,766 3,254 15,020 3,288 580 3,868 3,417 643 4,060
Net
income
(loss)(6). $ (746) $ (19) $ (214) $ (159) $ (373) $ 137 $ (235) $ (98) $ (100) $ (92) $ (192)
====== ====== ======= ======= ======= ====== ====== ======= ====== ====== =======
</TABLE>

- ---------------
SUNSTONE INITIAL HOTELS
(PREDECESSOR)

SELECTED COMBINED HISTORICAL FINANCIAL DATA(7)
(IN THOUSANDS)

<TABLE>
<CAPTION>
FOR THE
PERIOD
YEAR ENDED DECEMBER 31, JAN. 1, 1995
--------------------------------------------- TO
1990 1991 1992 1993 1994 AUG. 15, 1995
------- ------ ------ ------- ------- -------------
<S> <C> <C> <C> <C> <C> <C>
Operating Data:
Room revenue..................................................... $ 6,679 $7,219 $8,768 $10,236 $11,965 $ 8,443
Other revenue.................................................... 1,071 1,206 1,609 1,701 1,898 1,232
------- ------- ------- -------- -------- -------
Total revenue.................................................... 7,750 8,425 10,377 11,937 13,863 9,675
------- ------- ------- -------- -------- -------
Hotel operating expenses......................................... 4,668 5,219 6,718 7,510 9,165 5,679
Depreciation and amortization.................................... 1,659 1,033 1,132 1,299 1,247 696
Interest expense................................................. 2,617 2,555 2,426 2,261 2,360 1,270
Other corporate expenses......................................... 425 608 595 622 693 356
------- ------- ------- -------- -------- -------
Income (loss) before extraordinary item.......................... (1,619) (990) (494) 245 398 1,674
Extraordinary item from forgiveness of interest.................. 536
------- ------- ------- -------- -------- -------
Net income (loss)................................................ $(1,619) $ (990) $ 42 $ 245 $ 398 $ 1,674
======= ======= ======= ======== ======== =======
</TABLE>

- ---------------

(2) With respect to the pro forma information, Rent revenue from the Lessee to
the Company is calculated on a pro forma basis by applying the Rent
provisions of the Percentage Leases to the historical room revenue of the
Hotels as if the beginning of the periods were the beginning of the lease
year. Assumes the Company owned and leased the Current Hotels and the
Acquisition Hotels throughout the periods presented.

32
<PAGE> 38

(5) Pro forma balance sheet data reflects the sale of 4,000,000 shares of Common
Stock and the application of the net proceeds as set forth in "Use of
Proceeds."

(6) The Lessee has elected status as a Subchapter S corporation for federal
income tax purposes and pays no corporate level tax on its net income.

(7) Sunstone Initial Hotels are deemed to be the predecessor of the Company and
do not include the Hampton Inn-Arcadia, California hotel, the Hampton
Inn-Silverthorne, Colorado hotel, the Doubletree-Santa Fe, New Mexico hotel
or any of the hotels acquired after the IPO.

33
<PAGE> 39

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

OVERVIEW

The Company completed a $60 million IPO on August 16, 1995 and contributed
all of the net proceeds of the IPO to the Partnership in exchange for an
approximately 82.5% aggregate equity interest in the Partnership. The Company
used the proceeds of the IPO to fund the purchase of three of the Current Hotels
and repay indebtedness incurred in connection with the acquisition of the
Sunstone Initial Hotels. Upon completion of the Offering the Company will
contribute an additional $36.8 million of net proceeds to the Partnership and
will own an approximately 87.6% interest in the Partnership. Following the
Offering, the Company will own 20 hotels with an aggregate of 2,612 rooms in
seven states, including Arizona (1 hotel), California (5), Colorado (6), New
Mexico (1), Utah (2), Oregon (2), and Washington (3), and will have doubled the
number of hotels in its portfolio in the 12 months since the IPO, and increased
the number of rooms by 96.7% from 1,328 to 2,612 rooms.

Since the IPO, the Company has implemented its growth strategy by (i)
acquiring underperforming hotels and redeveloping and repositioning certain of
such hotels into nationally franchised mid-price and upscale hotels and (ii)
enhancing the operating performance of its hotels through selective renovation
and improved management and marketing. Additionally, the Company has
significantly increased its franchise and geographic diversification within the
western United States and expanded its ability to finance future growth through
increased borrowing capacity on its Line of Credit.

The Company has implemented its external growth strategy by (i) acquiring
six of the Current Hotels for purchase prices aggregating $19.3 million; (ii)
acquiring and substantially completing the construction of a Residence Inn for
approximately $5.0 million, which is expected to be opened during the third
quarter of 1996; (iii) acquiring one of the Acquisition Hotels, and contracting
to acquire the other two Acquisition Hotels, for purchase prices aggregating
$24.2 million (including estimated acquisition costs), and with the Acquisition
Hotels will have increased the number of rooms in its portfolio by 96.7% since
the IPO; and (iv) entering into a letter of intent to acquire a 166-room
full-service convention hotel for $8.4 million upon completion of construction
by an unaffiliated developer, which is expected to occur in 1997.

The Company has implemented its internal growth strategy by (i) completing
an aggregate of $4.4 million in redevelopment to two of the Current Hotels; (ii)
completing $1.2 million in renovations to two other Current Hotels; (iii)
commencing redevelopment budgeted at $5.5 million to four of the Current Hotels;
and (iv) increasing REVPAR for the seven Current Hotels that were owned by the
Company or its predecessor for the entire first quarter of 1995 and 1996 and
were not undergoing redevelopment or significant renovation by 5.5%, from $39.82
to $42.03. Management believes that the increases in REVPAR for hotels, other
than the renovated hotels in Santa Fe, New Mexico and Steamboat Springs,
Colorado, resulted primarily from the success of the Company's renovation and
redevelopment program, from improvements in management and marketing and from
increases in demand for mid-price and upscale hotel rooms throughout the western
United States.

Additionally, the Company has increased availability under the Line of
Credit from $30 million to $50 million, reduced its borrowing rate from LIBOR
plus 2.75% to LIBOR plus 2.25% with additional reductions to LIBOR plus 1.90%
after the Offering and to LIBOR plus 1.75% upon meeting certain other financial
conditions, and applied for a $9 million year fixed-rate Term Loan which will be
secured by two of the Current Hotels.

PRO FORMA RESULTS OF OPERATIONS OF THE COMPANY

Comparison of the Quarter ended March 31, 1996 to March 31, 1995

Lease revenue, which is based primarily on hotel room revenues, increased
$132,000, or 8.8%, for seven of the eight Current Hotels that were owned by the
Company or its predecessor for the entire first quarter of 1995 and 1996. This
increase was principally due to an 5.5% increase in REVPAR, from $39.82 to
$42.03, at

34
<PAGE> 40

the seven hotels during such periods. The lease revenue increase was partially
offset by a $89,000, or 31.4%, decrease in lease revenue from the eighth Current
Hotel that was owned by the Company or its predecessor which was undergoing
redevelopment during the first quarter of 1996. With respect to all of the
Current Hotels and Acquisition Hotels, REVPAR for those hotels not undergoing
redevelopment or renovation (i.e., all except the Doubletree-Santa Fe, New
Mexico hotel, Hampton Inn-Oakland, California hotel and Holiday Inn-Steamboat
Springs, Colorado hotel), rose 7.0%, from $37.87 to $40.50.

Overall, lease revenue for the Company, including the Acquisition Hotels,
increased $192,000, or 5.0%, to $4.1 million for the three months ended March
31, 1996 as compared to the corresponding period in 1995, based on an overall
increase in REVPAR of 1.6%, from $38.22 to $38.82. Room revenues at certain of
the hotels, primarily those undergoing or expected to undergo redevelopment or
renovation, produced lease revenue to the Company at approximately the Base Rent
levels of the Percentage Leases for such hotels. The Company expects that future
increases in REVPAR for those hotels will result in significantly increased
lease revenue to the Company due to the structure of the Percentage Leases.

Redevelopment Activity. During the first quarter of 1996, the Company
completed its redevelopment and conversion of the Best Western High Mesa Inn in
Santa Fe, New Mexico to a Doubletree Hotel and the redevelopment of the Holiday
Inn in Steamboat Springs, Colorado. REVPAR for these hotels decreased 38.8%,
from $42.29 to $25.88, for the quarter ended March 31, 1996, when compared to
the corresponding period in 1995. Both hotels are expected to generate increased
revenue under their Percentage Leases beginning in the second quarter of 1996.

For the first quarter ended March 31, 1996 compared to the corresponding
period in 1995, pro forma net income increased $11,000 to $1,562,500, while
total revenues and depreciation increased $211,000 and $111,000, respectively.

Year Ended December 31, 1995

Lease revenue for the year ended December 31, 1995 was $15,020,000.

For those hotels not undergoing renovations or redevelopment in 1995, pro
forma results for the year ended December 31, 1995 reflect a REVPAR increase of
9.2%, from $35.04 to $38.27, when compared to the corresponding period in 1994.
REVPAR for all of the Current Hotels and Acquisition Hotels for such period
increased 5.3%, from $36.53 to $38.48

Redevelopment Activity. During the fourth quarter of 1995 and the first
quarter of 1996, the Company redeveloped and converted the Best Western High
Mesa Inn in Santa Fe, New Mexico to a Doubletree Hotel. The Holiday Inn in
Steamboat Springs, Colorado was also redeveloped. REVPAR for these two hotels
decreased 15.8%, from $47.54 to $40.05, for the year ended December 31, 1995,
when compared to the year ended December 31, 1994.

For the year ended December 31, 1995, pro forma net income of the Company
was $5.4 million, and on a per-share basis was $0.52 per share, and revenues
were $15.1 million.

PRO FORMA RESULTS OF OPERATIONS OF THE LESSEE

Three Months Ended March 31, 1996

For the three months ended March 31, 1996, the Lessee, on a pro forma
basis, would have had $10.1 million in total revenue. The Percentage Lease
payments and operating expenses would have been $4.1 million and $6.2 million,
respectively, and the net loss would have been $192,000. For further discussion
of the Lessee's operations see "Pro Forma Results of Operations of the Company."

Year Ended December 31, 1995

For the fiscal year ending December 31, 1995, the Lessee, on a pro forma
basis, would have had $41.3 million in total revenue. The Percentage Lease
payments and operating expenses would have been $15.0 million and $26.6 million,
respectively, and net losses would have been $373,000. Management believes

35
<PAGE> 41

that the completion by the Company of the redevelopment and conversion of the
Best Western-Santa Fe, New Mexico hotel to a Doubletree Hotel and the
redevelopment of the Holiday Inn-Steamboat Springs, Colorado hotel will improve
the Lessee's results of operation for such hotels.

SEASONALITY AND DIVERSIFICATION

Demand is affected by normally recurring seasonal patterns. Generally, the
Company's portfolio of hotels as a whole has performed better in the first and
third quarters due to the positive and negative effects of the winter season.
Future acquisitions may further affect the seasonality of the Company's current
portfolio.

The Company has implemented a business strategy of franchise and geographic
diversification. The following tables summarize certain information for the
Hotels, on a pro forma basis, with respect to franchise affiliations and
distribution of hotels throughout the western United States.

FRANCHISE AFFILIATIONS

<TABLE>
<CAPTION>
PRO FORMA
GROSS REVENUES
NUMBER OF PERCENTAGE OF FOR THE YEAR ENDED PERCENTAGE OF
ROOMS ROOMS DECEMBER 31, 1995 GROSS REVENUES
--------- ------------- ------------------- --------------
<S> <C> <C> <C> <C>
CURRENT HOTELS
Courtyard by Marriott................... 279 10.7% $ 3,745,434 9.1%
Doubletree Hotel........................ 213 8.2 3,161,936 7.7
Hampton Inn............................. 939 35.9 15,103,141 36.6
Residence Inn........................... 78 3.0
Holiday Inn............................. 160 6.1 3,210,155 7.8
Holiday Inn Hotel & Suites.............. 291 11.1 4,105,263 9.9
Holiday Inn Express..................... 148 5.7 1,809,748 4.4
----- ----- ---------- -----
Subtotal........................... 2,108 80.7 31,135,677 75.5
----- ----- ---------- -----
ACQUISITION HOTELS
Comfort Suites.......................... 165 6.3 3,319,188 8.0
Holiday Inn Hotel & Suites.............. 151 5.8 2,270,609 5.5
Holiday Inn Select...................... 188 7.2 4,534,930 11.0
----- ----- ---------- -----
Subtotal........................... 504 19.3 10,124,727 24.5
----- ----- ---------- -----
Total......................... 2,612 100.0% $41,260,404 100.0%
===== ===== ========== =====
</TABLE>

See the table on page 3 for the status of franchise licenses.

GEOGRAPHIC DIVERSIFICATION

<TABLE>
<CAPTION>
PRO FORMA
GROSS REVENUES
NUMBER OF PERCENTAGE OF FOR THE YEAR ENDED PERCENTAGE OF
STATE ROOMS ROOMS DECEMBER 31, 1995 GROSS REVENUES
- ---------------------------------------- --------- ------------- ------------------- --------------
<S> <C> <C> <C> <C>
Arizona................................. 118 4.5% $ 2,206,150 5.3%
California.............................. 727 27.8 11,286,788 27.4
Colorado................................ 753 28.8 11,934,659 28.9
New Mexico.............................. 213 8.2 3,161,936 7.7
Oregon.................................. 199 7.6 2,051,518 5.0
Utah.................................... 229 8.8 3,614,142 8.8
Washington.............................. 373 14.3 7,005,211 17.0
----- ----- ---------- -----
Total......................... 2,612 100.0% $41,260,404 100.0%
===== ===== ========== =====
</TABLE>

36
<PAGE> 42

ACTUAL RESULTS OF OPERATIONS OF THE COMPANY

Comparison of Year Ended December 31, 1994 to Year Ended December 31,
1993 -- Sunstone Initial Hotels, Predecessor

Room revenue for the Sunstone Initial Hotels increased by $1.7 million, or
16.9%, to $12.0 million in 1994 from $10.2 million in 1993. Approximately
$304,000 of this increase was due to the repositioning of the Holiday Inn in
Provo, Utah, approximately $324,000 of this increase was due to an increase in
occupancy at the Hampton Inn in Mesa, Arizona, and approximately $261,000 of
this increase was due to new corporate business and other increased demand at
the Hampton Inn in Pueblo, Colorado. The remainder of the increase was primarily
due to a 9.3% increase in ADR to $54.65 in 1994 from $50.02 in 1993. Greater
emphasis was placed on setting room rates during 1994 in order to increase
occupancy. Occupancy increased from 70.4% in 1993 to 72.5% in 1994. Of the total
room revenue increase of $1.7 million, approximately $950,000 was attributable
to increases in ADR and approximately $778,000 was attributable to increases in
occupancy. REVPAR also increased 12.5% to $39.61 in 1994 from $35.21 in 1993.
Net income increased by $153,000 to $398,000 for 1994 from $245,000 for 1993, an
increase of 62.4%.

Accounting Policies

In March and October 1995, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 121 "Accounting for the
Impairment of Long Lived Assets and for Long Lived Assets to be Disposed Of" and
No. 123 "Accounting for Stock-Based Compensation," respectively. These
statements shall be effective for financial statements for fiscal years
beginning after December 15, 1995. Management believes that adoption of Standard
No. 121 will not have a material effect on its financial position or results of
operations. Management intends to adopt the disclosure method on Standard No.
123 and, accordingly, there will be no impact on the Company's financial
position or results of operations.

PRO FORMA LIQUIDITY AND CAPITAL RESOURCES

On a pro forma basis, as of March 31, 1996, after giving effect to the
Offering and the use of proceeds therefrom, the Company will have total debt
outstanding of approximately $18.2 million resulting in a pro forma debt to
investment in hotels, at cost, of 16.3%.

Cash Flows Provided by Operating Activities. The Company's operating
activities provide the principal source of cash to fund the Company's operating
expenses, interest expense, recurring capital expenditures and dividend
payments. The Company anticipates that its cash flow provided by leasing the
hotels to the Lessee will provide the necessary funds on a short and long term
basis to meet its operating cash requirements. The Company is required under the
Percentage Leases to make available to the Lessee for the repair, replacement
and refurbishment of furniture, fixtures and equipment an amount equal to 4% of
the room revenue per quarter on a cumulative basis, provided that such amount
may be used for capital expenditures made by the Company with respect to the
hotels. The Company expects that this reserve will be adequate to fund such
periodic repairs, replacements and refurbishments. Since inception, the Company
has paid dividends and distributions totaling $4.4 million representing $0.23
per share on a quarterly basis.

Cash flows from Investing and Financing Activities. Additionally, the
Company intends to finance the acquisition of additional hotels, hotel
renovations and non-recurring capital improvements principally through the Line
of Credit with Bank One of Arizona, N.A. and, when market conditions warrant, to
issue additional equity or debt securities. On a pro forma basis, as of March
31, 1996, the Company had $34.8 million available on its $50.0 million Line of
Credit. Interest accrues on advances under the Line of Credit at a rate equal to
LIBOR plus 2.25% reduced to LIBOR plus 1.90% upon completion of the Offering,
and further reduced to LIBOR plus 1.75% if the Company satisfies certain
financial requirements. The Line of Credit provides for a $5 million working
capital subfacility and a $5 million construction subfacility. The Company has
the option each year to extend the two-year revolving term period by an
additional year upon the payment of a 0.375% extension fee and certain other
conditions. Upon termination of the revolving term period, the Company may under
certain conditions, including payment of a 1% fee, convert the outstanding
balance into a three-year term loan. The Line of Credit is guaranteed by Mr.
Alter, Mr. Biederman and certain other individuals and is secured by first
mortgages on 15 of its Current Hotels and may be secured by additional hotels
acquired by the Company in the future. However, the Company has the option of
owning hotels not subject to the lien

37
<PAGE> 43

securing the Line of Credit so long as no proceeds under the Line of Credit are
used with respect to such hotel and any other lender loaning against such hotel
limits its liens to only that hotel. This feature of the Line of Credit gives
the Company the ability to separately finance on a long-term basis certain of
its Hotels. The Company has applied for a $9 million 10-year fixed rate loan to
be secured by the Hampton Inns in Denver, Colorado, and Mesa, Arizona. The Line
of Credit may be retired in whole or in part from the proceeds of public or
private issuances of equity or debt securities by the Company and may be
refinanced in whole or in part with fixed-rate financing. However, because
Messrs. Alter and Biederman and certain affiliates would suffer adverse tax
consequences if the Company's mortgage indebtedness were reduced below $8.4
million, the Company does not anticipate reducing its mortgage indebtedness
below this amount.

The Company continues to pursue its strategy of redeveloping, renovating
and repositioning underperforming hotels. As of March 31, 1996, redevelopment
and renovation work was substantially completed at three hotels for $5.1
million. The Company expects that redevelopment of additional hotels will be
completed by the first quarter of 1997 for an additional $7.4 million. The
redevelopment and renovation program is expected to be funded entirely by excess
operating cash flows and borrowings under the Line of Credit.

Since the IPO, the Company has expended over $27.5 million in acquiring
hotel assets. As part of its investment strategy, the Company plans to acquire
additional hotels. Future acquisitions are expected to be funded through the use
of the Line of Credit or other borrowings and the issuance of additional equity
or debt securities. The Company's Articles of Incorporation limits consolidated
indebtedness to 50% of the Company's investment in hotel properties, at cost on
a consolidated basis, after giving effect to the Company's use of proceeds from
any indebtedness. Management believes that it will have access to capital
resources sufficient to satisfy the Company's cash requirements and to expand
and develop its business in accordance with its strategy for future growth.

Funds From Operations. Management believes that FFO is one measure of
financial performance of an equity REIT such as the Company. On a pro forma
basis, FFO for the first quarter of 1996 grew by 4.0% to $3.2 million from $3.0
million for the corresponding period of 1995 based on an overall increase in
REVPAR of 1.6%, from $38.22 to $38.82. For the year ended December 31, 1995, on
a pro forma basis, FFO would have been $11.4 million. The Company expects its
FFO to increase due to the impact of its internal and external growth strategies
and particularly its recently completed and proposed redevelopment and
renovation activities.

<TABLE>
<CAPTION>
QUARTER ENDED
MARCH 31, YEAR ENDED
----------------- DECEMBER 31,
1996 1995 1995
------ ------ ------------
<S> <C> <C> <C>
Income before minority interest.............................. $1,784 $1,772 $ 6,119
Real estate related depreciation............................. 1,388 1,277 5,330
------ ------ -------
Funds From Operations(1)..................................... $3,172 $3,049 $11,449
====== ====== =======
</TABLE>

- ---------------
(1) With respect to the presentation of FFO, management elected early adoption
of the "new definition" as recommended in the March 1995 NAREIT White Paper
on Funds From Operations beginning January 1, 1995. Management and industry
analysts generally consider funds from operations to be one measure of the
financial performance of an equity REIT that provides a relevant basis for
comparison among REITs and it is presented to assist investors in analyzing
the performance of the Company. Funds From Operations is defined as income
before minority interest (computed in accordance with generally accepted
accounting principles), excluding gains (losses) from debt restructuring and
sales of property and real estate related depreciation and amortization
(excluding amortization of financing costs). Funds From Operations does not
represent cash generated from operating activities in accordance with
generally accepted accounting principles and is not necessarily indicative
of cash available to fund cash needs. Funds From Operations should not be
considered an alternative to net income as an indication of the Company's
financial performance or as an alternative to cash flows from operating
activities as a measure of liquidity.

INFLATION

Operators of hotels in general possess the ability to adjust room rates
quickly. However, competitive pressures may limit the Lessee's ability to raise
room rates in the face of inflation.

38
<PAGE> 44

BUSINESS AND PROPERTIES

THE LODGING INDUSTRY

The fundamentals of the lodging industry have improved significantly in
each year since 1991. The industry as a whole generated record earnings in 1995,
with industry-wide pre-tax profits of $8.5 billion. This was up 55% from $5.5
billion in pre-tax profits in 1994, and represented the industry's third
consecutive year of profitability. Hospitality Directions projects that industry
pre-tax profits will reach $14.7 billion in 1998.

The industry's profitability has been fueled by four consecutive years in
which the growth in demand for hotel rooms has exceeded the growth in room
supply. Industry-wide growth in room demand exceeded the growth in total room
supply by 2.0%, 2.6%, 2.8% and 1.4% in 1992, 1993, 1994 and 1995, respectively.
This trend has continued in the first quarter of 1996, with demand growth
eclipsing supply growth by 1.2% despite harsh winter weather conditions
affecting many markets.

The graphs on the following page illustrate REVPAR growth over the previous
comparable period for all upscale and mid-price U.S. hotels.

39
<PAGE> 45

REVPAR GROWTH OF LODGING INDUSTRY

[UPSCALE HOTELS REVPAR GROWTH & MID-PRICE HOTELS REVPAR GROWTH CHARTS]

Note: All REVPAR data has been obtained from the January 1996 issue of
Hospitality Directions except for Q1 1996 which the Company has calculated from
data provided by Smith Travel Research.

OVERVIEW OF THE COMPANY

The Company is a self-administered REIT that, through the Partnership, owns
mid-price and upscale hotels in the western United States. The hotels operate or
will operate under nationally recognized franchises, including Courtyard by
Marriott, Doubletree, Hampton Inn, Holiday Inn, Holiday Inn Hotel & Suites,
Holiday Inn Express, Holiday Inn Select, Comfort Suites and Residence Inn. The
Company owns 18 hotels, eight of which were acquired subsequent to the IPO in
August 1995. The Company recently acquired one of the Acquisition Hotels and
intends to acquire the other two Acquisition Hotels concurrently with the
closing of this Offering. Following such acquisitions, the Company will own 20
hotels with an aggregate of 2,612 rooms in seven states, including Arizona (1
hotel), California (5), Colorado (6), New Mexico (1), Utah (2), Oregon (2), and
Washington (3), and will have doubled the number of hotels in its portfolio in
the 12 months since the IPO.

In addition to significantly expanding its portfolio, the Company has
generated internal revenue growth by renovating or redeveloping many of the
Current Hotels, and improving their management and marketing programs. REVPAR
for the seven Current Hotels that were owned by the Company or its predecessor
for the entire first quarter of 1995 and 1996 and were not undergoing
redevelopment or significant renovation during such periods increased 5.5%, from
$39.82 to $42.03. REVPAR for all of the Current Hotels and the Acquisition
Hotels during such periods increased 1.6%, from $38.22 to $38.82. The Company
believes that its recently completed and future redevelopment and renovation
activities, as well as improvements in management and marketing, will continue
to fuel REVPAR growth at its hotels, thereby increasing revenue to the Company.

GROWTH STRATEGY

The Company's growth strategy is to enhance shareholder value by increasing
Cash Available for Distribution by acquiring or selectively developing
additional hotels that meet the Company's investment criteria and by
participating, through Percentage Leases, in room revenue from its hotels. This
strategy is designed to capitalize on improving occupancy rates and ADRs
prevailing in the U.S. lodging industry.

40
<PAGE> 46

The Company's external growth strategy is to: (i) acquire underperforming
hotels located primarily in the western United States that are, or can be
redeveloped and repositioned into, nationally franchised mid-price and upscale
hotels, with an increasing emphasis on multi-property acquisitions; (ii) develop
extended-stay Hawthorn Suites hotels through property conversions or new
construction in several major urban markets on the West Coast pursuant to a
proposed master development agreement with USFS; and (iii) selectively develop
new mid-price and upscale hotels in markets where room demand and other
competitive factors justify new construction.

The Company's internal growth strategy is to enhance the operating
performance of hotels owned and acquired by the Company by: (i) selectively
renovating the hotels, and in some cases redeveloping and rebranding them under
national franchises; (ii) improving the marketing and management of the hotels;
(iii) leasing restaurants in the hotels to national or regional restaurant
companies; and (iv) in selective cases, expanding the number of rooms at certain
hotels where market conditions justify expansion.

External Growth Strategy

Acquisitions. The Company intends to acquire hotels located primarily in
the western United States which meet one or more of the following criteria: (i)
underperforming hotels which have the potential for improved performance through
the implementation of quality management and marketing programs, and/or
association with a national franchisor; (ii) hotels in a deteriorated physical
condition that would benefit significantly from renovation or redevelopment;
(iii) hotels in attractive locations that would benefit significantly by
changing franchises to a brand that can increase REVPAR, such as Courtyard by
Marriott, Doubletree Hotel, Hampton Inn, Holiday Inn, Holiday Inn Select,
Holiday Inn Hotel & Suites, Holiday Inn Express and Residence Inn; (iv) hotels
owned by franchisees who are unable or unwilling to meet capital improvement
requirements of the franchisor; (v) nationally franchised hotels in locations
with favorable room supply and demand fundamentals; and (vi) hotels in markets
where there are significant barriers to entry, such as limited opportunities to
change existing franchises at competitive hotels, scarcity of suitable hotel
sites or zoning restrictions.

Multiple Property Acquisitions. Since the IPO, the Company has positioned
itself to acquire multiple hotels in a single transaction, enabling it to more
quickly and efficiently expand its portfolio by accelerating the pace of growth
while reducing acquisition expenses per hotel. The Company has increased its
access to capital for multi-property acquisitions by increasing the availability
under its Line of Credit from $30 million to $50 million and by pursuing a $9
million, 10-year fixed rate Term Loan to be secured by two of the Current Hotels
(proceeds of which are expected to reduce borrowings under the Line of Credit).
In addition, rather than paying cash, the Company also has the flexibility of
issuing its Common Stock or Units in the Partnership to acquire hotels, which
under certain circumstances allows the sellers to defer tax liability which
would otherwise arise upon a sale for cash. In addition to its financial
resources, the Company's experience successfully operating hotels in seven
states has given it significant knowledge of a variety of markets and the
ability to quickly identify strategic acquisition opportunities in them. The
Company believes that its increasing profile in the hotel industry and its
record of closing acquisitions will enable it to attract sellers of hotel
portfolios. Additionally, the Company expects its ability to attract such
sellers to be further enhanced by its proposed consulting arrangement with
Geller & Co. See "Management -- Strategic Consultant."

Hawthorn Suites Master Development Agreement. Under a proposed master
development agreement with USFS, the Company intends to develop extended-stay
Hawthorn Suites hotels in several major urban markets in California, Oregon and
Washington, including San Diego, San Francisco, San Jose, Portland, Seattle and
certain areas of Los Angeles. The Company entered into a letter of intent with
USFS in June 1996, intended to lead to a five-year master development agreement
under which the Company will have the first right to develop Hawthorn Suites in
the markets it selects. In the event that another party applies to USFS for a
Hawthorn Suites franchise license in one of the markets prior to the time the
Company has initiated a development opportunity in the market, USFS may grant a
franchise license for the market to such other party. If a license is granted to
such party, the Company may select an alternative market from the list of
available markets in which to develop a hotel. Development may consist of
conversions of existing properties or new construction and may be performed by
the Company, or by unaffiliated developers who will sell the

41
<PAGE> 47

project to the Company upon completion (and thus allow the Company to minimize
development risks). Under the proposed master development agreement the Company
will have to develop a certain number of hotels in each year of the five-year
term, or the right to develop those hotels will expire. It is intended that USFS
will be required to help the Company identify hotel sites, provide architectural
plans and development oversight and assist in marketing the hotels. The Hawthorn
Suites relationship is only in the letter of intent stage, and there is no
assurance that the Company will enter into a definitive master development
agreement, or, if it does, that the agreement will contain the terms described
herein. See "Risk Factors -- Hawthorn Suites Development Risks" and
"-- Development Risks."

Hawthorn Suites are upscale, extended-stay hotels competing primarily with
Residence Inns and Homewood Suites. The franchise rights to this brand were
recently acquired by USFS, a hotel franchise company founded by Michael Leven,
the former President of Holiday Inn. The Company believes USFS intends to grow
the Hawthorn Suites brand into a leading national hotel chain from its current
base of 17 Hawthorn Suites hotels. The Company believes the arrangement with
USFS will give it a significant advantage in the growing extended-stay market in
the western United States.

Selective Development of Additional Hotels. In addition to its plans to
develop Hawthorn Suites hotels, the Company may selectively develop new upscale
and mid-price hotels which will operate under other national franchises in
markets where room demand and other competitive factors justify new
construction. The Company intends, however, to focus its development efforts on
Hawthorn Suites in the foreseeable future, and to develop other hotels only as a
secondary development strategy. As in the case of the intended development of
Hawthorn Suites, the Company may develop other hotels itself or may contract
with unaffiliated developers who will build hotels and then sell them to the
Company upon completion on pre-agreed terms. Such arrangements with developers
will enable the Company to minimize risks associated with development. Other
than the Company's current development of a 78-room Residence Inn hotel in
Highlands Ranch (Denver), Colorado, and the letter of intent to acquire a
166-room hotel to be developed by an unaffiliated developer in Pueblo, Colorado,
each of which is described under "Recent Developments" in the Prospectus
Summary, the Company is not currently involved in any development projects.

Internal Growth Strategy.

The Company's internal growth strategy is to improve the operating
performance of the hotels it acquires by improving their marketing and
management, and by renovating, redeveloping, rebranding, and in some cases
expanding the number of rooms, when the Company believes such improvements will
provide returns on investment and increased revenue.

Redevelopment and Renovation. In conjunction with the Company's strategy
of acquiring hotels that can benefit from extensive improvements, reflagging and
repositioning, the Company's principal internal growth strategy is to redevelop
or extensively renovate such hotels and reflag them with a national franchise
that the Company believes will generate higher REVPAR than that currently being
generated. In addition to the redevelopment strategy, the Company periodically
renovates its hotels, not only to satisfy requirements of the Franchise
Agreements, but to maintain or increase market share. The Company believes that
after taking into account the purchase price of each Hotel in its portfolio and
the cost of renovating or redeveloping it, the overall expenditure for each
Hotel is 30% to 40% below its replacement cost. The Company has and intends, to
the extent practicable, to continue to keep hotels operational while conducting
renovation and redevelopment work by performing such work during off-peak
periods and in a manner least disruptive to hotel operations.

42
<PAGE> 48

SCOPE OF RENOVATION

For those hotels whose franchise affiliation will not be changed, the
Company typically makes renovations following acquisition in order to satisfy
the existing franchisor's product improvement plan. The Company also performs
periodic routine maintenance to all hotels in order to keep them competitive.
Renovations typically consist of many of the following:

<TABLE>
<CAPTION>
GUEST ROOMS PUBLIC AREAS EXTERIOR
-------------------------- -------------------------- --------------------------
<S> <C> <C>
selectively replacing replacing drapes and repainting
bedspreads, linens, drapes valences seal coating parking lot
and refinishing and adding lighting
valances selectively
refinishing and replacing furniture
selectively replacing wallpaper and
replacing furniture vinyl
adding televisions, wallcovering
telephones repainting
with data ports and recarpeting
voicemail, clock radios,
coffeemakers, irons and
ironing boards
replacing wallpaper and
vinyl
wallcovering
repainting
recarpeting
</TABLE>

SCOPE OF REDEVELOPMENT

Redevelopment is more extensive than renovation and is used to completely
upgrade a hotel so that in certain instances it can be branded with a national
franchise if it is not already, or rebranded with a national franchise that the
Company believes will generate higher REVPAR than that currently being generated
at its hotels. Redevelopment typically involves many of the following:

<TABLE>
<CAPTION>
GUEST ROOMS PUBLIC AREAS EXTERIOR
-------------------------- -------------------------- --------------------------
<S> <C> <C>
replacing all bedspreads, replacing drapes and repainting
linens, drapes and valances installing new window
valences replacing wallpaper and treatments and grill work
replacing all furniture vinyl modifying the facade
adding televisions, wallcovering constructing port-cochere
telephones repainting repaving or seal coating
with data ports and recarpeting parking lot
voicemail, clock radios, redecorating adding lighting
coffeemakers, irons and replacing furniture re-roofing
ironing boards rebuilding reception area
replacing wallpaper and redesigning lobby for
vinyl improved traffic flow
wallcovering remodeling restaurant to
repainting standards of regional or
recarpeting national restaurant
remodeling guestrooms, operator
including changing room installing fire safety
layout and modifying equipment, including
closets sprinklers and smoke
remodeling guest bathrooms detectors
with new countertops, tile
floors, plumbing fixtures,
lights and valances
installing fire safety
equipment, including
sprinklers and smoke
detectors
</TABLE>

43
<PAGE> 49

The following table sets forth certain information with respect to the
Company's completed, outstanding and planned renovation and redevelopment
activity. The table includes renovation and redevelopment work on the Sunstone
Initial Hotels, which was completed by the Sunstone Affiliates prior to the
transfer of the Sunstone Initial Hotels to the Company in connection with the
IPO. The table does not include work completed by any other prior owners of the
Hotels.

<TABLE>
<CAPTION>
SCOPE OF RENOVATION OR REDEVELOPMENT WORK
----------------------------------------------------------------------------------
ADD/ ROOMS RENOVATION
COMPLETED OR REPLACE/ UPGRADE ----------------------- PRIOR
EXPECTED TO BE REFURBISH MEETING SOFT GUEST FRANCHISE
COMPLETED EXTERIOR RESTAURANT LOBBY SPACE GOODS FURNITURE BATH AFFILIATION
------------------ --------- ---------- ----- ------- ----- --------- ----- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CURRENT HOTELS
Courtyard by Marriott:
Fresno, California..... February 1994 'X' 'X' 'X' 'X' 'X' 'X' Hampton Inn
Riverside,
California........... June 1994 'X' 'X' 'X' 'X' 'X' 'X' 'X'
Doubletree Hotel:
Santa Fe, New Mexico... April 1996 'X' 'X' 'X' 'X' 'X' 'X' 'X' Best Western
Hampton Inn:
Mesa, Arizona..........
Arcadia, California....
Oakland, California.... July 1996 'X' 'X' 'X' 'X' 'X'
Denver, Colorado.......
Pueblo, Colorado.......
Silverthorne,
Colorado............. June 1996 'X' 'X' 'X' 'X'
December 1996 'X'
Clackamas (Portland),
Oregon(1)............ July 1996 'X' 'X' 'X' 'X' 'X' 'X' Cypress Inn
Holiday Inn:
Steamboat Springs,
Colorado............. February 1996 'X' 'X' 'X' 'X' 'X'
Provo, Utah............ June 1994 'X' 'X' 'X' 'X' 'X' 'X'
Holiday Inn Hotel &
Suites:
Craig, Colorado(1)..... August 1992 'X' 'X' 'X' 'X' 'X' 'X' 'X' Holiday Inn
Kent (Seattle),
Washington(1)........ July 1996 'X' 'X' 'X' 'X' 'X' 'X' Cypress Inn
Holiday Inn Express:
Portland, Oregon(1).... August 1996 'X' 'X' 'X' 'X' 'X' 'X' Cypress Inn
Poulsbo,
Washington(1)........ July 1996 'X' 'X' 'X' 'X' 'X' Cypress Inn
Residence Inn:
Highlands Ranch
(Denver), Colorado... August 1996 CURRENTLY UNDER CONSTRUCTION
ACQUISITION HOTELS
Comfort Suites:
South San Francisco,
California........... December 1996 'X' 'X'
Holiday Inn Hotel &
Suites:(1)
Price, Utah............ December 1996 'X' 'X' 'X' 'X' 'X' 'X' 'X'
Holiday Inn Select:
Renton (Seattle),
Washington(1)........ December 1996 'X' 'X' 'X' 'X' 'X' 'X' Holiday Inn
</TABLE>

- ---------------
(1) The Company has obtained a franchise license from the franchisor to rebrand
the hotel with the brand listed in the left-hand column of this table
subject to the completion of renovation or redevelopment.

44
<PAGE> 50

Comprehensive Marketing and Management Strategies. The hotels acquired by
the Company often lack adequate management and marketing programs. Through the
Management Company and the Lessee, the Company implements a full complement of
management and marketing programs at each acquired hotel designed to maximize
sales and operational efficiency. The Management Company developed a sales
program that the Lessee uses to direct and manage the sales activities of
personnel located at each hotel and a program to ensure that staff is properly
trained and that staffing levels are efficient. As part of the required
reporting process, each hotel must contact every business within a five-mile
radius to evaluate possible hotel use and revenue potential. The sales
department within each hotel reports to the Vice President -- Marketing and the
Director of Sales of the Lessee. The Lessee is required under the applicable
Percentage Lease to implement these programs. See "Business and
Properties -- The Percentage Leases" and "-- The Management Agreement."

Expansions. In certain cases, the Company may expand the number of rooms
at a hotel where occupancy, ADR and other market conditions justify such
expansion, and building permits can be obtained. The Company owns adjacent land
at five of the Current Hotels suitable for building additional rooms, however,
the Company currently believes that the Residence Inn in Highlands Ranch
(Denver), Colorado, and the Holiday Inn Hotel & Suites in Poulsbo, Washington,
are the only Hotels which are in markets that would support expansion. The
Residence Inn in Highlands Ranch has been designed to add a 42-room building if
and when market demand at the initial 78-room phase justifies the expansion. The
Holiday Inn Hotel & Suites in Poulsbo has land that can accommodate a 30- to
40-room expansion. The Company currently has no plans to expand either hotel.

Restaurant Leases. The Company's growth strategy includes encouraging the
Lessee to sublease restaurant facilities in the hotels (other than the Courtyard
by Marriott Hotels) to regional or national restaurant companies. The Company
believes this strategy is beneficial because it: (i) allows the Lessee to
concentrate on increasing room revenue, which benefits the Company because of
the higher Percentage Rent thresholds (from 60% to 65%) than the 5% of food and
beverage revenue; (ii) creates rents payable from the independent restaurant
company sublessee, which the Company believes will be greater than the
percentage rents from the Lessee for food and beverage because of the greater
expertise and resources of the restaurant company sublessee; and (iii) enhances
guest satisfaction by providing food service from experienced national or
regional restaurant companies. Eight of the Current Hotels have restaurant
facilities, of which the Lessee has subleased four to unaffiliated restaurant
companies including Old Chicago Bar & Grill, Mitzell American Restaurant, Ruby
River Steak House and Village Inn, and is actively seeking to sublease
restaurants at two of the four other Current Hotels.

DESCRIPTION OF FRANCHISES

Courtyard by Marriott Hotels

Two of the Current Hotels are licensed to operate as Courtyard by Marriott
hotels. Courtyard by Marriott hotels seek to offer guests moderately-priced
lodging with superior accommodations. Courtyard by Marriott hotels feature
in-room coffee makers, a limited-service restaurant and lounge and a toll-free
reservation number. According to Marriott, the first Courtyard by Marriott hotel
was opened in 1983, and, as of June 17, 1996, there were over 265 Courtyard by
Marriott hotels operating in the United States, Mexico and Canada.

Doubletree Hotels

One of the Current Hotels is licensed to operate as a full-service
Doubletree hotel. Full-service Doubletree hotels are targeted at business
travelers, group meetings and leisure travelers, and range in size from 120 to
720 rooms. Full-service Doubletree hotels typically include a swimming pool,
gift shop, meeting and banquet facilities, at least one restaurant and cocktail
lounge, room service, parking facilities and other services. As of March 31,
1996, there were 60 full-service Doubletree hotels in the United States and
Mexico.

Hampton Inn Hotels

Seven of the Current Hotels are licensed to operate as Hampton Inn hotels.
Hampton Inn hotels seek to offer guests consistent quality and value at all
locations. Hampton Inn was among the first hotel companies to offer guests an
unconditional 100% satisfaction guarantee. Most Hampton Inn hotels are limited
service hotels that feature complimentary continental breakfasts, free local
telephone and in-room movie channel, a toll-free

45
<PAGE> 51

reservation number and a special discount program for guests over 50 years of
age, but do not generally provide a restaurant or lounge. According to Hampton,
the first Hampton Inn hotel was opened August 1, 1984, and, as of March 31,
1996, there were over 531 Hampton Inn hotels operating in the United States,
Mexico and Canada. In 1985, Mr. Alter and Mr. Biederman developed and opened the
Hampton Inn hotel in Aurora, Colorado, which was the fourteenth hotel franchised
in the Hampton Inn system.

Holiday Inn Hotels

Six of the Current Hotels are licensed to operate as various Holiday Inn
brand hotels, and two of the Acquisition Hotels are licensed as Holiday Inn
brand hotels subject to the completion of certain renovations and improvements.
Mr. Alter is the immediate past President of the International Association of
Holiday Inns, the franchisee association for Holiday Inn hotels, and, through
his Affiliates, has been a Holiday Inn franchisee since 1980. All Holiday Inn
brand hotels participate in the Holiday Inn Priority Club frequent guest
program, and all offer a toll-free reservation number. As of July 1, 1996, there
were an aggregate of 1,792 hotels with Holiday Inn brands. Each of the Holiday
Inn brands is described below.

Holiday Inn. Holiday Inn hotels offer a full-service restaurant and
lounge, swimming pool, meeting and banquet facilities, optional fitness center,
and electronic locks. In-room amenities include a hairdryer, coffee maker, iron
and ironing board, alarm/clock radio and 25" televisions.

Holiday Inn Express. Holiday Inn Express is a limited-service hotel that
offers comfortable guest rooms that include a 25" television, alarm/clock radio,
and free local phone calls. A free continental breakfast on the hallmark
"breakfast bar" is also included in the Great Room/Lobby.

Holiday Inn Select. Holiday Inn Select specializes in servicing the
business traveler. Each room offers a residential decor with a well lighted work
area including a dataport and voicemail, and an in-room coffee maker. Amenities
offered at the hotel include full business services such as photocopying and
faxing, meeting capabilities for small to mid-size groups, swimming pool,
exercise facilities, and a full-service restaurant and lounge.

Holiday Inn Hotel & Suites. Holiday Inn Hotel & Suites are designed for
extended stay travelers who desire more room than is offered in a typical hotel
room. At least 15% of a hotel's rooms generally must be suites in order to
qualify for this franchise. Suites include a hairdryer, coffee maker, iron and
ironing board, alarm/clock radio, microwave oven, refrigerator, 25" television
and a sofa bed. Amenities at the hotel include guest laundry, fitness center,
restaurant and lounge, free continental breakfast, meeting facilities, and
swimming pool. Convenience store items are typically sold at a gift shop or
other service area.

Hawthorn Suites

The Company does not currently operate any hotels as Hawthorn Suites;
however, one of the Company's external growth strategies is to develop
extended-stay Hawthorn Suites hotels in several major urban markets on the West
Coast. See "Growth Strategy -- External Growth Strategy -- Hawthorn Suites
Master Development Agreement."

Hawthorn Suites offer travelers spacious suite accommodations, a free
breakfast buffet, swimming and fitness facilities and other amenities designed
to facilitate a more comfortable extended stay. Guest suites include separate
sleeping and living areas (many with fireplaces), fully equipped kitchens,
complimentary newspaper and manager's reception, irons and ironing boards in
every suite, on-site guest laundry facilities with available valet service,
on-site convenience store and grocery shopping services (at some locations),
business services, barbecue grills, airport shuttle service (at some locations),
and meeting facilities with full-service catering at most locations.

Comfort Suites

One of the Acquisition Hotels is licensed to operate as a Comfort Suites
hotel. Comfort Suites have separate living and sleeping areas, a 60 square foot
oversized bath, a sleeper sofa, television, a mini-refrigerator and microwave.
The hotels also generally feature a two-story vaulted lobby, on-site convenience
store, meeting space, fitness center and guest amenities such as a complimentary
newspaper and continental breakfast. According to Choice Hotels International,
currently a subsidiary of Manor Care and owner of the Comfort Suites franchise,
as of May 20, 1996 there were 81 Comfort Suites hotels.

46
<PAGE> 52

- --------------------------------------------------------------------------------

DESCRIPTION OF THE HOTELS

The following table contains descriptions of the Hotels, including
location, size, amenities, nearby points of interest and businesses, and
competition.
<TABLE>
<CAPTION>
NUMBER NUMBER
YEAR OF GUEST OF CORRIDOR LOT
HOTEL BUILT LOCATION ROOMS FLOORS DESIGN ACREAGE
-------------------------- ----- ------------------------- --------- --------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
THE CURRENT HOTELS
----------------------
Courtyard by Marriott..... 1989 1551 N. Peach Avenue 116 4 interior 3.0
Fresno, California Fresno, CA 93727
Courtyard by Marriott..... 1988 1510 University Avenue 163 6 interior 2.6
Riverside, California Riverside, CA 92507
Doubletree Hotel.......... 1985 3347 Cerrillos Road 213 3 exterior 4.6
Santa Fe, New Mexico Santa Fe, NM 87505
Hampton Inn............... 1987 1563 S. Gilbert Road 118 4 interior 2.1
Mesa, Arizona Mesa, AZ 85204
Hampton Inn............... 1988 311 East Huntington Drive 131 4 interior 2.2
Arcadia, California Arcadia, CA 91006
Hampton Inn............... 1986 8465 Enterprise Way 152 3 interior 2.3
Oakland, California Oakland, CA 94621

LOCAL POINTS OF
HOTEL INTEREST/BUSINESS AMENITIES COMPETITION
-------------------------- ------------------------- ------------------------- -------------------------
<S> <C> <C> <C>
THE CURRENT HOTELS
----------------------
Courtyard by Marriott..... Fresno Airport, Fresno Outdoor pool and spa, Holiday Inn, The Chateau
Fresno, California State University, 52 exercise room, two and The Piccadilly Inn.
miles south of Yosemite meeting rooms, voice mail
National Park and 57 and on command video and
miles from Kings Canyon limited service
National Park. restaurant.
Courtyard by Marriott..... University of California Outdoor heated pool and Holiday Inn, Hampton Inn
Riverside, California Riverside and Ontario spa and limited service and Days Inn.
Airport. restaurant.
Doubletree Hotel.......... Santa Fe, Taos, northern Restaurant and bar, Hilton, Hotel Santa Fe
Santa Fe, New Mexico New Mexico and the State indoor swimming pool, and Inn of Loretto.
Capitol. exercise room, two
whirlpools, guest laundry
facilities, six meeting
rooms, gift shop,
complimentary shuttle to
Historic Plaza, and
business center with
private conference
center.
Hampton Inn............... 20 miles from downtown Outdoor heated pool, Courtyard by Marriott,
Mesa, Arizona Phoenix and approximately whirlpool and two meeting Holiday Inn, Quality Inn,
14 miles from Phoenix rooms. Days Inn, Super 8 motel
International Airport, and Ramada Suites.
spring training for some
major league baseball
teams, local golf courses
and multiple business
parks.
Hampton Inn............... Commercial business Outdoor heated pool, a Holiday Inn and Wyndham
Arcadia, California related to companies hospitality suite and a Garden.
located in Pasadena, and meeting room.
group activities sports
events held at the Santa
Anita Racetrack, the Rose
Bowl and local
universities.
Hampton Inn............... Two miles from Oakland Deluxe complimentary Park Plaza Best Western,
Oakland, California International Airport, breakfast and snack in Holiday Inn and Hilton.
adjacent to the Coliseum, the evening,
five miles from Downtown complimentary 24 hour
Oakland, 16 miles from shuttle to and from the
San Francisco and 12 airport, Coliseum and Bay
miles from University of Areas Rapid Transit,
California-Berkeley. outdoor year-round heated
pool and spa and free
local calls.
</TABLE>

- --------------------------------------------------------------------------------

47
<PAGE> 53

- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NUMBER NUMBER
YEAR OF GUEST OF CORRIDOR LOT
HOTEL BUILT LOCATION ROOMS FLOORS DESIGN ACREAGE
-------------------------- ----- ------------------------- --------- --------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Hampton Inn............... 1986 9231 E. Arapahoe Road 152 5 interior 2.3
Denver, Colorado Englewood, CO 80112
Hampton Inn............... 1986 4703 North Freeway 112 2 exterior 4.0
Pueblo, Colorado Pueblo, CO 81008
Hampton Inn............... 1976 560 Silverthorne Lane 160 6 interior 5.4
Silverthorne, Colorado Silverthorne, CO 80498
Hampton Inn............... 1986 9040 SE Adams 114 4 interior 1.3
Clackamas (Portland), Clackamas, OR 97015
Oregon
Holiday Inn............... 1971 3190 S. Lincoln Avenue 82 2 interior 4.0
Steamboat Springs, Steamboat Springs, CO
Colorado 80477
Holiday Inn Express....... 1986 9707 SE Stark 85 3 interior 1.1
Portland, Oregon Portland, OR 97216

LOCAL POINTS OF
HOTEL INTEREST/BUSINESS AMENITIES COMPETITION
-------------------------- ------------------------- ------------------------- -------------------------
<S> <C> <C> <C>
Hampton Inn............... Denver Tech Center, Outdoor heated pool, Courtyard by Marriott,
Denver, Colorado Fiddlers Green Park exercise room, two Woodfield Suites, Holiday
Meadows Mall, Arapahoe meeting rooms, local Inn, Radisson and La
Racing Park, 20 miles to shuttle service, in-room Quinta.
factory outlet stores, coffee maker and
and near major business complimentary use of a
district. local health club.
Hampton Inn............... Colorado State Fair and Outdoor heated pool, in- Holiday Inn, Comfort Inn,
Pueblo, Colorado Exposition, University of room coffee maker, Ramada Inn and Best
Southern Colorado and meeting room and Western Inn.
Pueblo Industrial Park, complimentary use of a
nearby golfing, biking, local health club.
Pueblo Reservoir,
Greenway and Nature
Center, Colorado State
Fair, Greyhound Racing
and Royal Gorge
Hampton Inn............... Winter sport resorts Common areas on the main Luxury Suites, Days Inn,
Silverthorne, Colorado including Keystone, lobby level, game room, Holiday Inn, Best Western
Copper Mountain and indoor swimming pool, Old and The Inn in Keystone.
Breckenridge, fishing and Chicago Bar & Grill,
mountain climbing. guest laundry facilities,
gift/ski shop and meeting
room.
Hampton Inn............... 11 miles south of Complimentary breakfast Days Inn, Best Western
Clackamas (Portland), Portland International buffet and hospitality Sunnyside Inn, Monarch
Oregon Airport and 15 miles hour, indoor spas, Hotel and Holiday Inn
southeast of downtown exercise room and small Express.
Portland, near Clackamas conference room.
Town Center Mall, the
gateway to Mt. Hood
recreation areas and
Eastern Oregon.
Holiday Inn............... Steamboat Ski Area and Completely renovated Harbor Hotel, Sheraton
Steamboat Springs, winter sports, Steamboat outdoor heated pool, hot Hotel, Comfort Inn and
Colorado special events in the tub, exercise facility, Super 8.
summer time, Routt meeting room and ski
National Forest, fishing, shop, restaurant leased
mountain climbing, hot to Village Inn and
air-ballooning and Fireside Cocktail Lounge.
hunting.
Holiday Inn Express....... Four miles south of the Complimentary continental Chestnut Tree Inn,
Portland, Oregon Portland International breakfast buffet, heated Sunnyside Best Western,
Airport, across the outdoor pool, meeting Quality Inn, Travel Lodge
street from Mall 205 and room and complimentary and Days Inn.
six miles from downtown. shuttle service to and
from Portland
International Airport.
</TABLE>

- --------------------------------------------------------------------------------

48
<PAGE> 54

- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NUMBER NUMBER
YEAR OF GUEST OF CORRIDOR LOT
HOTEL BUILT LOCATION ROOMS FLOORS DESIGN ACREAGE
-------------------------- ----- ------------------------- --------- --------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Holiday Inn............... 1968 1460 S. University Ave. 78 2 interior 4.9
Provo, Utah Provo, UT 84601
Holiday Inn............... 1981 300 S. Highway 13 169 2 interior 47.0
Hotel & Suites Craig, CO 81625
Craig, Colorado
Holiday Inn Hotel......... 1986 22218 84th Avenue South 122 2 interior & 3.8
& Suites, Kent, WA 98032 exterior
Kent, Washington
Holiday Inn Express....... 1986 19801 NE 7th 63 2 interior 2.7
Poulsbo, Washington Poulsbo, WA 98370
Residence Inn............. 1996 93 Centennial Blvd. 78 4 interior 3.5
Highlands Ranch Highlands Ranch, CO 80126
(Denver), Colorado

LOCAL POINTS OF
HOTEL INTEREST/BUSINESS AMENITIES COMPETITION
-------------------------- ------------------------- ------------------------- -------------------------

<S> <C> <C> <C>
Holiday Inn............... East Bay Industrial Park, Complimentary continental Fairfield Inn, Comfort
Provo, Utah headquarters of Novell, breakfast, in-room Inn, Days Inn, Best
Sundance ski area and ironing boards/iron, Western, Hampton Inn and
Brigham Young University. outdoor heated pool, Provo Park.
exercise room, meeting
room, 600 square foot
boardroom and Ruby River
Steak House.
Holiday Inn............... Hunting, fishing, Holidome with indoor Best Western and four
Hotel & Suites bicycling, guided heated pool, whirlpool, independent hotels.
Craig, Colorado wilderness tours, near children's play area and
Steamboat Ski Area, arcade, fitness center,
corporate group and meeting room and 300
leisure business. square foot boardroom.
Holiday Inn Hotel......... 20 miles south of Complimentary continental Two small Best Western
& Suites, downtown Seattle, four breakfast buffet, large affiliates, Hawthorne
Kent, Washington miles from Boeing, eight seasonal outdoor pool and Suites, Value Inn,
miles from the airport, spa, comfortable meeting Embassy Suites, Residence
15 miles from facilities and exercise Inn, Hampton Inn,
Donnas/Supermall, 20 room, and Mitzel's Courtyard by Marriott,
miles from International American Kitchen. Homewood Suites and
Raceway and 90 miles from Doubletree Suites.
Mount Ranier.
Holiday Inn Express....... 35 miles via ferry or 70 Complimentary continental Silverdale on the Bay
Poulsbo, Washington miles via roadway from breakfast, buffet and Hotel and Resort and
downtown Seattle, seasonal outdoor pool. Poulsbo Inn.
extensive leisure market,
30 miles from Olympic
National park, one mile
from Historic Poulsbo
Norwegian Marine Science
Center, six miles from
Keyport Naval Museum and
18 miles from Bremerton
Naval Shipyard.
Residence Inn............. Chatfield reservoir, Fully-equipped kitchen Holtz Executive Village,
Highlands Ranch Fiddlers Green Park with full-sized Residence Inn and Embassy
(Denver), Colorado Meadows Mall, Arapahoe appliances in each unit, Suites.
Racing Park and 20 miles exercise room,
to factory outlet stores Continental breakfast,
and Roxborough State pool, spa, evening social
park. hour, sports court, guest
laundry, and grocery
shopping service.
</TABLE>

- --------------------------------------------------------------------------------

49
<PAGE> 55

- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NUMBER NUMBER
YEAR OF GUEST OF CORRIDOR LOT
HOTEL BUILT LOCATION ROOMS FLOORS DESIGN ACREAGE
-------------------------- ----- ------------------------- --------- --------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
THE ACQUISITION HOTELS
----------------------
Comfort Suites............ 1985 121 E. Grand Avenue 165 3 interior & 2.7
South San Francisco, South San Francisco, CA exterior
California 94003
Holiday Inn............... 1984 838 Westwood Boulevard 151 2 interior 4.5
Hotel & Suites Price, UT 84501
Price, Utah
Holiday Inn Select........ 1968 800 Rainier Avenue South 188 6 interior 5.2
Renton (Seattle), Renton, WA 98057-0487
Washington

LOCAL POINTS OF
HOTEL INTEREST/BUSINESS AMENITIES COMPETITION
-------------------------- ------------------------- ------------------------- -------------------------
<S> <C> <C> <C>
THE ACQUISITION HOTELS
----------------------
Comfort Suites............ Two miles from San Television, VCR and mini- La Quinta Inn, Ramada,
South San Francisco, Francisco Airport, 13 bar. Holiday Inn, Travelodge
California miles from downtown San North and Best Western
Francisco and Gateway Grosvenor.
Business Park.
Holiday Inn............... Coal mining, agriculture, Restaurant and lounge Super 8, National 9,
Hotel & Suites tourism, camping and (Golden Rock Cafe and Carriage House, Greenwell
Price, Utah trail rides through Nine Rockie's Lounge). Inn and Budget Host Inn.
Mile Canyon, Dinosaur
Museum, Margi-La Sal
National Forest and
College of Eastern Utah.
Holiday Inn Select........ Five miles from Sea-Tac Whirlpool, outdoor pool Embassy Suites, Homewoods
Renton (Seattle), Int'l Airport, one mile and restaurant on Suites, Hampton Inn,
Washington from South Center Mall, location. Residence Inn, Doubletree
12 miles from Downtown Inn and Doubletree
Seattle and waterfront, Suites.
eight miles from
Bellevue, next door to
six-plex movie theater.
</TABLE>

- --------------------------------------------------------------------------------

50
<PAGE> 56

OPERATING PERFORMANCE OF THE HOTELS

The following table sets forth certain information with respect to the
Current Hotels by franchise:

SUMMARY OF KEY OPERATING STATISTICS BY FRANCHISE
YEAR ENDED DECEMBER 31,

<TABLE>
<CAPTION>
ADR OCCUPANCY REVPAR(1)
$ % ($)
NO. OF ----------------------- ----------------- -----------------------
ROOMS 1993 1994 1995 1993 1994 1995 1993 1994 1995
------ ----- ----- ----- --- --- --- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Courtyard by Marriott....... 279 44.21 51.49 53.01 59.1 50.4 61.0 26.13 25.95 32.34
Doubletree Hotel............ 213 72.62 73.12 72.14 71.6 64.0 51.8 51.99 46.80 37.37
Hampton Inn(2).............. 939 55.83 55.71 57.75 70.5 71.2 72.4 39.36 39.67 41.81
Holiday Inn brands.......... 599 49.56 52.17 55.22 62.4 61.4 61.2 30.93 32.03 33.79
Residence Inn(3)............ 78 N/A N/A N/A N/A N/A N/A N/A N/A N/A
------
Total.............. 2,108
======
</TABLE>

- ---------------
(1) REVPAR is determined by dividing room revenues by available rooms for the
applicable period.

(2) The Hampton Inn-Silverthorne, Colorado hotel was closed during most of 1993
for a complete renovation and reopened in the fourth quarter of 1993.

(3) This Hotel is currently under construction, which the Company expects to be
completed during the third quarter of 1996.

The following table sets forth certain information with respect to each
Current Hotel and Acquisition Hotel and the Current Hotels and Acquisition
Hotels on a combined basis:

<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
---------------------------------------------- ----------------
HOTELS(1)(2) 1991 1992 1993 1994 1995 1995 1996
- --------------------------------- ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Courtyard by Marriott --
Fresno, California
Occupancy...................... 71.8% 69.2% 75.7% 64.6% 72.5% 70.2% 67.3%
ADR............................ $46.69 $49.71 $48.26 $60.21 $58.11 $58.83 $66.01
REVPAR......................... $33.52 $34.40 $36.53 $38.90 $42.13 $41.30 $44.43
Courtyard by Marriott --
Riverside, California
Occupancy...................... N/A N/A 47.3% 40.4% 52.9% 57.3% 55.2%
ADR............................ N/A N/A $39.59 $41.56 $48.04 $47.91 $51.04
REVPAR......................... N/A N/A $18.73 $16.79 $25.41 $27.45 $28.17
Doubletree Hotel --
Santa Fe, New Mexico
Occupancy...................... 57.5% 61.3% 71.6% 64.0% 51.8% 44.6% 21.0%
ADR............................ $71.64 $72.62 $72.62 $73.12 $72.14 $60.43 $55.16
REVPAR......................... $41.19 $44.52 $51.99 $46.80 $37.37 $26.95 $11.58
Hampton Inn --
Mesa, Arizona
Occupancy...................... 58.6% 61.1% 71.6% 81.8% 82.3% 93.4% 90.9%
ADR............................ $48.94 $48.68 $51.71 $53.68 $59.35 $76.44 $91.00
REVPAR......................... $28.68 $29.74 $37.02 $43.91 $48.85 $71.39 $82.72
</TABLE>

51
<PAGE> 57

<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
HOTELS(1)(2) 1991 1992 1993 1994 1995 1995 1996
- --------------------------------- ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Hampton Inn --
Arcadia, California
Occupancy...................... 68.6% 70.9% 65.3% 75.9% 64.2% 73.3% 59.0%
ADR............................ $52.64 $54.06 $57.02 $56.95 $60.78 $60.18 $66.51
REVPAR......................... $36.11 $38.33 $37.23 $43.23 $39.02 $44.11 $39.24
Hampton Inn --
Oakland, California
Occupancy...................... 68.7% 66.1% 64.9% 60.6% 85.0% 73.2% 88.3%
ADR............................ $53.18 $56.66 $55.98 $55.28 $47.13 $47.96 $46.30
REVPAR......................... $36.53 $37.45 $36.33 $33.50 $40.06 $35.11 $40.88
Hampton Inn --
Denver, Colorado
Occupancy...................... 65.3% 73.4% 77.0% 83.3% 80.2% 76.3% 73.6%
ADR............................ $45.70 $48.07 $51.82 $55.51 $62.32 $59.71 $67.01
REVPAR......................... $29.84 $35.28 $39.90 $46.24 $49.98 $45.56 $49.32
Hampton Inn --
Pueblo, Colorado
Occupancy...................... 68.5% 72.5% 82.0% 88.6% 87.4% 86.9% 80.7%
ADR............................ $45.31 $46.28 $48.06 $51.67 $57.38 $51.04 $52.78
REVPAR......................... $31.04 $33.55 $39.41 $45.78 $50.15 $44.35 $42.59
Hampton Inn --
Silverthorne, Colorado(3)
Occupancy...................... N/A N/A N/A 53.2% 58.6% 80.3% 84.0%
ADR............................ N/A N/A N/A $69.92 $69.57 $89.65 $87.73
REVPAR......................... N/A N/A N/A $37.20 $40.77 $71.99 $73.69
Hampton Inn --
Clackamas, Oregon
Occupancy...................... N/A 54.5% 57.1% 60.0% 48.9% 47.7% 44.9%
ADR............................ N/A $39.92 $42.74 $45.01 $47.95 $45.69 $48.26
REVPAR......................... N/A $21.76 $24.40 $27.01 $23.45 $21.79 $21.67
Holiday Inn --
Steamboat Springs, Colorado
Occupancy...................... 75.4% 74.3% 77.9% 72.6% 66.3% 91.0% 71.7%
ADR............................ $62.48 $63.45 $64.67 $68.14 $70.94 $90.24 $87.94
REVPAR......................... $47.11 $47.14 $50.38 $49.47 $47.03 $82.12 $63.05
Holiday Inn --
Provo, Utah
Occupancy...................... N/A 48.0% 59.7% 67.3% 78.5% 77.9% 76.8%
ADR............................ N/A $47.25 $49.09 $51.97 $54.67 $49.95 $51.75
REVPAR......................... N/A $22.68 $29.31 $34.98 $42.92 $38.91 $39.74
Holiday Inn Hotel & Suites --
Kent, Washington
Occupancy...................... N/A 55.0% 51.9% 49.3% 52.3% 47.4% 42.7%
ADR............................ N/A $48.49 $51.77 $53.05 $59.58 $56.24 $67.97
REVPAR......................... N/A $26.67 $26.87 $26.15 $31.16 $26.66 $29.02
</TABLE>

52
<PAGE> 58

<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
HOTELS(1)(2) 1991 1992 1993 1994 1995 1995 1996
- --------------------------------- ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Holiday Inn Hotel & Suites --
Craig, Colorado
Occupancy...................... 37.6% 51.2% 51.2% 53.0% 55.7% 46.5% 42.9%
ADR............................ $50.33 $41.32 $43.71 $46.18 $47.54 $45.07 $45.30
REVPAR......................... $18.92 $21.16 $22.38 $24.48 $26.48 $20.96 $19.43
Holiday Inn Express --
Portland, Oregon
Occupancy...................... N/A 79.9% 78.4% 76.7% 63.5% 60.6% 65.1%
ADR............................ N/A $39.23 $42.54 $45.30 $49.89 $44.18 $46.87
REVPAR......................... N/A $31.34 $33.35 $34.75 $31.68 $26.77 $30.51
Holiday Inn Express --
Poulsbo, Washington
Occupancy...................... N/A 70.2% 75.7% 65.9% 62.1% 39.9% 49.1%
ADR............................ N/A $42.74 $46.53 $51.12 $52.90 $49.79 $52.95
REVPAR......................... N/A $30.00 $35.22 $33.69 $32.85 $19.87 $26.00
Combined Totals --
Occupancy...................... 61.9% 64.2% 66.6% 64.7% 65.4% 65.6% 61.5%
ADR............................ $53.73 $51.53 $54.59 $56.09 $57.64 $60.46 $63.40
REVPAR......................... $33.26 $33.08 $36.36 $36.29 $37.70 $39.66 $38.99
ACQUISITION HOTELS
Comfort Suites --
South San Francisco, California
Occupancy...................... N/A 67.3% N/A 77.8% 83.3% 74.2% 85.2%
ADR............................ N/A $58.46 N/A $62.57 $63.91 $58.32 $58.84
REVPAR......................... N/A $39.34 N/A $48.68 $53.24 $43.27 $50.13
Holiday Inn Hotel & Suites --
Price, Utah
Occupancy...................... N/A N/A N/A 70.3% 69.0% 58.0% 55.5%
ADR............................ N/A N/A N/A $41.47 $40.85 $36.30 $37.38
REVPAR......................... N/A N/A N/A $29.15 $28.19 $21.05 $20.75
Holiday Inn Select --
Renton (Seattle), Washington
Occupancy...................... 55.0% 68.3% 66.9% 63.8% 74.3% 60.3% 66.6%
ADR............................ $57.37 $50.73 $51.78 $52.22 $57.18 $52.75 $62.12
REVPAR......................... $31.55 $34.64 $34.64 $33.32 $42.48 $31.81 $41.37
Total Hotels --
Occupancy...................... 61.0% 64.8% 66.7% 65.8% 67.4% 65.3% 63.1%
ADR............................ $54.16 $52.04 $54.35 $55.54 $57.08 $58.50 $61.54
REVPAR......................... $33.04 $33.72 $36.25 $36.55 $38.47 $38.22 $38.82
</TABLE>

- ---------------
(1) See the first table and footnotes thereto under the heading "The Hotels" in
the Prospectus Summary for information on the status of franchise licenses.

(2) Information with respect to the Sunstone Initial Hotels was obtained from
the owners of the Sunstone Initial Hotels and is only for the period such
Hotels were managed by the Sunstone Affiliates.

(3) The Hampton Inn-Silverthorne, Colorado hotel was closed during most of 1993
for a complete renovation and reopened in the fourth quarter of 1993.

53
<PAGE> 59

THE PERCENTAGE LEASES

In order for the Company to qualify as a REIT, neither the Company nor the
Partnership can operate any hotels. See "Risk Factors -- Lack of Control Over
Operations of the Hotels." The Partnership, therefore, leases the Current
Hotels, and will lease the Acquisition Hotels, to the Lessee for an initial term
of ten years pursuant to Percentage Leases which provide for Rent equal to the
greater of Base Rent or Percentage Rent. The Lessee is a corporation in which
Mr. Alter and Mr. Biederman are the sole stockholders. Other than working
capital sufficient to operate the Lessee and the Hotels, the Lessee has only
nominal assets. Each Percentage Lease will contain the provisions generally
described below, and the Company intends that future Percentage Leases with
respect to additional hotels it may acquire will contain substantially similar
provisions, although the Independent Directors may, in their discretion, alter
any of these provisions with respect to any proposed percentage lease, depending
on the purchase price paid, economic conditions and other factors deemed
relevant at the time. The Lessee will not lease or operate any hotel other than
those owned by the Partnership. The following summary is qualified in its
entirety by the Percentage Leases, the form of which has been filed as an
exhibit to the Registration Statement of which this Prospectus is a part.

Percentage Lease Terms

Each Percentage Lease has a non-cancelable initial term of ten years,
subject to earlier termination upon the occurrence of defaults thereunder and
certain other events described therein (including, particularly, the provisions
described herein under "Damage to Hotels," "Condemnation of Hotels" and
"Termination of Percentage Leases on Disposition of the Hotels"). In instances
where the Company buys a group of hotels which includes a hotel the Company does
not intend to retain, the Percentage Lease will be a month to month tenancy with
a right to terminate without a termination fee.

Amounts Payable Under the Percentage Leases

During the term of each Percentage Lease, the Lessee is obligated to pay to
the Partnership (i) the greater of Base Rent or Percentage Rent (which includes
a specified percentage of room revenues, 5% of the Lessee's food and beverage
revenues, 100% of any sublease and concession rentals and other net revenues
described in the Percentage Leases at the applicable hotels) and (ii) certain
other amounts, including interest accrued on any late payments or charges (the
"Additional Charges"). Base Rent accrues and is required to be paid monthly in
arrears. Both the Base Rent and the threshold room revenue amount in each
Percentage Rent formula is adjusted annually for inflation beginning January 1,
1996. The adjustment is calculated at the beginning of each calendar year based
upon the change in the CPI during the prior calendar year. Percentage Rent (if
any) is due monthly within forty-five days after the end of each calendar month
and is reconciled on a quarterly basis.

Except for the four hotels in the recently acquired Cypress Inns portfolio,
for the 12-month period ended December 31, 1995, room revenues from each Current
Hotel on an actual basis exceeded the revenue threshold for the payment of the
higher tier Percentage Rent under the applicable Percentage Lease.

The following table sets forth (i) the annual Base Rent, (ii) Percentage
Rent formulas and (iii) the pro forma Rent that would have been paid for each
Hotel pursuant to the terms of the Percentage Leases based on historical
revenues for the twelve months ended December 31, 1995, as if the Company had
owned the Hotels and the Percentage Leases had been in effect since January 1,
1995. For each Hotel, Percentage Rent would have been greater than Base Rent,
and the pro forma rents shown below represent such Percentage Rent.

54
<PAGE> 60

PERCENTAGE LEASE SUMMARY

<TABLE>
<CAPTION>
PRO FORMA
FOR THE
YEAR ENDED
ANNUAL DECEMBER
PERCENTAGE LEASE 31, 1995
ANNUAL ----------------- ROOM -----------
BASE FIRST SECOND REVENUE ROOM PERCENTAGE
LOCATION RENT(1) TIER(2) TIER(3) BREAKPOINT(1) REVENUE RENT(4)
- -------------------------------------- ---------- ------- ------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
CURRENT HOTELS:
Courtyard by Marriott:
Fresno, California.................. $ 405,000 30.0% 63.0% $ 1,350,000 $ 1,784,403 $ 768,590
Riverside, California............... 426,000 30.0% 60.0% 1,420,000 1,510,480 524,250
Doubletree Hotel:
Santa Fe, New Mexico................ 660,000 30.0% 63.0% 2,200,000 2,904,098 1,108,599
Hampton Inn:
Mesa, Arizona....................... 476,000 34.0% 63.0% 1,400,000 2,103,230 980,574
Arcadia, California................. 396,000 36.0% 63.0% 1,100,000 1,866,039 896,010
Oakland, California................. 418,000 22.0% 63.0% 1,900,000 2,178,429 593,410
Denver, Colorado.................... 566,250 37.5% 63.0% 1,510,000 2,771,499 1,412,344
Pueblo, Colorado.................... 450,000 36.0% 63.0% 1,250,000 2,050,358 993,912
Silverthorne, Colorado.............. 483,000 30.0% 63.0% 1,610,000 2,380,277 980,809
Clackamas (Portland), Oregon........ 437,000 38.0% 63.0% 1,150,000 976,469 464,312
Holiday Inn:
Steamboat Springs, Colorado......... 375,000 30.0% 60.0% 1,250,000 1,408,569 504,593
Provo, Utah......................... 160,000 20.0% 65.0% 800,000 1,222,237 536,023
Holiday Inn Hotel & Suites:
Craig, Colorado..................... 426,000 30.0% 60.0% 1,420,000 1,632,494 646,100
Kent (Seattle), Washington.......... 567,000 36.0% 63.0% 1,575,000 1,386,483 641,062
Holiday Inn Express:
Portland, Oregon.................... 363,000 33.0% 63.0% 1,100,000 983,719 372,309
Poulsbo, Washington................. 323,750 35.0% 63.0% 925,000 755,818 343,022
Residence Inn:
Highlands Ranch (Denver),
Colorado.......................... N/A N/A N/A N/A N/A N/A
---------- -----------
Totals (Current Hotels)...... 6,932,000 27,914,602 11,765,919
---------- -----------
ACQUISITION HOTELS:
Comfort Suites:
South San Francisco, California..... 720,000 30.0% 60.0% 2,400,000 3,204,950 1,272,963
Holiday Inn Hotel & Suites:
Price, Utah......................... 270,000 24.0% 60.0% 1,125,000 1,553,590 714,696
Holiday Inn Select:
Renton (Seattle), Washington........ 810,000 30.0% 62.0% 2,700,000 2,914,026 1,266,454
---------- -----------
Totals (Acquisition
Hotels).................... 1,800,000 7,672,566 3,254,113
---------- -----------
Totals (Hotels).............. $8,732,000 $35,587,168 $15,020,032
========== ===========
</TABLE>

- ---------------
(1) Effective January 1, 1996, Rent payable under the Percentage Leases were
adjusted based upon change in the CPI.

(2) Represents percentage of room revenue to be paid as Percentage Rent up to
room revenue breakpoint.

(3) Represents percentage of room revenue to be paid as Percentage Rent in
excess of room revenue breakpoint.

(4) Represents payments of rent from the Lessee to the Company calculated on a
pro forma basis by applying the rent provisions in the Percentage Leases
using historical revenues of the Hotels as if January 1, 1995 were the
beginning of the lease year. Includes Percentage Rent earned related to food
and beverage

55
<PAGE> 61

operations, sublease revenues and other net revenues. For pro forma expenses
associated with the operation of the Lessee and the Hotels, see Sunstone
Hotel Properties, Inc. -- Unaudited Pro Forma Combined Statements of
Operations and the notes thereto, and for pro forma expenses related to the
Company, see "Sunstone Hotel Investors, Inc. -- Unaudited Pro Forma
Consolidated Statements of Income" and the notes thereto, included in the
financial statements elsewhere in this Prospectus.

Other than real estate and personal property taxes, ground lease rent
(where applicable), the cost of certain furniture, fixtures and equipment and
capital expenditures, and insurance (other than workers' compensation
insurance), which are obligations of the Partnership, the Percentage Leases
require the Lessee to pay Base Rent, Percentage Rent, Additional Charges and the
operating expenses of the Hotels (including workers' compensation insurance,
utility, repairs and maintenance costs and other charges incurred in the
operation of the Hotels) during the terms of the Percentage Leases. The
Percentage Leases also provide for Rent reductions and abatements in the event
of damage or destruction or a partial taking of any Hotel as described under
"Damage to Hotels" and "Condemnation of Hotels."

Maintenance and Modifications

Under the Percentage Leases, the Partnership is required to pay for capital
improvements at each Hotel. In addition, the Percentage Leases obligate the
Partnership to make available to the Lessee for the repair, replacement and
refurbishment of furniture, fixtures and equipment in the Hotels, when and as
deemed necessary by the Lessee, an amount equal to 4.0% of room revenue per
quarter on a cumulative basis, provided that such amount may be used for capital
expenditures made by the Company respecting the Hotels. The amount in the
reserve is carried forward to the extent that the Lessee or the Partnership has
not expended such amount, and any unexpended amounts will remain the property of
the Partnership upon termination of the Percentage Leases. In addition, the
Company intends to cause the Partnership to spend amounts in excess of the
obligated amounts if necessary to comply with the reasonable requirements of any
Franchise Agreement and otherwise to the extent that the Company deems such
expenditures to be in the best interests of the Company. Otherwise, the Lessee
will be required, at its expense, to maintain the Hotels in good order and to
repair and to pay for all operating expenses of the Hotels subject to a
Percentage Lease with the Lessee.

The Lessee, at its expense, may make non-capital and capital additions,
modifications or improvements to the Hotels, provided that such action does not
significantly alter the character or purposes of the Hotels or significantly
detract from the value or operating efficiencies of the Hotels. All such
alterations, replacements and improvements shall be subject to all the terms and
provisions of the Percentage Leases and will become the property of the
Partnership upon termination of the Percentage Leases. The Partnership will own
substantially all personal property (other than inventory, linens and other
nondepreciable personal property which shall be owned by the Lessee) including
that portion affixed to, or deemed a part of, the real estate or improvements
thereon, except to the extent that ownership of such personal property not so
affixed would cause the Rent under a Percentage Lease not to qualify as "rents
from real property" for REIT income test purposes. See "Federal Income Tax
Considerations -- Requirements for Qualification -- Income Tests."

Insurance and Property Taxes

The Partnership is responsible for paying real estate and personal property
taxes on the Hotels (except to the extent that personal property associated with
the Hotels is owned by the Lessee) and all premiums for property, casualty,
comprehensive general public liability (naming the Lessee as an additional named
insured) and other insurance appropriate and customary for properties similar to
the Hotels, as determined by the Partnership. The Lessee is required to pay for
workers' compensation insurance. The Company believes that the coverage
specified in the Percentage Leases are of the type and amount customarily
obtained by owners of hotels similar to the Hotels.

Assignment and Subleasing

The Lessee will not be permitted to sublet all or any part of the Hotels or
assign its interest under any of the Percentage Leases, other than to an
Affiliate of the Lessee, without the prior written consent of the Partnership.
No assignment or subletting will release the Lessee from any of its obligations
under the Percentage Leases.

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Damage to Hotels

In the event of damage to or destruction of any Hotel occurring prior to
the last 24 months of the term of the Percentage Lease covered by insurance
which renders the Hotel unsuitable for the Lessee's use and occupancy, the
Lessee will be obligated to repair, rebuild, or restore the Hotel or offer to
acquire the Hotel on the terms set forth in the applicable Percentage Lease. If
the Lessee rebuilds the Hotel, the Partnership is obligated to disburse to the
Lessee, from time to time and upon satisfaction of certain conditions, any
insurance proceeds actually received by the Partnership as a result of such
damage or destruction, and any excess costs of repair or restoration will be
paid by the Lessee. If the Lessee decides not to rebuild and the Partnership
exercises its right to reject the Lessee's mandatory offer to purchase the Hotel
on the terms set forth in the Percentage Lease, the Percentage Lease will
terminate and the insurance proceeds will be retained by the Partnership. If the
Partnership accepts the Lessee's offer to purchase the Hotel, the Percentage
Lease will terminate and the Lessee will be entitled to the insurance proceeds.
In the event that damage to or destruction of a Hotel which is covered by
insurance does not render the Hotel wholly unsuitable for the Lessee's use and
occupancy, the Lessee generally will be obligated to repair or restore the
Hotel. Rent payable under the Percentage Lease shall be equitably abated during
any period required for repair or restoration of any damaged or destroyed Hotel.
If any such damage or destruction rendering the Hotel unsuitable for the
Lessee's use and occupancy occurs during the last 24 months of the Percentage
Lease, then either party may terminate the Percentage Lease upon 30 days prior
notice to the other party.

Condemnation of Hotels

In the event of a total condemnation of any Hotel, the relevant Percentage
Lease will terminate with respect to such Hotel as of the date of taking, and
the Partnership will be entitled to the condemnation award. In the event of a
partial taking which does not render the Hotel unsuitable for the Lessee's use,
the Lessee shall restore the untaken portion of the Hotel to a complete
architectural unit and the Partnership shall contribute to the cost of such
restoration that part of the condemnation award specified for restoration.

Events of Default

Each of the Percentage Leases is cross-defaulted so that a default under
one Percentage Lease constitutes a default under all of the Percentage Leases.
Events of Default under the Percentage Leases include, among others, the
following:

(i) the occurrence of an Event of Default under any other Percentage
Lease between the Partnership and the Lessee or any Affiliate of the
Lessee;

(ii) the failure by the Lessee to pay Base Rent when due and the
continuation of such failure for a period of 10 days thereafter;

(iii) the failure by the Lessee to pay Percentage Rent when due and
the continuation of such failure for a period of 10 days thereafter;

(iv) the failure by the Lessee to observe or perform any other term of
a Percentage Lease and the continuation of such failure for a period of 30
days after receipt by the Lessee of notice from the Partnership thereof,
unless such failure cannot be cured within such period and the Lessee
commences appropriate action to cure such failure within such 30-day period
and thereafter acts, with diligence, to correct such failure within such
time as is necessary;

(v) if the Lessee shall file a petition in bankruptcy or
reorganization pursuant to any federal or state bankruptcy law or any
similar federal or state law, or shall be adjudicated a bankrupt or shall
make an assignment for the benefit of creditors or shall admit in writing
its inability to pay its debts generally as they become due, or if a
petition or answer proposing the adjudication of the Lessee as a bankrupt
or its reorganization pursuant to any federal or state bankruptcy law or
any similar federal or state law shall be filed in any court and the Lessee
shall be adjudicated a bankrupt and such adjudication shall not be vacated
or set aside or stayed within 60 days after the entry of an order in
respect thereof, or if a receiver of the Lessee or of the whole or
substantially all of the assets of the Lessee shall be appointed in any
proceeding brought by the Lessee or if any such receiver, trustee or
liquidator shall be appointed in any

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proceeding brought against the Lessee and shall not be vacated or set aside
or stayed within 60 days after such appointment;

(vi) if the Lessee voluntarily discontinues operations of any Hotel
except as a result of damage, destruction or condemnation;

(vii) if the Franchise Agreement with respect to a Hotel is terminated
by the franchisor as a result of any action or failure to act by the Lessee
or its agents, other than the failure to complete improvements required by
a franchisor pursuant to the Franchise Agreement because the Partnership
fails to provide funds for such improvements; or

(viii) if the Lessee or any shareholder of the Lessee defaults under
the Unit Purchase Agreement, the Third Party Pledge Agreement or any other
agreement entered into by and between such shareholder and the Company or
the Partnership.

If an Event of Default occurs and continues beyond any curative period, the
Partnership will have the option of terminating the Percentage Lease or any or
all other Percentage Leases by giving the Lessee 10 days' written notice of the
date for termination of the Percentage Leases and, unless such Event of Default
is cured prior to the termination date set forth in such notice, the Percentage
Leases shall terminate on the date specified in the Partnership's notice and the
Lessee is required to surrender possession of each affected Hotel.

Termination of Percentage Leases on Disposition of the Hotels

In the event the Partnership enters into an agreement to sell a Hotel, the
Partnership will have the right to terminate the Percentage Lease with respect
to such Hotel upon at least 90 days' notice. Within six months of such
termination of any long-term Percentage Lease the Partnership shall either (i)
unless Mr. Alter and Mr. Biederman no longer own, collectively, 50% or more of
the Lessee or the Lessee has been in default in the payment of Base Rent for
more than 30 days with respect to such Hotel, pay the Lessee a termination fee
in an amount equal to the Lessee's net profit for such Hotel for the 12 month
period ended as of the last day of the calendar month immediately prior to date
of such termination (or, in the case of a bulk sale of all of the Hotels, 50% of
such amount payable at the closing of such bulk sale), or (ii) lease to the
Lessee one or more substitute Hotels on terms that would create a leasehold
interest in such Hotel with a fair market value equal to or exceeding the fair
market value of the Lessee's remaining leasehold interest under the Percentage
Lease to be terminated.

Subordination of Management Fees

The Lessee is permitted to engage a management company to assist the Lessee
in the operation and maintenance of the Hotels. The Percentage Leases provide
that effective upon written notice by the Lessee of any Event of Default under
the Percentage Leases, and during the continuance thereof, no payments will be
made to any management company with respect to any Hotel. In addition, each
management agreement which the Lessee enters into must provide that the
management company will repay to the Company any payments made to it by the
Lessee while any such Event of Default has occurred and is continuing. This
obligation is personally guaranteed by Mr. Alter during the term of the
Management Agreement. See "The Management Company -- The Management Agreement."

Franchise Agreement

The Lessee will be the franchisee under the Franchise Agreements with
respect to the Hotels. Upon the occurrence of certain events of default by the
Lessee under a Franchise Agreement, certain of the franchisors have agreed,
subject to certain terms and conditions, to issue a new Franchise Agreement for
the affected Current Hotels. See "Business and Properties -- Franchise
Agreements."

Other Lease Covenants

The Lessee may only incur debt associated with ordinary operating expenses
related to the operation of the Hotels.

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Breach by Partnership

Upon notice from the Lessee that the Partnership has breached the Lease,
the Partnership has 30 days to cure the breach or proceed to cure the breach,
which period may be extended in the event of certain specified, unavoidable
delays.

Inventory and Personal Property

All inventory required in the operation of the Hotels will be purchased at
the Lessee's expense and owned by the Lessee. The Partnership will have the
option to purchase all personal property related to such Hotel and owned by the
Lessee at fair market value upon termination of the Percentage Lease for that
Hotel. Any inventory used by Lessee in the operation of the respective Hotel
shall, upon termination of the Percentage Lease, become the property of the
Company.

Security Interest

The Partnership has a blanket lien on substantially all assets of the
Lessee, subject to the rights of any lender financing the purchase of personal
property by the Lessee.

THE MANAGEMENT AGREEMENT

Pursuant to the terms of the Management Agreement, the Management Company
will provide management and administrative services to the Lessee with respect
to the Hotels for a fee equal to 2% of the Hotels' gross revenues and
reimbursement of expenses by the Lessee. The Lessee anticipates that if
additional Hotels are acquired, the Lessee and the Management Company will enter
into similar management agreements with respect to such additional Hotels.
However, the Lessee is not obligated to enter into any additional management
agreements with the Management Company with respect to such additional Hotels.
See "The Management Company -- The Management Agreement." Neither the
Partnership nor the Company have any contractual or other obligations to the
Management Company.

FRANCHISE AGREEMENTS

The Company has either existing Franchise Agreements (12 of the Hotels), or
commitments executed by the franchisor and the franchisee to issue Franchise
Agreements subject to completion of renovations or construction (eight of the
Hotels). See the first table and footnotes thereto under the heading "The
Hotels" in the Prospectus Summary for information on existing franchise licenses
and commitments to issue licenses.

The Company anticipates that each of the additional hotels which it
acquires will be operated under franchise agreements with strong national
franchisors. The public's perception of quality associated with a franchisor is
an important feature in the operation of a hotel. Franchisors provide a variety
of benefits for franchisees which include national advertising, publicity and
other marketing programs designed to increase brand awareness, training of
personnel, continuous review of quality standards and centralized reservation
systems.

Franchise agreements generally specify certain management, operational,
recordkeeping, accounting, reporting and marketing standards and procedures with
which the franchisee must comply. The Franchise Agreements obligate the Lessee
to comply with the franchisors' standards and requirements with respect to
training of operational personnel, safety, maintaining specified insurance, the
types of services and products ancillary to guest room services that may be
provided by the Lessee, display of signage, and the type, quality and age of
furniture, fixtures and equipment included in guest rooms, lobbies and other
common areas.

Holiday Inn announced in September 1994, that franchisees that had entered
the system prior to January 1, 1989, and had not undertaken a recent major
product improvement plan would have to make significant capital expenditures to
conform to Holiday Inn's revised franchise compliance standards. These
requirements do not apply to the Holiday Inn-Provo hotel, the Holiday Inn-Craig
hotel and the Holiday Inn-Steamboat Springs hotel.

The Franchise Agreements for the Current Hotels expire at various times
ranging between 2000 and 2016. The Franchise Agreements provide for termination
at the franchisor's option upon the occurrence of certain events, including the
Lessee's failure to pay royalties and fees or perform its other covenants under
the

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Franchise Agreement, bankruptcy, abandonment of the franchise, commission of a
felony, assignment of the Franchise Agreement without the consent of the
franchisor, or failure to comply with applicable law in the operation of the
applicable Hotel. The Lessee will be entitled to terminate the Franchise
Agreement (other than the Courtyard by Marriott Franchise Agreements) only by
giving prior written notice and only by paying a significant amount of
liquidated damages. The amount of liquidated damages payable upon a termination
of the Franchise Agreement for the Hampton Inn-Arcadia, California hotel is
significantly higher if terminated during the first five years of the term of
such Franchise Agreement. The Franchise Agreements do not renew automatically
upon expiration. The Lessee will be responsible for making all payments under
the Franchise Agreements to the franchisors, except that pursuant to three-party
agreement among Marriott, the Lessee and the Partnership, the Partnership and
the Lessee are jointly and severally liable for the material obligations of the
franchisee under the Courtyard by Marriott Franchise Agreements. Mr. Alter has
executed certain personal guaranties covering the obligations of the Lessee
under the Holiday Inn, Hampton Inn and Doubletree Franchise Agreements. Mr.
Alter has also agreed to indemnify the Company for defaults by the Lessee with
respect to unpaid franchise fees and termination fees under all Franchise
Agreements for so long as the Percentage Leases are in effect.

Under the Holiday Inn Franchise Agreements, the Lessee will pay a royalty
generally of between 4% and 5% of room revenue from the Holiday Inn Current
Hotels, plus additional charges for services of up to $5.90 per room and
additional fees for sales, gross receipts or similar taxes imposed upon the
franchisor and for Travel Agent Commission Programs and Hotel Marketing
Association fees. In addition, the Lessee will pay a reservation fee of 1% of
room revenue and a marketing fee of 1.5% of room revenue.

Under the Hampton Inn Franchise Agreements, the Lessee will pay a franchise
fee of 4% of room revenue (plus additional fees for sales, gross receipts or
similar taxes imposed upon the franchisor) from the Hampton Inn Current Hotels.
In addition, the Lessee will pay a reservation and marketing fee of 4% of room
revenue.

Under the Courtyard by Marriott Franchise Agreement, the Lessee will pay an
initial royalty fee of 4% of room revenue, increasing to 5% of room revenue
after the first two years. In addition, subject to possible annual system-wide
increases, the Lessee will pay a marketing fee of between 2% and 3% of room
revenue, a reservation fee of approximately $4.90 per average reservation from
the Courtyard by Marriott Current Hotel, a communication support fee equal to
the lesser of $4.00 per room or $600 per year and a Property Management System
fee equal to the lesser of $3.00 per room or $400 per year to update and
maintain proprietary software programs of the franchisor.

Under the Doubletree Hotel Franchise Agreement, the Lessee would pay a
royalty fee of 2% of room revenue for the first year of the term of the
Franchise Agreement, 3% of room revenue for the second year and 4% of room
revenue for the third year and every year thereafter from the Doubletree hotel
in Santa Fe, New Mexico. In addition, the Lessee would pay a reservation and
marketing fee of 3.5% of room revenue.

Under the Comfort Suites Franchise Agreement, the Lessee will pay a royalty
fee of 4% of gross room revenue plus a marketing assessment of $8.00 per room
plus 1.3% of gross room revenues. There is an additional supplemental marketing
fee equal to $0.28 per day times the number of rooms. The Lessee is also
required to pay a reservation fee of 1% of the gross room revenues and a
reservations delivered charge of $1.00 per room night confirmed through the
franchisor's reservations system.

Holiday Inn, Hampton, Doubletree and Marriott have each agreed that, in the
event of certain events of default by the Lessee under the Franchise Agreement
or the Partnership's termination of a Percentage Lease, upon request by the
Partnership and the curing of all existing franchisee events of default, such
franchisor will allow that Current Hotel to be operated by a designee of the
Partnership acceptable to such franchisor for a specified period of time.

HOLIDAY INN(R), HOLIDAY INN EXPRESS(SM), HOLIDAY INN SELECT(SM) AND HOLIDAY
INN(R) HOTEL & SUITES ARE REGISTERED TRADEMARKS OF HOLIDAY INNS FRANCHISING,
INC. HAMPTON INN(R) IS A REGISTERED TRADEMARK OF PROMUS HOTELS, INC. COURTYARD
BY MARRIOTT(R) AND RESIDENCE INN(R) ARE REGISTERED TRADEMARKS OF MARRIOTT
INTERNATIONAL, INC. DOUBLETREE(R) IS A REGISTERED TRADEMARK OF

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DOUBLETREE HOTELS CORPORATION. COMFORT SUITES(R) IS A REGISTERED TRADEMARK OF
CHOICE HOTELS INTERNATIONAL, INC. NEITHER HOLIDAY INNS FRANCHISING, INC., PROMUS
HOTELS, INC., DOUBLETREE HOTELS CORPORATION, MARRIOTT INTERNATIONAL, INC. OR
CHOICE HOTELS INTERNATIONAL, INC. HAS ENDORSED OR APPROVED THE OFFERING. A GRANT
OF A FRANCHISE LICENSE BY SUCH COMPANIES FOR CERTAIN OF THE HOTELS IS NOT
INTENDED AS, AND SHOULD NOT BE INTERPRETED AS, AN EXPRESS OR IMPLIED APPROVAL OR
ENDORSEMENT BY SUCH COMPANIES (OR ANY OF ITS AFFILIATES, SUBSIDIARIES OR
DIVISIONS) OF THE COMPANY, THE PARTNERSHIP OR THE COMMON STOCK OFFERED HEREBY.

OPERATING PRACTICES

The Company's management recognizes the need for aggressive, market driven,
creative management given the competition in the hospitality industry.
Management of the Company has owned and managed hotels since 1976. Employees of
Affiliates of Mr. Alter and Mr. Biederman are employed by the Lessee and by the
Management Company, who manage each of the Current Hotels and will manage the
Acquisition Hotels and any other hotels acquired in the future. The Management
Company implements management systems developed by affiliates of the Company.
Such affiliates have also developed systems for marketing, ADR enhancement,
expense management, physical facility maintenance, human resources, accounting
and internal auditing. The general manager of each hotel reports to lead
managers, who in turn report to the Vice President of Marketing and the Director
of Sales of the Management Company. The Management Company's strategy is to
place responsibility and authority in the hands of the on-site general manager
with supervision by senior staff of the Management Company. See "The Management
Company" for a description of the management systems to be used by the
Management Company at the hotels.

EMPLOYEES

The Company is self-advised and thus retains Mr. Alter and Mr. Biederman as
officers and employees in accordance with the terms of the Alter Employment
Agreement and Biederman Employment Agreement, respectively, rather than
retaining an advisor. See "Management -- Alter Employment Agreement" and
"-- Biederman Employment Agreement." In addition to Mr. Alter and Mr. Biederman,
the Company has added two project managers. The Lessee currently employs
approximately 744 people, and upon the closing of the Acquisition Hotels will
employ approximately 867 people. The Lessee and each of the current owners of
the Acquisition Hotels have advised the Company that their relationship with
their respective employees is good and that they are not parties to any
collective bargaining agreement or other similar agreement.

ENVIRONMENTAL MATTERS

Under various federal, state and local laws and regulations, an owner or
operator of real property may be liable for the costs of assessment and
remediation of petroleum and hazardous substances present on, in or under such
property. Such laws often impose liability without regard to fault. Further, a
person that arranges for the disposal or transports for disposal or treatment of
a hazardous substance to or at another property may be liable for the costs of
assessment and remediation of hazardous substances released into the environment
at that property. Response costs for assessment and/or remediation may be
substantial, and the presence of such substances, or the failure to promptly
remediate such substances, may adversely affect the owner's ability to sell the
property or to borrow using the property as collateral. Thus, if such potential
liability were to arise in connection with the ownership and operation of the
Hotels, the Company, the Partnership or the Lessee may be potentially liable for
such costs.

Phase I environmental site assessments ("ESAs") were performed on all of
the Hotels and the Holiday Inn-Renton (Seattle), Washington hotel by an
independent environmental engineering firm. The Phase I ESAs were completed in
accordance with ASTM standards for Phase I ESAs, as amended by supplemental
criteria. The Phase I ESAs were intended to identify any potential sources of
contamination. No assurance can be given that the Phase I ESAs identified all
significant environmental issues or that no potential environmental liabilities
exist. The Phase I ESAs included historical reviews of the Hotels, reviews of
certain public records, preliminary investigations of the sites and surrounding
properties, screening for the presence of

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asbestos, PCBs, radon, underground storage tanks, and in one applicable case,
wetlands, followed by the preparation and issuance of written reports. The Phase
I ESAs did not include invasive procedures, such as soil or groundwater sampling
and analysis.

The Phase I ESAs disclosed that three of the Current Hotels (the Holiday
Inn-Provo, Utah hotel, the Holiday Inn-Craig, Colorado hotel and the Hampton
Inn-Silverthorne, Colorado), and the Holiday Inn-Renton (Seattle), Washington
hotel have asbestos containing materials ("ACM") on or in the insulation, floor
or ceiling coverings and in various other items. While the precise amounts of
ACM contained in these Hotels cannot be accurately determined without incurring
additional expense, the environmental engineer reported to the Company that the
existing ACM presents no threat to human health if managed in-place in
accordance with applicable laws. The Company has no plans, and is not required
by law, to remove ACM unless such material would be affected by proposed
renovation or demolition work and is or would become friable. The Company
intends to manage ACM in-place in accordance with applicable laws.

The Phase I ESAs have not revealed any environmental liability or
compliance concerns that the Company believes would have a material adverse
effect on the Company's business, assets, results of operations or liquidity,
nor is the Company aware of any such liability. Nevertheless, it is possible
that these Phase I ESAs do not reveal all environmental liabilities and there
may be material environmental liabilities or compliance concerns of which the
Company is unaware. Moreover, no assurances can be given that (i) future laws,
ordinances or regulations will not impose any material environmental liability,
or (ii) the current environmental condition of the Current Hotels will not be
affected by the condition of the properties in the vicinity of the Current
Hotels (such as the presence of leaking underground storage tanks) or by third
parties unrelated to the Partnership, the Lessee or the Company.

The Company believes that the Current Hotels are in compliance in all
material respects with all federal, state and local laws, ordinances and
regulations regarding hazardous substances and other environmental matters.
Neither the Company nor, to the knowledge of the Company, any of the current
owners of the Current Hotels have been notified by any governmental authority of
any material noncompliance, liability or claim relating to hazardous or toxic
substances or other environmental matter in connection with any of its present
or former properties.

COMPETITION

The hotel industry is highly competitive. Each of the Company's hotels is
located in a developed area that includes other hotels, many of which are
competitive with the Company's hotels in their locality. The number of
competitive hotels in a particular area could have a material adverse effect on
occupancy, ADR and REVPAR of the Hotels or at hotels acquired in the future. See
"Business and Properties."

There will be competition for hotel investment opportunities in mid-price
and upscale hotels from entities organized for purposes substantially similar to
the Company's objectives as well as other purchasers of hotels. The Company may
be competing for such hotel investment opportunities with entities which have
substantially greater financial resources than the Company and better
relationships with franchisors, lenders and sellers. These entities may
generally be able to accept more risk than the Company prudently can manage.
Competition may generally reduce the number of suitable investment opportunities
offered to the Company and increase the bargaining power of property owners
seeking to sell.

DEPRECIATION

Concurrently with the closing of the IPO, the Company made a cash
contribution to the Partnership in exchange for general and limited partnership
interests in the Partnership. The Partnership concurrently acquired for cash
certain of the Current Hotels and the Holiday Inn-Renton, Washington hotel. To
that extent, the Partnership's initial basis for federal income tax purposes
generally was equal to the purchase price paid by the Partnership to acquire
those Hotels. The Partnership is depreciating such depreciable hotel properties
for federal income tax purposes under the alternative depreciation system of
depreciation ("ADS"). Under ADS, the Partnership generally (i) depreciates
buildings and improvements over a 40-year recovery period using a straight-line
method and a mid-month convention, and (ii) depreciates personal property over a
12-year recovery period using a straight-line method and a half-year convention.

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To the extent that the Partnership acquired its ownership interest in the
Sunstone Initial Hotels and in any other Hotel in exchange for Units, the
Partnership's initial basis in each such hotel for federal income tax purposes
was the same as the transferor's basis in that hotel on the Partnership's date
of acquisition. The Partnership is depreciating such hotel properties for
federal income tax purposes over the same remaining useful lives and under the
same methods used by the transferors. The Partnership's tax depreciation
deductions are being allocated among the partners in accordance with their
respective interests in the Partnership (except to the extent that the
Partnership is required under Code Section 704(c) to use a method for allocating
depreciation deductions attributable to the Sunstone Initial Hotels or other
contributed properties that results in the Company receiving a
disproportionately larger share of such deductions). Because the Partnership's
initial basis in the Sunstone Initial Hotels and such other Hotels was less than
the fair market value of those hotels on the date of acquisition, the Company's
depreciation deductions may be less than they otherwise would have been if the
Partnership had purchased such hotels entirely for cash.

LEGAL PROCEEDINGS

Neither the Company nor the Partnership is currently involved in any
material litigation nor, to the Company's knowledge, is any material litigation
currently threatened against the Company or the Partnership or any of the
Current Hotels. The Lessee and the Management Company have each advised the
Company that it currently is not involved in any litigation. The current owners
of the Acquisition Hotels have advised the Company that there is no material
litigation threatened against or affecting the Acquisition Hotels.

POLICIES AND OBJECTIVES WITH RESPECT TO CERTAIN ACTIVITIES

The following is a discussion of the Company's policies with respect to
investment, financing, conflicts of interest and certain other activities. The
policies with respect to these activities have been determined by the Board of
Directors and may be amended or revised from time to time at the discretion of
the Board of Directors without a vote of the stockholders, except that (i)
changes in certain policies with respect to conflicts of interest must be
consistent with legal requirements, (ii) certain policies with respect to
competition are imposed pursuant to contracts that cannot be amended without the
consent of all parties thereto, (iii) the Company cannot amend the Debt
Limitation provided for in its Articles of Incorporation without the approval of
the holders of two-thirds of the outstanding shares of Common Stock and (iv) the
Company cannot take any action intended to terminate its qualification as a REIT
without the approval of the holders of two-thirds of the outstanding shares of
Common Stock.

INVESTMENT POLICIES

Investments in Real Estate or Interests in Real Estate

The Company's investment objective is to increase Cash Available for
Distribution. The Company intends to pursue this objective by acquiring
additional hotels that meet the Company's investment criteria and by leasing the
hotels to the Lessee pursuant to Percentage Leases. The Board of Directors has
appointed Mr. Alter and Mr. Biederman and other representatives of the Company
to review potential hotel acquisitions, visit the sites of proposed hotel
acquisitions, review market studies, review the terms of proposed percentage
leases for proposed hotel acquisitions and make recommendations to the Board of
Directors with respect to proposed acquisitions.

The Company intends to consider hotel acquisitions in the mid-price and
upscale market segments located primarily in the western United States, which
meet some or all of the Company's investment criteria (as more particularly
described above in "Business and Properties -- Growth Strategy -- External
Growth").

Such policies may be changed from time to time by the Company's Board of
Directors. There can be no assurance that the Company will be able to acquire
hotels which meet its investment criteria. See "Risk Factors -- Risk that
Pending Acquisitions Will Not Close," "-- Competition for Acquisition," "Hotel
Industry Risks" and "Real Estate Investment Risks."

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Investments in Other Entities

The Company also may participate with other entities in property ownership,
through joint ventures or other types of co-ownership. Equity investments may be
subject to existing mortgage financing and other indebtedness which may have
priority over the equity interest of the Company.

Investments in Real Estate Mortgages

While the Company will emphasize hotel investments, it may, in its
discretion, invest in mortgage and other real estate interests, including
securities of other REITs. The Company does not presently intend to invest in
mortgages or securities of other REITs. The Company also does not presently
intend to trade or underwrite securities or to make investments for purposes of
exercising control over other issuers. The Company may invest in participating
or convertible mortgages if it concludes that by doing so it may benefit from
the cash flow or any appreciation in the value of the subject property. Such
mortgages are similar to equity participation, because they permit the lender to
either participate in increasing revenues from the property or convert some or
all of that mortgage to equity.

FINANCING

The Company intends to make additional acquisitions of hotels and intends
to incur indebtedness under the Line of Credit to make such acquisitions. In
addition, the Company may from time to time fix the interest rate on a portion
of the Company's indebtedness when the Company determines it is advantageous to
do so. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Pro Forma Liquidity and Capital Resources."

The Company's Articles of Incorporation limit consolidated indebtedness to
the Debt Limitation. Subject to the Debt Limitation, the Company intends to
consider methods of debt financing other than, or in addition to, the proposed
Line of Credit. Any such future borrowings may be incurred through the
Partnership or the Company subject to certain limitations described below.
Indebtedness incurred by the Company may be in the form of bank borrowings,
secured and unsecured, and publicly and privately placed debt instruments.
Indebtedness incurred by the Partnership may be in the form of purchase money
obligations to the sellers of properties, publicly or privately placed debt
instruments, financing from banks, institutional investors or other lenders, any
of which indebtedness may be unsecured or may be secured by mortgages or other
interests in the hotels and other property owned by the Partnership. Such
indebtedness may be recourse to all or any part of the property of the Company
or the Partnership, or may be limited to the particular property to which the
indebtedness relates. The proceeds from any borrowings by the Company must be
re-lent to the Partnership on identical terms and conditions, except for
borrowings required to satisfy REIT qualification requirements, which are
approved by a majority of the Independent Directors. Subject to the applicable
terms of the loan documents, the proceeds of any borrowing by the Partnership
may be used to pay distributions or dividends, working capital, to refinance
existing indebtedness or to finance acquisitions, expansions, additions or
renovations of hotels. See "Federal Income Tax Considerations -- Requirements
for Qualification -- Distribution Requirements."

If the Board of Directors determines to raise additional equity capital,
the Board has the authority, without stockholder approval, to issue additional
shares of Common Stock, preferred stock or other capital shares of the Company
in any manner (and on such terms and for such consideration) as it deems
appropriate, including in exchange for property. Existing stockholders have no
preemptive right to purchase shares issued in any offering, and any such
offering might cause a dilution of a stockholder's investment in the Company.

CONFLICT OF INTEREST POLICIES

The Company has adopted certain policies and entered into certain
agreements designed to minimize potential conflicts of interest. The Board of
Directors is subject to certain provisions of Maryland law, which are designed
to eliminate or minimize certain potential conflicts of interest. However, there
can be no assurance that these policies always will be successful in eliminating
the influence of such conflicts, and if they are not successful, decisions could
be made that might fail to reflect fully the interests of all stockholders.

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<PAGE> 70

Provisions of the Company's Articles of Incorporation and Bylaws

The Company's Articles of Incorporation and Bylaws, with limited
exceptions, requires that a majority of the Board of Directors be comprised of
persons who are not officers or employees of the Company, Affiliates of officers
or employees of the Company or Affiliates of any advisor to the Company under an
advisory agreement, any lessee or contract manager of any property of the
Company, any of its subsidiaries, or any partnership which is an Affiliate of
the Company. The Articles of Incorporation provide that such Independent
Director requirement may not be amended, altered, changed or repealed unless
approved and advised by not less than 80% of the Board of Directors and only
with the affirmative vote of not less than two-thirds of the outstanding shares
of capital stock of the Company entitled to vote. In addition, the Company's
Articles of Incorporation and Bylaws provide that any agreement or transaction
in which the Company is purchasing, selling, leasing or mortgaging any real
estate asset, and any other agreement or transaction, in which an advisor,
director or officer of the Company, or any Affiliate of the foregoing, has any
direct or indirect interest, must, after disclosure of the interested party
relationship, be authorized, approved or ratified by a majority of the
directors, including a majority of the Independent Directors, even if the
Independent Directors constitute less than a quorum, or authorized, approved or
ratified by a majority of the votes entitled to be cast by the stockholders,
other than votes of the shares held of record by the interested person, or the
agreement or transaction is established to be fair and reasonable to the
Company.

Provisions of the Employment Agreements and Development by Mr. Alter and Mr.
Biederman

Pursuant to the Alter Employment Agreement and the Biederman Employment
Agreement, while any Percentage Lease is in effect, and for a specified period
thereafter, neither Mr. Alter nor Mr. Biederman nor any of their respective
Affiliates (including, in the case of Mr. Alter, the Lessee or the Management
Company), may (i) own, develop, invest in (other than any publicly-traded hotel
company in which they are not officers, directors or controlling shareholders)
or have any interest in any hotel and, with respect only to Mr. Biederman, any
other hotel is within a 20-mile radius of a hotel in which the Company has
invested or has the right to acquire, or (ii) with respect to Mr. Alter, manage
or lease any hotel or, with respect to Mr. Biederman, manage or lease any hotel
within a 20-mile radius of a hotel in which the Company has invested or has the
right to acquire, other than hotels owned directly or indirectly by an existing
client of the Management Company as of the closing of the IPO, provided, that
the total number of such hotels that can be so managed may not exceed one-half
of the number of hotels owned by the Company. See "Management -- Alter
Employment Agreement," and "-- Biederman Employment Agreement."

Each of Mr. Alter and Mr. Biederman has agreed that neither he nor any of
his Affiliates will receive any brokerage commissions or other fees with respect
to the acquisition of hotels by the Company.

The Partnership

A conflict of interest may arise between the Company, as general partner of
the Partnership, and certain of the Limited Partners of the Partnership,
including Mr. Alter and Mr. Biederman, due to the differing potential tax
liabilities to the Company and such Limited Partners from the sale of certain of
the Sunstone Initial Hotels resulting from the special allocation to such
partners of unrealized gain upon the sale of such Sunstone Initial Hotels. In an
effort to address this conflict of interest, the Company's bylaws provide that
the Company's decisions with respect to the sale of such Sunstone Initial Hotels
will be made by the Independent Directors. The Partnership Agreement gives the
Company, as General Partner of the Partnership, full, complete and exclusive
discretion in managing and controlling the business of the Partnership and in
making all decisions affecting the business and assets of the Partnership.

Provisions of Maryland Law

Pursuant to Maryland law (the jurisdiction under which the Company is
organized), each director of the Company is required to discharge his duties in
good faith with the care an ordinarily prudent person in a like position would
exercise under similar circumstances and in a manner he reasonably believes to
be in the best interest of the Company. In addition, under Maryland law, a
transaction with the Company in which a director or officer of the Company has a
direct or indirect interest is not voidable solely because of the directors' or
officers' interest in the transaction if (i) the transaction is authorized,
approved or ratified after disclosure of the interest, by the affirmative vote
of a majority of the disinterested directors, or by the affirmative vote of a

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<PAGE> 71

majority of the votes cast by disinterested stockholders, or (ii) the
transaction is fair and reasonable to the Company.

POLICIES WITH RESPECT TO OTHER ACTIVITIES

The Company's Articles of Incorporation authorize the Company to offer
shares of Common Stock or other securities and to repurchase or otherwise
reacquire its shares or any other securities and the Company may engage in such
activities in the future. As described under "Shares Available for Future Sale,"
the Company expects to issue shares of Common Stock to holders of Units upon
exercise of their Redemption Rights. The Company has not issued shares of Common
Stock, interests or any other securities to date, except in connection with the
formation of the Company and the issuance of restricted shares of Common Stock
to Mr. Enever and the Independent Directors. The Company has no outstanding
loans to other entities or persons, including its officers and directors. The
Company has not engaged in trading, underwriting or agency distribution or sale
of securities of other issuers, nor has the Company invested in the securities
of other issuers other than the Partnership for the purpose of exercising
control. The Company intends to make investments in such a way that it will not
be treated as an investment company under the Investment Company Act of 1940.

At all times, the Company intends to make investments in such a manner
consistent with the requirements of the Code for the Company to qualify as a
REIT unless, because of changing circumstances or changes in the Code (or in
Treasury Regulations), the Company's Board of Directors, with the approval of
the holders of at least two-thirds of the outstanding shares of all votes
entitled to be cast on the matter, determines to terminate its status as a REIT.

WORKING CAPITAL RESERVES

The Company will maintain working capital reserves in amounts that the
Board of Directors determines to be adequate to meet normal contingencies in
connection with the operation of the Company's business and investments.

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<PAGE> 72

MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

The Board of Directors consists of seven members, four of whom are
Independent Directors. The Board of Directors is divided into three classes. Mr.
Alter serves as the Company's Chairman of the Board, President, Chief Financial
Officer and Secretary and Mr. Biederman serves as the Company's Executive Vice
President.

Certain information regarding those individuals who serve as the directors
and executive officers of the Company is set forth below.

<TABLE>
<CAPTION>
NAME AGE POSITION CLASS EXPIRES
- -------------------------- --- ------------------------------------- ---------- -------
<S> <C> <C> <C> <C>
Robert A. Alter........... 45 Chairman of the Board, President, Class I 1998
Chief Financial Officer and Secretary
Charles L. Biederman...... 62 Executive Vice President and Director Class II 1997
C. Robert Enever.......... 68 Director Class III 1999
H. Raymond Bingham........ 51 Independent Director Class II 1997
Fredric H. Gould.......... 61 Independent Director Class I 1998
David Lambert............. 44 Independent Director Class III 1999
Edward H. Sondker......... 48 Independent Director Class III 1999
</TABLE>

ROBERT A. ALTER has served as Chairman of the Board of Directors,
President, Chief Financial Officer, and Secretary since August 1994. From 1990
until August 1995, Mr. Alter served as President of the Management Company,
which currently manages all of the Hotels owned by the Company. Mr. Alter also
serves as Chairman of the Board of Directors of both the Management Company and
the Lessee. Mr. Alter has been engaged in the hotel ownership, development and
management business since 1976. Affiliates of Mr. Alter owned interests in seven
of the ten hotels sold to the Company in the formation transactions consummated
at the IPO in August 1995. In 1991, the general contractor for the Courtyard by
Marriott-Fresno, California hotel, a corporation owned by Mr. Alter and Mr.
Biederman, was dissolved and liquidated pursuant to a bankruptcy proceeding. Mr.
Alter is a Certified Hotel Administrator, as designated by the American Hotel
and Motel Association, and is currently the immediate past President and a
member of the Board of Directors of the International Association of Holiday
Inns, the franchisee association for Holiday Inn hotels. Mr. Alter holds a
Bachelor of Science degree in Hotel Administration from Cornell University.

CHARLES L. BIEDERMAN has served as the Executive Vice President and a
director since September 1994. From 1990 until August 1995, Mr. Biederman served
as Executive Vice President of the Management Company. Mr. Biederman has
previously served as President of Provident Development Group Corporation which
engaged in the design, development and sale of luxury homes in South Florida,
from 1989 until 1992 and as President of Colorado Home Improvements, Inc., which
engaged in general contracting, renovation and related services for existing
homes in the Denver, Colorado area, since 1989. He is currently the President of
Woodstone Homes, Inc., which is engaged in luxury home construction in the Vail,
Colorado area, and a director of One Liberty Properties, Inc., a real estate
investment trust specializing in the purchase and leasing of single tenant net
leased properties throughout the United States. Mr. Biederman has been engaged
in the real estate development business since 1962. Affiliates of Mr. Biederman
owned interests in five of the ten hotels sold to the Company in the formation
transactions consummated in August 1995. In 1991, the general contractor for the
Courtyard by Marriott-Fresno, California hotel, a corporation owned by Mr. Alter
and Mr. Biederman, was dissolved and liquidated pursuant to a bankruptcy
proceeding. Mr. Biederman holds a Bachelor of Arts degree from Colgate
University, and a Bachelor of Architecture degree and a Masters in Architecture
degree from Columbia University and is a registered architect.

C. ROBERT ENEVER has served as a director since August 1995. Since 1983,
Mr. Enever has served as President of CRE Investments Ltd., a portfolio
management company, and has been engaged in the real estate development business
since 1972. Mr. Enever holds a Bachelor of Science degree in Economics from the
University of London, and a Masters in Business Administration degree in Finance
and Accounting from Northwestern University. Mr. Enever is a Certified Public
Accountant licensed in the State of Illinois.

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<PAGE> 73

FREDRIC H. GOULD has served as a director since August 1995. Mr. Gould has
served for the past five years as the General Partner of Gould Investors L.P., a
master limited partnership engaged in the ownership and operation of various
types of income-producing real property located throughout the United States and
which holds substantial interests in publicly held real estate investment trusts
and savings and commercial banks. Mr. Gould is currently a director of BFS
Bancorp Inc. and Bankers Federal Savings. In addition, Mr. Gould is currently
the Chairman of the Board of Trustees of BRT Realty Trust, a publicly-traded
mortgage real estate investment trust, and Chairman of the Board of Directors of
One Liberty Properties, Inc. Mr. Gould holds a Bachelor of Business
Administration degree from Lehigh University and an L.L.B. degree from New York
University Law School.

H. RAYMOND BINGHAM has served as a director since August 1995. Mr. Bingham
has served since 1993 as the Chief Financial Officer and Executive Vice
President of Cadence Design Systems, a publicly traded computer aided design
company. Prior to joining Cadence Design Systems, Mr. Bingham served as
Executive Vice President and Chief Financial Officer of Red Lion Hotels & Inns
for eight years. Mr. Bingham is the former Chairman of the American Hotel &
Motel Association Industry Real Estate Finance Council and a former Director of
the National Realty Committee. Mr. Bingham holds a Bachelor of Science degree in
Economics from Weber State College and a Masters in Business Administration
degree from Harvard Business School.

DAVID LAMBERT has served as a director since August 1995. Mr. Lambert has
served as Chief Financial Officer of Preview Media, a San Francisco Bay Area
online travel and media production company, since June 1995. Prior to joining
Preview Media, from 1992 to 1995 Mr. Lambert served as Chief Financial Officer
of Excalibur Technologies Corporation, a publicly traded computer software
company specializing in the indexing and retrieval of information. Mr. Lambert
served as a private consultant from 1991 to 1992, President and Chief Executive
Officer of Grand American Fare, Inc., a restaurant company, from 1985 to 1991,
served as Executive Vice President of Colony Hotels and Resorts, a subsidiary of
Radisson Hotels, from 1981 to 1985. Mr. Lambert holds a Bachelor of Arts degree
in Physics and Mathematics from Occidental College and a Masters in Business
Administration degree from the University of California, Los Angeles, and is a
real estate broker licensed in the State of California.

EDWARD H. SONDKER has served as a director since August 1995. Mr. Sondker
is currently President and Chief Executive Officer of Bayview Financial
Corporation, a publicly traded bank-holding company located in the San Francisco
Bay Area. Prior to joining Bayview Financial, Mr. Sondker served from 1990
through June 1995 as the President and Chief Executive Officer of Independence
One Bank of California. During the fifteen years prior to such time, Mr. Sondker
has served in senior executive positions with several independent financial
institutions having assets ranging in size from $200 million to over $1 billion.
Mr. Sondker holds a Bachelor of Arts degree and a J.D. degree from Washburn
University.

AUDIT COMMITTEE

The Audit Committee consists of Messrs. Gould, Bingham, Lambert and
Sondker. The Audit Committee will make recommendations concerning the engagement
of independent public accountants, review with the independent public
accountants the plans and results of the audit engagement, approve professional
services provided by the independent public accountants, review the independence
of the independent public accountants, consider the range of audit and non-audit
fees and review the adequacy of the Company's internal accounting controls. The
Audit Committee, with advice from the Company's attorneys and independent public
accountants, establishes procedures to monitor compliance with the REIT
provisions of the Code and the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and such other laws and regulations applicable to the Company.
The Company has engaged its independent public accountants for a period of two
years following the IPO to monitor compliance with the REIT provisions of the
Code.

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<PAGE> 74

COMPENSATION COMMITTEE

The Compensation Committee consists of Messrs. Gould, Bingham, Lambert and
Sondker. The Compensation Committee determines compensation for the Company's
executive officers and administers the Company's 1994 Stock Incentive Plan (the
"1994 Plan").

EXECUTIVE COMPENSATION

The table below sets forth the annual compensation paid in 1995 to Mr.
Alter, the President, Chairman of the Board, Chief Financial Officer and
Secretary, and Mr. Biederman, the Executive Vice President and a director of the
Company.

<TABLE>
<CAPTION>
ANNUAL COMPENSATION
------------------------------------------- LONG-TERM
OTHER ANNUAL ALL OTHER COMPENSATION
NAME OF INDIVIDUAL SALARY COMPENSATION(1) COMPENSATION(2) AWARDS
----------------------------------- ------- --------------- --------------- ------------
<S> <C> <C> <C> <C>
Robert A. Alter.................... $60,000 $ 5,976 $ 2,025 185,000(3)
Charles L. Biederman............... 30,000 5,100 8,235 55,000(4)
</TABLE>

- ---------------
(1) Represents payment of health insurance premiums by the Company on behalf of
the named Executive Officers.

(2) Represents life insurance premiums paid by the Company on behalf of the
named Executive Officers.

(3) Mr. Alter was granted incentive stock options to purchase 45,000 shares of
Common Stock and non-qualified stock options to purchase 140,000 shares of
Common Stock prior to the closing of the IPO. In 1996, Mr. Alter was granted
incentive stock options to purchase 15,043 shares of Common Stock and
non-qualified stock options to purchase 98,557 shares of Common Stock. The
terms of such options, including the exercise price thereof, are described
below under "1994 Stock Incentive Plan -- ISO and NQSO Awards." 213,600 of
Mr. Alter's stock options were granted to provide, at Mr. Alter's election,
a source of payment for the Lessee's obligations under its Stock
Appreciation Rights Plan, as discussed in footnote 4 on the following page.

(4) Mr. Biederman was granted incentive stock options to purchase 45,000 shares
of Common Stock and non-qualified stock options to purchase 10,000 shares of
Common Stock prior to the closing of the IPO. In 1996, Mr. Biederman was
granted incentive stock options to purchase 15,043 shares of Common Stock
and non-qualified stock options to purchase 68,357 shares of Common Stock.
The terms of such options, including the exercise price thereof, are
described below under "1994 Stock Incentive Plan -- ISO and NQSO Awards."
63,400 of Mr. Biederman's stock options were granted to provide, at Mr.
Biederman's election, a source of payment for the Lessee's obligations under
its Stock Appreciation Rights Plan, as discussed in footnote 4 on the
following page.

It is anticipated that as the Company makes hotel acquisitions increasing
the size of its asset base, the Compensation Committee will increase the annual
compensation of Mr. Alter. It is also anticipated that, based on recommendations
to the Compensation Committee by the President of the Company for performance of
special assignments, Mr. Biederman's compensation will also be increased. It is
further anticipated that future compensation of Mr. Alter, Mr. Biederman and
other employees of the Company will contain an incentive or bonus component
designed to reward improved operating performance of the Company. The Company
recently awarded Mr. Biederman a bonus of $200,000 for his work in connection
with renovation and redevelopment since the IPO. The compensation paid to the
officers and employees shall be commensurate with their position and determined
with reference to compensation paid to similarly situated employees and officers
of other REITs which the Compensation Committee deems comparable to the Company
and such other factors as the Compensation Committee deems relevant.

The Company's Bylaws provide that an annual meeting of stockholders shall
be held each year. At the annual meeting, the stockholders will vote on the
election of directors and transaction of such other business as may be properly
brought before the meeting. In addition, special meetings of the stockholders
may be called by the President, a majority of the directors, a majority of the
Independent Directors, or stockholders entitled to cast not less than 10% of all
the votes entitled to be cast at such meeting. The matters acted upon at any
meeting of stockholders shall be set forth in a notice from the Secretary
provided to each stockholder no less than 10 days and no more than 60 days
before the meeting.

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<PAGE> 75

The following table contains information concerning the grant of stock
options made under the Company's 1994 Plan for the fiscal year ended December
31, 1995 to the named Executive Officers.

OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE VALUE
----------------------------------------------------------- AT ASSUMED ANNUAL RATES
NUMBER OF OF STOCK PRICE
SECURITIES PERCENT OF TOTAL APPRECIATION
UNDERLYING OPTIONS GRANTED TO EXERCISE OR FOR OPTION TERM(S)(3)
OPTIONS EMPLOYEES IN BASIC PRICE EXPIRATION --------------------------
NAME GRANTED(1) 1995 ($/SH)(2) DATE 5%($) 10%($)
- --------------------- ---------- ------------------ ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Robert A. Alter...... 185,000(4) 77.0% $ 9.50 08/09/05 $1,105,282 $2,801,002
Charles L.
Biederman.......... 55,000(4) 23.0 9.50 08/09/05 328,597 832,730
</TABLE>

- ---------------
(1) All of the options were granted under the Company's 1994 Plan. Each of the
options will vest annually over five years from the grant date and are first
exercisable for up to 20% of the shares covered thereby one year from the
grant date. In addition, each of the options will automatically accelerate
in full in the event of an acquisition of the Company by a merger or asset
sale in which such option is not to be assumed or replaced by the successor
corporation. Each option includes a limited stock appreciation right which
provides the optionee with the right, exercisable upon the successful
completion of a hostile tender offer for more than 50% of the Company's
outstanding voting securities, to surrender the option to the Company, to
the extent the option is exercisable for vested shares, in return for a cash
distribution per surrendered option share equal to the excess of (i) the
fair market value on the surrender date over (ii) the option exercise price
payable per share. Each option will have a maximum term of 10 years, subject
to earlier termination following the optionee's cessation of service with
the Company.

(2) The exercise price may be paid in cash, in shares of the Common Stock valued
at fair market value on the exercise date or through a cashless exercise
procedure involving a same-day sale of the purchased shares. The Company may
also finance the option exercise by loaning the optionee sufficient funds to
pay the exercise price for the purchased shares, together with any federal
and state income tax liability incurred by the optionee in connection with
such exercise. The Compensation Committee of the Board of Directors, as the
Plan Administrator of the Company's 1994 Plan, has the discretionary
authority to reprice the options through the cancellation of those options
and the grant of replacement options with an exercise price based on the
fair market value of the option shares on the grant date.

(3) There is no assurance provided to any executive officer or any other holder
of the Company's securities that the actual stock price appreciation over
the 10-year option term will be at the assumed 5% and 10% levels or at any
other defined level. Unless the market price of the Common Stock does in
fact appreciate over the option term, no value will be realized from the
option grants made to the executive officers.

(4) The Company granted 130,000 of the stock options granted to Mr. Alter in
1995 and 10,000 of the stock options granted to Mr. Biederman in 1995,
together with an additional 83,600 stock options granted to Mr. Alter in
1996 and an additional 53,400 stock options granted to Mr. Biederman in
1996, in order to provide at Mr. Alter's and Biederman's election a source
of payment for the Lessee's obligations under its Stock Appreciation Rights
Plan (the "SAR Plan"). See "The Lessee -- 1996 Stock Appreciation Rights
Plan." Under the terms of the SAR Plan, the Lessee's employees will be
entitled to a cash payment equal to the increase in the share price of the
Common Stock over the base price at which the stock appreciation right is
granted. In order to fund this cash obligation of the Lessee, Mr. Alter and
Mr. Biederman have each agreed to contribute, in an 80/20 proportion
reflecting their stock ownership of the Lessee, an amount of money necessary
to make such payments to the extent that the Lessee does not otherwise have
sufficient cash.

There have been no options exercised for the fiscal year ended December 31,
1995 with respect to the above-named Executive Officers. No stock appreciation
rights were exercised by any such officer during such year and, except for the
stock appreciation rights described in footnote (1) above, no stock appreciation
rights were outstanding on December 31, 1995.

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<PAGE> 76

COMPENSATION OF DIRECTORS

Mr. Enever and each Independent Director is awarded Common Stock and is
granted options to purchase Common Stock pursuant to the 1994 Directors' Plan,
described below. See "Management -- The Directors Plan." In addition, the
Company will reimburse all directors for their out-of-pocket expenses incurred
in connection with their service on the Board of Directors. Neither Mr. Alter
nor Mr. Biederman will receive any compensation as a director, other than
reimbursement for their respective out-of-pocket expenses incurred in connection
with their attendance at meetings of the Board of Directors.

ALTER EMPLOYMENT AGREEMENT

In connection with the IPO, Mr. Alter entered into the Alter Employment
Agreement with the Company. Pursuant to the Alter Employment Agreement, Mr.
Alter serves as President of the Company. The Alter Employment Agreement
provided for an initial term of one-year, which term will renew automatically
until terminated. The Alter Employment Agreement provides for annual base
compensation of $60,000, subject to any increases in base compensation approved
by the Compensation Committee. The Alter Employment Agreement also provides for
certain severance payments upon termination by the Company without cause or by
Mr. Alter with cause. The Company maintains a comprehensive medical plan for the
benefit of Mr. Alter and provides life insurance and certain other fringe
benefits to Mr. Alter. The Alter Employment Agreement also contains the
agreement of Mr. Alter that he will devote substantially all of his time to the
business of the Company and that neither he nor his Affiliates will compete with
the Company for any development or management opportunities.

BIEDERMAN EMPLOYMENT AGREEMENT

In connection with the IPO, Mr. Biederman entered into the Biederman
Employment Agreement with the Company. Pursuant to the Biederman Employment
Agreement, Mr. Biederman serves as Executive Vice President of the Company. The
Biederman Employment Agreement provided for an initial term of one-year, which
term will renew automatically until terminated. The Biederman Employment
Agreement provides for annual base compensation of $30,000, subject to any
increases in such compensation based on recommendations by the President for
performance of special assignments. Given the scope of the renovation and
redevelopment work of the Company since the IPO, the Company recently awarded a
$200,000 bonus to Mr. Biederman. The Biederman Employment Agreement also
provides for certain severance payments upon termination by the Company without
cause or by Mr. Biederman with cause. The Company maintains a comprehensive
medical plan for the benefit of Mr. Biederman and will provide life insurance
and certain other fringe benefits to Mr. Biederman. The Biederman Employment
Agreement also contains the agreement of Mr. Biederman that neither he nor any
of his Affiliates will compete with the Company for any development or
management opportunities. It is not anticipated that Mr. Biederman will devote
substantially all of his time to the business of the Company.

1994 STOCK INCENTIVE PLAN

Administration

The Company has implemented the 1994 Plan to provide incentives to attract
and retain the services of executive officers and other employees and
consultants in the Company's service. The 1994 Plan is administered by the
Compensation Committee of the Board with respect to individuals who are subject
to the short-swing profit restrictions of the federal securities laws and may be
administered with respect to all other eligible individuals by either the
Compensation Committee or a secondary committee of two or more Board members. As
used in this summary, the term "Administrator" means the Compensation Committee
and any secondary committee acting within the scope of its administrative
discretion under the 1994 Plan. The Administrator generally has the authority,
within limitations described in the 1994 Plan, (i) to establish rules and
policies concerning the 1994 Plan, (ii) to determine the eligible individuals to
whom stock options, stock appreciation rights ("SARs"), restricted shares of
Common Stock and performance shares may be granted, (iii) to fix the number of
shares of Common Stock to be subject to each award and (iv) to set the terms and
provisions of each award.

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<PAGE> 77

Eligibility

Employees of the Company or its Affiliates, including officers and any
employees who are members of the Board, and consultants and other independent
advisors (including their respective employees) in the service of the Company
are eligible to participate in the 1994 Plan. Individuals selected by the
Administrator for participation in the 1994 Plan ("Participants") may, from time
to time, be granted stock options, SARs, restricted shares or performance
shares.

Options

Options granted under the 1994 Plan may be incentive stock options ("ISOs")
or nonqualified stock options ("NQSOs"). The exercise price will be equal to the
fair market value per share of Common Stock on the grant date and will be
payable in cash or with shares of Common Stock. No option may have a maximum
term in excess of 10 years, and each option will generally become exercisable in
a series of installments over the optionee's period of service with the Company.

SARs

SARs may be granted under the 1994 Plan in tandem with or independently of
options and will entitle the Participant to receive a payment from the Company
equal to the number of shares of Common Stock underlying the exercised SAR
multiplied by the excess of the fair market value per share of Common Stock on
the exercise date over the base price per share in effect for the SAR. The base
price per share in effect for each SAR may not be less than the fair market
value per share of Common Stock on the grant date of that SAR. The amount
payable upon the exercise of an SAR may be paid in cash or in shares of Common
Stock.

Restricted Direct Share Awards

Participants also may be awarded shares of Common Stock directly under the
1994 Plan, with the issue price payable in cash or by promissory note or as a
bonus for past services. The issued shares may either be fully vested upon
issuance or subject to a vesting schedule tied to the performance of certain
objectives established by the Administrator. These objectives may include a
minimum service requirement with the Company or the attainment of certain
performance milestones such as earnings per share, market price appreciation of
the Common Stock or return on assets.

Performance Share Awards

The 1994 Plan also provides for the award of performance shares which will
entitle the Participant to receive a payment equal to the fair market value of a
specified number of shares of Common Stock if certain objectives established by
the Administrator are met. Those objectives may be based on the appreciation on
the market price of the Common Stock, return on assets or earnings per share
targets. To the extent that performance shares are earned on the basis of the
attainment of the established objectives, payment of those awards may be made in
cash or in shares of Common Stock.

Share Authorization

A maximum of 500,000 shares of Common Stock may be issued under the 1994
Plan. However, no Participant may be granted, in any calendar year, options or
SARs that cover more than 250,000 shares of Common Stock. Options granted with
tandem SARs will be treated as a single award for purposes of applying such
limitation. The maximum number of shares of Common Stock that may be issued to a
Participant under the 1994 Plan in any calendar year pursuant to direct share
awards or in settlement of performance share awards is limited to 50,000 shares
of Common Stock in the aggregate. These share limitations and the terms of
outstanding awards will be adjusted, as the Compensation Committee deems
appropriate, in the event of a share dividend, share split, combination,
reclassification, recapitalization or other similar event.

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<PAGE> 78

Acceleration

In the event the Company is acquired by merger or asset sale, each
outstanding option which is not assumed by the successor corporation or replaced
with a cash incentive program which preserves the spread existing on the option
shares at the time of such acquisition will automatically accelerate in full,
and all unvested shares will immediately vest, except as otherwise provided in
the agreement evidencing the issuance of those shares. The Administrator will
have the discretion to provide for the accelerated vesting of any options or
unvested shares which do not otherwise vest at the time of the acquisition
should the service of the holder of those options or shares be terminated within
a designated period following the acquisition. The Administrator will also have
the discretion to provide for the accelerated vesting of all outstanding options
and unvested share issuances upon a hostile change in control of the Company
(whether effected by successful tender offer for more than 50% of the
outstanding voting stock or by proxy contest for the election of Board members)
or upon termination of the holder's service within a designated period following
such change in control.

Termination and Amendment

No option or SAR may be granted and no direct issuance or performance
shares may be made under the 1994 Plan after September 22, 2004. The Board may
amend or terminate the 1994 Plan at any time, but an amendment will not become
effective without stockholder approval if the amendment changes the eligibility
requirements or increases the benefits that may be provided under the 1994 Plan.

ISO and NQSO Awards

The Compensation Committee approved in connection with the IPO and
thereafter the grant of ISOs covering 60,043 shares of Common Stock and NQSOs
covering 238,557 shares of Common Stock to Mr. Alter and the grant of ISOs
covering 60,043 shares of Common Stock and NQSOs covering 78,357 shares of
Common Stock to Mr. Biederman. Both the ISOs and the NQSOs will become
exercisable in five successive equal annual installments upon their completion
of each year of service with the Company, measured from the grant date of the
option. The options have a maximum term of 10 years and an exercise price per
share equal to the fair market value of the Common Stock on the grant date of
the option.

Federal Income Taxes

No income is recognized by a Participant at the time an option is granted.
If the option is an ISO, no income will be recognized upon the Participant's
exercise of the option. Income is recognized by a Participant when he or she
disposes of shares acquired under an ISO. The exercise of a NQSO generally is a
taxable event that requires the Participant to recognize, as ordinary income,
the difference between the shares' fair market value on the exercise date and
the option price.

No income is recognized upon the grant of an SAR. The exercise of an SAR
generally is a taxable event. A Participant generally must recognize income
equal to any cash that is paid and the fair market value of the shares of Common
Stock that are received in settlement of an SAR.

A Participant will recognize income on account of a restricted share award
on the first day that the shares are either transferable or not subject to a
substantial risk of forfeiture. The amount of income recognized by the
Participant is equal to the fair market value of the shares of Common Stock on
that date.

A Participant will recognize income on account of the settlement of a
performance share award. A Participant will recognize income equal to any cash
that is paid and the fair market value of the shares of Common Stock (on the
date that the shares are first transferable or not subject to a substantial risk
of forfeiture) that is received in settlement of the award.

The employer (either the Company or its Affiliate) will be entitled to
claim a federal income tax deduction on account of the exercise of a NQSO or
SAR, the vesting of a restricted share award and the settlement of a performance
share award. The amount of the deduction is equal to the ordinary income
recognized by the Participant. The employer will not be entitled to a federal
income tax deduction on account

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of the grant or the exercise of an ISO. The employer may claim a federal income
tax deduction on account of certain dispositions of Common Stock acquired upon
the exercise of an ISO.

THE DIRECTORS PLAN

The Company has also implemented the 1994 Directors Plan (the "Directors
Plan") to provide incentives to attract and retain Independent Directors and
other nonemployee directors. 150,000 shares of Common Stock have been reserved
for issuance under the Directors Plan.

Eligibility

The Directors Plan provides for the award of shares of Common Stock and the
grant of options to purchase shares of Common Stock to each eligible director of
the Company. No director who is an employee of the Company or an Affiliate
(other than Mr. Enever) is eligible to participate in the Directors Plan. As a
non-employee director, Mr. Enever will be eligible to participate in the
Directors Plan. However, due to Mr. Enever's extensive personal relationship
history with Mr. Alter and as former general partner of certain of the Sunstone
Affiliates, Mr. Enever will not be deemed to be an Independent Director for
other purposes.

Options

In accordance with the Directors Plan, each eligible director who was a
member of the Board as of the closing of the IPO (a "Founding Director") was
granted an option covering 1,500 shares of Common Stock at the first Board
meeting following the first annual meeting of the Company's stockholders. An
option covering 1,500 shares of Common Stock was also granted to each other
eligible director at the first Board meeting following the annual meeting of the
Company's stockholders at which such director is first elected (the date of each
such Board meeting to be designated an "Award Date"). In addition, on the annual
anniversary of the date on which such eligible director became a member of the
Board, provided that such director is still a member of the Board on such date,
such eligible director will be granted an option covering an additional 1,500
shares of Common Stock. The exercise price per share of Common Stock subject to
each option will be the fair market value per share of Common Stock on the date
the option is granted. The exercise price may be paid in cash or in shares of
Common Stock. Options issued under the Directors Plan are exercisable for 10
years from the date of grant. The share reserve, the number of shares and
exercise price subject to outstanding options and the number of shares for which
options will thereafter be awarded will be subject to adjustment in the event of
a share dividend, share split, combination, reclassification, recapitalization
or other similar event.

Exercise of Options

An option granted under the Directors Plan is immediately exercisable and
may be exercisable for all the option shares as fully vested shares whether or
not the director is a member of the Board of Directors on the date of exercise.

Stockholder Rights

A director will have no rights as a stockholder with respect to shares of
Common Stock subject to his or her option until the option is exercised. A
director will have the right to vote all shares of Common Stock awarded to him
or her under the Directors Plan and will receive all dividends paid with respect
to the shares.

Share Awards

Each eligible Founding Director who was a member of the Board of Directors
(i.e., each Independent Director and Mr. Enever) as of the closing of the IPO
was awarded 1,500 shares of Common Stock on that date. Each individual who first
joins the Board as a non-employee Director after the IPO Closing will also
receive a 1,500 share award on the date of the first Board meeting following the
first annual shareholders meeting at which such individual is elected to the
Board. In addition, each eligible director will receive, on each anniversary of
the date on which he or she became a member of the Board of Directors, provided
that such director is still a member of the Board of Directors on such
anniversary date, a number of whole shares of

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Common Stock having a fair market value that as nearly as possible equals, but
does not exceed, $15,000. Any eligible director who, during the term of the
Directors Plan, ceases to be a member of the Board of Directors but is
subsequently reelected to the Board of Directors (a "Re-elected Director") will
receive, on the first Award Date after he or she is re-elected to the Board of
Directors, a number of shares of Common Stock having a fair market value on that
date that as nearly as possible equals, but does not exceed, $15,000.

Vesting of Awards

Each Founding Director immediately and fully vested in the shares awarded
to him at the closing of the IPO. Subsequent awards of shares under the
Directors Plan are subject to a six-month vesting period. Accordingly, such
shares will be forfeited in the event the director does not complete at least
six months of service as a member of the Board of Directors following the award
date of such shares. All shares outstanding under the Directors Plan will
immediately vest upon certain changes in control or ownership of the Company.

Amendment and Termination

The Directors Plan provides that the Board may amend or terminate the Plan,
but the Plan may not be amended more than once every six months other than to
comport with changes in the Internal Revenue Code or the rules and regulations
promulgated thereunder. An amendment will not become effective without
stockholder approval if the amendment changes the eligibility requirements or
increases the benefits that may be provided under the Directors Plan. The
Directors Plan will terminate on September 22, 2004.

LIMITATION OF LIABILITY AND INDEMNIFICATION

The Company's Articles of Incorporation and Bylaws limit the liability of
the Company's directors and officers for money damages to the Company and its
stockholders to the fullest extent permitted from time to time by Maryland law.
Maryland law presently permits the liability of directors and officers to a
corporation or its stockholders for money damages to be limited, except (i) to
the extent that it is proved that the director or officer actually received an
improper benefit or profit, or (ii) to the extent that a judgment or other final
adjudication is entered in a proceeding based on a finding that the director's
or officer's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action, as adjudicated in the
proceeding. This provision does not limit the ability of the Company or its
stockholders to obtain other relief, such as an injunction or rescission.

The Company's Articles of Incorporation and Bylaws require the Company to
indemnify its directors and officers to the fullest extent permitted from time
to time by Maryland law. The Company's Articles of Incorporation and Bylaws also
permit the Company to indemnify employees, agents and other persons acting on
behalf of or at the request of the Company. The MGCL permits a corporation to
indemnify its directors, officers and certain other parties 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 to or at the request of the Company, unless it is established
that: (i) the act or omission of the indemnified party was material to the
matter giving rise to the proceeding and was committed in bad faith or was the
result of active and deliberate dishonesty; (ii) the indemnified party actually
received an improper personal benefit; or (iii) in the case of any criminal
proceeding, the indemnified party had reasonable cause to believe that the act
or omission was unlawful. Indemnification may be made against judgments,
penalties, fines, settlements and reasonable expenses actually incurred by the
director or officer in connection with the proceeding; provided, however, that
if the proceeding is one by or in the right of the Company, indemnification may
not be made with respect to any proceeding in which the director or officer has
been adjudged to be liable to the Company. In addition, a director or officer
may not be indemnified with respect to any proceeding charging improper personal
benefit to the director or officer in which the director or officer was adjudged
to be liable on the basis that the personal benefit was improperly received. The
termination of any proceeding by conviction, or upon a plea of nolo contendere
or its equivalent, or an entry of any order of probation prior to judgment,
creates a rebuttable presumption that the director or officer did not meet the
requisite standard of conduct required for indemnification to be permitted.
Indemnification under the provisions of the MGCL is not deemed exclusive to any
other rights, by indemnification or otherwise, to which an officer or director
may

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be entitled under the Company's Articles of Incorporation or Bylaws, or under
resolutions of shareholders or directors, contract or otherwise. It is the
position of the Securities and Exchange Commission (the "Commission") that
indemnification of directors and officers for liabilities arising under the
Securities Act of 1933, as amended (the "Securities Act"), is against public
policy and is unenforceable pursuant to Section 14 of the Securities Act.

The Company has entered into indemnification agreements with each of its
directors and officers that require the Company to indemnify such directors and
officers to the fullest extent permitted by applicable provisions of the MGCL,
provided that any settlement of a third party action against a director or
officer is approved by the Company, and subject to limitations for actions
initiated by the director or officer, penalties paid by insurance, and
violations of Section 16(b) of the Securities Exchange Act of 1934, as amended,
and similar laws.

CERTAIN EVENTS WITH RESPECT TO MR. ALTER AND MR. BIEDERMAN

In 1991, the general contractor for the Courtyard by Marriott-Fresno,
California hotel, a corporation owned by Mr. Alter and Mr. Biederman, was
dissolved and liquidated pursuant to a bankruptcy proceeding.

In 1992, the loan secured by the Hampton Inn-Mesa, Arizona hotel went into
default and a receiver was appointed. The Sunstone Affiliate that owns this
Hotel renegotiated the loan and the receiver was discharged.

STRATEGIC CONSULTANT

The Company has a preliminary consulting agreement with Geller & Co., a
leading hotel consulting firm, to provide strategic advice to the Company in
connection with its external growth strategy, and anticipates entering into a
definitive consulting agreement following the closing of the Offering. Under the
proposed consulting agreement, Laurence Geller, principal of Geller & Co., will
help the Company identify acquisition and development opportunities and may also
assist the Company in negotiating such opportunities. The consulting agreement
will require that Geller & Co. and Laurence Geller be prohibited from entering
into certain engagements which are competitive with the Company. It is intended
that the consulting arrangement will be for an initial term of two years with
one option to extend for an additional year at the Company's election. The
Company will pay Geller & Co.'s expenses in connection with its consulting to
the Company, and will pay fees only in the form of grants of the Company's
Common Stock and options to acquire Common Stock. It is anticipated that the
Common Stock and options to acquire Common Stock will be granted in the
following amounts: (i) a restricted stock grant of 5,000 shares of Common Stock
per year, issued in blocks of 1,250 at the beginning of each quarter; and (ii)
non-qualified options to purchase 50,000 shares of Common Stock, which will vest
in equal installments each month over 24 months. Of the options to acquire
50,000 shares, 25,000 will be exercisable at the market price per share of
Common Stock on the date of grant, and 25,000 will be exercisable at the market
price at the time of the grant plus $5.00. The Company is currently discussing
with Geller & Co. the terms of the consulting arrangement, and there can be no
assurance that an agreement will be entered into.

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CERTAIN TRANSACTIONS

The Company and the Partnership have entered or will enter into a number of
transactions with Messrs. Alter, Biederman, Enever and the Sunstone Affiliates,
including the Lessee. Mr. Alter, the Chairman of the Board of Directors and the
President of the Company, is the sole stockholder of the Management Company, and
an 80% shareholder of the Lessee. Mr. Biederman, a director and Executive Vice
President of the Company, is a 20% shareholder of the Lessee. After the
Offering, Messrs. Alter, Biederman and Enever will collectively own
approximately 10.85% of the Units of the Partnership.

MINIMIZING THE RISKS OF POTENTIAL CONFLICTS OF INTEREST

In order to minimize conflicts of interest inherent in the legal structure
required to maintain the Company's status as a REIT, Mr. Alter and Mr. Biederman
each have entered into several agreements. Their respective Employment
Agreements restrict competitive activities and the Third Party Pledge Agreement
require each of Mr. Alter and Biederman to pledge Units to the Company to secure
obligations of the Lessee under the Percentage Leases with a value equal to four
months initial Base Rent for the hotels now leased or which are acquired in the
future and leased to the Lessee. In addition, Messrs. Alter and Biederman
entered into a Unit Purchase Agreement with the Company and the Lessee requiring
that the Lessee's income (net of shareholder tax liability) be used to either
accumulate reserves to pay Rent under the Percentage Leases or to purchase Units
from the Partnership at the then current price of the Common Stock. The
Percentage Leases also contain cross-default provisions permitting the Company
to terminate the Percentage Leases, subject to certain conditions, upon a
default by the Lessee under any Percentage Lease, Mr. Alter or Mr. Biederman
under the Unit Purchase Agreement or any other agreement with the Company.
Further, the Management Company has agreed not to collect any payments from the
Lessee after receiving notice of an event of default under a Percentage Lease.
Mr. Alter has personally guaranteed the Lessee's obligation to return any
amounts received by the Management Company in violation of this agreement.

INITIAL CAPITALIZATION

In connection with the incorporation and initial capitalization of the
Company, Mr. Alter and Mr. Biederman purchased for $123,000 and $90,000,
respectively, 12,300 Units and 9,000 Units, respectively, and Mr. Enever
purchased 3,200 shares of Common Stock for $32,000 (which shares were exchanged
for Units upon the closing of the IPO). In connection with such initial
capitalization, Messrs. Alter, Biederman and Enever were granted warrants to
purchase 17,042 Units, 12,470 Units and 4,434 Units at $9.50 per Unit,
respectively, having an aggregate estimated value of $123,000. The warrants are
exercisable for up to five years at a purchase price per share of $9.50.

PERCENTAGE LEASES

In order to qualify as a REIT, the Company has leased each of its Hotels to
the Lessee pursuant to the Percentage Leases. Each Percentage Lease has been
approved by a majority of the Independent Directors. The Percentage Leases are
designed to allow the Company to participate in revenue growth by providing that
(i) between approximately 60% to 65% of room revenues in excess of specified
amounts, (ii) 5% of the Lessee's food and beverage revenues, (iii) 100% of any
sublease and concession rentals, and (iv) 100% of other net revenues described
in the Percentage Lease for the applicable Hotel in excess of Base Rent will be
paid to the Partnership as Percentage Rent. Once such expenses together with all
other operating expenses of each hotel is paid by the Lessee, the Lessee will be
entitled to all of the net income from the Hotels.

ACQUISITION OF THE SUNSTONE INITIAL HOTELS

The Company acquired the seven Sunstone Initial Hotels from the Sunstone
Affiliates, in exchange for an aggregate consideration consisting of (i) the
assumption of approximately $23.5 million of mortgage indebtedness and other
obligations relating to the Sunstone Initial Hotels, (ii) approximately $832,000
in cash distributed to non-continuing investors for their equity interests, and
(iii) the issuance of approximately 1,288,500 Units in the Partnership, valued
at approximately $12.2 million based on the IPO price of $9.50 per share of
Common Stock. Each of the Units is exchangeable, at the option of the holder
thereof, at any time

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after August 16, 1996 (other than 219,068 Units issued to one of the Affiliates
of Mr. Alter and Mr. Enever, which are immediately redeemable for Common Stock),
for the same number of shares of Common Stock. Accordingly, consideration with a
value of approximately $10,250,605 was provided by the Partnership to acquire
assets having a net tangible book value deficit as of March 31, 1995 of
($7,166,000). Upon exercise of their redemption rights, the Sunstone Affiliates
would receive an aggregate of 1,288,500 shares of Common Stock or, at the
Company's option, an equivalent amount of cash or a combination thereof, except
that Common Stock cannot be issued to such persons if such issuance would cause
the Company to violate certain REIT restrictions. In addition, the Sunstone
Affiliates were released from approximately $6 million of joint and several
liability relating to the third party indebtedness paid by the Partnership in
the formation transactions related to the IPO.

MANAGEMENT AGREEMENT

The Lessee has entered into the Management Agreement with the Management
Company for each of the Hotels it leases from the Partnership. Pursuant to the
Management Agreement, the Management Company provides management and
administrative services to the Lessee in consideration for 2% of gross revenue
and reimbursement of certain direct expenses incurred by the Management Company
for the Lessee. As the sole shareholder of the Management Company, Mr. Alter is
entitled to the net income of the Management Company.

EMPLOYMENT AGREEMENTS

At the IPO, the Company entered into Employment Agreements with each of Mr.
Alter and Mr. Biederman that will continue in effect until August 16, 1996, and
will renew automatically each year until terminated. Mr. Alter serves as
President and is required to devote substantially all of his time to the
business of the Company with an annual base compensation of $60,000 a year
subject to any increases approved by the Compensation Committee. Mr. Biederman
serves as Executive Vice President for an annual base compensation of $30,000,
subject to any increases based on recommendations by the President of the
Company for performance of special assignments. Mr. Biederman is not required to
devote substantially all of his time to the business of the Company. Each of the
Employment Agreements restrict competitive activities by Mr. Alter, Mr.
Biederman or any of their affiliates.

THIRD PARTY PLEDGE AGREEMENT

Mr. Alter and Mr. Biederman, as the stockholders of the Lessee, have
pledged to the Partnership Units with a value on the date of the pledge equal to
four months of initial Base Rent (or approximately $2.6 million) under each
Percentage Lease for each Current Hotel and the Holiday Inn Select-Renton,
Washington hotel, to secure the Lessee's obligations under the Percentage
Leases. Since the IPO, the amount of pledged Units has been increased by $0.6
million and will be further increased by an amount equal to four months Base
Rent for each additional hotel leased by the Lessee from the Partnership.
Provided no event of default under one or more of the Percentage Leases exists,
these pledged Units will be returned to the pledgors on the third anniversary of
each such Percentage Lease.

UNIT PURCHASE AGREEMENT

Mr. Alter and Mr. Biederman entered into the Unit Purchase Agreement with
the Company, the Lessee and the Partnership to use distributions from the
Lessee, in excess of their tax liability for earnings of the Lessee, to either
accumulate reserves for the Lessee's rental obligations due under the Percentage
Leases or purchase from the Partnership additional Units at the then current
market price of the Common Stock. The Unit Purchase Agreement will remain in
effect so long as there is a Percentage Lease in effect.

PURCHASE OF COURTYARD BY MARRIOTT-RIVERSIDE, CALIFORNIA HOTEL

On April 1, 1996, the Partnership acquired the Courtyard by
Marriott-Riverside Hotel, California hotel subject to the existing first and
second trust deed with an outstanding principal balance of approximately $3
million together with the agreement to issue Units representing the difference
between the purchase price and the assumed indebtedness. The purchase price was
calculated based on an 11% capitalization rate times the "Net Operating Income"
for the 12 months ended March 31, 1996. An Affiliate of Mr. Alter and

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Mr. Biederman purchased this hotel in 1994 for $2.7 million and spent $950,000
substantially renovating and converting the hotel to a Courtyard by Marriott.

In connection with the acquisition by Mr. Alter's and Mr. Biederman's
Affiliate of the Courtyard by Marriott-Riverside, California hotel, Independence
One Bank of California made a loan in the amount of approximately $2.1 million
which is secured by this hotel. Edward H. Sondker, a director of the Company,
was the president and chief executive officer of Independence One Bank of
California at the time such loan was made, but was not then a director of the
Company.

PURCHASE OF RESIDENCE INN-HIGHLANDS RANCH, COLORADO HOTEL

The Company exercised the option to purchase the Highlands Ranch, Colorado
hotel in December 1995. To consummate the exercise of the option, an Affiliate
of Mr. Alter and Mr. Biederman assigned all of its right, title and interest in
and to a purchase agreement for the real property that comprised the building
site for the Residence Inn-Highlands Ranch, Colorado hotel and all rights under
any development agreements or related documents to the Company in exchange for
reimbursement of all out-of-pocket expenses incurred by such entity in an amount
of approximately $50,000.

PERSONNEL AND OFFICE SHARING ARRANGEMENT AND CERTAIN REIMBURSEMENTS

The Company shares offices with the Lessee and the Management Company and
shares the costs thereof, including rent, salaries of all office personnel
(except Mr. Alter and Mr. Biederman), office supplies and telephones. During
1995, the Company paid to the Lessee approximately $5,000 per month for its
portion of such costs. Such allocations of shared costs are subject to the
approval of a majority of the Independent Directors of the Company. In addition,
the Company reimburses, subject to approval of a majority of the Independent
Directors, the Lessee for certain due diligence costs, transactional costs and
allocated costs of certain Lessee employees relating to acquisitions of hotels
by the Company. In 1995, the Company paid approximately $115,000 of such
expenses to the Lessee.

INDEMNIFICATION AGREEMENTS

The Company has entered into an Indemnification Agreement with each of its
directors (the "Indemnification Agreements") which provides that, with certain
exceptions, the Company will hold harmless and indemnify its directors to the
fullest extent permitted under Maryland Law. Under the Indemnification
Agreements, the Company is obligated to indemnify each of its directors against
all expenses (including attorneys' fees), fines, judgments and settlement
amounts that such director may incur in connection with any action or proceeding
(other than an action by or in the right of the Company) to which the director
is or may be made a party to by reason of such director's position as a
director, officer, employee or agent of the Company or any other company or
enterprise to which the person provides services at the request of the Company.

Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the Company
pursuant to the foregoing provisions, or otherwise, the registrant has been
advised that in the opinion of the Commission such indemnification is against
public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Company of expenses incurred or paid
by a director, officer or controlling person of the Company in the successful
defense of any action, suit or proceeding) is asserted by such director, officer
or controlling person in connection with the securities being registered, the
Company will, unless in the opinion of its counsel the matter has been settled
by controlling precedent, submit to 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.

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THE LESSEE

GENERAL

The Lessee leases the Current Hotels and one of the Acquisition Hotels
pursuant to the Percentage Leases and it is anticipated that the Lessee will
lease the remaining Acquisition Hotels and any additional hotels acquired by the
Company pursuant to similar percentage leases. The Lessee presently employs
approximately 744 people and upon the closing of the Acquisition Hotels will
employ approximately 867 people. Under the Percentage Leases, the Lessee
generally will be required to perform all operational functions necessary to
operate the Current Hotels and the acquired Acquisition Hotel. Such functions
include ordering supplies, maid service, laundry and maintenance.

The Lessee will be entitled to all gross revenue from the Current Hotels
and the acquired Acquisition Hotel after payment of Rent and other amounts due
under the Percentage Leases, payment of a management fee to the Management
Company, initially equal to 2% of gross revenues, and of all accounting-related
expenses and all out-of-pocket expenses of the Management Company incurred in
connection with the performance of its obligations under the Management
Agreement, and other operating expenses. The Lessee is required to provide
operating information about each of the Current Hotels and the acquired
Acquisition Hotel, quarterly financial statements, annual audited financial
statements and any other information material to the Lessee's continuing ability
to perform its obligations under the Percentage Leases. The Company will include
this information in its periodic reports filed with the Commission under the
Exchange Act. Kenneth J. Biehl serves as Chief Financial Officer and Secretary
of the Lessee. Carol A. Verret serves as the Vice President -- Marketing of the
Lessee and David R. Kinkade serves as Vice President -- Acquisitions of the
Lessee.

The Partnership must rely on the Lessee to generate sufficient cash flow
from the operation of the Current Hotels and the acquired Acquisition Hotel to
enable the Lessee to pay the higher tier Percentage Rent necessary for the
Company to fund the distributions to holders of the Common Stock. The
obligations of the Lessee under the Percentage Leases are secured and
cross-defaulted so that a default under one Percentage Lease constitutes a
default under all of the Percentage Leases. Other than working capital
sufficient to operate the Current Hotels and the acquired Acquisition Hotel, the
Lessee has only nominal assets in addition to its rights and benefits under the
Percentage Leases. See "Business and Properties -- The Percentage Leases."

MANAGEMENT

Certain information with respect to key personnel of the Lessee is set
forth below.

Kenneth J. Biehl (age 42) is currently the Chief Financial Officer and
Secretary and has served in such position since February 1996. Prior to joining
the Lessee, Mr. Biehl served as Vice President and Corporate Controller of
Starwood Lodging Corporation, the hotel operating company for one of the largest
hotel REIT's in the United States. Prior to joining the Lessee, Mr. Biehl served
with E & Y Kenneth Leventhal Real Estate Group, Price Waterhouse and KPMG Peat
Marwick. Mr. Biehl has ten years of experience in the real estate and
hospitality industry. Mr. Biehl holds a Bachelor of Science degree in Accounting
from Brigham Young University and is a Certified Public Accountant licensed in
the State of California.

Carol A. Verret (age 46) is currently the Vice President -- Marketing of
the Lessee and has served in such position since 1990. During the seven years
prior to joining the Lessee, Ms. Verret served as a Director of Marketing for
Radisson, Ramada and Sheraton Hotels and The Warwick, an independent hotel in
Denver, Colorado. Ms. Verret holds a Bachelor of Arts degree and a Master of
Arts degree in Political Science from McGill University in Montreal, Quebec.

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David R. Kinkade (age 58) is currently the Vice President -- Acquisitions
of the Lessee and has served in such position since December 1995. During the
six years prior to joining the Lessee, Mr. Kinkade served as Director of Systems
Development -- Western Region for Hampton, Director of Development for
Crossroads Hospitality Company and Director of Operations for Oceanside Pier
Restaurant. Mr. Kinkade holds a Bachelor of Business Administration degree from
the University of Oregon and a Master of Business Administration degree in
Hotel, Restaurant and Institutional Management from Michigan State University.
Mr. Kinkade is also a Certified Public Accountant licensed in the State of
California.

Sheila Bowen (age 34) is Director of Sales of the Lessee. Prior to
employment with the Lessee, Ms. Bowen was Director of Sales for Lodging
Unlimited and has over ten years of hospitality sales experience. At the Lessee,
Ms. Bowen is responsible for sales and marketing of the Company's existing
properties.

Rosemary Stoll (age 39) is currently the Director of Human Resources of the
Lessee Company and has served in such position since November 1995. During the
13 years prior to joining the Lessee, Ms. Stoll served as Director of Human
Resources for Holiday Inns, Registry, and Sheraton Hotels. Ms. Stoll holds a
Bachelor of Arts degree in Education from Rutgers University in New Brunswick,
New Jersey.

Heidi Torr (age 40) is Asset Manager for the Lessee and has served in such
position since 1995. Prior to joining the Lessee, Ms. Torr served as Real Estate
Specialist with the Federal Deposit Insurance Company in Irvine, California and
as Assistant Project Manager for Rielly Homes Development, a real estate
development company in Irvine, California. Ms. Torr has 16 years of experience
in the real estate industry.

Robert G. Combie (age 40) is currently a Lead Manager for the Lessee and
joined the Lessee in January 1996. During the past ten years he has been a
Project Manager for The Hotel Group; General Manager, Hampton Inn Seattle
Airport and Operations Manager for Beachwood Resort, Blaine, Washington. Mr.
Combie is a Certified Hotel Administrator, is Hampton Inn Manager certified and
holds a degree from the University of Massachusetts in Hotel, Travel and
Tourism. Mr. Combie has 22 years experience in the hospitality industry.

Susan R. Landgraf (age 45) is currently a Lead Manager for the Lessee. Ms.
Landgraf joined a predecessor of the Lessee in 1993. In the ten years prior to
joining the Lessee, Ms. Landgraf served as Director of Marketing and General
Manager at Holiday Inns in Wisconsin, Oklahoma and Texas. Ms. Landgraf is a
Certified Hotel Administrator and holds a degree in Business Communication from
the University of Wisconsin and studied technical writing at the University of
New Orleans. Ms. Landgraf has 17 years experience in the hospitality industry.

Karen Trujillo (age 38) is currently a Lead Manager for the Lessee. Ms.
Trujillo joined a predecessor of the Lessee in 1983. Ms. Trujillo is certified
in the Hampton Inn Management Development Program, Hampton Inn Mentor Training
Program, and Hampton Inn Revenue Maximization. Ms. Trujillo has 23 years
experience in the hospitality industry.

1996 STOCK APPRECIATION RIGHTS PLAN

The Lessee has implemented a special stock appreciation rights plan (the
"SAR Plan") for employees and consultants in the service of the Lessee and the
non-employee members of the Lessee's Board of Directors. Under the SAR Plan,
stock appreciation rights ("SARs") tied to the value of the Company's publicly
traded shares of Common Stock may be granted with respect to 277,000 shares of
Common Stock. However, the granted SARs will not provide the holders with any
shareholder or other equity interest in the Company or the Lessee. Each granted
SAR may have a base price less than, equal to, or greater than, the fair market
value per share of Common Stock on the grant date and will become exercisable in
a series of installments over the holder's period of service with the Lessee.
Upon exercise, the holder will receive a cash payment from the Lessee equal to
the number of shares of Common Stock underlying the exercised SAR multiplied by
the excess of (i) the fair market value per share of Common Stock on the
exercise date over

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(ii) the base price per share in effect for the exercised right. Outstanding
SARs will have a maximum term of ten years, subject to earlier termination in
connection with the holder's termination of service with the Lessee. SARs will
be subject to full and immediate vesting and cash out upon certain changes in
ownership of either the Company or the Lessee.

The Lessee intends to grant 162,400 SARs with a base price of $9.50 per SAR
to 98 of the Lessee's employees, including each of the corporate officers and
key employees at the corporate office of the Lessee (Chief Financial Officer,
Vice President -- Marketing, Vice President -- Acquisitions, Director of Sales,
and Asset Manager) and each of the management personnel at the property level
(Lead Hotel General Managers, Hotel General Managers, Sales Directors and
Department Heads). The Lessee intends to increase the number of SARs covered by
the SAR Plan, to continue to grant SARs to new management personnel at each of
the hotels it acquires and to periodically grant additional SARs to both
corporate and hotel level management personnel in order to create incentives for
performance that increases the value of the Common Stock. Mr. Alter and Mr.
Biederman each intend to contribute to the Lessee in proportion to their stock
ownership (80%/20%) of the amounts necessary to fund any SAR payments to the
extent that the Lessee does not otherwise have sufficient operating cash flow to
make such payments. The Company has granted to Mr. Alter and Mr. Biederman stock
options to purchase 213,600 and 63,400 shares respectively of Common Stock in
order to provide, at the election of Mr. Alter and Mr. Biederman, a source of
funding for their obligations to make such contributions to the Lessee.

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THE MANAGEMENT COMPANY

GENERAL

The Management Company currently manages the Current Hotels and the
acquired Acquisition Hotel. The Management Company generally is required to
perform management functions necessary to manage the Current Hotels and the
acquired Acquisition Hotel. Such functions include accounting, periodic
reporting, advertising and marketing. As consideration for such services, the
Management Company receives a management fee from the Lessee initially equal to
2% of gross revenues. In addition, the Management Company is reimbursed by the
Lessee for all accounting-related expenses and all out-of-pocket expenses
incurred in connection with the management and administration of the Current
Hotels and the acquired Acquisition Hotel. Neither the Company nor the
Partnership has any contractual or other obligations to the Management Company.

Kenneth J. Biehl serves as the Chief Financial Officer and Secretary of the
Management Company. Carol A. Verret serves as the Vice President -- Marketing of
the Management Company, and David R. Kinkade serves as Vice President of the
Management Company. For a description of the qualifications and experience of
Mr. Biehl, Ms. Verret and Mr. Kinkade, see "The Lessee -- Management."

Affiliates of the Company have developed systems for marketing, ADR
enhancement, expense management, physical facility maintenance, human resources,
accounting and internal auditing. The on-site general manager of each Current
Hotel and the acquired Acquisition Hotel will report to lead managers, who in
turn report to the Vice President -- Marketing and the Director of Sales of the
Lessee. This strategy is designed to place responsibility and authority in the
hands of the on-site general manager with supervision by senior staff of the
Management Company and the Lessee.

Each Current Hotel and the acquired Acquisition Hotel have an on-site
general manager. In addition, the Lessee is obligated pursuant to the Percentage
Leases to employ a sales manager for each Hotel, as reasonably required by the
Company. All sales managers work with their on-site general manager, with
supervision by the Vice President -- Marketing of the Management Company and the
Lessee. Each year, the on-site general manager and sales manager of each Hotel
will develop an annual marketing plan with careful attention given to measurable
results. The Company will monitor the results for each quarter as compared to
the plan. The Management Company uses a management by objective sales program to
coordinate, direct and manage the sales activities of personnel located at the
Hotels.

THE MANAGEMENT AGREEMENT

Pursuant to the terms of the Management Agreement, the Management Company
will provide management and administrative services to the Lessee with respect
to the Current Hotels and the acquired Acquisition Hotel. The Management
Agreement provides for an initial term of one year with an automatic renewal for
additional one-year periods subject to the right of either party to terminate
the Management Agreement upon at least 90 days notice to the other party. As
consideration for such services, the Management Company will receive from the
Lessee a management fee equal to 2% of gross revenues of the Current Hotels and
the acquired Acquisition Hotel. In addition, the Management Company will be
reimbursed by the Lessee for all accounting-related expenses and all
out-of-pocket expenses incurred in connection with the management and
administration of the Current Hotels and the acquired Acquisition Hotel. The
Company anticipates that if additional hotels are acquired and leased to the
Lessee, the Lessee and the Management Company will enter into similar management
agreements with respect to such additional hotels. However, the Lessee is not
obligated to enter into any additional management agreements with the Management
Company with respect to such additional hotels. As required by the Percentage
Leases, the Management Agreement provides, and any such other management
agreements must provide, that the Management Company will repay to the Company
any payments made to it by the Lessee after the Management Company receives
notice that an event of default has occurred and is continuing. This obligation
is personally guaranteed by Mr. Alter. Neither the Partnership nor the Company
is a party to the Management Agreement and, therefore, neither shall have any
obligations or liabilities under the Management Agreement or to the Management
Company.

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PRINCIPAL STOCKHOLDERS

The following table sets forth information, as of July 25, 1996, regarding
the beneficial ownership of Common Stock by (i) each person known to the Company
to be the beneficial owner of more than five percent (5%) of its Common Shares,
(ii) each director of the Company, (iii) each executive officer of the Company
and (iv) by all directors and executive officers of the Company as a group.
Unless otherwise indicated, all shares of Common Stock are owned directly and
the indicated person has sole voting and investment power.

<TABLE>
<CAPTION>
PERCENT OF
CLASS(1)
---------------------
NUMBER OF SHARES BEFORE AFTER
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED(1) OFFERING OFFERING
- ------------------------------------------------------- --------------------- -------- --------
<S> <C> <C> <C>
DIRECTORS AND EXECUTIVE OFFICERS
Robert A. Alter........................................ 677,913 8.71% 5.75%
Charles L. Biederman................................... 407,047 5.23 3.45
C. Robert Enever....................................... 194,350 2.50 1.65
Fredric H. Gould....................................... 2,500 * *
H. Raymond Bingham..................................... 1,500 * *
David Lambert.......................................... 5,500 * *
Edward H. Sondker...................................... 3,500 * *
All Directors and Officers as a Group (7 persons)...... 1,292,310 16.61 10.97
Sirach Capital Management, Inc......................... 480,000 6.17 4.07
3323 One Union Square
Seattle, Washington 98101
Wasatch Advisors, Inc.................................. 1,536,574(2) 19.74 13.04
68 South Main Street, Suite 400
Salt Lake City, Utah 84101
</TABLE>

- ---------------
* Less than one percent.

(1) The Partnership had 7,782,300 Units outstanding as of July 25, 1996, of
which 6,323,500 were owned by the Company, corresponding to the number of
shares of Common Stock outstanding as of that date, and 1,458,800 by other
limited partners. Each of the Units are redeemable pursuant to certain
redemption rights (the "Redemption Rights") on a one-for-one basis for
shares of Common Stock. Redemption Rights are not exercisable by the holder
of Units until August 16, 1996 (except for 210,008 Units issued to one of
the Affiliates of Mr. Alter and Mr. Enever, which are immediately redeemable
for Common Stock). The number and percentages set forth above assumes that
all Units held by the person are redeemed for shares of Common Stock. The
total number of shares of Common Stock outstanding used in calculating the
percentage assumes that all of the Units held by other persons are redeemed
for shares of Common Stock and that 4,000,000 shares of Common Stock are
issued in the Offering and excludes the over-allotment option.

(2) Wasatch Advisors, Inc. is deemed a beneficial owner of the shares only by
virtue of the direct or indirect investment and/or voting discretion it
possesses pursuant to the provisions of investment advisory agreements with
its investment advisory clients.

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DESCRIPTION OF CAPITAL STOCK

The following summary description of capital stock of the Company is
subject to and qualified in its entirety by reference to Maryland law described
herein, and to the Articles of Incorporation and Bylaws of the Company which are
filed as exhibits to the Registration Statement of which this Prospectus is a
part.

GENERAL

The Articles of Incorporation of the Company provide that the Company may
issue up to 60,000,000 shares of capital stock, consisting of 50,000,000 shares
of Common Stock, $0.01 par value per share, and 10,000,000 shares of Preferred
Stock, $0.01 par value per share ("Preferred Stock"). Upon the closing of the
Offering, 10,323,500 shares of Common Stock will be issued and outstanding and
no shares of Preferred Stock will be issued and outstanding. Under Maryland law,
stockholders generally are not liable for a corporation's debt or obligations
solely by reason of ownership of stock of the corporation.

COMMON STOCK

All shares of Common Stock offered hereby will be duly authorized, fully
paid and nonassessable. Subject to the preferential rights of any other shares
or series of shares of capital stock and to the provisions of the Company's
Articles of Incorporation regarding the consequences of actually or
constructively owning shares of Common Stock in violation of the Ownership Limit
(as discussed below), holders of Common Stock will be entitled to receive
dividends on such Common Stock if, as and when authorized and declared by the
Board of Directors of the Company out of assets legally available therefor and
to share ratably in the assets of the Company legally available for distribution
to its stockholders in the event of its liquidation, dissolution or winding-up
after payment of, or adequate provision for, all known debts and liabilities of
the Company. The Company intends to continue its practice of paying regular
quarterly dividends to its stockholders. See "Price Range of Common Stock and
Distributions."

Subject to the provisions of the Company's Articles of Incorporation
regarding the consequences of actually or constructively owning shares of Common
Stock in violation of the Ownership Limit and to the matters discussed below
under "Certain Provisions of Maryland Law and of the Company's Articles of
Incorporation and Bylaws -- Control Share Acquisitions," each outstanding share
of Common Stock entitles the holder to one vote on all matters submitted to a
vote of stockholders, including the election of directors, and, except as
otherwise required by law or except as provided with respect to any other class
or series of shares of stock, the holders of such shares of Common Stock will
possess the exclusive voting power. There is no cumulative voting in the
election of directors, which means that the holders of a majority of the
outstanding shares of Common Stock can elect all of the directors then standing
for election and the holders of the remaining shares, if any, will not be able
to elect any directors.

Holders of Common Stock have no conversion, sinking fund, redemption rights
or any preemptive rights to subscribe for any securities of the Company. See
"Description of Capital Stock -- Restrictions on Ownership."

Subject to the provisions of the Articles of Incorporation regarding the
consequences of actually or constructively owning shares of Common Stock in
violation of the Ownership Limit, all shares of Common Stock will have equal
dividend, distribution, liquidation and other rights, and will have no
preference, appraisal or exchange rights.

Pursuant to the MGCL, a Maryland corporation generally cannot dissolve,
amend its articles of incorporation, merge, sell all or substantially all of its
assets, engage in a share exchange or engage in similar transactions outside the
ordinary course of business unless approved by the affirmative vote or written
consent of stockholders holding at least two-thirds of the shares entitled to
vote on the matter unless a lesser percentage (but not less than a majority of
all of the votes entitled to be cast on the matter) is set forth in the
corporation's articles of incorporation. The Articles of Incorporation provides
that a majority of all of the votes entitled to be cast is the required vote of
stockholders in such situations, except that any proposal (i) to permit
cumulative voting in the election of directors, (ii) to alter provisions of the
Articles of Incorporation requiring

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a majority of the directors to be independent directors or provisions of the
Articles of Incorporation relating to the classification of the Board of
Directors into three classes, removal of directors, preemptive rights,
indemnification of corporate agents and limitation of liability of officers and
directors or (iii) that would terminate the Company's status as a REIT for tax
purposes, requires, in each case, the approval of at least two-thirds of all of
the votes entitled to be cast on such matter. In addition, a number of other
provisions of the MGCL could have a significant effect on the Common Stock and
the rights and obligations of holders thereof. See "Certain Provisions of
Maryland Law and of the Company's Articles of Incorporation and Bylaws --
Control Share Acquisitions."

PREFERRED STOCK

Shares of Preferred Stock may be issued from time to time, in one or more
classes, as authorized by the Board of Directors. Prior to issuance of shares of
any such class, the Board of Directors is required by the MGCL and the Articles
of Incorporation to set for such class, subject to the provisions of the
Articles of Incorporation regarding Shares-in-Trust, the preferences, conversion
or other rights, voting powers, restrictions, limitations as to dividends or
other distributions, qualifications and terms or conditions of redemption for
each class as are permitted by Maryland law. The Board of Directors could
authorize the issuance of shares of Preferred Stock with terms and conditions
which could have the effect of delaying, deferring, discouraging or preventing
an attempt by a third party to obtain control of the Company or other
transaction which holders of some, or a majority, of the shares might receive a
premium for their shares of Common Stock over the then prevailing market price
of such shares. As of the date hereof, no shares of Preferred Stock are
outstanding and the Company has no present plans to issue any shares of
Preferred Stock. If and when issued, the Preferred Stock will be subject to the
restrictions on ownership set forth below.

CLASSIFICATION OR RECLASSIFICATION OF COMMON STOCK OR PREFERRED STOCK

The Company's Articles of Incorporation authorizes the Board of Directors
to classify or reclassify any unissued shares of Common Stock or Preferred Stock
by setting or changing the preferences, conversion or other rights, voting
powers, restrictions, limitations as to dividends, distributions, qualifications
or terms or conditions of redemption.

RESTRICTIONS ON OWNERSHIP

For the Company to qualify as a REIT under the Code, it must meet certain
requirements concerning the ownership of its outstanding shares of capital
stock. Specifically, not more than 50% in value of the Company's outstanding
shares may be owned, directly or indirectly, by five or fewer individuals (as
defined in the Code to include certain entities) during the last half of a
taxable year, and the Company must be beneficially owned by 100 or more persons
during at least 335 days of a taxable year of 12 months or during a
proportionate part of a shorter taxable year. See "Federal Income Tax
Considerations -- Requirements for Qualification." In addition, the Company must
meet certain requirements regarding the nature of its gross income in order to
qualify as a REIT. One such requirement is that at least 75% of the Company's
gross income for each year must consist of rents from real property and income
from certain other real property investments. The rents received by the
Partnership from the Lessee would not qualify as rents from real property, which
would result in loss of REIT status for the Company, if the Company were at any
time to own, directly or constructively, 10% or more of the ownership interests
in the Lessee within the meaning of Section 856(d)(2)(B) of the Code. See
"Federal Income Tax Considerations -- Requirements for Qualification -- Income
Tests."

Because the Board of Directors believes it is essential for the Company to
qualify as a REIT, the Articles of Incorporation, subject to certain exceptions
described below, provides that no person may own, or be deemed to own by virtue
of the constructive ownership provisions of the Code, more than 9.8% of the
lesser in value of the total number or value of the outstanding shares of Common
Stock or the outstanding shares of Preferred Stock (the "Ownership Limit"). The
constructive ownership rules of the Code are complex and may cause shares owned
actually or constructively by two or more related individuals and/or entities to
be constructively owned by one individual or entity. As a result, the
acquisition of less than 9.8% of the outstanding shares of Common Stock or 9.8%
of the shares of Preferred Stock (or the acquisition of an interest in an entity
which owns the shares) by an individual or entity could cause that individual or
entity (or another individual or entity) to own constructively in excess of 9.8%
of the outstanding shares of Common

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Stock or 9.8% of the outstanding shares of Preferred Stock, and thus subject
such shares to the Ownership Limit provisions of the Articles of Incorporation.
The Ownership Limit also prohibits any transfer of Common or Preferred Stock
that would (i) result in the Common and Preferred Stock being owned by fewer
than 100 persons (determined without reference to any rules of attribution),
(ii) result in the Company being "closely held" within the meaning of Section
856(h) of the Code, or (iii) cause the Company to own, directly or
constructively, 10% or more of the ownership interests in a tenant of the
Company's real property, within the meaning of Section 856(d)(2)(B) of the Code.
Except as otherwise provided below, any such acquisition or transfer of the
Company's capital stock (including any constructive acquisition or transfer of
ownership) shall be null and void, and the intended transferee or owner will
acquire no rights to, or economic interests in, the shares.

Subject to certain exceptions described below, any purported transfer of
Common or Preferred Stock that would (i) result in any person owning, directly
or indirectly, Common or Preferred Stock in excess of the Ownership Limit, (ii)
result in the Common and Preferred Stock being owned by fewer than 100 persons
(determined without reference to any rules of attribution), (iii) result in the
Company being "closely held" within the meaning of Section 856(h) of the Code,
or (iv) cause the Company to own, directly or constructively, 10.0% or more of
the ownership interests in a tenant of the Company's or the Partnership's real
property, within the meaning of Section 856(d)(2)(B) of the Code, will be
designated as "Shares-in-Trust" and transferred automatically to a trust (the
"Share Trust") effective on the day before the purported transfer of such Common
or Preferred Stock. The record holder of the Common or Preferred Stock that are
designated as Shares-in-Trust (the "Prohibited Owner") will be required to
submit such number of Common or Preferred Stock to the Share Trust for
designation in the name of the Share Trustee. The Share Trustee will be
designated by the Company. The beneficiary of the Share Trust (the
"Beneficiary") will be one or more charitable organizations that are named by
the Company.

Shares-in-Trust will remain issued and outstanding Common or Preferred
Stock and will be entitled to the same rights and privileges as all other shares
of the same class or series. The Share Trust will receive all dividends and
distributions on the Shares-in-Trust and will hold such dividends or
distributions in trust for the benefit of the Beneficiary. The Share Trustee
will vote all Shares-in-Trust. The Share Trustee will designate a permitted
transferee of the Shares-in-Trust, provided that the permitted transferee (i)
purchases such Shares-in-Trust for valuable consideration and (ii) acquires such
Shares-in-Trust without such acquisition resulting in a transfer to another
Share Trust.

The Prohibited Owner with respect to Shares-in-Trust will be required to
repay to the Share Trust the amount of any dividends or distributions received
by the Prohibited Owner (i) that are attributable to any Shares-in-Trust and
(ii) that the record date of which was on or after the date that such shares
became Shares-in-Trust. The Prohibited Owner generally will receive from the
Share Trustee the lesser of (i) the price per share such Prohibited Owner paid
for the Common or Preferred Stock that were designated as Shares-in-Trust (or,
in the case of a gift or devise, the Market Price (as defined below) per share
on the date of such transfer) and (ii) the price per share received by the Share
Trustee from the sale or other disposition of such Shares-in-Trust. Any amounts
received by the Share Trustee in excess of the amounts to be paid to the
Prohibited Owner will be distributed to the Beneficiary.

The Shares-in-Trust will be deemed to have been offered for sale to the
Company, or its designee, at a price per share equal to the lesser of (i) the
price per share in the transaction that created such Shares-in-Trust (or, in the
case of a gift or devise, the Market Price per share on the date of such
transfer) or (ii) the Market Price per share on the date that the Company, or
its designee, accepts such offer. The Company will have the right to accept such
offer for a period of ninety days after the later of (i) the date of the
purported transfer which resulted in such Shares-in-Trust and (ii) the date the
Company determines in good faith that a transfer resulting in such
Shares-in-Trust occurred.

"Market Price" on any date shall mean the average of the Closing Price (as
defined below) for the five consecutive Trading Days (as defined below) ending
on such date. The "Closing Price" on any date shall mean the last sale price,
regular way, or, in case no such sale takes place on such day, the average of
the closing bid and asked prices, regular way, in either case as reported in the
principal consolidated transaction

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reporting system with respect to securities listed or admitted to trading on the
NYSE or, if the Common or Preferred Stock are not listed or admitted to trading
on the NYSE, as reported in the principal consolidated transaction reporting
system with respect to securities listed on the principal national securities
exchange on which the shares of Common or Preferred Stock are listed or admitted
to trading or, if the shares of Common or Preferred Stock are not listed or
admitted to trading on any national securities exchange, the last quoted price,
or if not so quoted, the average of the high bid and low asked prices in the
over-the-counter market, as reported by the National Association of Securities
Dealers, Inc. Automated Quotation System or, if such system is no longer in use,
the principal other automated quotations system that may then be in use or, if
the shares of Common or Preferred Stock are not quoted by any such organization,
the average of the closing bid and asked prices as furnished by a professional
market maker making a market in the Common or Preferred Stock as selected by the
Board of Directors. "Trading Day" shall mean a day on which the principal
national securities exchange on which the shares of Common or Preferred Stock
are listed or admitted to trading is open for the transaction of business or, if
the shares of Common or Preferred Stock are not listed or admitted to trading on
any national securities exchange, shall mean any day other than a Saturday, a
Sunday or a day on which banking institutions in the State of New York are
authorized or obligated by law or executive order to close.

Any person who acquires or attempts to acquire Common or Preferred Stock in
violation of the foregoing restrictions, or any person who owned shares of
Common or Preferred Stock that were transferred to a Share Trust, will be
required (i) to give immediately written notice to the Company of such event and
(ii) to provide to the Company such other information as the Company may request
in order to determine the effect, if any, of such transfer on the Company's
status as a REIT.

All persons who own, directly or indirectly, more than 5% (or such lower
percentages as required pursuant to regulations under the Code) of the
outstanding shares of Common and Preferred Stock must within 30 days after
January 1 of each year, provide to the Company a written statement or affidavit
stating the name and address of such direct or indirect owner, the number of
shares of Common and Preferred Stock owned directly or indirectly, and a
description of how such shares are held. In addition, each direct or indirect
stockholder shall provide to the Company such additional information as the
Company may request in order to determine the effect, if any, of such ownership
on the Company's status as a REIT and to ensure compliance with the Ownership
Limit.

The Ownership Limit generally will not apply to the acquisition of shares
of Common or Preferred Stock by an underwriter that participates in a public
offering of such shares. In addition, the Board of Directors, upon receipt of a
ruling from the Service or an opinion of counsel and upon such other conditions
as the Board of Directors may direct, may exempt a person from the Ownership
Limit under certain circumstances. The foregoing restrictions will continue to
apply until the Board of Directors, with the approval of the holders of at least
two-thirds of the outstanding shares of all votes entitled to vote on such
matter at a regular or special meeting of the stockholders of the Company,
determines to terminate its status as a REIT.

The Ownership Limit will not be automatically removed even if the REIT
provisions of the Code are changed so as to remove any ownership concentration
limitation. Any change of the Ownership Limit would require an amendment to the
Articles of Incorporation. Such amendment requires the affirmative vote of
holders holding at least two-thirds of the outstanding shares entitled to vote
on the matter. In addition to preserving the Company's status as a REIT, the
Ownership Limit may have the effect of delaying, deferring, discouraging or
preventing an acquisition of control of the Company without the approval of the
Board of Directors.

All certificates representing shares of Common or Preferred Stock will bear
a legend referring to the restrictions described above.

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CERTAIN PROVISIONS OF MARYLAND LAW AND
OF THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS

The following summary of certain provisions of Maryland law and of the
Articles of Incorporation and Bylaws of the Company is subject to and qualified
in its entirety by reference to the Articles of Incorporation and Bylaws of the
Company which are filed as exhibits to the Registration Statement of which this
Prospectus is a part.

CLASSIFICATION OF THE BOARD OF DIRECTORS

The Bylaws provide that the number of directors of the Company may be
established by the Board of Directors but may not be fewer than three nor more
than nine. The directors may increase the number of directors by a vote of a
least 80% of the members of the Board of Directors, provided that the number of
directors shall never be less than the number required by Maryland law and that
the tenure of office of a director shall not be affected by any decrease in the
number of directors. Any vacancy will be filled, including a vacancy created by
an increase in the number of directors, at any regular meeting or at any special
meeting called for that purpose, by a majority of the remaining directors,
except that a vacancy resulting from an increase in the number of directors must
be filled by a majority of the entire Board of Directors.

Pursuant to the Articles of Incorporation the Board of Directors will be
divided into three classes of directors. The initial terms of the first, second
and third classes will expire in 1997 and 1998, respectively. The term of the
two Class I directors elected at the 1996 annual meeting of stockholders expires
in 1999. As the term of each class expires, directors in that class will be
elected by the stockholders of the Company for a term of three years and until
their successors are duly elected and qualify. Classification of the Board of
Directors is intended to assure the continuity and stability of the Company's
business strategies and policies as determined by the Board of Directors.
Holders of Common Stock will have no right to cumulative voting in the election
of directors. Consequently, at each annual meeting of stockholders, the holders
of a majority of the shares of Common Stock present in person or by proxy at
such meeting will be able to elect all of the successors of the class of
directors whose terms expire at that meeting.

The classified board provision could have the effect of making the
replacement of incumbent directors more time consuming and difficult, which
could delay, defer, discourage or prevent an attempt by a third party to obtain
control of the Company or other transaction, even though such an attempt or
other transaction might be beneficial to the Company and its stockholders. At
least two annual meetings of stockholders, instead of one, will generally be
required to effect a change in a majority of the Board of Directors. Thus, the
classified board provision could increase the likelihood that incumbent
directors will retain their positions. See "Risk Factors -- Limitation on
Acquisition and Change of Control."

REMOVAL OF DIRECTORS

The Articles of Incorporation provide that a director may be removed with
or without cause by the affirmative vote of at least two-thirds of the votes
entitled to be cast in the election of directors. This provision when coupled
with the provision in the Bylaws authorizing the Board of Directors to fill
vacant directorships, could preclude stockholders from removing incumbent
directors except upon the existence of a substantial affirmative vote and by
filling the vacancies created by such removal with their own nominees upon the
affirmative vote of a majority of the votes entitled to be cast in the election
of directors.

LIMITATION OF LIABILITY AND INDEMNIFICATION

The Articles of Incorporation and Bylaws limit the liability of the
Company's directors and officers for money damages to the Company and its
stockholders to the fullest extent permitted from time to time by Maryland law.
Maryland law presently permits the liability of directors and officers to a
corporation or its stockholders for money damages to be limited, except (i) to
the extent that it is proved that the director or officer actually received an
improper benefit or profit, or (ii) to the extent that a judgment or other final
adjudication is entered in a proceeding based on a finding that the director's
or officer's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action, as adjudicated in the

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proceeding. This provision does not limit the ability of the Company or its
stockholders to obtain other relief, such as an injunction or rescission.

The Articles of Incorporation and Bylaws require the Company to indemnify
its directors and officers to the fullest extent permitted from time to time by
Maryland law. The Company's Articles of Incorporation and Bylaws also permit the
Company to indemnify employees, agents and other persons acting on behalf of or
at the request of the Company. The MGCL permits a corporation to indemnify its
directors, officers and certain other parties 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 to or at the request of the Company, unless it is established
that: (i) the act or omission of the indemnified party was material to the
matter giving rise to the proceeding and was committed in bad faith or was the
result of active and deliberate dishonesty; (ii) the indemnified party actually
received an improper personal benefit; or (iii) in the case of any criminal
proceeding, the indemnified party had reasonable cause to believe that the act
or omission was unlawful. Indemnification may be made against judgments,
penalties, fines, settlements and reasonable expenses actually incurred by the
director or officer in connection with the proceeding; provided, however, that
if the proceeding is one by or in the right of the Company, indemnification may
not be made with respect to any proceeding in which the director or officer has
been adjudged to be liable to the Company. In addition, a director or officer
may not be indemnified with respect to any proceeding charging improper personal
benefit to the director or officer in which the director or officer was adjudged
to be liable on the basis that the personal benefit was improperly received. The
termination of any proceeding by conviction, or upon a plea of nolo contendere
or its equivalent, or an entry of any order of probation prior to judgment,
creates a rebuttable presumption that the director or officer did not meet the
requisite standard of conduct required for indemnification to be permitted.
Indemnification under the provisions of the MGCL is not deemed exclusive to any
other rights, by indemnification or otherwise, to which an officer or director
may be entitled under the Articles of Incorporation or Bylaws, or under
resolutions of stockholders or directors, contract or otherwise. It is the
position of the Commission that indemnification of directors and officers for
liabilities arising under the Securities Act is against public policy and is
unenforceable pursuant to Section 14 of the Securities Act.

BUSINESS COMBINATIONS

Under the MGCL, certain "business combinations" (including a merger,
consolidation, share exchange or, in certain circumstances, an asset transfer or
issuance or reclassification of equity securities) between a Maryland
corporation and any person who beneficially owns ten percent or more of the
voting power of such corporation's shares or an affiliate of such corporation
who, at any time within the two-year period prior to the date in question, was
the beneficial owner of ten percent or more of the voting power of the
then-outstanding voting shares of such corporation (an "Interested Stockholder")
or an affiliate thereof are prohibited for five years after the most recent date
on which the Interested Stockholder became an Interested Stockholder.
Thereafter, any such business combination must be recommended by the board of
directors of such corporation and approved by the affirmative vote of at least
(a) 80% of the votes entitled to be cast by holders of outstanding voting shares
of such corporation and (b) two-thirds of the votes entitled to be cast by
holders of voting shares of such corporation other than shares held by the
Interested Stockholder with whom (or with whose affiliate) the business
combination is to be effected, unless, among other things, the corporation's
stockholders receive a minimum price (as defined in the MGCL) for their shares
and the consideration is received in cash or in the same form as previously paid
by the Interested Stockholder for its shares. These provisions of Maryland law
do not apply, however, to business combinations that are approved or exempted by
the board of directors of the corporation prior to the time that the Interested
Stockholder becomes an Interested Stockholder. The Board of Directors has
exempted from these provisions of the MGCL any business combination with certain
officers and directors of the Company, including Messrs. Alter, Biederman and
Enever, and all present or future Affiliates or associates of, or any other
person acting in concert or as a group with, any of the foregoing persons and
any other business combination which may arise in connection with the Company
formation transactions generally.

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CONTROL SHARE ACQUISITIONS

The MGCL provides that "control shares" of a Maryland corporation acquired
in a "control share acquisition" have no voting rights except to the extent
approved by a vote of two-thirds of the votes entitled to be cast on the matter,
excluding shares owned by the acquiror, by officers or by directors who are
employees of the corporation. "Control Shares" are voting shares which, if
aggregated with all other such shares previously acquired by the acquiror, or in
respect of which the acquiror is able to exercise or direct the exercise of
voting power (except solely by virtue of a revocable proxy), would entitle the
acquiror to exercise voting power in electing directors within one of the
following ranges of voting power: (i) one-fifth or more but less than one-third
(ii) one-third or more but less than a majority, or (iii) a majority or more of
all voting power. Control Shares do not include shares the acquiring person is
then entitled to vote as a result of having previously obtained stockholder
approval. A "control share acquisition" means the acquisition of control shares,
subject to certain exceptions.

A person who has made or proposes to make a control share acquisition, upon
satisfaction of certain conditions (including an undertaking to pay expenses),
may compel the board of directors of the corporation to call a special meeting
of stockholders to be held within 50 days of demand to consider the voting
rights of the shares. If no request for a meeting is made, the corporation may
itself present the question at any stockholders meeting.

If voting rights are not approved at the meeting or if the acquiring person
does not deliver an acquiring person statement as required by the statute, then,
subject to certain conditions and limitations, the corporation may redeem any or
all of the control shares (except those for which voting rights have previously
been approved) for fair value determined, without regard to the absence of
voting rights for the control shares, as of the date of the last control share
acquisition by the acquiror or of any meeting of stockholders at which the
voting rights of such shares are considered and not approved. If voting rights
for control shares are approved at a stockholders meeting and the acquiror
becomes entitled to vote a majority of the shares entitled to vote, all other
stockholders may exercise appraisal rights. The fair value of the shares as
determined for purposes of such appraisal rights may not be less than the
highest price per share paid by the acquiror in the control share acquisition,
and certain limitations and restrictions otherwise applicable to the exercise of
dissenters' rights do not apply in the context of a control share acquisition.

The control share acquisition statute does not apply to shares acquired in
a merger, consolidation or share exchange, if the corporation is a party to the
transaction, or to acquisitions approved or exempted by the articles of
incorporation or bylaws of the corporation.

The Bylaws of the Company contain a provision exempting from the control
share acquisition statute any and all acquisitions by any person of the
Company's Common Stock or Preferred Stock. There can be no assurance that such
provision will not be amended or eliminated at any time in the future.

AMENDMENTS TO THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS

The Articles of Incorporation may only be amended by the affirmative vote
of the holders of not less than a majority of the votes entitled to be cast on
the matter, except that any proposal (i) to permit cumulative voting in the
election of directors, (ii) to alter provisions of the Articles of Incorporation
requiring a majority of the directors to be independent directors or provisions
of the Articles of Incorporation relative to the classification of the Company's
Board of Directors into three classes, removal of directors, preemptive rights,
indemnification of corporate agents and limitation of liability of officers and
directors, or (iii) that would terminate the Company's status as a REIT for tax
purposes, may not be amended, altered, changed or repealed without the
affirmative vote of at least two-thirds of all of the votes entitled to be cast
on the matter. Subject to the right of the Company's stockholders to adopt,
alter or repeal the Bylaws, the Bylaws may be amended by the Board of Directors,
except for provisions of the Bylaws relating to the sale of a Sunstone Hotel and
transactions involving the Company in which an advisor, director or officer has
an interest, which may be altered or repealed only upon the vote of stockholders
holding at least two-thirds of the outstanding shares of Common Stock entitled
to vote generally in the election of directors.

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DISSOLUTION OF THE COMPANY

Pursuant to the Articles of Incorporation, the dissolution of the Company
must be approved and advised by the Board of Directors and approved by the
affirmative vote of the holders of a majority of all of the votes entitled to be
cast on the matter.

OPERATIONS

The Company is generally prohibited from engaging in certain activities,
including incurring consolidated indebtedness, in the aggregate, in excess of
the Debt Limitation and acquiring or holding property or engaging in any
activity that would cause the Company to fail to qualify as a REIT.

ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE COMPANY'S
ARTICLES OF INCORPORATION AND BYLAWS

The provisions in the Articles of Incorporation regarding the Ownership
Limit and the classification of the Board of Directors, the business combination
provisions of the MGCL, the control shares acquisition provisions of the MGCL,
and the advance notice provisions of the Bylaws could have the effect of
delaying, deferring, discouraging or preventing a transaction or a change of
control of the Company in which holders of some, or a majority, of the capital
stock of the Company might receive a premium for their shares over the then
prevailing market price or which such holders might believe to be otherwise in
their best interest.

OTHER MATTERS

The shares of Common Stock are currently listed on the NYSE under the
symbol "SSI."

The transfer agent and registrar for the Company's Common Stock is Chase
Mellon Shareholder Services.

SHARES AVAILABLE FOR FUTURE SALE

Upon the closing of the Offering, the Company will have outstanding or
reserved for issuance upon redemption of Units or pursuant to the 1994 Plan or
Directors Plan approximately 12,432,300 shares of Common Stock. In addition to
Units issued to the Company, the Partnership has outstanding an aggregate of
1,458,800 Units. The Common Stock issued in the Offering will be freely
tradeable by persons other than "Affiliates" of the Company without restriction
under the Securities Act, subject to certain limitations on ownership set forth
in the Company's Articles of Incorporation. See "Description of Capital Stock --
Restrictions on Ownership."

Pursuant to the Partnership Agreement, the Limited Partners will receive
the Redemption Rights, which will enable them to cause the Partnership to redeem
their Units in exchange for shares of Common Stock on a one-for-one basis (or
for cash at the election of the Company or if the issuance of shares of Common
Stock would result in any person owning, directly or indirectly, more than 9.8%
of the shares of Common Stock). The Redemption Rights may be exercised by the
Limited Partners at any time after August 16, 1996 (except with respect to
Messrs. Alter, Biederman and Enever who are subject to lock-up agreements for
120 days after the date of the Offering), in whole or in part, provided that the
Redemption Rights granted to one limited partner are not subject to this
redemption restriction. Any amendment to the Partnership Agreement that would
(i) affect the Redemption Rights, (ii) adversely affect the Limited Partners'
rights to receive cash distributions, (iii) alter the Partnership's allocations
of income or (iv) impose on the Limited Partners any obligations to make
additional contributions to the capital of the Partnership, would require the
consent of Limited Partners holding more than two-thirds of the Units held by
Limited Partners (other than the Company as a Limited Partner).

Shares of Common Stock issued to holders of Units upon exercise of the
Redemption Rights and shares issued pursuant to the 1994 Plan and the Directors
Plan will be "restricted" securities under the meaning of Rule 144 promulgated
under the Securities Act ("Rule 144") and may not be sold in the absence of
registration under the Securities Act unless an exemption from registration is
available, including exemptions contained in Rule 144. As described below, the
Company has granted certain holders registration rights with respect to their
shares of Common Stock.

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In general, under Rule 144 as currently in effect, if two years have
elapsed since the later of the date of acquisition of restricted shares from the
Company or any "Affiliate" of the Company, as that term is defined under the
Securities Act, the acquiror or subsequent holder thereof is entitled to sell
within any three-month period a number of shares that does not exceed the
greater of 1.0% of the then outstanding shares of Common Stock or the average
weekly trading volume of the Common Stock during the four calendar weeks
preceding the date on which notice of the sale is filed with the Commission.
Sales under Rule 144 also are subject to certain manner of sale provisions,
notice requirements and the availability of current public information about the
Company. If three years have elapsed since the date of acquisition of restricted
shares from the Company or from any Affiliate of the Company, and, the acquiror
or subsequent holder thereof is deemed not to have been an Affiliate of the
Company at any time during the three months preceding a sale, such person would
be entitled to sell such shares in the public market under Rule 144(k) without
regard to the volume limitations, manner of sale provisions, public information
requirements or notice requirements.

The Company has agreed to file, on or before December 31, 1996, a
registration statement with the Commission for the purpose of registering the
sale of shares of up to approximately 1,458,800 shares of Common Stock issuable
to holders of Units upon redemption thereof. The Company will use its best
efforts to have the registration statement declared effective and to keep it
effective for a period of two years. Upon effectiveness of such registration
statement, those persons who receive shares of Common Stock upon redemption of
Units may sell such shares in the secondary market without being subject to the
volume limitations or other requirements of Rule 144. The Company will bear
expenses incident to such registration requirements, except that such expenses
shall not include any underwriting discounts or commissions, Commission or state
securities registration fees, transfer taxes or certain other fees or taxes
relating to such shares. Registration rights may be granted to future sellers of
hotels to the Partnership who elect to receive, in lieu of cash, shares of
Common Stock, Units, or other securities convertible into shares of Common
Stock.

For a description of certain restrictions on transfers of Common Stock held
by certain stockholders of the Company, see "Underwriting."

PARTNERSHIP AGREEMENT

The following summary of the Partnership Agreement, and the descriptions of
certain provisions thereof set forth elsewhere in this Prospectus, is qualified
in its entirety by reference to the Partnership Agreement, which is filed as an
exhibit to the Registration Statement of which this Prospectus is a part.

MANAGEMENT

The Partnership has been organized as a Delaware limited partnership
pursuant to the terms of the Partnership Agreement. Pursuant to the Partnership
Agreement, the Company, as the sole general partner of the Partnership, will
have full, exclusive and complete responsibility and discretion in the
management and control of the Partnership, and the Limited Partners will have no
authority in their capacity as Limited Partners to transact business for, or
participate in the management activities or decisions of, the Partnership except
as required by applicable law. However, any amendment to the Partnership
Agreement that would (i) affect the Redemption Rights, (ii) adversely affect the
Limited Partners' rights to receive cash distributions, (iii) alter the
Partnership's allocations of income or loss, or (iv) impose on the Limited
Partners any obligations to make additional contributions to the capital of the
Partnership, would require the consent of Limited Partners (other than the
Company as a Limited Partner) holding more than two-thirds of the Units held by
such partners.

TRANSFERABILITY OF INTERESTS

The Company may not voluntarily withdraw from the Partnership or transfer
or assign its interest in the Partnership unless the transaction in which such
withdrawal or transfer occurs results in the Limited Partners receiving property
in an amount equal to the amount they would have received had they exercised
their Redemption Rights immediately prior to such transaction, or unless the
successor to the Company contributes substantially all of its assets to the
Partnership in return for an interest in the Partnership. With certain limited
exceptions, the Limited Partners may not transfer their interests in the
Partnership, in whole or in part, without the written consent of the Company,
which the Company may withhold in its sole discretion. The

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Company may not consent to any transfer that would cause the Partnership to be
treated as a corporation for federal income tax purposes.

CAPITAL CONTRIBUTION

The Company will contribute to the Partnership the net proceeds of the
Offering in exchange for approximately 4,000,000 Units. After such Unit
issuance, the Company will have a 87.6% interest in the Partnership. Although
the Partnership will receive the net proceeds of the Offering, the Company will
be deemed to have made a capital contribution to the Partnership in the amount
of the gross proceeds of the Offering and the Partnership will be deemed
simultaneously to have paid the underwriter's discount and other expenses paid
or incurred in connection with the Offering. The Partnership Agreement provides
that if the Partnership requires additional funds at any time or from time to
time in excess of funds available to the Partnership from borrowing or capital
contributions, the Company may borrow such funds from a financial institution or
other lender and lend such funds to the Partnership on the same terms and
conditions as are applicable to the Company's borrowing of such funds. Moreover,
the Company is authorized to cause the Partnership to issue partnership
interests for less than fair market value if the Company has concluded in good
faith that such issuance is in the best interests of the Company and the
Partnership. Under the Partnership Agreement, the Company generally is obligated
to contribute the proceeds of a share offering as additional capital to the
Partnership. Upon such contribution, the Company will receive additional Units
and the Company's percentage interest in the Partnership will be increased on a
proportionate basis based upon the amount of such additional capital
contributions. Conversely, the percentage interests of the Limited Partners will
be decreased on a proportionate basis in the event of additional capital
contributions by the Company. In addition, if the Company contributes additional
capital to the Partnership, the Company will revalue the property of the
Partnership to its fair market value (as determined by the Company) and the
capital accounts of the partners will be adjusted to reflect the manner in which
the unrealized gain or loss inherent in such property (that has not been
reflected in the capital accounts previously) would be allocated among the
partners under the terms of the Partnership Agreement if there were a taxable
disposition of such property for such fair market value on the date of the
revaluation.

REDEMPTION RIGHTS

Pursuant to the Partnership Agreement, the Limited Partners have received
the Redemption Rights, which will enable them to cause the Partnership to redeem
their interests in the Partnership in exchange for cash at the election of the
Company. At the election of the Company, the Company may purchase the Units for
either cash or shares of Common Stock. The redemption price will be paid in cash
in the event that the issuance of shares of Common Stock to the redeeming
Limited Partner would (i) result in any person owning, directly or indirectly,
shares of Common Stock in excess of the Ownership Limit, (ii) result in the
Common Stock of the Company being owned by fewer than 100 persons (determined
without reference to any rules of attribution), (iii) result in the Company
being "closely held" within the meaning of Section 856(h) of the Code, (iv)
cause the Company to own, actually or constructively, 10% or more of the
ownership interests in a tenant of the Company's or the Partnership's real
property, within the meaning of Section 856(d)(2)(B) of the Code, or (v) cause
the acquisition of shares of Common Stock by such redeeming Limited Partner to
be "integrated" with any other distribution of shares of capital stock for
purposes of complying with the Securities Act. The Redemption Rights may be
exercised by the Limited Partners at any time after one year following the
closing of the IPO (other than the immediate Redemption Rights of one Limited
Partner), provided that not more than two redemptions may occur during each
calendar year and each Limited Partner may not exercise the Redemption Right for
less than 500 Units or, if such Limited Partner holds less than 500 Units, all
of the Units held by such Limited Partner. The aggregate number of shares of
Common Stock issuable upon exercise of the Redemption Rights, excluding shares
of Common Stock issuable upon redemption of Units issuable upon exercise of
warrants to be issued to Messrs. Alter, Biederman and Enever and MRC, is
1,458,800. The number of shares of Common Stock issuable upon exercise of the
Redemption Rights will be adjusted upon the occurrence of share splits, mergers,
consolidations or similar pro rata share transactions, which otherwise would
have the effect of diluting the ownership interests of the Limited Partners or
the stockholders of the Company.

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REGISTRATION RIGHTS

For a description of certain registration rights held by the Limited
Partners, see "Shares Available for Future Sale."

OPERATIONS

The Partnership Agreement requires that the Partnership be operated in a
manner that will enable the Company to satisfy the requirements for being
classified as a REIT, to avoid any federal income or excise tax liability
imposed by the Code, and to ensure that the Partnership will not be classified
as a "publicly traded partnership" for purposes of Section 7704 of the Code.

In addition to the administrative and operating costs and expenses incurred
by the Partnership, the Partnership will pay all administrative costs and
expenses of the Company (the "Company Expenses") and the Company Expenses will
be treated as expenses of the Partnership. The Company Expenses generally will
include (i) all expenses relating to the formation and continuity of existence
of the Company, (ii) all expenses relating to the public offering and
registration of securities of the Company, (iii) all expenses associated with
the preparation and filing of any periodic reports by the Company under federal,
state or local laws or regulations, (iv) all expenses associated with compliance
by the Company with laws, rules and regulations promulgated by any regulatory
body and (v) all other operating or administrative costs of the Company incurred
in the ordinary course of its business on behalf of the Partnership. The Company
Expenses, however, will not include any administrative and operating costs and
expenses incurred by the Company that are attributable to hotel properties owned
by the Company directly. The Company currently does not have any such
properties.

DISTRIBUTIONS

The Partnership Agreement provides that the Partnership will distribute
cash from operations (including net sale or refinancing proceeds, but excluding
net proceeds from the sale of the Partnership's property in connection with the
liquidation of the Partnership) on a quarterly (or, at the election of the
Company, more frequent) basis, in amounts determined by the Company in its sole
discretion, to the partners in accordance with their respective percentage
interests in the Partnership. Upon liquidation of the Partnership, after payment
of, or adequate provision for, debts and obligations of the Partnership,
including any partner loans, any remaining assets of the Partnership will be
distributed to all partners with positive capital accounts in accordance with
their respective positive capital account balances. If the Company has a
negative balance in its capital account following a liquidation of the
Partnership, it will be obligated to contribute cash to the Partnership equal to
the negative balance in its capital account.

ALLOCATIONS

Income, gain and loss of the Partnership for each fiscal year generally
will be allocated among the partners in accordance with their respective
interests in the Partnership, subject to compliance with the provisions of Code
Section 704(b) and 704(c) and Treasury Regulations promulgated thereunder.

TERM

The Partnership will continue until December 31, 2050, or until sooner
dissolved upon (i) the bankruptcy, dissolution or withdrawal of the Company
(unless the Limited Partners elect to continue the Partnership), (ii) the sale
or other disposition of all or substantially all the assets of the Partnership,
(iii) the redemption of all limited partnership interests in the Partnership
(other than those held by the Company, if any), or (iv) the election by the
General Partner.

TAX MATTERS

Pursuant to the Partnership Agreement, the Company will be the tax matters
partner of the Partnership and, as such, will have authority to handle tax
audits and to make tax elections under the Code on behalf of the Partnership.

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FEDERAL INCOME TAX CONSIDERATIONS

The following is a summary of material federal income tax considerations
that may be relevant to a prospective holder of Common Stock in the Company.
Brobeck, Phleger & Harrison LLP has acted as counsel to the Company and has
reviewed this summary and is of the opinion that it fairly summarizes the
federal income tax considerations that are likely to be material to a holder of
the Common Stock. The discussion contained herein does not address all aspects
of taxation that may be relevant to particular stockholders in light of their
personal investment or tax circumstances, or to certain types of stockholders
(including insurance companies, tax-exempt organizations, financial institutions
or broker-dealers, foreign corporations, and persons who are not citizens or
residents of the United States) subject to special treatment under the federal
income tax laws.

The statements in this discussion and the opinions of Brobeck, Phleger &
Harrison LLP as to tax consequences expressed herein are based on current
provisions of the Code, existing, temporary, and currently proposed Treasury
Regulations promulgated under the Code, the legislative history of the Code,
existing administrative rulings and practices of the Service, and judicial
decisions. No assurance can be given that future legislative, judicial, or
administrative actions or decisions, which may be retroactive in effect, will
not affect the accuracy of any statements in this Prospectus with respect to the
transactions entered into or contemplated prior to the effective date of such
changes.

EACH PROSPECTIVE PURCHASER IS ADVISED TO CONSULT HIS OWN TAX ADVISOR
REGARDING THE SPECIFIC TAX CONSEQUENCES TO HIM OF THE PURCHASE, OWNERSHIP, AND
SALE OF THE COMMON STOCK AND OF THE COMPANY'S ELECTION TO BE TAXED AS A REIT,
INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN, AND OTHER TAX CONSEQUENCES OF SUCH
PURCHASE, OWNERSHIP, SALE, AND ELECTION, AND OF POTENTIAL CHANGES IN APPLICABLE
TAX LAWS.

SUMMARY OF TAX OPINIONS

Brobeck, Phleger & Harrison LLP will provide the Company with an opinion
letter addressing certain federal tax consequences material to the purchase,
ownership and disposition of the Common Stock. The specific opinions that
Brobeck, Phleger & Harrison LLP will provide are:

1. The description of law and legal conclusions herein under the
heading "Federal Income Tax Considerations," are correct in all material
respects, and the discussion fairly summarizes the federal income tax
considerations that are material to a holder of Common Stock.

2. The Partnership will be treated as a partnership for federal income
tax purposes and not as an association taxable as a corporation.

3. Commencing with the inception of its taxable year ended December
31, 1995, the Company has been organized and operated in conformity with
the requirements for qualification as a REIT under the Code, and the
Company's organization and contemplated method of operation will enable it
to continue to meet the requirements for qualification and taxation as a
REIT under the Code in 1996 and subsequent years.

The opinions to be rendered by Brobeck, Phleger & Harrison LLP are based on
the Code and Treasury Regulations thereunder currently in effect, current
administrative interpretations and positions of the Service, and existing court
decisions. No assurance can be given that future legislation, Treasury
Regulations, administrative interpretations and court decisions will not
significantly change the law or the conclusions reached by counsel. Any such
change could apply retroactively to transactions preceding the date of change.
Accordingly, no assurance can be provided that such opinions (which do not bind
the Service or the courts) will not be challenged by the Service or will be
sustained by a court if so challenged. In addition, counsel is relying on
certain representations of the Company and the Partnership in rendering its
opinions. To the extent any representations upon which counsel is relying in
rendering its opinion are incorrect, counsel's opinion as to the tax
consequences could be altered. Counsel has not rendered any opinions as to the
tax consequences of an

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investment in or the taxation of the Company or the Partnership except as
specifically stated herein. See "Risk Factors -- Tax Risks."

TAXATION OF THE COMPANY

The Company plans to make an election to be taxed as a REIT under Sections
856 through 860 of the Code, effective for its taxable year ended on December
31, 1995. The Company believes that, commencing with such taxable year, it has
been organized and has operated in such a manner as to qualify for taxation as a
REIT under the Code, and the Company intends to continue to operate in such a
manner. However, no assurance can be given that the Company will operate in a
manner so as to remain qualified as a REIT. See "Risk Factors -- Tax Risks."

The sections of the Code relating to qualification and operation as a REIT
are highly technical and complex. The following discussion sets forth the
material aspects of the Code sections that govern the federal income tax
treatment of a REIT and its stockholders. The discussion is qualified in its
entirety by the applicable Code provisions, Treasury Regulations promulgated
thereunder, and administrative and judicial interpretations thereof, all of
which are subject to change prospectively or retrospectively.

Brobeck, Phleger & Harrison LLP has acted as counsel to the Company in
connection with the Offering and the Company's election to be taxed as a REIT.
In the opinion of Brobeck, Phleger & Harrison LLP, commencing with the inception
of the Company's taxable year ended December 31, 1995, the Company has been
organized and operated in conformity with the requirements for qualification as
a REIT under the Code, and its organization and contemplated method of operation
will enable it to continue to meet the requirements for qualification and
taxation as a REIT under the Code in 1996 and subsequent years. Investors should
be aware, however, that opinions of counsel are not binding upon the Service or
any court. It must be emphasized that Brobeck, Phleger & Harrison LLP's opinion
is based on various assumptions and is conditioned upon certain representations
made by the Company as to factual matters, including representations regarding
the nature of the Company's properties and income during 1995 and subsequently
and the future conduct of its business. Such factual assumptions and
representations are described below in this discussion of "Federal Income Tax
Considerations" and are set out in the federal income tax opinion that will be
delivered by Brobeck, Phleger & Harrison LLP at the closing of the Offering.
Moreover, such qualification and taxation as a REIT depends upon the Company's
ability to meet on a continuing basis, through actual annual operating results,
distribution levels, and share ownership, the various qualification tests
imposed under the Code discussed below. Brobeck, Phleger & Harrison LLP will not
review the Company's compliance with those tests on a continuing basis.
Accordingly, no assurance can be given that the actual results of the Company's
operation for 1996 and subsequent taxable years will satisfy such requirements.
For a discussion of the tax consequences of failure to qualify as a REIT, see
"Federal Income Tax Considerations -- Failure to Qualify" and "Risk
Factors -- Tax Risks."

If the Company qualifies for taxation as a REIT, it generally will not be
subject to federal corporate income tax on its net income that is distributed
currently to its stockholders. That treatment substantially eliminates the
"double taxation" (i.e., taxation at both the corporate and stockholder levels)
that generally results from investment in a corporation. However, the Company
will be subject to federal income tax in the following circumstances. First, the
Company will be taxed at regular corporate rates on any undistributed REIT
taxable income, including undistributed net capital gains. Second, under certain
circumstances, the Company may be subject to the "alternative minimum tax" on
its items of tax preference. Third, if the Company has (i) net income from the
sale or other disposition of "foreclosure property" that is held primarily for
sale to customers in the ordinary course of business or (ii) other nonqualifying
income from foreclosure property, it will be subject to tax at the highest
corporate rate on such income. Fourth, if the Company has net income from
prohibited transactions (which are, in general, certain sales or other
dispositions of property (other than foreclosure property) held primarily for
sale to customers in the ordinary course of business), such income will be
subject to a 100% tax. Fifth, if the Company should fail to satisfy the 75%
gross income test or the 95% gross income test (as discussed below), and has
nonetheless maintained its qualification as a REIT because certain other
requirements have been met, it will be subject to a 100% tax on the net income
attributable to the greater of the amount by which the Company fails the 75% or
95% gross income test. Sixth,

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if the Company should fail to distribute during each calendar year at least the
sum of (i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT
capital gain net income for such year, and (iii) any undistributed taxable
income from prior periods, the Company would be subject to a 4% excise tax on
the excess of such required distribution over the amounts actually distributed.
Seventh, if the Company acquires any asset from a C corporation (i.e., a
corporation generally subject to full corporate-level tax) in a transaction in
which the basis of the asset in the Company's hands is determined by reference
to the basis of the asset (or any other asset) in the hands of the C corporation
and the Company recognizes gain on the disposition of such asset during the
10-year period beginning on the date on which such asset was acquired by the
Company, then to the extent of such asset's "built-in-gain" (i.e., the excess of
the fair market value of such asset at the time of acquisition by the Company
over the adjusted basis in such asset at such time), such gain will be subject
to tax at the highest regular corporate rate applicable (as provided in Treasury
Regulations that have not yet been promulgated). The results described above
with respect to the recognition of "built-in-gain" assume that the Company would
make an election pursuant to IRS Notice 88-19 if it were to make any such
acquisition.

REQUIREMENTS FOR QUALIFICATION

The Code defines a REIT as a corporation, trust or association (i) that is
managed by one or more trustees or directors; (ii) the beneficial ownership of
which is evidenced by transferable shares, or by transferable certificates of
beneficial interest; (iii) that would be taxable as a domestic corporation, but
for Sections 856 through 860 of the Code; (iv) that is neither a financial
institution nor an insurance company subject to certain provisions of the Code;
(v) the beneficial ownership of which is held by 100 or more persons; (vi) not
more than 50% in value of the outstanding shares of which is owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities) during the last half of each taxable year (the "5/50 Rule");
(vii) that makes an election to be a REIT (or has made such election for a
previous taxable year) and satisfies all relevant filing and other
administrative requirements established by the Service that must be met in order
to elect and to maintain REIT status; (viii) that uses a calendar year for
federal income tax purposes and complies with the recordkeeping requirements of
the Code and Treasury Regulations promulgated thereunder; and (ix) that meets
certain other tests, described below, regarding the nature of its income and
assets. The Code provides that conditions (i) to (iv), inclusive, must be met
during the entire taxable year and that condition (v) must be met during at
least 335 days of a taxable year of 12 months, or during a proportionate part of
a taxable year of less than 12 months. Conditions (v) and (vi) will not apply
until after the first taxable year for which an election is made by the Company
to be taxed as a REIT. The Company anticipates issuing sufficient Common Stock
with sufficient diversity of ownership pursuant to the Offering to allow it to
satisfy requirements (v) and (vi). In addition, the Company's Articles of
Incorporation will provide for restrictions regarding transfer of the Common
Stock that are intended to assist the Company in continuing to satisfy the share
ownership requirements described in (v) and (vi) above. Such transfer
restrictions are described in "Description of Capital Shares -- Restrictions on
Ownership."

For purposes of determining stock ownership under the 5/50 Rule, a
supplemental unemployment compensation benefits plan, a private foundation, or a
portion of a trust permanently set aside or used exclusively for charitable
purposes generally is considered an individual, although a trust that is
qualified as a trust under Code Section 401(a) is not considered an individual
and beneficiaries of such trust are treated as holding shares of a REIT in
proportion to their actuarial interests in such trust for purposes of the 5/50
Rule.

The Company has not had and does not currently have any subsidiaries, nor
will it have any subsidiaries immediately after closing of the Offering,
although it may have subsidiaries in the future. Code Section 856(i) provides
that a corporation that is a "qualified REIT subsidiary" shall not be treated as
a separate corporation, and all assets, liabilities, and items of income,
deduction, and credit of a "qualified REIT subsidiary" shall be treated as
assets, liabilities, and items of income, deduction, and credit of the REIT. A
"qualified REIT subsidiary" is a corporation, all of the capital stock of which
has been held by the REIT at all times during the period such corporation was in
existence. Thus, in applying the requirements described herein, any "qualified
REIT subsidiaries" acquired or formed by the Company will be ignored, and all
assets, liabilities, and items of income, deduction, and credit of such
subsidiaries will be treated as assets, liabilities and items of income,
deduction, and credit of the Company.

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In the case of a REIT that is a partner in a partnership, Treasury
Regulations provide that the REIT will be deemed to own its proportionate share
of the assets of the partnership and will be deemed to be entitled to the gross
income of the partnership attributable to such share. In addition, the assets
and gross income of the partnership will retain the same character in the hands
of the REIT as in the partnership for purposes of Section 856 of the Code,
including satisfying the gross income and asset tests, described below. Thus,
assuming the Partnership is classified as a partnership rather than as a
corporation for tax purposes, the Company's proportionate share of the assets,
liabilities and items of income of the Partnership will be treated as assets and
gross income of the Company for purposes of applying the requirements described
herein.

Income Tests

In order for the Company to maintain its qualification as a REIT, there are
three requirements relating to the Company's gross income that must be satisfied
annually. First, at least 75% of the Company's gross income (excluding gross
income from prohibited transactions) for each taxable year must consist of
defined types of income derived directly or indirectly from investments relating
to real property or mortgages on real property (including "rents from real
property" and, in certain circumstances, interest) or temporary investment
income. Second, at least 95% of the Company's gross income (excluding gross
income from prohibited transactions) for each taxable year must be derived from
such real property or temporary investments, and from dividends, other types of
interest, and gain from the sale or disposition of stock or securities, or from
any combination of the foregoing. Third, not more that 30% of the Company's
gross income (including gross income from prohibited transactions) for each
taxable year may be gain from the sale or other disposition of (i) stock or
securities held for less than one year, (ii) dealer property that is not
foreclosure property, and (iii) certain real property held for less than four
years (apart from involuntary conversions and sales of foreclosure property).
The specific application of these tests to the Company is discussed below.

Rents received by the Company will qualify as "rents from real property" in
satisfying the gross income requirements for a REIT described above only if
several conditions are met. First, the amount of rent must not be based in whole
or in part on the income or profits of any person. However, an amount received
or accrued generally will not be excluded from the term "rents from real
property" solely by reason of being based on a fixed percentage or percentages
of receipts or sales. Second, rents received from a tenant will not qualify as
"rents from real property" in satisfying the gross income tests if the Company,
or an owner of 10% or more of the Company, directly or constructively owns 10%
or more of such tenant (a "Related Party Tenant"). Third, if rent attributable
to personal property leased in connection with a lease of real property is
greater than 15% of the total rent received under the lease, then the portion of
rent attributable to such personal property will not qualify as "rents from real
property." Finally, for rents received to qualify as "rents from real property,"
the Company generally must not operate or manage the property or furnish or
render services to the tenants of such property, other than through an
"independent contractor" who is adequately compensated and from whom the Company
derives no revenue. The "independent contractor" requirement, however, does not
apply to the extent the services provided by the Company are "usually or
customarily rendered" in connection with the rental of space for occupancy only
and are not otherwise considered "rendered to the occupant."

Pursuant to the Percentage Leases, the Lessee will lease from the
Partnership the land, buildings, improvements, furnishings and equipment
comprising the Hotels for a 10-year period. The Percentage Leases provide that
the Lessee will be obligated to pay to the Partnership (i) the greater of the
Base Rent or the Percentage Rent (collectively, the "Rents") and (ii) certain
other Additional Charges. The Percentage Rent is calculated by multiplying fixed
percentages by the revenues for each of the Hotels in excess of certain levels.
Both the Base Rent and the threshold room revenue amount in each Percentage Rent
formula will be adjusted for inflation. The adjustment will be calculated at the
beginning of each calendar year based on the change in the CPI during the prior
calendar year. The Base Rent accrues and is required to be paid monthly and the
Percentage Rent (if any) accrues and is required to be paid quarterly.

In order for the Base Rent, the Percentage Rent and the Additional Charges
to constitute "rents from real property," the Percentage Leases must be
respected as true leases for federal income tax purposes and not treated as
service contracts, joint ventures or some other type of arrangement. The
determination of whether the Percentage Leases are true leases depends on an
analysis of all the surrounding facts and circumstances. In

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making such a determination, courts have considered a variety of factors,
including the following: (i) the intent of the parties, (ii) the form of the
agreement, (iii) the degree of control over the property that is retained by the
property owner (e.g., whether the lessee has substantial control over the
operation of the property, which is indicative of a lease, or whether the lessee
was required simply to use its best efforts to perform its obligations under the
agreement, which is indicative of a service contract), (iv) the extent to which
the property owner retains the ultimate benefits and burdens of ownership, and
(v) the extent to which the lessee rather than the property owner bears the risk
of increases in operating expenses and damage to the property during the term of
the lease (and has the benefits of a decrease in operating expenses) with
respect to the property.

In addition, Code Section 7701(e) provides that a contract that purports to
be a service contract (or a partnership agreement) is treated instead as a lease
of property if the contract is properly treated as such, taking into account all
relevant factors, including whether or not: (i) the service recipient is in
physical possession of the property, (ii) the service recipient controls the
property, (iii) the service recipient has a significant economic or possessory
interest in the property (e.g., the property's use is likely to be dedicated to
the service recipient for a substantial portion of the useful life of the
property, the recipient shares the risk that the property will decline in value,
the recipient shares in any appreciation in the value of the property, the
recipient shares in savings in the property's operating costs, or the recipient
bears the risk of damage to or loss of the property), (iv) the service provider
does not bear any risk of substantially diminished receipts or substantially
increased expenditures if there is nonperformance under the contract, (v) the
service provider does not use the property concurrently to provide significant
services to entities unrelated to the service recipient, and (vi) the total
contract price does not substantially exceed the rental value of the property
for the contract period. Since the determination whether a service contract
should be treated as a lease is inherently factual, the presence or absence of
any single factor may not be dispositive in every case.

Brobeck, Phleger & Harrison LLP is of the opinion that the Percentage
Leases will be treated as true leases for federal income tax purposes. Such
opinion is based, in part, on the following facts: (i) the Partnership and the
Lessee intend for their relationship to be that of a lessor and lessee and such
relationship will be documented by lease agreements, (ii) the Lessee will have
the right to exclusive possession and use and quiet enjoyment of the Hotels
during the term of the Percentage Leases, (iii) the Lessee will bear the cost
of, and be responsible for, day-to-day maintenance and repair of the Hotels,
other than the cost of certain capital expenditures and will dictate how the
Hotels are operated, maintained and improved, (iv) the Lessee will bear all of
the costs and expenses of operating the Hotels (including the cost of any
inventory used in their operation) during the term of the Percentage Leases
(other than real and personal property taxes, insurance (other than workers'
compensation insurance) and the cost of repairing, replacing or refurbishing
furniture, fixtures and equipment, to the extent such costs do not exceed the
amounts to be made available to the Lessee for such costs by the Partnership
under each Percentage Lease), (v) the Lessee will benefit from any savings in
the costs of operating the Hotels during the term of the Percentage Leases, (vi)
in the event of damage or destruction to a Hotel, the Lessee will be at economic
risk because it will be obligated either (A) to restore the property to its
prior condition, in which event it will bear all costs of such restoration in
excess of any insurance proceeds or (B) to purchase the Hotel for an amount
generally equal to the fair market value of the Property, less any insurance
proceeds, (vii) the Lessee will indemnify the Partnership against all
liabilities imposed on the Partnership during the term of the Percentage Leases
by reason of (A) injury to persons or damage to property occurring at the Hotels
or (B) the Lessee's use, management, maintenance or repair of the Hotels, and
(viii) the Lessee will be obligated to pay substantial fixed rent for the period
of use of the Hotels, and (ix) the Lessee stands to incur substantial losses (or
reap substantial gains) depending on how successfully it operates the Hotels.

Investors should be aware that there are no controlling Treasury
Regulations, published rulings, or judicial decisions involving leases with
terms substantially the same as the Percentage Leases that discuss whether such
leases constitute true leases for federal income tax purposes. Therefore, the
opinion of Brobeck, Phleger & Harrison LLP with respect to the relationship
between the Partnership and the Lessee is based upon all of the facts and
circumstances and upon administrative pronouncements and judicial decisions
involving situations that are considered to be analogous. Opinions of counsel
are not binding upon the Service

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or any court, and there can be no assurance that the Service will not assert
successfully a contrary position. If the Percentage Leases are recharacterized
as service contracts or partnership agreements, rather than true leases, part or
all of the payments that the Partnership receives from the Lessee would not be
considered rent or would not otherwise satisfy the various requirements for
qualification as "rents from real property." In that case, the Company would not
be able to satisfy either the 75% or 95% gross income tests and, as a result,
would lose its REIT status.

As stated above, in order for the Rents to constitute "rents from real
property," the Rents attributable to personal property leased in connection with
the lease of the real properties comprising a Hotel must not be greater than 15%
of the Rents received under the Percentage Lease. The portion of the Rents
attributable to the personal property in a Hotel is the amount that bears the
same ratio to total Rent for the taxable year as the average of the adjusted
bases of the personal property in the Hotel at the beginning and at the end of
the taxable year bears to the average of the aggregate adjusted bases of both
the real and personal property comprising the Hotel at the beginning and at the
end of such taxable year (the "Adjusted Basis Ratio"). With respect to each
Hotel, the Company has determined that the adjusted tax bases of the personal
property in such Hotel has, at all times while the Partnership has owned such
Hotel, been less than 15% of the adjusted tax bases of both the real and
personal property comprising such Hotel. The Partnership has represented that in
no event will it acquire additional personal property for any Hotel to the
extent that such acquisition would cause the adjusted tax bases of such personal
property to exceed 15% of the total adjusted tax bases of the real and personal
property comprising such Hotel. There can be no firm assurance, however, that
the Company will not fail the 15% adjusted basis ratio test described above as
to one or more of the Percentage Leases, which in turn potentially could cause
it to fail to satisfy the 95% or 75% gross income test and thus lose its REIT
status.

Another requirement for qualification of the Rents as "rents from real
property" is that the Percentage Rent must not be based in whole or in part on
the income or profits of any person. The Percentage Rent, however, will qualify
as "rents from real property" if it is based on percentages of receipts or sales
and the percentages (i) are fixed at the time the Percentage Leases are entered
into, (ii) are not renegotiated during the term of the Percentage Leases in a
manner that has the effect of basing Percentage Rent on income or profits, and
(iii) conform with normal business practice. More generally, the Percentage Rent
will not qualify as "rents from real property" if, considering the Percentage
Leases and all the surrounding circumstances, the arrangement does not conform
with normal business practice, but is in reality used as a means of basing the
Percentage Rent on income or profits. Since the Percentage Rent is based on
fixed percentages of the gross revenues from the Hotels that are established in
the Percentage Leases, and the Company has represented that the percentages (i)
will not be renegotiated during the terms of the Percentage Leases in a manner
that has the effect of basing the Percentage Rent on income or profits and (ii)
conform with normal business practice, the Percentage Rent should not be
considered based in whole or in part on the income or profits of any person.
Furthermore, the Company has represented that, with respect to other hotels that
it acquires in the future, it will not charge rent for any property that is
based in whole or in part on the income or profits of any person (except by
reason of being based on a fixed percentage of gross revenues, as described
above). In the event that any of the foregoing representations of the Company
are inaccurate, the Company could fail or cease to qualify as a REIT.

A third requirement for qualification of the Rents as "rents from real
property" is that the Company must not own, directly or constructively, 10% or
more of the Lessee. The constructive ownership rules generally provide that, if
10% or more in value of the shares of the Company are owned, directly or
indirectly, by or for any person, the Company is considered as owning the shares
of the Lessee owned, directly or indirectly, by or for such person. The Company
has represented that it has not and will not at any time directly or indirectly
own any stock of the Lessee. However, because Mr. Alter is the sole stockholder
of the Lessee, the Company would be deemed to own all of the stock of the Lessee
if Mr. Alter at any time owns, directly, indirectly or constructively, 10% or
more of the shares of Common Stock. Mr. Alter owns 617,870 Units and 6,000
shares of Common Stock and may acquire additional Units or shares of Common
Stock and will constructively own any shares of Common Stock that he has an
option to acquire. The Partnership Agreement provides that a redeeming Limited
Partner will receive cash, rather than shares of Common Stock, at the election
of the Company or if the acquisition of shares of Common Stock by such partner
would result in such partner or any

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other person owning, directly or constructively, more than 9.8% of the Company
for purposes of the Related Party Tenant rule. Thus, Mr. Alter will never be
entitled to acquire a 10% interest in the Company, and the Company should never
own, directly or constructively, 10% of more of the Lessee. Furthermore, the
Company has represented that, with respect to other hotels that it acquires in
the future, it will not rent any property to a Related Party Tenant.

A fourth requirement for qualification of the Rents as "rents from real
property" is that the Company cannot furnish or render noncustomary services to
the Lessee (or tenants of the Hotels), or manage or operate the Hotels or any
leased properties, other than through an independent contractor who is
adequately compensated and from whom the Company itself does not derive or
receive any income. Provided that the Percentage Leases are respected as true
leases, the Company should satisfy that requirement because neither the Company
nor the Partnership will be performing any services other than customary ones
for the Lessee. The Company has also represented that, with respect to other
hotels that it acquires in the future, it will not perform noncustomary services
with respect to the tenant of the property and will not be managing or operating
the Hotels or such other hotels. As described above, if the Percentage Leases
are recharacterized as service contracts or partnership agreements, the Rents
likely would be disqualified as "rents from real property" because the Company
would be considered to furnish or render nonqualifying services to the occupants
of the Hotels and to manage or operate the Hotels other than through an
independent contractor who is adequately compensated and from whom the Company
derives or receives no income.

If the Rents do not qualify as "rents from real property" because the rents
attributable to personal property exceed 15% of the total Rents for a taxable
year, the portion of the Rents that is attributable to personal property will
not be qualifying income for purposes of either the 75% or 95% gross income
tests. The Company would lose its REIT status in this event only if the Rents
attributable to personal property (plus any other nonqualifying income) during a
taxable year exceed 5% of the Company's gross income during the year. If,
however, the Rents do not qualify as "rents from real property" because either
(i) the Percentage Rent is considered based on income or profits of the Lessee,
(ii) the Company owns, directly or constructively, 10% or more of the Lessee, or
(iii) the Company furnishes noncustomary services to the tenants of the Hotels,
or manages or operates the Hotels, other than through a qualifying independent
contractor, none of the Rents would qualify as "rents from real property." In
that case, the Company would lose its REIT status because it would be unable to
satisfy either the 75% or 95% gross income tests.

In addition to the Rents, the Lessee is required to pay to the Partnership
the Additional Charges. To the extent that the Additional Charges represent
either (i) reimbursements of amounts paid by the Partnership to third parties
that the Lessee is obligated to bear or (ii) penalties for nonpayment or late
payment of such amounts, the Additional Charges should qualify as "rents from
real property." To the extent, however, that the Additional Charges represent
interest that is accrued on the late payment of the Rents or the Additional
Charges, the Additional Charges should not qualify as "rents from real
property," but instead should be treated as interest that qualifies for the 95%
gross income test.

Based on the foregoing discussion and subject to the limitations described
therein, Brobeck, Phleger & Harrison LLP is of the opinion that the Rents and
the Additional Charges will qualify as "rents from real property" for purposes
of the 75% and 95% gross income tests, except to the extent that the Additional
Charges represent interest that is accrued on the late payment of the Rents or
the Additional Charges (which will be qualifying gross income for the 95% test
but not the 75% test). As described above, the opinion of Brobeck, Phleger &
Harrison LLP is based upon an analysis of all the facts and circumstances and
upon rulings and judicial decisions involving situations that are considered to
be analogous, as well as representations by the Company and assumptions that are
described above and set out in the federal income tax opinion of Brobeck,
Phleger & Harrison LLP. Opinions of counsel are not binding upon the Service or
a court. Accordingly, there can be no assurance that the Service will not assert
successfully a contrary position and, therefore, prevent the Company from
qualifying as a REIT.

Any gross income derived from a prohibited transaction is taken into
account in applying the 30% income test necessary to qualify as a REIT (and the
net income from that transaction is subject to a 100% tax). The

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term "prohibited transaction" generally includes a sale or other disposition of
property (other than foreclosure property) that is held primarily for sale to
customers in the ordinary course of a trade or business. The Company and the
Partnership believe that no asset owned by the Company or the Partnership will
be held for sale to customers in the ordinary course of business of the Company
or the Partnership. Whether property is held "primarily for sale to customers in
the ordinary course of a trade or business" depends, however, on the facts and
circumstances from time to time. The Company and the Partnership will attempt to
comply with the terms of safe-harbor provisions in the Code prescribing when
asset sales will not be characterized as prohibited transactions. Complete
assurance cannot be given, however, that the Company or the Partnership can
comply with the safe-harbor provisions of the Code or avoid owning property that
may be characterized as property held "primarily for sale to customers in the
ordinary course of a trade or business."

The Company will be subject to tax at the maximum corporate rate on any
income from foreclosure property (other than income that would be qualified
income under the 75% gross income test), less expenses directly connected with
the production of such income. However, gross income from such foreclosure
property will qualify under the 75% and 95% gross income tests. "Foreclosure
property" is defined as any real property (including interests in real property)
and any personal property incident to such real property (i) that is acquired by
a REIT as the result of such REIT having bid on such property at foreclosure, or
having otherwise reduced such property to ownership or possession by agreement
or process of law, after there was a default (or default was imminent) on a
lease of such property or on an indebtedness that such property secured and (ii)
for which such REIT makes a proper election to treat such property as
foreclosure property. However, a REIT will not be considered to have foreclosed
on a property where such REIT takes control of the property as a
mortgagee-in-possession and cannot receive any profit or sustain any loss except
as a creditor of the mortgagor. Under the Code, property generally ceases to be
foreclosure property with respect to a REIT on the date that is two years after
the date such REIT acquired such property (or longer if an extension is granted
by the Secretary of the Treasury). The foregoing grace period is terminated and
foreclosure property ceases to be foreclosure property on the first day (i) on
which a lease is entered into with respect to such property that, by its terms,
will give rise to income that does not qualify under the 75% gross income test
or any amount is received or accrued, directly or indirectly, pursuant to a
lease entered into on or after such day that will give rise to income that does
not qualify under the 75% gross income test, (ii) on which any construction
takes place on such property (other than completion of a building, or any other
improvement, where more than 10% of the construction of such building or other
improvement was completed before default became imminent), or (iii) which is
more than 90 days after the day on which such property was acquired by the REIT
and the property is used in a trade or business that is conducted by the REIT
(other than through an independent contractor from whom the REIT itself does not
derive or receive any income). As a result of the rules with respect to
foreclosure property, if the Lessee defaults on its obligations under a
Percentage Lease for a Hotel, the Company terminates the Lessee's leasehold
interest, and the Company is unable to find a qualifying replacement Lessee for
such Hotel within 90 days of such foreclosure, gross income from hotel
operations conducted by the Company from such Hotel would cease to qualify for
the 75% and 95% gross income tests. In such event, the Company likely would be
unable to satisfy the 75% and 95% gross income tests and, thus, would fail to
qualify as a REIT.

It is possible that, from time to time, the Company or the Partnership will
enter into hedging transactions with respect to one or more of its assets or
liabilities. Any such hedging transactions could take a variety of forms,
including interest rate swap contracts, interest rate cap or floor contracts,
futures or forward contracts, and options. To the extent that the Company or the
Partnership enters into an interest rate swap or cap contract to hedge any
variable rate indebtedness incurred to acquire or carry real estate assets, any
periodic income or gain from the disposition of such contract should be
qualifying income for purposes of the 95% gross income test, but not the 75%
gross income test. Furthermore, any such contract would be considered a
"security" for purposes of applying the 30% gross income test. To the extent
that the Company or the Partnership hedges with other types of financial
instruments or in other situations, it may not be entirely clear how the income
from those transactions will be treated for purposes of the various income tests
that apply to REITs under the Code. The Company intends to structure any hedging
transactions in a manner that does not jeopardize its status as a REIT.

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If the Company fails to satisfy one or both of the 75% or 95% gross income
tests for any taxable year, it may nevertheless qualify as a REIT for such year
if it is entitled to relief under certain provisions of the Code. Those relief
provisions will be generally available if the Company's failure to meet such
tests is due to reasonable cause and not due to willful neglect, the Company
attaches a schedule of the sources of its income to its return, and any
incorrect information on the schedule was not due to fraud with intent to evade
tax. It is not possible, however, to state whether in all circumstances the
Company would be entitled to the benefit of these relief provisions. As
discussed above in "Federal Income Tax Considerations -- Taxation of the
Company," even if those relief provisions apply, a 100% tax would be imposed
with respect to the amount by which it fails the 75% or 95% gross income tests.
No such relief is available for violations of the 30% income test.

Asset Tests

The Company, at the close of each quarter of its taxable year, also must
satisfy two tests relating to the nature of its assets. First, at least 75% of
the value of the Company's total assets must be represented by cash or cash
items (including certain receivables), government securities, "real estate
assets," or, in cases where the Company raises new capital through share or
long-term (at least five-year) debt offerings, temporary investments in stock or
debt instruments during the one-year period following the Company's receipt of
such capital. The term "real estate assets" includes interests in real property,
interests in mortgages on real property to the extent the mortgage balance does
not exceed the value of the associated real property, and shares of other REITs.
For purposes of the 75% asset test, the term "interest in real property"
includes an interest in land and improvements thereon, such as buildings or
other inherently permanent structures (including items that are structural
components of such buildings or structures), a leasehold in real property, and
an option to acquire real property (or a leasehold in real property). Second, of
the investments not included in the 75% asset class, the value of any one
issuer's securities owned by the Company may not exceed 5% of the value of the
Company's total assets and the Company may not own more than 10% of any one
issuer's outstanding voting securities (except for its ownership interest in the
stock of a qualified REIT subsidiary).

For purposes of the asset requirements, the Company will be deemed to own
its proportionate share of the assets of the Partnership, rather than its
partnership interest in the Partnership, assuming that the Partnership is
treated as a partnership and not as a corporation for tax purposes. The Company
has represented that at all times since the commencement of its taxable year
ended December 31, 1995, (i) at least 75% of the value of its total assets were
represented by assets qualifying under the 75% asset test, and (ii) it has not
owned any securities that do not satisfy the 75% asset test. The Company has
represented that it has not and will not acquire or dispose, or cause the
Partnership to acquire or dispose, of assets during 1995, 1996 or in later years
in a way that would cause it to violate the asset tests for REIT status. Based
on the foregoing, Brobeck, Phleger & Harrison LLP is of the opinion that the
Company has and will satisfy the asset tests for REIT status.

If the Company should fail to satisfy the asset tests at the end of a
calendar quarter, such a failure would not cause it to lose its REIT status if
(i) it satisfied all of the asset tests at the close of the preceding calendar
quarter and (ii) the discrepancy between the value of the Company's assets and
the asset requirements either did not exist immediately after the acquisition of
any particular asset or was not wholly or partly caused by such an acquisition
(i.e., the discrepancy arose from changes in the market values of its assets).
If the condition described in clause (ii) of the preceding sentence were not
satisfied, the Company still could avoid disqualification by eliminating any
discrepancy within 30 days after the close of the quarter in which it arose.

Distribution Requirements

The Company, in order to qualify as a REIT, is required to distribute
dividends (other than capital gain dividends) to its stockholders in an amount
at least equal to (i) the sum of (A) 95% of its "REIT taxable income"(computed
without regard to the dividends paid deduction and its net capital gain) and (B)
95% of the net income (after tax), if any, from foreclosure property, minus (ii)
the sum of certain items of noncash income. Such distributions must be paid in
the taxable year to which they relate, or in the following taxable year if
declared before the Company timely files its tax return for such year and if
paid on or before the first

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regular dividend payment after such declaration. To the extent that the Company
does not distribute all of its net capital gain or distributes at least 95%, but
less than 100%, of its "REIT taxable income," as adjusted, it will be subject to
tax thereon at regular ordinary and capital gains corporate tax rates.
Furthermore, if the Company should fail to distribute during each calendar year
at least the sum of (i) 85% of its REIT ordinary income for such year, (ii) 95%
of its REIT capital gain income for such year, and (iii) any undistributed
taxable income from prior periods, the Company would be subject to a 4%
nondeductible excise tax on the excess of such required distribution over the
amounts actually distributed. The Company has represented that, for its taxable
year ended December 31, 1995, the Company made distributions sufficient to
satisfy the foregoing distribution requirements. Furthermore, the Company
intends in the future to make timely distributions sufficient to satisfy all
annual distribution requirements.

It is possible that, from time to time, the Company may experience timing
differences between (i) the actual receipt of income and inclusion of that
income in REIT taxable income and (ii) the actual payment of expenses and the
deduction of such expenses in arriving at its REIT taxable income. For example,
under the Percentage Leases, the Lessee may defer payment of the excess of the
Percentage Rent over the Base Rent for a period of up to 90 days after the end
of the calendar year in which such payment was due. In that case, the
Partnership still would be required to recognize as income the excess of the
Percentage Rent over the Base Rent in the calendar quarter to which it relates.
Further, it is possible that, from time to time, the Company may be allocated a
share of net capital gain attributable to the sale of depreciated property that
exceeds its allocable share of cash attributable to that sale. Therefore, the
Company may have less cash than is necessary to meet its annual 95% distribution
requirement or to avoid corporate income tax or the excise tax imposed on
certain undistributed income. In such a situation, the Company may find it
necessary to arrange for short-term (or possibly long-term) borrowings or to
raise funds through the issuance of additional common or preferred shares.

Under certain circumstances, the Company may be able to rectify a failure
to meet the distribution requirement for a year by paying "deficiency dividends"
to its stockholders in a later year, which may be included in the Company's
deduction for dividends paid for the earlier year. Although the Company may be
able to avoid being taxed on amounts distributed as deficiency dividends, it
will be required to pay to the Service interest based upon the amount of any
deduction taken for deficiency dividends.

Recordkeeping Requirement

Pursuant to applicable Treasury Regulations, in order to qualify as a REIT,
the Company must maintain certain records and request on an annual basis certain
information from its stockholders designed to disclose the actual ownership of
its outstanding shares. The Company has represented that it complied with these
requirements on a timely basis for its taxable year ended December 31, 1995 and
intends to comply with such requirements in the future. Brobeck, Phleger &
Harrison LLP's opinion as to the Company's status as a REIT assumes that the
Company has complied and will at all times comply with such requirements.
Counsel will not, however, monitor such compliance by the Company.

Anti-Abuse Regulations

The United States Treasury Department recently issued regulations that
authorize the Service, in certain "abusive" transactions involving partnerships,
to disregard the form of the transaction and recast it for federal tax purposes
as the Service deems appropriate (the "Anti-Abuse Regulations"). The Anti-Abuse
Regulations would apply where a partnership is formed or utilized in connection
with a transaction (or series of related transactions) with a principal purpose
of substantially reducing the present value of the partners' aggregate federal
tax liability in a manner inconsistent with the intent of the partnership
provisions of the Code.

Prior to the issuance of the Anti-Abuse Regulations, officials at the
Service and the Treasury Department stated publicly that the Anti-Abuse
Regulations are not intended to affect a corporation, such as the Company, that
owns an interest in a partnership and is seeking to qualify as a REIT. The
Anti-Abuse Regulations contain an example in which a corporation that elects to
be treated as a REIT contributes substantially all of the proceeds from a public
offering to a partnership in exchange for a general partner

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interest. The limited partners of the partnership contribute real property
assets to the partnership, subject to liabilities that exceed their respective
aggregate bases in such property. In addition, some of the limited partners have
the right, beginning two years after the formation of the partnership, to
require the redemption of their limited partnership interests in exchange for
cash or REIT stock (at the REIT's option) equal to the fair market value of
their respective interests in the partnership at the time of the redemption. The
example concludes that the use of the partnership is not inconsistent with the
intent of the partnership provisions of the Code and, thus, cannot be recast by
the Service. Based on the foregoing, Brobeck, Phleger & Harrison LLP is of the
opinion that the Anti-Abuse Regulations will not have any adverse impact on the
Company's ability to qualify as a REIT. However, because the Anti-Abuse
Regulations are extremely broad in scope and would be applied based on an
analysis of all of the facts and circumstances, counsel can give no assurance
that the Service will not attempt to apply the Anti-Abuse Regulations to the
Company.

FAILURE TO QUALIFY

If the Company fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, the Company will be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to the stockholders in any year in which
the Company fails to qualify will not be deductible by the Company nor will they
be required to be made. In such event, to the extent of current and accumulated
earnings and profits, all distributions to stockholders will be taxable as
ordinary income and, subject to certain limitations of the Code, corporate
distributees may be eligible for the dividends received deduction. Unless
entitled to relief under specific statutory provisions, the Company also will be
disqualified from taxation as a REIT for the four taxable years following the
year during which the Company ceased to qualify as a REIT. It is not possible to
state whether in all circumstances the Company would be entitled to such
statutory relief.

TAXATION OF TAXABLE U.S. STOCKHOLDERS

As long as the Company qualifies as a REIT, distributions made to the
Company's taxable U.S. stockholders out of current or accumulated earnings and
profits (and not designated as capital gain dividends) will be taken into
account by such U.S. stockholders as ordinary income and will not be eligible
for the dividends received deduction generally available to corporations. As
used herein, the term "U.S. stockholder" means a holder of shares of Common
Stock that for U.S. federal income tax purposes is (i) a citizen or resident of
the United States, (ii) a corporation, partnership, or other entity created or
organized in or under the laws of the United States or of any political
subdivision thereof, or (iii) an estate or trust the income of which is subject
to U.S. federal income taxation regardless of its source. Distributions that are
designated as capital gain dividends will be taxed as long-term capital gains
(to the extent they do not exceed the Company's actual net capital gain for the
taxable year) without regard to the period for which the stockholder has held
his shares of Common Stock. However, corporate stockholders may be required to
treat up to 20% of certain capital gain dividends as ordinary income.
Distributions in excess of current and accumulated earnings and profits will not
be taxable to a stockholder to the extent that they do not exceed the adjusted
basis of the stockholder's Common Stock, but rather will reduce the adjusted
basis of such shares. To the extent that distributions in excess of current and
accumulated earnings and profits exceed the adjusted basis of a stockholder's
Common Stock, such distributions will be included in income as long-term capital
gain (or short-term capital gain if the shares of Common Stock have been held
for one year or less) assuming the shares of Common Stock are capital assets in
the hands of the stockholder. In addition, any distribution declared by the
Company in October, November, or December of any year and payable to a
stockholder of record on a specified date in any such month shall be treated as
both paid by the Company and received by the stockholder on December 31 of such
year, provided that the distribution is actually paid by the Company during
January of the following calendar year.

Stockholders may not include in their individual income tax returns any net
operating losses or capital losses of the Company. Instead, such losses would be
carried over by the Company for potential offset against its future income
(subject to certain limitations). Taxable distributions from the Company and
gain from the disposition of the Common Stock will not be treated as passive
activity income and, therefore, stockholders

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generally will not be able to apply any "passive activity losses" (such as
losses from certain types of limited partnerships in which the stockholder is a
limited partner) against such income. In addition, taxable distributions from
the Company and gain from the disposition of shares of Common Stock generally
will be treated as investment income for purposes of the investment interest
limitations. The Company will notify stockholders after the close of the
Company's taxable year as to the portions of the distributions attributable to
that year that constitute ordinary income, return of capital, and capital gain.

TAXATION OF STOCKHOLDERS ON THE DISPOSITION OF THE COMMON STOCK

In general, any gain or loss realized upon a taxable disposition of the
Common Stock by a stockholder who is not a dealer in securities will be treated
as long-term capital gain or loss if the shares of Common Stock have been held
for more than one year and otherwise as short-term capital gain or loss.
However, any loss upon a sale or exchange of shares of Common Stock by a
stockholder who has held such shares for six months or less (after applying
certain holding period rules), will be treated as a long-term capital loss to
the extent of distributions from the Company required to be treated by such
stockholder as long-term capital gain. All or a portion of any loss realized
upon a taxable disposition of the shares of Common Stock may be disallowed if
the shares of Common Stock are purchased within 30 days before or after the
disposition.

CAPITAL GAINS AND LOSSES

A capital asset generally must be held for more than one year in order for
gain or loss derived from its sale or exchange to be treated as long-term
capital gain or loss. The highest marginal income tax rate on ordinary income of
individuals is 39.6%, whereas the highest rate applicable to net capital gains
of individuals is 28%. Thus the tax rate differential between capital gain and
ordinary income for individuals may be significant. In addition, the
characterization of income as capital or ordinary may affect the deductibility
of capital losses. Capital losses not offset by capital gains may be deducted
against an individual's ordinary income only up to a maximum annual deduction of
$3,000. Unused capital losses may be carried forward. All net capital gain of a
corporate taxpayer is subject to tax at ordinary corporate rates. A corporate
taxpayer can deduct capital losses only to the extent of capital gains, with
unused losses being carried back three years and forward five years.

INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING

The Company will report to its U.S. stockholders and the Service the amount
of distributions paid during each calendar year, and the amount of tax withheld,
if any. Under the backup withholding rules, a stockholder may be subject to
backup withholding at the rate of 31% with respect to distributions paid unless
such holder (i) is a corporation or comes within certain other exempt categories
and, when required, demonstrates this fact or (ii) provides a taxpayer
identification number, certifies as to no loss of exemption from backup
withholding, and otherwise complies with the applicable requirements of the
backup withholding rules. A stockholder who does not provide the Company with
his correct taxpayer identification number also may be subject to penalties
imposed by the Service. Any amount paid as backup withholding will be creditable
against the stockholder's income tax liability. In addition, the Company may be
required to withhold a portion of capital gain distributions to any stockholders
who fail to certify their nonforeign status to the Company. See "Federal Income
Tax Considerations -- Taxation of Non-U.S. Stockholders."

TAXATION OF TAX-EXEMPT STOCKHOLDERS

Tax-exempt entities, including qualified employee pension and profit
sharing trusts and individual retirement accounts ("Exempt Organizations"),
generally are exempt from federal income taxation. However, they are subject to
taxation on their unrelated business taxable income ("UBTI"). While many
investments in real estate generate UBTI, the Service has issued a published
ruling that dividend distributions by a REIT to an exempt employee pension trust
do not constitute UBTI, provided that the shares of the REIT are not otherwise
used in an unrelated trade or business of the exempt employee pension trust.
Thus, amounts distributed by the Company to Exempt Organizations generally
should not constitute UBTI. However, if an Exempt Organization finances its
acquisition of the Common Stock with debt, a portion of its income from the
Company will constitute UBTI pursuant to the "debt-financed property" rules.
Furthermore, social clubs,

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voluntary employee benefit associations, supplemental unemployment benefit
trusts, and qualified group legal services plans that are exempt from taxation
under paragraphs (7), (9), (17), and (20), respectively, of Code Section 501(c)
are subject to different UBTI rules, which generally will require them to
characterize distributions from the Company as UBTI. In addition, in certain
circumstances a pension trust that owns more than 10% of the Company's shares is
required to treat a percentage of the dividends from the Company as UBTI (the
"UBTI Percentage"). The UBTI Percentage is the gross income derived from an
unrelated trade or business (determined as if the Company were a pension trust)
divided by the gross income of the Company for the year in which the dividends
are paid. The UBTI rule applies only if (i) the UBTI Percentage is at least 5%,
(ii) the Company qualifies as a REIT by reason of the modification of the 5/50
Rule that allows the beneficiaries of the pension trust to be treated as holding
shares of the Company in proportion to their actuarial interests in the pension
trust, and (iii) either (A) one pension trust owns more than 25% of the value of
the Company's shares or (B) a group of pension trusts individually holding more
than 10% of the value of the Company's shares collectively own more than 50% of
the value of the Company's shares.

While an investment in the Company by an Exempt Organization generally is
not expected to result in UBTI except in the circumstances described in the
preceding paragraph, any UBTI that does arise from such an investment will be
combined with all other UBTI of the Exempt Organization for a taxable year. Any
net UBTI will be subject to tax. If the gross income taken into account in
computing UBTI exceeds $1,000, the Exempt Organization is obligated to file a
tax return for such year on IRS Form 990-T. Neither the Company, the Board of
Directors, nor any of their Affiliates expects to undertake the preparation or
filing of IRS Form 990-T for any Exempt Organization in connection with an
investment by such Exempt Organization in the Common Stock.

TAXATION OF NON-U.S. STOCKHOLDERS

The rules governing U.S. federal income taxation of nonresident alien
individuals, foreign corporations, foreign partnerships, and other foreign
stockholders (collectively, "Non-U.S. Stockholders") are complex and no attempt
will be made herein to provide more than a summary of such rules. PROSPECTIVE
NON-U.S. STOCKHOLDERS SHOULD CONSULT WITH THEIR OWN TAX ADVISORS TO DETERMINE
THE IMPACT OF FEDERAL, STATE, AND LOCAL INCOME TAX LAWS WITH REGARD TO AN
INVESTMENT IN THE COMMON STOCK, INCLUDING ANY REPORTING REQUIREMENTS.

Distributions to Non-U.S. Stockholders that are not attributable to gain
from sales or exchanges by the Company of U.S. real property interests and are
not designated by the Company as capital gains dividends will be treated as
dividends of ordinary income to the extent that they are made out of current or
accumulated earnings and profits of the Company. Such distributions ordinarily
will be subject to a withholding tax equal to 30% of the gross amount of the
distribution unless an applicable tax treaty reduces or eliminates that tax.
However, if income from the investment in the Common Stock is treated as
effectively connected with the Non-U.S. Stockholder's conduct of a U.S. trade or
business, the Non-U.S. Stockholder generally will be subject to federal income
tax at graduated rates, in the same manner as U.S. stockholders are taxed with
respect to such distributions (and also may be subject to the 30% branch profits
tax in the case of a Non-U.S. Stockholder that is a foreign corporation). The
Company expects to withhold U.S. income tax at the rate of 30% on the gross
amount of any such distributions made to a Non-U.S. Stockholder unless (i) a
lower treaty rate applies and any required form evidencing eligibility for that
reduced rate is filed with the Company or (ii) the Non-U.S. Stockholder files an
IRS Form 4224 with the Company claiming that the distribution is effectively
connected income. Distributions in excess of current and accumulated earnings
and profits of the Company will not be taxable to a stockholder to the extent
that such distributions do not exceed the adjusted basis of the stockholder's
Common Stock, but rather will reduce the adjusted basis of such shares. To the
extent that distributions in excess of current and accumulated earnings and
profits exceed the adjusted basis of a Non-U.S. Stockholder's Common Stock, such
distributions will give rise to tax liability if the Non-U.S. Stockholder would
otherwise be subject to tax on any gain from the sale or disposition of his
Common Stock, as described below. Because it generally cannot be determined at
the time a distribution is made whether or not such distribution will be in
excess of current and accumulated earnings and profits, the entire amount of

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any distribution normally will be subject to withholding at the same rate as a
dividend. However, amounts so withheld are refundable to the extent it is
determined subsequently that such distribution was, in fact, in excess of
current and accumulated earnings and profits of the Company.

For any year in which the Company qualifies as a REIT, distributions that
are attributable to gain from sales or exchanges by the Company of U.S. real
property interests will be taxed to a Non-U.S. Stockholder under the provisions
of the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"). Under
FIRPTA, distributions attributable to gain from sales of U.S. real property
interests are taxed to a Non-U.S. Stockholder as if such gain were effectively
connected with a U.S. business. Non-U.S. Stockholders thus would be taxed at the
normal capital gain rates applicable to U.S. stockholders (subject to applicable
alternative minimum tax and a special alternative minimum tax in the case of
nonresident alien individuals). Distributions subject to FIRPTA also may be
subject to a 30% branch profits tax in the hands of a foreign corporate
stockholder not entitled to treaty relief or exemption. The Company is required
by currently applicable Treasury Regulations to withhold 35% of any distribution
that is designated by the Company as a capital gains dividend. The amount
withheld is creditable against the Non-U.S. Stockholder's FIRPTA tax liability.

Gain recognized by a Non-U.S. Stockholder upon a sale of his Common Stock
generally will not be taxed under FIRPTA if the Company is a "domestically
controlled REIT," defined generally as a REIT in which at all times during a
specified testing period less than 50% in value of the stock was held directly
or indirectly by foreign persons. It is currently anticipated that the Company
will be a "domestically controlled REIT" and, therefore, the sale of the Common
Stock will not be subject to taxation under FIRPTA. However, because the Common
Stock will be publicly traded, no assurance can be given that the Company will
continue to be a "domestically controlled REIT." Furthermore, gain not subject
to FIRPTA will be taxable to a Non-U.S. Stockholder if (i) investment in the
Common Stock is effectively connected with the Non-U.S. Stockholder's U.S. trade
or business, in which case the Non-U.S. Stockholder will be subject to the same
treatment as U.S. stockholders with respect to such gain, or (ii) the Non-U.S.
Stockholder is a nonresident alien individual who was present in the United
States for 183 days or more during the taxable year and certain other conditions
apply, in which case the nonresident alien individual will be subject to a 30%
tax on the individual's capital gains. If the gain on the sale of the shares of
Common Stock were to be subject to taxation under FIRPTA, the Non-U.S.
Stockholder would be subject to the same treatment as U.S. stockholders with
respect to such gain (subject to applicable alternative minimum tax, a special
alternative minimum tax in the case of nonresident alien individuals and the
possible application of the 30% branch profits tax in the case of foreign
corporations). IN ADDITION, NON-U.S. STOCKHOLDERS SHOULD BE AWARE THAT
LEGISLATIVE PROPOSALS HAVE BEEN MADE TO SUBJECT FOREIGN PERSONS TO U.S. TAX IN
CERTAIN CIRCUMSTANCES ON THEIR GAINS FROM THE SALE OF STOCK IN U.S.
CORPORATIONS. THERE CAN BE NO ASSURANCE THAT SUCH A PROPOSAL WILL NOT BE ENACTED
INTO LAW IN A FORM DETRIMENTAL TO FOREIGN HOLDERS OF THE COMMON STOCK.

OTHER TAX CONSEQUENCES

The Company, the Partnership, or the Company's stockholders may be subject
to state or local taxation in various state or local jurisdictions, including
those in which it or they own property, transact business, or reside. The state
and local tax treatment of the Company and its stockholders may not conform to
the federal income tax consequences discussed above. CONSEQUENTLY, PROSPECTIVE
STOCKHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS REGARDING THE EFFECT OF STATE
AND LOCAL TAX LAWS ON AN INVESTMENT IN THE COMPANY.

TAX ASPECTS OF THE PARTNERSHIP

The following discussion summarizes certain federal income tax
considerations applicable to the Company's investment in the Partnership. The
discussion does not cover state or local tax laws or any federal tax laws other
than income tax laws.

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Classification as a Partnership

The Company will be entitled to include in its income its distributive
share of the Partnership's income and to deduct its distributive share of the
Partnership's losses only if the Partnership is classified for federal income
tax purposes as a partnership rather than as association taxable as a
corporation. An organization formed as a partnership will be treated as a
partnership, rather than as a corporation, for federal income tax purposes if
(i) it has no more than two of the four corporate characteristics that the
Treasury Regulations use to distinguish a partnership from a corporation for tax
purposes (continuity of life, centralization of management, limited liability,
and free transferability of interests); and (ii) it is not treated as a
corporation by virtue of being classified as a "publicly traded partnership."

The Partnership will not request a ruling from the Service that it will be
classified as a partnership for federal income tax purposes. Instead, at the
Closing, Brobeck, Phleger & Harrison LLP will deliver its opinion that, based on
the provisions of the Partnership Agreement, certain factual assumptions and
certain representations described in the opinion, the Partnership will be
treated for federal income tax purposes as a partnership and not as an
association taxable as a corporation. Unlike a tax ruling, an opinion of counsel
is not binding upon the Service, and no assurance can be given that the Service
will not challenge the status of the Partnership as a partnership for federal
income tax purposes. If such challenge were sustained by a court, the
Partnership would be treated as a corporation for federal income tax purposes,
as described below. In addition, the opinion of Brobeck, Phleger & Harrison LLP
is based on existing law, which is to a great extent the result of
administrative and judicial interpretation. No assurance can be given that
administrative or judicial changes would not modify the conclusions expressed in
the opinion.

Under Section 7704 of the Code, a partnership is treated as a corporation
for federal income tax purposes if it is a "publicly traded partnership" (except
in situations in which 90% or more of the partnership's gross income is of a
specified type). A partnership is deemed to be publicly traded if its interests
are either (i) traded on an established securities market, or (ii) readily
tradable on a secondary market (or the substantial equivalent thereof). While
the Partnership Units will not be traded on an established securities market,
they could possibly be deemed to be traded on a secondary market or its
equivalent due to the redemption rights enabling the partners to dispose of
their Units.

The Treasury Department recently issued regulations (the "PTP Regulations")
governing the classification of partnerships under Section 7704. These
regulations provide that the classification of partnerships is generally based
on a facts and circumstances analysis. However, the regulations also provide
limited "safe harbors" which preclude publicly traded partnership status.
Pursuant to one of those safe harbors, interests in a partnership will not be
treated as readily tradable on a secondary market or the substantial equivalent
thereof if (i) all interests in the partnership were issued in a transaction (or
transactions) that was not required to be registered under the Securities Act of
1933 (the "1933 Act"), and (ii) the partnership does not have more than 100
partners at any time during the partnership's taxable year. In determining the
number of partners in a partnership for this purpose, a person owning an
interest in a flowthrough entity (i.e., a partnership, grantor trust, or S
corporation) that owns an interest in the partnership is treated as a partner in
such partnership only if (x) substantially all of the value of the person's
interest in the flow-through entity is attributable to the flow-through entity's
interest (direct or indirect) in the partnership and (y) a principal purpose of
the use of the tiered arrangement is to permit the partnership to satisfy the
100-partner limitation. Furthermore, pursuant to Notice 88-75 issued by the
Internal Revenue Service, through the year 2005, an existing partnership may
qualify for non-publicly traded status if it has less than 500 partners (looking
through to the ultimate owners in the case of flow-through entities), does not
issue any Units registered under the 1933 Act and does not enter into a
substantial new line of business.

The Partnership currently has less than 100 actual partners and less than
500 partners calculated on a "lookthrough" basis. The Partnership has not issued
any Units required to be registered under the 1933 Act. Thus, the Partnership
presently qualifies for the safe harbors provided in Notice 88-75 and the PTP
Regulations. However, there is no assurance that the Partnership will at all
times in the future be able to avoid treatment as a publicly traded partnership.

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Even if the Partnership were ever to be classified as a publicly traded
partnership, it would nevertheless be treated as a partnership for federal
income tax purposes (rather than an association taxable as a corporation) if at
least 90% of its gross income in each taxable year (commencing with the year in
which it is treated as a publicly traded partnership) consists of "qualifying
income" within the meaning of Section 7704(c)(2) of the Code (including
interest, dividends, "real property rents" and gains from the disposition of
real property). The Partnership has represented that, if in any taxable year the
Partnership falls outside of an applicable safe harbor from publicly traded
partnership status, it will satisfy the gross income test set forth in Section
7704(c)(2) of the Code in that taxable year and each subsequent taxable year.
Among other things, this will require that Mr. Alter (or any other shareholder
of the Lessee who owns at least 10% of the stock of the Lessee) own less than a
5% interest in the Partnership in the particular taxable year. Mr. Alter
currently owns more than a 5% interest in the Partnership, but anticipates a
reduction to less than 5% by reason of the Offering. The opinion of Brobeck,
Phleger & Harrison LLP as to the classification of the Partnership is based on
an assumption that the Partnership will either (i) continue to fall within a
safe harbor from publicly traded partnership status, or (ii) if the Partnership
is ever treated as a publicly traded partnership, it will satisfy the qualifying
income test of Section 7704(c)(2) of the Code in the taxable year in which such
treatment commences and all years thereafter.

If for any reason the Partnership was taxable as a corporation, rather than
as a partnership, for federal income tax purposes, the Company would not be able
to satisfy the income and asset requirements for REIT status. Thus the Company
would be subject to tax as a regular corporation and would not receive a
deduction for dividends paid to its stockholders. See "Federal Income Tax
Considerations -- Requirements for Qualification -- Income Tests" and
"Requirements for Qualification -- Asset Tests." In addition, any change in the
Partnership's status for tax purposes might be treated as a taxable event, in
which case the Company might incur a tax liability without any related cash
distribution. Further, items of income and deduction of the Partnership would
not pass through to its partners, and its partners would be treated as
stockholders for tax purposes. Consequently, the Partnership would be required
to pay income tax at corporate tax rates on its net income, and distributions to
its partners would constitute dividends that would not be deductible in
computing the Partnership's taxable income.

The following discussion assumes that the Partnership will be treated as a
partnership for federal income tax purposes.

Income Taxation of the Partnership and Its Partners

Partners, Not the Partnership, Subject to Tax. A partnership is not a
taxable entity for federal income tax purposes. Rather, the Company will be
required to take into account its allocable share of the Partnership's income,
gains, losses, deductions, and credits for any taxable year of the Partnership
ending within or with the taxable year of the Company, without regard to whether
the Company has received or will receive any distribution from the Partnership.

Partnership Allocations. Although a partnership agreement generally will
determine the allocation of income and losses among partners, such allocations
will be disregarded for tax purposes under Section 704(b) of the Code if they do
not comply with the provisions of Section 704(b) of the Code and the Treasury
Regulations promulgated thereunder. If an allocation is not recognized for
federal income tax purposes, the item subject to the allocation will be
reallocated in accordance with the partners' interests in the partnership, which
will be determined by taking into account all of the facts and circumstances
relating to the economic arrangement of the partners with respect to such item.
Brobeck, Phleger & Harrison LLP is of the opinion that the Partnership's
allocations of taxable income and loss comply with the requirements of Section
704(b) of the Code and the Treasury Regulations promulgated thereunder.

Tax Allocations With Respect to Contributed Properties. 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 in
exchange for an interest in the 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 the contribution. The amount of such unrealized gain or unrealized

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<PAGE> 117

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. The Treasury Department has issued
regulations requiring partnerships to use a "reasonable method" for allocating
items affected by Section 704(c) of the Code and outlining certain reasonable
allocation methods.

Under the Partnership Agreement, depreciation or amortization deductions of
the Partnership generally will be allocated among the partners in accordance
with their respective interests in the Partnership, except to the extent that
the Partnership is required under Code Section 704(c) to use a method for
allocating tax depreciation deductions attributable to contributed properties
that results in the Company receiving a disproportionately large share of such
deductions. In addition, gain on sale of a Hotel will be specially allocated to
the Limited Partners (other than the Company as a Limited Partner) to the extent
of any "built-in" gain with respect to such Hotel for federal income tax
purposes.

Basis in Partnership Interest. The Company's adjusted tax basis in its
partnership interest in the Partnership generally will be equal to (i) the
amount of cash and the basis of any other property contributed to the
Partnership by the Company, (ii) increased by (A) its allocable share of the
Partnership's income and (B) its allocable share of indebtedness of the
Partnership, and (iii) reduced, but not below zero, by (A) the Company's
allocable share of the Partnership's loss and (B) the amount of cash distributed
to the Company (including deemed distributions as a result of reductions in the
Company's allocable share of indebtedness of the Partnership).

If the allocation of the Company's distributive share of the Partnership's
loss would reduce the adjusted tax basis of the Company's partnership interest
in the Partnership below zero, the recognition of such loss will be deferred
until such time as the recognition of such loss would not reduce the Company's
adjusted tax basis below zero. To the extent that the Partnership's
distributions, or any decrease in the Company's share of the indebtedness of the
Partnership (such decrease being considered a constructive cash distribution to
the partners), would reduce the Company's adjusted tax basis below zero, such
distributions (including such constructive distributions) would constitute
taxable income to the Company. Such distributions and constructive distributions
normally would be characterized as capital gain, and, if the Company's
partnership interest in the Partnership has been held for longer than the
long-term capital gain holding period (currently one year), the distributions
and constructive distributions would constitute long-term capital gain.

Depreciation Deductions Available to the Partnership. Subsequent to the
IPO, the Partnership purchased certain of the Current Hotels and the acquired
Acquisition Hotel with cash. The Partnership acquired certain other Current
Hotels partially in exchange for interests in the Partnership. To the extent the
Partnership purchased the Current Hotels and the acquired Acquisition Hotel with
cash, the Partnership's initial basis in such Current Hotels and the acquired
Acquisition Hotel for federal income tax purposes generally was equal to the
purchase price paid by the Partnership. The Partnership is depreciating such
depreciable Hotels for federal income tax purposes under the ADS system of
depreciation. Under ADS, the Partnership is generally depreciating furnishings
and equipment over a twelve-year recovery period using a straight-line method
and a half-year convention. (If, however, the Partnership places more than 40%
of its furnishings and equipment in service during the last three months of a
taxable year, a mid-quarter depreciation convention must be used for the
furnishings and equipment placed in service during that year.) Under ADS, the
Partnership is generally depreciating buildings and improvements over a 40-year
recovery period using a straight line method and a mid-month convention. The
Partnership intends to depreciate all hotels acquired in the future using the
same depreciation methods. To the extent that the Partnership acquired the
Current Hotels in exchange for limited partnership interests in the Partnership,
the Partnership's initial basis in such Current Hotels for federal income tax
purposes was the same as the transferor's basis in that Hotel on the date of
acquisition. Although the law is not entirely clear, the Partnership is
depreciating such depreciable property for federal income tax purposes over the
same remaining useful lives and under the same methods used by the transferors.

The Partnership's tax depreciation deductions have been and will be
allocated among the partners in accordance with their respective interests in
the Partnership (except to the extent that the Partnership is required under
Code Section 704(c) to use a method for allocating depreciation deductions
attributable to the

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<PAGE> 118

Sunstone Initial Hotels or other contributed properties that results in the
Company receiving a disproportionately large share of such deductions).

Sale of the Partnership's Property. Generally, any taxable gain realized
by the Partnership on the sale of property by the Partnership held for more than
one year will be long-term capital gain, except for any portion of such gain
that is treated as depreciation or cost recovery recapture. Any taxable gain
recognized by the Partnership on the disposition of the Sunstone Initial Hotels
or any other hotels originally contributed to the Partnership by the Limited
Partners other than the Company will be allocated first to the Limited Partners
(other than the Company as a Limited Partner) under Section 704(c) of the Code
to the extent of their "built-in gain" on those Hotels for federal income tax
purposes. The Limited Partners' "built-in gain" on such Hotels sold will equal
the excess of the Limited Partners' proportionate share of the book value of
those Hotels over the Limited Partners' tax basis allocable to those Hotels at
the time of the sale. Any remaining taxable gain recognized by the Partnership
on the disposition of the Hotels will be allocated among the partners in
accordance with their respective percentage interests in the Partnership.

The Company's share of any gain realized by the Partnership on the sale of
any property held by the Partnership as inventory or other property held
primarily for sale to customers in the ordinary course of the Partnership's
trade or business will be treated as income from a prohibited transaction that
is subject to a 100% penalty tax. See "Federal Income Tax
Considerations -- Requirements for Qualification -- Income Tests." Such
prohibited transaction income also may have an adverse effect upon the Company's
ability to satisfy the income tests for REIT status. See "Federal Income Tax
Considerations -- Requirements For Qualification -- Income Tests" above. The
Company, however, does not presently intend to allow the Partnership to acquire
or hold any property that represents inventory or other property held primarily
for sale to customers in the ordinary course of the Company's or the
Partnership's trade or business.

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<PAGE> 119

UNDERWRITING

The underwriters named below (the "Underwriters"), represented by
Montgomery Securities, Bear, Stearns & Co. Inc., EVEREN Securities, Inc. and
Raymond James & Associates, Inc. (the "Representatives"), have severally agreed,
subject to the terms and conditions contained in the Underwriting Agreement, to
purchase from the Company the number of shares of Common Stock indicated below
opposite their respective names at the initial public offering price less the
underwriting discount set forth on the cover page of this Prospectus. The
Underwriting Agreement provides that the obligations of the Underwriters are
subject to certain conditions precedent and that the Underwriters are committed
to purchase all of the shares, if they purchase any. In the event of a default
by an Underwriter, the Underwriting Agreement provides that, in certain
circumstances, the purchase commitments of the nondefaulting Underwriters may be
increased or the Underwriting Agreement may be terminated.

<TABLE>
<CAPTION>
NUMBER OF
SHARES TO BE
UNDERWRITERS PURCHASED
------------------------------------------------------------------------- ------------
<S> <C>
Montgomery Securities.................................................... 1,000,000
Bear, Stearns & Co. Inc. ................................................ 1,000,000
EVEREN Securities, Inc. ................................................. 1,000,000
Raymond James & Associates, Inc. ........................................ 1,000,000
------------
Total.......................................................... 4,000,000
=========
</TABLE>

The Representatives propose initially to offer the Common Stock to the
public at the Price to Public set forth on the cover page of this Prospectus.
The Underwriters may allow to selected dealers a concession of not more than
$0.36 per share; and the Underwriters may allow, and such dealers may allow, a
concession of not more than $0.10 per share to certain other dealers. The shares
of Common Stock are offered subject to receipt and acceptance by the
Underwriters, and to certain other conditions, including the right to reject
orders in whole or in part. After the initial public offering, the public
offering price, allowances, concessions and other selling terms may be changed
by the Representatives.

The Company has granted an option to the Underwriters, exercisable during
the 30-day period after the date of this Prospectus, to purchase up to a maximum
of 600,000 additional shares to cover over-allotments. To the extent that the
Underwriters exercise this option, the Underwriters will be committed, subject
to certain conditions, to purchase such additional shares in approximately the
same proportion as set forth in the above table. The Underwriters may purchase
such shares only to cover over-allotments made in connection with this Offering.

The Underwriting Agreement provides that the Company will indemnify the
Underwriters against certain liabilities, including civil liabilities under the
Securities Act, or will contribute to payments the Underwriters may be required
to make in respect thereof.

The Company and the officers of the Company will agree that, except under
certain circumstances, for a period of 120 days after the date of this
Prospectus, they will not, without the consent of Montgomery Securities, issue,
sell or dispose of any shares of Common Stock or any shares convertible or
exchangeable into any shares of Common Stock. See "Shares Eligible for Future
Sale."

At the IPO, MYPC, an affiliate of Montgomery Securities, acquired 24,500
Units in the Partnership. Additionally, MYPC received warrants to purchase
33,946 Units which are exercisable at any time between the first and the fifth
anniversary of the closing of the IPO at an exercise price per share equal to
the IPO offering price of $9.50 per share of Common Stock. At any time after one
year following the closing of the IPO, the Units may be redeemed on a
one-for-one basis for shares of Common Stock (or for cash at the election of the
Company).

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<PAGE> 120

EXPERTS

The consolidated balance sheets of Sunstone Hotel Investors, Inc. as of
December 31, 1995 and 1994, the combined balance sheet of Sunstone Initial
Hotels as of December 31, 1994 and the related consolidated and combined
statements of operations, equity and cash flows for the periods August 16, 1995,
through December 31, 1995 and January 1, 1995 through August 15, 1995,
respectively and the years ended December 31, 1994 and 1993 including the
accompanying financial statement schedule as of December 31, 1995, the financial
statements of Sunstone Hotel Properties, Inc. as of December 31, 1995 and for
the period August 16, 1995, inception, through December 31, 1995, the financial
statements of Renton Joint Venture as of December 31, 1995 and for the year then
ended and the combined financial statements of Bay City Hospitality, Inc. and
Price Hospitality, Inc. as of October 31, 1995 and for the year then ended,
included in this Registration Statement have been audited by Coopers & Lybrand
L.L.P., independent accountants, as set forth in their reports thereon included
elsewhere herein. Such financial statements are included in reliance upon such
reports given on their authority as experts in accounting and auditing.

The balance sheets of Bay City Hospitality, Inc. as of October 31, 1994 and
1993 and the related statements of income, changes in shareholder's equity and
of cash flows for the year ended October 31, 1994 and the period from February
5, 1993 (inception) to October 31, 1993 and the balance sheet of Price
Hospitality, Inc., as of October 31, 1994 and the related statements of income,
changes in shareholder's equity, and cash flows for the period from inception of
operations, December 29, 1993, to October 31, 1994, included in this Prospectus
have been audited by Griffing & Company, P.C., independent accountants, as set
forth in their reports thereon included elsewhere herein and in the Registration
Statement. Such financial statements are included in reliance upon such reports
given on their authority as experts in accounting and auditing.

REPORTS TO STOCKHOLDERS

The Company intends to furnish its stockholders with annual reports
containing consolidated financial statements audited by its independent
certified public accountants and with quarterly reports containing unaudited
condensed consolidated financial statements for each of the first three quarters
of each fiscal year. The consolidated financial statements of the Partnership
are presently included in the financial statements of the Company. In the event
the Company is not required to separately report the consolidated financial
statements of the Partnership, the Company will nonetheless undertake to provide
to its stockholders annual reports containing consolidated financial statements
of the Partnership audited by independent certified public accountants.

LEGAL MATTERS

The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Brobeck, Phleger & Harrison LLP. In addition, the
description of federal income tax consequences contained in the section of the
Prospectus entitled "Federal Income Tax Considerations" is based on the opinion
of Brobeck, Phleger & Harrison LLP. Certain legal matters related to this
Offering will be passed upon for the Underwriters by O'Melveny & Myers LLP. In
rendering their opinions, Brobeck, Phleger & Harrison LLP and O'Melveny & Myers
LLP will rely upon the opinion of Ballard Spahr Andrews & Ingersoll as to
certain matters of Maryland law.

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<PAGE> 121

ADDITIONAL INFORMATION

The Company has filed with the SEC a Registration Statement on Form S-11
(of which this Prospectus is a part) under the Securities Act with respect to
the securities offered hereby. This Prospectus does not contain all of the
information set forth in the Registration Statement, certain portions of which
have been omitted as permitted by the rules and regulations of the SEC.
Statements contained in this Prospectus as to the content of any contract or
other document are not necessarily complete, and in each instance reference is
made to the copy of such contract or other document filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference and the exhibits and schedules hereto. For further information
regarding the Company and the shares of Common Stock offered hereby, reference
is hereby made to the Registration Statement and such exhibits and schedules.

The Registration Statement and the exhibits and schedules forming a part
thereof filed by the Company with the Commission can be inspected and copies
obtained from the Commission at Room 1204, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549, and at the following regional offices of the
Commission: 7 World Trade Center, 13th Floor, New York, New York 10048 and
Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661. Copies of such material can be obtained from the Public
Reference Section of the Commission, 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. The Commission also maintains a web site that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission, including
the Company, and the address is http://www.sec.gov.

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<PAGE> 122

GLOSSARY OF SIGNIFICANT TERMS

Unless the context otherwise requires, the following capitalized terms
shall have the meanings set forth below for the purposes of this Prospectus.

"ACM" means asbestos containing materials.

"Acquisition Hotels" means the Holiday Inn-Renton, Washington hotel
acquired on June 28, 1996, and the two hotels which the Company intends to
acquire concurrently with the closing of the Offering.

"ADA" means the Americans with Disabilities Act of 1990.

"Additional Charges" means certain amounts payable by the Lessee in
connection with Percentage Leases, including interest accrued on any late
payments or charges.

"Administrator" means the Compensation Committee or its designee.

"ADR" means average daily room rate.

"Affiliate" means (i) any person that, directly or indirectly, controls or
is controlled by or is under common control with such person, (ii) any other
person that owns, beneficially, directly or indirectly, five percent (5%) or
more of the outstanding capital shares, shares or equity interests of such
person, or (iii) any officer, director, employee, partner or trustee of such
person or any person controlling, controlled by or under common control with
such person (excluding trustees and persons serving in similar capacities who
are not otherwise an Affiliate of such person). The term "person" means and
includes individuals, corporations, general and limited partnerships, shares
companies or associations, joint ventures, associations, companies, trusts,
banks, trust companies, land trusts, business trusts, or other entities and
governments and agencies and political subdivisions thereof. For the purposes of
this definition, "control" (including the correlative meanings of the terms
"controlled by" and "under common control with"), as used with respect to any
person, shall mean the possession, directly or indirectly, of the power to
direct or cause the direction of the management and policies of such person,
through the ownership of voting securities, partnership interests or other
equity interests.

"Alter Employment Agreement" means the employment agreement between the
Company and Robert A. Alter.

"Anti-Abuse Regulations" means certain federal tax regulations issued by
the Service respecting abusive transactions involving partnerships.

"Articles of Incorporation" means the Amended Articles of Incorporation of
the Company, as amended by the Articles of Amendment of the Company, as filed
with the State Department of Assessment and Taxation of Maryland on November 9,
1994, and as further amended by the Articles of Amendment of the Company, as
filed with the State Department of Assessment and Taxation of Maryland on June
19, 1995.

"Award Date" means the first meeting of the Board of Directors following
the annual meeting of the Company's stockholders at which they are elected.

"Base Rent" means the fixed obligation of the Lessee to pay a sum certain
in monthly rent under each of the Percentage Leases.

"Beneficiary" means the Beneficiary of a Share Trust.

"Biederman Employment Agreement" means the employment agreement between the
Company and Charles L. Biederman.

"Board of Directors" means the Board of Directors of the Company.

"Bylaws" means the Bylaws of the Company.

"Cash Available for Distribution" means net income (loss) (computed in
accordance with generally accepted accounting principles) of the Company plus
depreciation and amortization and minority interest minus capital expenditures
and principal payments on indebtedness.

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<PAGE> 123

"Closing Price" shall mean on any date the last sale price, regular way,
or, if no such sale takes place on such day, the average of the closing bid and
asked prices, regular way, as reported in the principal consolidated transaction
reporting system.

"Code" means the Internal Revenue Code of 1986, as amended.

"Commission" means the Securities and Exchange Commission.

"Common Stock" means the Common Stock, par value $.01 per share, of the
Company.

"Company" means Sunstone Hotel Investors, Inc., a Maryland corporation, and
Sunstone Hotel Investors, L.P., unless the context otherwise indicates.

"CPI" means the United States Consumer Price Index, All Urban Consumers,
U.S. City Average, All Items (1982-84 = 100).

"Current Hotels" means the 17 hotels owned by the Company, exclusive of the
Acquisition Hotels.

"Cypress Inn Hotels" means the Company's four hotels located in Washington
and Oregon previously operated as Cypress Inns Hotels.

"Debt Limitation" means the provisions in the Company's Articles of
Incorporation which limits consolidated indebtedness to 50% of the Company's
investment in Hotels, at cost, after giving effect to the Company's use of
proceeds from any indebtedness.

"Directors Plan" means the 1994 Directors Plan adopted by the Board of
Directors.

"Exchange Act" means the Securities Exchange Act of 1934, as amended.

"Exempt Organizations" means entities, including qualified employee pension
and profit sharing trusts and individual retirement accounts, that are generally
exempt from federal income taxation under Section 501(a) of the Code.

"FFO" means funds from operations, defined as income before minority
interest (computed in accordance with generally accepted accounting principles),
excluding gains (losses) from debt restructuring and sales of property and real
estate related depreciation and amortization (excluding amortization of
financing costs).

"FIRPTA" means Foreign Investment in Real Property Tax Act of 1980, as
amended.

"Founding Director" means those directors who are members of the Board of
Directors at the close of the Offering.

"Franchise Agreement" shall mean the franchise agreement by and between the
franchisor and the Lessee for each Current Hotel and any subsequently acquired
Hotel pursuant to which a franchise agreement is executed. The term "Franchise
Agreement" includes the applicable franchise license under which each Current
Hotel and any subsequently acquired Hotel is operated.

"General Partner" means Sunstone Hotel Investors, Inc., the sole general
partner of the Partnership.

"Hampton" means Promus Hotels, Inc.

"Holiday Inn" means Holiday Inns Franchising, Inc.

"Hospitality Directions" means the report dated January 1996 entitled
"Coopers & Lybrand Hospitality Directions".

"Hotels" means collectively the Current Hotels and the Acquisition Hotels.

"Independent Director" means a director of the Company who is not an
officer or employee of the Company, any Affiliate of an officer or employee or
any Affiliate of (i) any advisor to the Company under an advisory agreement,
(ii) any lessee of any property of the Company, (iii) any subsidiary of the
Company, or (iv) any partnership which is an Affiliate of the Company. Due to
Mr. Enever's extensive personal relationship

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<PAGE> 124

history with Mr. Alter and as former general partner of certain of the Sunstone
Affiliates, Mr. Enever will not be deemed to be an Independent Director but will
be eligible to participate in the Directors Plan.

"ISOs" means incentive stock options granted under the 1994 Plan.

"Lessee" means Sunstone Hotel Properties, Inc., a Colorado corporation.

"Limited Partners" means the limited partners of the Partnership.

"Line of Credit" means the $45 million line of credit facility (with an
option to increase the total commitment to $50 million) obtained by the Company
from Bank One of Arizona.

"Management Agreement" means the Management Agreement between the Lessee
and the Management Company pursuant to which the Management Company will provide
certain management functions for the Company's hotels.

"Management Company" means Sunstone Hotel Management, Inc., a Colorado
corporation.

"Market Price" shall mean on any date the average of the Closing Price for
the five consecutive trading days ending on such date.

"Marriott" means Marriott International, Inc.

"MGCL" means the Maryland General Corporation Law, as amended from time to
time.

"MRC" means M R C Hotel Partners, Ltd., a Colorado limited partnership and
a Sunstone Affiliate.

"MYPC" means MYPC Partners, an affiliate of Montgomery Securities, one of
the Representatives.

"Nasdaq National Market" means the National Association of Securities
Dealers, Automated Quotation National Market.

"1994 Plan" means the Company's 1994 Stock Incentive Plan.

"Non-U.S. Stockholders" means nonresident alien individuals, foreign
corporations, foreign partnerships and other foreign stockholders.

"Offering" means the offering of Common Stock hereby.

"Option Agreement" means that certain Right of First Refusal and Option to
Purchase to be executed by the Company, Mr. Alter and Mr. Biederman granting the
Company certain rights to acquire certain hotels in which Affiliates of Mr.
Alter and Mr. Biederman own an interest.

"Ownership Limit" means the restriction on ownership (or deemed ownership
by virtue of the attribution provisions of the Code) of more than 9.8% of the
outstanding shares of Common Stock or of the outstanding shares of Preferred
Stock.

"Participants" means those employees of the Company who are eligible to
participate in the 1994 Plan.

"Partnership" means Sunstone Hotel Investors, L.P., a limited partnership
organized under the laws of the State of Delaware.

"Partnership Agreement" means the partnership agreement of the Partnership,
as amended and restated.

"Partnership Provisions" means the partnership provisions of the Code.

"Percentage Leases" means collectively the operating leases between the
Lessee and the Partnership pursuant to which the Lessee leases the Current
Hotels from the Partnership and will lease the Acquisition Hotels from the
Partnership and any additional Hotels acquired by the Company after the
Offering, as each may be amended or restated.

"Percentage Rent" means rent based on percentages of revenue payable by the
Lessee pursuant to the Percentage Leases.

"Preferred Stock" means the preferred stock, par value $.01 per share, of
the Company.

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<PAGE> 125

"Prohibited Owner" means the record holder of shares that become
Shares-in-Trust.

"Proposed Regulations" means a regulation issued by the U.S. Treasury
Department under the partnership provisions of the Code that authorize the
Service, in certain abusive transactions involving partnerships, to disregard
the form of the transaction and recast it for federal income tax purposes as the
Service deems appropriate.

"Redemption Right" means the right of the persons receiving Units in the
Formation Transactions to cause the redemption of Units in exchange for shares
of Common Stock on a one-for-one basis (or for cash at the election of the
Company or if the issuance of shares of Common Stock would result in any person
owning, directly or indirectly, more than 9.8% of the shares of Common Stock).

"Reelected Director" means any eligible director who, during the term of
the Directors Plan, ceases to be a member of the Board but is subsequently
reelected.

"REIT" means real estate investment trust, as defined in Section 856 of the
Code.

"Rent" means the greater of Base Rent and Percentage Rent payable under the
Percentage Leases.

"Representatives" means Montgomery Securities, Bear, Stearns & Co. Inc.,
EVEREN Securities, Inc. and Raymond James & Associates, Inc.

"REVPAR" means revenue per available room for the applicable period.

"Rule 144" means the rule promulgated under the Securities Act that permits
holders of restricted securities as well as Affiliates of an issuer of the
securities, pursuant to certain conditions and subject to certain restrictions,
to sell their securities publicly without registration under the Securities Act.

"SARs" means share appreciation rights.

"SEC" means the United States Securities and Exchange Commission.

"Securities Act" means the Securities Act of 1933, as amended.

"Service" means the United States Internal Revenue Service.

"Share Trust" means a trust established to hold shares of Common Stock or
Preferred Stock that cause a person or entity to violate the Ownership Limit.

"Share Trustee" means the trustee of a Share Trust.

"Shares-in-Trust" means any shares of Common Stock in the REIT designated
as Shares-in-Trust pursuant to the Restrictions on Ownership provisions of the
Company's Articles of Incorporation.

"Smith Travel" means Smith Travel Research, Inc., an unaffiliated hotel
industry research firm.

"Steamboat Partnership" means Steamboat Hotel Partners, Ltd., a Colorado
limited partnership, which is a Sunstone Affiliate that owns one of the Sunstone
Initial Hotels.

"Subscription Agreement" means that certain Subscription Agreement by and
among the Company, MRC, MYPC, Mr. Alter, Mr. Biederman and Mr. Enever dated as
of September 23, 1994.

"Sunstone Affiliates" means the Affiliates of Messrs. Alter, Biederman or
Enever, including the predecessors of such entities, that owned or managed the
Sunstone Initial Hotels.

"Sunstone Initial Hotels" means the Holiday Inn-Provo, Utah, the Holiday
Inn-Craig Colorado, the Holiday Inn-Steamboat Springs, Colorado, the Hampton
Inn-Denver, Colorado, the Hampton Inn-Pueblo, Colorado, the Hampton Inn-Mesa,
Arizona and the Courtyard by Marriott-Fresno, California.

"Third Party Pledge Agreement" means the Third Party Pledge Agreement
entered into by and among the Partnership, Mr. Alter and Mr. Biederman, as
amended.

"Trading Day" shall mean a day on which the principal national securities
exchange on which the shares of Common or Preferred Stock are listed or admitted
to trading is open for the transaction of business.

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<PAGE> 126

"Treasury Regulations" means the income tax regulations promulgated under
the Code.

"UBTI" means unrelated business taxable income as defined in Section 512 of
the Code.

"UBTI Percentage" means the gross income derived from an unrelated trade or
business (determined as if the Company were a pension trust) divided by the
gross income of the Company for the year in which the dividends are paid.

"Underwriters" means the Underwriters named in this Prospectus.

"Underwriting" means information concerning indemnification of the
Underwriters and other matters.

"Underwriting Agreement" means the Underwriting Agreement between the
Representatives, as Representatives of the several Underwriters, and the
Company.

"Unit Purchase Agreement" means the Agreement Respecting Lessee Unit
Purchase to be entered into by and among the Company, the Partnership, the
Lessee, Mr. Alter and Mr. Biederman.

"Units" means units of partnership interest in the Partnership.

"USFS" means U.S. Franchise Systems, Inc., franchisor of Hawthorn Suites
hotels.

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INDEX TO FINANCIAL STATEMENTS

<TABLE>
<S> <C>
Sunstone Hotel Investors, Inc. -- Pro Forma Consolidated Financial Information
Unaudited Pro Forma Consolidated Balance Sheet as of March 31, 1996................. F-3
Notes to Unaudited Pro Forma Consolidated Balance Sheet............................. F-4
Unaudited Pro Forma Consolidated Statement of Income for the Year Ended
December 31, 1995................................................................ F-6
Unaudited Pro Forma Consolidated Statement of Income for the Three Months Ended
March 31, 1996................................................................... F-7
Unaudited Pro Forma Consolidated Statement of Income for the Three Months Ended
March 31, 1995................................................................... F-8
Notes to Unaudited Pro Forma Consolidated Statements of Income...................... F-9
Sunstone Hotel Properties, Inc. -- Pro Forma Combined Statements of Operations
Unaudited Pro Forma Combined Statement of Operations for the Year Ended
December 31, 1995................................................................ F-11
Unaudited Pro Forma Combined Statement of Operations for the Three Months Ended
March 31, 1996................................................................... F-12
Unaudited Pro Forma Combined Statement of Operations for the Three Months Ended
March 31, 1995................................................................... F-13
Notes to Unaudited Pro Forma Combined Statements of Operations...................... F-14
Sunstone Hotel Investors, Inc. and Sunstone Initial Hotels (the "Predecessor")
Report of Independent Accountants................................................... F-15
Sunstone Hotel Investors, Inc. -- Consolidated Balance Sheets as of March 31, 1996
(unaudited), December 31, 1995 and 1994; Sunstone Initial Hotels (Predecessor) --
Combined Balance Sheet as of December 31, 1994................................... F-16
Sunstone Hotel Investors, Inc. -- Consolidated Statement of Income for the Three
Months
Ended March 31, 1996 (unaudited) and for the Period August 16, 1995 (Inception)
through
December 31, 1995; Sunstone Initial Hotels (Predecessor) -- Combined Statement of
Income for the Three Months Ended March 31, 1995 (unaudited) and for the Period
January 1, 1995 Through August 15, 1995 and for the Years Ended December 31, 1994
and 1993......................................................................... F-17
Sunstone Hotel Investors, Inc. -- Consolidated Statement of Cash Flows for the Three
Months Ended March 31, 1996 (unaudited) and for the Period August 16, 1995
(Inception) Through December 31, 1995; Sunstone Initial Hotels
(Predecessor) -- Combined Statement of Cash Flows for the Three Months Ended
March 31, 1995 (unaudited) and for the Period January 1, 1995 Through August 15,
1995 and for the Years Ended December 31, 1994 and 1993.......................... F-18
Sunstone Hotel Investors, Inc. -- Consolidated Statement of Equity for the Year
Ended December 31, 1995; Sunstone Initial Hotels (Predecessor) -- Combined
Statement of
Deficit for the Period January 1, 1995 to August 15, 1995 and the Years Ended
December 31, 1994 and 1993....................................................... F-19
Notes to Consolidated and Combined Financial Statements............................. F-20
Schedule III -- Real Estate and Accumulated Depreciation as of December 31, 1995.... F-26
Sunstone Hotel Properties, Inc. (the Lessee)
Report of Independent Accountants................................................... F-27
Balance Sheets as of March 31, 1996 (unaudited) and December 31, 1995............... F-28
</TABLE>

F-1
<PAGE> 128

<TABLE>
<S> <C>
Statements of Operations and Deficit for the Three Months Ended March 31, 1996
(unaudited) and for the Period From Inception, August 16, 1995 through December
31, 1995......................................................................... F-29
Statements of Cash Flows for the Three Months Ended March 31, 1996 (unaudited) and
for the Period From Inception, August 16, 1995 Through December 31, 1995......... F-30
Notes to Combined Financial Statements.............................................. F-31
Renton Joint Venture (A Washington General partnership)
Report of Independent Accountants................................................... F-33
Balance Sheets as of March 31, 1996 (unaudited) and December 31, 1995............... F-34
Statements of Operations for the Three Months Ended March 31, 1995 and 1996
(unaudited) and for the Year Ended December 31, 1995............................. F-35
Statement of Partners' Equity for the Year Ended December 31, 1995 and for the Three
Months Ended March 31, 1996 (unaudited).......................................... F-36
Statements of Cash Flows for the Three Months Ended March 31, 1996 (unaudited) and
for the Year Ended December 31, 1995............................................. F-37
Notes to Financial Statements....................................................... F-38
Bay City Hospitality, Inc. and Price Hospitality, Inc.
Report of Independent Accountants................................................... F-41
Combined Balance Sheets as of January 31, 1996 (unaudited) and October 31, 1995..... F-42
Combined Statements of Operations and Equity for the Three Months Ended January 31,
1996 (unaudited) and for the Year Ended October 31, 1995......................... F-43
Combined Statements of Cash Flows for the Three Months Ended January 31, 1996
(unaudited) and for the Year Ended October 31, 1995.............................. F-44
Notes to Combined Financial Statements.............................................. F-45
Bay City Hospitality, Inc.
Report of Independent Accountants................................................... F-48
Balance Sheets as of October 31, 1994 and 1993...................................... F-49
Income Statements for the Year Ended October 31, 1994 and for the Period From
Inception, February 5, 1993, Through October 31, 1993............................ F-50
Statement of Changes in Shareholder's Equity for the Period From Inception, February
5, 1993, Through October 31, 1994................................................ F-51
Statements of Cash Flows for the Year Ended October 31, 1994 and for the Period From
Inception, February 5, 1993, Through October 31, 1993............................ F-52
Notes to Financial Statements....................................................... F-53
Price Hospitality, Inc.
Report of Independent Accountants................................................... F-56
Balance Sheet as of October 31, 1994................................................ F-57
Statement of Income and Changes in Shareholder's Equity for the Period From
Inception of Operations Through October 31, 1994................................. F-58
Statement of Cash Flows for the Period From Inception of Operations Through October
31, 1994......................................................................... F-59
Notes to Financial Statements....................................................... F-60
</TABLE>

F-2
<PAGE> 129

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
AS OF MARCH 31, 1996

The following Unaudited Pro Forma Consolidated Balance sheet is presented
as if the Offering as set forth under the caption "Use of Proceeds" had occurred
on March 31, 1996. Such information should be read in conjunction with the
Financial Statements listed in the index at page F-1 of this Prospectus. In
management's opinion, all adjustments necessary to reflect the effects of the
Offering and related transactions have been made.

The following unaudited Pro Forma Consolidated Balance Sheet is not
necessarily indicative of what the actual financial position would have been
assuming such transactions had been completed as of March 31, 1996, nor does it
purport to represent the future financial position of the Company.

<TABLE>
<CAPTION>
PRO FORMA
SUNSTONE SUNSTONE HOTEL
HOTEL PRO FORMA CURRENT ACQUISITION PRO FORMA INVESTORS,
INVESTORS, INC. ADJUSTMENTS HOTELS PROPERTIES ADJUSTMENTS INC.
--------------- ----------- ----------- ----------- ------------ --------------
(HISTORICAL) (PRO FORMA)
(A) (B) (C)
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Investment in hotel properties,
net............................. $67,076,000 $6,800,000 $73,876,000 $24,200,000 $ $ 98,076,000
Mortgage notes receivable......... 2,850,000 2,850,000 2,850,000
Cash.............................. 407,000 407,000 407,000
Rent receivable -- Lessee......... 2,227,000 2,227,000 2,227,000
Due from affiliates............... 128,000 128,000 128,000
Prepaid expenses and
other assets, net............... 1,206,000 1,206,000 1,206,000
--------- --------- --------- --------- --------- ---------
$71,044,000 $9,650,000 $80,694,000 $24,200,000 $104,894,000
========= ========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Revolving line of credit.......... 22,000,000 5,750,000 27,750,000 24,200,000 (36,800,000)(D) 15,150,000
Mortgage notes payable............ 3,025,000 3,025,000 3,025,000
Accounts payable and other accrued
expenses........................ 1,690,000 1,690,000 1,690,000
--------- --------- --------- --------- --------- ---------
23,690,000 8,775,000 32,465,000 24,200,000 (36,800,000) 19,865,000
--------- --------- --------- --------- --------- ---------
Minority interest................. 8,722,000 875,000 9,597,000 988,000(E) 10,585,000
--------- --------- --------- --------- --------- ---------
Stockholders' equity:
Common stock, $.01 par value,
50,000,000 authorized;
6,322,000 shares outstanding;
10,322,000 pro forma............ 63,000 63,000 40,000(D) 103,000
Preferred stock, $.01 par value,
10,000,000 authorized, no shares
issued or outstanding...........
Additional paid-in capital........ 37,432,000 37,432,000 36,760,000(D) 73,204,000
(988,000)(E)
Retained earnings................. 1,137,000 1,137,000 1,137,000
--------- --------- --------- --------- --------- ---------
38,632,000 38,632,000 35,812,000 74,444,000
--------- --------- --------- --------- --------- ---------
$71,044,000 $9,650,000 $80,694,000 $24,200,000 $104,894,000
========= ========= ========= ========= ========= =========
</TABLE>

The accompanying notes are an integral part of the pro forma balance sheets.

F-3
<PAGE> 130

SUNSTONE HOTEL INVESTORS, INC.

NOTES TO UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
AS OF MARCH 31, 1996

(A) Reflects the Company's historical consolidated balance sheet as of March 31,
1996.

(B) Represents pro forma adjustments to reflect the assets, liabilities and
equity of the acquisition of the Riverside, California property, the sale
of two Cypress Inn properties and the redevelopment and renovation draws on
the Revolving Line of Credit subsequent to March 31, 1996.

(D) Reflects the effects of the Offering and the use of proceeds therefrom as
described in "Use of Proceeds" as if the Offering occurred on March 31,
1996.

(E) Reflects a reallocation between minority interest and shareholders' equity
to reflect the Limited Partners' 12.4% interest in the Partnership after
the Offering.

F-4
<PAGE> 131

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1995,
THE THREE MONTHS ENDED MARCH 31, 1996 AND
THE THREE MONTHS ENDED MARCH 31, 1995
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE DATA)

The following Unaudited Pro Forma Consolidated Statement of Income of
Sunstone Hotel Investors, Inc. for the year ended December 31, 1995, the three
months ended March 31, 1996 and the three months ended March 31, 1995, are
presented as if the closing of the Offering described under the caption "Use of
Proceeds" had occurred as of January 1, 1995. Such information should be read in
conjunction with the Financial Statements listed in the Index at page F-1 of
this Prospectus. In management's opinion, all adjustments necessary to reflect
the effects of the Offering and related transactions have been made.

These Statements are not necessarily indicative of what actual results of
operation of the Company would have been assuming such transactions had been
completed as of the beginning of the periods presented, nor do they purport to
represent the results of operations for future periods.

F-5
<PAGE> 132

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1995

<TABLE>
<CAPTION>
SUNSTONE
PRO FORMA HOTEL
HOTELS HOTELS ADJUSTMENTS INVESTORS, INC.
----------- ------------ ----------- ---------------
(ESTIMATED) (PRO FORMA) (PRO FORMA)
(A) (C)
<S> <C> <C> <C> <C>
REVENUES:
Lease revenue......................... $11,766,000 $ 3,254,000 $ $15,020,000
Interest income....................... 47,000 47,000
----------- ----------- ----------- -----------
11,813,000 3,254,000 15,067,000
----------- ----------- ----------- -----------
EXPENSES:
Real estate related depreciation and
amortization........................ 3,282,000 2,048,000 5,330,000
Interest expense and amortization of
financing costs..................... 1,503,000 1,931,000 (1,924,000)(D) 1,510,000
Real estate, personal property taxes
and insurance....................... 1,301,000 432,000 1,733,000
General and administrative............ 375,000 375,000
----------- ----------- ----------- -----------
Total expenses................... 6,461,000 4,411,000 (1,924,000) 8,948,000
----------- ----------- ----------- ------------
Income before minority interest
and extraordinary items........ 5,352,000 $ (1,157,000) $ 1,924,000 $ 6,119,000
=========== ===========
Minority interest(E).................. 1,011,000 762,000
----------- ------------
Net income....................... $ 4,341,000 $ 5,357,000
=========== ============
Net income per Common Share
outstanding......................... $ 0.52
============
Weighted average number of shares of
Common Stock and Common Stock
equivalents outstanding (in
000's).............................. 10,322
============
</TABLE>

F-6
<PAGE> 133

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1996

<TABLE>
<CAPTION>
SUNSTONE
HOTEL PRO FORMA CURRENT ACQUISITION PRO FORMA SUNSTONE HOTEL
INVESTORS, INC. ADJUSTMENTS HOTELS HOTELS ADJUSTMENTS INVESTORS, INC.
--------------- ----------- ----------- ----------- ----------- ---------------
HISTORICAL) (B) (PRO FORMA) (C) (PRO FORMA)
(A)

<S> <C> <C> <C> <C> <C> <C>
REVENUES:
Lease revenue............. $ 3,190,000 $ 227,000 $3,417,000 $ 643,000 $ $ 4,060,000
Interest income........... 19,000 19,000 19,000
--------------- ----------- ----------- ----------- ----------- ---------------
3,209,000 227,000 3,436,000 643,000 4,079,000
--------------- ----------- ----------- ----------- ----------- ---------------
EXPENSES:
Real estate related
depreciation and
amortization............ 849,000 27,000 876,000 512,000 1,388,000
Interest expense and
amortization of
financing costs......... 324,000 143,000 467,000 483,000 (586,500)(D) 363,500
Real estate, personal
property taxes and
insurance............... 253,000 21,000 274,000 116,000 390,000
General and
administrative.......... 153,000 153,000 153,000
--------------- ----------- ----------- ----------- ----------- ---------------
Total expenses........ 1,579,000 191,000 1,770,000 1,111,000 (586,500) 2,294,500
--------------- ----------- ----------- ----------- ----------- ---------------
Income before minority
interest............ 1,630,000 $ 36,000 1,666,000 $ (468,000) $ 586,500 1,784,500
=========== ========== ===========
Minority interest (E)..... 293,000 293,000 222,000
--------------- ----------- ---------------
Net income............ $ 1,337,000 $1,373,000 $ 1,562,500
============ ============ ==============
Net income per Common
Share outstanding....... $ 0.15
==============
Weighted average number of
shares of Common Stock
and Common Stock
equivalents outstanding
(in 000's).............. 10,322
==============
</TABLE>

F-7
<PAGE> 134

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1995

SUNSTONE SUNSTONE HOTEL
HOTEL PRO FORMA CURRENT ACQUISITION PRO FORMA INVESTORS,
INVESTORS, INC. ADJUSTMENTS HOTELS HOTELS ADJUSTMENTS INC.
--------------- ----------- ----------- ----------- ----------- --------------
(PRO FORMA) (B) (PRO FORMA) (PRO FORMA)
(A)

<S> <C> <C> <C> <C> <C> <C>
REVENUES:
Lease revenue............ $ 2,593,000 $ 695,000 $3,288,000 $ 580,000(C) $ $3,868,000
Interest income..........
--------------- ----------- ----------- ----------- ----------- --------------
2,593,000 695,000 3,288,000 580,000 3,868,000
--------------- ----------- ----------- ----------- ----------- --------------
EXPENSES:
Real estate related
depreciation and
amortization........... 505,000 260,000 765,000 512,000(C) 1,277,000
Interest expense and
amortization of
financing costs........ 364,000 364,000 483,000(C) (483,500)(D) 363,500
Real estate, personal
property taxes and
insurance.............. 127,000 109,000 236,000 115,000(C) 351,000
General and
administrative......... 104,000 104,000 104,000
--------------- ----------- ----------- ----------- ----------- --------------
Total expenses....... 736,000 733,000 1,469,000 1,110,000 (483,500) 2,095,500
--------------- ----------- ----------- ----------- ----------- --------------
Income before
minority
interest........... 1,857,000 $ (38,000) 1,819,000 $ (530,000) $ 483,500 1,772,500
=========== ========== ===========
Minority interest(E)..... 324,000 324,000 221,000
--------------- ----------- --------------
Net income........... $ 1,533,000 $1,495,000 $1,551,500
============ ============ ==============
Net income per Common
Share outstanding...... $ 0.15
==============
Weighted average number
of shares of Common
Stock and Common Stock
equivalents outstanding
(in 000's)............. 10,322
==============
</TABLE>

F-8
<PAGE> 135

SUNSTONE HOTEL INVESTORS, INC.

NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1995, THE THREE MONTHS ENDED MARCH 31, 1996
AND THE THREE MONTHS ENDED MARCH 31, 1995

(A) The Company began operations on August 16, 1995. Estimated revenues and
expenses for the Current Hotels for the year ended December 31, 1995,
include the actual results of operations for the period August 16, 1995 to
December 31, 1995 for the Hotels owned by the Company during that period
plus estimated results of operations for all the Current Hotels to reflect
results from operations as if the Lessee had leased all the Current Hotels
from the Company beginning January 1, 1995. For the three months ended
March 31, 1996 and the three months ended March 31, 1995, amounts represent
the Company's historical consolidated income statement for that period.

(B) Represents pro forma adjustments to reflect the results of operations for
the effect of the acquisition of the Riverside, California and Cypress Inn
properties and the subsequent sale of two Cypress Inn hotels each occurring
subsequent to March 31, 1996.

(D) Represents an adjustment to reflect the elimination of historical and pro
forma interest expense related to the debt repaid from the proceeds of the
Offering and the addition of interest expense at LIBOR plus 1.90% on the
amount to be outstanding immediately after the Offering.

(E) Calculated as a percentage of income before minority interest. The
percentage is equal to the percentage of the Partnership owned by parties
other than the Company for the time periods and hotels in question.

F-9
<PAGE> 136

SUNSTONE HOTEL PROPERTIES, INC.

UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1995, THE THREE MONTHS ENDED MARCH 31, 1996
AND THE THREE MONTHS ENDED MARCH 31, 1995

The following Unaudited Pro Forma Combined Statements of Operations are
presented as if the application of the net proceeds of the Offering as set forth
under the caption "Use of Proceeds" had occurred as of the beginning of the
period presented. Such information should be read in conjunction with the
Financial Statements listed in the Index at page F-1 of this Prospectus. In
management's opinion, all adjustments necessary to reflect the effects of the
Offering and related transactions have been made.

The following unaudited Pro Forma Combined Statements of Operations are not
necessarily indicative of what actual results of operations of the Lessee and
Initial Hotels would have been assuming such transactions had been completed as
of the beginning of the periods presented nor do they purport to represent the
results of operations for future periods.

F-10
<PAGE> 137

SUNSTONE HOTEL PROPERTIES, INC.

UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1995

<TABLE>
<CAPTION>
ACQUISITION SUNSTONE
HOTELS PRO FORMA HOTEL
----------- ADJUSTMENTS PROPERTIES, INC.
CURRENT ----------- -----------------
HOTEL (C) (PRO FORMA)
-----------
(ESTIMATED)
(A)
<S> <C> <C> <C> <C>
OPERATING REVENUES:
Room............................. $27,914,000 $ 7,673,000 $ $35,587,000
Food and beverage................ 1,933,000 2,112,000 4,045,000
Other............................ 1,288,000 340,000 1,628,000
----------- ----------- ----------- -----------
31,135,000 10,125,000 41,260,000
----------- ----------- ----------- -----------
OPERATING EXPENSES:
Room............................. 7,816,000 1,949,000 9,765,000
Food and beverage................ 1,955,000 1,642,000 3,597,000
Other............................ 658,000 181,000 839,000
----------- ----------- ----------- -----------
10,429,000 3,772,000 14,201,000
----------- ----------- ----------- -----------
Departmental profit............ 20,706,000 6,353,000 27,059,000
----------- ----------- ----------- -----------
General and administrative....... 2,889,000 1,052,000 3,941,000
Sales and marketing.............. 1,901,000 853,000 2,754,000
Repairs and maintenance.......... 1,282,000 541,000 1,823,000
Utilities and other operating
costs.......................... 1,666,000 610,000 2,276,000
Management fees.................. 790,000 360,000 (325,000)(D) 825,000
Franchise fees................... 793,000 793,000
Real estate, personal property
taxes and insurance............ 846,000 432,000 (1,278,000)(E)
----------- ----------- ----------- -----------
Gross operating profit......... 10,539,000 2,505,000 1,603,000 14,647,000
----------- ----------- ----------- -----------
Real estate related depreciation
and amortization............... 540,000 (540,000)(F)
Interest expense and amortization
of financing costs............. 1,377,000 (1,377,000)(G)
Rent expense..................... 3,013,000 12,007,000(H) 15,020,000
----------- ----------- ----------- -----------
Net income..................... $ 7,526,000 $ 588,000 $(8,487,000) $ (373,000)
=========== =========== =========== ===========
</TABLE>

F-11
<PAGE> 138

SUNSTONE HOTEL PROPERTIES, INC.

UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1996

<TABLE>
<CAPTION>
SUNSTONE HOTEL PRO FORMA CURRENT ACQUISITION PRO FORMA SUNSTONE HOTEL
PROPERTIES, INC. ADJUSTMENTS HOTELS HOTELS ADJUSTMENTS PROPERTIES, INC.
---------------- ---------- ----------- ---------- ----------- ----------------
(HISTORICAL) (PRO FORMA) (PRO FORMA)
(A)
<S> <C> <C> <C> <C> <C> <C>
OPERATING REVENUES:
Room............................. $6,786,000 $421,000 $7,207,000 $1,746,000 $ $ 8,953,000
Food and beverage................ 232,000 32,000 264,000 436,000 700,000
Other............................ 318,000 53,000 371,000 77,000 448,000
---------- -------- ---------- ---------- ---------- ----------
7,336,000 506,000 7,842,000 2,259,000 10,101,000
---------- -------- ---------- ---------- ---------- ----------
OPERATING EXPENSES:
Room............................. 1,697,000 113,000 1,810,000 462,000 2,272,000
Food and beverage................ 242,000 26,000 268,000 374,000 642,000
Other............................ 193,000 34,000 227,000 49,000 276,000
---------- -------- ---------- ---------- ---------- ----------
2,132,000 173,000 2,305,000 885,000 3,190,000
---------- -------- ---------- ---------- ---------- ----------
Departmental profit............ 5,204,000 333,000 5,537,000 1,374,000 6,911,000
---------- -------- ---------- ---------- ---------- ----------
General and administrative....... 461,000 109,000 570,000 296,000 866,000
Sales and marketing.............. 638,000 46,000 684,000 195,000 879,000
Repairs and maintenance.......... 316,000 (10,000) 306,000 139,000 445,000
Utilities and other operating
costs.......................... 294,000 (29,000) 265,000 148,000 413,000
Management fees.................. 132,000 33,000 165,000 80,000 (43,000)(D) 202,000
Franchise fees................... 192,000 46,000 238,000 238,000
Real estate, personal property
taxes and insurance............ 21,000 21,000 116,000 (137,000)(E)
---------- -------- ---------- ---------- ---------- ----------
Gross operating profit......... 3,171,000 117,000 3,288,000 400,000 180,000 3,868,000
---------- -------- ---------- ---------- ---------- ----------
Real estate related depreciation
and amortization............... 136,000 (136,000)(F)
Interest expense and amortization
of financing costs............. 294,000 (294,000)(G)
Rent expense..................... 3,190,000 3,190,000 870,000(H) 4,060,000
---------- -------- ---------- ---------- ---------- ----------
Net income..................... $ (19,000) $117,000 $ 98,000 $ (30,000) $(260,000) $ (192,000)
========== ======== ========== ========== ========== ==========
</TABLE>

F-12
<PAGE> 139

SUNSTONE HOTEL PROPERTIES, INC.

UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1995

<TABLE>
<CAPTION>
SUNSTONE
CURRENT ACQUISITION PRO FORMA HOTEL
HOTELS HOTELS ADJUSTMENTS PROPERTIES, INC.
---------- ---------- ----------- ----------------
<S> <C> <C> <C> <C>
(ESTIMATED) (HISTORICAL) (PRO FORMA)
(A)
OPERATING REVENUES:
Room................................... $7,248,000 $1,468,000 $ $ 8,716,000
Food and beverage...................... 496,000 479,000 975,000
Other.................................. 341,000 75,000 416,000
---------- ---------- ----------- -----------
8,085,000 2,022,000 10,107,000
---------- ---------- ----------- -----------
OPERATING EXPENSES:
Room................................... 1,759,000 447,000 2,206,000
Food and beverage...................... 512,000 401,000 913,000
Other.................................. 212,000 45,000 257,000
---------- ---------- ----------- -----------
2,483,000 893,000 3,376,000
---------- ---------- ----------- -----------
Departmental profit.................. 5,602,000 1,129,000 6,731,000
---------- ---------- ----------- -----------
General and administrative............. 743,000 281,000 1,024,000
Sales and marketing.................... 451,000 199,000 650,000
Repairs and maintenance................ 268,000 118,000 386,000
Utilities and other operating costs.... 379,000 146,000 525,000
Management fees........................ 234,000 72,000 (104,000)(B) 202,000
Franchise fees......................... 174,000 174,000
Real estate, personal property taxes
and insurance........................ 205,000 115,000 (320,000)(C)
---------- ---------- ----------- -----------
Gross operating profit............... 3,148,000 198,000 424,000 3,770,000
---------- ---------- ----------- -----------
Real estate related depreciation and
amortization......................... 73,000 (73,000)(D)
Interest expense and amortization of
financing costs...................... 257,000 (257,000)(E)
Rent expense........................... 3,868,000(F) 3,868,000
---------- ---------- ----------- -----------
Net income........................... $3,148,000 $ (132,000) $(3,114,000) $ (98,000)
========== ========== =========== ===========
</TABLE>

F-13
<PAGE> 140

SUNSTONE HOTEL PROPERTIES, INC.,
THE LESSEE

NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1995,
THE THREE MONTHS ENDED MARCH 31, 1996
AND THE THREE MONTHS ENDED MARCH 31, 1995

(A) The Lessee began operations on August 16, 1995. Estimated revenues and
expenses for the Current Hotels include the actual results of
operations for the period August 16, 1995 to December 31, 1995 for the
Hotels owned by the Company during that period plus estimated results
of operations for all the Current Hotels to reflect results from
operations as if the Lessee had leased all the Current Hotels from the
Company beginning January 1, 1995. For the three months ended March 31,
1996 and the three months ended March 31, 1995, amounts represent the
Lessee's historical combined statement of operations for that period.

(B) Represents pro forma adjustments to reflect the results of operations
for the effect of the Company's acquisition of the Riverside,
California and Cypress Inn properties and the subsequent sale of two
Cypress Inn hotels, each occurring subsequent to March 31, 1996.

(D) Represents an adjustment to reflect management fees of 2% of total
revenues.

(E) Reflects the real estate and personal property taxes, and property
insurance which would be incurred by the Company.

(F) Represents the elimination of depreciation expense which would be a pro
forma expense incurred by the Company.

(G) Represents the elimination of interest expense which would be a pro
forma cost incurred by the Company.

(H) Represents rent expense calculated on a pro forma basis by applying the
rent provisions of the Percentage Leases to the historical revenues of
the Hotels.

F-14
<PAGE> 141

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
Sunstone Hotel Investors, Inc.

We have audited the accompanying consolidated balance sheets of Sunstone
Hotel Investors, Inc. (the "Company") as of December 31, 1995 and 1994, the
combined balance sheet of Sunstone Initial Hotels (the "Predecessor") as of
December 31, 1994, and the related consolidated and combined statements of
operations, equity and cash flows for the periods August 16, 1995, through
December 31, 1995 and January 1, 1995 through August 15, 1995, respectively and
the years ended December 31, 1994 and 1993. Our audit also included the
accompanying financial statement schedule as of December 31, 1995. These
financial statements are the responsibility of the Company'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 audits 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 consolidated and combined financial statements referred
to above present fairly, in all material respects, the consolidated and combined
financial position of Sunstone Hotel Investors, Inc. and Sunstone Initial Hotels
as of December 31, 1995 and 1994, and the consolidated and combined results of
their operations and cash flows for the periods August 16, 1995, through
December 31, 1995 and January 1, 1995 through August 15, 1995, respectively and
the years ended December 31, 1994 and 1993, in conformity with generally
accepted accounting principles.

In addition, in our opinion, the financial statement schedule referred to
above, when considered in relation to the basic financial statements taken as a
whole, presents fairly, in all material respects, the information required to be
included therein.

COOPERS & LYBRAND L.L.P.

Newport Beach, California
March 28, 1996

F-15
<PAGE> 142

SUNSTONE HOTEL INVESTORS, INC. -- CONSOLIDATED BALANCE SHEETS

SUNSTONE INITIAL HOTELS (PREDECESSOR) -- COMBINED BALANCE SHEET

<TABLE>
<CAPTION>
SUNSTONE HOTEL INVESTORS, INC.
-------------------------------------- SUNSTONE
INITIAL HOTELS
DECEMBER 31, YEAR ENDED
----------------------- DECEMBER 31,
1995 1994 1994
MARCH 31, ----------- -------- --------------
1996
-----------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS:
Investment in hotel properties, net........ $67,076,000 $49,926,000 $ 5,000 $ 17,539,000
Cash....................................... 407,000 5,222,000 6,000 718,000
Restricted cash............................ 104,000
Rent receivable -- Lessee.................. 2,227,000 646,000
Due from affiliates........................ 128,000 21,000
Trade Receivables.......................... 254,000
Prepaid expenses and other assets, net..... 1,206,000 1,421,000 615,000 324,000
----------- ----------- -------- -----------
$71,044,000 $57,236,000 $626,000 $ 18,939,000
=========== =========== ======== ===========
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Long-term debt............................. $ $ $ $ 23,698,000
Revolving line of credit................... 22,000,000 8,400,000
Accounts payable and other accrued
expenses................................. 1,690,000 1,346,000 136,000 2,215,000
Dividends/distributions payable............ 1,764,000
Due to affiliates.......................... 1,300,000
----------- ----------- -------- -----------
23,690,000 11,510,000 136,000 27,213,000
----------- ----------- -------- -----------
Minority interest.......................... 8,722,000 8,231,000
----------- -----------
Stockholders' equity:
Common stock, $.01 par value, 50,000,000
authorized; 6,322,000 and 32,000 issued
and outstanding as of December 31, 1995
and 1994, respectively................... 63,000 63,000
Preferred stock, $.01 par value, 10,000,000
authorized, no shares issued or
outstanding
Additional paid-in capital................. 37,432,000 37,432,000 490,000
Retained earnings.......................... 1,137,000
Predecessor deficit........................ (8,274,000)
----------- ----------- -------- -----------
38,632,000 37,495,000 490,000 (8,274,000)
----------- ----------- -------- -----------
$71,044,000 $57,236,000 $626,000 $ 18,939,000
=========== =========== ======== ===========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-16
<PAGE> 143

SUNSTONE HOTEL INVESTORS, INC. -- CONSOLIDATED STATEMENT OF INCOME

SUNSTONE INITIAL HOTELS (PREDECESSOR) -- COMBINED STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
SUNSTONE INITIAL HOTELS
SUNSTONE HOTEL INVESTORS, INC. ------------------------------
-------------------------------- FOR THE
FOR THE THREE FOR THE PERIOD FOR THE THREE PERIOD SUNSTONE INITIAL HOTELS
MONTHS ENDED AUGUST 16, 1995 MONTHS ENDED JANUARY 1, YEARS ENDED DECEMBER 31,
MARCH 31, TO DECEMBER 31, MARCH 31, TO AUGUST 15, -------------------------
1996 1995 1995 1995 1994 1993
------------- --------------- -------------- ------------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
REVENUES:
Lease revenue................... $3,190,000 $ 3,013,000
Hotel operating revenue......... $3,458,000 $ 9,675,000 $13,863,000 $11,937,000
Interest income................. 19,000 47,000
Other revenue................... 497,000
---------- ---------- ---------- ---------- ----------- -----------
3,209,000 3,060,000 3,955,000 9,675,000 13,863,000 11,937,000
---------- ---------- ---------- ---------- ----------- -----------
EXPENSES:
Real estate related depreciation
and amortization............. 849,000 968,000 273,000 696,000 1,248,000 1,298,000
Interest expense and
amortization of financing
costs........................ 324,000 47,000 585,000 1,270,000 2,360,000 2,261,000
Real estate, personal property
taxes and insurance.......... 253,000 312,000 87,000 356,000 689,000 619,000
Property operating costs........ 1,346,000 3,550,000 5,801,000 4,770,000
General and administrative...... 153,000 109,000 282,000 721,000 1,063,000 940,000
Management fees................. 167,000 409,000 620,000 463,000
Franchise costs................. 128,000 323,000 624,000 412,000
Advertising and promotion....... 269,000 676,000 1,056,000 926,000
Other........................... 4,000 3,000
---------- ---------- ---------- ---------- ----------- -----------
Total expenses............... 1,579,000 1,436,000 3,137,000 8,001,000 13,465,000 11,692,000
---------- ---------- ---------- ---------- ----------- -----------
Income before minority
interest and extraordinary
items...................... 1,630,000 1,624,000 818,000 1,674,000 398,000 245,000
Minority interest................. 293,000 284,000
---------- ---------- ---------- ---------- ----------- -----------
Income before extraordinary
item....................... 1,340,000
Extraordinary item due to early
extinguishment of debt (net of
$34,000 of minority interest)... 159,000
---------- ---------- ---------- ---------- ----------- -----------
NET INCOME.............. $1,337,000 $ 1,181,000 $ 818,000 $ 1,674,000 $ 398,000 $ 245,000
========== ========== ========== ========== =========== ===========
Earnings per share:
Income before extraordinary
item......................... $ 0.21 $ 0.21
Extraordinary item (net of
$34,000 of minority
interest).................... (0.02)
---------- ----------
NET INCOME PER SHARE.............. $ 0.21 $ 0.19
========== ==========
Weighted average number of
shares.......................... 6,322,000 6,322,000
========== ==========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-17
<PAGE> 144

SUNSTONE HOTEL INVESTORS, INC. -- CONSOLIDATED STATEMENT OF CASH FLOWS

SUNSTONE INITIAL HOTELS (PREDECESSOR) -- COMBINED STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
SUNSTONE HOTEL INVESTORS, INC. SUNSTONE INITIAL HOTELS
-------------------------------- -------------------------------
FOR THE THREE FOR THE PERIOD FOR THE THREE FOR THE PERIOD SUNSTONE INITIAL HOTELS
MONTHS ENDED AUGUST 16, 1995 MONTHS ENDED JANUARY 1, YEARS ENDED DECEMBER 31,
MARCH 31, TO DECEMBER 31, MARCH 31, TO AUGUST 15, -------------------------
1996 1995 1995 1995 1994 1993
------------- --------------- ------------- -------------- ----------- ----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income.................... $ 1,337,000 $ 1,181,000 $ 818,000 $ 1,674,000 $ 398,000 $ 245,000
Extraordinary item due to
early extinguishment of
debt........................ 159,000
Adjustments to reconcile net
income to net cash provided
by operating activities:
Minority interest........... 293,000 284,000
Depreciation................ 849,000 968,000 273,000 696,000 1,248,000 1,298,000
Amortization of financing
costs..................... 56,000 35,000
Loss on disposal of
assets.................... 108,000
Increase due to affiliates
for management fees....... 70,000 70,000 73,000 69,000
Management fees waived by
partner................... 15,000 15,000 160,000 46,000
Interest expense added to
principal balance for
revenue participation
clause.................... 51,000
Changes in assets and
liabilities:
Receivables, net.......... (134,000) 255,000 33,000 12,000
Rent receivable-Lessee.... (1,581,000 ) (646,000)
Due from affiliates....... (108,000 ) (21,000)
Inventories............... 158,000 18,000 3,000 (2,000)
Prepaids and other assets,
net..................... (879,000) (22,000) 61,000 94,000 (94,000)
Accounts payable and
accrued expenses........ 344,000 1,210,000 (383,000) (1,115,000) 262,000 (26,000)
Accrued interest payable
and deferred............ (17,000) (480,000) 167,000 33,000
------- ------- ------- ------- ------- -------
Net cash provided by
operating
activities............ 1,348,000 2,291,000 620,000 1,194,000 2,597,000 1,581,000
------- ------- ------- ------- ------- -------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Acquisition, improvements
and additions
to hotel properties....... (17,999,000 ) (32,831,000) (176,000) (463,000) (1,081,000) (395,000)
Payment of franchise
transfer fees............. (68,000)
Decrease (increase) in
restricted cash........... ............ 49,000 104,000 263,000 (301,000)
------- ------- ------- ------- ------- -------
Net cash used in
investing
activities............ (17,999,000 ) (32,899,000) (127,000) (359,000) (818,000) (696,000)
------- ------- ------- ------- ------- -------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Net proceeds from offering.... 52,982,000
Payments to noncontinuing
equity investors of
Predecessor................. (832,000)
Financing costs............... (425,000) (87,000)
Borrowings on revolving line
of credit................... 13,600,000 8,400,000
Principal payments on
long-term debt.............. (23,420,000) (463,000) (846,000) (1,055,000) (873,000)
Proceeds from issuance of
long-term debt.............. 200,000 72,000
Advances from affiliates...... 9,000 40,000 89,000
Payments on advances from
affiliates.................. (125,000) (418,000) (460,000) (327,000)
Partners' capital
contributions............... 436,000
Dividends paid................ (1,454,000 ) (727,000)
Partnership distributions
paid........................ (310,000 ) (154,000) (42,000) (42,000) (50,000) (8,000)
------- ------- ------- ------- ------- -------
Net cash provided by (used
in) financing
activities................ 11,836,000 35,824,000 (621,000) (1,306,000) (1,325,000) (698,000)
------- ------- ------- ------- ------- -------
Net change in cash...... (4,815,000 ) 5,216,000 (128,000) (471,000) 454,000 187,000
Cash, beginning of period..... 5,222,000 6,000 718,000 718,000 264,000 77,000
------- ------- ------- ------- ------- -------
Cash, end of period........... $ 407,000 $ 5,222,000 $ 590,000 $ 247,000 $ 718,000 $ 264,000
======= ======= ======= ======= ======= =======
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-18
<PAGE> 145

SUNSTONE HOTEL INVESTORS, INC.

CONSOLIDATED STATEMENT OF EQUITY

<TABLE>
<CAPTION>
ADDITIONAL RETAINED
COMMON PAID-IN EARNINGS
TOTAL STOCK CAPITAL (DEFICIT)
----------- ------- ----------- -----------
<S> <C> <C> <C> <C>
Balances at December 31, 1994........ $ 490,000 $ $ 490,000 $
Reorganization and issuance of
stock........................... 53,306,000 63,000 53,243,000
Predecessor deficit................ (6,627,000) (6,627,000)
Issuance of stock to directors..... 71,000 71,000
Dividends/distributions declared... (2,695,000) (1,514,000) (1,181,000)
Net income......................... 1,181,000 1,181,000
Minority interest.................. (8,231,000) (8,231,000)
----------- ------- ----------- -----------
Balances at December 31, 1995........ $37,495,000 $63,000 $37,432,000 $
=========== ======= =========== ===========
</TABLE>

SUNSTONE INITIAL HOTELS (PREDECESSOR)

COMBINED STATEMENT OF DEFICIT

<TABLE>
<CAPTION>
PARTNERS
DEFICIT
-----------
<S> <C>
Balance at December 31, 1992........................................ $(9,500,000)
Net income........................................................ 245,000
Capital contributions............................................. 482,000
Distributions..................................................... (8,000)
----------
Balance at December 31, 1993........................................ (8,781,000)
Net income........................................................ 398,000
Capital contributions............................................. 159,000
Distributions..................................................... (50,000)
----------
Balance at December 31, 1994........................................ (8,274,000)
Net income........................................................ 1,674,000
Capital contributions............................................. 15,000
Distributions..................................................... (42,000)
----------
Balance at August 15, 1995.......................................... $(6,627,000)
==========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-19
<PAGE> 146

SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE INITIAL HOTELS -- PREDECESSOR

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS

1. ORGANIZATION AND INITIAL PUBLIC OFFERING

Sunstone Hotel Investors, Inc. (the "Company"), a Maryland corporation, was
formed on September 21, 1994, as a real estate investment trust ("REIT"). The
Company completed an initial public offering (the "Offering") of 5,910,000
shares of its common stock on August 16, 1995. An additional 404,500 shares of
common stock were issued by the Company on September 3, 1995 upon a partial
exercise of the underwriters' over-allotment option. The offering price of all
shares sold in the Offering was $9.50 per share, resulting in gross proceeds of
approximately $60.0 million and net proceeds (less the underwriters' discount
and offering expenses) of approximately $53.0 million.

The Company contributed all of the net proceeds of the Offering to Sunstone
Hotel Investors, L.P. (the "Partnership") in exchange for an approximately 82.5%
aggregate equity interest in the Partnership. The Company conducts all its
business through and is the sole general partner of the Partnership (hereafter
referred to as the "Company").

In connection with the Offering, the Company acquired seven hotels (the
"Sunstone Initial Hotels") from seven entities controlled by officers and a
director of the Company and acquired the three additional hotels (the
"Acquisition Hotels" and together, the "Initial Hotels") from unrelated third
parties in exchange for (i) 1,288,500 units ("Units") in the Partnership
(representing the remaining 17.5% of equity interest in the Partnership) which
are exchangeable for a like number of shares of the common stock of the Company
and (ii) the payment of mortgage indebtedness for the Sunstone Initial Hotels of
approximately $23.5 million and other obligations relating to the Sunstone
Initial Hotels and (iii) payment of approximately $25.8 million to purchase the
Acquisition Hotels. The Initial Hotels together with the Hampton Inn in Oakland,
California (the "Hotels") acquired by the Company in December 1995 comprise all
of the investments of the Company at December 31, 1995.

The Company owns the Hotels and leases them to Sunstone Hotel Properties,
Inc. (the "Lessee") under operating leases (the "Percentage Leases") providing
for the payment of base and percentage rent. The Lessee is owned by Robert A.
Alter, Chairman and President of the Company (80%), and Charles L. Biederman,
Director and Executive Vice President of the Company (20%). The Lessee has
entered into a management agreement pursuant to which all of the Hotels are
managed by Sunstone Hotel Management, Inc. (the "Management Company"), of which
Mr. Alter is the sole shareholder.

Basis Of Presentation

For accounting purposes, the Company exercises unilateral control over the
Partnership; hence, the financial statements of the Company and the Partnership
are consolidated. All significant intercompany transactions and balances have
been eliminated.

The accompanying unaudited interim financial statements reflect, in the
opinion of the Company's management, all adjustments necessary for a fair
presentation of the interim financial statements. All such adjustments are of a
normal and recurring nature.

The Predecessor

The predecessor to the Company was Sunstone Initial Hotels (the
"Predecessor"), consisting of the seven entities referred to above. Due to a
common ownership and management of the Predecessor, the historical combined
financial statements have been accounted for as a group of entities under common
control. All significant intercompany transactions and balances have been
eliminated in the combined presentations. The financial statements of the
Predecessor do not include the Acquisition Hotels or the Oakland, California
property and are, therefore, not comparable to the financial statements of the
Company.

F-20
<PAGE> 147

SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS -- PREDECESSOR

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Investment In Hotel Properties

The Sunstone Initial Hotels are recorded at the historical cost of the
Predecessor including accumulated depreciation and do not reflect the Company's
cost to acquire the Sunstone Initial Hotels. All other Hotels are recorded at
cost. Hotel assets are stated at the lower of cost or the amounts described
below and are depreciated using the straight-line method over estimated useful
lives of five to thirty-five years for buildings and improvements and three to
ten years for furniture, fixtures and equipment.

The Company estimates the fair values of each of their hotels on a
quarterly basis. Fair value is estimated as the expected undiscounted future
cash flows of the asset (generally over a five-year period), which is compared
to the net book values of the asset. If the expected undiscounted future cash
flows are less than the net book value of the asset, the excess of the net book
value over the estimated fair value is charged to current earnings. No such
charges to earnings have occurred to date. Fair value is determined based upon
discounted cash flows of the hotel assets at rates deemed reasonable for the
type of property and prevailing market conditions and appraisals. A gain or loss
is recorded to the extent the amounts ultimately received differ from the
adjusted book values of the hotel assets.

Cash And Cash Equivalents

Cash and cash equivalents are defined as cash on hand and in banks plus all
short-term investments with an original maturity of three months or less.

Other Assets

Other assets consist primarily of unearned compensation, deposits,
franchise fees and deferred loan fees. Amortization of deferred loan costs is
computed using the straight-line method over the life of the loan based upon the
terms of the loan agreements.

Concentrations Of Credit Risk

At December 31, 1995, the Company had significant amounts in banks that
were in excess of federally-insured amounts.

Revenue Recognition

The Company recognizes lease revenue on an accrual basis over the terms of
the respective leases.

Income Taxes

The Company expects to qualify as a real estate investment trust (REIT)
under the Internal Revenue Code of 1986, as amended (the "Code"). A REIT will
generally not be subject to federal income taxation to the extent that it
distributes at least 95% of its taxable income to its stockholders and complies
with other requirements. The Company is subject to state income and franchise
taxes in certain states in which it operates.

Net Income Per Share and Partnership Units

Net income per share is based on the weighted average number of common and
common equivalent shares outstanding during the year. Outstanding options are
included as common equivalent shares using the treasury stock method when the
effect is dilutive. The weighted average number of shares used in determining
net income per share was 6,322,000 for the period August 16, 1995 through
December 31, 1995. At

F-21
<PAGE> 148

SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS -- PREDECESSOR

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

December 31, 1995, a total of 7,709,859 partnership units were issued and
outstanding. The weighted average number of units for the same period was
7,662,121.

Fair Value Of Financial Instruments

For disclosure purposes, fair market value is determined by using available
market information and appropriate valuation methodologies. Cash and cash
equivalents and accrued liabilities are carried at amounts which reasonably
approximate fair value.

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.

Recently Issued Accounting Standards

In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 121 "Accounting for the Impairment of Long
Lived Assets and for Long Lived Assets to be Disposed Of." This statement shall
be effective for financial statements for fiscal years beginning after December
15, 1995. Management has elected early adoption of this statement.

In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 123, "Accounting for Stock-Based
Compensation" which shall be effective for financial statements for fiscal years
beginning after December 15, 1995. Management intends to adopt the disclosure
method and, accordingly, there will be no impact on the Company's financial
position or results of operations.

3. INVESTMENT IN HOTEL PROPERTIES

Investment in hotel properties as of December 31, 1995 and December 31,
1994 ("Predecessor") consists of the following:

<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Land...................................................... $11,597,000 $ 5,078,000
Building and improvements................................. 40,415,000 17,071,000
Furniture and equipment................................... 8,239,000 6,332,000
Construction in process................................... 2,280,000
------------ ------------
62,531,000 28,481,000
Less, Accumulated depreciation.......................... (12,605,000) (10,942,000)
------------ ------------
Net investment in hotel properties...................... $49,926,000 $17,539,000
============ ============
</TABLE>

4. REVOLVING LINE OF CREDIT

In October 1995, the Company obtained a three-year commitment for a $30
million credit facility bearing interest at a floating rate of 2.75% over LIBOR
(8.5% at December 31, 1995) that may be used for acquisitions, capital
improvements and working capital and general corporate purposes. The Company is
required to pay a .25% fee on the unused portion. As of December 31, 1995, the
Company had $21.6 million of unused credit.

F-22
<PAGE> 149

SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS -- PREDECESSOR

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

The line of credit is collateralized by the hotel properties currently
owned and by future acquisitions, including lease revenues generated from such
properties. In addition, the line of credit is guaranteed by certain Directors
of the Company.

The line of credit requires the Company to maintain a specified debt to net
worth ratio, a coverage ratio of EBITDA to debt service and a debt service
coverage ratio. In addition, the Company is restricted in the amount of
dividends it may distribute and must maintain a specified liquidity. Further,
the Company is required to maintain national franchises at each of its
properties and maintain its REIT status. At December 31, 1995, the Company was
in compliance with its covenants.

5. LONG-TERM DEBT (PREDECESSOR)

Long-term debt of the Predecessor at December 31, 1994 consists of the
following:

<TABLE>
<CAPTION>
DECEMBER 31,
PROPERTY PLEDGED AS COLLATERAL 1994 INTEREST RATE
---------------------------------------------------------- ------------ -------------
<S> <C> <C>
Hampton Inn -- Pueblo..................................... $ 3,691,087 8.5%
Hampton Inn -- Denver..................................... 5,652,045 10.0
Hampton Inn -- Mesa....................................... 4,389,193 8.5
Holiday Inn -- Steamboat.................................. 2,089,351 8.5
Holiday Inn -- Craig...................................... 356,187 9.0
Holiday Inn -- Provo...................................... 1,986,692 8.5
Courtyard by Marriott -- Fresno........................... 4,810,597 11.0
Land -- Craig............................................. 170,000 8.0
Various................................................... 552,889 4.0 - 10.0
-----------
$ 23,698,041
===========
</TABLE>

All long-term debt of the Predecessor was paid off with proceeds of the
Offering.

6. COMMITMENTS

Pursuant to the Leases, the Company is required to make available to the
Lessee for the repair, replacement and refurbishment of furniture, fixtures and
equipment in the Initial Hotels, when and as deemed necessary by the Lessee, an
amount equal to 4.0% of room revenue per quarter on a cumulative basis. To the
extent the reserve is not fully utilized by the Lessee in any year, the Company
may use the reserve to fund certain capital expenditures.

7. PREFERRED STOCK

The Company has the authority to issue 10,000,000 shares of preferred
stock, par value $0.01 per share, undesignated as to class, series or terms. No
shares of preferred stock have been issued or are outstanding as of December 31,
1995.

F-23
<PAGE> 150

SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS -- PREDECESSOR

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

8. LEASE RENTAL AGREEMENTS:

Future minimum rentals to be received by the Company from the Lessee under
the Leases at December 31, 1995 due for the next five years ended December 31
and in total thereafter are as follows:

<TABLE>
<S> <C>
1996............................................ $ 4,837,250
1997............................................ 4,837,250
1998............................................ 4,837,250
1999............................................ 4,837,250
2000............................................ 4,837,250
Thereafter...................................... 22,500,824
-----------
$46,687,074
===========
</TABLE>

The term of each lease is ten years. The rent due under each Lease is the
greater of Base Rent (subject to annual adjustments beginning January 1, 1996
based on increases in the United States Consumer Price Index ("CPI")) or
percentage rent. Percentage rent is calculated as 20% to 37% of room revenues,
up to a certain baseline revenue, then 60% to 65% of room revenues in excess of
the baseline revenues. Generally, percentage rent includes 5% of food and
beverage revenue and 100% of other net revenues. Rental income pursuant to the
leases for the period August 16, 1995 through December 31, 1995 was
approximately $3,013,000, of which approximately $1,328,000 was in excess of
base rents. All rents have been assigned as collateral under the line of credit.

9. STOCK OPTION PLANS

Under the Stock Incentive Plan adopted by the Board of Directors in 1994,
executive officers and other key employees of the Company may be granted share
options, restricted share awards or performance share awards. Restricted share
awards are subject to restrictions determined by the Company's Compensation
Committee. The Compensation Committee, comprised of independent Directors,
determines compensation for the Company's executive officer, and administers
awards under the Stock Incentive Plan. No restricted shares have been issued as
of December 31, 1995.

During the period August 16, 1995 through December 31, 1995 the Company
granted options to purchase 240,000 shares at an exercise price of $9.50 per
share. Such options, which are granted at a minimum of fair market value on the
date of grant, vest over 5 years. As of December 31, 1995, no options have been
exercised.

10. QUARTERLY FINANCIAL INFORMATION (UNAUDITED):

Summarized quarterly financial data for the period August 16, 1995 through
December 31, 1995 is as follows:

<TABLE>
<CAPTION>
PERIOD ENDED QUARTER ENDED
SEPTEMBER 30 DECEMBER 31
------------ -------------
<S> <C> <C>
Lease revenues............................................ $1,145,000 $ 1,868,000
Net income before extraordinary item...................... 629,000 711,000
Net income per share before extraordinary item............ $0.10 $0.11
Net income................................................ 470,000 711,000
Net income per share...................................... $0.08 $0.11
</TABLE>

11. FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying value of the line of credit approximates fair value at
December 31, 1995 as the related interest rates are variable and in line with
market rates.

F-24
<PAGE> 151

SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS -- PREDECESSOR

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

12. RELATED PARTY TRANSACTIONS

The Company leases hotel properties to the Lessee. The revenue recognized
on these leases is classified as rental income in the statement of income. The
amount due from the Lessee under these lease agreements at December 31, 1995 is
approximately $645,000.

The Management Company provides certain accounting and management services
for the Company. The cost of these services amounted to $11,000 for the period
August 16, 1995 through December 31, 1995 and is included in general and
administrative services in the statement of operations.

At December 31, 1995 the Company has a due from affiliate of $21,000 which
represents interest expense incurred by the Company that is to be reimbursed by
affiliates. The interest is reimbursable pursuant to an understanding whereby
the Company has agreed to maintain debt in an amount of approximately $8.4
million in order to avoid triggering a taxable event to certain affiliates. Such
affiliates, in return have agreed to cover the negative interest spread under
this arrangement.

13. STATEMENT OF CASH FLOWS, SUPPLEMENTAL DISCLOSURES

The Company. During the period August 16, 1995 through December 31, 1995,
noncash transactions were as follows: (i) approximately $18.1 million of
historical basis in hotel property was contributed to the Partnership and
approximately $23.5 million in debt was assumed by the Partnership in exchange
for Partnership units, (ii) approximately $1.8 million of dividends and
distributions were declared but not paid, and (iii) approximately 50,000 Units
of the Partnership were issued in conjunction with the purchase of the Oakland
Hampton Inn.

The Predecessor. Interest paid in cash by Sunstone Initial Hotels, the
predecessor in the years ended December 31, 1994 and 1993 was $2,193,000 and
$2,228,000 respectively. Sunstone Initial Hotels also acquired land and building
and improvements of $647,000 and $2,000,000 through issuance of notes payable in
the years ended December 31, 1994 and 1993, respectively.

14. PRO FORMA FINANCIAL INFORMATION

The pro forma financial information set forth below is presented as if: (i)
the Offering and related formation transactions had been consummated as of
January 1, 1995, and (ii) the acquisition of the Hampton Inn in Oakland,
California had occurred as of January 1, 1995.

The pro forma financial information is not necessarily indicative of what
actual results of operations of the Company would have been assuming the
Offering and related formation transactions and the acquisition of the Oakland
Hampton Inn had been consummated as of January 1, 1995, nor does it purport to
represent the results of operations for future periods.

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1995
-----------------
(UNAUDITED)
<S> <C>
Lease revenues............................... $ 9,421,000
Net income................................... $ 4,930,000
Net income per share......................... $ 0.78
</TABLE>

15. SUBSEQUENT EVENTS

In February 1996, the Company purchased six Cypress Inn properties located
in Oregon and Washington for an aggregate amount of approximately $15 million in
cash, of which approximately $12 million was funded through a draw on the line
of credit.

F-25
<PAGE> 152

SUNSTONE HOTEL INVESTORS, INC.

SCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION
AS OF DECEMBER 31, 1995
<TABLE>
<CAPTION>
COST CAPITALIZED GROSS AMOUNTS AT
SUBSEQUENT TO WHICH CARRIED AT
INITIAL COST ACQUISITION CLOSE OF PERIOD
------------------------- ---------------------- -------------------------
BUILDINGS BUILDINGS BUILDINGS
AND AND AND
DESCRIPTION ENCUMBRANCE LAND IMPROVEMENTS LAND IMPROVEMENTS LAND IMPROVEMENTS TOTAL
- ------------------------- ----------- ----------- ------------ -------- ------------ ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Hampton Inn -- Pueblo.... $ 607,183 $ 1,745,054 $ $ 406,290 $ 607,183 $ 2,151,344 $ 2,758,527
Hampton Inn -- Denver.... 1,250,462 2,597,505 674,935 1,250,462 3,272,440 4,522,902
Holiday Inn -- Steamboat
Springs................ 400,000 2,959,000 277,826 400,000 3,236,826 3,636,826
Holiday Inn -- Craig..... 70,000 915,024 202,187 665,347 272,187 1,580,371 1,852,558
Hampton Inn -- Mesa...... 900,000 2,117,321 194,573 900,000 2,311,894 3,211,894
Courtyard by Marriott --
Fresno................. 800,000 2,936,460 767,764 800,000 3,704,224 4,504,224
Holiday Inn -- Provo..... 850,000 1,116,708 63,488 850,000 1,180,196 2,030,196
Best Western -- Santa
Fe..................... 2,296,000 8,610,000 2,296,000 8,610,000 10,906,000
Hampton Inn -- Arcadia... 1,660,500 6,226,875 4,166 1,660,500 6,231,041 7,891,541
Hampton Inn
-- Silverthorne....... 1,337,625 5,016,094 11,564 1,337,625 5,027,658 6,365,283
Hampton Inn -- Oakland... 1,223,045 3,109,435 1,223,045 3,109,435 4,332,480
------ ----------- ----------- -------- ----------- ----------- ----------- -----------
$11,394,815 $37,349,476 $202,187 $3,065,953 $11,597,002 $40,415,429 $52,012,431
====== =========== =========== ======== =========== =========== =========== ===========

DEPRECIATION
ACCUMULATED NET DATE OF YEAR OF IS
DESCRIPTION DEPRECIATION BOOK VALUE CONSTRUCTION ACQUISITION CONDUCTED
- ------------------------- ----------- ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Hampton Inn -- Pueblo.... $1,013,344 $ 1,745,183 1985 31.5
Hampton Inn -- Denver.... 1,643,667 2,879,235 1985 31.5
Holiday Inn -- Steamboat
Springs................ 1,948,346 1,688,480 1984 31.5
Holiday Inn -- Craig..... 347,326 1,505,232 1991 31.5
Hampton Inn -- Mesa...... 590,391 2,621,503 1987 31.5
Courtyard by Marriott --
Fresno................. 685,717 3,818,507 1989 31.5
Holiday Inn -- Provo..... 79,251 1,950,945 1993 31.5
Best Western -- Santa
Fe..................... 219,555 10,686,445 1995 25.0
Hampton Inn -- Arcadia... 123,919 7,767,622 1995 29.0
Hampton Inn
-- Silverthorne....... 84,648 6,280,635 1995 33.0
Hampton Inn -- Oakland... 4,332,480 1995 27.0
----------- -----------
$6,736,164 $45,276,267
=========== ===========
</TABLE>

F-26
<PAGE> 153

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
Sunstone Hotel Investors, Inc.

We have audited the accompanying balance sheet of Sunstone Hotel
Properties, Inc. (the "Lessee") as of December 31, 1995, and the related
statements of operations, deficit and cash flows for the period August 16, 1995,
inception, through December 31, 1995. These financial statements are the
responsibility of the Lessee's management. Our responsibility is to express an
opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 audit provides 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 Sunstone Hotel Properties,
Inc. as of December 31, 1995, and the results of its operations and cash flows
for the period August 16, 1995, inception, through December 31, 1995, in
conformity with generally accepted accounting principles.

COOPERS & LYBRAND L.L.P.

Newport Beach, California
March 22, 1996

F-27
<PAGE> 154

SUNSTONE HOTEL PROPERTIES, INC.

BALANCE SHEETS

MARCH 31, 1996 DECEMBER 31, 1995
-------------- -----------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Cash.......................................................... $2,074,000 $ 800,000
Receivables, net.............................................. 710,000 466,000
Inventories................................................... 69,000 125,000
Prepaid expenses and other assets............................. 790,000 70,000
---------- ----------
$3,643,000 $ 1,461,000
========== ==========
LIABILITIES AND SHAREHOLDERS' DEFICIT:
Rent payable -- REIT.......................................... $2,227,000 $ 645,000
Accounts payable, trade....................................... 735,000 294,000
Advanced deposits............................................. 61,000 199,000
Sales taxes payable........................................... 222,000 225,000
Accrued payroll............................................... 220,000 242,000
Accrued vacation.............................................. 89,000 82,000
Accrued bonus................................................. 115,000
Due to affiliates............................................. 367,000 104,000
Other accrued expenses........................................ 487,000 301,000
---------- ----------
4,408,000 2,207,000
---------- ----------
Shareholders' deficit:
Common Stock, no par value, 1,000 shares authorized 100 shares
issued and outstanding
Shareholders' deficit......................................... (765,000) (746,000)
---------- ----------
$3,643,000 $ 1,461,000
========== ==========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-28
<PAGE> 155

SUNSTONE HOTEL PROPERTIES, INC.

STATEMENTS OF OPERATIONS AND DEFICIT

<TABLE>
<CAPTION>
FROM INCEPTION,
FOR THE THREE AUGUST 16, 1995,
MONTHS ENDED THROUGH DECEMBER
MARCH 31, 1996 31, 1995
-------------- -----------------
(UNAUDITED)
<S> <C> <C>
OPERATING REVENUES:
Room........................................................ $6,786,000 $ 7,060,000
Food and beverage........................................... 232,000 572,000
Other....................................................... 318,000 293,000
---------- ----------
Total revenue....................................... 7,336,000 7,925,000
---------- ----------
OPERATING EXPENSES:
Room........................................................ 1,697,000 2,487,000
Food and beverage........................................... 242,000 531,000
Other....................................................... 193,000 131,000
General and administrative.................................. 461,000 726,000
Franchise costs............................................. 192,000 285,000
Advertising and promotion................................... 638,000 602,000
Utilities................................................... 294,000 363,000
Repairs and maintenance..................................... 316,000 376,000
Management fees............................................. 132,000 157,000
Rent expense................................................ 3,190,000 3,013,000
---------- ----------
Total expenses...................................... 7,355,000 8,671,000
---------- ----------
Net loss............................................ $ (19,000) $ (746,000)
========== ==========
Deficit, beginning of period.................................. (746,000) --
---------- ----------
Deficit, end of period........................................ $ (765,000) $ (746,000)
========== ==========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-29
<PAGE> 156

SUNSTONE HOTEL PROPERTIES, INC.

STATEMENTS OF CASH FLOWS

FROM
INCEPTION,
AUGUST 16,
1995,
FOR THE THREE THROUGH
MONTHS ENDED DECEMBER 31,
MARCH 31, 1996 1995
----------------- --------------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................... $ (19,000) $ (746,000)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Changes in assets and liabilities:
Receivables, net....................................... (244,000) (466,000)
Inventories............................................ 56,000 (125,000)
Prepaid expenses and other assets...................... (320,000) (70,000)
Rent payable -- REIT................................... 1,582,000 645,000
Accounts payable, trade................................ 442,000 294,000
Advanced deposits...................................... (138,000) 199,000
Sales taxes payable.................................... (3,000) 225,000
Accrued payroll........................................ (22,000) 242,000
Accrued vacation....................................... 7,000 82,000
Accrued bonus.......................................... (116,000) 115,000
Due to affiliates...................................... 263,000 104,000
Other accrued expenses................................. 186,000 301,000
----------- ----------
Net cash provided by operating activities........... 1,674,000 800,000
----------- ----------
Cash flows from investing activities:
Capitalized construction costs.............................. (400,000)
----------- ----------
Net cash used in investing activities:.............. (400,000)
----------- ----------
Net change in cash.................................. 1,274,000
----------- ----------
Cash, beginning of period..................................... 800,000
----------- ----------
Cash, end of period........................................... $ 2,074,000 $ 800,000
=========== ==========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-30
<PAGE> 157

SUNSTONE HOTEL PROPERTIES

NOTES TO COMBINED FINANCIAL STATEMENTS

1. ORGANIZATION AND BASIS OF PRESENTATION

Organization

Sunstone Hotel Properties, Inc. (the "Company") was incorporated in
Colorado in August 1995 and commenced operations effective with the completion
of an initial public stock offering (the "Offering") by Sunstone Hotel
Investors, Inc. (the "REIT") on August 16, 1995. The Company leases hotel
properties primarily located in the western United States and leases the
properties from the REIT pursuant to long term leases.

Basis of Presentation

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Cash And Cash Equivalents

Cash and cash equivalents are defined as cash on hand and in banks plus all
short-term investments with an original maturity of three months or less.

Inventories

Inventories are stated at the lower of cost or market with cost determined
on a first-in, first-out basis.

Concentrations Of Credit Risk

At December 31, 1995, the Company had amounts in banks that were in excess
of the federally-insured amounts.

Revenue Recognition

Revenue is recognized as earned. Earned is generally defined as the date
upon which a guest occupies a room and utilizes the hotel's services. Ongoing
credit evaluations are performed and potential credit losses are expensed at the
time the account receivable is estimated to be uncollectible. Historically,
credit losses have not been material to the hotels' results of operations. The
Company has recorded an allowance for doubtful accounts of approximately $7,000
at December 31, 1995.

Fair Value of Financial Instruments

The carrying value of cash and cash equivalents, accounts receivable,
accounts payable and accrued expenses are deemed to represent their fair value
at December 31, 1995.

Use of Estimates

F-31
<PAGE> 158

SUNSTONE HOTEL PROPERTIES

NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

3. INCOME TAXES

The Company has elected to be treated as an S Corporation under Subchapter
S of the Internal Revenue Code. As an S Corporation, the tax attributes of the
Company will pass through to its stockholders, who will then owe any related
taxes. As a result, the accompanying Statements of Operations and Deficit show
no income tax expense.

4. COMMITMENTS

Franchise costs represent the expense for franchise royalties under the
terms of hotel franchise agreements, generally ranging from 10-20 years. Fees
are computed based upon percentages (generally 4%) of gross room revenue.

5. LEASE RENTAL AGREEMENTS

Future minimum rentals to be paid by the Lessee under the Leases at
December 31, 1995 are due for the next five years ended December 31 and in total
thereafter as follows:

The term of each lease is ten years. The rent payable under each Lease is
the greater of Base Rent (subject to annual adjustments beginning January 1,
1996 based on increases in the United States Consumer Price Index ("CPI")) or a
percentage rent. Percentage rent is calculated as 20% to 37% of room revenues,
up to a certain baseline revenue, then 60% to 65% of room revenues in excess of
the baseline revenues. In addition, percentage rent includes 5% of food and
beverage revenue and 100% of other net revenues. Rent expense for the period
August 16, 1995 through December 31, 1995 was approximately $3,013,000, of which
approximately $1,328,000 was in excess of base rent. The stockholders of the
Lessee have collateralized the lease payments by pledging units owned in
Sunstone Hotel Investors, L.P.

6. RELATED PARTY TRANSACTIONS

The Company leases hotel properties from the REIT. The amount due from the
Company to the REIT under these lease agreements at December 31, 1995 is
approximately $645,000.

Sunstone Hotel Management, Inc. (the "Management Company"), a company
wholly owned by Robert A. Alter, provided management services to the Company.
The cost of these services is classified as management fees in the statement of
operations.

F-32
<PAGE> 159

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
Sunstone Hotel Investors, Inc.:

We have audited the accompanying balance sheet of Renton Joint Venture
(referred to as the "Partnership") as of December 31, 1995, and the related
statements of operations, partners' equity, and cash flows for the year then
ended. These financial statements are the responsibility of the Partnership's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.

We conducted our audit 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 audit provides 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 Renton Joint Venture as of
December 31, 1995, and the results of its operations and its cash flows the year
then ended, in conformity with generally accepted accounting principles.

COOPERS & LYBRAND L.L.P.

Dallas, Texas
June 7, 1996

F-33
<PAGE> 160

RENTON JOINT VENTURE
(A WASHINGTON GENERAL PARTNERSHIP)

BALANCE SHEETS

MARCH 31, DECEMBER 31,
1996 1995
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Investments in hotel properties, at cost:
Land............................................................ $ 627,145 $ 627,145
Building and improvements....................................... 1,993,213 1,993,213
Furniture and equipment......................................... 1,606,196 1,552,961
Accumulated depreciation........................................ (1,458,529) (1,422,105)
---------- -----------
Net Investment in hotel properties...................... 2,768,025 2,751,214
---------- -----------
Cash.............................................................. 285,252 357,353
Receivables....................................................... 445,369 266,684
Inventory......................................................... 26,970 24,858
Prepaids.......................................................... 23,010 30,795
Intangible assets (net of accumulated amortization)............... 24,005 25,811
---------- -----------
Total assets............................................ $ 3,572,631 $3,456,715
========== ===========
LIABILITIES AND PARTNERS' EQUITY:
Accounts payable, trade........................................... $ 158,213 $ 146,264
Accrued expenses.................................................. 211,396 164,193
Notes payable..................................................... 2,227,929 2,215,108
---------- -----------
Total liabilities....................................... 2,597,538 2,525,565
---------- -----------
Commitments and contingencies
Partners' equity.................................................. 975,093 931,150
---------- -----------
Total liabilities and partners' equity.................. $ 3,572,631 $3,456,715
========== ===========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-34
<PAGE> 161

RENTON JOINT VENTURE
(A WASHINGTON GENERAL PARTNERSHIP)

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
THREE MONTHS ENDED FOR THE YEAR
------------------------ ENDED
MARCH 31, MARCH 31, DECEMBER 31,
1995 1996 1995
--------- ---------- ------------
(UNAUDITED)
<S> <C> <C> <C>
OPERATING REVENUES:
Room revenue.......................................... $ 538,514 $ 708,025 $2,914,025
Food and beverage revenue............................. 344,825 287,354 1,472,683
Other revenue......................................... 31,334 39,081 148,222
---------- -------- ----------
Total revenue................................. 914,673 1,034,460 4,534,930
OPERATING EXPENSES:
Room.................................................. 167,158 174,002 753,735
Food and beverage..................................... 290,081 246,005 1,148,926
Other................................................. 24,355 28,965 96,379
---------- -------- ----------
481,594 448,972 1,999,040
---------- -------- ----------
Departmental profit........................... 433,079 585,488 2,535,890
General and administrative.............................. 107,083 97,894 389,665
Utilities and other operating costs..................... 84,787 90,680 356,467
Property operating costs and maintenance................ 62,516 79,828 303,845
Management fee.......................................... 27,460 30,961 136,048
Advertising and promotion............................... 100,467 100,629 407,260
Personal property taxes and insurance................... 40,570 44,029 167,710
---------- -------- ----------
Gross operating profit........................ 10,196 141,467 774,895
---------- -------- ----------
Interest expense........................................ 61,685 59,294 272,796
Depreciation and amortization........................... 29,883 38,230 136,541
---------- -------- ----------
Net (loss) income........................... $ (81,372) $ 43,943 $ 365,558
========== ======== ==========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-35
<PAGE> 162

RENTON JOINT VENTURE
(A WASHINGTON GENERAL PARTNERSHIP)

STATEMENT OF PARTNERS' EQUITY

<TABLE>
<S> <C>
Balance December 31, 1994......................................................... $565,592
Contributions................................................................... 50,000
Distributions................................................................... (50,000)
Net income...................................................................... 365,558
--------
Balance December 31, 1995......................................................... 931,150
Net income (unaudited).......................................................... 43,943
--------
Balance March 31, 1996 (unaudited)................................................ $975,093
========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-36
<PAGE> 163

RENTON JOINT VENTURE
(A WASHINGTON GENERAL PARTNERSHIP)

STATEMENTS OF CASH FLOWS

THREE MONTHS FOR THE YEAR
ENDED ENDED
MARCH 31, DECEMBER 31,
1996 1995
------------ ------------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net income....................................................... $ 43,943 $ 365,558
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization................................. 38,230 136,541
Change in assets and liabilities:
Receivables................................................... (178,685) (11,001)
Inventory..................................................... (2,112) 1,112
Prepaid expenses and other assets............................. 7,785 9,313
Accounts payable, trade....................................... 11,949 (35,385)
Accrued expenses.............................................. 47,203 (6,887)
--------- ---------
Net cash provided by (used in) operating activities...... (31,687) 459,251
--------- ---------
Cash flows from investing activities:
Acquisition, improvements and additions to hotel properties...... (53,235) (189,626)
--------- ---------
Net cash used in investing activities.................... (53,235) (189,626)
--------- ---------
Cash flows from financing activities:
Principal payments on notes payable.............................. (33,800) (101,876)
Proceeds from notes payable...................................... 46,621
Contributions.................................................... -- 50,000
Distributions.................................................... -- (50,000)
--------- ---------
Net cash (used in) provided by financing activities...... 12,821 (101,876)
--------- ---------
Net change in cash................................................. (72,101) 167,749
Cash, beginning of period.......................................... 357,353 189,604
--------- ---------
Cash, end of period................................................ $ 285,252 $ 357,353
========= =========
Supplemental disclosures of cash flow information:
Cash paid during the period for interest......................... $ 59,294 $ 256,119
========= =========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-37
<PAGE> 164

RENTON JOINT VENTURE
(A WASHINGTON GENERAL PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS

1. ORGANIZATION AND BASIS OF PRESENTATION

The Renton Joint Venture (the "Partnership") was formed for the purpose of
owning, operating, and holding for investment and ultimate resale the Holiday
Inn-Renton (a 188 room, full service "Hotel" in Renton, Washington).

The accompanying unaudited interim financial statements reflect, in the
opinion of the Partnership's management, all adjustments necessary for a fair
presentation of the interim financial statements. All such adjustments are of a
normal and recurring nature.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Cash and Cash Equivalents

For purpose of reporting cash flows, all highly liquid debt instruments
with maturities of three months or less on the date of acquisition are
considered to be cash equivalents.

Inventories

Inventories consist of food, beverages and guest supplies and are stated at
cost, which approximates market, with cost determined using the first-in,
first-out method.

Investment in Hotel Properties

The Hotel is stated at cost less reductions due to debt restructuring in
1993. Depreciation is computed using the straight-line method based upon the
following useful lives

<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Building and improvements............................. 40
Furniture and fixtures................................ 7
Equipment............................................. 5
</TABLE>

The Partnership's management periodically reviews the hotel property to
determine if its carrying costs will be recovered from future operations and,
accordingly, whether a reduction in carrying value should be recorded. No such
reductions have occurred to date.

Maintenance and repairs are charged to operations as incurred; major
renewals and betterments are capitalized. Upon the sale or disposition, the
asset and related accumulated depreciation are removed from the accounts, and
the gain or loss is included in operations.

Amortizable Assets

Amortizable assets consist primarily of deferred finance costs which are
recorded at cost and amortized over the life of the loan.

Income Taxes

No provision has been made in the accompanying financial statements for
federal or state income taxes as the taxable income or loss of the Partnership
is included in the owners' federal and state income tax returns. The
Partnership's tax returns and the amount of allocable income or loss are subject
to examination by the federal and state taxing authorities. If such examinations
result in changes to income or loss, the tax liability of the partners could be
changed accordingly.

F-38
<PAGE> 165

RENTON JOINT VENTURE
(A WASHINGTON GENERAL PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Revenue Recognition

Revenue is recognized as earned. Earned is generally defined as the date
upon which a guest occupies a room and/or utilizes the Hotel's services. Ongoing
credit evaluations are performed and potential credit losses are expensed at the
time the accounts receivable is estimated to be uncollectible. Historically,
credit losses have not been material to the Hotel's results of operations and,
accordingly, no allowance for doubtful accounts is recorded.

Impact of New Accounting Standards

In March, 1995, the Financial Accounting Standards issued Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of Long
Lived Assets and for Long Lived Assets to be Disposed Of." This statement shall
be effective for financial statements for fiscal years beginning after December
15, 1995. Management believes that adoption of this standard will not have a
material effect on its financial position or results of operations.

Accounting 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,
including disclosure of contingent assets and liabilities at the date of the
financial statements. Ultimate actual results may, in some instances, differ
from previously estimated amounts.

3. NOTES PAYABLE:

<TABLE>
<S> <C>
Mortgage note payable with interest rate of 11.5%,
collateralized by the property of the Partnership, due in
monthly installments with original maturity on November 1,
2000.......................................................... $1,912,695
Notes payable to GIAC, due in monthly installments with original
maturity on October 1, 1999................................... 302,413
----------
$2,215,108
==========
</TABLE>

Scheduled principal payments of notes payable are as follows for fiscal
years ending December 31:

<TABLE>
<S> <C>
1996............................................................ $ 119,413
1997............................................................ 128,933
1998............................................................ 149,639
1999............................................................ 136,199
2000............................................................ 72,956
Thereafter...................................................... 1,607,968
----------
$2,215,108
==========
</TABLE>

F-39
<PAGE> 166

RENTON JOINT VENTURE
(A WASHINGTON GENERAL PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

4. OPERATING LEASES

The Partnership leases certain equipment under noncancelable operating
leases with terms ranging from 12 months to 10 years. The following are the
future minimum rental payments under noncancelable operating leases for each of
the remaining years ending December 31:

<TABLE>
<S> <C>
1996............................................................ $ 76,144
1997............................................................ 56,710
1998............................................................ 34,140
1999............................................................ 13,876
2000 and thereafter............................................. 4,625
----------
$ 185,495
==========
</TABLE>

Rental expense for the year ended December 31, 1995, including additional
percentage rents, was $81,636.

5. RELATED PARTIES

In 1995, the Partnership paid management fees of $136,048 to 405 Renton
Inc., a partner, and accounting fees of $24,000 to Westminster Hotel.

6. SUBSEQUENT EVENT

The Partners of the Partnership intend to sell the Hotel to Sunstone Hotel
Investors, Inc. for approximately $8.1 million.

F-40
<PAGE> 167

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
Sunstone Hotel Investors, Inc.

We have audited the accompanying combined balance sheet of Bay City
Hospitality, Inc. and Price Hospitality, Inc. (referred to as the "Companies")
as of October 31, 1995, and the related combined statements of operations,
equity, and cash flows for the year then ended. These combined financial
statements are the responsibility of the Companies' management. Our
responsibility is to express an opinion on these combined financial statements
based on our audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the combined financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the combined financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall combined
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of Bay City
Hospitality, Inc. and Price Hospitality, Inc. as of October 31, 1995, and the
results of their operations and their cash flows the year then ended, in
conformity with generally accepted accounting principles.

COOPERS AND LYBRAND L.L.P.

Newport Beach, California
July 2, 1996

F-41
<PAGE> 168

BAY CITY HOSPITALITY, INC. AND PRICE HOSPITALITY, INC.

COMBINED BALANCE SHEETS

JANUARY 31, OCTOBER 31,
1996 1995
----------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Investments in hotel properties, at cost:
Land............................................................ $ 1,971,535 $ 1,971,535
Building and improvements....................................... 5,299,579 5,298,890
Furniture and equipment......................................... 1,712,536 1,547,279
Accumulated depreciation........................................ (1,058,066) (960,294)
----------- -----------
Net investment in hotel properties...................... 7,925,584 7,857,410
----------- -----------
Cash.............................................................. 1,413,332 1,963,001
Receivables....................................................... 133,540 140,720
Inventory......................................................... 10,565 9,235
Other assets...................................................... 300,508 128,580
Receivable from shareholder....................................... 33,880
----------- -----------
Total assets............................................ $ 9,817,409 $10,098,946
=========== ===========
LIABILITIES AND EQUITY:
Accounts payable, trade........................................... 243,137 260,354
Accrued interest.................................................. 401,375 378,084
Accrued expenses.................................................. 110,353 199,100
Notes payable..................................................... 8,707,264 8,593,262
Loans from shareholder............................................ 271,120
----------- -----------
Total liabilities....................................... 9,462,129 9,701,920
----------- -----------
Commitments and contingencies
Equity............................................................ 355,280 397,026
----------- -----------
Total liabilities and equity............................ $ 9,817,409 $10,098,946
=========== ===========
</TABLE>

The accompanying notes are an integral part of these combined financial
statements.

F-42
<PAGE> 169

BAY CITY HOSPITALITY, INC. AND PRICE HOSPITALITY, INC.

COMBINED STATEMENTS OF OPERATIONS AND EQUITY

<TABLE>
<CAPTION>
FOR THE YEAR
ENDED
OCTOBER 31, 1995
FOR THE THREE ----------------
MONTHS ENDED
JANUARY 31, 1996
----------------
(UNAUDITED)
<S> <C> <C>
OPERATING REVENUES:
Room revenue.................................................. $1,037,663 $4,758,540
Other revenue................................................. 185,881 831,257
---------- ----------
Total revenue....................................... 1,223,544 5,589,797
---------- ----------
OPERATING EXPENSES:
Room.......................................................... 288,046 1,195,532
Food and beverage............................................. 128,378 493,449
Other......................................................... 19,938 84,839
---------- ----------
436,362 1,773,820
---------- ----------
Departmental profit................................. 787,182 3,815,977
---------- ----------
General and administrative.................................... 200,453 662,066
Advertising and promotion..................................... 59,458 445,967
Utilities..................................................... 57,014 253,526
Repairs and maintenance....................................... 59,022 236,898
Real estate, personal property taxes, and insurance........... 71,780 264,292
Management fees............................................... 48,880 223,591
---------- ----------
496,607 2,086,340
---------- ----------
Gross operating profit...................................... 290,575 1,729,637
---------- ----------
Interest expense.............................................. 234,551 1,103,944
Depreciation and amortization................................. 97,772 403,453
---------- ----------
Net (loss) income................................... $ (41,748) $ 222,240
========== ==========
Equity at beginning of period................................. 397,028 174,788
Equity at end of period....................................... $ 355,280 $ 397,028
</TABLE>

The accompanying notes are an integral part of these combined financial
statements.

F-43
<PAGE> 170

BAY CITY HOSPITALITY, INC. AND PRICE HOSPITALITY, INC.

COMBINED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE YEAR
ENDED
OCTOBER 31,
1995
FOR THE THREE ---------------
MONTHS ENDED
JANUARY 31,
1996
---------------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income............................................ $ (41,748) $ 222,240
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 97,772 403,453
Changes in assets and liabilities:
Escrow funds............................................ 123,054
Receivables............................................. 7,180 29,415
Inventory............................................... (1,330)
Other assets............................................ (171,928) 6,616
Accounts payable, trade................................. (17,217) 54,556
Accrued interest........................................ 23,291 1,875
Accrued expenses........................................ (88,747) 76,398
---------- ----------
Net cash provided by operating activities............ (192,727) 917,607
---------- ----------
Cash flows from investing activities:
Acquisition, improvements and additions to hotel
properties................................................ (165,944) (329,730)
---------- ----------
Net cash used in investing activities................ (165,944) (329,730)
---------- ----------
Cash flows from financing activities:
Net borrowings (payments) on notes payable................... 114,002 (17,519)
Principal payments on loans from shareholders................ (305,000) (29,880)
---------- ----------
Net cash used in financing activities................ (190,998) (47,399)
---------- ----------
Net change in cash................................... (549,669) 540,478
---------- ----------
Cash, beginning of period...................................... 1,963,001 1,422,523
Cash, end of period............................................ 1,413,332 $ 1,963,001
========== ==========
Supplemental disclosures of cash flow information:
Cash paid during the period for interest..................... $ 211,260 $ 1,027,546
========== ==========
</TABLE>

The accompanying notes are an integral part of these combined financial
statements.

F-44
<PAGE> 171

BAY CITY HOSPITALITY, INC. AND PRICE HOSPITALITY, INC.

NOTES TO COMBINED FINANCIAL STATEMENTS

1. ORGANIZATION AND BASIS OF PRESENTATION

Organization

Bay City Hospitality, Inc. and Price Hospitality, Inc., (the "Companies")
are corporations that own a 165-room hotel located in South San Francisco,
California and a 148-room hotel in Price, Utah, respectively (the "Hotels"). The
Hotels are operated pursuant to franchise agreements with Choice Hotels
International, Inc. and another national franchise, respectively, and are
managed by Westmont Hospitality, Inc.

Basis Of Presentation

The accompanying financial statements have been presented on a combined
basis because the Companies are ultimately owned by the same parent company.

The accompanying unaudited interim financial statements reflect, in the
opinion of the Companies' management, all adjustments necessary for a fair
presentation of the interim financial statements. All such adjustments are of a
normal and recurring nature.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Investment In Hotel Properties

The Hotels are stated at cost. Depreciation is computed using the
straight-line method based upon the following estimated useful lives:

The Companies' management periodically reviews each hotel property to
determine if its carrying costs will be recovered from future operations and,
accordingly, whether a reduction in carrying value should be recorded. No such
reductions have occurred to date.

Cash

The Companies consider all temporary cash investments purchased with
maturity dates of three months or less on the date of acquisition to be cash
equivalents.

Inventory

Inventory consists of food and beverages that are stated at cost, which
approximates market, with cost determined using the first-in, first-out method.

Income Taxes

No provision has been made in the accompanying financial statements for
federal or state income taxes as the taxable income or loss of the Company is
included in the owners' federal and state income tax returns.

F-45
<PAGE> 172

BAY CITY HOSPITALITY, INC. AND PRICE HOSPITALITY, INC.

NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

Revenue Recognition

Revenue is recognized as earned. Earned is generally defined as the date
upon which a guest occupies a room and/or utilizes the Hotels' services. Credit
evaluations are performed at year end and potential credit losses are expensed
at the time the accounts receivable is estimated to be uncollectible.
Historically, credit losses have not been material to the Hotels' results of
operations and, accordingly, no allowance for doubtful accounts is recorded.

Management 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 of revenues and expenses during the reporting period. Actual
results could differ from those estimates.

Impact Of New Accounting Standards

In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of Long
Lived Assets and for Long Lived Assets to be Disposed Of." This statement shall
be effective for financial statements for fiscal years beginning after December
15, 1995. Management believes that adoption of this standard will not have a
material effect on its financial position or results of operations.

3. NOTES PAYABLE

<TABLE>
<CAPTION>
BAY CITY HOSPITALITY, INC.
---------------------------------------------------------------------
<S> <C>
Mortgage note payable with interest rate of 7% through May 1994, 8%
through June 1995, and 9% thereafter, collateralized by the assets
of the Company and personal guarantees of certain officers of the
Company's parent, due in monthly installments, with original
maturity on May 1, 1997............................................ $3,995,098
Mortgage note payable................................................ 1,592,500
---------
$5,587,598
=========
</TABLE>

<TABLE>
<CAPTION>
PRICE HOSPITALITY, INC.
---------------------------------------------------------------------
<S> <C>
Promissory note payable with interest rate of 8%, collateralized by a
deed of trust on the hotel property, due in monthly installments,
with a maturity date of December 1, 2000........................... $1,875,265
Mortgage note payable................................................ 1,090,000
----------
2,965,265
----------
Other notes payable.................................................. 40,399
----------
$8,593,262
=========
</TABLE>

The Companies entered into loan agreements with CSSF in 1993 in the
original amounts of $1,592,500 and $1,090,000, respectively, that are
collateralized by second liens on the related Hotel property and its
improvements. The entire principal amounts are due in May and December 1998, but
can be extended to May and December 2000, respectively.

The loan agreements define several methods for the accrual and payment of
interest, including (1) accrual throughout the term of the obligation at one
rate (11%); (2) payment of interest at another rate (currently 8% throughout the
remaining term of the loan); (3) computation of additional interest based on the
net cash flow of the Hotels; and (4) computation of interest based on
appreciation of the Hotels' property and

F-46
<PAGE> 173

BAY CITY HOSPITALITY, INC. AND PRICE HOSPITALITY, INC.

NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

improvements during the term of the loan. Additional interest is paid currently,
first reducing the obligation for the accrued but unpaid interest, and then as
an incremental amount of interest. The interest computation based on
appreciation in property values must be positive, meaning CSSF will not share in
depreciation of the property. Additional interest is accrued when incremental
amounts are due, but no amount has been provided for the potential obligation
for shared appreciation because there is no objective basis for doing so.

4. COMMITMENTS

Operating Leases:

The Companies lease certain land and equipment under noncancellable
operating leases with terms ranging from 36 to 60 months. The following are the
future minimum rental payments under noncancellable operating leases for each of
the remaining years ending October 31:

Rental expense for the year ended October 31, 1995, was $9,781.

5. RELATED PARTY TRANSACTIONS:

The Companies have entered into management agreements with Westmont
Hospitality, Inc. which require the Companies to remit to Westmont a monthly
management fee equal to 4% of related hotel room revenue, as defined.
Additionally, the Companies each pay Westmont $1,500 per month in accounting
fees. Westmont is owned by the Companies' parent.

6. CONCENTRATION OF CREDIT RISK

At October 31, 1995, the Companies collectively had approximately
$1,286,000 on deposit with financial institutions that exceeded the FDIC limit.

F-47
<PAGE> 174

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholder of
Bay City Hospitality, Inc.
Houston, Texas

We have audited the accompanying balance sheets of Bay City Hospitality,
Inc., a California Corporation, as of October 31, 1994 and 1993, and the related
statements of income, changes in shareholder's equity and of cash flows for the
year and period then ended. These financial statements are the responsibility of
the Company'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 accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe 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 Bay City Hospitality, Inc.
as of October 31, 1994 and 1993, and the results of its operations and of its
cash flows for the year and period then ended in conformity with generally
accepted accounting principles.

GRIFFING & COMPANY, P.C.

Houston, Texas
December 4, 1995

F-48
<PAGE> 175

BAY CITY HOSPITALITY, INC.

BALANCE SHEETS

<TABLE>
<CAPTION>
OCTOBER 31,
-------------------------
1994 1993
---------- ----------
<S> <C> <C>
ASSETS:
Current assets
Cash.............................................................. $ 755,727 $ 868,854
Accounts receivable (Note 2)...................................... 122,791 94,440
---------- ----------
Total current assets...................................... 878,518 963,294
---------- ----------
Property & equipment (Notes 2 & 3)
Land.............................................................. 1,731,368 1,731,368
Buildings......................................................... 3,114,510 3,114,510
Furniture & fixtures.............................................. 898,514 562,153
Equipment......................................................... 39,576 9,728
---------- ----------
5,783,968 5,417,759
Accumulated depreciation.......................................... (462,838) (86,515)
---------- ----------
Net property & equipment.................................. 5,321,130 5,331,244
---------- ----------
Other assets, net of amortization (Note 2)
Deferred loan costs............................................... 41,936 53,918
Franchise license fee............................................. 17,500 22,500
Deposit........................................................... 17,000 17,000
Liquor license.................................................... 10,500 7,500
---------- ----------
Total other assets........................................ 86,936 100,918
---------- ----------
Total assets........................................................ $6,286,584 $6,395,456
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY:
Current liabilities
Accounts payable.................................................. $ 71,575 $ 67,802
Accrued liabilities
Interest....................................................... 183,697 165,726
Taxes other than income........................................ 80,975 84,928
Wages & payroll taxes.......................................... 53,702 40,338
Management & accounting fees (Note 3).......................... 23,145 22,420
Other.......................................................... 8,256 2,709
Current maturities of long-term debt (Note 2)..................... 17,373
Income taxes payable.............................................. 41,119 28,621
---------- ----------
Total current liabilities................................. 479,842 412,544
Long-term debt, net of current maturities (Note 2).................. 5,729,627 5,899,000
---------- ----------
Total liabilities......................................... 6,209,469 6,311,544
---------- ----------
Commitments & contingencies (Note 4)................................
Shareholder's Equity
Common stock, $1.00 par value, 10,000 shares authorized, 1,000
shares issued and outstanding.................................. 1,000 1,000
Retained earnings................................................. 76,115 82,912
---------- ----------
Total shareholders's equity............................... 77,115 83,912
---------- ----------
Total liabilities & shareholder's equity.................. $6,286,584 $6,395,456
========== ==========
</TABLE>

The accompanying notes are an integral part of these statements.

F-49
<PAGE> 176

BAY CITY HOSPITALITY, INC.

INCOME STATEMENTS

<TABLE>
<CAPTION>
FOR THE PERIOD
FROM INCEPTION,
FOR THE YEAR FEBRUARY 5,
ENDED 1993, THROUGH
OCTOBER 31, OCTOBER 31,
1994 1993
------------------ -----------------
<S> <C> <C>
REVENUE
Rooms..................................................... $2,933,269 $ 1,628,235
Food...................................................... 8,023 5,383
Telephone................................................. 76,367 30,939
Other..................................................... 8,157 4,227
------------------ -----------------
Total revenue.......................................... 3,025,816 1,668,784
------------------ -----------------
DEPARTMENTAL EXPENSE
Rooms..................................................... 803,150 401,703
Food...................................................... 84 143
Telephone................................................. 30,821 14,696
------------------ -----------------
Total departmental expenses............................ 834,055 416,542
------------------ -----------------
Interest income............................................. 8,766 3,158
------------------ -----------------
UNDISTRIBUTED EXPENSES
Administrative & general (Note 3)......................... 370,468 199,284
Marketing................................................. 304,801 180,240
Repairs and maintenance................................... 125,207 66,377
Management fee (Note 3)................................... 121,383 66,863
Energy costs.............................................. 108,553 62,819
------------------ -----------------
Total undistributed expense............................ 1,030,412 575,583
------------------ -----------------
Income before fixed charges................................. 1,170,115 679,817
------------------ -----------------
FIXED CHARGES
Interest.................................................. 569,816 364,889
Depreciation and amortization............................. 381,323 89,015
Property taxes............................................ 158,878 79,075
Insurance................................................. 53,663 34,176
Rent...................................................... 734 1,129
------------------ -----------------
Total fixed charges.................................... 1,164,414 568,284
------------------ -----------------
Income before income taxes.................................. 5,701 111,533
Income taxes................................................ 12,498 28,621
------------------ -----------------
Net (loss) income........................................... $ (6,797) $ 82,912
============== =============
</TABLE>

The accompanying notes are an integral part of these statements.

F-50
<PAGE> 177

BAY CITY HOSPITALITY, INC.

STATEMENT OF CHANGES IN SHAREHOLDER'S EQUITY
FOR THE YEAR ENDED OCTOBER 31, 1994
AND THE PERIOD FROM INCEPTION, FEBRUARY 5, 1993, THROUGH OCTOBER 31, 1993

<TABLE>
<CAPTION>
COMMON RETAINED
STOCK EARNINGS TOTAL
------ -------- -------
<S> <C> <C> <C>
Stock issued................................................... $1,000 $ 1,000
Net income..................................................... $ 82,912 82,912
------ ------- -------
Balance, October 31, 1993...................................... 1,000 82,912 83,912
Net loss....................................................... (6,797) (6,797)
------ ------- -------
Balance, October 31, 1994...................................... $1,000 $ 76,115 $77,115
====== ======= =======
</TABLE>

The accompanying notes are an integral part of these statements.

F-51
<PAGE> 178

BAY CITY HOSPITALITY, INC.

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE PERIOD
FROM INCEPTION,
FEBRUARY 5,
1993,
FOR THE YEAR ENDED THROUGH
OCTOBER 31, OCTOBER 31,
1994 1993
------------------ ----------------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income.......................................... $ (6,797) $ 82,912
--------- --------
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation & amortization, including amortized
interest.............................................. 393,305 95,006
Increase (decrease) in cash from changes in working
capital:
Accounts receivable..................................... (28,350) (81,063)
Prepaid expenses........................................ 27,554
Accounts payable........................................ 3,773 67,802
Accrued liabilities..................................... 33,654 310,003
Income taxes payable.................................... 12,498 28,621
--------- --------
Total adjustments.................................. 414,880 447,923
--------- --------
Cash provided by operating activities.............. 408,083 530,835
--------- --------
Cash flows from investing activities:
Additions to property & equipment.......................... (366,210) (63,030)
Additions to other assets.................................. (3,000) (24,500)
--------- --------
Cash used by investing activities (369,210) (87,530)
--------- --------
Cash flows from financing activities:
Repayments of shareholder advances......................... (152,000)
Proceeds from long-term debt............................... 425,549
--------- --------
Cash provided by financing activities.............. (152,000) 425,549
--------- --------
Change in cash and cash equivalents.......................... (113,127) 868,854
Cash and cash equivalents, beginning......................... 868,854
--------- --------
Cash and cash equivalents, ending.................. $ 755,727 $ 868,854
========= ========
Supplemental disclosures of cash flow information:
Interest paid during the year.............................. $ 401,119 $ 193,000
Supplemental schedule of noncash investing and financing
activities:
Net assets acquired at the inception of operations using
long-term debt, net of cash retained.................... $5,480,000
Stock issuance financed using shareholder advance.......... $ 1,000
</TABLE>

The accompanying notes are an integral part of these statements.

F-52
<PAGE> 179

BAY CITY HOSPITALITY, INC.

NOTES TO FINANCIAL STATEMENTS

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Bay City Hospitality, Inc. (the "Company"), is a corporation that owns a
165-room hotel located in South San Francisco, California (the "Hotel"). The
Hotel is operated pursuant to a franchise agreement with Choice Hotels
International, Inc. and managed by Westmont Hospitality Group, Inc.
("Westmont"). The Company is a wholly-owned subsidiary of Sedko Group, Inc.
("Sedko").

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 of revenues and expenses during the reporting period. Actual
results could differ from those estimates.

Significant accounting policies of the Company are set out below.

Cash and Cash Equivalents

For purposes of the Statement of Cash Flows, the Company considers all
temporary cash investments purchased with a maturity of three months or less to
be cash equivalents.

Inventory

Inventory consists of food and beverages that are stated at cost, which is
not materially different from market.

Property and Equipment

Property and equipment are stated at cost in the accompanying financial
statements. Depreciation is computed using the double-declining balance method
over estimated useful lives of 5 years for furniture, fixtures, and equipment,
and over 31 1/2 and 39 years for the underlying real estate.

Renewals, additions, and betterments which extend the life of the property
are capitalized while repairs and maintenance are charged to operations as
incurred. Disposals are removed at cost less accumulated depreciation with any
resulting gain or loss reflected in income.

Franchise Fees

"Franchise License Fees" included in the accompanying financial statements
as an asset represent the initial cost to the Company, net of accumulated
amortization, to enter the Choice hotel system. The fee is amortized to
operations over the 20 year term of the license agreement. Accumulated
amortization at October 31, 1994 and 1993 is $7,500 and $2,500, respectively.

In addition to the initial license fee, the Company pays Choice each month
continuing franchise fees, assessments for marketing & reservations, and other
fees. Monthly fees aggregating $199,000 in 1994 and $121,000 in 1993 are
included in operations in the caption "Administrative & General" and
"Marketing." Deferred Loan Costs

Deferred loan costs are amounts incurred to obtain the financing described
in Note 2. The costs are amortized to operations, included in "Interest
Expense," using the straight line method over the life of the loan. Accumulated
amortization at October 31, 1994 and 1993 are $17,973 and $5,991, respectively.

Federal Income Taxes

The Company's federal income tax return filing requirements are to be met
by its inclusion in the consolidated federal income tax return of Sedko. The
federal tax amounts presented in the accompanying

F-53
<PAGE> 180

BAY CITY HOSPITALITY, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

financial statements as "Income Taxes" are the amounts the Company would have to
pay if it filed a separate tax return. The accounting policy used by the Company
and its parent require, among other things, that deferred taxes be recognized
for the tax consequences in future years of differences between the tax basis of
assets and liabilities and their financial report amounts. The tax and financial
reporting bases of the Company are the same; deferred taxes are not recognized
in the accompanying financial statements.

2. LONG-TERM DEBT

Long-term debt at October 31, 1994 and 1993 consists of the obligations set
out below to LW-SP2, L.P. (Lennar), Comfort Suites-San Francisco, Ltd (CSSF),
and to Sedko that were incurred to acquire the real property and improvements of
an existing hotel site, and to fund the construction and renovation of those
improvements.

<TABLE>
<CAPTION>
1994 1993
---------- ----------
<S> <C> <C>
Lennar (See A below)........................................ $4,012,500 $4,012,500
CSSF (See B below).......................................... 1,592,500 1,592,500
Shareholder Advance (See C below)........................... 142,000 294,000
---------- ----------
Total long-term debt........................................ 5,747,000 5,899,000
Less: current maturities.................................... 17,373
---------- ----------
Long-term debt, net of current maturities................... $5,729,627 $5,899,000
========== ==========
</TABLE>

Repayment of principal is scheduled as follows:

<TABLE>
<CAPTION>
FOR THE YEARS ENDING OCTOBER 31,
-------------------------------------------------------------------------
<S> <C>
1995..................................................................... $ 17,373
1996..................................................................... 45,697
1997..................................................................... 3,949,430
1998.....................................................................
1999.....................................................................
Thereafter............................................................... 1,734,500
----------
Total.......................................................... $5,747,000
==========
</TABLE>

- ---------------
(A) The Company entered into a Promissory Note agreement in 1993 in the original
amount of $4,012,500 that is collateralized by a first lien on all property
and equipment, as well as the liquor license, franchise agreement,
receivables, and the personal guarantees of certain officers of Sedko. The
obligation is payable interest only for the first two years, blended
payments for the next two years using a 25 year amortization period, and a
final payment of $3,949,430 due May 1, 1997. The obligation bears interest
of 7% through May 1994, 8% until June 1995, and 9% thereafter.

(B) The Company entered into a Loan Agreement with CSSF in 1993 in the original
amount of $1,592,500 that is collateralized by a second lien on the Hotel
property and its improvements. The entire principal amount is due May 6,
1998, but that date can be extended to May 6, 2000.

The Loan Agreement defines several methods for the accrual and payment of
interest, including (1) accrual throughout the term of the obligation at one
rate (11%); (2) payment of interest at another rate (currently 7% through
May 6, 1995 and 8% throughout the remaining term of the loan); (3)
computation of additional interest based on the net cash flow of the Hotel;
and (4) computation of interest based on appreciation of the Hotel property
and improvements during the term of the loan. The difference between the
accrued interest and paid interest described above is added to the principal
of the loan at each loan year and is due at the maturity of the loan unless
paid earlier. Additional interest is paid

F-54
<PAGE> 181

BAY CITY HOSPITALITY, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

currently, first reducing the obligation for the accrued but unpaid interest
described above, and then as an incremental amount of interest. The interest
computation based on appreciation in property values must be positive,
meaning CSSF will not share in depreciation of the property. Additional
interest is accrued when incremental amounts are due, but no amount has been
provided for the potential obligation for shared appreciation because there
is no objective basis for doing so.

The interest accruals and payments described above are limited to the
maximum rate of interest allowed by the State of New York, which is
currently 25%. The effective interest rates paid on this obligation in
fiscal 1994 and 1993 were 16 and 14%, respectively.

(C) Amounts due to Sedko are considered long-term as no payments are scheduled.
No interest is imputed or charged on these related party advances.

The loan agreements for the Lennar and CSSF notes described above include
certain restrictive Covenants and Events of Default which, if violated, would
cause repayment of the obligations to accelerate. Management believes the
Company is in compliance with all such Covenants and Events of Default.

3. MANAGEMENT OF HOTEL

The Company entered into an agreement with Westmont in 1993 granting
Westmont the sole and exclusive right to supervise and direct the management and
operations of the Hotel. Sedko is the parent company of both the Company and
Westmont.

The initial term of the Management Agreement is ten years, with two
five-year renewal terms available at the option of Westmont. In exchange for its
management services, Westmont is paid a Management Fee equal to 4% of gross
revenues of the Hotels as defined in the Management Agreement, plus $1,500 per
month for providing accounting services to the Company. The Company's fees to
Westmont aggregating $139,000 and $75,000 in fiscal 1994 and 1993, respectively,
are included in the captions "Administrative & General" and "Management Fee."
Amounts payable to Westmont were about $14,000 and $13,000, respectively at
October 31, 1994 and 1993.

The Management Agreement includes certain restrictive Covenants and Events
of Default which provide Westmont certain remedies in the event they are
violated. Westmont was granted a lien and a secured interest in the Hotel real
property as security for amounts due or to become due under the Management
Agreement, including a Termination Fee, as defined in this Agreement. Management
believes the Company is in compliance with all such Covenants and Events of
Default.

4. CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the Company to credit risk
include cash on deposit with two financial institutions which exceed federally
insured deposit limits by about $410,500 at October 31, 1994.

The Company's customers include overnight guests as well as companies and
individuals who have arranged for guest rooms or seminar or banquet facilities.
Most customers secure their rooms with credit cards. When credit is extended to
customers, the Company performs periodic credit evaluations of its customers and
provides an allowance for doubtful accounts when necessary. Management believes
that no allowance was necessary at October 31, 1994 or 1993.

F-55
<PAGE> 182

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholder of
Price Hospitality, Inc.
Houston, Texas

We have audited the accompanying balance sheet of Price Hospitality, Inc.,
a Utah Corporation, as of October 31, 1994, and the related statements of
income, changes in shareholder's equity, and cash flows for the period from
inception of operations, December 29, 1993 to October 31, 1994. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.

We conducted our audit 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 accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides 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 Price Hospitality, Inc. as
of October 31, 1994, and the results of its operations and of cash flows for the
period then ended in conformity with generally accepted accounting principles.

GRIFFING & COMPANY, P.C.

Houston, Texas
July 2, 1996

F-56
<PAGE> 183

PRICE HOSPITALITY, INC.

BALANCE SHEET
OCTOBER 31, 1994

<TABLE>
<S> <C> <C>
ASSETS:
CURRENT ASSETS
Cash.............................................................. $ 789,855
Accounts receivable............................................... 47,343
Inventory......................................................... 12,760
----------
Total current assets...................................... 849,958
PROPERTY AND EQUIPMENT (Note 1)
Land.............................................................. 240,167
Buildings......................................................... 2,036,797
Furniture and fixtures............................................ 411,115
Equipment......................................................... 16,017
----------
2,704,096
Accumulated depreciation............................................ (90,841)
----------
Net property and equipment................................ 2,613,255
----------
OTHER ASSETS, NET OF AMORTIZATION
Franchise fee..................................................... 18,889
Loan escrow....................................................... 43,110
Liquor license.................................................... 10,458
----------
Total other assets........................................ 72,457
----------
Total assets.............................................. $3,535,670
=========
LIABILITIES AND SHAREHOLDER'S EQUITY:
CURRENT LIABILITIES
Accounts payable.................................................. $ 36,098
Accrued liabilities
Taxes other than income........................................ 42,609
Interest....................................................... 81,319
Wages and payroll taxes........................................ 40,565
Management and accounting (Note 5)............................. 8,021
Auditing....................................................... 9,000
Current maturities of long-term debt (Note 2)....................... 44,085
Income taxes payable................................................ 35,074
----------
Total current liabilities................................. 296,771
LONG-TERM DEBT, NET OF CURRENT MATURITIES...........................
Note payable (Note 2)............................................. 3,120,696
Deferred income taxes payable (Note 4)............................ 12,081
----------
Total long term liabilities............................... 3,132,777
----------
Total liabilities......................................... $3,429,548
----------
Commitments and contingencies (Note 7)..............................
Shareholder's equity
Common Stock, $1.00 par value, 10,000 shares authorized, 1,000
shares issued and outstanding.................................. 1,000
Retained earnings................................................. 105,122
----------
Total shareholder's equity................................ 106,122
----------
Total liabilities and shareholder's equity.......................... $3,535,670
=========
</TABLE>

The accompanying notes are an integral part of these statements.

F-57
<PAGE> 184

PRICE HOSPITALITY, INC.

STATEMENT OF INCOME AND CHANGES IN SHAREHOLDER'S EQUITY
FOR THE PERIOD FROM INCEPTION OF OPERATIONS
THROUGH OCTOBER 31, 1994

<TABLE>
<S> <C>
REVENUES
Rooms.......................................................................... $1,317,546
Food & beverage................................................................ 497,101
Telephone...................................................................... 50,022
Other.......................................................................... 3,629
----------
Total revenues.............................................................. $1,868,298
----------
DEPARTMENTAL EXPENSES
Rooms.......................................................................... 298,748
Food & beverage................................................................ 358,502
Telephone...................................................................... 27,607
----------
Total departmental expenses................................................. 684,857
Interest income.................................................................. 7,444
UNDISTRIBUTED EXPENSES
Administrative & general (Note 5).............................................. 221,702
Management fee (Note 5)........................................................ 75,030
Marketing...................................................................... 115,843
Repairs & maintenance.......................................................... 84,329
Energy costs................................................................... 98,515
----------
Total undistributed expenses................................................ 595,419
----------
Income before fixed charges...................................................... 595,466
----------
FIXED CHARGES
Property taxes................................................................. 35,771
Insurance...................................................................... 26,728
Interest....................................................................... 280,820
Depreciation & amortization (Note 2)........................................... 99,870
----------
Total fixed charges......................................................... 443,189
----------
Income before income taxes....................................................... 152,277
Federal income taxes........................................................... 41,089
State income taxes............................................................. 6,066
----------
Net income....................................................................... $ 105,122
==========
Common Stock issued.............................................................. $ 1,000
Net Income....................................................................... 105,122
----------
Balance, October 31, 1994........................................................ $ 106,122
==========
</TABLE>

The accompanying notes are an integral part of these statements.

F-58
<PAGE> 185

PRICE HOSPITALITY, INC.

STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM INCEPTION OF OPERATIONS
THROUGH OCTOBER 31, 1994

<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income....................................................................... $ 105,122
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization.................................................... 99,870
Increase (decrease) in cash from changes in working
Accounts receivable............................................................ (48,764)
Inventory...................................................................... (3,178)
Accounts payable............................................................... 36,098
Accrued liabilities............................................................ 180,887
Income taxes payable........................................................... 47,155
----------
Total adjustments.............................................................. 312,068
----------
Cash provided by operating activities.......................................... $ 417,190
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment............................................ (34,490)
Payment of franchise fees...................................................... (20,000)
Payment of loan cost........................................................... (1,511)
----------
Cash used by investing activities.............................................. $ (56,001)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt................................................... 457,885
Principal payments on long-term debt........................................... (34,219)
Advances from shareholder...................................................... 5,000
----------
Cash provided by financing activities.......................................... $ 428,666
----------
Change in cash and cash equivalents.............................................. 789,855
Cash and cash equivalents, beginning............................................. 0
----------
Cash and cash equivalents, ending................................................ $ 789,855
=========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid during the year.................................................... $ 199,483
SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND FINANCING ACTIVITIES
Net assets acquired at the inception of operations using long-term debt, net of
cash........................................................................... $2,737,115
Stock issuance financed using shareholder advance................................ $ 1,000
</TABLE>

The accompanying notes are an integral part of these statements.

F-59
<PAGE> 186

PRICE HOSPITALITY, INC.

NOTES TO FINANCIAL STATEMENTS

1. NATURE OF ORGANIZATION

Price Hospitality, Inc. (the "Company"), is a Corporation which was formed
under the laws of Utah on September 27, 1993. On December 29, 1993 (date of
inception of operations) the Company purchased a hotel located in Price, Utah
(the "Hotel"). The Hotel is operated pursuant to a franchise agreement with a
national franchisor. The Company is a wholly-owned subsidiary of Sedko
Investment Services Corp. ("Sedko")

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 of revenues and expenses during the reporting period. Actual
results could differ from those estimates.

Significant accounting policies of the Company are set out below.

Cash and Cash Equivalents

For purposes of the Statement of Cash Flows, the Company considers all
temporary cash investments purchased with a maturity of three months or less to
be cash equivalents.

Inventory

Inventory consists of food and beverages stated at cost, which is not
materially different from market.

Property and Equipment

Property and equipment are stated at cost in the accompanying financial
statements. Depreciation is computed using the straight line method over
estimated useful lives of 7 years for furniture, fixtures, and equipment, and 40
years for the underlying real estate.

Renewals, additions, and/or betterments which extend the life of the
property are capitalized while repairs and maintenance are charged to operations
as incurred. Disposals are removed at cost less accumulated depreciation with
any resulting gain or loss reflected in income.

Franchise Fees

"Franchise License Fees" included in the accompanying financial statements
as an asset represents the initial cost to the Company, net of accumulated
amortization, to enter the franchise system in which the hotel has operated. The
fee is amortized to operations over the 15 year term of the license agreement.
Accumulated amortization at October 31, 1994 is about $1,100.

In addition to the initial license fee, the Company pays the franchisor
each month continuing franchise fees, assessments for reservations, and other
fees. Monthly fees aggregating approximately $97,500 in 1994 are included in
operations in the caption "Administrative & General" and "Marketing."

Federal Income Taxes

The Company's federal income tax return filing requirements are met by its
inclusion in the consolidated federal income tax return of Sedko. The amounts
presented in the accompanying financial statements as "Federal Income Taxes" are
the amounts the Company would have to pay if it filed a separate tax return. The
accounting policy used by the Company and its parent require, among other
things, that deferred taxes be recognized for the tax consequences in future
years of differences between the tax basis of assets and liabilities and their
financial report amounts (Note 4).

F-60
<PAGE> 187

PRICE HOSPITALITY, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

2. LONG-TERM DEBT

Long-term debt at October 31, 1994 consists of the obligations set out
below to Solus Arkansas Portfolio ("Solus"), Castle Limited ("Castle"), and to
Sedko Investment Services Corp. ("Sedko") that were incurred to acquire the real
property and improvements of an existing hotel site, and to fund the
construction and renovation of those improvements.

<TABLE>
<S> <C>
Solus (See A below).............................................. $1,915,781
Castle (See B below)............................................. 1,090,000
Shareholder advance (See C below)................................ 159,000
----------
Total long-term debt............................................. 3,164,781
Less: current maturities......................................... 44,085
----------
Long-term debt, net of current maturities........................ $3,120,696
=========
</TABLE>

Repayment of principal is scheduled as follows:

<TABLE>
<CAPTION>
FOR THE YEAR ENDED
OCTOBER 31, TOTAL
------------------ ----------
<S> <C>
1995........................................................ $ 44,085
1996........................................................ 47,313
1997........................................................ 51,671
1998........................................................ 1,145,959
1999........................................................ 60,604
Thereafter..................................................... 1,815,149
----------
Total................................................ $3,164,781
=========
</TABLE>

(A) The Company entered into a promissory note agreement in 1993 in the
original amount of $1,950,000 that is collateralized by a first lien on
all property and equipment, as well as the liquor license, franchise
agreement, receivables, and the personal guarantees of certain officers
of Sedko. The obligation is payable interest only for the initial
payment, blended payments starting February 1, 1994 of $16,311 using a
20 year amortization, and a final payment of $1,578,840 due December
31, 2000. The obligation bears an interest rate of 8% for the term of
the loan.

(B) The Company entered into a loan agreement with Castle in 1993 in the
original amount of $1,090,000 that is collateralized by a second lien
on the Hotel property and its improvements. The entire principal is due
December 28, 1998, but that date can be extended to December 28, 2000.

The loan agreement defines several methods for the accrual and payment
of interest, including (1) accrual throughout the term of the
obligation at one rate (11%); (2) payment of interest at another rate
(currently 7% through December 28, 1995 and 8% through the remaining
term of the loan); (3) computation of additional interest based on the
net cash flow of the Hotel; and (4) computation of interest based on
appreciation of the Hotel property and improvements during the term of
the loan. The difference between the accrued interest and paid interest
described above is added to the principal of the loan at each loan year
and is due at the maturity of the loan unless paid earlier. Additional
interest is paid currently, first reducing the obligation for the
accrued but unpaid interest described above, and then as an incremental
amount of interest. The interest computation based on appreciation in
property values must be positive, meaning Castle will not share in the
depreciation of the property. Additional interest is accrued when
incremental amounts are due, but no amount has been provided for the
potential obligation for shared appreciation because there is no
objective basis for doing so.

F-61
<PAGE> 188

PRICE HOSPITALITY, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

(C) Amounts due to Sedko are considered long-term as no payments are
scheduled. No interest is imputed or charged on these related party
advances.

The loan agreements for the Solus and Castle notes described above include
certain restrictive Covenants and Events of Default which, if violated, would
cause repayment of the obligation to accelerate. Management believes the Company
is in compliance with all such Covenants and Events of Default.

3. LEASE OBLIGATIONS

The Company leases certain assets under noncancelable leases presented in
the accompanying financial statements as operating leases. All leases require
minimum monthly payments that include applicable taxes.

Rental Expense related for the operating leases were about $5,000 in the
accompanying financial statements for October 31, 1994. Following is a schedule
of future minimum lease payments for the operating leases.

<TABLE>
<CAPTION>
YEAR ENDED
OCTOBER 31,
------------
<S> <C>
1995............................................ $ 5,390
1996............................................ 5,299
1997............................................ 4,305
1998............................................ 3,229
-------
Total........................................... $18,223
=======
</TABLE>

4. INCOME TAXES

Effective October 31, 1994, the Company adopted Statement of Financial
Accounting Standards No. 109 "Accounting for Income Taxes" (FAS 109). Under the
provisions of FAS 109, an entity recognizes deferred tax assets and liabilities
for future tax consequences of events that have been previously recognized in
the Company's financial statements or tax returns. The measurement of deferred
tax assets and liabilities is based on provisions of the enacted tax law: the
effects of future changes in tax laws or rates are not anticipated.

As of October 31, 1994, the federal and state income tax liabilities
consists of the following:

<TABLE>
<CAPTION>
FEDERAL STATE TOTAL
------- ------ -------
<S> <C> <C> <C>
Current Income Taxes Payable........................... $30,557 $4,517 $35,074
Deferred Tax Liability................................. 10,532 1,549 12,081
------- ------ -------
Total Income Tax Liability............................. $41,089 $6,066 $47,155
======= ====== =======
</TABLE>

As of October 31, 1994, the provisions for federal and state income tax
expense is as follows:

<TABLE>
<CAPTION>
FEDERAL STATE TOTAL
------- ------ -------
<S> <C> <C> <C>
Current................................................ $30,557 $4,517 $35,074
Deferred............................................... 10,532 1,549 12,081
------- ------ -------
Total Income Taxes..................................... $41,089 $6,066 $47,155
======= ====== =======
</TABLE>

The tax liability exists because the Company uses the straight line method
of depreciation over estimated lives of seven years for furniture, fixtures and
equipment, and 40 years for the underlying real estate for book purposes. For
tax purposes, the Company uses the Modified Accelerated Cost Recovery System
(MACRS) over the estimated useful lives which range from 5 to 39 years.
Therefore, depreciation is deducted over shorter lives for tax purposes then
permitted by generally accepted accounting principles.

F-62
<PAGE> 189

PRICE HOSPITALITY, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

5. MANAGEMENT OF HOTEL

The Company entered into an agreement with Westmont Hospitality Group, Inc.
in 1993 granting Westmont the sole and exclusive right to supervise and direct
the management and operation of the Hotel. Sedko is the parent company of both
the Company and Westmont.

The initial term of the Management Agreement is ten years with two
five-year renewal terms available at the option of Westmont. In exchange for its
management services, Westmont is paid a Management Fee equal to 4% of the gross
revenues of the Hotel, as defined in the Management Agreement, plus $1,500 per
month for providing accounting services to the Company. The Company's fees to
Westmont were about $90,000 in the fiscal year ended 1994. Amounts payable to
Westmont were about $8,000 at October 31, 1994.

The Management Agreement includes certain restrictive Covenants and Events
of Default which provide Westmont certain remedies in the event they are
violated. Westmont was granted a lien and a secured interest in the Hotel real
property as security for amounts due or to become due under the Management
Agreement, including a Termination Fee, as defined in this agreement. Management
believes the Company is in compliance with all such Covenants and Events of
Default.

6. CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the Company to credit risk
include cash on deposit with three financial institutions amounting to
approximately $530,000 at October 31, 1994 which were insured up to only
$300,000 by the U.S. Federal Deposit Insurance Corporation.

7. SUBSEQUENT EVENT

The Company has executed a letter of intent with Sunstone Hotel Properties,
Inc. for the sale of the Hotel.

F-63
<PAGE> 190

[COLOR PHOTOS OF HOTELS]
<PAGE> 191

- ------------------------------------------------------
- ------------------------------------------------------

No dealer, salesperson or any other individual has been authorized to give
any information or to make any representations other than those contained in
this Prospectus in connection with the offer made by this Prospectus and, if
given or made, such information or representations must not be relied upon as
having been authorized by the Company or the Underwriters. This Prospectus does
not constitute an offer to sell, or a solicitation of an offer to buy any
securities in any jurisdiction in which such offer or solicitation is not
authorized or in which the person making such offer or solicitation is not
qualified to do so, or to any person to whom it is unlawful. Neither the
delivery of this Prospectus nor any sale made hereunder shall, under any
circumstances, create any implication that there has been no change in the
affairs of the Company or that the information contained herein is correct as of
any time subsequent to the date hereof.

----------------------------

TABLE OF CONTENTS

----------------------------

<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary.................... 1
Risk Factors.......................... 14
The Company........................... 26
Use of Proceeds....................... 27
Price Range of Common Stock and
Distributions....................... 28
Capitalization........................ 29
Selected Financial Information........ 30
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 34
Business and Properties............... 39
Policies and Objectives with Respect
to Certain Activities............... 63
Management............................ 67
Certain Transactions.................. 77
The Lessee............................ 80
The Management Company................ 83
Principal Stockholders................ 84
Description of Capital Stock.......... 85
Certain Provisions of Maryland Law and
of the Company's Articles of
Incorporation and Bylaws............ 89
Shares Available for Future Sale...... 92
Partnership Agreement................. 93
Federal Income Tax Considerations..... 96
Underwriting.......................... 114
Experts............................... 115
Reports to Stockholders............... 115
Legal Matters......................... 115
Additional Information................ 116
Glossary of Significant Terms......... 117
Index to Financial Statements......... F-1
</TABLE>

- ------------------------------------------------------
- ------------------------------------------------------

4,000,000 SHARES

LOGO

COMMON STOCK
------------------------

PROSPECTUS

------------------------

MONTGOMERY SECURITIES

BEAR, STEARNS & CO. INC.

EVEREN SECURITIES, INC.

RAYMOND JAMES &
ASSOCIATES, INC.

August 7, 1996

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