<PAGE> 1
This filing is made pursuant
PROSPECTUS SUPPLEMENT to Rule 424(b)(5) under the
(TO PROSPECTUS DATED JANUARY 6, 1997) Securities Act of 1933 in
connection with Registration
No. 333-16887.
700,000 SHARES
[LOGO OF SUNSTONE HOTEL INVESTORS]
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 under nationally recognized franchises, including Courtyard
by Marriott(R), Doubletree(R) Hotel, Hampton Inn(R), Holiday Inn(R), Holiday
Inn(R) Hotel & Suites, Holiday Inn Express(TM), Holiday Inn Select(TM), Comfort
Suites(R), Residence Inn(R) by Marriott and Hawthorn Suites. The Company
recently acquired one hotel and intends to acquire one additional hotel
(collectively, the "Acquisition Hotels") promptly following the closing of this
offering (the "Offering"). Following such acquisition, the Company will own 28
hotels with an aggregate of 4,212 rooms in seven states, including Arizona (4
hotels), California (9), Colorado (6), New Mexico (1), Oregon (2), Utah (2) and
Washington (4).
The net proceeds to the Company from the Offering will be approximately
$9.24 million all of which will be used to fund the purchase of one of the
Acquisition Hotels to be purchased promptly following the closing of the
Offering. The Company's Articles of Incorporation limits its consolidated
indebtedness to 50% of the Company's investment in hotel properties, at cost.
Upon the closing of the Offering and the purchase of the Acquisition Hotel to be
purchased promptly following the closing of the Offering, the Company's
consolidated indebtedness will be approximately 18.5% 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 March 24, 1997, the last reported sales price per
share of the Company's Common Stock on the NYSE was $13.875. Since November
1996, the Company has paid regular quarterly dividends representing an annual
distribution of $1.00 per share.
THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" BEGINNING
ON PAGE S-9 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.
<TABLE>
<CAPTION>
==========================================================================================================
Price to Underwriting Proceeds to
Public Discount(1) Company(2)
<S> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------
Per Share............................. $13.75 $0.55 $13.20
- ----------------------------------------------------------------------------------------------------------
Total (3)............................. $9,625,000 $385,000 $9,240,000
==========================================================================================================
</TABLE>
(1) See "Underwriting" for information concerning indemnification of the
Underwriter and other matters.
(2) Before deducting expenses payable by the Company estimated at $175,000.
(3) The Company has granted to the Underwriter a 30-day option to purchase up to
105,000 additional shares of Common Stock solely to cover over-allotments,
if any, at the Price to Public less the Underwriting Discount. If the
Underwriter exercises this option in full, the Price to Public will total
$11,068,750, and the Proceeds to Company will total $10,626,000. See
"Underwriting."
The shares offered hereby are offered by the Underwriter subject to prior
sale, when, as and if delivered to and accepted by them and subject to approval
of certain legal matters by counsel for the Underwriter. The Underwriter
reserves the right to withdraw, cancel or modify such offer and to reject orders
in whole or in part. It is expected that delivery of the Common Stock offered
hereby will be made against payment therefor at the office of Montgomery
Securities on or about March 28, 1997.
------------------------
MONTGOMERY SECURITIES
The date of this Prospectus Supplement is March 24, 1997
<PAGE> 2
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING PURCHASES OF THE COMMON STOCK TO STABILIZE ITS MARKET PRICE, PURCHASES
OF THE COMMON STOCK TO COVER SOME OR ALL OF A SHORT POSITION IN THE COMMON STOCK
MAINTAINED BY THE UNDERWRITER AND THE IMPOSITION OF PENALTY BIDS. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
S-2
<PAGE> 3
PROSPECTUS SUPPLEMENT SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements and the notes thereto appearing elsewhere
in or incorporated by reference in the accompanying Prospectus to which this
Prospectus Supplement relates. 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 Supplement assumes no exercise of the
Underwriters' over-allotment option. The offering of 700,000 shares of Common
Stock pursuant to this Prospectus Supplement 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. This Prospectus Supplement may contain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. The Company's
actual results could differ materially from those set forth in any such
forward-looking statements. Certain factors that might cause such a difference
are discussed in the section entitled "Risk Factors" starting on page S-9 of
this Prospectus Supplement. The Company cautions the reader, however, that the
factors discussed in that section may not be exhaustive.
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 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, Residence Inn by Marriott and
Hawthorn Suites. As of the date of this Prospectus Supplement, the Company owns
27 hotels, 16 of which were acquired and one of which was developed subsequent
to the Company's initial public offering (the "IPO") in August 1995. The Company
recently acquired one of the 27 hotels and intends to acquire an additional
hotel with the proceeds of the Offering promptly following the closing of the
Offering (collectively, the "Acquisition Hotels"). Following such acquisition,
the Company will own 28 hotels with an aggregate of 4,212 rooms in seven states,
including Arizona (4 hotels), California (9), Colorado (6), New Mexico (1),
Oregon (2), Utah (2) and Washington (4). The 26 hotels owned prior to January
31, 1997 are referred to as the "Current Hotels," and together with the two
Acquisition Hotels are referred to as the "Hotels."
In order for the Company to qualify as a REIT under Federal income tax law,
neither the Company nor the Partnership can operate hotels. Therefore, the
Partnership leases its hotels to Sunstone Hotel Properties, Inc., a Colorado
corporation (the "Lessee") pursuant to percentage leases (the "Percentage
Leases") with initial terms of ten years, which provide for rent payments based
principally on a percentage of room revenues at the hotels. The Lessee pays 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 hotels are managed by Sunstone Hotel Management, Inc., a Colorado
corporation (the "Management Company") pursuant to a management agreement
between the Lessee and the Management Company for a fee equal to 2% of gross
revenues of the hotels plus reimbursement of accounting costs. The Management
Company is wholly-owned by Mr. Alter.
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 implementing new management and marketing programs. The
Company believes that its recently completed and planned future redevelopment
and renovation activities, as well as improvements in management and marketing,
will continue to fuel revenue per available room ("REVPAR") growth at its
hotels, thereby increasing revenue to the Company. The Company is currently
planning to redevelop or renovate, during the first and second quarters of 1997,
twelve of its hotels for an estimated aggregate cost of $18.7 million.
S-3
<PAGE> 4
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
implementing new management and marketing programs;
- 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 master development
agreement with U.S. Franchise Systems, Inc. and Hawthorn Suites
Franchising, Inc.; and
- 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 18 hotels (including the Acquisition Hotels) for purchase prices
aggregating $139.9 million;
- Increased the number of rooms in its portfolio by 216%, to 4,212, through
acquisition and development;
- Completed $9.6 million in redevelopment and renovations to seven of its
hotels, and is planning redevelopment budgeted at $18.7 million to twelve
additional hotels;
- Entered into a contract to acquire a 166-room full-service convention
hotel located in Pueblo, Colorado for $8.4 million upon completion of
construction by an unaffiliated developer, which is expected to occur in
the second quarter of 1998;
- Completed construction of a 78-room Residence Inn for approximately $5.0
million, which opened in September 1996;
- Completed two secondary offerings of Common Stock in August 1996 and
January 1997 with aggregate gross proceeds of $105.8 million (including
the full exercise of the underwriters' over-allotment option in each
offering);
- Increased availability under the Company's line of credit from $30
million to $50 million, and reduced the borrowing cost from LIBOR plus
2.75% per annum to LIBOR plus 1.75% per annum;
- Added two project managers and a Chief Financial Officer and benefitted
from the addition of a President, a Director of Development, an asset
manager and other management personnel to the Lessee;
- Increased the annualized quarterly dividend on its Common Stock, from
$0.92 per share to $1.00 per share;
- Implemented a Dividend Reinvestment and Stock Purchase Plan;
- Appointed Laurence Geller, a leading hotel industry consultant, to the
Board of Directors; and
- Entered into a master development agreement with U.S. Franchise Systems,
Inc. and Hawthorn Suites Franchising, Inc. to franchise extended-stay
Hawthorn Suites in several major urban markets on the West Coast.
S-4
<PAGE> 5
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 CUMULATIVE
DATE ACQUIRED PROPERTIES HOTELS TOTAL OF ROOMS TOTAL
- -------------------- --------------------------------- --------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C>
August 1995 (IPO) Initial Hotels 10 10 1,331(2) 1,331
December 1995 Hampton Inn, 1 11 152 1,483
Oakland, California
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 Hotel & Suites
Kent, Washington
Holiday Inn Express,
Poulsbo, Washington
Holiday Inn Express,
Portland, Oregon
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 Comfort Suites, South San 1 19 165 2,461
Francisco, California
Holiday Inn Hotel & Suites, 1 20 151 2,612
Price, Utah(3)
October 1996 Holiday Inn, Mesa, Arizona 3 23 527 3,139
Holiday Inn, Flagstaff, Arizona
Hampton Inn, Tucson, Arizona
December 1996 Radisson Suites Hotel, 1 24 250 3,389
Oxnard, California(4)
January 1997 Holiday Inn-Harbor View, 2 26 382 3,771
San Diego, California
Ramada Hotel,
Cypress, California(5)
March 1997 Hawthorn Suites, 1 27 152 3,923
Kent, Washington
March 1997 est. Holiday Inn, 1 28 289 4,212
La Mirada, California
</TABLE>
- ---------------
(1) The Company acquired the land on this date; the hotel opened on September
20, 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 a Holiday Inn Hotel & Suites franchise license for the
hotel, subject to the completion of certain renovations and improvements,
which the Company estimates will be completed during the second quarter of
1997.
(4) The Company has received a Residence Inn by Marriott franchise license for
the hotel, subject to completion of certain renovations and improvements,
which the Company estimates will be completed during the second quarter of
1997.
(5) The Company has received a Courtyard by Marriott franchise license for the
hotel, subject to completion of certain renovations and improvements, which
the Company estimates will be completed during the third quarter of 1997.
S-5
<PAGE> 6
The Acquisition Hotels
On March 11, 1997, the Company purchased a 152 all-suite Hawthorn Suites
hotel in Kent, Washington from ING Barings and an affiliate of Westmont
Hospitality for approximately $13.6 million, or $89,000 per room. The Company
believes that this acquisition price is below replacement cost. The Hawthorn
Suites hotel in Kent is a two-story, all-suite hotel built in a similar fashion
to a Residence Inn. Every suite has a fully-equipped kitchen and a fireplace,
and the hotel has meeting rooms, a heated pool and spa, an exercise room and a
tennis court. This extended-stay hotel was built in the mid-1980s and is located
within five miles of Seattle International Airport (SEA-TAC) and is proximate to
Boeing Space & Defense Center and Boeing Customer Training Facility. It is also
five miles away from Sunstone's Holiday Inn Hotel and Suites in Kent. Occupancy
and average daily room rates for the twelve months ended October 31, 1996 were
70.7% and $80.50, respectively. For the same period, room revenue was
$3,166,000, an increase of 32% over the prior twelve-month period.
Promptly after the closing of the Offering, the Company intends to acquire
the 289-room Holiday Inn in La Mirada, California for a purchase price of
approximately $18.0 million. The Company believes this price represents
approximately 65% of replacement cost. The Holiday Inn-La Mirada was built in
1983 and the Company believes the reported 1996 ADR of $51.89 has upside
potential after the Company implements its management and marketing programs.
The Company is also evaluating repositioning and rebranding opportunities.
Future Acquisitions
The Company is continually identifying, evaluating and negotiating
potential portfolio and individual hotel acquisitions. From time to time, the
Company enters into letters of intent relating to the acquisition of hotels. The
consummation of any hotel acquisition, including the pending acquisition of the
Holiday Inn-La Mirada Acquisition Hotel, is subject to the approval of the Board
of Directors, satisfactory completion of the Company's valuation analysis and
due diligence review and the negotiation of definitive documentation. There can
be no assurance that any pending or contemplated acquisitions will be
consummated or, if consummated, the nature of the terms or timing thereof or
whether any of the pending acquisitions will be beneficial to the Company.
Dividend Reinvestment and Stock Purchase Plan
In October 1996, the Company adopted a Dividend Reinvestment and Stock
Purchase Plan whereby stockholders may automatically reinvest their dividends in
additional shares of Common Stock, and stockholders and non-stockholders may
purchase shares of Common Stock directly from the Company. See "Price Range of
Common Stock and Distributions" for a discussion of the Company's recently
adopted Dividend Reinvestment and Stock Purchase Plan.
Executive Compensation
In addition to his $30,000 annual base salary, Charles Biederman's
employment agreement provides for bonuses based on the recommendation by the
President for performance of special assignments. During 1996, Mr. Alter
recommended, and the Compensation Committee of the Board of Directors approved,
an aggregate of $430,000 in bonuses for Mr. Biederman's role in supervising all
phases of the renovation or rehabilitation of nine of the Company's hotels with
an aggregate of 909 rooms, for an aggregate cost of $14.6 million. The
Compensation Committee also approved a bonus of $150,000 for Mr. Alter's
contributions to the Company's accomplishments in 1996 and an increase in Mr.
Alter's annual base salary to $120,000 commencing January 1, 1997.
During 1996, Mr. Alter was awarded 113,600 stock options and Mr. Biederman
50,900 stock options. Of these amounts, 83,600 stock options were granted to Mr.
Alter and 20,900 stock options were granted to Mr. Biederman in order to
provide, at Mr. Alter's and Mr. Biederman's election, a source of payment for
the Lessee's obligations under its Stock Appreciation Rights Plan ("SAR Plan").
Under the terms of the SAR Plan, the Lessee's employees will be entitled to a
cash payment for each SAR that may be issued and vested
S-6
<PAGE> 7
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 proportion to their relative stock ownership of the Lessee (80%
Alter and 20% Biederman), an amount of money necessary to make such payments
under the SAR Plan to the extent that the Lessee does not otherwise have
sufficient cash to do so.
Appointment of Laurence Geller to Board of Directors
The Company appointed Laurence Geller, a leading hotel industry consultant,
to the Board of Directors, effective November 1, 1996. From 1984 through
December 1989, Mr. Geller served as the Executive Vice President and Chief
Operating Officer of Hyatt Development Corporation, a developer of domestic and
international hotels and resorts, and from 1976 to 1981, as a Senior Vice
President of Holiday Inns, Inc. Mr. Geller serves as a consultant to the Company
through his company, Geller & Co., pursuant to a consulting agreement entered
into in July 1996. Pursuant to the consulting agreement, Mr. Geller will provide
strategic consulting services to the Company for a two-year period with an
option at the Company's election to extend for an additional year. The Company
will pay Geller & Co.'s expenses in connection with services rendered to the
Company. In consideration for services rendered by Mr. Geller under the
consulting agreement, Mr. Geller has been granted non-qualified options to
purchase 50,000 shares of Common Stock, which will vest in equal installments
each month over 24 months. Of these options, 25,000 are exercisable at $10.50
per share and 25,000 at $15.50 per share. In addition, Mr. Geller receives each
quarter during the term of the agreement a restricted stock grant of 1,250
shares of Common Stock. To date, 2,500 of such shares of Common Stock have been
issued.
S-7
<PAGE> 8
THE OFFERING
All of the shares of Common Stock are being sold by the Company. None of
the Company's stockholders is selling any Common Stock in the Offering.
<TABLE>
<S> <C>
Shares of Common Stock offered by the
Company................................... 700,000 shares
Shares of Common Stock and Units to be
outstanding after the Offering............ 18,475,177 shares and Units(1)
Use of Proceeds............................. To fund a portion of the purchase price of
the Acquisition Hotel to be acquired
promptly following the closing of the
Offering.
NYSE symbol of the Company.................. SSI
</TABLE>
- ---------------
(1) Includes 2,224,933 shares of Common Stock issuable at the option of the
Company upon redemption of the Units of the Partnership by limited partners
of the Partnership and 17,750 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 Stock Incentive Plan and the 1994 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 the Underwriter.
S-8
<PAGE> 9
RISK FACTORS
In evaluating the Company's business, prospective investors should
carefully consider the factors set forth in this section in addition to other
information set forth in the accompanying Prospectus before making investment
decisions with respect to the shares of the Company's Common Stock. This
Prospectus Supplement may contain forward-looking statements which involve risks
and uncertainties, and actual results could differ materially from those
discussed in any such forward-looking statements. Certain of the factors that
could cause actual results to differ materially are discussed below.
IMPEDIMENTS TO GROWTH AND INCREASING CASH AVAILABLE FOR DISTRIBUTION
The Company's ability to increase cash available for distribution on its
Common Stock ("Cash Available for Distribution") will depend significantly on
the Company's ability to acquire or develop additional hotels at attractive
prices. Risks associated with this growth strategy include:
Acquisition Risks. There is significant competition for investment
opportunities in mid-price and upscale economy hotels for entities organized for
purposes similar to the Company's. Such entities may have substantially greater
financial resources than the Company or better relationships with franchisors,
sellers or lenders. They may also generally be able to accept more risk than the
Company can.
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
hotel once construction has commenced and other risks inherent in the
construction process. In particular, renovation and redevelopment must comply
with the Americans with Disabilities Act of 1990 (the "ADA"), which provides
that all public accommodations meet certain federal requirements related to
access and use by disabled persons. The Company may be required to make
substantial modifications at the hotels to comply with the ADA. Delays or cost
overruns in connection with renovations or redevelopments could have a material
adverse effect on Cash Available for Distribution.
Development Risks. A component of the Company's growth strategy is to
develop new hotels in markets where room supply and other competitive factors
justify new construction or to purchase such hotels from unaffiliated developers
after they have been completed. New project development will increase the
Company's indebtedness and is subject to a number of other risks, including
risks of construction delays or cost overruns, and the risk that required
zoning, occupancy and other governmental permits might not be obtained and the
risk that projects might not be completed. Additional risks of development
projects include the risks associated with effectively marketing a hotel in
order to ramp-up occupancy at projected room rates after the hotel has been
opened. 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.
TOTAL DEPENDENCE ON THE LESSEE AND PAYMENTS UNDER THE PERCENTAGE LEASES
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. 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's 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 the event that all or a portion of such higher tier 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 such higher tier rent from the Lessee or that the Lessee will even
be able to pay base rent. The Lessee controls the daily operations of the hotels
under the Percentage
S-9
<PAGE> 10
Leases, which have non-cancelable initial terms of ten years. The Company
selected the Lessee without consideration of other lessees because Mr. Alter and
Mr. Biederman, who own the Lessee, owned and were involved in the management of
a number of the hotels contributed to the Company in connection with its IPO and
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. Except as set forth in the Percentage
Leases, neither the Company nor the Partnership has the authority to require the
Lessee to operate the hotels in a manner that results in a maximization of rent
to the Company. Other than working capital to operate the hotels, the Lessee
will have only nominal assets, which will likely be insufficient to satisfy any
claims the Company may have if the Lessee defaults under the Percentage Leases.
Mr. Alter and Mr. Biederman have entered into an agreement (the "Third Party
Pledge Agreement") whereby the obligations of the Lessee under the Percentage
Leases are secured with a pledge by Mr. Alter and Mr. Biederman 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.
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. 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 addition, there may be conflicts of
interest in connection with the sale of certain hotels. Unrealized gain from the
sale to the Company of certain hotels in connection with its IPO is specially
allocated to Mr. Alter and Mr. Biederman and any sale of such hotels by the
Partnership may cause adverse tax consequences to them. In addition, the
reduction of mortgage indebtedness by the Partnership at any time below certain
levels would create adverse tax consequences to Mr. Alter and Mr. Biederman.
These conflicts may result in decisions relating to the sale of certain hotels
and/or the incurrence or repayment of indebtedness which do not reflect solely
the interests of the Company and the stockholders. In addition, 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. 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 and the
stockholders.
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
and President. 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.
HOTEL INDUSTRY RISKS
Operating Risks and Competition. Many of the Company's competitors have
substantially greater marketing and financial resources than the Company and the
Lessee. In addition, 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. Hotel industry risks include, among
other things, competition from other hotels; over-building in the hotel industry
which has adversely affected occupancy, average daily rate ("ADR") and REVPAR
increases in operating costs due to inflation and other factors, which may not
S-10
<PAGE> 11
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, and therefore reduce Cash Available for
Distribution.
Seasonality of Hotel Business and the Company's 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 in a given
quarter.
Increased Competition Resulting From Overbuilding. The hotel industry has
historically experienced cycles of overbuilding in certain geographic markets
and product segments. Such overbuilding increases competition for hotel guests,
resulting in lower occupancies and lower ADRs, thereby reducing the
profitability of the hotels affected by the increased competition. While the
Company's investment strategy is to acquire underperforming hotels or hotels
where there are significant barriers to entry, there can be no assurance that
the current hotel development activities, particularly in the limited service
segment, will not create additional significant competition for the Company's
hotels. Such increased competition would reduce the revenue generated by the
Lessee, thus reducing percentage rent paid to the Company and Cash Available for
Distribution.
RISKS OF INCREASES IN OPERATING COSTS AND CAPITAL EXPENDITURES; FRANCHISE
AGREEMENTS
Hotels in general, including the Company's hotels, have an ongoing need for
renovations and other capital improvements, including periodic replacement of
furniture, fixtures and equipment. In addition, the franchise agreements under
which the Company's hotels are operated impose specified operating standards and
may permit the franchisor to condition the continuation of a franchise agreement
on the completion of capital improvements. 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.
RISK THAT PENDING ACQUISITION WILL NOT CLOSE
The Company intends to acquire one of the Holiday Inn-La Mirada Acquisition
Hotel promptly following the closing of the Offering. The Company has not,
however, finalized its physical, environmental and economic analysis of this
hotel and, therefore, could decide not to acquire such hotel based on such
analysis. If the Company does not complete the acquisition of this Acquisition
Hotel, for whatever reason, then following the closing of the Offering 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-HOTEL ACQUISITION RISKS
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-hotel acquisitions are, however, more
complex than single-hotel acquisitions and the risk that a multiple-hotel
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 hotel acquisition. If the Company
fails to close hotel acquisitions, its ability to
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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-hotel 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. The
Company may finance multi-hotel acquisitions by issuing shares of Common Stock
or Units in the Partnership which are convertible into Common Stock. Such
issuances may have an adverse effect on the market price of the Common Stock.
See "Risk Factors -- Adverse Effect of Shares Available for Future Issuance and
Sale on Market Price of Common Stock."
HAWTHORN SUITES DEVELOPMENT RISKS
The Company entered into a five-year master development agreement with U.S.
Franchise Systems, Inc. and Hawthorn Suites Franchising, Inc. on March 10, 1997
to permit the Company to franchise properties operated under the Hawthorn Suites
brand. Pursuant to the agreement, the Company will have the right to obtain
franchise licenses in several major urban markets on the West Coast. Under the
agreement, certain development rights may terminate if the Company does not
establish a certain minimum number of licenses for Hawthorn Suites during each
year. This timetable may cause the Company to overcommit to building and owning
Hawthorn Suites at the expense of other growth opportunities. As a franchise
with a limited number of hotels currently operating, 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.
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.
REAL ESTATE INVESTMENT RISKS IN GENERAL
The Company's hotels will be subject to varying degrees of risk generally
incident to the ownership of real property. Income from the hotels may be
adversely affected by changes in national and local economic conditions, changes
in interest rates and in the availability, cost and terms of mortgage funds, the
impact of
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present or future environmental legislation and compliance with environmental
laws, the ongoing need for capital improvements, changes in real estate tax
rates and other operating expenses, changes in governmental rules (such as those
requiring upgrades for disabled persons) 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. In addition, real estate
investments are relatively illiquid, and the ability of the Company to vary its
portfolio in response to changes in economic and other conditions will be
limited.
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 annual distributions to stockholders
have constituted a high percentage of the Company's Cash Available for
Distribution. If this continues, the Company will retain little or no cash from
the rent payments under the Percentage Leases, and expenditures for additional
acquisitions or future capital improvements would have to be funded from
borrowings, or from proceeds from the sale of assets (including the hotels) or
equity securities. In addition, a percentage of the estimated annual
distribution has constituted a return of capital rather than a distribution of
retained earnings. Consequently, there is a risk that the distribution rate has
been set too high and may not be sustainable.
TAX RISKS
The Company intends to operate so as to be taxed as a REIT under Sections
856-860 of the Internal Revenue Code of 1986, as amended (the "Code"). As long
as the Company qualifies for taxation as a REIT, with certain exceptions, the
Company will not be taxed at the corporate level on its taxable income that is
distributed to its stockholders. A REIT is subject to a number of organizational
and operational requirements, including requirements as to the nature of its
income and assets, distribution requirements, diversity of stock ownership
requirements and record-keeping requirements. While the Company intends to
satisfy all of these requirements for treatment as a REIT, it is possible that
the Company may in the future fail to satisfy one or more of these requirements.
Failure to qualify as a REIT would render the Company subject to tax (including
any applicable minimum tax) on its taxable income at regular corporate rates and
distributions to the stockholders in any such year would not be deductible by
the Company. 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. Even if the
Company qualifies for taxation as a REIT, the Company may be subject to certain
state and local taxes on its income and property.
In order for the Company to be taxed as a REIT, the Partnership must be
classified as a partnership for federal income tax purposes. If the Partnership
were to be taxable as a corporation, because 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.
OWNERSHIP LIMITATION
In order for the Company to maintain its qualification as a REIT, not more
than 50% in value of its outstanding stock 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 stock of the
Company, the Lessee could become a related party tenant of the Partnership,
which likely 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 any class of the Company's stock by any person or group
(the "Ownership Limitation"). Generally, the capital stock owned by affiliated
owners will be aggregated for purposes of the Ownership Limitation. Subject to
certain exceptions, any transfer of Common or Preferred Stock that would prevent
the Company from continuing to qualify as a REIT under the Code will be
designated as "Shares-in-Trust" and transferred automatically to a trust (the
"Share Trust") effective on
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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 will be required to submit such number of Common or Preferred
Stock to the Share Trust and the beneficiary of the Share Trust will be one or
more charitable organizations that are named by the Company.
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 30.1 million 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
2,224,933 shares of Common Stock that could be issued upon the redemption of
Units of the Partnership. The Company may at any time 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.
USE OF PROCEEDS
The net proceeds to the Company from the Offering are estimated to be
approximately $9.24 million (approximately $10.6 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 87.96% interest in the Partnership (88.03%
if the over-allotment option is fully exercised). The Partnership intends to use
all of the net proceeds of the Offering to fund a portion of the purchase of the
Holiday Inn-La Mirada Acquisition Hotel to be purchased promptly after the
Offering.
Pending the use of proceeds referenced above, the net proceeds from this
Offering 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 agent securities, certificates of deposit and
interest-bearing bank deposits.
Under the Company's recently implemented Dividend Reinvestment and Stock
Purchase Plan, the Company's stockholders may elect to automatically reinvest
their dividends in shares of Common Stock, and stockholders and non-stockholders
may purchase shares of Common Stock directly from the Company. 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 to fulfill such obligations.
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FEDERAL INCOME TAX CONSIDERATIONS
The Company believes it has operated, and the Company intends to continue
to operate, in such a manner as to qualify as a REIT under the Code, but no
assurance can be given that it will at all times so qualify. In connection with
the Offering, Brobeck, Phleger & Harrison LLP, counsel to the Company, has
rendered a legal opinion that the Company has qualified as a REIT under the
Code, commencing with the Company's taxable year ended December 31, 1995. Such
legal opinion was incorporated by reference as an exhibit to the Registration
Statement of which the accompanying Prospectus is a part. Such legal opinion and
any opinions contained in this Prospectus Supplement or the accompanying
Prospectus as to the Company's qualification as a REIT under the Code are
qualified in their entirety by the assumptions and qualifications contained in
such legal opinion. For a more specific discussion of the federal income tax
treatment of the Company and its stockholders, reference is made to the section
of the accompanying Prospectus entitled "Federal Income Tax Considerations."
The provisions of the Code pertaining to REITs are highly technical and
complex. Investors are urged to consult their own tax advisors with respect to
the appropriateness of an investment in the Common Stock offered hereby and with
respect to the tax consequences arising under federal law and the laws of any
state, municipality or other taxing jurisdiction, including tax consequences
resulting from such investor's own tax characteristics. In particular, foreign
investors should consult their own tax advisors concerning the tax consequences
of an investment in the Company, including the possibility of United States
income tax withholding on Company distributions.
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UNDERWRITING
The underwriter named below (the "Underwriter") has agreed, subject to the
terms and conditions contained in the Underwriting Agreement, to purchase from
the Company 700,000 shares of Common Stock at the public offering price, less
the underwriting discount set forth on the cover page of this Prospectus
Supplement. The Underwriting Agreement provides that the obligations of the
Underwriter is subject to certain conditions precedent and that the Underwriter
is committed to purchase all of the shares, if it purchases any.
The Underwriter has advised the Company that it proposes initially to offer
the Common Stock to the public at the price to public set forth on the cover
page of this Prospectus Supplement. The shares of Common Stock are offered
subject to receipt and acceptance by the Underwriter, and to certain other
conditions, including the right to reject orders in whole or in part.
The Company has granted an option to the Underwriter, exercisable during
the 30-day period after the date of this Prospectus Supplement, to purchase up
to a maximum of 105,000 additional shares to cover over-allotments, if any. The
Underwriter 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
Underwriter against certain liabilities, including civil liabilities under the
Securities Act of 1933, as amended, or will contribute to payments the
Underwriter may be required to make in respect thereof.
The Company and certain of the officers of the Company will agree that,
except under certain circumstances, for a period of 120 days after the date of
this Prospectus Supplement, they will not, without the consent of the
Underwriter, issue, sell or dispose of any shares of Common Stock or any shares
convertible or exchangeable into any shares of Common Stock.
At the IPO, MYPC, an affiliate of the Underwriter, 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 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 at the request of MYPC,
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).
Until the distribution of Common Stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the Underwriter and
certain selling group members to bid for and purchase the Common Stock. As an
exception to these rules, the Underwriter is permitted to engage in certain
transactions that stabilize the price of the Common Stock. Such transactions
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of the Common Stock. If the Underwriter creates a short position in
the Common Stock in connection with the Offering, i.e., if it sells more shares
of Common Stock than are set forth on the cover page of this Prospectus, then
the Underwriter may reduce that short position by purchasing Common Stock in the
open market. The Underwriter may also elect to reduce any short position by
exercising all or part of the over-allotment option described above. The
Underwriter may also impose a penalty bid on
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certain selling group members. This means that if the Underwriter purchases
shares of Common Stock in the open market to reduce the Underwriter's short
position or to stabilize the price of the Common Stock, it may reclaim the
amount of the selling concession from the selling group members who sold those
shares as part of the Offering. In general, purchases of a security for the
purpose of stabilization or to reduce a short position could cause the price of
the security to be higher than it might be in the absence of such purchases. The
imposition of a penalty bid might also have an effect on the price of a security
to the extent that it were to discourage resales of the security. Neither the
Company nor the Underwriter makes any representation or prediction as to the
direction or magnitude of any effect that the transactions described above may
have on the price of the Common Stock. In addition, neither the Company nor the
Underwriter makes any representation that the Underwriter will engage in such
transactions or that such transactions, once commenced, will not be discontinued
without notice.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby and certain
federal income tax matters pertaining to the Company's status as a REIT 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 Supplement and the accompanying Prospectus entitled "Federal Income
Tax Considerations" is based on the opinion of Brobeck, Phleger & Harrison LLP.
Roger Cohen, a partner at Brobeck, Phleger & Harrison LLP, is Assistant
Secretary of the Company and owns 1,500 shares of Common Stock and has been
granted options to purchase 1,000 shares of Common Stock. Certain legal matters
related to the Offering will be passed upon for the Underwriters by O'Melveny &
Myers LLP in San Francisco. 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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PROSPECTUS
$200,000,000
[LOGO OF SUNSTONE HOTEL]
COMMON STOCK
PREFERRED STOCK
WARRANTS
------------------------
Sunstone Hotel Investors, Inc. ("Sunstone" or the "Company") may from time
to time offer in one or more series or classes (i) shares of its common stock,
par value $0.01 per share (the "Common Stock"), (ii) shares of its preferred
stock, par value $0.01 per share (the "Preferred Stock"), and (iii) warrants to
purchase Preferred Stock or Common Stock (the "Warrants") in amounts, at prices
and on terms to be determined at the time of offering, with an aggregate public
offering price of up to $200,000,000 in amounts, at prices and on terms to be
determined at the time of offering. The Common Stock, Preferred Stock, and
Warrants (collectively, the "Offered Securities") may be offered, separately or
together, in separate series in amounts, at prices and on terms to be set forth
in one or more supplements to the Prospectus (each a "Prospectus Supplement").
The specific terms of the Offered Securities in respect to which this
Prospectus is being delivered will be set forth in the applicable Prospectus
Supplement and will include, where applicable (i) in the case of Common Stock,
the specific title and stated value and any public offering price; (ii) in the
case of Preferred Stock, the specific title and stated value, any dividend,
liquidation, redemption, conversion, voting and other rights, and any public
offering price; and (iii) in the case of Warrants, the duration, offering price,
exercise price and detachability. In addition, such specific terms may include
limitations on direct or beneficial ownership and restrictions on transfer of
the Offered Securities, in each case as may be appropriate to preserve the
status of the Company as a real estate investment trust ("REIT") for Federal
income tax purposes.
The applicable Prospectus Supplement will also contain information, where
applicable, about certain Federal income tax considerations relating to, and any
listing on a securities exchange of, the Offered Securities covered by such
Prospectus Supplement.
The Offered Securities may be offered directly, through agents designated
from time to time by the Company, or to or through underwriters or dealers. If
any agents or underwriters are involved in the sale of any of the Offered
Securities, their names, and any applicable purchase price, fee, commission or
discount arrangement between or among them, will be set forth, or will be
calculable from the information set forth, in the applicable Prospectus
Supplement. See "Plan of Distribution." No Offered Securities may be sold
without delivery of the applicable Prospectus Supplement describing the method
and terms of the offering of such series of Offered Securities.
------------------------
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 date of this Prospectus is January 6, 1997.
<PAGE> 19
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 with the
Securities and Exchange Commission (the "Commission"). Such 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, such as the Company, and the address is http://www.sec.gov. The
Company's Common Stock is listed on the New York Stock Exchange, Inc. (the
"NYSE"), and reports, proxy statements and other information concerning the
Company can be inspected at the offices of the NYSE, 20 Broad Street, New York,
New York 10005.
The Company has filed with the Commission a Registration Statement on Form
S-3 under the Securities Act of 1933, as amended (the "Securities Act"), and the
rules and regulations promulgated thereunder, with respect to the Offered
Securities. 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 Offered
Securities, reference is made to the Registration Statement and the exhibits and
schedules filed therewith, which may be obtained as described above.
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
The following documents, which have been filed with the Commission, are
hereby incorporated by reference:
1. Annual Report (i) on Form 10-K of the Company for the fiscal year
ended December 31, 1995; and (ii) on Form 10-K/A filed with the Commission
on October 11, 1996;
2. Quarterly Reports (i) on Form 10-Q for the quarters ended March 31,
1996, June 30, 1996 and September 30, 1996; and (ii) on Form 10-Q/A for the
quarter ended March 31, 1996 filed with the Commission on May 21, 1996 and
June 27, 1996;
3. Current Reports (i) on Form 8-K filed with the Commission on
February 20, 1996, July 13, 1996, August 28, 1996, and November 12, 1996;
and (ii) on Form 8-K/A filed with the Commission on April 19, 1996 and
August 28, 1996;
4. The description of the Common Stock of the Company included in the
Company's Registration Statement on Form 8-A, filed with the Commission on
June 26, 1995; and on Form 8-A/A, filed with the Commission on July 17,
1996.
In addition, all reports and other documents subsequently filed by the
Company with the Commission pursuant to Section 13, 14 or 15(d) of the Exchange
Act after the date of this Prospectus and prior to the termination of the
offering shall be deemed to be incorporated by reference in this Prospectus and
to be a part hereof from the date of the filing of such documents (such
documents, and the documents enumerated above, being herein referred to as
"Incorporated Documents," provided however, that the documents enumerated above
or subsequently filed by the Company pursuant to Section 13, 14 or 15(d) of the
Exchange Act prior to the filing of the Company's next Annual Report on Form
10-K with the Commission shall not be Incorporated Documents or be incorporated
by reference in this Prospectus or be a part hereof from and after any such
filing of an Annual Report on Form 10-K). Any statement contained in a document
incorporated or deemed to be incorporated by reference herein shall be deemed to
be modified or superseded for purposes of this Prospectus to the extent that a
statement contained herein (or in any other subsequently filed document which
also is or is deemed to be incorporated by reference herein) modifies or
supersedes such statement. Any statements so
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<PAGE> 20
modified or superseded shall not be deemed to constitute a part of this
Prospectus, except as so modified or superseded.
The Company will provide without charge to each person to whom this
Prospectus is delivered, upon written or oral request of such person, a copy of
any or all of the documents referred to above which have been or may be
incorporated by reference in this Prospectus (other than certain exhibits to
such documents). Requests for such documents should be directed to Sunstone
Hotel Investors, Inc., 115 Calle de Industrias, Suite 201, San Clemente,
California 92672, Attention: Secretary (telephone: (714) 361-3900).
THE COMPANY
The Company, a Maryland corporation, is a self-administered real estate
investment trust ("REIT") that owns mid-priced and upscale hotels in the western
United States through Sunstone Hotel Investors, L.P., a Delaware limited
partnership (the "Partnership") of which the Company is the sole general
partner. The hotels 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 by Marriott. As of December 31, 1996, the Company owned an
approximately 83.5% partnership interest in the Partnership and the Partnership
owned 24 hotels, with an aggregate of 3,389 rooms in seven states, including
Arizona (4 hotels), California (6), Colorado (6), New Mexico (1), Utah (2),
Oregon (2), and Washington (3).
In order for the Company to qualify as a REIT under Federal income tax law,
neither the Company nor the Partnership can operate hotels. Therefore, the
Partnership leases the hotels to Sunstone Hotel Properties, Inc., a Colorado
corporation (the "Lessee") pursuant to percentage leases with an initial term of
ten years, which provide for rent payments based principally on a percentage of
room revenues at the hotels. The Lessee pays 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 hotels are
managed by Sunstone Hotel Management, Inc., a Colorado corporation (the
"Management Company") pursuant to a management agreement between the Lessee and
the Management Company for a fee equal to 2% of gross revenues of the hotels
(plus reimbursement of accounting costs). The Management Company is wholly-owned
by Mr. Alter.
The Company's principal executive office is located at 115 Calle de
Industrias, Suite 201, San Clemente, California 92672; telephone number (714)
361-3900.
The Company's Common Stock is listed on the New York Stock Exchange under
the symbol "SSI."
USE OF PROCEEDS
The Company intends to invest the net proceeds of any sale of the Offered
Securities in the Partnership in exchange for an additional ownership interest
in the Partnership. Unless otherwise indicated in the applicable Prospectus
Supplement, the Partnership intends to use such net proceeds for general
corporate purposes including, without limitation, the acquisition and
development of additional hotels, the maintenance and renovation of currently
owned hotels, and the repayment of debt. Pending application of the net
proceeds, they may be invested in interest-bearing accounts and short-term,
interest-bearing securities, in a manner consistent with the Company's intention
to qualify for taxation as a REIT. Such investments may include, for example,
governmental and government agency securities, certificates of deposit,
interest-bearing bank deposits and mortgage loan participations.
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DESCRIPTION OF COMMON STOCK AND PREFERRED STOCK
The following summary description of Common Stock and Preferred 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 (and any amendments or supplements thereto) which are filed as exhibits
to (or incorporated by reference in) 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. As of December 31, 1996, (i) 10,934,957 shares
of Common Stock were issued and outstanding, (ii) 1,000,000 shares of Common
Stock were reserved for issuance under the Company's Dividend Reinvestment and
Stock Purchase Plan, (iii) 500,000 shares of Common Stock were reserved for
issuance under the Company's 1994 Stock Incentive Plan, (iv) 150,000 shares of
Common Stock were reserved for issuance under the 1994 Directors Plan, and (v)
2,162,147 shares of Common Stock were reserved for issuance upon the conversion
of units of Partnership interest ("Units") into Common Stock (each Unit is
convertible into one share of Common Stock at the Unitholder's election). As of
December 31, 1996, no shares of Preferred Stock were issued and outstanding.
COMMON STOCK
The following description of the Common Stock sets forth certain general
terms and provisions of the Common Stock to which any Prospectus Supplement may
relate, including a Prospectus Supplement providing that Common Stock will be
issuable upon conversion of Preferred Stock or upon the exercise of Warrants
issued by the Company. The Common Stock is listed on the New York Stock Exchange
under the symbol "SSI." ChaseMellon Shareholder Services is the Company's
registrar and transfer agent for the Common Stock.
All shares of Common Stock offered hereby will, when issued, 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 owning shares in excess of the
Ownership Limit (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 the holders of its Common Stock.
Holders of the Company's Common Stock can elect to participate in the
Company's Dividend Reinvestment and Stock Purchase Plan (the "Plan") and have
all or part of their dividends reinvested in additional shares of Common Stock.
Participants in the Plan can also purchase additional shares of Common Stock
with cash (subject to certain limitations). The terms of the Plan are described
in a separate prospectus which may be obtained by calling the Plan
administrator, Mellon Bank, N.A., at (888) 261-6776.
Subject to the provisions of the Articles of Incorporation regarding owning
shares in excess of the Ownership Limit, 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, nor do
they have any preference, appraisal or exchange rights.
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PREFERRED STOCK
As of the date of this Prospectus, no shares of Preferred Stock are
outstanding. Subject to limitations prescribed by Maryland law and the Company's
Articles of Incorporation, the Board of Directors is authorized to issue, from
the 10,000,000 authorized but unissued shares of capital stock of the Company,
Preferred Stock in such classes or series as the Board of Directors may
determine and to establish from time to time the number of shares of Preferred
Stock to be included in any such class or series and to fix the designation and
any preferences, conversion and other rights, voting powers, restrictions,
limitations as to dividends, qualifications and terms and conditions of
redemption of the shares of any such class or series, and such other subjects or
matters as may be fixed by resolution of the Board of Directors. The issuance of
Preferred Stock may have the effect of delaying, deferring or preventing a
change in control of the Company or other transaction in which holders of shares
of Common Stock might receive a premium for such shares over the market price.
Terms
Preferred Stock, upon issuance against full payment of the purchase price
therefor, will be fully paid and nonassessable. The specific terms of a
particular class or series of Preferred Stock will be described in the
Prospectus Supplement relating to that class or series, including a Prospectus
Supplement providing that Preferred Stock may be issuable upon the exercise of
Warrants issued by the Company. In addition, the terms of any class or series of
Preferred Stock which may be issued will be set forth in articles supplementary
to the Company's Articles of Incorporation which will be filed with the Maryland
Department of Assessments and Taxation and as an exhibit to (or incorporated by
reference in) the Registration Statement of which this Prospectus is a part. The
description of Preferred Stock set forth below and the description of the terms
of a particular class or series of Preferred Stock set forth in a Prospectus
Supplement do not purport to be complete and are qualified in their entirety by
reference to the articles supplementary relating to that class or series.
The preferences and other terms of the Preferred Stock of each class or
series will be fixed by the articles supplementary relating to such class or
series. A Prospectus Supplement, relating to each class or series, will specify
the terms of the Preferred Stock as follows:
(1) The title and stated value of such Preferred Stock;
(2) The number of shares of such Preferred Stock offered, the
liquidation preference per share and the offering price of such Preferred
Stock;
(3) The dividend rate(s), period(s), and/or payment date(s) or
method(s) of calculation thereof applicable to such Preferred Stock;
(4) Whether such Preferred Stock is cumulative or not and, if
cumulative, the date from which dividends on such Preferred Stock shall
accumulate;
(5) The provision for a sinking fund, if any, for such Preferred
Stock;
(6) The provision for redemption, if applicable, of such Preferred
Stock;
(7) Any listing of such Preferred Stock on any securities exchange;
(8) The terms and conditions, if applicable, upon which such Preferred
Stock will be converted into Common Stock of the Company, including the
conversion price (or manner of calculation thereof);
(9) A discussion of any material Federal income tax considerations
applicable to such Preferred Stock (in addition to those discussed herein);
(10) Any limitations on direct or beneficial ownership and restrictions
on transfer, in each case as may be appropriate to preserve the status of
the Company as a REIT;
(11) The relative ranking and preferences of such Preferred Stock as to
dividend rights and rights upon liquidation, dissolution or winding up of
the affairs of the Company;
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(12) Any limitations on issuance of any class or series of preferred
stock ranking senior to or on parity with such class or series of Preferred
Stock as to dividend rights and rights upon liquidation, dissolution or
winding up of the affairs of the Company;
(13) Any voting rights of such Preferred Stock; and
(14) Any other specific terms, preferences, rights, limitations or
restrictions of such Preferred Stock.
Registrar and Transfer Agent
The registrar and transfer agent for the Preferred Stock will be set forth
on the applicable Prospectus Supplement.
CLASSIFICATION OR RECLASSIFICATION OF COMMON STOCK OR PREFERRED STOCK
Subject to limitations prescribed by Maryland law and the Company's
Articles of Incorporation, the Board of Directors is authorized to reclassify
any unissued portion of the authorized shares of capital stock to provide for
the issuance of shares in other classes or series, including other classes or
series of Common Stock or Preferred Stock, to establish the number of shares in
each class or series and to fix the designation and any preferences, conversion
and other rights, voting powers, restrictions, limitations as to dividends,
qualifications and terms and conditions of redemption of such class or series.
The rights, preferences, privileges and restrictions of such class or series
will be fixed by articles supplementary to the Company's Articles of
Incorporation relating to such class or series. A Prospectus Supplement will
specify the terms of such class or series.
RESTRICTIONS ON OWNERSHIP OF COMMON STOCK OR PREFERRED STOCK
The following is a description of the restrictions on ownership of the
Common Stock and Preferred Stock. There may be additional provisions that
further restrict ownership and transfer, which will be described in the
applicable Prospectus Supplement. Such description will be qualified in its
entirety by any supplements to the Articles of Incorporation or Bylaws filed as
an exhibit to (or incorporated by reference in) the Registration Statement of
which this Prospectus is a part.
For the Company to qualify as a REIT under the Internal Revenue Code of
1986, as amended (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 Stock or 9.8%
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<PAGE> 24
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 (based on a five day trading
average) 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.
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.
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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.
Any certificates representing shares of Common or Preferred Stock will bear
a legend referring to the restrictions described above.
DESCRIPTION OF WARRANTS
The Company has no Warrants outstanding (other than options issued under
the Company's 1994 Stock Incentive Plan and 1994 Directors Plan). The Company
may issue Warrants for the purchase of Preferred Stock or Common Stock. Warrants
may be issued independently or together with any other Offered Securities
offered by any Prospectus Supplement and may be attached to or separate from
such Offered Securities. Each series of Warrants will be issued under a separate
warrant agreement (each, a "Warrant Agreement") to be entered into between the
Company and a warrant agent specified in the applicable Prospectus Supplement
(the "Warrant Agent"). The Warrant Agent will act solely as an agent of the
Company in connection with the Warrants of such series and will not assume any
obligation or relationship of agency or trust for or with any provisions of the
Warrants offered hereby. Further terms of the Warrants and the applicable
Warrant Agreements will be set forth in the applicable Prospectus Supplement.
The applicable Prospectus Supplement will describe the terms of the
Warrants in respect of which this Prospectus is being delivered, including,
where applicable, the following: (1) the title of such Warrants; (2) the
aggregate number of such Warrants; (3) the price or prices at which such
Warrants will be issued; (4) the designation, terms and number of shares of
Preferred Stock or Common Stock purchasable upon exercise of such Warrants; (5)
the designation and terms of the Common Stock or Preferred Stock, if any, with
which such Warrants are issued and the number of such Warrants issued with the
Common Stock or Preferred Stock; (6) the date, if any, on and after which such
Warrants and the related Preferred Stock or Common Stock will be separately
transferable; (7) the price at which each share of Preferred Stock or Common
Stock purchasable upon exercise of such Warrants may be purchased; (8) the date
on which the right to exercise such Warrants shall commence and the date on
which such right shall expire; (9) the minimum or maximum amount of such
Warrants which may be exercised at any one time; (10) information with respect
to book-entry procedures, if any; (11) a discussion of certain Federal income
tax considerations; and (12) any other terms of such Warrants, including terms,
procedures and limitations relating to the exchange and exercise of such
Warrants.
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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 does not purport to be
complete and is qualified in its entirety by reference to Maryland law and the
Articles of Incorporation and Bylaws of the Company (and any amendments and
supplements thereto) which are filed as exhibits to or incorporated by reference
in the Registration Statement of which this Prospectus is a part.
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. Certain significant provisions which might have this effect
are described below.
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. 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. Stockholders 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.
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.
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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 monetary 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 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 Maryland General Corporation Law (the "MGCL")
generally 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. 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, 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.
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
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<PAGE> 28
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 certain hotels 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 stock entitled to vote
generally in the election of directors.
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.
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OPERATIONS
The Company is generally prohibited from engaging in certain activities,
including incurring consolidated indebtedness, in the aggregate, in excess of
50% of the Company's investment in hotels at cost, and acquiring or holding
property or engaging in any activity that would cause the Company to fail to
qualify as a REIT.
FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of material federal income tax considerations
that may be relevant to a prospective holder of the Common Stock or Preferred
Stock. The discussion contained herein does not address all aspects of taxation
that may be relevant to particular holders of the Common Stock or Preferred
Stock in light of their personal investment or tax circumstances, or to certain
types of holders (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 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 OR PREFERRED 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.
TAXATION OF THE COMPANY
The Company has elected 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 has previously received an opinion of its counsel, Brobeck, Phleger &
Harrison LLP, that, 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
that 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. In addition to the opinion previously
rendered, counsel to the Company may in connection with a particular offering of
the Offered Securities render an opinion that as of the time of such offering
the Company continues to qualify as a REIT under the Code. Investors should be
aware, however, that opinions of counsel are not binding upon the Service or any
court. It must be emphasized that counsel's prior opinion was, and any
subsequent opinion will be, based on various assumptions and was and will be
conditioned upon the accuracy of 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. Moreover, 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. Counsel 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 all of the
requirements for qualification as a REIT.
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.
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Assuming 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. Furthermore, 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, 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 the Company would be
taxable to the extent of such asset's "built-in-gain."
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 Company's Articles of Incorporation provide for restrictions
regarding transfer of the Company's stock that are intended to assist the
Company in continuing to satisfy the share ownership requirements described in
(v) and (vi) above. See "Description of Common Stock and Preferred Stock --
Restrictions on Ownership of Common Stock or Preferred Stock."
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.
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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 percentage leases (the "Percentage Leases"), Sunstone Hotel
Properties, Inc., a Colorado corporation (the "Lessee") has leased 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 is obligated to pay to the Partnership (i) the greater of base rent
("Base Rent") or percentage rent ("Percentage Rent," and with Base Rent,
collectively, the "Rents") and (ii) certain other additional charges (the
"Additional Charges"). The Percentage Rent is calculated by multiplying fixed
percentages by the room 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.
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, as well as representations of
the Company described below: (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
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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. Counsel's opinion
regarding the Percentage Leases is not binding on the Service or the courts.
Thus, 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
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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 Robert A. Alter is currently 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. 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 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.
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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 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" will depend, 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."
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 termination, 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.
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.
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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 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. For its taxable year ended
December 31, 1995, the Company made distributions sufficient to satisfy the
foregoing distribution requirements. The Company intends in the future to make
timely distributions sufficient to satisfy all annual distribution requirements.
However, there can be no assurance that the Company will at all times have
sufficient available cash to satisfy such distribution requirements.
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. Counsel will not monitor
such compliance by the Company.
Anti-Abuse Regulations
The United States Treasury Department recently issued Treasury 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. Counsel believes 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
successfully 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.
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<PAGE> 36
TAXATION OF TAXABLE STOCKHOLDERS
As long as the Company qualifies as a REIT, distributions made to the
Company's taxable stockholders out of current or accumulated earnings and
profits (and not designated as capital gain dividends) will be taken into
account by such stockholders as ordinary income and will not be eligible for the
dividends received deduction generally available to corporations. 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 or Preferred 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 or
Preferred 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 or Preferred
Stock, such distributions will be included in income as long-term capital gain
(or short-term capital gain if the shares of Common Stock or Preferred Stock
have been held for one year or less) assuming the shares of Common Stock or
Preferred 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 or Preferred Stock will not be
treated as passive activity income and, therefore, stockholders 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 or Preferred 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 OR PREFERRED
STOCK
In general, any gain or loss realized upon a taxable disposition of the
Common Stock or Preferred 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 or Preferred 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 or Preferred 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 or Preferred Stock may be disallowed
if the shares of Common Stock or Preferred Stock are purchased within 30 days
before or after the disposition.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING
The Company will generally report to its 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.
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<PAGE> 37
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, 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 Offered Securities.
OTHER TAX CONSEQUENCES
State or Local Taxes
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.
Dividend Reinvestment Program
Under the Company's Dividend Reinvestment and Stock Purchase Plan,
stockholders participating in the program will be deemed to have received the
gross amount of any cash distributions which would have been paid by the Company
to such stockholders had they not elected to participate. These deemed
distributions will be treated as actual distributions from the Company to the
participating stockholders and will retain the character and tax effect
applicable to distributions from the Company generally. See "Federal Income Tax
Considerations -- Taxation of Stockholders." Shares of Common Stock received
under the program will have a holding period beginning with the day after
purchase, and a tax basis equal to the gross amount of the deemed distribution.
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TAX ASPECTS OF THE PARTNERSHIP
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. The Company has received an opinion of its counsel, Brobeck,
Phleger & Harrison LLP, that the Partnership will be treated as a partnership
for Federal income tax purposes. This opinion was based on the provisions of the
Partnership Agreement and certain factual representations of the Company and the
Partnership. 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.
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 has 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.
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 the President of the Company, Mr.
Robert A. 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
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<PAGE> 39
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. Counsel's opinion 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 were 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 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
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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).
Treatment of Partnership Distributions. Partnership distributions to the
Company will not generally constitute taxable distributions. However, to the
extent that partnership 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), exceeds the Company's adjusted
tax basis in its Partnership interest, 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.
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 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 generally 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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PLAN OF DISTRIBUTION
The Company may sell the Offered Securities to one or more underwriters for
public offering and sale by them or may sell the Offered Securities to investors
directly or through agents, which agents may be affiliated with the Company.
Any such underwriter or agent involved in the offer and sale of the Offered
Securities will be named in the applicable Prospectus Supplement.
Sales of Offered Securities offered pursuant to any applicable Prospectus
Supplement may be effected from time to time in one or more transactions at a
fixed price or prices which may be changed, at prices related to the prevailing
market prices at the time of sale, or at negotiated prices. The Company also
may, from time to time, authorize underwriters acting as the Company's agents to
offer and sell the Offered Securities upon the terms and conditions set forth in
the applicable Prospectus Supplement. In connection with the sale of Offered
Securities, underwriters may be deemed to have received compensation from the
Company in the form of underwriting discounts or commissions and may also
receive commissions from purchasers of Offered Securities for whom they may act
as agent. Underwriters may sell Offered Securities to or through dealers, and
such dealers may receive compensation in the form of discounts, concessions or
commissions from the underwriters and/or commissions from the purchasers for
whom they may act as agent.
Any underwriting compensation paid by the Company to underwriters or agents
in connection with the offering of Offered Securities, and any discounts,
concessions or commissions allowed by underwriters to participating dealers,
will be set forth in the applicable Prospectus Supplement. Underwriters, dealers
and agents participating in the distribution of the Offered Securities may be
deemed to be underwriters, and any discounts and commissions received by them
and any profit realized by them on resale of the Offered Securities may be
deemed to be underwriting discounts and commissions under the Securities Act.
Underwriters, dealers and agents may be entitled, under agreements entered into
with the Company and the Partnership, to indemnification against and
contribution toward certain civil liabilities, including liabilities under the
Securities Act. Any such indemnification agreements will be described in the
applicable Prospectus Supplement.
Unless otherwise specified in the related Prospectus Supplement, each
series of Offered Securities will be a new issue with no established trading
market, other than the Common Stock which is listed on the New York Stock
Exchange. Any shares of Common Stock sold pursuant to a Prospectus Supplement
will be listed on such exchange, subject to official notice of issuance. The
Company may elect to list any other series of Preferred Stock and any series of
Warrants on any exchange, but neither is obligated to do so. It is possible that
one or more underwriters may make a market in a series of Offered Securities,
but will not be obligated to do so and may discontinue any market making at any
time without notice. Therefore, no assurance can be given as to the liquidity of
the trading market for the Offered Securities.
If so indicated in the applicable Prospectus Supplement, the Company may
authorize dealers acting as the Company's agents to solicit offers by certain
institutions to purchase Offered Securities from the Company at the public
offering price set forth in such Prospectus Supplement pursuant to Delayed
Delivery Contracts ("Contracts") providing for payment and delivery on the date
or dates stated in such Prospectus Supplement. Each Contract will be for an
amount not less than, and the aggregate principal amount of Offered Securities
sold pursuant to Contracts shall be not less nor more than, the respective
amounts stated in the applicable Prospectus Supplement. Institutions with whom
Contracts, when authorized, may be made include commercial and savings banks,
insurance companies, pension funds, investment companies, educational and
charitable institutions, and other institutions but will in all cases be subject
to the approval of the Company, as the case may be. Contracts will not be
subject to any conditions except (i) the purchase by an institution of the
Offered Securities covered by its Contracts shall not at the time of delivery be
prohibited under the laws of any jurisdiction in the United States to which such
institution is subject, and (ii) if the Offered Securities are being sold to
underwriters, the Company, as the case may be, shall have sold to such
underwriters the total principal amount of the Offered Securities less the
principal amount thereof covered by Contracts.
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Certain of the underwriters and their affiliates may be customers of,
engage in transactions with and perform services for, the Company or the
Partnership in the ordinary course of business.
LEGAL MATTERS
The validity of the Offered Securities and certain federal income tax
matters pertaining to the Company's status as a REIT will be passed upon for the
Company by Brobeck, Phleger & Harrison LLP, Newport Beach, California. In
rendering its opinions, Brobeck, Phleger & Harrison LLP will rely on the opinion
of Ballard Spahr Andrews & Ingersoll, Baltimore, Maryland, as to certain matters
of Maryland law. In addition, the description of federal income tax consequences
contained in the section of this Prospectus entitled "Federal Income Tax
Consequences" is based on the opinion of Brobeck, Phleger & Harrison LLP. Roger
Cohen, a partner at Brobeck, Phleger & Harrison LLP, is Assistant Secretary of
the Company and owns 1,500 shares of Common Stock and has been granted options
to purchase 1,000 shares of Common Stock.
EXPERTS
The following financial statements have been audited by Coopers & Lybrand
L.L.P., independent auditors, as set forth in their reports thereon included
therein and incorporated herein by reference: (1) the consolidated financial
statements of Sunstone Hotel Investors, Inc. as of December 31, 1995 and 1994,
and for the period August 16, 1995 (inception) through December 31, 1995, and
the combined financial statements of Sunstone Initial Hotels (Predecessor) as of
December 31, 1994, and for the period January 1, 1995 through August 15, 1995,
and for the years ended December 31, 1994 and 1993, the financial statements of
Sunstone Hotel Properties, Inc. (the Lessee) as of December 31, 1995 and for the
period August 16, 1995 (inception) through December 31, 1995, all appearing in
the Company's Annual Report (Form 10-K) for the year ended December 31, 1995;
(2) the combined financial statements of The Cypress Inns, Acquisition Hotels as
of December 31, 1995 and 1994 and for each of the years then ended, appearing in
the Company's Current Report (Form 8-K/A) filed April 19, 1996; and (3) 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, appearing in the Company's Prospectus filed pursuant to Rule 424(b)(4) on
August 8, 1996 (which were in turn incorporated by reference into the Company's
Current Reports (Form 8-K and 8-K/A) filed August 28, 1996). Such financial
statements are incorporated by reference in reliance upon such reports given
upon the authority of such firm as experts in accounting and auditing.
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======================================================
No persons have been authorized to give any information or to make any
representations other than those contained or incorporated by reference in this
Prospectus Supplement or the 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 Supplement and the Prospectus do
not constitute an offer to sell or a solicitation of an offer to buy any
securities other than those to which it relates, or an offer or solicitation
with respect to those securities to which it relates to any persons in any
jurisdiction where such offer or solicitation would be unlawful. The delivery of
this Prospectus Supplement and the Prospectus at any time does not imply that
the information contained or incorporated by reference herein at its date is
correct as of any time subsequent to its date.
----------------------------
TABLE OF CONTENTS
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<TABLE>
<CAPTION>
Page
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<S> <C>
PROSPECTUS SUPPLEMENT
Prospectus Supplement Summary......... S-3
Risk Factors.......................... S-9
Use of Proceeds....................... S-14
Federal Income Tax Considerations..... S-15
Underwriting.......................... S-16
Legal Matters......................... S-17
PROSPECTUS
Available Information................. 2
Incorporation of Certain Information
by Reference........................ 2
The Company........................... 3
Use of Proceeds....................... 3
Description of Common Stock and
Preferred Stock..................... 4
Description of Warrants............... 8
Certain Provisions of Maryland Law and
of the Company's Articles of
Incorporation and Bylaws............ 9
Federal Income Tax Considerations..... 12
Plan of Distribution.................. 24
Legal Matters......................... 25
Experts............................... 25
======================================================
</TABLE>
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700,000 SHARES
[LOGO SUNSTONE HOTEL]
COMMON STOCK
----------------------------
PROSPECTUS SUPPLEMENT
----------------------------
MONTGOMERY SECURITIES
March 24, 1997
======================================================
