Sunstone Hotel Investors, Inc. (Form: S-11/A, Received: 08/19/2004 14:02:51)

Paid by Us

No Exercise

Full Exercise

As filed with the Securities and Exchange Commission on August 19, 2004

Registration No. 333-117141

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Amendment No. 1

FORM S-11

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

SUNSTONE HOTEL INVESTORS, INC.

(Exact Names of Registrant as Specified in Governing Instrument)

903 Calle Amanecer, Suite 100

San Clemente, California 92673

(949) 369-4000

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrants Principal Executive Offices)

Jon D. Kline

Executive Vice President and Chief Financial Officer

903 Calle Amanecer, Suite 100

San Clemente, California 92673

(949) 369-4000

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent For Service)

Copies to:

Alison S. Ressler

Steven B. Stokdyk

Sullivan & Cromwell LLP

1888 Century Park East

Los Angeles, CA 90067

(310) 712-6600

Peter T. Healy

O’Melveny & Myers LLP

Embarcadero West

275 Battery Street

San Francisco, CA 94111-3305

(415) 984-8700

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. ¨

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED AUGUST 19, 2004.

PROSPECTUS

Shares

Sunstone Hotel Investors, Inc.

Common Stock

$ per share

This is the initial public offering of our common stock. No public market currently exists for our common stock. We are selling shares of our common stock.

We intend to apply to have our common stock listed on the New York Stock Exchange, or the NYSE, under the symbol “SHO”. We currently expect the initial public offering price to be between $ and $ per share.

Shares of our common stock are subject to ownership and transfer limitations that must be applied to maintain our status as a real estate investment trust, or REIT, which are described under “Description of Stock.”

See “ Risk Factors ” beginning on page 18 to read about factors you should consider before buying shares of our common stock, including:

•	In the recent past, events beyond our control, including an economic slowdown and terrorism, have harmed the hotel industry generally and the performance of our hotels, and if these or similar events occur again, our results may be harmed.

•

On a pro forma basis as of June 30, 2004, we expect to have approximately $ million of debt, approximately % of which will be variable rate secured debt, with covenants that impose restrictions on our business and may harm our financial position and cash flow if there are increases in interest rates that we have not adequately protected against.

•	Our organizational documents contain no limitations on the amount of debt we may incur and, therefore, we may become too highly leveraged.

•	We may experience conflicts of interest with our largest stockholders and our executive officers and directors, including with respect to their sales of shares of our stock, evaluation of acquisition opportunities and ownership of interests in other hotels.

•	We may not be successful in identifying or completing hotel acquisitions that meet our criteria, which may impede our growth.

•	Most of our hotels are upper upscale and upscale hotels, and the upper upscale and upscale segments of the lodging market are highly competitive and generally subject to greater volatility than other segments of the market, which could harm our profitability.

•	Our hotels are geographically concentrated in California and, accordingly, we could be disproportionately harmed by an economic downturn in this area of the country or a natural disaster, such as an earthquake.

•	We rely heavily on our arrangements with our franchisors and management companies, including the new arrangement with Interstate Hotels & Resorts, Inc., or the Management Company, and any disruptions to those arrangements could harm our business and financial results.

•

We have not obtained independent third party appraisals of our hotels and, thus, the economic consideration paid to the Contributing Entities may exceed the fair market value of the hotels. Further, because the number of shares of our common stock and membership units received by the Contributing Entities is fixed, the value of the consideration they receive will increase if our common stock price increases.

•

Our affiliates will receive material benefits in connection with this offering, including $ of the net proceeds of this offering to be paid to entities affiliated with Westbrook Real Estate Partners, L.L.C. in redemption of membership units, and those entities will distribute approximately $ to Robert A. Alter, our Chief Executive Officer, $ to Jon D. Kline, our Chief Financial Officer, and $ to Gary A. Stougaard, our Chief Investment Officer, as a result of their interests in those entities. The Contributing Entities will own shares of our common stock and membership units in Sunstone Hotel Partnership with a value of approximately $ million based on an initial public offering price of $ per share, the midpoint of the price range set forth above.

•

The use of the net proceeds from this offering to repay $63.5 million of indebtedness that has been extended by an affiliate of Citigroup Global Markets, Inc., one of our underwriters, creates a conflict of interest because this underwriter will have an interest in the successful completion of this offering beyond the underwriting discounts and commissions it will receive.

•	If we fail to qualify as a REIT for Federal income tax purposes, our earnings will be subject to Federal income taxation, which will reduce the amount of cash available for distribution to our stockholders.

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.


	Per Share	Total
Initial Public Offering Price	$	$
Underwriting Discount	$	$
Proceeds to Sunstone Hotel Investors, Inc. (before expenses)	$	$

We have granted the underwriters an option to purchase up to additional shares of common stock to cover over-allotments. The underwriters expect to deliver the shares in New York, New York on or about , 2004.


Citigroup		Merrill Lynch & Co.		Morgan Stanley

Prospectus dated , 2004

[Photos or Map]

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with different information. We are not making an offer of these securities in any state where the offer is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than the date on the front of this prospectus.

TABLE OF CONTENTS


		Page
SUMMARY		1
Our Company		1
Competitive Strengths		2
Business and Growth Strategy		2
Lodging Industry Outlook		3
Our Portfolio		4
Corporate Governance Profile		5
Risk Factors		5
Formation and Structuring Transactions		6
Our Corporate Structure After the Formation and Structuring Transactions		8
Benefits to Related Parties From the Formation and Structuring Transactions		8
Conflicts of Interest		9
Restrictions on Ownership of Our Stock		10
Tax Status		11
Distribution Policy		11
THE OFFERING		12
SUMMARY HISTORICAL AND PRO FORMA FINANCIAL AND OPERATING DATA		14
RISK FACTORS		18
Risks Related to Our Business		18
Risks Related to This Offering		26
Risks Related to Our Organization and Structure		29
Risks Related to the Lodging and Real Estate Industries		31
Tax and Employee Benefit Plan Risks		34
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS		37
USE OF PROCEEDS		38
DISTRIBUTION POLICY		39
DILUTION		41
Net Tangible Book Value		41
Dilution After This Offering		41
Differences Between New and Existing Stockholders in Number of Shares of Common Stock and Amount Paid		42
FORMATION AND STRUCTURING TRANSACTIONS		43
CAPITALIZATION		46
SELECTED FINANCIAL AND OPERATING DATA		47
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		52
Overview		52
Factors Affecting Our Results of Operations		53
Operating Results		58
Comparison of First Half of 2004 to 2003		58
Comparison of 2003 to 2002		61


		Page
Comparison of 2002 to 2001		64
Contractual Obligations		69
Reserve Funds for Capital Expenditures		69
Derivative Financial Instruments		70
Off-Balance Sheet Arrangements		70
Critical Accounting Policies		70
Quantitative and Qualitative Disclosures About Market Risk		72
Seasonality		72
Inflation		72
New Accounting Standards and Accounting Changes		72
LODGING INDUSTRY		74
OUR BUSINESS		79
Our Company		79
Competitive Strengths		79
Business and Growth Strategy		80
Hotel Properties		88
Geographic Diversity		89
Franchise Agreements		91
Portfolio by Chain Scale Segment		93
Management Company		94
Management Agreements		94
Ground Lease Agreements		101
Insurance		101
Offices		101
Employees		101
Founders		102
Environmental		102
Legal Proceedings		102
MANAGEMENT		103
Directors and Executive Officers		103
Corporate Governance Profile		105
Committees of Our Board of Directors		105
Compensation Committee Interlocks and Insider Participation		106
Compensation of Directors		107
Executive Compensation		107
Employment Agreements		107
Long-Term Incentive Plan		107
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS		110
The Contributing Entities		110
Excluded Propert ies		111
Other Properties		111
Franchise Agreements		112
Registration Rights Agreement		112
INVESTMENT POLICIES AND POLICIES WITH RESPECT TO CERTAIN ACTIVITIES		114
Investments in Real Estate or Interests in Real Estate		114
Investments in Real Estate Mortgages		114
Investments in Securities of or Interests in Persons Primarily Engaged in Real Estate Activities and Other Issuers		114
Disposition Policies		115
Financing Policies		115
Lending Policies		116


		Page
Equity Capital Policies		116
Conflict of Interest Policies		116
Corporate Opportunities		117
Reporting Policies		117
Regulatory Compliance Policies		117
PRINCIPAL STOCKHOLDERS		118
DESCRIPTION OF STOCK		119
General		119
Common Stock		119
Preferred Stock		119
Restrictions on Ownership and Transfer		119
Other Matters		120
CERTAIN PROVISIONS OF MARYLAND LAW AND OF OUR CHARTER AND BYLAWS		121
Amendment of Charter and Bylaws		121
Meetings of Stockholders		121
Advance Notice Provisions for Stockholder Nominations and Stockholder Proposals		121
Board of Directors		122
Removal of Directors		122
Extraordinary Transactions		122
Business Combinations		122
Control Share Acquisitions		123
Maryland Unsolicited Takeover Act		124
Limitation of Liability and Indemnification		124
Anti-Takeover Effect of Certain Provisions of Maryland Law and of our Charter and Bylaws		125
REIT Status		125
DESCRIPTION OF THE OPERATING AGREEMENT OF SUNSTONE HOTEL PARTNERSHIP, L.L.C.		126
Management of Sunstone Hotel Partnership		126
Transferability of Interests		126
Amendments to the Operating Agreement		127
Distributions to Members		128
Redemption and Exchange Rights		128
Issuance of Additional Units, Common Stock or Convertible Securities		128
Tax Matters		128
Allocations of Net Income and Net Losses to Members		128
Operations		129
Termination Transactions		129
Term		129
Indemnification and Limitation of Liability		129
SHARES ELIGIBLE FOR FUTURE SALE		130
Rule 144		130
Rule 144(k)		130
Rule 701		130
Registration Rights		131
Lock-up Agreements		131
OUTSTANDING INDEBTEDNESS		132
U.S. FEDERAL INCOME TAX CONSIDERATIONS		137
Taxation as a REIT		137
Requirements for Qualification as a REIT		139
Taxable REIT Subsidiaries		140
Income Tests		141

iii


		Page
Asset Tests		143
Annual Distribution Requirement		143
Failure to Qualify as a REIT		144
Tax Basis of Assets		144
Taxation of Stockholders		144
Other Tax Consequences		149
ERISA CONSIDERATIONS		150
UNDERWRITING		152
EXPERTS		155
VALIDITY OF SECURITIES		155
WHERE YOU CAN FIND MORE INFORMATION		155
INDEX TO FINANCIAL STATEMENTS		F-1

This prospectus contains registered trademarks that are the exclusive property of companies other than us, including Courtyard by Marriott ^® , Crowne Plaza ^® , Doubletree ^® , Embassy Suites ^® , Four Points ^® , Hawthorn Suites ^® , Hilton ^® , Holiday Inn ^® , Hyatt ^® , Marriott ^® , Residence Inn by Marriott ^® , Sheraton ^® , Wyndham ^® and Starbucks ^® . We are a party to license agreements with the owners of these trademarks, which enable hotels we own to be operated using those trademarks. None of the owners of those marks or their affiliates, officers, directors, agents or employees own any of our hotels. None of the owners of these trademarks, or any of their affiliates, officers, directors, agents or employees is an issuer or underwriter of the shares of common stock being offered hereby or a participant in this offering. In addition, none of the owners of these trademarks, or any of their officers, directors, agents or employees has or will endorse the offering or assume any liability arising out of or related to the sale or offer of the shares of our common stock being offered hereby, including any liability or responsibility for any financial statements or other financial information contained in this prospectus.

Unless otherwise indicated, industry statistics are from Smith Travel Research, an independent statistical research service that specializes in the lodging industry. Some of the terms used in the prospectus, such as upper upscale, upscale and midscale, are consistent with Smith Travel Research terms. The category of “upper upscale” includes hotels such as Doubletree, Embassy Suites, Hilton, Hyatt, Marriott and Sheraton; the category of “upscale” includes hotels such as Courtyard by Marriott, Crowne Plaza, Hawthorn Suites, Hilton Garden Inn, Radisson, Residence Inn and Wyndham; and the category of “midscale” includes hotels such as Four Points—Sheraton, Holiday Inn, Holiday Inn Express and Holiday Inn Select.

SUMMARY

The following summary highlights information contained elsewhere in this prospectus. However, you should read this entire prospectus, including “Risk Factors” and our historical and pro forma combined financial statements and related notes appearing elsewhere in this prospectus, before deciding to invest in our common stock.

As used in this prospectus, references to the “Contributing Entities” are to Sunstone Hotel Investors, L.L.C., Sunstone/WB Hotel Investors IV, LLC, Sunstone/WB Manhattan Beach, LLC and WB Hotel Investors, LLC, each of which is controlled by Westbrook Real Estate Partners, L.L.C. References to “we,” “our” and “us” are to Sunstone Hotel Investors, Inc. and, except as the context otherwise requires, its consolidated subsidiaries, including Sunstone Hotel Partnership, LLC and its consolidated subsidiaries. Our historical information includes hotels that were or will be sold or distributed prior to this offering. Unless otherwise indicated, the information contained in this prospectus assumes that the underwriters’ over-allotment option is not exercised and the shares of our common stock offered pursuant to this prospectus are sold at an initial public offering price of $ per share, which is the midpoint of the price range set forth on the cover of this prospectus. Pro forma information assumes that the Formation and Structuring Transactions described herein and this offering are consummated.

SUNSTONE HOTEL INVESTORS, INC.

Our Company

We are a hospitality company that will own primarily upper upscale and upscale hotels in the United States upon consummation of the Formation and Structuring Transactions described in this prospectus and this offering. Our hotels are operated under leading brand names franchised or licensed from others, such as Marriott, Hilton, InterContinental, Hyatt, Starwood, Carlson and Wyndham. As of June 30, 2004, on a pro forma basis, we owned 55 hotels, comprising 13,339 rooms, located in 17 states in the United States. The terms upper upscale and upscale are classifications of hotels by brand that are defined by Smith Travel Research, a provider of lodging industry statistical data. Smith Travel Research classifies hotel chains into the following segments: luxury; upper upscale; upscale; midscale with food and beverage; midscale without food and beverage; economy; and independent. We expect to qualify and will elect to be treated as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code.

Our predecessors were formed in 1984 and completed an initial public offering in 1995. In November 1999, one of the Contributing Entities, Sunstone Hotel Investors, L.L.C., purchased our predecessor public company, taking it private. Since that time through June 30, 2004, we have acquired $744.0 million of hotels and sold $362.7 million of hotels, which increased the percentage of our upper upscale and upscale hotel revenue from 65.0% in 1999 to 87.9% in 2003 on a pro forma basis. Additionally, since November 1999, we increased our room count by 31.1% to 13,339 rooms and our average rooms per hotel by 35.7% to 243 on a pro forma basis.

Although we have historically self-managed most of our hotels, we will engage Interstate Hotels & Resorts, Inc., which we refer to as the Management Company or Interstate, to manage 50 of our 55 hotels. Interstate is the largest independent hotel management company in the United States not affiliated with a hotel brand. We believe operational efficiencies will be realized through the relationship with Interstate, in addition to allowing us to comply with the restrictions imposed on us by the applicable rules governing lodging REITs. Our remaining five hotels will continue to be managed by Marriott or Hyatt under existing management agreements.

To optimize the cash flow from, and the profitability of, our hotels, we intend to structure our management agreements with the Management Company to align its incentives with ours and to maintain, to the greatest extent practicable, the hotel management practices we employed prior to electing REIT status. Most of our current hotel management employees will become employees of the Management Company, and will generally continue in their current roles. The Management Company will maintain offices in the same building as our headquarters for many of the employees responsible for operations, sales and marketing of our hotels.

We believe our business, and the lodging industry as a whole, is in the early phases of recovery after the dramatic negative effects of the economic slowdown and the terrorist attacks of September 11, 2001. Since June 30, 2003, our hotel portfolio has experienced consistent quarterly increases in revenue per available room, or RevPAR, one of the key performance indicators widely used in the lodging industry. RevPAR for the 55 hotels we will own following the Formation and Structuring Transactions increased over the prior year’s comparable period by 1.5% in the third quarter of 2003, 3.7% in the fourth quarter of 2003, 4.6% in the first quarter of 2004 and 8.1% in the second quarter of 2004.

Competitive Strengths

We believe the following competitive strengths distinguish us from other owners of lodging properties:

•

Positioned to Capitalize on Industry Recovery.

Significant Recent Investments. Since January 2003, we have completed $64.3 million of significant renovations and redevelopments at 24 of our hotels, which we believe will improve the competitiveness of our hotels and better position us to capitalize on a lodging industry recovery.

Upper Upscale and Upscale Concentration. We believe the upper upscale and upscale segments, which represented approximately 87.9% of our 2003 pro forma revenues, tend to outperform the lodging industry generally during an economic recovery.

Nationally Recognized Brands. We operate substantially all of our hotels under nationally recognized brands, including Marriott, Hilton and Hyatt.

Presence in Markets with High Barriers to Entry. We believe that our hotels are located in desirable urban and suburban markets with major demand generators and significant barriers to entry for new supply, including a strong presence in California, where our hotels generated 32.2% of our 2003 pro forma revenues.

•

Proven Acquisition and Disposition Capabilities. We believe that our significant acquisition and disposition experience will allow us to continue to redeploy capital from slower growth to higher growth hotels.

•

Strategic Relationship with the Management Company. We believe that our agreements with Interstate will align its interests with ours to maximize the operating performance of our hotels.

•

Experienced Management Team. We have a seasoned senior management team with an average of 15 years of experience in real estate, lodging or finance.

•

Flexible Capital Structure. We believe our capital structure will provide us with the financial flexibility required to fund our growth strategy and meet our liquidity needs.

Business and Growth Strategy

Our principal business objectives are to generate attractive returns on our invested capital and long-term growth in cash flow in order to maximize total returns to our stockholders. Our focus is to own upper upscale and upscale hotels located in urban and suburban markets with major demand generators and significant barriers to entry. Our strategies for achieving our business objectives include the following key elements:

•

Active Asset Management . We intend to use our extensive hotel management expertise to enhance our relationships with our hotel operators and to maximize the operating performance, cash flow and value of our hotels.

•

Opportunistic Hotel Redevelopment and Rebranding . We will continue to invest capital to renovate, redevelop and rebrand our hotels when we believe it will increase market share, enhance property-level cash flow and generate attractive returns on invested capital.

•

Selective Hotel Acquisition and Development . We will seek to create value by acquiring premium-branded hotels, or hotels that have the attributes to facilitate their conversion to premium brands, that have been undermanaged or undercapitalized, that are located in growth markets or that offer expansion and renovation opportunities. We may also develop hotels in markets where we believe room demand and other competitive factors support new supply.

•

Capital Redeployment . We intend to continue to sell hotels on an opportunistic basis and redeploy our capital to acquire or redevelop other hotels with greater cash flow growth potential.

Lodging Industry Outlook

We believe the U.S. hotel industry and our hotel portfolio are in the early phase of a recovery following a pronounced downturn. We believe improving industry fundamentals will lead to improved operating performance of our hotels in 2004 and thereafter based on the following factors:

•

Rebound in Lodging Demand. Following the industry downturn, which began in 2001, lodging demand, measured by total rooms sold, increased by 0.3% in 2002 and 1.6% in 2003. Smith Travel Research projects that it will increase by 4.0% in 2004.

•

Limited New Supply. New lodging supply grew by 1.6% in 2002 and 1.2% in 2003, and Smith Travel Research projects that it will increase by 1.2% in 2004, approximately one-half of its 15-year historical average of 2.3%.

•

Improving Operating Performance . According to Smith Travel Research, the current favorable supply and demand environment is expected to result in continued improvement of industry operating fundamentals. RevPAR for the industry decreased by 2.6% in 2002, but increased moderately by 0.5% in 2003. Smith Travel Research projects that it will increase by 5.2% in 2004.

Our Portfolio

The charts below show the franchise affiliations, hotel chain scale segments and geographic regions of the 55 hotels included in our 2003 pro forma revenues:

Revenue Percentage by Franchise Brand Family

LOGO

Revenue Percentage by Chain Scale Segment

LOGO

Revenue Percentage by Geographic Region

LOGO

Corporate Governance Profile

We believe that we have organized our corporate structure and governance to align our interests with those of our stockholders. For example:

•

the terms of our board of directors are not staggered, which means that all of our directors are subject to re-election annually;

•

at least four of our seven directors will be independent for purposes of the listing standards and rules of the NYSE;

•

we have provided for a simple majority vote of our common stockholders for all matters requiring a stockholder vote, which means that Westbrook Real Estate Partners, L.L.C. will not have veto power over such voting matters;

•

we have opted out of the Maryland business combination and control share acquisition statutes and have waived the ability of our board to opt back in without a stockholder vote, which means that it may be easier for an interested party or third party to acquire control of us;

•

we do not have a stockholder rights plan;

•

we do not have any agreements or arrangements to provide tax protection to any stockholder or any holder of membership units in Sunstone Hotel Partnership, the operating partnership;

•

our nominating and corporate governance committee must approve any transaction between us and (1) any of our directors, officers or employees, or any entity in which any of our directors, officers or employees is employed or has any interest of more than 5%, or (2) the Contributing Entities or their affiliates; and

•

we intend to adopt a code of business conduct and ethics which, among other things, will address corporate opportunity issues relevant to directors, officers and employees.

Risk Factors

Our ability to achieve our goals and implement the strategies described above may be affected by matters discussed under “Risk Factors” beginning on page 18, which you should carefully consider prior to deciding whether to invest in our common stock, including:

•

in the recent past, events beyond our control, including an economic slowdown and terrorism, have harmed the hotel industry generally and the performance of our hotels, and if these or similar events occur again, our results may be harmed;

•

on a pro forma basis as of June 30, 2004, we expect to have approximately $ million of debt, approximately % of which will be variable rate secured debt, with covenants that impose restrictions on our business and may harm our financial position and cash flow if there are increases in interest rates that we have not protected against;

•

our organizational documents contain no limitations on the amount of debt we may incur and, therefore, we may become too highly leveraged;

•

we may experience conflicts of interest with our largest stockholders and our executive officers and directors, including with respect to their sales of shares of our stock, evaluation of acquisition opportunities and ownership of interests in other hotels;

•

we may not be successful in identifying or completing hotel acquisitions that meet our criteria, which may impede our growth;

•

most of our hotels are upper upscale and upscale hotels, and the upper upscale and upscale segments of the lodging market are highly competitive and generally subject to greater volatility than other segments of the market, which could harm our profitability;

•

our hotels are geographically concentrated in California and, accordingly, we could be disproportionately harmed by an economic downturn in this area of the country or a natural disaster, such as an earthquake;

•

we rely heavily on our arrangements with our franchisors and management companies, including the new arrangement with the Management Company, and any disruptions to those arrangements could harm our business and financial results;

•

we have not obtained independent third party appraisals of our hotels and, thus, the economic consideration paid to the Contributing Entities may exceed the fair market value of the hotels. Further, because the number of shares of our common stock and membership units received by the Contributing Entities is fixed, the value of the consideration they receive will increase if our common stock price increases;

•

our affiliates will receive material benefits in connection with this offering, including $ of the net proceeds of this offering to be paid to entities affiliated with Westbrook Real Estate Partners, L.L.C. in redemption of membership units, and those entities will distribute approximately $ to Robert A. Alter, our Chief Executive Officer, $ to Jon D. Kline, our Chief Financial Officer, and $ to Gary A. Stougaard, our Chief Investment Officer, as a result of their interests in those entities. The Contributing Entities will own shares of our common stock and membership units in Sunstone Hotel Partnership with a value of approximately $ million based on an initial public offering price of $ per share, the midpoint of the price range set forth on the cover page of this prospectus;

•

the use of the net proceeds from this offering to repay $63.5 million of indebtedness that has been extended by an affiliate of Citigroup Global Markets, Inc., one of our underwriters, creates a conflict of interest because this underwriter will have an interest in the successful completion of this offering beyond the underwriting discounts and commissions it will receive; and

•

if we fail to qualify as a REIT for Federal income tax purposes, our earnings will be subject to Federal income taxation, which will reduce the amount of cash available for distribution to our stockholders.

Formation and Structuring Transactions

Immediately prior to the completion of the initial public offering of our common stock, we and the other entities identified below will enter into a series of transactions to create our new corporate structure. We call these transactions our Formation and Structuring Transactions. These transactions, along with schematic charts showing the ownership of our properties before and after these transactions, are described more fully on page 43 under “Formation and Structuring Transactions.” These transactions are also set forth in a contribution agreement filed as an exhibit to the registration statement of which this prospectus is a part.

The Formation and Structuring Transactions include the following:

•

the Contributing Entities will contribute or sell all of their assets, including their ownership interests in our hotels and Buy Efficient L.L.C., but excluding the assets referred to in the following three bullet points, to us and Sunstone Hotel Partnership in return for shares of our common stock and membership units in Sunstone Hotel Partnership;

•

Sunstone Hotel Investors, L.L.C. will distribute its interests in the Embassy Suites, Los Angeles, California to Alter SHP LLC, an entity affiliated with Robert A. Alter, in consideration for the redemption of a 3.3% interest in Sunstone Hotel Investors, L.L.C.;

•

Sunstone/WB Hotel Investors IV, LLC will retain its interests in the JW Marriott, Cherry Creek, Colorado;

•

Sunstone Hotel Investors, L.L.C. will sell the corporate subsidiary that manages our hotels to the Management Company and will receive from the Management Company $8.0 million in cash; and

•

we will enter into management agreements with the Management Company.

Following the Formation and Structuring Transactions, we will complete this offering by issuing shares of our common stock for cash, or shares if the underwriters fully exercise their option to purchase additional shares of our common stock. Sunstone Hotel Investors, Inc. will use $ of the proceeds to purchase Sunstone Hotel Partnership membership units from the Contributing Entities at a price per unit equal to the net proceeds per share to us, after underwriting discounts and commissions but before any other expenses, and contribute the remaining net proceeds and assets held by us to Sunstone Hotel Partnership in exchange for Sunstone Hotel Partnership membership units. If the underwriters fully exercise their option to purchase additional shares of our common stock, Sunstone Hotel Investors, Inc. will then purchase additional Sunstone Hotel Partnership membership units for $ in cash from the Contributing Entities. As a result, immediately after the consummation of the Formation and Structuring Transactions and this offering, the Contributing Entities will own % of our common stock and the purchasers in this offering will own % of our common stock, and the Contributing Entities will own % of Sunstone Hotel Partnership and we will own % of Sunstone Hotel Partnership. If the underwriters’ over-allotment option is exercised, the Contributing Entities will own % of our common stock and the purchasers in this offering will own % of our common stock, and the Contributing Entities will own % of Sunstone Hotel Partnership and we will own % of Sunstone Hotel Partnership. Assuming conversion of all of the membership units in Sunstone Hotel Partnership, the Contributing Entities would own % of our common stock, or % if the underwriters’ over-allotment is exercised.

The Contributing Entities agreed to receive shares of our common stock in the steps above in exchange for interests that were held in corporate subsidiaries and in which they had a higher tax basis and membership units in Sunstone Hotel Partnership in the steps above in exchange for interests in which they had a lower tax basis.

In the Formation and Structuring Transactions, Alter SHP LLC will receive the interests in the Embassy Suites, Los Angeles, California in exchange for redemption of a portion of its membership interest in Sunstone Hotel Investors, L.L.C. so that Alter SHP LLC would not seek an agreement to protect it from adverse tax consequences associated with the sale of hotels as a result of its tax basis in Sunstone Hotel Investors, L.L.C. Following the distribution, Alter SHP LLC will have a 1.0% membership interest in Sunstone Hotel Investors, L.L.C.

The Contributing Entities and some of our directors and officers may be considered our founders because they participated in founding and organizing our business. The Contributing Entities formed us and will cause the Formation and Structuring Transactions to occur. Messrs. Kazilionis, Paul and Alter serve on the executive committees of the Contributing Entities and Mr. Alter is also an officer of the Contributing Entities, and Mr. Kline served as an officer of the Contributing Entities prior to the Formation and Structuring Transactions. Messrs. Kazilionis, Paul and Alter will serve as members of our board of directors, and Messrs. Alter, Kline and Stougaard will serve as executive officers of us following the Formation and Structuring Transactions.

Our Corporate Structure After the Formation and Structuring Transactions

After giving effect to the Formation and Structuring Transactions, we will own our hotel properties and Sunstone Hotel TRS Lessee, Inc., or the TRS Lessee, through Sunstone Hotel Partnership.

The diagram below sets forth a simplified presentation of our corporate structure immediately following the Formation and Structuring Transactions and this offering:

LOGO

The Contributing Entities consist of Sunstone Hotel Investors, L.L.C., Sunstone/WB Hotel Investors IV, LLC, WB Hotel Investors, LLC and Sunstone/WB Manhattan Beach, LLC. Each of the Contributing Entities is controlled by Westbrook Real Estate Partners, L.L.C.

As illustrated in the chart above, Sunstone Hotel Partnership will become the operating partnership in an umbrella partnership real estate investment trust, or UPREIT, structure with the following owners: Sunstone Hotel Investors, Inc., which is the REIT and the sole managing member of the operating partnership, and the Contributing Entities. In an UPREIT, the operating partnership directly owns all properties, and the REIT owns a substantial interest in and, in our case, is the sole managing member of the operating partnership.

The TRS Lessee, as tenant, will lease the hotels from Sunstone Hotel Partnership, the operating partnership, as landlord. The TRS Lessee will contract with the Management Company and, with respect to five hotels, with Marriott or Hyatt, so that such parties may operate the hotels for the TRS Lessee.

Benefits to Related Parties From the Formation and Structuring Transactions

Our affiliates will receive material benefits in connection with the Formation and Structuring Transactions, as follows:

•

the Contributing Entities will receive shares of our common stock and membership units in Sunstone Hotel Partnership. The membership units, excluding those units purchased by us in connection with this offering, are exchangeable for shares of our common stock after the transfer

restrictions expire 12 months after this offering. These shares of common stock and membership interests will be more liquid than any of their current interests in any of our hotels;

•

Messrs. Alter, Kline and Stougaard will have indirect ownership interests in the membership units in Sunstone Hotel Partnership and shares of our common stock to the extent of their indirect minority interests in the Contributing Entities as described under “Certain Relationships and Related Transactions—The Contributing Entities;”

•

$ million of the net proceeds of this offering will be paid to the Contributing Entities to purchase membership units in Sunstone Hotel Partnership and, if the underwriters’ over-allotment option is exercised, $ million of the net proceeds of this offering will be paid to the Contributing Entities;

•

as a result of their interests in the Contributing Entities, Mr. Alter will receive $ , Mr. Kline will receive $ and Mr. Stougaard will receive $ in cash from the purchase of the membership units in Sunstone Hotel Partnership and the distribution of the proceeds to the holders of interests in the Contributing Entities and, if the underwriters’ over-allotment option is exercised, Mr. Alter will receive $ , Mr. Kline will receive $ and Mr. Stougaard will receive $ in cash;

•

the Embassy Suites, Los Angeles, California will be distributed to Alter SHP LLC, an entity affiliated with Mr. Alter, in connection with the redemption of a portion of that entity’s interests in Sunstone Hotel Investors, L.L.C.;

•

Sunstone Hotel Investors, L.L.C. will sell the corporate subsidiary that manages our hotels to the Management Company and will receive from the Management Company $8.0 million in cash;

•

we will replace letters of credit in the amount of $20.0 million provided by an affiliate of Westbrook Real Estate Partners, L.L.C. with new letters of credit under our new revolving credit facility;

•

a promissory note from us to Mr. Alter and a promissory note from Mr. Alter to us, both in the amount of $650,000, will be cancelled; and

•

we will indemnify the Management Company from any liabilities that may arise prior to the closing of this offering from the operations of our corporate subsidiary that will be sold by Sunstone Hotel Investors, L.L.C. to the Management Company.

The shares of our common stock and the membership units in Sunstone Hotel Partnership that we issue to the Contributing Entities in exchange for the interests described above will have an aggregate value of $ million, based on an assumed initial public offering price of $ , which is the midpoint of the range set forth on the cover page of this prospectus and will increase or decrease if the price of our common stock increases or decreases. The initial public offering price of our common stock will be determined in consultation with the representatives of the underwriters. Among the factors to be considered in determining the initial public offering price of our common stock, in addition to prevailing market conditions, will be our historical performance, estimates of our business potential and earnings prospects, an assessment of our management and the consideration of the above factors in relation to the market valuation of companies in related businesses. The initial public offering price does not necessarily bear any relationship to our book value or the fair market value of our hotel properties. We have not obtained any third-party appraisals of our hotels or any other independent third-party valuations in connection with the Formation and Structuring Transactions. As a result, the economic consideration given by us in the Formation and Structuring Transactions may exceed the fair market value of our hotels.

Conflicts of Interest

In the Formation and Structuring Transactions and this offering, the Contributing Entities had conflicts of interest in negotiating the consideration to be received for their contribution. Our directors prior to this offering

are members of the executive committees of the Contributing Entities, and Mr. Alter, our Chief Executive Officer, and Mr. Kline, our Chief Financial Officer are officers of the Contributing Entities prior to this offering. As a result, the consideration given by us in the Formation and Structuring Transactions may exceed the fair market value of the hotels contributed to us by the Contributing Entities.

In addition, following this offering, conflicts of interest between us, the Contributing Entities, their affiliates and some of our executive officers and directors could arise, including the following:

•

The Contributing Entities may sell their shares of our common stock received in connection with the Formation and Structuring Transactions beginning 180 days after the consummation of this offering. In addition, the Contributing Entities are finite life investment entities and, beginning 12 months from the date of this offering, may seek to convert their membership units in Sunstone Hotel Partnership in an amount up to shares of our common stock. The Contributing Entities may sell these shares of our common stock pursuant to an exemption under the Securities Act of 1933 and also have the right to cause us to file registration statements related to these shares. They may sell their shares of our common stock at times or in amounts that could be disruptive to us, our other stockholders or our stock price. Sales of shares of our common stock by the Contributing Entities:

•

will provide cash for distribution to Messrs. Alter, Kline and Stougaard as a result of their interests in the Contributing Entities;

•

may cause Messrs. Kazilionis and Paul, both of whom are Managing Principals of Westbrook Real Estate Partners, L.L.C., to resign from our board if Westbrook Real Estate Partners, L.L.C., which controls each of the Contributing Entities, no longer has an ownership interest in us; and

•

may cause our stock price to decline.

•

Since two of our directors, Messrs. Kazilionis and Paul, are managing principals of real estate private equity funds, those directors may have conflicts of interest in evaluating acquisition opportunities in which we and those funds both have a potential interest. Accordingly, these directors may take actions that are more favorable to these other entities than to us.

•

The Contributing Entities and its affiliates and Messrs. Alter, Kline and Stougaard continue to own interests in other hotels in which we have no interest or rights, including hotels located in geographic areas where we own hotels. In addition, we may buy hotels in the same geographic areas where the Contributing Entities, their affiliates and our executive officers own hotels. Hotels located in the same geographic area will compete for business, and such competition could harm our results of operations.

Restrictions on Ownership of Our Stock

Due to limitations on the concentration of ownership of REIT stock imposed by the Code and other concerns relating to concentration of stock ownership, our organizational documents generally prohibit any stockholder from actually or constructively owning more than 9.8% of the lesser of the number or value of outstanding shares of our common stock or 9.8% of the value of the aggregate outstanding shares of our capital stock. If we fail to qualify as a REIT in any taxable year, we will be subject to Federal income tax at regular corporate rates.

Our board of directors may, in its sole discretion, waive from time to time the ownership limit with respect to particular stockholders if our board of directors is presented with evidence satisfactory to it that the increased ownership will not then or in the future jeopardize our status as a REIT. Immediately after this offering, the Contributing Entities and their affiliates will continue to beneficially own more than 9.8% of the outstanding shares of our common stock. Our board of directors has granted an exemption from the ownership limits to the Contributing Entities and their affiliates.

Tax Status

We intend to elect to be taxed as a REIT under Sections 856 through 859 of the Code commencing with our taxable year ended December 31, 2004. As a REIT, we will be permitted to deduct for Federal income tax purposes the amount of REIT taxable income that we distribute currently to our stockholders, and as a consequence we generally will not be subject to Federal income tax on the amount of REIT taxable income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to Federal income tax at regular corporate rates, and we will not be eligible to make a REIT election for four taxable years after the taxable year in which we fail to so qualify. Even if we qualify for taxation as a REIT, we may be subject to Federal, state and local taxes on our income and property.

Distribution Policy

To maintain our qualification as a REIT, we intend to make quarterly distributions to our stockholders of at least 90% of our taxable income (which excludes net capital gains and does not necessarily equal net income as calculated in accordance with accounting principles generally accepted in the United States of America, or GAAP). The timing and frequency of distributions will be authorized by our board of directors and declared by us based upon a variety of factors deemed relevant by our board of directors. Our cash available for distribution may be less than 90% of our REIT taxable income in which case we could be required to either sell assets or borrow funds to make distributions. Following this offering, we intend to pay a quarterly distribution to our stockholders of $ per share. On an annualized basis, this distribution would be $ per share, or an annual distribution rate of approximately % based on an initial public offering price of $ per share, which is the midpoint of the price range set forth on the cover of this prospectus. Distributions to our stockholders generally will be taxable to our stockholders as ordinary income; however, because a significant portion of our investments will be equity ownership interests in hotels, which will result in depreciation and non-cash charges against our income, a portion of our distributions may constitute a tax-free return of capital. Distributions in excess of our current and accumulated earnings and profits generally will constitute a tax-free return of capital rather than dividend income to stockholders.

Corporate Information

On June 28, 2004, Sunstone Hotel Investors, Inc. was formed as a Maryland corporation with perpetual existence, and on June 29, 2004 Sunstone Hotel Partnership was formed as a Delaware limited liability company.

Our principal executive offices are at 903 Calle Amanecer, Suite 100, San Clemente, California 92673. Our telephone number is (949) 369-4000. Our website is located at www.sunstonehotels.com. Information on the website is not deemed to be a part of this prospectus.

THE OFFERING

Shares of common stock outstanding prior to this offering ⁽¹⁾

Membership units outstanding prior to this offering ⁽²⁾

units

Common stock offered by us

Total shares of common stock and membership units outstanding immediately after this offering ⁽³⁾

shares and units

Use of proceeds

We will use the net proceeds of this offering as follows:

•

$ million to purchase membership units in Sunstone Hotel Partnership held by the Contributing Entities;

•

$ million to repay a portion of our existing indebtedness;

•

$6.3 million to exercise the option to acquire the ground lessor’s interest in the ground lease relating to the Embassy Suites, Chicago, Illinois and pay related expenses;

•

$ million to pay franchise application fees; and

•

$ million for general corporate purposes.

Risk factors

See “Risk Factors” beginning on page 18 and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in shares of our common stock.

Distribution policy

To maintain our qualification as a REIT, we intend to make quarterly distributions to our stockholders of at least 90% of our REIT taxable income (which excludes net capital gains and does not necessarily equal net income as calculated in accordance with GAAP). Following this offering, we intend to pay a quarterly distribution to our stockholders of $ per share, or an annual distribution rate of approximately % based on an initial public offering price of $ per share, which is the midpoint of the price range set forth on the cover of this prospectus.

Proposed New York Stock Exchange symbol

We intend to apply to have our common stock listed on the NYSE under the symbol “SHO.”

(1)	Prior to the Formation and Structuring Transactions, since our formation on June 28, 2004, our capitalization consisted of 100 shares of common stock owned by Sunstone Hotel Investors, L.L.C.

(2)

Includes membership units in Sunstone Hotel Partnership expected to be issued to the Contributing Entities in connection with the Formation and Structuring Transactions that may, subject to limits in the operating agreement of Sunstone Hotel Partnership, be exchanged for cash or, at our option, shares of our common stock on a one-for-one basis generally commencing 12 months after this offering.

(3)

Consists of shares of our common stock and membership units in Sunstone Hotel Partnership, but excludes membership units in Sunstone Hotel Partnership owned by us. If the underwriters’ over-allotment option is exercised, the aggregate number of shares and units will be , consisting of shares of our common stock and membership units in Sunstone Hotel Partnership, but excluding membership units in Sunstone Hotel Partnership owned by us.

SUMMARY HISTORICAL AND PRO FORMA FINANCIAL AND OPERATING DATA

We present in this prospectus certain historical financial data and pro forma financial data. We also present certain statistical information and non-GAAP financial measures on a historical and pro forma basis.

The summary historical financial data as of December 31, 2002 and 2003, and for the years ended December 31, 2001, 2002 and 2003, has been derived from our audited combined financial statements included elsewhere in this prospectus. The summary historical combined financial data as of June 30, 2004 and for the six months ended June 30, 2003 and 2004 has been derived from our unaudited combined financial statements included elsewhere in this prospectus.

The unaudited pro forma financial information presented gives effect to (1) hotel acquisitions and hotels held for sale (discontinued operations), (2) the Formation and Structuring Transactions and (3) this offering and the application of the net proceeds from this offering. It presents the unaudited pro forma combined balance sheet data as of June 30, 2004 as if these transactions had occurred as of June 30, 2004 and the unaudited pro forma combined statement of operations data for the year ended December 31, 2003 and the six months ended June 30, 2004 as if these transactions had occurred as of the beginning of the periods indicated. The adjustments are discussed in detail under “Unaudited Pro Forma Financial Data.” The unaudited pro forma financial data does not purport to represent what our financial position or results of operations would actually have been if this offering and the application of the net proceeds from this offering had in fact occurred on the dates discussed above. You should read the assumptions on which the unaudited pro forma financial data is based from pages F-2 through F-9 in connection with the pro forma financial data contained in this summary.

We present the following two non-GAAP financial measures throughout this prospectus that we believe are useful to investors as key measures of our operating performance: (1) Earnings Before Interest Expense, Taxes, Depreciation and Amortization, or EBITDA; and (2) Funds From Operations, or FFO. The financial measures are discussed further under “Selected Financial and Operating Data.” However, we caution investors that amounts presented in accordance with our definitions of EBITDA and FFO may not be comparable to similar measures disclosed by other companies, since not all companies calculate these non-GAAP measures in the same manner. EBITDA and FFO should not be considered as an alternative measure of our net income (loss), operating performance, cash flow or liquidity. EBITDA and FFO may include funds that may not be available for our discretionary use due to functional requirements to conserve funds for capital expenditures and property acquisitions and other commitments and uncertainties. Although we believe that EBITDA and FFO can enhance your understanding of our results of operations, these non-GAAP financial measures, when viewed individually, are not necessarily a better indicator of any trend as compared to GAAP measures such as net income (loss) or cash flow from operations. In addition, you should be aware that adverse economic and market conditions may harm our cash flow. In this section and under “Selected Financial and Operating Data,” as required, we include a quantitative reconciliation of EBITDA and FFO to the most directly comparable GAAP financial performance measure, which is net income (loss).

You should read the following summary historical and pro forma financial and operating data together with “Selected Financial and Operating Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our combined unaudited pro forma financial data and financial statements and related notes included elsewhere in this prospectus.


	Historical									Pro Forma	Historical						Pro Forma
	Year ended or as of December 31,									Year ended or as of December 31,	Six months ended or as of June 30,						Six months ended or as of June 30,
	2001			2002			2003			2003	2003			2004			2004
	(in thousands, except per share and statistical data)
Statement of operations data:
Total revenues	$	243,480		$	261,409		$	460,702		$	$	220,881		$	243,904		$
Operating costs and expenses:
Hotel operating expenses		139,100			159,015			300,090				143,552			151,496
General and administrative		46,689			39,122			64,229				30,156			32,853
Depreciation and amortization		30,117			34,213			53,481				26,398			28,444
Impairment loss		—			6,789			11,382				—			7,439
Goodwill amortization		4,925			—			—				—			—

Total operating expenses		220,831			239,139			429,182				200,106			220,232

Operating income (loss)		22,649			22,270			31,520				20,775			23,672
Interest and other income		1,070			2,080			712				328			216
Interest expense		(42,338	)		(29,186	)		(55,235	)			(26,202	)		(26,576	)

Loss before minority interest, income taxes cumulative effect of change in accounting principle and discontinued operations		(18,619	)		(4,836	)		(23,003	)			(5,099	)		(2,688	)
Minority interest		—			—			(17	)			—			166
Income tax benefit (provision) ⁽¹⁾		8,770			4,715			2,017				(359	)		(780	)

Loss from continuing operations before cumulative effect of change in accounting principle and discontinued operations		(9,849	)		(121	)		(21,003	)			(5,458	)		(3,302	)
Cumulative effect of change in accounting principle		(1,326	)		—			—				—			—
Loss from discontinued operations		(7,632	)		(10,265	)		(1,263	)			(1,207	)		(18,188	)

Net loss	$	(18,807	)	$	(10,386	)	$	(22,266	)	$	$	(6,665	)	$	(21,490	)	$

Net loss per common share										$							$

EBITDA	$	73,293		$	59,533		$	96,855			$	53,713		$	36,025
FFO		19,071			29,602			23,465				23,827			8,682
Cash flows from operating activities		43,317			26,720			60,034				26,190			28,628

Balance sheet data:
Investment in hotel properties, net	$	821,588		$	1,316,659		$	1,227,537				1,345,143			1,194,216
Hotel properties held for sale, net		—			—			—				—			22,232
Total assets		915,654			1,445,889			1,364,942				1,487,807			1,355,519
Notes payable		515,407			942,423			917,652				969,690			912,973
Total liabilities		616,869			1,047,147			1,033,993				1,085,358			1,024,260
Equity		298,785			398,742			330,345				402,449			330,731

Statistical data:
Number of hotels		52			66			61				66			60
Number of rooms		10,804			15,664			14,901				15,664			14,529
Occupancy ⁽²⁾		66.2	%		68.0	%		68.1	%			66.4	%		70.2	%
Average daily rate ⁽²⁾	$	88.36		$	87.40		$	95.09			$	95.59		$	96.51
RevPAR ⁽²⁾	$	58.49		$	59.43		$	64.76			$	63.47		$	67.75

(1)	See Note 9 to the Combined Financial Statements of Sunstone Hotel Investors, L.L.C., WB Hotel Investors, LLC and Sunstone/WB Hotel Investors IV, LLC.

(2)	Excludes hotels held in discontinued operations, which are described elsewhere in this prospectus.

The following tables show the reconciliation between net income (loss) and EBITDA and net income (loss) and FFO for the periods indicated:

Reconciliation of Net Income (Loss) to EBITDA


	Historical									Pro Forma	Historical						Pro Forma
	Year ended December 31,									Year ended December 31,	Six months ended June 30,						Six months ended June 30,
	2001			2002			2003			2003	2003			2004			2004
	(in thousands)
Net income (loss)	$	(18,807	)	$	(10,386	)	$	(22,266	)	$	$	(6,665	)	$	(21,490	)	$
Depreciation and amortization—continuing operations		35,042			34,213			53,481				26,398			28,444
Depreciation and amortization—discontinued operations		8,023			5,732			7,007				4,094			1,346
Interest expense—continuing operations		42,338			29,186			55,235				26,202			26,576
Interest expense—discontinued operations		15,767			5,172			6,262				3,106			1,288
Income tax provision (benefit)— continuing operations		(8,770	)		(4,715	)		(2,017	)			359			780
Income tax provision (benefit)—discontinued operations		(300	)		331			(847	)			219			(919	)

EBITDA ⁽¹⁾	$	73,293		$	59,533		$	96,855		$	$	53,713		$	36,025		$


(1) EBITDA has not been adjusted for the cumulative effect of a change in accounting principle of $1.3 million in 2001 pertaining to the adoption of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , as amended, which required us to recognize all derivatives on the balance sheet at fair value. EBITDA also has not been adjusted for the following amounts included in net income (loss) because these items have either occurred during the prior two years or are reasonably likely to occur within two years:

	Historical									Pro Forma	Historical						Pro Forma
	Year ended December 31,									Year ended December 31,	Six months ended June 30,						Six months ended June 30,
	2001			2002			2003			2003	2003			2004			2004
	(in thousands)
(Gain) loss on sale of assets	$	(262	)	$	43		$	(14,757	)	$	$	—		$	382		$
Impairment loss—continuing operations		—			6,789			11,382				—			7,439
Impairment loss—discontinued operations		3,985			9,658			16,991				—			16,954

Total	$	3,723		$	16,490		$	13,616		$	$	—		$	24,775		$

Reconciliation of Net Income (Loss) to Funds From Operations or FFO


	Historical									Pro Forma	Historical						Pro Forma
	Year ended December 31,									Year ended December 31,	Six months ended June 30,						Six months ended June 30,
	2001			2002			2003			2003	2003			2004			2004
	(in thousands)
Net income (loss)	$	(18,807	)	$	(10,386	)	$	(22,266	)	$	$	(6,665	)	$	(21,490	)	$
Depreciation and amortization—continuing operations ⁽¹⁾		30,117			34,213			53,481				26,398			28,444
Depreciation and amortization—discontinued operations		8,023			5,732			7,007				4,094			1,346
(Gain) loss on sale of assets		(262	)		43			(14,757	)			—			382

FFO ⁽²⁾	$	19,071		$	29,602		$	23,465		$	$	23,827		$	8,682		$


(1) Depreciation and amortization—continuing operations for FFO reconciliation purposes excludes $4.9 million in 2001 of goodwill amortization.
(2) FFO has not been adjusted for cumulative effect of change in accounting principle of $1.3 million in 2001 related to the adoption of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , as amended, which required us to recognize all derivatives on the balance sheet at fair value. FFO also has not been adjusted for the following amounts included in net income (loss) because these items have either occurred during the prior two years or are reasonably likely to occur within two years, which relate to hotels that we sold:



	Historical						Pro Forma	Historical				Pro Forma
	Year ended December 31,						Year ended December 31,	Six months ended June 30,				Six months ended June 30,
	2001		2002		2003		2003	2003		2004		2004
	(in thousands)
Impairment loss—continuing operations	$	—	$	6,789	$	11,382	$	$	—	$	7,439	$
Impairment loss—discontinued operations		3,985		9,658		16,991			—		16,954

Total	$	3,985	$	16,447	$	28,373	$	$	—	$	24,393	$

RISK FACTORS

An investment in our common stock presents risks. You should consider the material risks discussed in this section in addition to the other information contained in this prospectus before making your investment decision. If any of the material risks described below actually occurs, our business, financial condition or results of operations could be harmed. In that event, the trading price of our shares of common stock could decline and you may lose all or part of your investment.

Risks Related to Our Business

In the recent past, events beyond our control, including an economic slowdown and terrorism, harmed the operating performance of the hotel industry generally and the performance of our hotels, and if these or similar events occur again, our operating and financial results may be harmed by declines in average daily room rates or occupancy.

The performance of the lodging industry has traditionally been closely linked with the performance of the general economy and, specifically, growth in United States gross domestic product. RevPAR in the lodging industry declined 6.9% in 2001 and 2.6% in 2002. RevPAR for our hotels in continuing operations increased by 1.7% in 2002, but after excluding six of the hotels located in the Salt Lake City, Utah area, which experienced a significant one-time gain from the 2002 Winter Olympic Games, our RevPAR declined by 1.4%. The majority of our hotels are classified as upper upscale or upscale hotels. In an economic downturn, these types of hotels may be more susceptible to a decrease in revenue, as compared to hotels in other categories that have lower room rates. This characteristic may result from the fact that upper upscale and upscale hotels generally target business and high-end leisure travelers. In periods of economic difficulties, business and leisure travelers may seek to reduce travel costs by limiting travel or seeking to reduce costs on their trips. In addition, the terrorist attacks of September 11, 2001 had a dramatic adverse effect on business and leisure travel, and on our occupancy and average daily rate, or ADR. Future terrorist activities could have a similarly harmful effect on both the industry and us.

As of June 30, 2004, on a pro forma basis, we will have approximately $ million of outstanding debt, and carrying such debt may harm our financial flexibility or harm our business and financial results by imposing requirements on our business.

Carrying our outstanding debt may harm our business and financial results by:

•

requiring us to use a substantial portion of our funds from operations to make required payments on principal and interest, which will reduce the amount of cash available to us for distributions to our stockholders and for our operations and capital expenditures, future business opportunities and other purposes;

•

making us more vulnerable to economic and industry downturns and reducing our flexibility in responding to changing business and economic conditions;

•

limiting our ability to borrow more money for operations, capital expenditures or to finance acquisitions in the future; and

•

requiring us to sell one or more properties, possibly on disadvantageous terms, in order to make required payments of interest and principal.

We also intend to incur additional debt in connection with future acquisitions of real estate, which may include loans secured by a portfolio of some or all of the hotels we acquire. If necessary or advisable, we may also borrow funds to satisfy the requirement that we distribute to our stockholders at least 90% of our annual REIT taxable income or otherwise to ensure that we maintain our qualification as a REIT for Federal income tax purposes.

A significant portion of our debt will be variable rate debt and, accordingly, increases in interest rates against which we have not adequately protected will harm our financial condition and cash flow.

As of June 30, 2004, on a pro forma basis, $ million, or % of our outstanding debt, will bear interest at a variable rate. In addition, we will have the ability to borrow approximately $ million of additional variable rate debt under our new revolving credit facility. Although we have interest rate caps for some of our existing variable rate secured debt, increases in interest rates on our variable rate debt would increase our interest expense, which could harm our cash flow and ability to pay distributions to our stockholders. For example, if market rates of interest on our variable rate debt outstanding as of June 30, 2004 on a pro forma basis increase by approximately 1.00%, or 100 basis points, the increase in interest expense on our variable rate debt would decrease future earnings and cash flow by approximately $ million annually.

If we were to default on our secured debt in the future, the loss of property securing the debt would harm our ability to satisfy other obligations.

A majority of our debt is secured by first deeds of trust on our properties. Using our properties as collateral increases our risk of property losses because defaults on indebtedness secured by properties may result in foreclosure actions initiated by lenders and ultimately our loss of the property that secures any loans for which we are in default. For tax purposes, a foreclosure on any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure but would not receive any cash proceeds. As a result, we may be required to identify and utilize other sources of cash for distributions to our stockholders of that income. In addition, because of various cross-collateralization provisions in our notes payable, our default under some of our mortgage debt obligations may result in a default on our other indebtedness. If this occurs, our financial condition, cash flow and ability to satisfy our other debt obligations or ability to pay dividends may be harmed.

We anticipate that we will refinance our indebtedness from time to time to repay our debt, and our inability to refinance on favorable terms, or at all, could harm our operating results.

Since we anticipate that our internally generated cash will be adequate to repay only a portion of our indebtedness prior to maturity, we expect that we will be required to repay debt from time to time through refinancings of our indebtedness and/or offerings of equity or debt. Prior to December 31, 2005, on a pro forma basis, $ million, or % of our outstanding debt, will mature. The amount of our existing indebtedness may harm our ability to repay our debt through refinancings. If we are unable to refinance our indebtedness on acceptable terms, or at all, we might be forced to sell one or more of our properties on disadvantageous terms, which might result in losses to us and reduce the amount of cash available to us for distributions to our stockholders. If prevailing interest rates or other factors at the time of any refinancing result in higher interest rates on refinancing, our interest expense would increase, which would harm our operating results.

Financial covenants in our existing notes payable may restrict our operating or acquisition activities.

Some of our existing notes payable contain restrictions, requirements and other limitations on our ability to incur additional debt on specific properties, as well as financial covenants relating to the performance of those properties. Our ability to borrow under these agreements is subject to compliance with these financial and other covenants. If we are unable to engage in activities that we believe would benefit those properties or we are unable to incur debt to pursue those activities, our growth may be limited.

Our new revolving credit facility will contain financial covenants that could harm our financial condition.

Our new revolving credit facility will contain financial and operating covenants, including coverage ratios and other limitations on our ability to incur secured and unsecured indebtedness, make distributions or other

payments to our stockholders (other than those required by the Code), sell all or substantially all of our assets and engage in mergers, consolidations and certain acquisitions. Failure to meet our financial covenants could result from, among other things, changes in our results of operations or changes in general economic conditions. These covenants may restrict our ability to engage in transactions that we believe would otherwise be in the best interests of our stockholders. Failure to comply with any of the covenants in our new revolving credit facility could result in a default under one or more of our debt instruments. This could cause one or more of our lenders to accelerate the timing of payments and could harm our business, operations, financial condition or liquidity.

Our organizational documents contain no limitations on the amount of debt we may incur, so we may become too highly leveraged.

Our organizational documents do not limit the amount of indebtedness that we may incur. If we become highly leveraged, then the resulting increase in cash flow that must be used for debt service would reduce cash available for distribution and could harm our ability to make payments on our outstanding indebtedness and our financial condition.

Five of our directors and executive officers have economic interests in other real estate investments, including hotels, which will result in conflicts and competing demands on their time and attention.

Since two of our directors, Messrs. Kazilionis and Paul, are managing principals of real estate private equity funds, these directors may have conflicts of interest in evaluating acquisition opportunities in which we and those funds have a potential interest. Messrs. Kazilionis and Paul are Managing Principals of Westbrook Real Estate Partners, L.L.C. and Mr. Paul is a Managing Principal of Rockpoint Group, LLC. Accordingly, these individuals will have competing demands on their time and attention and may take actions that are more favorable to these other entities than to us. In addition, Messrs. Alter, Kline and Stougaard have economic interests in other hotel investments and, therefore, may have competing demands on their time.

The Contributing Entities and their affiliates will continue to own interests in hotels that will compete with us.

The Contributing Entities and their affiliates, including our executive officers, will continue to own interests in other hotels in which we have no interest or rights. Some of these hotels are located in the same geographic area as our hotels, and hotels we acquire in the future also may be located in the same geographic area as the hotels owned by the Contributing Entities and their affiliates. Hotels located in the same geographic area compete for business, and this competition may harm our results of operations.

Because the Contributing Entities, in which Messrs. Alter, Kline and Stougaard have indirect interests, will receive a fixed number of shares of our common stock and membership units in the operating partnership, which is set by reference to our initial public offering price, they will benefit from an increase in the value of these securities if the price of our common stock increases.

The Contributing Entities will receive a fixed number of shares of our common stock and membership units in the operating partnership in connection with the Formation and Structuring Transactions, and that number will be determined by reference to our initial public offering price. The value of a membership unit will then correspond to the price of our common stock. Accordingly, the value of our common stock and the membership units will increase if the price of our common stock increases. The Contributing Entities, in whom Messrs. Alter, Kline and Stougaard have interests, hold membership units in our operating partnership. Therefore, if the price of our common stock increases, our affiliates will benefit from the resulting increase in value in the membership units.

Sales of our common stock by the Contributing Entities may reduce or eliminate the desire of two of our directors to serve on our board.

Messrs. Kazilionis and Paul are Managing Principals of Westbrook Real Estate Partners, L.L.C., which is the managing member of entities that have controlling ownership interests in the Contributing Entities. If the Contributing Entities sell their shares of our common stock, Messrs. Kazilionis and Paul, in light of their role at Westbrook Real Estate Partners, L.L.C., may resign from our board if Westbrook Real Estate Partners, L.L.C., which controls each of the Contributing Entities, no longer has an indirect ownership interest in us.

We face competition for the acquisition of hotels, and we may not be successful in identifying or completing hotel acquisitions that meet our criteria, which may impede our growth.

One component of our business strategy is expansion through acquisitions, and we may not be successful in identifying or completing acquisitions that are consistent with our strategy. We compete with institutional pension funds, private equity investors, other REITs, owner-operators of hotels, franchise-owned hotels and others who are engaged in the acquisition of hotels. These competitors may affect the supply/demand dynamics and, accordingly, increase the price we must pay for hotels or hotel companies we seek to acquire, and these competitors may succeed in acquiring those hotels or hotel companies themselves. Furthermore, our potential acquisition targets may find our competitors to be more attractive suitors because they may have greater marketing and financial resources, may be willing to pay more, or may have a more compatible operating philosophy. In addition, the number of entities competing for suitable hotels may increase in the future, which would increase demand for these hotels and the prices we must pay to acquire them. If we pay higher prices for hotels, our profitability may be reduced. Also, future acquisitions of hotels or hotel companies may not yield the returns we expect and, if financed using our equity, may result in stockholder dilution. In addition, our profitability may suffer because of acquisition-related costs or amortization costs for acquired goodwill and other intangible assets, and the integration of such acquisitions may cause disruptions to our business and may strain management resources.

The acquisition of a portfolio of hotels presents more risks to our business and financial results than the acquisition of a single hotel.

We have focused, and may continue to focus, on the acquisition of multiple hotels in single transactions to seek to reduce acquisition costs per hotel and enable us to expand our hotel portfolio more rapidly. Multiple hotel acquisitions, however, are generally more complex than single hotel acquisitions and, as a result, the risk that they will not be completed is greater. These acquisitions may also result in us owning hotels in geographically dispersed markets, which places additional demands on our ability to actively asset manage the hotels. In addition, we may be required by a seller to purchase a group of hotels as a package, even though one or more of the hotels in the package do not meet our investment criteria. In those events, we expect to attempt to sell the hotels that do not meet our investment criteria, but may not be able to do so on acceptable terms. These hotels may harm our operating results if they operate at a loss or we sell them at a loss. Also, a portfolio of hotels may also be more difficult to integrate with our existing hotels than a single hotel, may strain our management resources and may make it more difficult to find one or more management companies to operate the hotels. Any of these risks could harm our operating results.

Most of our hotels are upper upscale and upscale hotels, and the upper upscale and upscale segments of the lodging market are highly competitive and generally subject to greater volatility than other segments of the market, which could harm our profitability.

The upper upscale and upscale segments of the hotel business are highly competitive. Our hotels compete on the basis of location, room rates and quality, service levels, reputation and reservations systems, among many other factors. There are many competitors in our hotel chain scale segments, and many of these competitors have substantially greater marketing and financial resources than we have. This competition could reduce occupancy

levels and rental revenue at our hotels, which would harm our operations. Over-building in the hotel industry may increase the number of rooms available and may decrease occupancy and room rates. We will also face competition from nationally recognized hotel brands with which we will not be associated. In addition, in periods of weak demand, profitability is negatively affected by the relatively high fixed costs of operating upper upscale and upscale hotels when compared to other classes of hotels. For example, from 1998 to 2003, upscale RevPAR growth was lower than RevPAR growth for the overall lodging industry, and from 2001 to 2003, upper upscale RevPAR growth was lower than RevPAR growth for the overall lodging industry.

Rising operating expenses could reduce our cash flow and funds available for future distributions.

Our hotels, and any hotels we buy in the future, are and will be subject to operating risks common to the lodging industry in general. If any hotel is not occupied at a level sufficient to cover our operating expenses, then we could be required to spend additional funds for that hotel’s operating expenses. In the future, our hotels will be subject to increases in real estate and other tax rates, utility costs, operating expenses, insurance costs, repairs and maintenance and administrative expenses, which could reduce our cash flow and funds available for future distributions.

Our hotels are geographically concentrated in California and, accordingly, we could be disproportionately harmed by an economic downturn in this area of the country or a natural disaster, such as an earthquake.

Approximately 35% of our hotels, the largest concentration of our hotels in any state, representing 30% of our rooms and 32% of our 2003 pro forma revenues, are located in California. The concentration of hotels in California makes our business disproportionately affected by economic conditions, competition and real and personal property tax rates in California. Natural disasters in California, such as earthquakes, fires or mudslides, would disproportionately affect our hotel portfolio. The California economy and tourism industry, in comparison to other parts of the country, is negatively affected to a greater extent by changes and downturns in certain industries, including the entertainment and high technology industries. It is also possible that because of our California concentration, a change in California laws applicable to hotels and the lodging industry may have a greater impact on us than a change in comparable laws in another geographical area in which we have hotels. Adverse developments in California could harm our revenue or increase our operating expenses in that state.

Because most of our hotels are operated under franchise agreements with national franchisors, termination of franchise agreements or circumstances that negatively affect the franchisor itself could cause us to lose business at hotels operated under the franchisor’s name or lead to a default or acceleration of our obligations under certain of our notes payable.

Approximately 95% of our hotels, representing 91% of our rooms, on a pro forma basis, are operated under franchise or management agreements with national franchisors. In general, under franchise arrangements, the franchisor provides marketing services and room reservations and certain other operating assistance, but requires us, as the franchisee, to pay significant fees to it, and to maintain the hotel in a certain required condition. If the Management Company or other management companies fail to maintain these required standards, then the franchisor may terminate the franchise agreement and obtain damages for any liability we may have caused. Moreover, from time to time, we may receive notices from franchisors regarding our alleged non-compliance with the franchise agreements, and we may disagree with a franchisor’s claim that we are not in compliance with applicable franchise agreements. Any disputes arising under our franchise agreements could also lead to a termination of a franchise agreement and a payment of liquidated damages. Such a termination may trigger a default or acceleration of our obligations under some of our notes payable. In addition, as our agreements expire, we may not be able to renew them on favorable terms or at all. The franchise agreements on three of our hotels expire before December 31, 2005. If we were to lose a franchise on a particular hotel, it could harm the operation, financing, financeability or value of that hotel due to the loss of the franchise name, marketing support and centralized reservation system. Moreover, negative publicity affecting a franchisor in general could reduce the revenue we receive from the hotels subject to that particular franchise. Any loss of revenue at a hotel could

harm the TRS Lessee’s ability to pay rent to Sunstone Hotel Partnership and could harm our ability to make distributions to our stockholders.

Our franchisors require us to make capital expenditures pursuant to property improvement plans, or PIPs, under our franchise agreements, and the failure to make the expenditures required under the PIPs could cause the franchisors to terminate the franchise agreements.

As a result of the Formation and Structuring Transactions, some of our franchisors will require that new franchise agreements be executed with the TRS Lessee. As a condition to receiving the new franchise agreements, some of our franchisors will require that we make renovations to some of our hotels, which we expect to do as part of our ordinary capital expenditure programs. In addition, upon regular inspection of our hotels, our franchisors may determine that additional renovations are required to bring the physical condition of our hotels into compliance with the specifications and standards each franchisor has developed in connection with the operation of our hotels. The franchisors generally set forth their renovation requirements in PIPs and if we do not satisfy the PIP renovation requirements pursuant to the franchisor’s criteria, the franchisor will have the right to terminate the applicable franchise agreement. We cannot assure you that these requirements, which have not been determined by the franchisors at this time, will not be material or that we will agree that all renovations need to be made. In addition, in the event that we are in default under any franchise agreement as a result of our failure to comply with the PIP requirements, in general, we will be required to pay the franchisor liquidated damages, generally equal to a percentage of gross room revenue for the preceding two-, three- or five-year period for the hotel or a percentage of gross room revenue for the preceding twelve-month period for all hotels operated under the franchised brand if the hotel has not been operating for at least two years.

Our hotels have an ongoing need for renovations and other capital improvements, some of which are mandated by applicable laws or regulations or agreements with third parties, and the costs of such improvements may exceed our expectations or cause other problems.

In addition to capital expenditures required by our franchise and loan agreements, we will need to make capital expenditures to comply with applicable laws and regulations, remain competitive with other hotels and maintain the economic value of our hotels. Occupancy and ADR are often affected by the maintenance and improvements at a hotel. The costs of capital improvements we need or choose to make could harm our financial condition and reduce amounts available for distribution to our stockholders. These capital improvements may give rise to the following additional risks, among others:

•

construction cost overruns and delays;

•

a possible shortage of available cash to fund capital improvements and the related possibility that financing for these capital improvements may not be available to us on affordable terms;

•

uncertainties as to market demand or a loss of market demand after capital improvements have begun;

•

disruption in service and room availability causing reduced demand, occupancy and rates;

•

possible environmental problems; and

•

disputes with franchisors regarding our compliance with the requirements under the relevant franchise agreement.

Our returns depend on management of our hotels by third parties and, in particular, on the performance of Interstate Hotels & Resorts, Inc., or the Management Company.

In order to qualify as a REIT under the Code, we cannot directly operate our hotels or participate in the decisions affecting the daily operations of our hotels. Accordingly, we must enter into management agreements with eligible independent contractors to manage the hotels. Thus, independent management companies, including, among others, the Management Company, under management agreements with us, will control the daily operations of our hotels.

The Management Company will initially manage 50 of our 55 hotels, with three hotels being independently managed under franchise/management agreements with Marriott and two hotels being independently managed under franchise/management agreements with Hyatt. Under the terms of these management agreements, although we will be able to actively participate in setting operation strategies, we will not have the authority to require any hotel to be operated in a particular manner or to govern any particular aspect of the daily operations of any hotel (e.g., setting room rates, etc.). We will depend on these independent management companies to adequately operate our hotels as provided in the applicable management agreements. Thus, even if we believe a hotel is being operated inefficiently or in a manner that does not result in satisfactory average daily rates, occupancy rates and RevPAR, we may not have a contractual right to cause an independent management company to change its method of operation at our hotels. We can only seek redress if a management company violates the terms of its applicable management agreement with us or fails to meet performance objectives set forth in the applicable management agreement, and then only to the extent of the remedies provided in the management agreement. Additionally, while our management agreements typically provide for limited contractual penalties in the event that we terminate the applicable management agreement upon an event of default and, therefore, need to replace any of our management companies, those events could result in significant disruptions at the affected hotels upon the termination of a manager. If any of the foregoing occurs, our relationships with franchisors may be damaged, and we may be in breach of one or more of our franchise agreements.

Therefore, we will be dependent to a large degree on the operating performance of the Management Company and its ability to generate revenue at our hotels in excess of our operating expenses. We cannot assure you that the Management Company will successfully manage our hotels. A failure by the Management Company to successfully manage our hotels could lead to an increase in our operating expenses or a decrease in our revenue, which would reduce the amount available for distributions to our stockholders. In addition, the management companies may operate other hotels that may compete with our hotels or divert attention away from the management of our hotels.

Our contractual arrangements with the Management Company will be new. Accordingly, we cannot assure you that our relationship with the Management Company will be satisfactory to us, or that our expectations regarding the quality and effectiveness of its performance will be met. As a result, the management agreements with the Management Company could be terminated by us prior to the expiration of their respective terms, which would be disruptive to our business and could harm our profitability and cash flow.

Because we are a REIT, we depend on the TRS Lessee to make rent payments to us, and its inability to do so could harm our revenue and our ability to make distributions to our stockholders.

Due to certain Federal income tax restrictions on hotel REITs, we cannot directly operate our hotel properties. Therefore, we intend to lease our hotel properties to Sunstone Hotel TRS Lessee, Inc., our wholly owned subsidiary, or the TRS Lessee, who will contract with the Management Company and other third party hotel managers to manage our hotels. Our revenue and our ability to make distributions to our stockholders will depend solely upon the ability of the TRS Lessee to make rent payments under these leases. In general, under the leases with the TRS Lessee, we will receive from the TRS Lessee, both base rent and percentage rent based upon a percentage of gross revenue above a certain minimum level. As a result, we will participate in the economic operations of our hotels only through our share of gross revenue under the leases.

The TRS Lessee’s ability to pay rent will be affected by factors beyond its control, such as changes in general economic conditions, the level of demand for hotels and the related services of our hotels, competition in the lodging and hospitality industry, the ability to maintain and increase gross revenue at our hotels and other factors relating to the operations of our hotels.

Although failure on the part of the TRS Lessee to materially comply with the terms of a lease (including failure to pay rent when due) will give us the right to terminate the lease, repossess the hotel and enforce the payment obligations under the lease, such steps may not provide us with any substantive relief since the TRS

Lessee is our subsidiary. If we were to terminate a lease, we would then be required to find another lessee to lease the hotel since we cannot operate hotel properties directly and remain qualified as a REIT. We cannot assure you that we would be able to find another lessee or that, if another lessee were found, we would be able to enter into a new lease on terms as favorable to us.

Because land underlying eight of our hotels will be held by ground leases after the offering, termination of these leases by the ground lessors could cause us to lose the ability to operate these hotels altogether and incur substantial costs in restoring the premises.

Our rights to use the land underlying eight of our hotels following this offering will be based upon our interest under long-term ground leases. Pursuant to the terms of the ground leases for these hotels, we are required to pay all rent due and comply with all other lessee obligations under the ground leases. As of June 30, 2004, the terms of these ground leases (including renewal options) range from 27 to 92 years. Any pledge of our interest in a ground lease may also require the consent of the applicable ground lessor and its lenders. As a result, we may not be able to sell, assign, transfer or convey our lessee’s interest in any hotel subject to a ground lease in the future absent consent of such third parties even if such transactions may be in the best interest of our stockholders.

The ground lessor may require us, at the expiration or termination of the ground lease to surrender or remove any improvements, alterations or additions to the land at our own expense. The ground leases also generally require us to restore the premises following a casualty or taking and to apply in a specified manner any proceeds received in connection therewith. We may have to restore the premises if a material casualty, such as a fire or an act of God, occurs and the cost thereof may exceed available insurance proceeds.

Our hedging strategies may not be successful in mitigating our risks associated with interest rates.

We use various derivative financial instruments to provide a level of protection against interest rate risks, but no hedging strategy can protect us completely. When rates change, we expect to record a gain or loss on derivatives. Our hedging activities may include entering into interest rate swaps, caps and floors and options to purchase these items. We currently use interest rate caps to manage our interest rate risks related to our variable rate indebtedness; however, our actual hedging decisions will be determined in light of the facts and circumstances existing at the time and may differ from our currently anticipated hedging strategy. We cannot assure you that our hedging strategy and the derivatives that we use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses, and such losses could harm our results of operations, financial condition and business prospects.

In addition, we also may be limited in the type and amount of hedging transactions we may use in the future by our need to satisfy the REIT income tests under the Code. Only income from certain hedging transactions qualifies for purposes of the 95% gross income test, and no hedging income qualifies for purposes of the 75% gross income test. As a result, our ability to effectively hedge against changes in interest rates could be limited, and our earnings could be reduced and could vary more from period to period.

Risks Related to This Offering

Of our total outstanding shares of common stock immediately after this offering, shares will be restricted from immediate resale but may be sold into the market in the near future. This could cause the market price of our common stock to drop significantly, even if our business is doing well.

Immediately after this offering, we will have approximately shares of our common stock outstanding. Of these shares, the shares we are selling in this offering will be freely tradable, except for any shares purchased by our “affiliates,” as that term is used in Rule 144 of the Securities Act. Affiliates may only sell their shares pursuant to the requirements of Rule 144, in a registered public offering or pursuant to an exemption under the Securities Act. Unless sold earlier pursuant to a registered public offering, the remaining shares will become available for resale in the public market at various times in the future. In addition, after this offering, we intend to register all shares of our common stock that we may issue under our 2004 long-term incentive plan, and once we register these shares, they can be freely sold in the public market after issuance.

The sale of these shares, or the possibility of the sale of these shares, could cause the market price of our common stock to decline significantly and could impair our ability to raise capital through the sale of additional stock.

The Contributing Entities may sell their shares of our common stock at times or in amounts that could cause our stock price to decline.

The Contributing Entities may sell their shares of our common stock received in connection with the Formation and Structuring Transactions beginning 180 days after the consummation of this offering. In addition, the Contributing Entities are finite life investment entities and, beginning 12 months from the date of this offering, may seek to convert their membership units in Sunstone Hotel Partnership in an amount up to shares of our common stock. The Contributing Entities may sell these shares of our common stock pursuant to an exemption under the Securities Act and also have the right to cause us to file registration statements related to these shares. These sales may cause our stock price to decline.

Our affiliates will receive material benefits in connection with this offering and the related transactions.

The Contributing Entities, all of which are controlled by Westbrook Real Estate Partners, L.L.C., will receive an aggregate of ____ shares of our common stock (with an aggregate value of approximately $_________, based on an assumed initial public offering price of $______, which is the midpoint of the price range set forth on the cover of this prospectus), $______ in cash in exchange for our purchase of ________ membership units and ______ membership units net of such purchase (with an aggregate value of approximately $______, based on an assumed initial public offering price of $______, which is the midpoint of the price range set forth on the cover of this prospectus). By virtue of their interests in entities that are members of the Contributing Entities, Mr. Alter will receive $_____, Mr. Kline will receive $_____ and Mr. Stougaard will receive $______ in cash from the purchase of the membership units and the distribution of the proceeds to the holders of interests in the Contributing Entities, and each will maintain an indirect minority interest in the common stock and membership units held by the Contributing Entities by virtue of those interests and the arrangements those members have to receive certain pro rata portions of distributions made by the Contributing Entities. If the underwriters’ over-allotment option is exercised, the dollar amounts of the cash that the Contributing Entities and Messrs. Alter, Kline and Stougaard will receive will be higher.

We have not obtained independent third party appraisals of our hotels and, thus, the economic consideration paid in the Formation and Structuring Transactions to the Contributing Entities may exceed the fair market value of the hotels.

In connection with the Formation and Structuring Transactions, we did not obtain independent third party appraisals for any of the hotels owned by the Contributing Entities, and the terms of the contribution agreement

related to those entities were not negotiated on an arm’s length basis. Because the allocation of interests in Sunstone Hotel Partnership and common stock in us has been fixed, the actual value of the consideration paid for the assets of the Contributing Entities will depend on the initial public offering price of shares of our common stock. As a result, the consideration paid by us in the Formation and Structuring Transactions may exceed the fair market value of the assets we receive, and we could realize less value in the transaction than we would have realized if the agreements had been entered into with an unrelated third party or if we had obtained independent third party appraisals.

The use of the net proceeds from this offering to repay $63.5 million of indebtedness that has been extended by an affiliate of one of our underwriters creates a conflict of interest because this underwriter will have an interest in the successful completion of this offering beyond the underwriting discounts and commissions it will receive.

One of the lenders under our outstanding indebtedness is an affiliate of Citigroup Global Markets, Inc., one of our underwriters. We intend to use $63.5 million, or %, of the net proceeds of this offering to pay down indebtedness owed to this affiliate. Accordingly, this underwriter will have interests that are different from us and the other underwriters in the successful completion of this offering. This payment could affect actions and decisions by this underwriter, including its due diligence activities under the Securities Act.

The terms of our management agreements with the Management Company were negotiated by us and Sunstone Hotel Investors, L.L.C., which had a conflict of interest because of the payment it will receive from the Management Company for its interests in the subsidiary that managed our hotels prior to the Formation and Structuring Transactions.

The terms of the management agreements with the Management Company are the result of negotiations among us, Sunstone Hotel Investors, L.L.C. and the Management Company. The Management Company will purchase the corporate subsidiary that manages our hotels and employs the employees of our hotels from Sunstone Hotel Investors, L.L.C., and will pay $8.0 million in cash to Sunstone Hotel Investors, L.L.C., which payment will not be contributed to us in the Formation and Structuring Transactions. As a result of this payment, Sunstone Hotel Investors, L.L.C. had a conflict of interest with us in negotiating the management agreements with the Management Company.

We could be exposed to substantial liabilities for events or circumstances that predate the consummation of this offering.

In connection with the contribution by the Contributing Entities of the hotel properties and entities to us in connection with the Formation and Structuring Transactions, we assumed the liabilities associated with those properties and entities that were incurred prior to the consummation of the Formation and Structuring Transactions. In addition, in connection with the Management Company’s agreement to purchase the corporate subsidiary of Sunstone Hotel Investors, L.L.C. that manages our hotels and employs the employees of our hotels, the Management Company required that we indemnify it from any liabilities of the corporate subsidiary that accrued prior to the consummation of this offering. These potential liabilities may include, without limitation, liabilities associated with the employees who currently work or previously worked for the corporate subsidiary. At this time, we are not able to quantify the potential liabilities, if any, which may arise as a result of our acquisition of the hotel properties and entities in the Formation and Structuring Transactions or the indemnification of the Management Company. Any such claims could give rise to economic liabilities which could be substantial and for which we would have no recourse. If any such liability is established against us, our financial condition could be harmed.

There is no prior public market for our common stock, and our stock price could be volatile and decline substantially following this offering.

Prior to this offering, there has not been any public market for our common stock and, even though we intend to apply for listing of our common stock on the NYSE under the symbol “SHO,” we cannot assure you

that an active trading market for our common stock will develop or, if developed, that any such market will be sustained. In the absence of a public trading market, an investor may be unable to liquidate an investment in our common stock. The initial public offering price will be determined in consultation with representatives of the underwriters. Among the factors to be considered in determining the initial public offering price of our common stock, in addition to prevailing market conditions, will be our historical performance, estimates of our business potential and earnings prospects, an assessment of our management and the consideration of the above factors in relation to the market valuation of companies in related businesses. The initial public offering price does not necessarily bear any relationship to our book value or the fair market value of our hotel properties. We have not obtained any third-party appraisals of our hotels or any other independent third-party valuations in connection with the Formation and Structuring Transactions. As a result, the economic consideration given by us in the Formation and Structuring Transactions may exceed the fair market value of our hotels. The price at which the shares of our common stock will sell in the public market after the completion of this offering may be lower than the price at which they are sold by the underwriters.

The market price of our equity securities may vary substantially.

The trading prices of equity securities issued by REITs may be affected by changes in market interest rates. One of the factors that may influence the price of our common stock or preferred stock, if any, in public trading markets is the annual yield from distributions on our common stock or preferred stock, if any, as compared to yields on other financial instruments. An increase in market interest rates, or a decrease in our distributions to stockholders, may lead prospective purchasers of our stock to demand a higher annual yield, which could reduce the market price of our equity securities.

Other factors that could affect the market price of our equity securities include the following:

•

actual or anticipated variations in our quarterly or annual results of operations;

•

changes in market valuations of companies in the hotel or real estate industries;

•

changes in expectations of our future financial performance or changes in our estimates by securities analysts;

•

the trading volumes of our stock;

•

the reputation and performance of our franchisors;

•

the reputation and performance of the Management Company and our other management companies;

•

additional issuances of our common stock or other securities in the future;

•

the addition or departure of key personnel or board members;

•

announcements by us or our competitors of acquisitions, investments or strategic alliances;

•

adverse market reaction to any increased indebtedness we incur in the future; and

•

general market, economic and political conditions and world events.

Our actual distributions to stockholders may differ from the estimate set forth in this prospectus.

We intend to make regular quarterly distributions of $ per share to holders of our common stock. We established this distribution amount based upon an estimate of cash available for distribution after this offering. Distributions will be authorized and determined by our board of directors in its sole discretion and will be dependent upon a number of factors, including restrictions under applicable law and our capital requirements. Our estimate may not prove to be accurate, particularly if actual results of operations, economic conditions or other factors differ materially from the assumptions used in our estimate. In addition, if we have underestimated our cash available for distribution, we may need to increase our borrowings to fund our intended distributions. Accordingly, actual distributions may be significantly different from the expected distributions set forth in this prospectus.

If you purchase shares of our common stock in this offering, you will experience immediate dilution.

We expect the initial public offering price of our common stock to be higher than the tangible book value per share of our outstanding common stock. Accordingly, if you purchase shares of our common stock in this offering, you will experience immediate dilution of approximately $ in the tangible book value per share of common stock. This means that investors who purchase shares of our common stock in this offering will pay a price per share that exceeds the book value of our assets after subtracting our liabilities. In addition, each person purchasing common stock in this offering will experience further dilution to the extent that additional shares of our common stock are issued upon the conversion of outstanding membership units of Sunstone Hotel Partnership.

Risks Related to Our Organization and Structure

Immediately after this offering, the Contributing Entities will own approximately % of our shares and may exercise significant control over our company and possibly delay or prevent us from or cause us to defer taking actions that would be beneficial to our other stockholders.

Immediately after this offering, our largest stockholders, the Contributing Entities and their affiliates, will beneficially own approximately % of our common stock. Accordingly, the Contributing Entities and their affiliates will be able to exercise significant control over the outcome of substantially all matters required to be submitted to our stockholders for approval, including decisions relating to the election of our board of directors, and influence the determination of our day-to-day corporate and management policies, the appointment of executive officers, the amount of distributions, the timing of additional offerings (including offerings of our securities held by them) and the terms of the management agreements with the Management Company and the other independent management companies and the leases with the TRS Lessee. In addition, we intend to enter into an agreement with the Contributing Entities pursuant to which the Contributing Entities, acting as a group, will have the right to require our board of directors and nominating and corporate governance committee to nominate up to two of their designees to our board of directors based on their percentage ownership interest in us at that time. Also, the Contributing Entities and their affiliates will together be able to exercise significant control over the outcome of any proposed merger or consolidation of our company under Maryland law. The Contributing Entities and their affiliates’ ownership interest in our company may discourage third parties from seeking to acquire control of our company, which may harm the market price of our shares of common stock.

Provisions of Maryland law and our organizational documents may limit the ability of a third party to acquire control of our company and may depress our stock price.

Provisions of Maryland law and our charter and bylaws could have the effect of discouraging, delaying or preventing transactions that involve an actual or threatened change of control of us, and may have the effect of entrenching our management and members of our board of directors, regardless of performance. These provisions include the following:

Aggregate Share and Common Share Ownership Limits . In order for us to qualify as a REIT, no more than 50% of the value of outstanding shares of our stock may be owned, actually or constructively, by five or fewer individuals at any time during the last half of each taxable year. To assure that we will not fail to qualify as a REIT under this test, subject to some exceptions, our charter prohibits any stockholder from owning actually or constructively more than 9.8% of the value or number of outstanding shares of our common stock, whichever is more restrictive, or 9.8% of the value of the aggregate outstanding shares of our capital stock. Any attempt to own or transfer shares of our capital stock in excess of the ownership limit without the consent of our board of directors will be void and could result in the shares (and all dividends thereon) being automatically transferred to a charitable trust. This ownership limitation may prevent a third party from acquiring control of us if our board of directors does not grant an exemption from the ownership limitation, even if our stockholders believe the change of control is in their best interests. Immediately after this offering, the Contributing Entities and their affiliates will continue to beneficially own more than 9.8% of the outstanding shares of our common stock, or % thereof. Our board of directors has granted an exemption from the ownership limit to the Contributing Entities and their affiliates.

Authority to Issue Stock . Our charter authorizes our board of directors to cause us to issue up to 500,000,000 shares of common stock and up to 100,000,000 shares of preferred stock. Our charter authorizes our board of directors to amend our charter without stockholder approval to increase or decrease the aggregate number of shares of stock or the number of shares of any class or series of our stock that it has authority to issue, to classify or reclassify any unissued shares of our common stock or preferred stock and to set the preferences, rights and other terms of the classified or reclassified shares. Issuances of additional shares of stock may have the effect of delaying or preventing a change in control of our company, including change of control transactions offering a premium over the market price of shares of our common stock, even if our stockholders believe that a change of control is in their interest.

Number of directors, board vacancies, term of office . Under our charter and bylaws, we have elected to be subject to certain provisions of Maryland law which vest in the board of directors the exclusive right to determine the number of directors and the exclusive right, by the affirmative vote of a majority of the remaining directors, to fill vacancies on the board even if the remaining directors do not constitute a quorum. Any director elected to fill a vacancy shall hold office until the next annual meeting of stockholders, and until his or her successor is elected and qualifies. As a result, stockholder influence over these matters is limited.

Limitation on stockholder requested special meetings . Our bylaws provide that our stockholders have the right to call a special meeting only upon the written request of the stockholders entitled to cast not less than a majority of all the votes entitled to be cast by the stockholders at such meeting. This provision makes it more difficult for stockholders to call special meetings.

Advance notice provisions for stockholder nominations and proposals . Our bylaws require advance written notice for stockholders to nominate persons for election as directors at, or to bring other business before, any meeting of our stockholders. This bylaw provision limits the ability of our stockholders to make nominations of persons for election as directors or to introduce other proposals unless we are notified in a timely manner prior to the meeting.

Exclusive authority of our board to amend our bylaws . Our bylaws provide that our board of directors has the exclusive power to adopt, alter or repeal any provision of the bylaws or to make new bylaws. Thus, our stockholders may not effect any changes to our bylaws.

Duties of directors . Maryland law requires that a director perform his or her duties (1) in good faith, (2) in a manner he or she reasonably believes to be in the best interests of the corporation and (3) with the care that an ordinary prudent person in a like position would use in similar circumstances. Maryland law provides protection for Maryland corporations against unsolicited takeovers because the duties of directors of Maryland corporations do not require them to (1) accept, recommend or respond to any proposal by a person seeking to acquire control of the corporation, (2) authorize the corporation to redeem any rights under, of modify or render inapplicable, any stockholders rights plan, (3) make a determination under the Maryland Business Combination Act or the Maryland Control Share Acquisition Act or (4) act or fail to act solely because of the effect the act or failure to act may have on an acquisition or potential acquisition of control of the corporation or the amount or type of consideration that may be offered or paid to the stockholders in an acquisition. Moreover, under Maryland law the act of the directors of a Maryland corporation relating to or affecting an acquisition or potential acquisition of control is not subject to any higher duty or greater scrutiny than is applied to any other act of a director. Maryland law also contains a statutory presumption that an act of a director of a Maryland corporation satisfies the applicable standards of conduct for directors under Maryland law. This provision increases the ability of our directors to respond to a takeover and makes it more difficult for a third party to effect a takeover.

Unsolicited Takeover Provisions. Provisions of Maryland law permit the board of a corporation with a class of equity securities registered under the Securities Exchange Act of 1934 and at least three independent directors, without stockholder approval, to implement possible takeover defenses, such as a classified board. These provisions may make it more difficult for a third party to effect a takeover.

Our management team has no history of operating a REIT and managing a public company, which may give rise to inefficiencies or strain our operations and resources.

We have recently been organized and we have no operating history as a REIT. Our management team has operated our business as a privately-owned company for the past five years and, therefore, other than Mr. Alter, has no experience operating a REIT and managing a publicly-owned company. We will need to develop control systems and procedures adequate to support a public REIT, and this transition could place a significant strain on our management systems, infrastructure, financial condition and other resources.

We rely on our executive officers, the loss of whom could significantly harm our business.

Our continued success will depend to a significant extent on the efforts and abilities of our executive officers, especially Messrs. Alter, Kline and Stougaard. These individuals are important to our business and strategy and to the extent that any of them departs and is not replaced with an experienced substitute, such person’s departure could harm our operations, financial condition and operating results.

Because we expect to make changes to our operations to effect the Formation and Structuring Transactions and to qualify and elect to be treated as a REIT, our future financial performance may be affected by unanticipated changes and may differ materially from our historical and pro forma performance.

The historical financial data presented in this prospectus is the historical financial data for our predecessor companies. The Formation and Structuring Transactions will result in changes to our assets and operations, which are reflected in our pro forma financial data. However, we are unable to predict all changes that will result under our new structure, including our agreements with the Management Company. Accordingly, you should not rely on our historical or pro forma financial data as a predictor of our future performance.

Risks Related to the Lodging and Real Estate Industries

A number of factors, many of which are common to the lodging industry and beyond our control, could affect our business, including the following:

•

increased threat of terrorism, terrorist events, airline strikes or other factors that may affect travel patterns and reduce the number of business and commercial travelers and tourists and other factors that may not be offset by increased room rates;

•

increased competition from other hotels in our markets;

•

new hotel supply in our markets, which could harm our occupancy levels and revenue at our hotels;

•

dependence on business and commercial travel, leisure travel and tourism;

•

increases in operating costs due to inflation, labor costs (including the impact of unionization), workers’ compensation and health-care related costs, utility costs, insurance and unanticipated costs such as acts of nature and their consequences and other factors that may not be offset by increased room rates;

•

changes in interest rates and in the availability, cost and terms of debt financing and other changes in our business that adversely affect our ability to comply with covenants in our debt financing;

•

changes in our relationships with, and the performance and reputation of, our management companies and franchisors;

•

changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance with laws and regulations, fiscal policies and ordinances;

•

adverse effects of international market conditions, which may diminish the desire for leisure travel or the need for business travel, as well as national, regional and local economic and market conditions where our hotels operate and where our customers live; and

•

adverse effects of a downturn in the lodging industry.

These factors could harm our financial condition, results of operations and ability to make distributions to our stockholders.

The hotel business is seasonal and seasonal variations in revenue at our hotels can be expected to cause quarterly fluctuations in our revenue.

Our revenue is generally highest in the second and third quarters. Quarterly revenue also may be harmed by events beyond our control, such as extreme weather conditions, terrorist attacks or alerts, contagious diseases, airline strikes, economic factors and other considerations affecting travel. To the extent that cash flow from operations is insufficient during any quarter due to temporary or seasonal fluctuations in revenue, we may have to enter into short-term borrowings to make distributions to our stockholders.

The threat of terrorism has harmed the hotel industry generally, including our results of operations and these harmful effects may continue or worsen, particularly if there are further terrorist events.

The threat of terrorism has had a negative impact on hotel operations and caused a significant decrease in hotel occupancy and average daily rates due to disruptions in business and leisure travel patterns and concerns about travel safety. Hotels in major metropolitan areas and near airports, such as many of our hotels, have been harmed due to concerns about air travel safety and a significant overall decrease in the amount of air travel, particularly transient business travel, which includes the corporate and premium business segments that generally pay the highest average room rates. Future terrorist acts, terrorism alerts or outbreaks of hostilities could have a negative effect on travel and, correspondingly, on our business.

The attacks of September 11, 2001 had a dramatic adverse impact on business and leisure travel, hotel occupancy and RevPAR. While there have been recent improvements, the uncertainty associated with the continuing war on terrorism and the possibility of future attacks may continue to hamper business and leisure travel patterns and, accordingly, the performance of our business.

The use of Internet travel intermediaries by consumers may harm our profitability as a result of increased commissions or lower room rates.

Some of our hotel rooms are booked through independent Internet travel intermediaries such as Travelocity.com, Expedia.com, Orbitz.com, Hotels.com and Priceline.com. For the first half of 2004, 1.9% of our room revenues were attributable to bookings through these intermediaries. As we may continue to selectively use these Internet intermediaries to generate sales, they may be able to obtain higher commissions, reduced room rates or other significant contract concessions from us. If the amount of sales made through Internet intermediaries increases significantly and we fail to appropriately price room inventory in a manner that maximizes yields, or we are unable to do so, our room revenue may flatten or decrease and our profitability may decline.

The illiquidity of real estate investments and the lack of alternative uses of hotel properties could significantly limit our ability to respond to adverse changes in the performance of our hotels and harm our financial condition.

Because real estate investments are relatively illiquid, our ability to promptly sell one or more of our hotels in response to changing economic, financial and investment conditions is limited. The real estate market, including our hotels, is affected by many factors, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond our control. We may not be able to sell any of our hotels on favorable terms. It may take a long time to find a willing purchaser and to close the sale of a hotel if we want to sell. Should we decide to sell a hotel during the term of that particular hotel’s management agreement, we may have to pay termination fees, which could be substantial, to the appropriate management company.

In addition, hotels may not readily be converted to alternative uses if they were to become unprofitable due to competition, age of improvements, decreased demand or other factors. The conversion of a hotel to alternative uses would also generally require substantial capital expenditures and may give rise to substantial payments to our franchisors, management companies and lenders.

We may be required to expend funds to correct defects or to make improvements before a hotel can be sold. We may not have funds available to correct those defects or to make those improvements and, as a result, our ability to sell the hotel would be restricted. In acquiring a hotel, we may agree to lock-out provisions that materially restrict us from selling that hotel for a period of time or impose other restrictions on us, such as a limitation on the amount of debt that can be placed or repaid on that hotel to address specific concerns of sellers. These lock-out provisions would restrict our ability to sell a hotel. These factors and any others that would impede our ability to respond to adverse changes in the performance of our hotels could harm our financial condition and results of operations.

Claims by persons relating to our properties could affect the attractiveness of our hotels or cause us to incur additional expenses.

We could incur liabilities resulting from loss or injury to our hotels or to persons at our hotels. These losses could be attributable to us or result from actions taken by a management company, including the Management Company. For example, during 2003, a suit was filed against us by a hotel guest who alleged that an illness resulted from exposure to legionella bacteria during a stay at one of our hotels. Claims such as these, whether or not they have merit, could harm the reputation of a hotel or cause us to incur expenses to the extent of insurance deductibles or losses in excess of policy limitations, which could harm our results of operations.

Uninsured and underinsured losses could harm our financial condition, results of operations and ability to make distributions to our stockholders.

Various types of catastrophic losses, such as losses due to wars, terrorist acts, earthquakes, floods, hurricanes, pollution or environmental matters, generally are either uninsurable or not economically insurable, or may be subject to insurance coverage limitations, such as large deductibles or co-payments. Immediately upon the completion of this offering, 19 of our hotels are located in California, which has been historically at greater risk to certain acts of nature (such as fires and earthquakes) than other states.

In the event of a catastrophic loss, our insurance coverage may not be sufficient to cover the full current market value or replacement cost of our lost investment. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a hotel, as well as the anticipated future revenue from the hotel. In that event, we might nevertheless remain obligated for any notes payable or other financial obligations related to the property, in addition to obligations to our ground lessors, franchisors and managers. Inflation, changes in building codes and ordinances, environmental considerations and other factors might also keep us from using insurance proceeds to replace or renovate a hotel after it has been damaged or destroyed. Under those circumstances, the insurance proceeds we receive might be inadequate to restore our economic position on the damaged or destroyed hotel.

Since September 11, 2001, it has generally become more difficult and expensive to obtain property and casualty insurance, including coverage for terrorism. When our current insurance policies expire, we may encounter difficulty in obtaining or renewing property or casualty insurance on our hotels at the same levels of coverage and under similar terms. Such insurance may be more limited and for some catastrophic risks (e.g., earthquake, fire, flood and terrorism) may not be generally available at current levels. Even if we are able to renew our policies or to obtain new policies at levels and with limitations consistent with our current policies, we cannot be sure that we will be able to obtain such insurance at premium rates that are commercially reasonable. If we are unable to obtain adequate insurance on our hotels for certain risks, it could cause us to be in default under specific covenants on certain of our indebtedness or other contractual commitments we have to our ground

lessors, franchisors and managers which require us to maintain adequate insurance on our properties to protect against the risk of loss. If this were to occur, or if we were unable to obtain adequate insurance and our properties experienced damages which would otherwise have been covered by insurance, it could harm our financial condition and results of operations.

Laws and governmental regulations may restrict the ways in which we use our hotel properties and increase the cost of compliance with such regulations. Noncompliance with such regulations could subject us to penalties, loss of value of our properties or civil damages.

Our hotel properties are subject to various Federal, state and local laws relating to the environment, fire and safety and access and use by disabled persons. Under these laws, courts and government agencies have the authority to require us, if we are the owner of a contaminated property, to clean up the property, even if we did not know of or were not responsible for the contamination. These laws also apply to persons who owned a property at the time it became contaminated. In addition to the costs of cleanup, environmental contamination can affect the value of a property and, therefore, an owner’s ability to borrow funds using the property as collateral or to sell the property. Under such environmental laws, courts and government agencies also have the authority to require that a person who sent waste to a waste disposal facility, such as a landfill or an incinerator, to pay for the clean-up of that facility if it becomes contaminated and threatens human health or the environment.

Furthermore, various court decisions have established that third parties may recover damages for injury caused by property contamination. For instance, a person exposed to asbestos while staying in or working at a hotel may seek to recover damages for injuries suffered. Additionally, some of these environmental laws restrict the use of a property or place conditions on various activities. For example, some laws require a business using chemicals (such as swimming pool chemicals at a hotel) to manage them carefully and to notify local officials that the chemicals are being used.

We could be responsible for the types of costs discussed above. The costs to clean up a contaminated property, to defend against a claim, or to comply with environmental laws could be material and could reduce the funds available for distribution to our stockholders. Future laws or regulations may impose material environmental liabilities on us, or the current environmental condition of our hotel properties may be affected by the condition of the properties in the vicinity of our hotels (such as the presence of leaking underground storage tanks) or by third parties unrelated to us.

Our hotel properties are also subject to the Americans with Disabilities Act of 1990, or the ADA. Under the ADA, all public accommodations must meet various Federal requirements related to access and use by disabled persons. Compliance with the ADA’s requirements could require removal of access barriers and non-compliance could result in the U.S. government imposing fines or in private litigants’ winning damages. If we are required to make substantial modifications to our hotels, whether to comply with the ADA or other changes in governmental rules and regulations, our financial condition, results of operations and the ability to make distributions to our stockholders could be harmed. In addition, we are required to operate our hotel properties and laundry facilities in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted by governmental agencies and become applicable to our properties.

Tax and Employee Benefit Plan Risks

Your investment has various Federal income tax risks.

Although the provisions of the Code relevant to your investment are generally described in “U.S. Federal Income Tax Considerations,” we strongly urge you to consult your own tax advisor concerning the effects of Federal, state and local income tax law on an investment in our common stock and on your individual tax situation.

If we fail to qualify as a REIT, our distributions will not be deductible by us and our income will be subject to Federal taxation, reducing our cash available for distribution.

We intend to qualify as a REIT under the Code, which will afford us significant tax advantages. The requirements for this qualification, however, are complex. If we fail to meet these requirements, our distributions will not be deductible by us and we will have to pay a corporate Federal level tax on our income. This would substantially reduce our cash available to pay distributions and your yield on your investment in our common stock. In addition, such a tax liability might cause us to borrow funds, liquidate some of our investments or take other steps which could negatively affect our results of operations. Moreover, if our REIT status is terminated because of our failure to meet a technical REIT requirement or if we voluntarily revoke our election, we would generally be disqualified from electing treatment as a REIT for the four taxable years following the year in which REIT status is lost.

Even if we qualify and maintain our status as a REIT, we may become subject to Federal, state or local taxes on our income or property, reducing our cash available for distribution.

Even if we qualify and maintain our status as a REIT, we may become subject to Federal income taxes and related state taxes. For example, if we have net income from a “prohibited transaction,” that income will be subject to a 100% tax. A “prohibited transaction” is, in general, the sale or other disposition of inventory or property, other than foreclosure property, held primarily for sale to customers in the ordinary course of business. We may not be able to make sufficient distributions to avoid excise taxes applicable to REITs. We may also decide to retain income we earn from the sale or other disposition of our property and pay Federal income tax directly on that income. In that event, our stockholders would be treated as if they earned that income and paid the tax on it directly. However, stockholders that are tax-exempt, such as charities or qualified pension plans, would have no benefit from their deemed payment of that tax liability.

We may also be subject to state and local taxes on our income or property, either directly or at the level of our operating partnership or at the level of the other companies through which we indirectly own our assets. We cannot assure you that we will be able to continue to satisfy the REIT requirements, or that it will be in our best interests to continue to do so.

In view of the complexity of the tax aspects of this offering, particularly in light of the fact that some of the tax aspects of this offering will not be the same for all investors, prospective investors are strongly advised to consult their own tax advisors with specific reference to their own tax situation prior to an investment in shares of our common stock.

If the leases of our hotels to our taxable REIT subsidiary are not respected as true leases for Federal income tax purposes, we would fail to qualify as a REIT.

To qualify as a REIT, we must satisfy two gross income tests, under which specified percentages of our gross income must be passive income, like rent. For the rent paid pursuant to the leases of our hotels to Sunstone Hotel Partnership by our taxable REIT subsidiary, the TRS Lessee, which constitutes substantially all of our gross income, to qualify for purposes of the gross income tests, the leases must be respected as true leases for Federal income tax purposes and not be treated as service contracts, joint ventures or some other type of arrangement. If the leases are not respected as true leases for Federal income tax purposes, we would fail to qualify as a REIT.

Our taxable REIT subsidiary is subject to special rules that may result in increased taxes.

Several Code provisions ensure that a taxable REIT subsidiary is subject to an appropriate level of Federal income taxation. For example, a taxable REIT subsidiary, such as the TRS Lessee, is limited in its ability to deduct interest payments made to an affiliated REIT. In addition, the REIT has to pay a 100% penalty tax on

some payments that it receives if the economic arrangements between us and the taxable REIT subsidiary are not comparable to similar arrangements between unrelated parties. The IRS may successfully assert that the economic arrangements of any of our inter-company transactions, including the hotel leases, are not comparable to similar arrangements between unrelated parties.

We may be required to pay a penalty tax upon the sale of a hotel.

The Federal income tax provisions applicable to REITs provide that any gain realized by a REIT on the sale of property held as inventory or other property held primarily for sale to customers in the ordinary course of business is treated as income from a “prohibited transaction” that is subject to a 100% penalty tax. Under current law, unless a sale of real property qualifies for a safe harbor, the question of whether the sale of a hotel (or other property) constitutes the sale of property held primarily for sale to customers is generally a question of the facts and circumstances regarding a particular transaction. We may make sales that do not satisfy the requirements of the safe harbors or the IRS may successfully assert that one or more of our sales are prohibited transactions and, therefore we may be required to pay a penalty tax.

We also may be subject to corporate level income tax on certain built-in gains.

We will hold certain properties acquired from C corporations (and may acquire additional such properties in the future), in which we must adopt the C corporation’s tax basis in that asset as our tax basis. If we sell any such property within ten years of the date on which we acquire it, then we will have to pay tax on the gain at the highest regular corporate tax rate.

An investment in our common stock may not be suitable for every employee benefit plan.

When considering an investment in our common stock, an individual with investment discretion over assets of any pension plan, profit-sharing plan, retirement plan, individual retirement account under Section 408(a) of the Code or other employee benefit plan covered by the Employee Retirement Income Security Act of 1974, as amended, or ERISA, should consider whether the investment satisfies the requirements of Section 404 of ERISA or other applicable laws. In particular, attention should be paid to the diversification requirements of Section 404(a)(1)(C) of ERISA in light of all the facts and circumstances, including the portion of the plan’s portfolio of which the investment will be a part. All plan investors should also consider whether the investment is prudent and meets plan liquidity requirements as there may be only a limited market in which to sell or otherwise dispose of our common stock, and whether the investment is permissible under the plan’s governing instrument. We have not, and will not, evaluate whether an investment in our common stock is suitable for any particular plan.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements contained in this prospectus constitute forward-looking statements. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or the negative of these terms or other comparable terminology.

The forward-looking statements contained in this prospectus reflect our current views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from those expressed in any forward-looking statement. The factors that could cause actual results to differ materially from expected results include changes in economic, business, competitive market and regulatory conditions. Important risks and factors that could cause our actual results to differ materially from any forward-looking statements include, without limitation, the following:

•

the factors discussed in this prospectus set forth under the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations;”

•

downturns in economic and market conditions, particularly levels of spending in the travel and leisure industries in the markets where we invest;

•

hostilities, including future terrorist attacks, or fear of hostilities that affect travel within or to the United States;

•

the performance and reputation of the Management Company and the other independent hotel management companies with whom we contract;

•

the risks associated with the Formation and Structuring Transactions;

•

unknown liabilities and our indemnity of the Management Company;

•

the performance and reputation of our franchisors;

•

increases in interest rates and operating costs;

•

difficulties in identifying hotels to acquire and completing and integrating acquisitions;

•

our ability to sell existing hotels in a manner consistent with our business strategy;

•

changes in our board and executive officers;

•

risks related to natural disasters, including earthquakes;

•

general volatility of the capital markets and the market price of our shares of common stock;

•

our failure to qualify and maintain our status as a REIT;

•

changes in real estate and zoning laws or regulations;

•

increases in real property tax rates; and

•

changes in the competitive environment in our industry.

We do not intend, and disclaim any duty or obligation, to update or revise any industry information or forward-looking statements set forth in this prospectus to reflect new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the events described by our forward-looking statements might not occur. We qualify any and all of our forward-looking statements by these cautionary factors. Please keep this special note in mind as you read this prospectus.

This prospectus contains market data, industry statistics and other data that have been obtained from, or compiled from, information made available by third parties. We have not independently verified their data.

USE OF PROCEEDS

We estimate that the net cash proceeds to us from this offering will be approximately $ million, assuming an initial public offering price of $ per share, which is the midpoint of the price range set forth on the cover of this prospectus, and after deducting the underwriting discount and estimated offering expenses of $ payable by us. If the underwriters’ over-allotment option is exercised in full, we will sell an additional shares in this offering and will receive additional net proceeds of approximately $ million.

Sunstone Hotel Investors will use the net proceeds of this offering to purchase membership units in Sunstone Hotel Partnership held by the Contributing Entities for $ in cash (at a price per unit equal to the net proceeds per share to us after underwriting discounts and commissions but before any other expenses) and contribute the remaining net proceeds of this offering to Sunstone Hotel Partnership in exchange for an additional membership units from Sunstone Hotel Partnership. In addition, all net proceeds from the exercise of the underwriters’ overallotment option will be used for the purchase of additional membership units in Sunstone Hotel Partnership held by the Contributing Entities.

Sunstone Hotel Partnership intends to use the net proceeds received from Sunstone Hotel Investors as follows:

•

approximately $ million to retire or pay down outstanding principal and interest on the following indebtedness immediately upon the completion of this offering, with such principal paydowns based upon the outstanding principal as of June 30, 2004:

•

approximately $ million of debt to Bear Stearns Commercial Mortgage, Inc. that bears interest at the greater of one-month LIBOR or 2.0% plus a spread of 345 basis points (5.5% at June 30, 2004) and matures on January 1, 2006, which will reduce the spread to a maximum of 240 basis points;

•

approximately $ million of debt to Citigroup Global Markets Realty Corp. that bears interest at one-month LIBOR plus a spread of 325 basis points (4.6% at June 30, 2004) and matures on October 11, 2005;

•

approximately $ million of debt to Citigroup Global Markets Realty Corp. that bears interest at the greater of one-month LIBOR or 2.5% plus a spread of 800 basis points (10.5% at June 30, 2004) and matures on October 11, 2005;

•

approximately $ million of debt to Deutsche Bank Mortgage Capital, L.L.C. that bears interest at one-month LIBOR plus a spread of 290 basis points (4.3% at June 30, 2004) and matures on January 9, 2005; and

•

approximately $ million of debt to GE Commercial Finance that bears interest at one-month LIBOR plus a spread of 360 basis points (5.0% at June 30, 2004) and matures on February 1, 2005;

•

approximately $6.3 million to exercise the option to acquire the ground lessor’s interest in the ground lease relating to the Embassy Suites, Chicago, Illinois;

•

approximately $ million to pay application fees to our franchisors related to the execution of franchise agreements with the TRS Lessee as part of the Formation and Structuring Transactions; and

•

approximately $ million for general corporate purposes.

We have discretion in the manner in which we will use the net proceeds from this offering and may do so in ways not specified in this section.

DISTRIBUTION POLICY

In order to qualify as a REIT, we must annually distribute to our stockholders an amount at least equal to:

•

90% of our REIT taxable income (determined before the deduction for dividends paid and excluding any net capital gain); plus

•

90% of the excess of our net income from foreclosure property over the tax imposed on such income by the Code; less

•

any excess non-cash income (as determined under Sections 856 through 860 of the Code).

Accordingly, we intend to make quarterly distributions. However, the timing and frequency of distributions will be authorized by our board of directors and declared by us out of assets legally available therefor based upon a number of factors, including:

•

our actual results of operations;

•

distributions we receive from Sunstone Hotel Partnership, which depends on payments received by it from the TRS Lessee;

•

our debt service requirements;

•

capital expenditure requirements for our hotels;

•

unforeseen expenditures at the hotels;

•

unforeseen liabilities arising from acts or omissions prior to or after this offering;

•

our taxable income;

•

the annual distribution requirement under the REIT provisions of the Code;

•

our operating expenses; and

•

other factors that our board of directors may deem relevant.

Our cash available for distributions may be less than 90% of our REIT taxable income in which case we could be required to either sell assets or borrow funds to make distributions.

Following this offering, we intend to pay a quarterly distribution of $ per share. On an annualized basis, this distribution would be $ per share, or an annual distribution rate of approximately % based on an initial public offering price of $ per share, which is the midpoint of the price range of set forth on the cover of this prospectus. Our ability to make distributions to our stockholders will depend, in part, upon the management of our hotels by the Management Company and other independent management companies that the TRS Lessee has contracted with to operate our hotels. Distributions to our stockholders will generally be taxable to our stockholders as ordinary income. Because a significant portion of our investments will be equity ownership interests in hotels, which will result in depreciation and non-cash charges against our income, a portion of our distributions may constitute a tax-free return of capital. Distributions in excess of our current and accumulated earnings and profits and not treated by us as a dividend will not be taxable to a taxable U.S. stockholder under current Federal income tax law to the extent those distributions do not exceed the stockholder’s adjusted tax basis in his or her common stock, but rather will reduce the adjusted basis of the common stock. Therefore, the gain (or loss) recognized on the sale of that common stock or upon our liquidation will be increased (or decreased) accordingly. To the extent those distributions exceed a taxable U.S. stockholder’s adjusted tax basis in his or her common stock, they generally will be treated as a capital gain realized from the taxable disposition of those shares. Sunstone Hotel Partnership intends to make quarterly distributions to holders of membership units, including us. The TRS Lessee intends to distribute cash it does not need in its business to us, which will then be available for distribution by us to our stockholders and will generally be taxable to our stockholders as dividends.

The following table sets forth calculations relating to intended initial distributions based on our pro forma financial data. The calculations are being made solely for the purpose of illustrating the initial distribution and are not necessarily intended to be a basis for determining future distributions.


		Pro Forma Six months ended June 30, 2004
		(dollars in thousands)
Net income (loss)		$
FFO ⁽¹⁾
Required capital expenditures ⁽²⁾
Scheduled principal amortization payments on notes payable ⁽³⁾

Cash available for distribution		$

Intended initial distribution ⁽⁴⁾
Ratio of intended initial distribution to pro forma cash available for distribution		$

(1)	For a definition and discussion of FFO, and a reconciliation to net income (loss), see “Selected Financial and Operating Data.”

(2)	Based on the amount of capital expenditures required pursuant to our management, franchise and loan agreements, which ranged from % to % of the revenues for each hotel.

(3)	Based on pro forma notes payable as of June 30, 2004.

(4)

Based on shares of our common stock and membership units in Sunstone Hotel Partnership outstanding and not owned by us following this offering. This amount will not increase if the underwriters’ over-allotment option is exercised since the aggregate number of shares and membership units not owned by us will not change.

DILUTION

Net Tangible Book Value

As of June 30, 2004, on a pro forma basis after giving effect to the Formation and Structuring Transactions, but before this offering, our net tangible book value was $ million, or $ per share. Net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the number of shares of our common stock outstanding and issuable upon exchange of membership units of Sunstone Hotel Partnership convertible into shares of our common stock.

Dilution After This Offering

Purchasers of our common stock in this offering will experience an immediate dilution of the net tangible book value of our common stock from the initial public offering price. Dilution in net tangible book value per share represents the difference between the amount per share paid by the purchasers of our common stock in this offering and the net tangible book value per share immediately after this offering. After giving effect to:

•

the sale of our common stock offered by this prospectus;

•

the issuance of shares of our common stock issuable upon the conversion of outstanding membership units in Sunstone Hotel Partnership; and

•

the deduction of underwriting discounts and estimated offering expenses and the application of the net proceeds as described under “Use of Proceeds”

our pro forma net tangible book value as of June 30, 2004 would have been $ million, or $ per share of common stock. This amount represents an immediate dilution in pro forma net tangible book value of $ per share of common stock to purchasers of common stock in this offering. The following table illustrates this per share dilution:


Initial public offering price per share		$

Pro forma net tangible book value per share before this offering ⁽¹⁾	$

Increase in pro forma net tangible book value per share to existing stockholders attributable to this offering and the Formation and Structuring Transactions	$

Decrease in pro forma net tangible book value per share to existing stockholders attributable to the conversion of outstanding membership units of our operating partnership	$

Pro forma net tangible book value per share after this offering ⁽²⁾		$

Dilution in pro forma net tangible book value per share to new investors ⁽³⁾		$

(1)

Net tangible book value per share of common stock before this offering is determined by dividing tangible book value of $ million (total tangible assets less total liabilities) on a pro forma basis after giving effect to the Formation and Structuring Transactions, by shares of our common stock outstanding and shares of our common stock issuable upon conversion of membership units in Sunstone Hotel Partnership.

(2)	Based on pro forma net tangible book value after this offering of approximately $ million divided by shares of our common stock outstanding and shares of our common stock issuable upon conversion of membership units in Sunstone Hotel Partnership.

(3)	Dilution is determined by subtracting pro forma net tangible book value per share of our common stock after giving effect to the Formation and Structuring Transactions and this offering from the initial public offering price paid by a new investor for a share of our common stock.

Differences Between New and Existing Stockholders in Number of Shares of Common Stock and Amount Paid

The table below summarizes, as of June 30, 2004, on the pro forma basis discussed above, the differences between the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid by existing stockholders and by the new investors purchasing shares of common stock in this offering. We used the initial public offering price of $ per share, and we have not deducted estimated underwriting discounts and commissions and estimated offering expenses in our calculations.

Shares/

Units Issued

Cash/Tangible

Book Value

Cash/Tangible
Book Value
Per Share

Number

Percentage

Amount

Percentage

Existing stockholders

⁽¹

⁾

Units of our operating partnership

⁽²

⁾

New investors in this offering

⁽³

⁾

Total

100

(1)	Based on the June 30, 2004 net tangible book value (consisting of total tangible assets less total liabilities) less minority interest.

(2)	Represents the pro forma net tangible book value of minority interest attributable to the units of Sunstone Hotel Partnership owned by the Contributing Entities.

(3)	Represents the gross proceeds from this offering, before deducting underwriting discounts, commissions and other expenses of this offering.

FORMATION AND STRUCTURING TRANSACTIONS

The following simplified chart sets forth our ownership structure prior to the Formation and Structuring Transactions described below.

LOGO

On June 28, 2004, Sunstone Hotel Investors, Inc. was formed as a Maryland corporation with perpetual existence. On June 29, 2004, Sunstone Hotel Partnership was formed as a Delaware limited liability company. Each of the Contributing Entities is controlled by Westbrook Real Estate Partners, L.L.C.

In connection with the Formation and Structuring Transactions, the following steps will occur immediately prior to this offering of our common stock:

Step One : Each corporation that is directly or indirectly owned by a corporate subsidiary of Sunstone Hotel Investors, L.L.C., other than any corporation that is a lessee, management company or holding company with no assets or economic participation, will convert into a limited liability company.

Step Two : The Contributing Entities will contribute to Sunstone Hotel Partnership all of their assets, other than (1) the corporation that currently manages our hotels and employs the employees for our hotels, (2) interests in the Embassy Suites, Los Angeles, California and the JW Marriott, Cherry Creek, Colorado, and (3) the ownership interests in hotel properties and corporations, which will be sold or merged with and into us in Step Eight, in return for membership units in Sunstone Hotel Partnership.

Step Three : Each of the specific corporations referenced in part (3) in Step Two will distribute to the Contributing Entities all of its current and accumulated earnings and profits, which aggregated approximately $4.4 million at June 30, 2004. This distribution will be satisfied through the distribution of the Embassy Suites, Los Angeles, California referenced in Step Six.

Step Four : All of the lessee companies, which will be subsidiaries of Sunstone Hotel Partnership, will merge into a single surviving lessee corporation, Sunstone Hotel TRS Lessee, Inc., which we refer to as the TRS Lessee.

Step Five : Sunstone Hotel Partnership will contribute all of the membership units in Buy Efficient, L.L.C. that it received in Step Two to the TRS Lessee.

Step Six : Sunstone Hotel Investors, L.L.C. will distribute its interests in the Embassy Suites, Los Angeles, California to Alter SHP LLC, an entity affiliated with Robert A. Alter, in consideration for the redemption of a 3.3% interest in Sunstone Hotel Investors, L.L.C.

Step Seven : The Contributing Entities will sell the corporate subsidiary that currently manages our hotels and employs the employees for our hotels to the Management Company and will receive from the Management Company $8.0 million in cash, of which $6.0 million will be paid at the closing of this offering and $2.0 million will be paid on or before December 31, 2005, and the TRS Lessee will enter into management agreements with the Management Company.

Step Eight : Simultaneously,

•

the Contributing Entities will sell their interests in the specific hotels not contributed in Step Two to us and will cause each of the specific corporations not contributed in part (3) in Step Two to merge with and into us in exchange for shares of our common stock; and

•

we will complete this offering by issuing shares of our common stock for cash, or shares if the underwriters fully exercise their option to purchase additional shares of our common stock.

Sunstone Hotel Investors, Inc. will use $ of the proceeds to purchase Sunstone Hotel Partnership membership units from the Contributing Entities at a price per unit equal to the net proceeds per share to us, after underwriting discounts and commissions but before any other expenses, and contribute the remaining net proceeds and assets held by us to Sunstone Hotel Partnership in exchange for Sunstone Hotel Partnership membership units. If the underwriters fully exercise their option to purchase additional shares of our common stock, Sunstone Hotel Investors, Inc. will then purchase additional Sunstone Hotel Partnership membership units for $ in cash from the Contributing Entities. As a result, immediately after the Formation and Structuring Transactions, the Contributing Entities will own % of our common stock and the purchasers in this offering will own % of our common stock, and the Contributing Entities will own % of Sunstone Hotel Partnership and we will own % of Sunstone Hotel Partnership. If the underwriters’ over-allotment option is exercised, the Contributing Entities will own % of our common stock and the purchasers in this offering will own % of our common stock, and the Contributing Entities will own % of Sunstone Hotel Partnership and we will own % of Sunstone Hotel Partnership. Assuming conversion of all of the membership units in Sunstone Hotel Partnership, the Contributing Entities would own % of our common stock, or % if the underwriters’ over-allotment is exercised.

The Contributing Entities and some of our directors and officers may be considered our founders because they participated in founding and organizing our business. The Contributing Entities formed us and will cause the Formation and Structuring Transactions to occur. Messrs. Kaziolionis, Paul and Alter serve on the executive committees of the Contributing Entities. Mr. Alter is also an officer of the Contributing Entities, and Mr. Kline served as an officer of the Contributing Entities prior to the Formation and Structuring Transactions. Messrs. Kaziolionis, Paul and Alter will serve as members of our board of directors and Messrs. Alter, Kline and Stougaard will serve as executive officers of us following the Formation and Structuring Transactions.

The following simplified chart sets forth our corporate structure immediately following the Formation and Structuring Transactions described above and this offering:

LOGO

The Contributing Entities consist of Sunstone Hotel Investors, L.L.C., Sunstone/WB Hotel Investors IV, LLC, WB Hotel Investors, LLC, and Sunstone/WB Manhattan Beach, LLC. Each of the Contributing Entities is controlled by Westbrook Real Estate Partners, L.L.C.

As illustrated in the chart above, Sunstone Hotel Partnership becomes the operating partnership in an umbrella partnership real estate investment trust, or UPREIT, structure with the following owners: Sunstone Hotel Investors, Inc., which is the REIT and the sole managing member of the operating partnership, and the Contributing Entities. In an UPREIT, the operating partnership directly owns all properties, and the REIT owns a substantial interest in and, in our case, is the sole managing member of the operating partnership.

The TRS Lessee, as tenant, will lease the hotels from Sunstone Hotel Partnership, the operating partnership, as landlord. The TRS Lessee will contract with the Management Company and, with respect to five hotels, with Hyatt or Marriott, so that such parties may operate the hotels for the TRS Lessee.

CAPITALIZATION

The following table sets forth our capitalization as of June 30, 2004, on an historical basis, on a pro forma basis to give effect to the Formation and Structuring Transactions and the elimination of hotels held for sale (discontinued operations), and on a pro forma basis to give effect to the Formation and Structuring Transactions, the elimination of hotels held for sale (discontinued operations) and this offering and the use of the net proceeds from this offering as described in “Use of Proceeds.”


	June 30, 2004
	Historical		Pro Forma for Formation and Structuring Transactions		Pro Forma
	(unaudited)
	(dollars in thousands)
Long-term debt:
Line of credit	$	—	$	—	$
Notes payable, less current portion ⁽¹⁾		848,307		785,121

Total long-term debt		848,307		785,121
Minority interests		528		528
Members’ equity		330,731		312,894		—
Preferred stock, $0.01 par value, no shares authorized, issued and outstanding, historical; 100,000,000 shares authorized, shares issued and outstanding, pro forma		—		—		—
Common stock, $0.01 par value, 100 shares authorized, issued and outstanding, historical; 500,000,000 shares authorized, shares issued and outstanding, pro forma for Formation and Structuring Transactions; and shares issued and outstanding, pro forma ⁽²⁾		—		—
Additional paid-in capital		—		—

Total equity		330,731		312,894

Total capitalization	$	1,179,566	$	1,098,543	$

(1)	See “Outstanding Indebtedness” for a description of our notes payable, including our new revolving credit facility. Excludes current portion of long-term debt of $64,666 and $64,487 as of June 30, 2004 for the Historical and Pro Forma for Formation and Structuring Transactions, respectively.

(2)	The common stock outstanding as shown includes shares of our common stock to be issued in this offering and the common stock to be issued to the Contributing Entities as part of the Formation and Structuring Transactions and excludes:

•

shares of our common stock issuable upon exercise of the underwriters’ option to purchase additional shares;

•

additional shares of our common stock available for future issuance under our 2004 long-term incentive plan; and

•

shares of our common stock reserved for issuance with respect to units of Sunstone Hotel Partnership that may, subject to limits in the operating agreement for Sunstone Hotel Partnership, be exchanged for cash or, at our option, shares of our common stock generally commencing 12 months after the completion of this offering.

SELECTED FINANCIAL AND OPERATING DATA

You should read the following selected historical financial and operating data together with “Unaudited Pro Forma Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our combined financial statements and related notes included elsewhere in this prospectus.

The selected historical financial data as of December 31, 2002 and 2003 and for the years ended December 31, 2001, 2002 and 2003 has been derived from our combined financial statements audited by Ernst & Young LLP, independent registered public accounting firm, whose report with respect thereto is included elsewhere in this prospectus. The selected historical financial data as of June 30, 2004 and for the six months ended June 30, 2003 and 2004 has been derived from our unaudited combined financial statements included elsewhere in this prospectus.

The unaudited pro forma financial information presented gives effect to (1) hotel acquisitions and hotels held for sale (discontinued operations), (2) the Formation and Structuring Transactions and (3) this offering and the application of the net proceeds. It presents the unaudited pro forma combined balance sheet data as of June 30, 2004 as if these transactions had occurred as of June 30, 2004 and the unaudited pro forma combined statement of operations data for the year ended December 31, 2003 and the six months ended June 30, 2004 as if these transactions had occurred as of the beginning of the periods indicated. The adjustments are discussed in detail under “Unaudited Pro Forma Financial Data.” The unaudited pro forma financial data does not purport to represent what our financial position or results of operations would actually have been if this offering and the application of the net proceeds from this offering had in fact occurred on the dates discussed above. You should read the assumptions on which the pro forma financial data is based from pages F-2 through F-9 in connection with the pro forma financial data contained in this summary.

EBITDA represents net income (loss) excluding: (1) interest expense; (2) provision for income taxes, including income taxes applicable to sale of assets; and (3) depreciation and amortization. We believe EBITDA is useful to an investor in evaluating our operating performance because it provides an indication of our ability to incur and service debt, to satisfy general operating expenses, to make capital expenditures and to fund other cash needs or reinvest cash into our business. We also believe it helps investors evaluate and compare the results of our operations from period to period by removing the impact of our asset base (primarily depreciation and amortization) from our operating results. We also use EBITDA as one measure in determining the value of hotel acquisitions and dispositions.

We compute FFO in accordance with standards established by the National Association of Real Estate Investment Trusts, or NAREIT, an industry trade group. The Board of Governors of NAREIT in its March 1995 White Paper (as amended in November 1999 and April 2002) defines FFO to mean net income (loss) before minority interests (computed in accordance with GAAP), excluding gains and losses from debt restructuring and sales of property, plus real estate-related depreciation and amortization (excluding amortization of deferred financing costs), and after adjustment for unconsolidated partnerships and joint ventures. We believe that the presentation of FFO provides useful information to investors regarding our operating performance because it is a measure of our ability to pay distributions, fund capital expenditures and expand our business. In addition, we use FFO to measure our operating performance without regard to items such as real estate depreciation and amortization.

We caution investors that amounts presented in accordance with our definitions of EBITDA, and FFO may not be comparable to similar measures disclosed by other companies, since not all companies calculate these non-GAAP measures in the same manner. EBITDA and FFO should not be considered as an alternative measure of our net income (loss), operating performance, cash flow or liquidity. EBITDA and FFO may include funds that may not be available for our discretionary use due to functional requirements to conserve funds for capital expenditures and

property acquisitions and other commitments and uncertainties. Although we believe that EBITDA and FFO can enhance your understanding of our results of operations, these non-GAAP financial measures, when viewed individually, are not necessarily a better indicator of any trend as compared to GAAP measures such as net income (loss) or cash flow from operations. In addition, you should be aware that adverse economic and market conditions may harm our cash flow. Under “Summary Historical and Pro Forma Financial and Operating Data” and this section, as required, we include a quantitative reconciliation of EBITDA and FFO to the most directly comparable GAAP financial performance measure, which is net income (loss).

We acquired 15 hotels in December 2002, as discussed in more detail in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which affects the comparability of the data reflected herein.

You should read the following historical and pro forma financial and operating data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Unaudited Pro Forma Financial Data” and our combined financial statements and related notes included elsewhere in this prospectus.


	Year ended or as of December 31,																Six months ended or as of June 30,
	1999 ⁽¹⁾			2000			2001			2002			2003			2003 Pro Forma	2003			2004			2004 Pro Forma
	(unaudited)			(unaudited)						(in thousands)

Combined statement of operations data:
Revenues:
Room	$	140,007		$	165,748		$	181,284		$	191,794		$	315,812		$	$	151,531		$	166,957		$
Food and beverage		31,227			38,373			41,885			47,700			107,200				51,670			54,849
Other operating		20,783			18,206			20,311			21,721			36,985				17,548			21,576
Management and other fees from affiliates		—			—			—			194			705				132			522

Total revenues		192,017			222,327			243,480			261,409			460,702				220,881			243,904

Operating expenses:
Room		31,519			35,886			41,288			43,318			74,471				35,338			37,267
Food and beverage		25,024			30,233			33,293			35,010			76,750				37,300			37,923
Other operating		13,548			13,312			13,744			14,537			25,582				11,534			14,320
Advertising and promotion		17,033			11,448			13,670			15,478			29,362				14,287			14,743
Repairs and maintenance		7,492			8,578			10,067			11,081			21,186				10,194			10,675
Utilities		7,399			8,807			11,243			11,464			19,538				9,110			10,129
Franchise costs		4,137			12,090			3,747			14,984			24,005				11,317			12,814
Property tax, ground lease and insurance		4,508			9,765			12,048			13,143			29,196				14,472			13,625
General and administrative		27,470			30,523			46,689			39,122			64,229				30,156			32,853
Depreciation and amortization		31,535			26,245			30,117			34,213			53,481				26,398			28,444
Impairment loss		—			—			—			6,789			11,382				—			7,439
Goodwill amortization		753			6,797			4,925			—			—				—			—
Merger and transactions cost		14,000			—			—			—			—				—			—

Total operating expenses		184,418			193,684			220,831			239,139			429,182				200,106			220,232

Operating income (loss)		7,599			28,643			22,649			22,270			31,520				20,775			23,672
Interest and other income		881			658			1,070			2,080			712				328			216
Interest expense		(23,812	)		(43,345	)		(42,338	)		(29,186	)		(55,235	)			(26,202	)		(26,576	)

Loss before minority interest, income taxes, cumulative effect of change in accounting principle and discontinued operations		(15,332	)		(14,044	)		(18,619	)		(4,836	)		(23,003	)			(5,099	)		(2,688	)
Minority interest		569			(424	)		—			—			(17	)			—			166
Income tax benefit (provision) ⁽²⁾		—			—			8,770			4,715			2,017				(359	)		(780	)

Loss from continuing operations before cumulative effect of change in accounting principle and discontinued operations		(14,763	)		(14,468	)		(9,849	)		(121	)		(21,003	)			(5,458	)		(3,302	)
Cumulative effect of change in accounting principle		—			—			(1,326	)		—			—				—			—
Income (loss) from discontinued operations		8,068			5,734			(7,632	)		(10,265	)		(1,263	)			(1,207	)		(18,188	)

Net loss	$	(6,695	)	$	(8,734	)	$	(18,807	)	$	(10,386	)	$	(22,266	)	$	$	(6,665	)	$	(21,490	)	$

EBITDA	$	72,772		$	101,027		$	73,293		$	59,533		$	96,855		$	$	53,713		$	36,025		$
FFO		37,168			29,575			19,071			29,602			23,465				23,827			8,682
Cash flows from operating activities					46,170			43,317			26,720			60,034				26,190			28,628


	Year ended or as of December 31,																Six months ended or as of June 30,
	1999 ⁽¹⁾			2000			2001			2002			2003			2003 Pro Forma	2003			2004			2004 Pro Forma
	(in thousands, except statistical data)
Combined balance sheet data:
Investment in hotel properties, net	$	892,932		$	992,509		$	821,588		$	1,316,659		$	1,227,537			$	1,345,143		$	1,194,216
Hotel properties held for sale, net		—			—			—			—			—				—			22,232
Total assets		1,028,700			1,132,312			915,654			1,445,889			1,364,942				1,487,807			1,355,519
Notes payable		583,842			665,157			515,407			942,423			917,652				969,690			912,973
Total liabilities		679,999			773,196			616,869			1,047,147			1,033,993				1,085,358			1,024,260
Equity		346,306			359,116			298,785			398,742			330,345				402,449			330,731

Statistical data:
Number of hotels		59			65			52			66			61				66			60
Number of rooms		10,525			12,502			10,804			15,664			14,901				15,664			14,529
Occupancy ⁽³⁾		65.0	%		68.0	%		66.2	%		68.0	%		68.1	%			66.4	%		70.2	%
Average daily rate ⁽³⁾	$	86.54		$	89.17		$	88.36		$	87.40		$	95.09			$	95.59		$	96.51
RevPAR ⁽³⁾	$	56.25		$	60.64		$	58.49		$	59.43		$	64.76			$	63.47		$	67.75

(1)	Combined for the periods before and after the going private transaction on November 22, 1999.

(2)	See Note 9 to the Combined Financial Statements of Sunstone Hotel Investors, L.L.C., WB Hotel Investors, LLC and Sunstone/WB Hotel Investors IV, LLC.

(3)	Excludes hotels held in discontinued operations, which are described elsewhere in this prospectus.

The following tables show the reconciliation between net income (loss) and EBITDA, and net income (loss) and FFO for the periods indicated:

Reconciliation of Net Income (Loss) to EBITDA


	Year ended December 31,																Six months ended June 30,
	1999 ⁽¹⁾			2000			2001			2002			2003			2003 Pro Forma	2003			2004			2004 Pro Forma
	(unaudited)			(unaudited)						(in thousands)
Net income (loss)	$	(6,695	)	$	(8,734	)	$	(18,807	)	$	(10,386	)	$	(22,266	)	$	$	(6,665	)	$	(21,490	)	$

Depreciation and amortization —continuing operations		32,288			33,042			35,042			34,213			53,481				26,398			28,444
Depreciation and amortization —discontinued operations		12,328			12,064			8,023			5,732			7,007				4,094			1,346
Interest expense —continuing operations		23,812			43,345			42,338			29,186			55,235				26,202			26,576
Interest expense —discontinued operations		11,039			21,310			15,767			5,172			6,262				3,106			1,288
Income tax provision (benefit) —continuing operations ⁽ ² ⁾		—			—			(8,770	)		(4,715	)		(2,017	)			359			780
Income tax provision (benefit) —discontinued operations		—			—			(300	)		331			(847	)			219			(919	)

EBITDA ⁽³⁾	$	72,772		$	101,027		$	73,293		$	59,533		$	96,855		$	$	53,713		$	36,025		$

(1)	Combined for the periods before and after the going private transaction on November 22, 1999.

(2)	See Note 9 to the Combined Financial Statements of Sunstone Hotel Investors, L.L.C., WB Hotel Investors, LLC and Sunstone/WB Hotel Investors IV, LLC.

(3)

EBITDA has not been adjusted for the cumulative effect of a change in accounting principle of $1.3 million in 2001 pertaining to the adoption of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , as amended, which required us to recognize all derivatives on the balance sheet at fair value. EBITDA also has not been adjusted for the following amounts included in net income (loss) because these items have either occurred during the prior two years or are reasonably likely to occur within two years:


	Year ended December 31,													Six months ended June 30,
	1999		2000		2001			2002		2003			2003 Pro Forma	2003		2004		2004 Pro Forma
	(unaudited)		(unaudited)					(in thousands)
(Gain) loss on sale of assets	$	—	$	—	$	(262	)	$	43	$	(14,757	)	$	$	—	$	382	$
Impairment loss—continuing operations		—		—		—			6,789		11,382				—		7,439
Impairment loss—discontinued operations		—		—		3,985			9,658		16,991				—		16,954

Total	$	—	$	—	$	3,723		$	16,490	$	13,616		$	$	—	$	24,775	$

Reconciliation of Net Income (Loss) to Funds From Operations, or FFO


	Year ended December 31,																Six months ended June 30,
	1999 ⁽¹⁾			2000			2001			2002			2003			2003 Pro Forma	2003			2004			2004 Pro Forma
	(in thousands)
Net income (loss)	$	(6,695	)	$	(8,734	)	$	(18,807	)	$	(10,386	)	$	(22,266	)	$	$	(6,665	)	$	(21,490	)	$
Depreciation and amortization—continuing operations ⁽²⁾		31,535			26,245			30,117			34,213			53,481				26,398			28,444
Depreciation and amortization—discontinued operations		12,328			12,064			8,023			5,732			7,007				4,094			1,346
(Gain) loss on sale of assets		—			—			(262	)		43			(14,757	)			—			382

FFO ⁽³⁾	$	37,168		$	29,575		$	19,071		$	29,602		$	23,465		$	$	23,827		$	8,682		$

(1)	Combined for the periods before and after the going private transaction on November 22, 1999.

(2)	Depreciation and amortization—continuing operations for FFO reconciliation purposes excludes $0.8 million, $6.8 million and $4.9 million of goodwill amortization in 1999, 2000 and 2001, respectively.

(3)

FFO has not been adjusted for the cumulative effect of a change in accounting principle of $1.3 million in 2001 pertaining to our adoption of the requirements of SFAS No. 133, Accounting for Derivatives and Hedging Activities , as amended, which required us to recognize all derivatives on the balance sheet at fair value. FFO also has not been adjusted for the following amounts included in net income (loss) because these items have either occurred during the prior two years or are reasonably likely to occur within two years:


	Year ended December 31,											Six months ended June 30,
	1999		2000		2001		2002		2003		2003 Pro Forma	2003		2004		2004 Pro Forma
	(in thousands)
Impairment loss—continuing operations	$	—	$	—	$	—	$	6,789	$	11,382	$	$	—	$	7,439	$
Impairment loss—discontinued operations		—		—		3,985		9,658		16,991			—		16,954

Total	$	—	$	—	$	3,985	$	16,447	$	28,373	$	$	—	$	24,393	$

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion together with “Selected Financial and Operating Data,” “Unaudited Pro Forma Financial Data” and our combined financial statements and related notes appearing elsewhere in this prospectus.

Overview

We own primarily upper upscale and upscale hotels in the United States operated under leading brand names franchised or licensed from others, such as Marriott, Hilton, InterContinental, Hyatt, Starwood, Carlson and Wyndham.

Operations

Our historical financial data is for our predecessor companies, who owned and operated the hotels during the periods presented. In connection with this offering, we expect to make substantial changes to our operations to effect the Formation and Structuring Transactions and to qualify and elect to be treated as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code. As a result, our historical results of operations and financial position are not indicative of our results of operations and financial position after completion of the Formation and Structuring Transactions.

Formation and Structuring Transactions and this offering . The following items associated with the completion of the Formation and Structuring Transactions and this offering will affect our future results of operations:

•

the payment of management fees to the Management Company, which will assume responsibility for our hotel operations pursuant to the management agreements with us;

•

the reduction of corporate general and administrative costs as a result of the employee transfers to the Management Company;

•

the reflection of a minority interest to give effect to the interests in Sunstone Hotel Partnership owned by the Contributing Entities;

•

the exclusion of the JW Marriott, Cherry Creek, Colorado (acquired in April 2004), the Embassy Suites, Los Angeles, California, and three other hotels that are held for sale as of June 30, 2004;

•

the reduction in interest expense as a result of the repayment of some of our notes payable;

•

the reduction in ground lease expense reflecting the exercise of our option to acquire the ground lessor’s interest in the land under the Embassy Suites, Chicago, Illinois; and

•

the incremental costs associated with operating as a public company, which are estimated to be approximately $2.2 million per year.

The effects of these matters are described under “Unaudited Pro Forma Financial Data.”

REIT structure . For us to qualify as a REIT, our income cannot be derived from our operation of hotels. Therefore, consistent with the provisions of the Code, Sunstone Hotel Partnership and its subsidiaries will lease our hotel properties to our taxable REIT subsidiary lessee, Sunstone Hotel TRS Lessee, Inc., or the TRS Lessee, who will in turn contract with “eligible independent contractors” to manage our hotels. Under the Code, an “eligible independent contractor” is an independent contractor who is actively engaged in the trade or business of operating “qualified lodging facilities” for any person unrelated to us and the TRS Lessee. Sunstone Hotel Partnership and the TRS Lessee will be consolidated into our financial statements for accounting purposes. Since we control both Sunstone Hotel Partnership and our TRS Lessee, our principal source of funds on a consolidated basis will be from the performance of our hotels. The earnings of the TRS Lessee will be subject to taxation like other C corporations, which will reduce our operating results, funds from operations and the cash otherwise available for distribution to our stockholders.

Factors Affecting Our Results of Operations

Revenues. Substantially all of our revenues are derived from the operation of our hotels. Specifically, our revenues consists of the following:

•

Room revenue , which is primarily driven by occupancy and average daily rate;

•

Food and beverage revenue , which is primarily driven by occupancy and banquet/catering bookings;

•

Other operating revenue , which consists of ancillary hotel revenue such as telephone, parking, spa, golf, entertainment and other guest services and is primarily driven by occupancy. Additionally, this category includes operating revenue from our two commercial laundry facilities located in Rochester, Minnesota and Salt Lake City, Utah and our electronic purchasing platform, Buy Efficient, L.L.C.; and

•

Management and other fees from affiliates , which consists of other non-operating income and management and other fees from our affiliates prior to the Formation and Structuring Transactions.

The following performance indicators are commonly used in the hotel industry:

•

occupancy;

•

average daily rate, or ADR;

•

revenue per available room, or RevPAR, which is the product of occupancy and ADR, but does not include food and beverage revenue, other operating revenue or management and other fees from affiliates; and

•

hotel operating margin, which tracks our profitability by measuring the percentage of hotel operating income (room, food and beverage and other operating revenues, less hotel operating expenses, which consist of room, food and beverage and other hotel expenses) divided by hotel operating revenues (room, food and beverage and other operating revenues).

Operating costs and expenses. Our operating costs and expenses consist of the following:

•

Room expense , which like room revenue, is primarily driven by occupancy and, therefore, has a significant correlation with room revenue;

•

Food and beverage expense , which like food and beverage revenue, is primarily driven by occupancy and banquet and catering bookings and, therefore, has a significant correlation with food and beverage revenue;

•

Other operating expense , which consists of the corresponding expense of other operating revenue, advertising and promotion, repairs and maintenance, utilities, and franchise fees and assessments categories;

•

Property tax, ground lease and insurance expense , which consists of the expenses associated with property tax, ground lease and insurance payments, each of which are primarily fixed expenses;

•

General and administrative expense , which consists of our property-level general and administrative expenses, as well as corporate level expenses such as payroll and related costs, professional fees, travel expenses and office rent, as well as management fees with respect to our hotels; and

•

Depreciation and amortization expense , which consists of depreciation on our hotel buildings, improvements, furniture, fixtures and equipment (since January 1, 2002, we have not amortized our goodwill).

Most categories of variable operating expenses, such as utilities and certain labor costs, such as housekeeping, fluctuate with changes in occupancy. Increases in RevPAR attributable to improvements in occupancy are accompanied by increases in most categories of variable operating costs and expenses. Increases in RevPAR attributable to improvements in ADR typically only result in increases in limited categories of operating costs and expenses, primarily credit card commissions, franchise fees and franchise assessments. Thus, improvements in ADR have a more significant impact on improving our operating margins than occupancy.

Following the events of September 11, 2001, we developed and implemented aggressive operating strategies to further increase operating efficiencies and reduce variable costs and expenses at our hotels to minimize the impact of reductions in RevPAR resulting from reductions in room occupancy. These strategies included reducing labor costs by streamlining staffing levels and responsibilities, reducing amenities and services where appropriate on a hotel-by-hotel basis, and refocusing marketing strategies. We expect many of these strategies will continue to be used by the Management Company and our other independent hotel operators.

We continually seek to improve our operating leverage, which generally refers to the ability to generate incremental profit based on limited variable costs. Notwithstanding our efforts to reduce variable costs, there are limits to how much we or, following the Formation and Structuring Transactions, the Management Company and our other operators, can accomplish in that regard without affecting the competitiveness of our hotels and our guests’ experiences at our hotels. Furthermore, we have significant fixed costs, such as depreciation and amortization, insurance and other expenses associated with owning hotels that do not necessarily decrease when circumstances such as market factors cause a reduction in our hotel revenue. For example, we have experienced increases in wages, employee benefits (especially workers’ compensation in our California hotels and health insurance) and utility costs, which negatively affected our operating margin. Our historical performance may not be indicative of future results, and our future results may be worse than our historical performance.

Acquisition, Sale and Major Redevelopment Activity

Our results during the periods discussed have been, and our future results will be, affected by our acquisition, sale and redevelopment activity during the applicable period.

Acquisition of hotels. The following table sets forth the hotels that we have acquired or developed since the beginning of 2001 and indicates their room count and acquisition date:


Hotel	Rooms		Acquisition Date
*2004*
*Second Quarter of 2004* Residence Inn by Marriott, Rochester, Minnesota	80		June 18, 2004 ⁽¹⁾
JW Marriott, Cherry Creek, Colorado ⁽²⁾	196		April 28, 2004

*First Quarter of 2004* None

*2003* Residence Inn by Marriott, Manhattan Beach, California Marriott, Ontario, California	176 299		June 20, 2003 January 24, 2003

*2002*
Crowne Plaza, Grand Rapids, Michigan	320		December 18, 2002
Wyndham, Houston, Texas Embassy Suites, Chicago, Illinois	472 358	⁽³⁾	December 18, 2002 December 18, 2002
Marriott, Woodland Hills, California	473		December 6, 2002
Doubletree, Minneapolis, Minnesota	230		December 5, 2002
Hilton, Del Mar, California	251	⁽³⁾	December 5, 2002
Hilton, Huntington, New York	302		December 5, 2002
Hyatt, Newport Beach, California	403		December 5, 2002
Marriott, Troy, Michigan	350		December 5, 2002
Marriott, Philadelphia, Pennsylvania	286		December 5, 2002
Marriott, Houston, Texas	391		December 5, 2002
Marriott, Tysons Corner, Virginia	390		December 5, 2002
Radisson, Englewood, New Jersey	194		December 5, 2002
Radisson, Williamsburg, Virginia	303		December 5, 2002
Valley River Inn, Eugene, Oregon	257		December 5, 2002

*2001* None

Total January 1, 2001 to June 30, 2004	5,731

(1)	Opening date of developed hotel.

(2)	Excluded from our total of 55 hotels following the Formation and Structuring Transactions.

(3)	Original acquisition room count prior to room expansions.

The aggregate cost for these 19 hotel acquisitions was approximately $612.6 million, or $107 thousand per room. The operations of the acquired hotels for each of the periods presented through June 30, 2004 are included in our financial results following the date of acquisition. The cost of the acquisitions is included in our cash flows from investing activities for each of the periods presented through June 30, 2004. The JW Marriott, Cherry Creek, Colorado will not be included in our results following the Formation and Structuring Transactions.

Sale of hotels. The following table sets forth the hotels that since the beginning of 2001 have been sold or are currently held for sale and indicates their room count and sale date:


Hotel	Rooms	Sale Date
*2004*
*Third Quarter of 2004*
Four Points—Sheraton, Silverthorne, Colorado ⁽¹⁾	160	Pending
San Marcos Resort, Chandler, Arizona ⁽²⁾	295	Pending
Concord Hotel and Conference Center, Concord, California ⁽³⁾	324	Pending

*Second Quarter of 2004*
Holiday Inn, Anchorage, Alaska	247	May 27, 2004
Holiday Inn, La Mirada, California	292	May 18, 2004
Hawthorn Suites, Anaheim, California	129	April 15, 2004

*First Quarter of 2004*
None

*2003*
Marriott, Woodland Hills, California	473	December 10, 2003
Hampton Inn, Clackamas, Oregon	114	October 30, 2003
Hilton Garden Inn, Sacramento, California	154	July 31, 2003
Hampton Inn, Denver, Colorado	152	July 24, 2003
Hampton Inn, Pueblo, Colorado	112	July 24, 2003
Hampton Inn, Mesa, Arizona	118	July 22, 2003
Hampton Inn, Tucson, Arizona	126	July 22, 2003

*2002*
Hilton Garden Inn, Rio Rancho, New Mexico	129	March 27, 2002

*2001*
Holiday Inn, Steamboat Springs, Colorado	82	October 12, 2001
Holiday Inn, Santa Clara, California	168	August 3, 2001
Comfort Suites, San Francisco, California	165	July 26, 2001
Fairfield Inn, Santa Clarita, California	66	July 2, 2001
Hampton Inn, Santa Clarita, California	130	July 2, 2001
Residence Inn by Marriott, Santa Clarita, California	90	July 2, 2001
Holiday Inn, Wilsonville, Oregon	169	May 2, 2001
Hampton Inn, Oakland, California	152	April 2, 2001
Courtyard by Marriott, Cypress, California	180	February 28, 2001
Residence Inn by Marriott, San Diego, California	144	February 28, 2001
Residence Inn by Marriott, San Diego, California	121	February 28, 2001
Residence Inn by Marriott, Highland Ranch, Colorado	117	February 28, 2001
Residence Inn by Marriott, Provo, Utah	114	February 28, 2001

Total January 1, 2001 to June 30, 2004	4,523

(1)	Excluded from our total of 55 hotels following the Formation and Structuring Transactions. This hotel is held under a contract to sell.

(2)	Excluded from our total of 55 hotels following the Formation and Structuring Transactions. This hotel is held under a contract to sell, subject to the purchaser securing the appropriate insurance coverages.

(3)	Excluded from our total of 55 hotels following the Formation and Structuring Transactions. This hotel is held for sale, and we are actively soliciting offers.

The aggregate sale price for the 24 closed hotel dispositions was $336.8 million, or $90 thousand per room. The results of operations of all of the hotels identified above and the gains or losses on dispositions through June 30, 2004 are included in discontinued operations for all periods presented through the time of sale. The proceeds from the sales through June 30, 2004 are included in our cash flows from investing activities for the respective periods.

The operations of the hotels that have been sold or are held for sale, as well as any gains or losses on sale for each of the periods presented through June 30, 2004 are included in our income (loss) from discontinued operations for the respective periods.

The following table summarizes our portfolio and room data since the beginning of 2001 adjusted for the hotels acquired and sold during the respective periods. From January 1, 2001 to June 30, 2004, we have increased the average number of rooms per hotel from 191 to 242 as a result of the above acquisitions and sales, as further detailed in the table below (third quarter 2004 figures represent pending transactions).


				2004
	2001	2002	2003	First Quarter	Second Quarter		Third Quarter
Portfolio Data—Hotels
Number of hotels—beginning of period	65	52	66	61	61		60
Add: Acquisitions	—	15	2	—	—		—
Add: Developments	—	—	—	—	2	⁽¹⁾	—
Less: Sales	13	1	7	—	3		3
Less: Assets not included	—	—	—	—	—		2	⁽²⁾

Number of hotels—end of period	52	66	61	61	60		55
Portfolio Data—Rooms
Number of rooms—beginning of period	12,421	10,804	15,664	14,901	14,901		14,529
Add: Acquisitions	—	4,980	475	—	—		—
Add: Developments	—	—	—	—	276	⁽¹⁾	—
Add: Room expansions	81	9	11	—	20		—
Less: Sales	1,698	129	1,249	—	668		779
Less: Assets not included	—	—	—	—	—		411	⁽²⁾

Number of rooms—end of period	10,804	15,664	14,901	14,901	14,529		13,339

Average rooms per hotel—end of period	208	237	244	244	242		243

(1)	Reflects the opening of the Residence Inn, Rochester, Minnesota and the acquisition of the JW Marriott, Cherry Creek, Colorado.

(2)	Reflects the exclusion of the JW Marriott, Cherry Creek, Colorado (196 rooms) and the Embassy Suites, Los Angeles, California (215 rooms) from this offering.

Renovation, redevelopment and rebranding of hotels. We have made significant investments in our hotels which we believe have improved and will continue to improve the competitiveness of our hotels. We have kept and, to the extent practicable, intend to continue to keep hotels operational and minimize disruptions to the hotels during renovation and redevelopment work.

The following table summarizes the major renovations and redevelopments we completed at our hotels during the periods indicated from January 1, 2001 through June 30, 2004.


	2001		2002		2003		Six months ended June 30, 2004		Total
Number of hotels		5		2		11		13		31
Number of rooms		1,201		442		3,382		3,820		8,845
Cost (thousands) ⁽¹⁾	$	24,852	$	4,728	$	23,728	$	40,547	$	93,855
Cost per room (thousands)	$	20.7	$	10.7	$	7.0	$	10.6	$	10.6

(1)	Aggregate amount spent on renovation made during the period indicated and prior periods during the redevelopment and renovation.

Operating Results

Comparison of First Half of 2004 to 2003

The following table presents our operating results for the first half of 2003 and 2004, including the amount and percentage change in the results between the two periods.


	First Half
	2003			2004			Change $			Change %
	(dollars in thousands, except statistical data)
Revenues
Room	$	151,531		$	166,957		$	15,426		10.2	%
Food and beverage		51,670			54,849			3,179		6.2
Other operating		17,548			21,576			4,028		23.0
Management and other fees from affiliates		132			522			390		295.5

Total revenues		220,881			243,904			23,023		10.4


Operating expenses
Room		35,338			37,267			1,929		5.5
Food and beverage		37,300			37,923			623		1.7
Other hotel		70,914			76,306			5,392		7.6
General and administrative		30,156			32,853			2,697		8.9
Depreciation and amortization		26,398			28,444			2,046		7.8
Impairment loss		—			7,439			7,439		—

Total operating expenses		200,106			220,232			20,126		10.1


Operating income		20,775			23,672			2,897		13.9
Interest and other income		328			216			(112	)	(34.1	)
Interest expense		(26,202	)		(26,576	)		(374	)	1.4


Loss before minority interest, income taxes and discontinued operations		(5,099	)		(2,688	)		2,411		(47.3	)

Minority interest		—			166			166		—
Income tax provision		(359	)		(780	)		(421	)	117.3


Loss from continuing operations before discontinued operations		(5,458	)		(3,302	)		2,156		(39.5	)
Income (loss) from discontinued operations		(1,207	)		(18,188	)		(16,981	)	1406.9

Net loss	$	(6,665	)	$	(21,490	)	$	(14,825	)	222.4

First half operating statistics
Occupancy ⁽¹⁾		66.4	%		70.2	%		3.8	%	5.7	%
Average daily rate ⁽¹⁾	$	95.59		$	96.51		$	0.92		1.0	%
RevPAR ⁽¹⁾	$	63.47		$	67.75		$	4.28		6.7	%
Hotel operating margin		35.0	%		37.8	%		2.8	%	8.0	%

Second quarter operating statistics
Occupancy ⁽¹⁾		69.6	%		73.2	%		3.6	%	5.2	%
Average daily rate ⁽¹⁾	$	94.85		$	97.23		$	2.38		2.5	%
RevPAR ⁽¹⁾	$	66.02		$	71.17		$	5.15		7.8	%
Hotel operating margin		36.2	%		38.8	%		2.6	%	7.2	%

(1)	Excludes hotels held in discontinued operations, which are described under “—Income (loss) from discontinued operations.”

Room revenue . Room revenue increased primarily as a result of increases in occupancy, particularly at our newly renovated hotels, along with a moderate increase in ADR due to improving pricing ability at our fully renovated hotels. The strong operating improvements in the first half of 2004 compared to the first half of 2003 are primarily attributable to five factors:

•

a number of our hotels were under renovation, causing significant operating disruption in the first half of 2003, and the hotels were fully renovated by the beginning of the first half of 2004;

•

a number of our hotels had new property-level management teams in the first half of 2003, and the management teams were in place for more than one year at the beginning of the first half of 2004 with a stronger understanding of their respective local markets and hotels;

•

short-term transient demand increased as both the general economy and the respective local economies started to recover in the first half of 2004 compared to the first half of 2003;

•

new long-term group contract business enabled us to establish a base occupancy at some of our hotels; and

•

an additional operating day in February 2004 due to the leap year.

Food and beverage revenue. The food and beverage revenue increase was primarily driven by higher occupancy during 2004 and the factors that drove our room revenue increase, as well as new banquet and catering menus and pricing programs primarily at our newly renovated hotels.

Other operating revenue . Our increased occupancy led to increases in other operating revenue, such as parking, entertainment and guest services. Through the increase in occupancy, we generated increases in banquet and conference room rental and ancillary services attributable to the banquet and catering business. We also generated increases from other services we provided to some of our group customers, including transportation. However, these increases were partially offset by the continuing trend of declining telephone revenue and providing complimentary Internet access.

Management and other fees from affiliates. The increase in management and other fees from affiliates is primarily due to the acquisition fees and management fees related to the Doubletree, Nashville, Tennessee and Residence Inn by Marriott, Beverly Hills, California, as described under “Certain Relationships and Related Transactions—Other Properties.” We will not receive any management or other fees from these hotels following the Formation and Structuring Transactions.

Hotel operating expenses. Several factors, including increases in wages, employee benefits (especially workers’ compensation for our California hotels and health insurance) and utility costs, led to the 5.5% increase in hotel operating expense for the first half of 2004 as compared to the first half of 2003. Our largest increase was in other operating expense, which increased as a result of the final increase in franchise fees pursuant to the terms of a multi-year agreement for our full-service Marriott hotels. These increases were partially offset by decreases in property tax expense, resulting from successful appeals with the local taxing jurisdictions, as well as reductions in our property insurance premiums after renewal in 2004.

Hotel operating margin . Our hotel operating margin increase is primarily the result of the increase in revenue and continued realization of savings from the operating controls we put in place in our hotels after September 11, 2001 to minimize variable costs and a reduction in fixed expenses, such as property taxes and insurance.

General and administrative expense. General and administrative expense increased as a result of one-time charges associated with pre-opening expenses for the JW Marriott, Cherry Creek, Colorado and hotel specific expenses, such as increased credit card commissions and franchise fees associated with the overall increase in revenue. General and administrative expense also increased due to increased expenses at Buy Efficient, L.L.C. and our laundry facility in Salt Lake City, Utah resulting from significant revenue improvements over the prior year. Overall, the increases in general and administrative expenses were partially offset by lower corporate expenses.

Depreciation and amortization expense. Depreciation and amortization increased as a result of the increase in our depreciable asset base following completion of major renovations at some of our hotels throughout 2003 and through June 30, 2004.

Interest expense. Interest expense increased primarily as a result of higher average borrowings from two mortgage refinancings, both of which closed in the third quarter of 2003, as well as a $0.5 million mark to market adjustment of our derivative instruments. Primarily offsetting the increases in interest expense are reductions in the interest payable due to reductions in the LIBOR index, the base rate for all of our floating rate debt, between the first half of 2003 and the first half of 2004 .

Our total notes payable, including current portion, was $913.0 million at June 30, 2004 and $917.7 million at December 31, 2003, with a weighted average interest rate per annum of approximately 5.4% at both June 30, 2004 and December 31, 2003. At June 30, 2004, 10.5% of the amount outstanding under our notes payable was fixed and 89.5% of the amount outstanding under our notes payable was floating.

Impairment loss. Impairment loss in the first half of 2004 consists of hotel impairment losses at three hotels and does not include any goodwill impairment loss. There was no impairment loss in the first half of 2003. The hotel impairment loss in the first half of 2004 related to our determination that the current carrying values of these three hotels were no longer recoverable based on estimated future cash flows to be generated by the hotels. This determination resulted from certain depressed hotel markets. The fair values of the hotels were determined using factors such as net operating cash flows, terminal capitalization rates and replacement costs as described under “—Critical Accounting Policies—Impairment of Long-lived Assets.”

Provision for income taxes. As limited liability companies, the Contributing Entities were pass-through entities and not liable for Federal and certain state income taxes, which were the responsibility of their respective members. However, some of our predecessor companies were corporations that were liable for taxes on their earnings. The increase in the tax provision was primarily attributable to changes in our valuation allowance associated with the current and future use of our net operating loss carryforwards.

The provision for income taxes applicable to continuing operations is as follows (in thousands):


	First Half
	2003			2004
Benefit from (provision for) income taxes for continuing operations:
Current	$	(102	)	$	(1,805	)
Deferred		(257	)		1,025

Provision for income taxes for continuing operations	$	(359	)	$	(780	)

Income (loss) from discontinued operations. As described under “—Acquisition, Sale and Major Redevelopment Activity—Sale of Hotels,” we sold 13 hotels in 2001, one hotel in 2002, seven hotels in 2003 and three hotels in the first half of 2004. Three hotels were held for sale and included in discontinued operations at June 30, 2004. Consistent with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we have reclassified the results of operations for these 27 hotels as discontinued operations. The amounts shown during the six months ended June 30, 2003 and 2004 relate primarily to the seven hotels sold during 2003, the three hotels sold in the first quarter of 2004, and the three hotels held for sale at June 30, 2004. The increase in loss from discontinued operations between the periods was primarily due to hotel impairment losses at four hotels totaling $17.0 million in the first quarter of 2004 and the sale of three hotels in the second quarter 2004. There were no goodwill impairment losses during the applicable periods.

Comparison of 2003 to 2002

The following table presents our operating results for 2002 and 2003, including the amount and percentage change in these results between the two periods:


	2002			2003			Change $			Change %
	(dollars in thousands except statistical data)
Revenues
Room	$	191,794		$	315,812		$	124,018		64.7	%
Food and beverage		47,700			107,200			59,500		124.7
Other operating		21,721			36,985			15,264		70.3
Management and other fees from affiliates		194			705			511		263.4

Total revenues		261,409			460,702			199,293		76.2


Operating expenses
Room		43,318			74,471			31,153		71.9
Food and beverage		35,010			76,750			41,740		119.2
Other hotel		80,687			148,869			68,182		84.5
General and administrative		39,122			64,229			25,107		64.2
Depreciation and amortization		34,213			53,481			19,268		56.3
Impairment loss		6,789			11,382			4,593		67.7

Total operating expenses		239,139			429,182			190,043		79.5


Operating income		22,270			31,520			9,250		41.5
Interest and other income		2,080			712			(1,368	)	(65.8	)
Interest expense		(29,186	)		(55,235	)		(26,049	)	89.3


Loss before minority interest, income taxes and discontinued operations		(4,836	)		(23,003	)		(18,167	)	375.7

Minority interest		—			(17	)		(17	)	—
Income tax benefit		4,715			2,017			(2,698	)	(57.2	)


Loss from continuing operations before discontinued operations		(121	)		(21,003	)		(20,882	)	1,7257.9
Loss from discontinued operations		(10,265	)		(1,263	)		9,002		(87.7	)

Net loss	$	(10,386	)	$	(22,266	)	$	(11,880	)	114.4

Operating statistics
Occupancy ⁽¹⁾		68.0	%		68.1	%		0.1	%	0.1	%
Average daily rate ⁽¹⁾	$	87.40		$	95.09		$	7.69		8.8	%
RevPAR ⁽¹⁾	$	59.43		$	64.76		$	5.33		9.0	%
Hotel operating margin		39.1	%		34.8	%		(4.3	)%	(11.0	)%

(1)	Excludes hotels held in discontinued operations, which are described under “—Income (loss) from discontinued operations.”

We acquired 15 hotels in December 2002, one hotel in January 2003 and one hotel in June 2003. We refer to the hotels we acquired in 2002 and 2003 as the Recent Acquisition Hotels. Historical financial information for 13 of the Recent Acquisition Hotels for 2001 and 2002 is included elsewhere in this prospectus, but is not included in our historical financial information.

Revenues. Revenues increased primarily as a result of an additional $214.7 million of hotel operating revenue generated by the Recent Acquisition Hotels. Offsetting this increase was a decline of $16.9 million, or

6.4%, in the balance of the portfolio resulting from the generally weak economic environment and the reduction in travel due to terrorist activities and the war in Iraq.

RevPAR increased primarily as a result of an increase in ADR from the Recent Acquisition Hotels, which generate some of our portfolio’s higher ADRs. However, occupancy remained flat as a result of continued soft economic conditions and operational disruption to the Recent Acquisition Hotels due to the extensive renovation programs and installation of new property-level management teams. In addition, RevPAR decreased in 2003 for our Utah hotels primarily as a result of the positive impact of the 2002 Winter Olympic Games. The RevPAR declines from the Utah hotels were partially offset by RevPAR increases from our California and Texas hotels primarily as a result of our ability to attract incremental short-term transient demand and secure new long-term group contract business.

Room revenue . The Recent Acquisition Hotels represented an additional $135.9 million of room revenue, which was partially offset by a $12.0 million, or 6.2%, decrease in room revenue for the balance of our portfolio. The decline in room revenue was primarily attributable to reduction in travel caused by terrorism concerns and the war in Iraq and renovation disruption at some of our hotels. We, as well as the industry in general, continued to have difficulty maintaining average daily rates in 2003. The diminished ability to achieve increases in room rates at the hotels during 2003 compared to 2002 was caused by several factors, including soft economic conditions, increased supply, a shorter booking cycle for group business and the impact of the electronic distribution channels available via the Internet. Securing new group business continued to be a challenge throughout 2003 as companies that typically utilize upper upscale and upscale hotels remained focused on reducing costs and shopped for the most favorable room rates and concessions.

Food and beverage revenue. The increase of $68.6 million in food and beverage revenue from the Recent Acquisition Hotels was offset by a decrease of $9.1 million, or 19.1%, from the balance of our hotel portfolio. The major factors contributing to the offsetting decline were the substantial decline in banquet revenue as a result of a decrease in group demand and a decrease in the demand for the ancillary services provided during banquet and catering events.

Other operating revenue . The Recent Acquisition Hotels accounted for $10.0 million of the increase in other operating revenue. The remaining increase is attributable to a number of factors, including the newly-installed Starbucks coffee retail outlets at three of our hotels, an increase in revenues at Buy Efficient, L.L.C. from both increased existing customer usage and additions of new third-party hotel contracts, and the acquisition of the Salt Lake City laundry business. However, consistent with trends in the lodging industry, the increases were partially offset by declines in our telephone revenue due to increased use of cellular telephones rather than in-room telephones and the trend towards providing complimentary Internet access.

Management and other fees from affiliates. The increase of $0.5 million in management and other fees from affiliates is primarily attributable to the receipt of a one-time disposition fee from the sale of one hotel by one of our affiliates.

Hotel operating expenses. The Recent Acquisition Hotels accounted for $142.2 million of the increase in our hotel operating expenses, which was partially offset by a $1.1 million, or 0.1%, decrease in the balance of our portfolio representing realized expense savings at those hotels.

Hotel operating margin . Our hotel operating margin declined primarily as a result of the shift in our revenue mix as a result of the Recent Acquisition Hotels, which have a lower percentage of room revenue than our other hotels. Room revenue represented 68.5% of our total revenues in 2003 compared to 73.4% in 2002. Room revenue has a higher margin than other sources of revenue, such as food and beverage revenue.

General and administrative expense . General and administrative expense increased primarily as a result of the addition of personnel relating to the Recent Acquisition Hotels.

Depreciation and amortization expense. Depreciation and amortization expense increased primarily as a result of the Recent Acquisition Hotels, as well as the increase in the depreciable asset base from their respective renovation programs during 2003.

Interest and other income . Our interest and other income was higher in 2002 than 2003 as a result of the forgiveness of $0.7 million of accrued franchise fees by one of our franchisors related to the final settlement and termination of a contract.

Interest expense. Interest expense increased as a result of the debt incurred to finance the acquisition of the Recent Acquisition Hotels. Partly offsetting the increases in interest expense were reductions in the interest rate as a result of continued reductions in the LIBOR index, the base rate for all of our floating rate debt.

Our total notes payable, including current portion, was $917.7 million at December 31, 2003 and $942.4 million at December 31, 2002. The weighted average interest rates per annum were 5.4% and 4.7%, respectively. At December 31, 2003, 10.6% of the amount outstanding under our notes payable was fixed and 89.4% of the amount outstanding under our notes payable was floating.

Impairment loss. Impairment loss in 2002 consists entirely of goodwill impairment loss of $6.8 million. Impairment loss in 2003 represents impairment loss at three hotels totaling $9.3 million and a goodwill impairment loss of $2.1 million. The hotel impairment losses in 2002 and 2003 relate to our determination that the carrying values of the hotels were no longer recoverable based on estimated future cash flows to be generated. The fair values of the hotels were determined using factors such as net operating cash flows, terminal capitalization rates and replacement costs. The goodwill impairment loss in 2002 relates to allocated goodwill amounts for nine hotels and in 2003 relates to allocated goodwill amounts for five hotels, and was determined based on the estimated fair value of the hotels.

Benefit from (provision for) income taxes. As limited liability companies, the Contributing Entities were pass-through entities and not liable for Federal and certain state income taxes, which were the responsibility of their respective members. However, some of our predecessor companies were corporations that were liable for taxes on their earnings. The decrease in the 2003 tax benefit was primarily attributable to changes in our valuation allowance associated with the current and future use of our net operating loss carryforwards.

Benefit from (provision for) income taxes applicable to continuing operations is as follows (in thousands):


	2002			2003
Benefit from (provision for) income taxes for continuing operations:
Current		(718	)		(329	)
Deferred		5,433			2,346

Benefit from income taxes for continuing operations	$	4,715		$	2,017

Income (loss) from discontinued operations. As described under “—Acquisition, Sale and Major Redevelopment Activity—Sale of Hotels,” we sold 13 hotels in 2001, one hotel in 2002, seven hotels in 2003 and three hotels in the first half of 2004. Three hotels were held for sale and included in discontinued operations at June 30, 2004. Consistent with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we reclassified the results of operations for these 27 hotels as discontinued operations for 2002 and 2003. Loss from discontinued operations decreased in 2003 primarily as a result of a net gain on sale of $14.8 million, primarily offset by an increase in impairment loss of $7.3 million. The impairment loss of $9.7 million in 2002 consists of hotel impairment loss of $7.1 million relating to four hotels and goodwill impairment loss of $2.6 million relating to six hotels. The impairment loss of $17.0 million in 2003 consists entirely of hotel impairment loss relating to four hotels and no goodwill impairment loss. Our determination of hotel and goodwill impairment loss used the same methods as described above for continuing operations.

Comparison of 2002 to 2001

The following table presents our operating results for 2001 and 2002, including the amount and percentage change in these results between the two periods:


	2001			2002			Change $			Change %
	(dollars in thousands except statistical data)
Revenues
Room	$	181,284		$	191,794		$	10,510		5.8	%
Food and beverage		41,885			47,700			5,815		13.9
Other operating		20,311			21,721			1,410		6.9
Management and other fees from affiliates		—			194			194		—

Total revenues		243,480			261,409			17,929		7.4


Operating expenses
Room		41,288			43,318			2,030		4.9
Food and beverage		33,293			35,010			1,717		5.2
Other hotel		64,519			80,687			16,168		25.1
General and administrative		46,689			39,122			(7,567	)	(16.2	)
Depreciation and amortization		30,117			34,213			4,096		13.6
Impairment loss		—			6,789			6,789		—
Goodwill amortization		4,925			—			(4,925	)	(100.0	)

Total operating expenses		220,831			239,139			18,308		8.3

Operating income		22,649			22,270			(379	)	(1.7	)
Interest and other income		1,070			2,080			1,010		94.4
Interest expense		(42,338	)		(29,186	)		13,152		(31.1	)


Loss before minority interest, income taxes, cumulative effect of change in accounting principle and discontinued operations		(18,619	)		(4,836	)		13,783		(74.0	)

Minority interest		—			—			—		—
Income tax benefit		8,770			4,715			(4,055	)	(46.2	)


Loss from continuing operations before cumulative effect of change in accounting principle and discontinued operations		(9,849	)		(121	)		9,728		(98.8	)

Cumulative effect of change in accounting principle		(1,326	)		—			1,326		(100.0	)
Loss from discontinued operations		(7,632	)		(10,265	)		(2,633	)	34.5

Net loss	$	(18,807	)	$	(10,386	)	$	8,421		(44.8	)%

Operating statistics
Occupancy ⁽¹⁾		66.2	%		68.0	%		1.8	%	2.7	%
Average daily rate ⁽¹⁾	$	88.36		$	87.40		$	(0.96	)	(1.1	)%
RevPAR ⁽¹⁾	$	58.49		$	59.43		$	0.94		1.6	%
Hotel operating margin		42.9	%		39.1	%		(3.8	)%	(8.9	)%

(1)	Excludes hotels held in discontinued operations which are described under “—Income (loss) from discontinued operations.”

Revenues. During 2002, our revenues continued to be affected by the soft economic conditions that commenced in the first half of 2001 and were exacerbated by the September 11, 2001 terrorist attacks and geopolitical conditions in the Middle East. However, during 2002, six of our hotels located in the Salt Lake City, Utah area experienced significant increases in revenue as a result of the 2002 Winter Olympic Games.

Excluding the impact of the 2002 Winter Olympic Games at our six Utah hotels, our RevPAR declined by 1.4% as a result of the following factors: first, there was a general softness in group demand at many of our hotels, which negatively affected our ability to increase ADR for our transient business; second, there was price competition caused by increased customer awareness of highly discounted rooms available at other hotels through various third-party electronic distribution channels via the Internet; and third, there was a negative impact on demand resulting from additional lodging supply in some of the markets in which we compete.

Room revenue . Our room revenue increases were offset by declines in business demand attributable to corporate travel restrictions implemented in late 2001 and early 2002, which negatively affected individual business travelers, who traditionally have been a consistent producer of business for the upper upscale and upscale segments of the hospitality industry.

Food and beverage revenue. The increase in food and beverage revenue was primarily related to the significant one-time banquet and catering events for the groups associated with the demand caused by the 2002 Winter Olympic Games and the holiday banquet events at the Recent Acquisition Hotels in December 2002.

Other operating revenue . Other operating revenue increased primarily due to the incremental revenue generated at the Utah hotels during the 2002 Winter Olympic Games.

Management and other fees from affiliates. The increase in management and other fees from affiliates is primarily due to the receipt of management and asset management fees from a hotel investment made by one of our affiliates in the second quarter of 2002.

Hotel operating expenses. Our hotel operating expenses increased 14.3% as a result of the increase in variable expense associated with the increase in revenues, the franchise fee increase for our full service Marriott hotels and the franchise fees attributable to additional revenue from the Recent Acquisition Hotels in December 2002.

Hotel operating margin . Our hotel operating margin decrease was primarily caused by the increase in franchise fees at our full-service Marriott hotels pursuant to the respective property franchise agreements, significant increases in utility costs, and significant increases in property insurance premium rates caused by the impact of the terrorist acts on September 11, 2001.

General and administrative expense. Our general and administrative expense decreased substantially as a result of cost-saving initiatives implemented company-wide after September 11, 2001.

Depreciation and amortization expense. The increase in depreciation and amortization expense is primarily attributable to the addition of the Recent Acquisition Hotels and the additions to the depreciable asset base following completion of routine renovations at various hotels in our portfolio.

Interest and other income . Our interest and other income increased in 2002 primarily due to the forgiveness of $0.7 million of accrued franchise fees by one of our franchisors related to the final settlement and termination of a contract.

Interest expense . Interest expense decreased primarily as a result of a significant reduction in our obligations under notes payable due to prepayment from 13 hotel sales, as well as reductions in the LIBOR index, the base rate for all of our floating rate debt.

Our total notes payable, including current portion, was $942.4 million at December 31, 2002 and $515.4 million at December 31, 2001. The increase is attributed to the new borrowings associated with the December 2002 hotel acquisitions. The weighted average interest rates per annum were 4.7% and 7.4%, respectively. At December 31, 2002, 10.5% of the amount outstanding under our notes payable was fixed and 89.5% of the amount outstanding under our notes payable was floating.

Impairment loss. We did not have any impairment loss in 2001, however impairment loss totaled $6.8 million in 2002, primarily as a result of a goodwill impairment writedown relating to our determination that the carrying values of nine hotels were no longer recoverable based on estimated future cash flows to be generated by the hotels. The fair values of the hotels were determined using factors such as net operating cash flows, terminal capitalization rates and replacement costs.

Benefit from (provision for) income taxes. As limited liability companies, the Contributing Entities were pass-through entities and not liable for Federal and certain state income taxes, which were the responsibility of their respective members. However, some of our predecessor companies were corporations that were liable for taxes on their earnings. The decrease in the 2002 tax benefit was primarily attributed to changes in our valuation allowance associated with the current and future use of our net operating loss carryforwards.

Benefit from (provision for) income taxes applicable to continuing operations is as follows (in thousands):


	2001		2002
Benefit from (provision for) income taxes for continuing operations:
Current	$	—	$	(718	)
Deferred		8,770		5,433

Benefit from income taxes for continuing operations	$	8,770	$	4,715

Income (loss) from discontinued operations. As described under “—Acquisition, Sale and Major Redevelopment Activity—Sale of Hotels,” we sold 13 hotels in 2001, one hotel in 2002, seven hotels in 2003 and three hotels in the first half of 2004. Three hotels were held for sale and included in discontinued operations at June 30, 2004. Consistent with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we reclassified the results of operations for these 27 hotels as discontinued operations for year 2001 and 2002. Loss from discontinued operations in 2001 included $4.0 million of hotel impairment loss relating to two hotels. There was no goodwill impairment loss in 2001. Loss from discontinued operations in 2002 included $9.7 million of impairment loss, consisting of hotel impairment loss of $7.1 million relating to four hotels and goodwill impairment loss of $2.6 million relating to allocated goodwill amounts for six hotels. Our determination of hotel and goodwill impairment loss used the same methods as described for continuing operations.

Liquidity and Capital Resources

Historical. During the periods presented, our historical sources of cash included our operating activities, working capital, long-term notes payable, bank credit facilities, and contributions by the Contributing Entities. Our primary uses for cash were for acquisitions of hotels, capital expenditures for hotels, operating expenses and distributions to the Contributing Entities.

Operating activities. Net cash provided by operating activities was $28.6 million for the first half of 2004 compared to $26.5 million for the first half of 2003. This increase was primarily caused by the improved economic environment and our improved profitability during the first half of 2004 due to completed renovation programs and stable property-level management teams. Net cash provided by operating activities was $60.0 million for 2003 compared to $26.7 million for 2002 primarily as a result of the additional hotels acquired in December 2002.

Net cash provided by operating activities was $26.7 million for 2002 compared to $43.3 million for 2001. This decrease was primarily due to an increase in our working capital as a result of the $18.3 million increase in restricted cash made available for the renovation program at the Recent Acquisition Hotels, $6.9 million decrease in cash collected from accounts receivable and $1.9 million decrease in cash used for inventories, prepaid expenses and other assets, which was partially offset by a $11.2 million increase in accounts payable and other liabilities. The incurrence of additional indebtedness can decrease cash provided by operating activities as a result of increased interest payments.

Investing activities . Net cash used in investing activities was $42.4 million in the first half of 2004 compared to $59.1 million in the first half of 2003. Net cash provided by investing activities was $18.4 million for 2003 compared to $541.4 million cash used in investing activities for 2002 and $144.4 million cash provided by investing activities for 2001. Our cash provided by or used in investment activities fluctuates primarily based on acquisitions, sales and renovations of hotels. The significant investing activities are summarized below.

•

In the first half of 2004, we developed and acquired two hotels (an aggregate of 276 rooms) for $49.5 million and sold three hotels (an aggregate of 668 rooms) for net proceeds of $29.4 million. We invested $33.0 million in our hotels, including the major redevelopment and renovation of our hotels.

•

In 2003, we acquired two hotels (an aggregate of 475 rooms) for $42.0 million and sold seven hotels (an aggregate of 1,249 rooms) for net proceeds of $119.3 million. In addition, we invested $59.0 million in our hotels, including the major redevelopment and renovation of our hotels.

•

In 2002, we acquired 15 hotels (an aggregate of 4,980 rooms) for $527.0 million and sold one hotel (an aggregate of 129 rooms) for net proceeds of $6.2 million. In addition, we invested $21.2 million in our hotels, including the major redevelopment and renovation of our hotels.

•

In 2001, we did not acquire any hotels and sold 13 hotels (an aggregate of 1,698 rooms) for net proceeds of $173.6 million. In addition, we invested $29.3 million in our hotels, including the major redevelopment and renovation of our hotels.

Financing activities . Net cash provided by financing activities decreased from $37.0 million in the first half of 2003 to $17.3 million in the first half of 2004. Net cash used in financing activities was $80.5 million in 2003, which consisted primarily of $72.0 million of distributions to the Contributing Entities, $508.7 million principal payments on notes payable, $9.1 million payment of loan financing costs, partly offset by the proceeds from notes payable of $483.9 million and contributions from the Contributing Entities of $26.0 million, compared to net cash provided by financing activities of $530.7 million for 2002, which consisted primarily of equity invested by one of the Contributing Entities of $135.1 million along with borrowings of $471.4 million, primarily to complete the acquisition of the Recent Acquisition Hotels, partly offset by $44.4 million principal payments of notes payable, $6.5 million payment of loan financing costs, $1.2 million payment on interest rate caps and $23.6 million of distributions to the Contributing Entities. Net cash used in financing activities in 2001 was $191.6 million, consisting of $61.4 million of proceeds from notes payable, offset by $211.2 million of principal payments on notes payable as a result of the sale of 13 hotels in 2001 and $40.9 million of distributions to the Contributing Entities.

Our significant financing activities are described below.

Notes payable . Our notes payable, less current portion, increased from $465.2 million at December 31, 2001 to $465.3 million at December 31, 2002, increased to $891.8 million at December 31, 2003 and decreased to $848.3 million at June 30, 2004. The net increase of $383.1 million from 2001 to June 30, 2004 was primarily caused by the following:

•

the incurrence in December 2002 of $279.5 million of notes payable consisting of $225.0 million of mortgage notes underwritten by Bear Stearns Commercial Mortgage, Inc. as commercial mortgage-backed securities and $54.5 million of mezzanine notes in connection with the acquisition of 11 hotels;

•

the incurrence in December 2002 of $77.1 million of notes payable through the assumption of existing debt on two acquired hotels;

•

the incurrence in December 2002 of $14.8 million of notes payable through the assumption of existing debt on the Crowne Plaza, Grand Rapids, Michigan;

•

the incurrence in January 2003 of $19.3 million of notes payable for the acquisition of the Marriott, Ontario, California;

•

the incurrence in June 2003 of $14.0 million of notes payable for the acquisition of the Residence Inn by Marriott, Manhattan Beach, California; and

•

the incurrence in August 2003 of $345.0 million of notes payable to Massachusetts Mutual Life Insurance Company in connection with the refinancing of $320.0 million of debt on 35 of our hotels.

Contributions . We received contributions from the Contributing Entities of $135.1 million in 2002, $26.0 million in 2003 and $25.3 million in the first half of 2004. These contributions were used to fund the equity portion of our acquisitions. We do not expect any further contributions from the Contributing Entities after June 30, 2004.

Cash distributions . We made cash distributions to the Contributing Entities of $40.9 million in 2001, $23.6 million in 2002, $72.0 million in 2003 and $3.4 million in the first half of 2004. We intend to continue to make cash distributions to the Contributing Entities prior to this offering in an amount approximately equal to our net income and will fund those distributions from our cash flow from operations. We also intend to distribute to the Contributing Entities the current and accumulated earnings and profits of our corporate subsidiaries, which aggregated approximately $4.4 million at June 30, 2004, which we intend to accomplish through the distribution of the Embassy Suites, Los Angeles, California to Alter SHP LLC, an entity affiliated with Robert A. Alter.

Future. Following this offering, we expect our primary uses for cash will continue to be for acquisitions of hotels, capital expenditures for hotels, operating expenses and distributions to holders of our common stock and membership units of our operating partnership. We also expect our primary sources of cash will continue to come from the operations of our hotels and our working capital. In addition, we expect to enter into a $ million revolving credit facility, as described under “Outstanding Indebtedness.”

We will use a portion of the net proceeds of this offering to retire or pay down a portion of our indebtedness, which we expect will result in savings on interest expense and increased cash flow in future periods.

We believe that our pro forma capital structure, including our expected $ million revolving credit facility and cash flow from operations, will provide us with sufficient liquidity to meet our operating expenses and other expenses directly associated with our business and properties. On a pro forma basis, our debt-to-total capitalization ratio will be approximately %. In addition, we have interest rate protection agreements covering % of our total variable rate debt, which accounts for % of our total outstanding indebtedness. We believe this debt capital structure is appropriate for the operating characteristics of our business and provides for significant prepayment and refinancing flexibility.

In the future, we may also explore other financing alternatives, including our sale of equity and debt securities. Our ability to incur additional debt depends on a number of factors, including our degree of leverage, the value of our unencumbered assets and borrowing restrictions imposed by existing lenders under our existing notes payable, including our expected new revolving credit facility. Our ability to raise funds through the issuance of equity securities depends on, among other things, general market conditions for hotel companies and REITs and market perceptions about us. We will continue to analyze which source of capital is most advantageous to us at any particular point in time, however, the capital markets may not be available to us when needed on favorable terms or at all.

Contractual Obligations

The following table summarizes our payment obligations and commitments as of June 30, 2004:


	Payment due by period
	Total		Less than 1 year		1 to 3 years		3 to 5 years		More than 5 years
Contractual obligations	(in thousands)
Notes payable	$	912,973	$	64,666	$	451,897	$	326,036	$	70,374
Operating lease obligations		198,739		3,907		6,894		6,657		181,281
Construction commitments		9,920		9,920		—		—		—
Franchise obligations		5,575		77		600		600		4,298
Employment obligations		4,561		1,460		2,715		386		—

Total	$	1,131,768	$	80,030	$	462,106	$	333,679	$	255,953

As set forth elsewhere in this prospectus, including “Unaudited Pro Forma Data,” following the Formation and Structuring Transactions and this offering, some of our notes payable will be repaid and we will have different franchise and employment obligations. In connection with our new franchise agreements with the TRS Lessee, our franchisors will require us to make renovations, which we expect to make over several years as part of our ordinary course capital expenditures and fund with the reserve funds described below.

Reserve Funds for Capital Expenditures

We believe we maintain each of our hotels in good repair and condition and in conformity with applicable franchise agreements, ground leases, laws and regulations.

With respect to our hotels that are operated under franchise agreements with major national hotel brands and for all of our hotels subject to a first mortgage lien, we are obligated to maintain a furniture, fixture and equipment, or FF&E, reserve account for future planned and emergency-related capital expenditures at these hotels. The amount funded into each of these reserve accounts is determined pursuant to the management, franchise and loan agreements for each of the respective hotels, ranging between 4.0% and 5.0% of the respective hotel’s total annual revenue. In the case of the Residence Inn by Marriott, Rochester, Minnesota, opened in June 2004, the loan agreement requires an increase in the reserve percentage from 0.0% to 4.0% of the gross revenue between the first operating year and the beginning of the third operating year, respectively. As of June 30, 2004, $13.1 million was available in restricted cash reserves for future capital expenditures at our hotels. According to the respective loan agreements, the reserve funds are to be held by the respective lenders in a restricted cash account.

Derivative Financial Instruments

We use derivative financial instruments, primarily interest rate caps, to manage our exposure to the interest rate risks related to the following variable rate debt. Following the repayment of some of this debt with the proceeds from this offering, we may decide to either keep or sell the corresponding interest rate caps. As of June 30, 2004, our interest rate caps consisted of the following:


Variable Rate Debt	As of June 30, 2004 Notional Amount		LIBOR Rate at which Exposure is Capped		Spread		Interest Rate Cap Maturity
	(in millions)
Massachusetts Mutual Life Insurance Company	$	359.5	5.90	%	3.4	%	9/1/2005
Bear Stearns Commercial Mortgage Securities Inc. (Mortgage)	$	224.5	6.75	% ⁽¹⁾	3.5	%	1/3/2006
Bear Stearns Commercial Mortgage Securities Inc. (Mezzanine)	$	54.5	6.50	%	3.5	%	1/3/2006
Citigroup Global Markets Realty Corp. (Mortgage)	$	60.0	4.50	%	3.3	%	10/11/2005
Citigroup Global Markets Realty Corp. (Mezzanine)	$	18.2	4.50	%	8.0	%	10/11/2005
Deutsche Bank Mortgage Capital, L.L.C.	$	14.5	2.65	%	2.9	%	1/15/2005
Salomon Brothers Realty Corp.	$	38.0	6.30	%	3.0	%	11/11/2005
Wells Fargo Bank, National Association	$	6.3	4.50	%	3.3	%	5/22/2006

(1)	Reflects the weighted average of the seven tranches of mortgages, each with specific notional amounts and LIBOR cap agreements.

The net settlements, if any, paid or received under these interest rate cap agreements are accrued consistent with the terms of the agreements and are recognized in interest expense over the term of the related debt. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors. We generally use outside consultants to determine the fair values of our derivative instruments. Such methods generally incorporate market conventions and techniques such as discounted cash flow analysis and option pricing models to determine fair value. We believe these methods of estimating fair value result in general approximation of value, and such value may or may not actually be realized. For the six months ended June 30, 2004 our mark to market adjustments of these contracts resulted in a net loss of $0.5 million.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements during the periods presented and will not have any upon the completion of this offering. An affiliate of Westbrook Real Estate Partners, L.L.C. provides letters of credit on our behalf to collateralize our workers’ compensation obligations and obligations under one of our notes payable. Following this offering, we will replace those letters of credit with new letters of credit under our new revolving credit facility.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our combined financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities.

We evaluate our estimates on an ongoing basis. We base our estimates on historical experience, information that is currently available to us and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the most significant judgments and estimates used in the preparation of our combined financial statements.

•

Impairment of long-lived assets . We periodically review each property for possible impairment. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an

asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. In this analysis of fair value, we use discounted cash flow analysis to estimate the fair value of our properties taking into account each property’s expected cash flow from operations, holding period and proceeds from the disposition of the property. The factors addressed in determining estimated proceeds from disposition include anticipated operating cash flow in the year of disposition, terminal capitalization rate and selling price per room. Our judgment is required in determining the discount rate applied to estimated cash flows, growth rate of the properties, the need for capital expenditures, as well as specific market and economic conditions. Additionally, the classification of these assets as held-for-sale requires the recording of these assets at their estimated fair value less estimated selling costs which can affect the amount of impairment recorded.

•

Depreciation and amortization expense. Depreciation expense is based on the estimated useful life of our assets. The life of the assets are based on a number of assumptions, including the cost and timing of capital expenditures to maintain and refurbish our hotels, as well as specific market and economic conditions. Hotel properties and other completed real estate investments are depreciated using the straight-line method over estimated useful lives ranging from five to 35 years for buildings and improvements and three to 12 years for furniture, fixtures and equipment. While management believes its estimates are reasonable, a change in the estimated lives could affect depreciation expense and net income or the gain or loss on the sale of any of our hotels. We have not changed the estimated useful lives of any of our assets during the periods discussed.

•

Consolidation policy and variable interest entities . In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, Consolidation of Variable Interest Entities , as amended (“FIN 46”), which applies to arrangements created after December 31, 2003. FIN 46 applies to arrangements created before December 31, 2003 beginning on March 31, 2004. Under FIN 46, we have determined that we are the primary beneficiary in an arrangement which has been determined to be a variable interest entity with respect to the JW Marriott, Cherry Creek, Colorado. Accordingly, we have consolidated the assets, liabilities and operations of this arrangement in our financial statements as of March 31, 2004 and for the three months then ended.

•

Derivative instruments and hedging activities. Derivative instruments and hedging activities require us to make judgments on the nature of our derivatives and their effectiveness as hedges. These judgments determine if the changes in fair value of the derivative instruments are reported in the combined statement of operations or as a component of equity on the consolidated balance sheet. While we believe our judgments are reasonable, a change in a derivative’s fair value or effectiveness as a hedge could affect expenses, net income and equity. None of our derivatives held during the periods presented qualified for effective hedge accounting treatment.

•

Accrual of self-insured obligations . We are self-insured up to certain amounts with respect to employee medical, employee dental, general liability insurance, personal injury claims, workers’ compensation, automobile liability and other coverages. We establish reserves for our estimates of the loss that we will ultimately incur on reported claims as well as estimates for claims that have been incurred but not yet reported. Our reserves, which are reflected in accrued payroll and employee benefits and other liabilities in our combined balance sheet, are based on actuarial valuations and our history of claims. Our actuaries incorporate historical loss experience and judgments about the present and expected levels of costs per claim. Trends in actual experience are an important factor in the determination of these estimates. We believe that our estimated reserves for such claims are adequate, however, actual experience in claim frequency and amount could materially differ from our estimates and adversely affect our results of operations, cash flow, liquidity and financial condition. We had approximately $12.6 million as of June 30, 2004 and $13.0 million as of December 31, 2003 reserved for such claims. The estimates obtained from our actuaries include a range of estimated losses, and we used a point within the range. Operating expenses in 2003 would have increased by $1.1 million at the highest end of the range, and operating expenses would have decreased by $0.3 million at the lowest end of the range.

Quantitative and Qualitative Disclosures About Market Risk

Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevailing market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. Some of our outstanding debt has a variable interest rate. As described in “—Derivative Financial Instruments” above, we use some derivative financial instruments, primarily interest rate caps, to manage our exposure to interest rate risks related to our floating rate debt. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors. As of June 30, 2004, on a pro forma basis, our total outstanding debt was approximately $ million, of which approximately $ million, or %, was variable rate debt. If market rates of interest on our variable rate debt decrease by 1.0% or approximately 100 basis points, the decrease in interest expense on our variable rate debt would increase future earnings and cash flows by approximately $ million annually. On the other hand, if market rates of interest on our variable debt increase by 1.0% or approximately 100 basis points, the increase in interest expense on our variable debt would decrease future earnings and cash flows by approximately $ million annually.

Interest risk amounts were determined by considering the impact of hypothetical interest rates on our financial instruments. These analyses do not consider the effect of a reduced level of overall economic activity. If overall economic activity is significantly reduced, we may take actions to further mitigate our exposure. However, because we cannot determine the specific actions that would be taken and their possible effects, these analyses assume no changes in our financial structure.

Seasonality

The lodging business is seasonal in nature, and we experience some seasonality in our business as indicated in the table below. Revenue for hotels in tourist areas generally are substantially greater during tourist season than other times of the year. Quarterly revenue also may be adversely affected by events beyond our control, such as extreme weather conditions, terrorist attacks or alerts, SARS, airline strikes, economic factors and other considerations affecting travel. Our revenue by quarter during 2002, 2003 and 2004 were as follows (dollars in thousands):


	First Quarter		Second Quarter		Third Quarter		Fourth Quarter
Revenu es
2002	$	65,826	$	64,219	$	66,064	$	65,300
2003		104,790		116,091		122,970		116,851
2004		116,884		127,020

Inflation

Inflation may affect our expenses, including, without limitation, by increasing such costs as taxes, property and casualty insurance and utilities.

New Accounting Standards and Accounting Changes

In May 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards as to how to classify and measure certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability or an asset in some circumstances. The provisions of SFAS No. 150 generally are effective for financial instruments entered into or modified after May 31, 2003, and otherwise are effective at the beginning of the first interim period beginning after June 15, 2003. Our adoption of SFAS No. 150 did not have a material effect on our combined results of operations or financial position.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging.” SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The provisions of SFAS No. 149 are effective for contracts entered into after June 30, 2003. Our adoption of SFAS No. 149 did not have a material effect on our combined results of operations or financial position.

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements” (FIN 46). This interpretation requires an existing unconsolidated variable interest entity to be consolidated by its primary beneficiary if the entity does not effectively disperse risk among all parties involved or if other parties do not have significant capital to finance activities without subordinated financial support from the primary beneficiary. The primary beneficiary is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both as a result of holding variable interests, which are the ownership, contractual, or other pecuniary interests in an entity. FIN 46 was effectively replaced in December 2003 by FIN 46(R). While retaining a majority of the provisions and concepts of FIN 46, FIN 46(R) provides additional scope exceptions and clarifies the description of variable interests. Public companies are required to apply either FIN 46 or FIN 46(R) to any interests in special purpose entities as of the first interim or annual period ending after December 15, 2003 and the decision to apply FIN 46 or FIN 46(R) may be made on an special purpose entities by special purpose entities basis. As of June 30, 2004, we did not have any variable interest entities.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to a fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123. SFAS No. 148 does not impact our current compensation plan or program.

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34. This interpretation outlines disclosure requirements in a guarantor’s financial statements relating to any obligations under guarantees for which it may have potential risk or liability, as well as clarifies a guarantor’s requirement to recognize a liability for the fair value, at the inception of the guarantee, of an obligation under that guarantee. The initial recognition and measurement provisions of this interpretation are effective for guarantees issued or modified after December 31, 2002 and the disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. As of December 31, 2003, we have not provided any guarantees that would require recognition as liabilities under this interpretation.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The standard requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. This statement is effective for exit or disposal activities initiated after December 31, 2002. We do not expect SFAS No. 146 to have a significant impact on our financial position or operating results. In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” The provisions of this standard, which primarily relate to the rescission of Statement No. 4, eliminate the requirement that gains and losses from the extinguishment of debt be classified as extraordinary items unless it can be considered unusual in nature and infrequent in occurrence. These provisions are effective in fiscal years beginning after May 15, 2002. The implementation of the provisions of SFAS No. 145 beginning in fiscal year 2003 had no impact on our combined results of operations or financial position.

LODGING INDUSTRY

We believe the U.S. lodging industry is in the early phases of a recovery from the dramatic negative effects of an economic slowdown and travel disruptions relating to the terrorist attacks of September 11, 2001. The overall decline in both business and leisure travel led to decreased demand for hotel rooms, which, together with an increase in hotel supply, led to declines in room rates as hotels competed more aggressively for guests. These events had a significant adverse effect on lodging industry RevPAR and operating performance in 2001 through 2003.

Fluctuations in lodging demand and, therefore, operating performance, are caused largely by general economic and local market conditions, which in turn affect levels of business and leisure travel. In addition to general economic conditions, new hotel room supply is another important factor that can affect the lodging industry’s performance. Room rates and occupancy, and thus RevPAR, tend to increase when demand growth exceeds supply growth. Accordingly, we believe that recent increases in demand coupled with limited new supply, which are projected by Smith Travel Research to continue for the U.S. lodging industry in 2004, will create opportunities for enhanced RevPAR growth and increased profitability.

Rebound in Lodging Demand. As shown in the graph below, growth in demand for hotel rooms has historically shown a positive correlation to growth in U.S. Gross Domestic Product, or GDP. From 1988 to 2000, demand for hotel rooms grew at an average annual rate of approximately 2.6%, corresponding to the 3.3% average annual growth rate in GDP. This period of growth was interrupted by disruptions in travel activities in 2001 and a weakening economy. Beginning in 2002, lodging demand and GDP began to show signs of recovery. In 2002 and 2003, lodging demand increased by 0.3% and 1.6%, while GDP increased by 2.2% and 3.1%. For 2004, Smith Travel Research projects GDP growth of 4.6% and an increase in lodging demand of 4.0%. Our occupancy rates for the 55 hotels we will own following the Formation and Structuring Transactions, which reflect demand for our rooms, increased 2.6% in 2002, were unchanged in 2003 and increased 5.8% in the first half of 2004.

U.S. Lodging Industry - Annual Change in Room Demand and GDP

LOGO

Source: Smith Travel Research and Bureau of Economic Analysis

Limited New Supply. Historically, periods of weak lodging performance have been followed by a decrease in the growth of new lodging supply as the availability of new development capital declines. Although improving operating fundamentals encourage new construction, development may require up to several years to complete. As a result, supply growth typically lags behind a lodging industry recovery. As reflected in the graph below, from 1988 to 2000 new supply growth averaged 2.6% annually; however, subsequent to the downturn beginning in 2001, new lodging supply for the U.S. lodging industry increased by only 1.6% in 2002 and 1.2% in 2003 and is projected to grow by 1.2% in 2004, approximately one-half of its 15-year historical average of 2.3%.

U.S. Lodging Industry - Annual Change in Hotel Room Supply

LOGO

Source: Smith Travel Research

Improving RevPAR. One of the key performance indicators widely used in the lodging industry is revenue per available room, or RevPAR, which is the product of average daily rate and occupancy. Periods of greater RevPAR growth generally occur when room demand exceeds new supply growth. As reflected in the graph below, during the period 1988 to 2000, industry RevPAR growth averaged 3.8%, including nine consecutive years of positive RevPAR growth from 1992 to 2000 following the economic recession of 1991. In 2001 and 2002, lodging demand fell significantly below new room supply resulting in RevPAR declines of 6.9% and 2.6%, respectively. As lodging demand stabilized in 2003, moderate industry RevPAR growth of 0.5% was realized. Based on the above described projected demand and supply trends, Smith Travel Research projects strong RevPAR growth of 5.2% in 2004 for the U.S. lodging industry. RevPAR for the 55 hotels we will own following the Formation and Structuring Transactions increased 1.5% in 2002, 9.0% in 2003 and 7.1% in the first half of 2004.

U.S. Lodging Industry - Annual Historical

and Projected Change in RevPAR, Room Demand and Room Supply

LOGO

Source: Smith Travel Research

Improving Margins. More efficient and flexible hotel operating practices have resulted in improving operating margins over the past decade, even after accounting for the industry downturn of 2001 to 2003. Within this context, strong operating leverage generally results from a relatively high fixed cost base. Periods of strong RevPAR growth tend to be characterized by increasing gross operating profit, or GOP, margins and periods of slower RevPAR growth or periods of RevPAR decline tend to be characterized by GOP margin decreases. For example, from 2000 through 2003, GOP margins declined from 39.1% to 35.0% as RevPAR declined by an average of 3.0% annually. As indicated above, Smith Travel Research projects RevPAR growth of 5.2% in 2004 for the U.S. lodging industry.

LOGO

Source: Smith Travel Research

Recent Trends. As shown in the chart below, we believe the lodging industry is in the early phases of a recovery, experiencing 12 consecutive months of RevPAR growth, averaging 5.7% per month.

U.S. Lodging Industry - Last Twelve Months RevPAR Growth

LOGO

Source: Smith Travel Research

Hotel Chain Scale Considerations. As illustrated in the graph below, the upper upscale and upscale segments, as defined by Smith Travel Research, outperformed the industry as a whole during the recovery that followed the 1991 economic recession and an industry downturn. For example, from 1992 to 1997, average upper upscale RevPAR growth was 6.5%, average upscale RevPAR growth was 5.8% and average RevPAR growth for the overall industry was 4.7%. Based on this past performance and the supply and demand trends discussed above, we believe that upper upscale and upscale properties will experience stronger RevPAR growth than the overall industry if the current economic recovery continues.

U.S. Lodging Industry - Annual Change in RevPAR

Total U.S. vs. Upper Upscale/Upscale

LOGO

Source: Smith Travel Research

OUR BUSINESS

Our Company

We are a hospitality company that will own primarily upper upscale and upscale hotels in the United States upon completion of the Formation and Structuring Transactions and this offering. Our hotels are operated under leading brand names franchised or licensed from others, such as Marriott, Hilton, InterContinental, Hyatt, Starwood, Carlson and Wyndham. As of June 30, 2004, on a pro forma basis, we owned 55 hotels, comprising 13,339 rooms, located in 17 states in the United States. We expect to qualify and will elect to be treated as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended.

Competitive Strengths

We believe the following competitive strengths distinguish us from other owners of lodging properties:

•

Positioned to Capitalize on Industry Recovery.

Significant Recent Investments . From January 1, 2003 through June 30, 2004, in addition to expenditures for regular ongoing maintenance of our hotels, we completed $64.3 million of significant renovations and redevelopments at 24 of our hotels, comprising 7,202 rooms. We believe these investments will improve the competitiveness of our hotels and better position us to capitalize on a lodging industry recovery.

Upper Upscale and Upscale Concentration. Our portfolio includes 42 upper upscale and upscale hotels, which generated approximately 87.9% of our 2003 pro forma revenue. Based on historical trends, we believe these hotel chain scale segments outperform the overall lodging industry during periods of economic recovery. For example, during the economic recovery from 1992 to 1997, average upper upscale RevPAR growth was 6.5%, average upscale RevPAR growth was 5.8% and average RevPAR growth for the overall lodging industry was 4.7%.

Nationally Recognized Brands. We operate substantially all of our hotels under nationally recognized brands, including Marriott, Hilton and Hyatt. We believe we will continue to benefit from our association with these brands as a result of their national advertising, guest loyalty programs and central reservations systems.

Presence in Markets with High Barriers to Entry . We believe that our hotels are located in desirable urban and suburban markets with major demand generators and significant barriers to entry for new supply. For example, we have a strong regional presence in the western United States, particularly in California, where our hotels generated 32.2% of our 2003 pro forma revenue.

•

Proven Acquisition and Disposition Capabilities . Since the beginning of 2001, we have been one of the more active buyers and sellers of hotels in the United States. From January 1, 2001 through June 30, 2004, we acquired 19 hotels with 5,731 rooms for an aggregate purchase price of $612.6 million. In addition, during this period, we sold 24 hotels with 3,744 rooms for an aggregate sales price of $336.8 million. We incurred losses, including impairment charges, on several of the hotels sold. We believe that our significant acquisition and disposition experience will allow us to continue to redeploy capital from slower growth to higher growth hotels.

•

Strategic Relationship with the Management Company. We intend to structure our agreements with Interstate Hotels & Resorts, Inc., the Management Company, to align its interests with ours by, among other things, having the flexibility to terminate agreements, providing for incentive fees and requiring our written consent for any material changes to budgets, key personnel and critical operating systems. We believe that our experience as an owner-operator and our historical working relationship with, and physical proximity to, the employees of the Management Company will allow us to work effectively with the Management Company to maximize the operating performance of our hotels.

•

Experienced Management Team . We have a seasoned senior management team with an average of 15 years of experience in real estate, lodging or finance.

•

Flexible Capital Structure. We are well capitalized, and on a pro forma basis as of June 30, 2004, we had a debt to total market capitalization ratio of approximately %. In addition, we expect to enter into a new $ million revolving credit facility, of which $ will be undrawn and available at the closing of this offering. We believe this capital structure will provide us with the financial flexibility that is required to fund our growth strategy and meet our liquidity needs.

Business and Growth Strategy

•

active asset management;

•

opportunistic hotel redevelopment, renovation and expansion;

•

franchise rebranding;

•

selective hotel acquisition and development;

•

capital redeployment; and

•

innovative management practices.

Active Asset Management. We have historically self-managed most of our hotels. As a result, we believe our employees have developed significant expertise in the management of our hotels. Subsequent to the Formation and Structuring Transactions, the operations of our hotels will be managed by third parties, including Interstate, which will manage 50 of our 55 hotels. To optimize the cash flow from, and profitability of, our hotels, we intend to structure our agreements with the Management Company to align its interests with ours and to maintain, to the greatest extent practicable, the hotel management practices we employed prior to electing REIT status. Our management agreements will allow us to closely monitor the performance of the hotels and terminate each agreement in case of underperformance. In addition, the Management Company will not be able to alter operating procedures or systems or make changes to personnel deemed integral to the operation of each of the managed hotels without our consent.

Most of our current hotel management employees will become employees of the Management Company, and will generally continue in their current roles. The Management Company will maintain offices in the same building as our headquarters for many of the employees responsible for the operation and sales and marketing of our hotels.

Opportunistic Hotel Redevelopment, Renovation and Expansion. We have made significant investments in our hotels, which we believe improved, and will continue to improve, the competitiveness of our hotels. We renovated or redeveloped the following hotels, which were completed during the indicated time period. The table below includes the number of rooms, the renovation investment and amount invested per room during the redevelopment and renovation (dollars in thousands):


Hotel	Rooms	Renovation Investment as of June 30, 2004 ⁽¹⁾		Per Room ⁽²⁾		Full Year 2004 Renovation Budget		Per Room
*2004—Ongoing Renovations*
Embassy Suites, Chicago, Illinois ⁽³⁾	365	$	6,034	$	16.5	$	6,269	$	17.2
Hyatt Regency, Newport Beach, California	403		5,890		14.6		8,289		20.6
Marriott, Tysons Corner, Virginia	390		5,796		14.9		6,775		17.4
Marriott, Houston, Texas	391		3,738		9.6		5,060		12.9
Marriott, Troy, Michigan	350		3,483		10.0		3,816		10.9
Marriott, Ontario, California	299		3,245		10.9		3,338		11.2
Courtyard by Marriott, San Diego, California (conversion from Holiday Inn & Suites and subsequent renovation) ⁽³⁾	176		2,663		15.1		3,065		17.4
Radisson, Williamsburg, Virginia	303		2,602		8.6		3,294		10.9
Residence Inn by Marriott, Manhattan Beach, California	176		2,557		14.5		2,603		14.8
Marriott, Philadelphia, Pennsylvania	286		1,449		5.1		3,320		11.6
Courtyard by Marriott, Oxnard, California (conversion from Radisson) ⁽³⁾ ⁽⁴⁾	167		1,338		8.0		1,311		7.9
Crowne Plaza, Grand Rapids, Michigan	320		1,024		3.2		1,306		4.1
Radisson, Englewood, New Jersey	194		728		3.8		2,145		11.1

2004 Subtotal	3,820		40,547		10.6		50,591		13.2


*2003*
Hilton, Del Mar, California ⁽³⁾	257	$	5,218		20.3
Hilton, Huntington, New York	302		3,377		11.2
Doubletree Suites, Minneapolis, Minnesota	230		3,017		13.1
Hyatt, Marietta, Georgia	202		2,804		13.9
The Kahler Grand, Rochester, Minnesota ⁽³⁾	707		2,520		3.6
Holiday Inn, Boise, Idaho	265		2,172		8.2
Valley River Inn, Eugene, Oregon	257		1,349		5.2
Wyndham, Houston, Texas	472		1,141		2.4
Marriott, Rochester, Minnesota ⁽³⁾	203		1,131		5.6
Sheraton, Salt Lake City, Utah	362		511		1.4
Holiday Inn Express, San Diego, California (conversion from Ramada Limited)	125		488		3.9

2003 Subtotal	3,382		23,728		7.0


*2002*
Marriott, Riverside, California (conversion from Holiday Inn Select)	286		4,320		15.1
Holiday Inn, Flagstaff, Arizona	156		408		2.6

2002 Subtotal	442		4,728		10.7


*2001*
Marriott, Napa, California ⁽³⁾	272		20,604		75.8
Holiday Inn, San Diego (Stadium), California	175		2,265		12.9
Courtyard by Marriott, Santa Fe, New Mexico	213		773		3.6
Sheraton, Salt Lake City, Utah	362		725		2.0
Courtyard by Marriott, Los Angeles, California	179		485		2.7

2001 Subtotal	1,201		24,852		20.7


*Total January 1, 2001 through June 30, 2004*	8,845	$	93,855		10.6

(1)	Amount of capital expenditures made during the period indicated and prior periods during the redevelopment and renovation period subsequent to acquisition.

(2)	Represents the aggregate investment as of June 30, 2004 divided by the corresponding number of rooms.

(3)	Includes addition of rooms.

(4)	Renovation investment is greater than the full year 2004 renovation budget for this hotel due to greater than anticipated expenditures.

For those hotels whose franchise affiliation we do not intend to change, we typically make renovations after acquisition to satisfy the existing franchisor’s property improvement plan, or PIP, and, more importantly, to attain a higher level of guest satisfaction and, as a result, increase market share and revenue. We also perform routine maintenance at all of our hotels to maintain their competitiveness.

Redevelopments and renovations typically consist of many of the following activities:

Guest Rooms

Public Areas

Exterior

• replacing all bedspreads, linens, coverlets/dust ruffles, drapes and valances

• replacing all furniture, mattresses and box springs

• replacing televisions, adding telephones with data ports and voicemail, high speed Internet access, other electronic entertainment equipment, coffeemakers, irons and ironing boards

• replacing wallpaper and vinyl wall covering

• reconfiguring work spaces with oversized work desks and ergonomic desk chairs

• repainting

• recarpeting

• remodeling guestrooms, including changing room layout and modifying closets.

• remodeling guest bathrooms with new vanities, floors, plumbing fixtures, mirrors and wall coverings

• installing fire safety equipment, including sprinklers and smoke detectors

• replacing drapes and valances

• replacing wallpaper and vinyl wall covering

• repainting

• recarpeting

• redecorating

• replacing furniture

• reconfiguring front desk reception areas

• redesigning lobby for improved traffic flow

• remodeling restaurant to standards of regional or national restaurant operators

• installing fire safety equipment, including sprinklers and smoke detectors

• repainting/weatherproofing

• installing energy efficient glazing and window systems

• architectural enhancements

• improvements to porte-cochere

• repaving or seal coating parking lot

• adding lighting

• re-roofing

• landscaping

In some cases, we may expand the number of rooms at a hotel where we believe we can achieve a favorable return on the cost of such expansion, and where we believe supply, demand and other market conditions justify such expansion. Since January 1, 2001, we have added rooms to the following hotels:


Hotel	Quarter Expansion Completed	Rooms Pre-Expansion	Rooms Added	Description
Embassy Suites, Chicago, Illinois	Second quarter of 2004	358	7	Conversion of suite parlors to additional guestrooms
Courtyard by Marriott, San Diego, California	Second quarter of 2004	171	5	Conversion of suite parlors to additional guestrooms
Courtyard by Marriott, Oxnard, California	Second quarter of 2004	159	8	Conversion of existing meeting/banquet rooms to guestrooms
Hilton, Del Mar, California	Third quarter of 2003	251	6	Conversion of suite parlors to additional guestrooms
The Kahler Grand, Rochester, Minnesota	Third quarter of 2003	702	5	Conversion of unfurnished / non-renovated rooms to additional guestrooms
Marriott, Rochester, Minnesota	Fourth quarter of 2002	194	9	Conversion of vacated commercial office space to additional guestrooms
Marriott, Napa, California	Fourth quarter of 2001	191	81	Additional guestrooms, ballroom and meeting space and health spa

Renovations—Changes in Hotel Operating Income. We have set forth below a summary regarding investments in renovations we have made in twelve of our hotels between 2001 and 2003, along with financial results of the hotels following the investments. Although we believe that the investments had a meaningful impact on the changes in hotel operating income discussed below, we note that other trends in the hotel industry generally, and the geographic region of the hotels specifically, also influenced the results. Hotel operating results during periods of redevelopment and renovation are also lower due to disruptions at the hotels resulting from the work being performed. Results from any one hotel are not necessarily indicative of results of any other hotel or our hotels generally.

For purposes of the discussions below, renovation investment is the amount of capital expenditures made by us during the redevelopment and renovation period subsequent to acquisition. Hotel operating income refers to room, food and beverage and other operating revenues less the corresponding departmental expenses, property tax, ground lease and insurance expenses for the specific period detailed. Hotel operating income is presented on the same basis as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and does not include any adjustments or allocation of general and administrative expenses, depreciation and amortization, interest expense or provision for income taxes. Renovation investment return refers to the change in hotel operating income divided by the additional investment amount. We use renovation investment return as a performance indicator of the renovation investments we make in our hotels.

In 2003, we completed the renovation of nine hotels where the additional investment was greater than $1.0 million dollars. The table below sets forth the renovation investment in hotels in 2003, the aggregate investment as of December 31, 2003, hotel operating income for both first half 2003 and 2004, the corresponding calculation for the change in the two periods and the renovation investment return (dollars in thousands).


Year 2003	2003 Renovation Investment		First Half of 2003 Hotel Operating Income		First Half of 2004 Hotel Operating Income		Change in Hotel Operating Income		First Half of 2004 Renovation Investment Returns ⁽¹⁾		2004 Annualized Renovation Investment Return ⁽²⁾
Hilton, Del Mar, California	$	5,218	$	454	$	1,088	$	634	12.2	%	24.3	%
Hilton, Huntington, New York		3,377		1,702		2,679		977	28.9		57.9
Doubletree Suites, Minneapolis, Minnesota		3,017		315		826		511	16.9		33.9
Hyatt, Marietta, Georgia		2,804		486		689		203	7.2		14.5
The Kahler Grand, Rochester, Minnesota		2,520		1,339		1,889		550	21.8		43.7
Holiday Inn, Boise, Idaho		2,172		718		902		184	8.5		16.9
Valley River Inn, Eugene, Oregon		1,349		485		897		412	30.5		61.1
Wyndham, Houston, Texas		1,141		2,954		4,992		2,038	178.6		357.2
Marriott, Rochester, Minnesota		1,131		1,483		1,860		377	33.3		66.7

Total	$	22,729	$	9,936	$	15,822	$	5,886	25.9	%	51.8	%

(1)	Reflects change in hotel operating income divided by renovation investment.

(2)	Reflects change in hotel operating income multiplied by two and divided by renovation investment. This is not a projection of results for 2004.

The following table sets forth similar information for the three hotels with renovations totaling more than $1.0 million completed in 2002 and 2001:


Year 2002	2002 Renovation Investment		2002 Hotel Operating Income		2003 Hotel Operating Income		Change in Hotel Operating Income ⁽¹⁾			2003 Renovation Investment Return ⁽²⁾
Marriott, Riverside, California	$	4,320	$	1,316	$	2,309	$	993		23.0	%

Year 2001	2001 Renovation Investment		2001 Hotel Operating Income		2002 Hotel Operating Income		Change in Hotel Operating Income ⁽¹⁾			2002 Renovation Investment Return ⁽²⁾
Marriott, Napa, California	$	20,604	$	2,396	$	3,638	$	1,242		6.0	%
Holiday Inn, San Diego (Stadium), California		2,265		1,390		1,340		(50	)	(2.2	)

Total	$	22,869	$	3,786	$	4,978	$	1,192		5.2	%

(1)	Reflects change in hotel operating income divided by renovation investment.

(2)	Reflects change in hotel operating income multiplied by two and divided by renovation investment. This is not a projection of results for the second half of 2004.

In addition to the 12 hotels described above, we are renovating 13 hotels in 2004 with a budgeted renovation investment totaling approximately $50.6 million, of which $40.6 million has been invested as of June 30, 2004.

In addition to the incremental hotel operating income and additional investment returns resulting from the improvements in redevelopments and renovations, we have also generated incremental hotel operating income through active asset management and capitalizing on opportunities available from either existing unused space or facilities within our existing hotels, including Starbucks coffee retail outlets and guest parking installations described below.

Renovations—Starbucks Installations . We have generated additional hotel operating income at three of our hotels through the installation of Starbucks coffee retail outlets in either vacant retail space or previously unused space in our hotel lobbies. The following table sets forth the amount of the investment in these installations and the hotel operating income attributable to the installations, and calculations of installation investment return (dollars in thousands). Installation investment is the amount of capital expenditures made by us for the installations. Installation operating income is calculated on the same basis as hotel operating income as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We are in the process of developing a new installation at the Doubletree Suites, Minneapolis, Minnesota, and we continue to identify additional such opportunities at other select hotels within our portfolio.


	Installation Date	Installation Investment		2003 Installation Operating Income		Installation Investment Return ⁽¹⁾		First Half of 2004 Installation Operating Income		First Half of 2004 Installation Investment Return ⁽²⁾		2004 Annualized Installation Investment Return ⁽³⁾
Starbucks Installation s
Wyndham, Houston, Texas	November 2003	$	239,626		N/A	N/A		$	46,919	19.6	%	39.2	%
The Kahler Grand, Rochester, Minnesota	April 2002		232,686	$	59,581	25.6	%		34,941	15.0		30.0
Sheraton, Salt Lake City, Utah	January 2002		255,660		64,271	25.1			43,402	17.0		34.0

Total		$	727,972					$	125,262	17.2		34.4

(1)	Reflects installation operating income divided by installation investment.

(2)	Reflects first half of 2004 installation operating income divided by installation investment.

(3)	Reflects first half of 2004 installation operating income multiplied by two and divided by installation investment. This is not a projection of results for 2004.

Renovations—Guest Parking Installations . We have generated additional hotel operating income at three of our hotels by charging for guest parking where we previously had not charged for parking. The introduction of guest parking charges has been at hotels in markets where charging for such services is generally accepted, primarily in downtown and urban markets. The following table sets forth the amount of the investment required to begin charging for parking, primarily hardware and computer equipment, and the operating income attributable to the installation. Installation operating income is calculated on the same basis as hotel operating income as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We have recently installed or are planning to install guest parking installations at the Hilton, Del Mar, California and the Marriott, Philadelphia, Pennsylvania, and we continue to identify additional such opportunities at other select hotels within our portfolio.


	Installation Date	Installation Investment		First Half of 2004 Installation Operating Income
Guest Parking Installations
Marriott, Riverside, California	June 2004	$	86,000	$	17,943
Holiday Inn Express, San Diego, California	March 2004		3,000		24,250
Courtyard by Marriott, San Diego, California	January 2004		5,000		120,365

Total		$	94,000	$	162,558

Franchise Rebranding. We seek to rebrand our hotels to increase market share, enhance property level cash flow, and generate attractive returns on invested capital. Since January 1, 2001, we rebranded four hotels, as follows:


Hotel Location	Quarter Rebranded	Former Franchise Brand	Current Franchise Brand
Oxnard, California	Second quarter of 2004	Radisson	Courtyard by Marriott
San Diego, California	Fourth quarter of 2002	Holiday Inn Hotel and Suites	Courtyard by Marriott
San Diego, California	Fourth quarter of 2002	Ramada Limited	Holiday Inn Express
Riverside, California	Fourth quarter of 2002	Holiday Inn Select	Marriott

For the three hotels rebranded in the fourth quarter of 2002, we have generated consistent operating improvements after the rebranding. The following table presents our occupancy, ADR and RevPAR for 2002, 2003 and the first half of 2004:


	2002						2003						First Half of 2004
	Occupancy		ADR		RevPAR		Occupancy		ADR		RevPAR		Occupancy		ADR		RevPAR
Courtyard by Marriott, San Diego, California	80.8	%	$	92.55	$	74.78	78.8	%	$	105.86	$	83.42	77.2	%	$	113.44	$	87.58
Holiday Inn Express, San Diego, California	79.3			86.36		68.48	74.7			94.25		70.40	80.2			93.30		74.83
Marriott, Riverside, California	66.9			78.95		52.82	78.4			87.29		68.44	78.3			95.48		74.76
Total	73.6	%	$	85.05	$	62.60	77.7	%	$	94.26	$	73.24	78.4	%	$	100.26	$	78.60

Selective Hotel Acquisition and Development. We will seek to create value by acquiring premium-branded hotels, or hotels that have the attributes to facilitate their conversion to premium brands, that have been undermanaged or undercapitalized, that are located in growth markets or that offer expansion and renovation opportunities. Furthermore, our acquisition initiatives will focus on hotels where our aggregate investment, including the costs of acquisition, rebranding and renovation, is below replacement cost.

From January 1, 2001 through June 30, 2004, we have been one of the more active buyers of hotels in the United States, acquiring 19 hotels with 5,731 rooms for an aggregate purchase price of $612.6 million. Our most significant portfolio acquisition was in December 2002, which consisted of 14 hotels acquired from Wyndham International (the 13 Wyndham Acquisition Hotels and the Marriott, Woodland Hills, California), with 4,660 rooms for $507.0 million. As of June 30, 2004, we did not have any acquisitions under contract. The following table summarizes our acquisitions from January 1, 2001 through June 30, 2004, including the Residence Inn, Rochester, Minnesota that we developed and which opened in June 2004 and the JW Marriott, Cherry Creek, Colorado, that we acquired in April 2004 which we will not own after the Formation and Structuring Transactions:


	2001	2002		2003		First Half of 2004		Total
Number of hotels	—		15		2		2		19
Number of rooms	—		4,980		475		276		5,731
Acquisition cost (thousands)	—	$	525,900	$	42,000	$	44,745	$	612,645

We may also develop new upper upscale and upscale hotels where we believe room demand and other competitive factors justify new construction. We may develop hotels ourselves or may contract with unaffiliated developers who will build hotels and then sell them to us upon completion at pre-agreed terms.

Capital Redeployment . We intend to sell hotels on an opportunistic basis to redeploy our capital to acquire or redevelop other hotels with greater cash flow growth potential. For example, we may sell hotels in circumstances where:

•

we can realize attractive pricing;

•

demand in the market in which the hotel is located is declining or static;

•

competition in the market requires substantial capital investment into a hotel that will not generate adequate returns; or

•

the hotel was acquired as a part of a portfolio and is not consistent with our business strategy.

The following table summarizes our hotel sales from January 1, 2001 through June 30, 2004:


	2001		2002		2003		First Half of 2004		Total
Number of hotels		13		1		7		3		24
Number of rooms		1,698		129		1,249		668		3,744
Sale price (thousands)	$	177,750	$	6,246	$	121,730	$	30,600	$	336,326

From January 1, 2001 through June 30, 2004, we realized net gains of $14.6 million and impairment charges of $73.2 million on the sale of these hotels.

One of the hotels sold in 2003 was the Marriott, Woodland Hills, California. We acquired the hotel in December 2002 for $69.5 million. We reinvested approximately $3.0 million of operating cash flow to renovate the hotel. We sold the hotel in December 2003 for $85.5 million, amounting to an approximately $11.9 million gain.

We currently have three hotels with an aggregate of 779 rooms (the Concord Hotel and Conference Center, Concord, California, the San Marcos Resort, Chandler, Arizona and the Four Points—Sheraton, Silverthorne, Colorado) under contract or negotiation for sale.

Innovative Management Practices. We will pursue innovative management practices to grow revenue, expand operating margins and achieve economies of scale. In addition, we will continue to share market intelligence and best management practices across our portfolio. We founded and own Buy Efficient, L.L.C., an electronic purchasing platform accessed via the Internet and currently used by both our hotels and 382 third-party member hotels to purchase supplies and equipment as a consortium, consolidate purchasing power, and negotiate volume purchase discounts and rebates for our members. Buy Efficient, L.L.C. also provides its members, including the Management Company and other third party management companies, with a managerial tool that allows managers to control inventory levels, set vendor and product specifications, streamline the accounting and invoice payment process and improve operational consistency. After paying an initial installation fee of $2,500, members enter into one-year contracts with Buy Efficient, L.L.C. and pay monthly fees equal to the greater of 1.75% of their monthly purchases or $149. Members place purchase orders for supplies on the website maintained by Buy Efficient, L.L.C., and the supplies are delivered directly by the supplier to the customer. Members are not required to use Buy Efficient, L.L.C. for their purchases.

Hotel Properties

The following table sets forth additional summary information with respect to our hotel portfolio on a pro forma basis as of June 30, 2004:


Hotel	City	State	Chain Scale Segment ⁽¹⁾	Service Category	Rooms	Year Acquired/ Developed	Year Opened/ Redeveloped	Year Last Renovated
Marriott	Houston	Texas	Upper Upscale	Full Service	391	2002	1981	2004
Marriott ⁽²⁾	Napa	California	Upper Upscale	Full Service	272	1998	1979	2001
Marriott	Ogden	Utah	Upper Upscale	Full Service	292	1997	1982	1999
Marriott	Ontario	California	Upper Upscale	Full Service	299	2003	1986	2004
Marriott	Park City	Utah	Upper Upscale	Full Service	199	1997	1985	2000
Marriott ^{(3) (4)} ⁽⁵⁾	Philadelphia	Pennsylvania	Upper Upscale	Full Service	286	2002	1991	2004
Marriott	Portland	Oregon	Upper Upscale	Full Service	249	2000	1999	N/A
Marriott ⁽⁵⁾ ⁽⁶⁾	Provo	Utah	Upper Upscale	Full Service	330	1997	1982	1999
Marriott ⁽³⁾	Pueblo	Colorado	Upper Upscale	Full Service	164	1998	1998	N/A
Marriott	Riverside	California	Upper Upscale	Full Service	286	2000	1987	2002
Marriott	Rochester	Minnesota	Upper Upscale	Full Service	203	1997	1991	2003
Marriott ⁽³⁾	Salt Lake City	Utah	Upper Upscale	Full Service	218	1997	1987	1999
Marriott ⁽⁵⁾	Troy	Michigan	Upper Upscale	Full Service	350	2002	1990	2004
Marriott ⁽⁵⁾	Tysons Corner	Virginia	Upper Upscale	Full Service	390	2002	1981	2004

Courtyard by Marriott	Fresno	California	Upscale	Full Service	116	1995	1989	2003
Courtyard by Marriott ⁽³⁾	Los Angeles	California	Upscale	Full Service	179	1997	1996	2001
Courtyard by Marriott	Lynwood	Washington	Upscale	Full Service	164	1999	1999	N/A
Courtyard by Marriott	Oxnard	California	Upscale	Full Service	167	1996	1987	2004
Courtyard by Marriott	Riverside	California	Upscale	Full Service	163	1996	1988	1998
Courtyard by Marriott	San Diego	California	Upscale	Full Service	176	1997	1986	2004
Courtyard by Marriott	Santa Fe	New Mexico	Upscale	Full Service	213	1995	1985	2001

Residence Inn	Manhattan Beach	California	Upscale	Extended Stay	176	2003	1986	2004
Residence Inn ⁽³⁾	Oxnard	California	Upscale	Extended Stay	252	1996	1987	2004
Residence Inn	Rochester	Minnesota	Upscale	Extended Stay	80	2004	2004	N/A
Residence Inn	Sacramento	California	Upscale	Extended Stay	126	1997	1992	2004

Hilton	Carson	California	Upper Upscale	Full Service	224	1998	1989	2002
Hilton	Del Mar	California	Upper Upscale	Full Service	257	2002	1989	2003
Hilton	Huntington	New York	Upper Upscale	Full Service	302	2002	1988	2003

Doubletree	Minneapolis	Minnesota	Upscale	Full Service	230	2002	1986	2003

Embassy Suites ⁽⁷⁾	Chicago	Illinois	Upper Upscale	Extended Stay	365	2002	1991	2004

Hilton Garden Inn	Lake Oswego	Oregon	Upscale	Full Service	181	2000	2000	N/A

Holiday Inn	Boise	Idaho	Midscale with F/B	Full Service	265	2000	1967	2003
Holiday Inn	Craig	Colorado	Midscale with F/B	Full Service	152	1995	1981	1998
Holiday Inn	Flagstaff	Arizona	Midscale with F/B	Full Service	156	1996	1987	2002
Holiday Inn	Hollywood	California	Midscale with F/B	Full Service	160	2000	1983	2000
Holiday Inn	Mesa	Arizona	Midscale with F/B	Full Service	246	1996	1985	2004
Holiday Inn	Price	Utah	Midscale with F/B	Full Service	151	1996	1983	1997
Holiday Inn	Provo	Utah	Midscale with F/B	Full Service	78	1995	1968	2001
Holiday Inn	Rochester	Minnesota	Midscale with F/B	Full Service	170	1997	1969	1999
Holiday Inn	San Diego (Harborview)	California	Midscale with F/B	Full Service	220	1997	1968	2002
Holiday Inn ⁽³⁾	San Diego (Stadium)	California	Midscale with F/B	Full Service	175	1997	1991	2001

Holiday Inn Select	Renton	Washington	Midscale with F/B	Full Service	226	1996	1968	2002

Crowne Plaza	Grand Rapids	Michigan	Upscale	Full Service	320	2002	1980	2004
Holiday Inn Express	San Diego (Old Town)	California	Midscale without F/B	Limited Service	125	1997	1986	2003

Hotel

City

State

Chain Scale
Segment ⁽¹⁾

Service
Category

Rooms

Year
Acquired/
Developed

Year
Opened/

Redeveloped

Year Last
Renovated

Hyatt ⁽⁵⁾

Marietta

Georgia

Upper Upscale

Full Service

202

2000

1984

2003

Hyatt Regency ⁽³⁾⁽⁵⁾

Newport Beach

California

Upper Upscale

Full Service

403

2002

1963

2004

Hawthorn Suites

Kent

Washington

Upscale

Extended Stay

152

1997

1990

1999

Hawthorn Suites

Sacramento

California

Upscale

Extended Stay

272

1997

1988

1998

Radisson ⁽³⁾

Englewood

New Jersey

Upscale

Full Service

194

2002

1989

2004

Radisson

Williamsburg

Virginia

Upscale

Full Service

303

2002

1978

2003

Sheraton

Salt Lake City

Utah

Upper Upscale

Full Service

362

1997

1975

2001

Wyndham

Houston

Texas

Upscale

Full Service

472

2002

1984

2003

Independent—Valley River Inn ⁽⁸⁾

Eugene

Oregon

Upscale

Full Service

257

2002

1973

2003

Independent—The Kahler Grand

Rochester

Minnesota

Upscale

Full Service

707

1997

1927, Various

2003

Independent—Economy Inn and Suites

Rochester

Minnesota

Midscale with F/B

Extended Stay

271

1997

Various

2002

(1)	As defined by Smith Travel Research. F/B refers to food and beverage.

(2)	Includes an 8,000 square foot spa.

(3)	Subject to a ground lease.

(4)	We are both the ground lessee and ground lessor.

(5)	Operated by a third-party management company.

(6)	Includes a 28,000 square foot conference facility.

(7)	We expect to exercise an option to acquire the ground lessor’s interest in the ground lease under this hotel property upon closing of this offering for approximately $6.3 million.

(8)	Hotel parking lot is subject to a reciprocal easement agreement with a third party regarding the use of parking facilities owned by that third party.

We also lease a hotel property in Houston, Texas with 110 rooms that we operate as a limited service facility. This lease term expires on December 31, 2004 and extends thereafter on a month to month basis thereafter. In addition to our hotel properties, we own a 88,000 square foot laundry facility in Rochester, Minnesota and lease a 65,000 square foot laundry facility in Salt Lake City, Utah. The facility in Rochester, Minnesota services our hotels in the area, as well as the Mayo Clinic. The facility in Salt Lake City, Utah services both our hotels in the area, as well as third party contracts. We also manage a 50,000 square foot third-party conference facility in Ogden, Utah for a third party. In addition, we own four undeveloped parcels of land, in Price, Utah; Craig, Colorado; Rochester, Minnesota; and Chandler, Arizona.

Geographic Diversity

We own a geographically diverse portfolio of hotels located in 17 states with a concentration of hotels in the western United States. We believe that a certain amount of geographic distribution helps to insulate our hotel portfolio from local market conditions that are typical in the hotel industry. The following table summarizes our portfolio by region, and includes the percentage of our 2003 pro forma revenue for the 55 hotels we will own following the Formation and Structuring Transactions:


Region	Number of Hotels	Number of Rooms	Percentage of 2003 Pro Forma Revenues
California ⁽¹⁾	19	4,048	32.2	%
Other West ⁽²⁾	16	3,440	19.7
Midwest ⁽³⁾	9	2,696	20.6
Middle Atlantic ⁽⁴⁾	3	782	8.9
South ⁽⁵⁾	3	895	7.8
Southwest ⁽⁶⁾	5	1,478	10.8

Total	55	13,339	100.0	%

(1)	All but four of these hotels are located in Southern California.

(2)	Includes Colorado, Idaho, Oregon, Utah and Washington.

(3)	Includes Illinois, Michigan and Minnesota.

(4)	Includes New Jersey, New York and Pennsylvania.

(5)	Includes Georgia and Virginia.

(6)	Includes Arizona, New Mexico and Texas.

The following table presents our occupancy, ADR and RevPAR by geographic region for our hotels for 2001, 2002, 2003 and for the first half of 2004. These statistics reflect the 55 hotels that we will own following the Formation and Structuring Transactions and may include periods prior to when we acquired our interest in the hotels. As shown in the chart below, our hotels in California, where we have the highest concentration of hotels, have generated increases in occupancy and RevPAR from 2001 to June 30, 2004.


	2001						2002						2003						First Half of 2004
	Occupancy		ADR		RevPAR		Occupancy		ADR		RevPAR		Occupancy		ADR		RevPAR		Occupancy		ADR		RevPAR
California	71.7	%	$	99.29	$	71.19	75.1	%	$	95.24	$	71.53	74.8	%	$	97.12	$	72.65	76.6	%	$	98.88	$	75.74
Other West	61.0			83.47		50.92	65.4			84.93		55.54	63.7			78.55		50.04	65.8			80.52		52.98
Midwest	67.7			111.81		75.70	64.1			107.41		68.85	61.1			110.03		67.23	61.5			108.58		66.78
Middle Atlantic	71.0			144.10		102.31	69.1			136.37		94.23	69.3			125.44		86.93	75.1			124.35		93.39
South	67.7			114.13		77.27	66.4			107.47		71.36	65.2			108.38		70.66	64.2			116.02		74.48
Southwest	67.7			86.36		58.47	63.2			82.80		52.33	72.9			77.13		56.23	78.0			81.17		63.31
Total	67.1	%	$	100.16	$	67.21	68.0	%	$	96.89	$	65.89	68.0	%	$	94.90	$	64.53	70.1	%	$	96.45	$	67.61

Competition

The hotel industry is highly competitive. Our hotels compete with other hotels for guests in each market in which we operate. Competitive advantage is based on a number of factors, including location, convenience, brand affiliation, room rates, range of services and guest amenities or accommodations offered and quality of customer service. Competition is often specific to the individual markets in which our hotels are located and includes competition from existing and new hotels operated under brands in the upper upscale and upscale segments. Increased competition could harm our occupancy, ADR and RevPAR, or may require us to provide additional amenities or make capital improvements that we otherwise would not have to make, which may reduce our profitability.

We believe that our hotels enjoy competitive advantages associated with their operations under well known brands. The national marketing programs and reservation systems of these brands combined with the strong management systems and expertise the franchisors provide should enable our hotels to continue to perform favorably relative to our competitors in terms of both occupancy and room rates. Our primary hotel operator, the Management Company, and our other third party hotel managers maintain reservation systems that monitor the current status of the rooms available and rates for the hotels. In addition, repeat guest business is enhanced by guest rewards programs offered by most of our brands, including Marriott and Hilton.

We believe that competition for the acquisition of hotels is highly fragmented. We face competition from institutional pension funds, private equity investors, other REITs and numerous local, regional and national owners, including franchisors, in each of our markets. Some of these entities may have substantially greater financial resources than we do and may be able and willing to accept more risk than we can prudently manage. Competition generally may increase the bargaining power of property owners seeking to sell and reduce the number of suitable investment opportunities offered to us.

Franchise Agreements

All but three of our hotels are operated under franchise or franchise management agreements. We believe that the public’s perception of the quality associated with a brand name hotel is an important feature in its attractiveness to guests. Franchisors provide a variety of benefits to franchisees, including centralized reservation systems, national advertising, marketing programs and publicity designed to increase brand awareness, training of personnel and maintenance of operational quality at hotels across the brand system.

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

The franchise agreements also provide for termination at the franchisor’s option upon the occurrence of certain events, including failure to pay royalties and fees or to perform other obligations under the franchise license, bankruptcy and abandonment of the franchise or a change in control. The subsidiary that is the franchisee will be responsible for making all payments under the franchise agreements to the franchisors.

The following table sets forth certain information with respect to the existing franchise affiliations for the 55 hotels that we will own following the Formation and Structuring Transactions. See also “Unaudited Pro Forma Financial Data.”


Franchise Affiliations	Number of Hotels	Number of Rooms	2003 Pro Forma Revenues			Percentage of 2003 Pro Forma Revenues		Franchise Fee ⁽¹⁾	Marketing/Reservation Fee ⁽¹⁾		Term Expires
			(in thousands)
Marriott
Marriott ⁽²⁾	14	3,929	$	161,548		36.4	%	4.0-6.0%	1.0%		2017-2023
Courtyard by Marriott	7	1,178		32,075		7.2		5.0-5.5%	2.0-4.0%		2017-2022
Residence Inn by Marriott	4	634		17,262		3.9		5.0-8.0%	2.5%		2018-2020

Subtotal	25	5,741		210,885		47.5


Hilton
Hilton	3	783		32,789		7.4		5.0%	1.0-2.7%		2005-2010
Doubletree	1	230		6,455		1.5		4.0%	4.0%		2012
Embassy Suites	1	365		18,238		4.1		4.0%	3.5%		2017
Hilton Garden Inn	1	181		3,031		0.7		5.0%	1.0%		2020

Subtotal	6	1,559		60,513		13.7


InterContinental Hotels Group
Holiday Inn	10	1,773		40,737		9.2		4.0-5.0%	2.5%		2004-2010
Holiday Inn Select	1	226		3,772		0.8		5.0%	2.5%		2006
Crowne Plaza	1	320		8,016		1.8		5.0%	3.0%		2012
Holiday Inn Express	1	125		3,322		0.7		5.0%	3.0%		2010

Subtotal	13	2,444		55,847		12.5


Hyatt
Hyatt ⁽³⁾	2	605		27,782		6.3		4.0% ⁽²⁾			2039-2040
Hawthorn Suites	2	424		9,150		2.1		4.0-5.0%	2.5%		2007

Subtotal	4	1,029		36,932		8.3


Other franchise affiliations ⁽⁴⁾	4	1,331		47,275		10.6		4.0-5.0%	1.0-4.0%		2009-2022

Independent	3	1,235		32,807		7.4			0.0-2.5	%

Total ⁽⁵⁾	55	13,339	$	444,259	⁽⁶⁾	100.0	%

(1)	Percentage of room revenue payable to the franchisor.

(2)

Three Marriott hotels are operated under management agreements with Marriott Hotel Services, Inc. and Marriott International, Inc., which require a payment of a percentage of total hotel revenue and an incentive fee based on either performance thresholds or percentages of room revenue and food and beverage revenue.

(3)	Hyatt hotels are operated under management agreements with Hyatt Corporation. A percentage of total hotel revenue is payable to Hyatt Corporation.

(4)	Includes Radisson, Sheraton and Wyndham.

(5)	Excludes three hotels held for sale as of June 30, 2004.

(6)

This total consists of room, food and beverage and other operating revenues relating to our hotels and does not include other operating revenues relating to Buy Efficient, L.L.C. and our laundry facilities (totaling $11.3 million) and management and other fees from affiliates (totaling $0.7 million).

Three of our hotels, The Kahler Grand and the Economy Inn & Suites, each located in Rochester, Minnesota and the Valley River Inn in Eugene, Oregon are operated independently, with no franchise affiliations. In each of the markets where an independent hotel is located, we have determined that the existing hotel name is well known and generates significant demand. We have also determined that the potential incremental revenues resulting from the addition of a brand name to the hotel would not exceed the incremental cost of operation in accordance with the related brand standards by an amount sufficient to justify the cost of such conversion.

The following table presents our occupancy, ADR and RevPAR by franchise affiliation for our hotels for 2001, 2002, 2003 and for the first half of 2004. These statistics are for the 55 hotels that we will own following the Formation and Structuring Transactions and may include periods prior to when we owned the hotels.


	2001						2002						2003						First Half of 2004
Franchise Affiliations	Occupancy		ADR		RevPAR		Occupancy		ADR		RevPAR		Occupancy		ADR		RevPAR		Occupancy		ADR		RevPAR
Marriott	68.4	%	$	106.72	$	73.00	69.8	%	$	104.13	$	72.68	70.0	%	$	102.72	$	71.90	71.8	%	$	106.52	$	76.48
Hilton	67.0			129.71		86.91	67.0			121.46		81.38	65.6			122.21		80.17	69.6			117.47		81.76
InterContinental Hotels Group	66.4			77.81		51.67	69.4			73.91		51.29	67.8			73.31		49.70	69.6			73.78		51.35
Hyatt	66.8			111.72		74.63	70.6			101.78		71.86	68.3			98.45		67.24	68.8			99.74		68.62
Other franchise affiliations ⁽¹⁾	65.9			90.70		59.77	64.6			91.93		59.39	72.0			81.08		58.38	74.4			82.76		61.57
Independent	66.5			79.26		52.71	61.4			78.23		48.03	57.8			78.68		45.48	59.9			78.33		46.92
Total	67.1	%	$	100.16	$	67.21	68.0	%	$	96.89	$	65.89	68.0	%	$	94.90	$	64.53	70.1	%	$	96.45	$	67.61

(1)	Includes Radisson, Sheraton and Wyndham.

Portfolio by Chain Scale Segment

We own upper upscale, upscale and midscale hotels.

The following tables present summary information by chain scale segment, including occupancy, ADR and RevPAR for our hotels for 2001, 2002, 2003 and for the first half of 2004. These statistics are only for the 55 hotels that we will own following the Formation and Structuring Transactions and may include periods prior to when we owned the hotels. See also “Unaudited Pro Forma Financial Data.”


Chain Scale Segment	Number of Hotels	Number of Rooms	Percentage of 2003 Pro Forma Revenues
Chain Scale Segment	Number of Hotels	Number of Rooms	Percentage of 2003 Pro Forma Revenues
Upper upscale ⁽¹⁾	21	6,044	56.4	%
Upscale ⁽²⁾	21	4,900	31.5
Midscale with food and beverage ⁽³⁾	12	2,270	11.4
Midscale without food and beverage ⁽⁴⁾	1	125	0.7

Total	55	13,339	100.0	%

(1)	Upper upscale hotels include Marriott, Hilton, Embassy Suites, Hyatt and Sheraton.

(2)	Upscale hotels include Courtyard by Marriott, Residence Inn by Marriott, Doubletree, Hilton Garden Inn, Crowne Plaza, Hawthorn Suites, Radisson and Wyndham.

(3)	Midscale hotels with food and beverage include Holiday Inn and Holiday Inn Select.

(4)	Our one midscale hotel without food and beverage is the Holiday Inn Express, San Diego, California.


Chain Scale Segment	2001						2002						2003						First Half of 2004
Chain Scale Segment	Occupancy		ADR		RevPAR		Occupancy		ADR		RevPAR		Occupancy		ADR		RevPAR		Occupancy		ADR		RevPAR
Upper upscale	66.3	%	$	118.86	$	78.80	67.9	%	$	114.41	$	77.68	67.7	%	$	111.08	$	75.20	70.0	%	$	113.23	$	79.26
Upscale	68.0			90.29		61.40	66.5			87.52		58.20	67.3			85.71		57.68	69.2			87.15		60.31
Midscale with food and beverage	68.3			74.65		50.99	71.5			71.92		51.42	69.9			71.79		50.18	71.4			72.57		51.81
Midscale without food and beverage	74.6			96.13		71.71	79.3			86.36		68.48	74.7			94.25		70.40	80.2			93.30		74.83
Total ⁽¹⁾	67.1	%	$	100.16	$	67.21	68.0	%	$	96.89	$	65.89	68.0	%	$	94.90	$	64.53	70.1	%	$	96.45	$	67.61

(1)	Excludes three hotels held for sale as of June 30, 2004.

Management Company

Interstate Hotels & Resorts, Inc., the Management Company, is the largest independent hotel management company in the United States not affiliated with a hotel brand, measured by number of rooms under management. As of June 30, 2004, Interstate managed approximately 270 properties, with more than 60,000 rooms in 40 states, the District of Columbia, Canada, Russia, Portugal and Belgium. Interstate’s portfolio of managed properties is diversified by brand, franchise and ownership. The portfolio of managed hotels includes more than 30 franchise and brand affiliations and more than 30 independent hotels. Interstate manages hospitality properties for several large, publicly-owned hotel companies, large institutional real estate investment companies, as well as owners of individual or multiple hotel properties. Interstate is a NYSE-listed public company.

Management Agreements

Fifty of 55 of our hotels will be managed and operated by the Management Company pursuant to management agreements with the TRS Lessee. Our remaining five hotels will continue to be managed by Marriott or Hyatt under existing management agreements. The following is a general description of these agreements.

Management Company . These management agreements will require us to pay, on a monthly basis, a management fee equal to: (1) for the period commencing on the closing of this offering and ending on June 30, 2005, $ per month, (2) for the period commencing on July 1, 2005 and ending on December 31, 2005, % of our gross revenues from the hotels and (3) for the period commencing on January 1, 2006 and thereafter, % of our gross revenues from the hotels to the Management Company. In addition, we will pay an accounting fee of $10 per room per month and commencing January 1, 2005, an incentive fee of 10.0% of the excess of net operating income over a threshold. The initial term of these management agreements will be 20 years with renewal provisions absent a prior termination by either party. The operations of the hotels will be overseen by a separate division of the Management Company located in the same building as our headquarters in San Clemente, California. Pursuant to the terms of the management agreements, without the prior written consent of the TRS Lessee, the Management Company may not replace any person deemed to be a “necessary” corporate or hotel employee in each management agreement. All of these key personnel will initially be our former employees. In addition, without the prior written consent of the TRS Lessee, the Management Company will not be able to alter certain operating procedures or systems deemed integral to the operation of each of the managed hotels. We will be responsible for determining and funding certain furniture, fixtures and equipment replacements and the construction of building alterations, improvements and renovations.

Hyatt. Our Hyatt hotels are operated under management agreements with Hyatt Corporation. The agreement with respect to the Hyatt, Newport Beach, California requires us to pay 3.5% of total revenue as a base management fee, with an additional 0.5% of total revenue based upon the hotel achieving specific operating thresholds, to Hyatt and expires in 2039. The management agreement with respect to the Hyatt, Marietta, Georgia requires us to pay 4.0% of our total hotel revenue to Hyatt and expires in 2040. These management agreements include incentive fees ranging between 10.0% and 33.0% of net profit above the achievement of certain net profit thresholds. The management agreements with Hyatt may be terminated earlier than the stated term if certain events occur, including the failure of Hyatt to satisfy certain performance standards, a condemnation of, a casualty to, or force majeure event involving a hotel and upon a default by Hyatt or us that is not cured prior to the expiration of any applicable cure period.

Marriott. Three of our Marriott hotels are operated under management agreements with Marriott Hotel Services, Inc. or Marriott International, Inc. These management agreements require us to pay a base management fee between 2.3% and 3.0% of total hotel revenue to Marriott and expire between 2014 and 2020. Additionally, one of the management agreements requires an incentive fee of 20.0% of net cash flow and another management agreement requires an incentive fee of 20.0% of the excess of gross operating profit over a certain threshold. In the third instance, the management agreement requires us to pay specific percentages of both room revenue and food and beverage revenue. The management agreements with Marriott may be terminated earlier than the stated term if certain events occur, including the failure of Marriott to satisfy certain performance standards, a condemnation of, a casualty to, or force majeure event involving a hotel, the withdrawal or revocation of any license or permit required in connection with the operation of a hotel and upon a default by Marriott or us that is not cured prior to the expiration of any applicable cure periods. In the event of a sale of the Marriott, Troy, Michigan, Marriott has a right of first refusal to either purchase or lease the hotel or terminate the management agreement.

All of our management agreements typically will have the terms described below:

Operational services. The managers of the Management Company, and such other managers of other management companies with whom we have contracted, will have exclusive authority to supervise, direct and control the day-to-day operation and management of the hotels, including establishing all room rates, processing reservations, procuring inventories, supplies and services, and preparing public relations, publicity and marketing plans for the hotels.

Executive supervision and management services. The managers will supervise all managerial and other employees for the hotels, review the operation and maintenance of the hotels, prepare reports, budgets and projections and provide other administrative and accounting support services for the hotels. In some cases, we will maintain authority to approve the appointment of the general manager and other key employees at each hotel.

Chain services. The existing management agreements with Marriott and Hyatt require the manager to furnish chain services that are generally made available to other hotels managed by that operator. Such services include: (1) the development and operation of computer systems and reservation services, (2) management and administrative services, (3) marketing and sale services, (4) human resources training services and (5) such additional services as may from time to time be more efficiently performed on a national, regional or group level.

Working capital and fixed asset supplies. The management agreements will typically require us to maintain property-level working capital for each hotel ranging from $5,000 to $25,000 and to fund the cost of fixed operating supplies such as linen and other similar items. We also will be responsible for providing funds to meet the cash needs for the operations of the hotels if at any time funds available from hotel operations become insufficient to meet the financial requirements of the hotels. We are required to deposit sufficient working capital on an as-needed basis to pay all costs and expenses of maintaining, conducting and supervising the operation of the hotels and all of its facilities and any other amounts that are the Management Company’s responsibility under the management agreements. If we fail to provide sufficient funds, the Management Company is not required to provide services under the management agreements, including, among other things, employing and supervising on-site staff for the operation of the hotels, negotiating and entering into leases and providing services necessary for the day-to-day operation, management and supervision of the hotels.

Furniture, fixtures and equipment replacements. The management agreements will generally provide that once each year, the managers must prepare a list of furniture, fixtures and equipment to be acquired and certain routine repairs to be performed in the next year and an estimate of the necessary funds, subject to our review or approval. Under the management agreements, we will be required to provide to the managers all necessary furniture, fixtures and equipment for the operation of the hotels, including funding for any required furniture, fixtures and equipment replacements. For purposes of fulfilling our obligation to fund the furniture, fixtures and equipment replacements, a specified percentage of the gross revenues of the hotel is deposited by the manager in an escrow account held by the respective first-mortgage note holders. This percentage is 4% under our

agreements with the Management Company, 5% under our agreement with Marriott for three of our hotels and 4% and 5% with Hyatt for the Marietta and Newport Beach hotels, respectively.

Building alterations, improvements and renewals. The management agreements will generally require the managers to prepare an annual estimate of the expenditures necessary for major repairs, alterations, improvements, renewals and replacements to the structural, mechanical, electrical, heating, ventilating, air conditioning, plumbing and vertical transportation elements of each hotel. In addition to the foregoing, the management agreements will generally provide that the managers may propose such changes, alterations and improvements to the hotel as are required by reason of laws or regulations or, in the manager’s reasonable judgment, to keep the hotel in a safe, competitive and efficient operating condition.

Insurance. The management agreements typically require us to maintain and pay for: (1) insurance covering the building, (2) commercial general liability insurance, (3) worker’s compensation insurance, (4) fidelity insurance, (5) employee crime insurance, (6) business interruption insurance, (7) employment practices liability insurance, (8) flood insurance if the hotel is located in an area designated as “flood prone” and (9) other additional insurance as may be required.

Damage or destruction. The management agreements will generally remain in full force and effect subsequent to damage by fire or other casualty. Some management agreements allow either party to terminate upon 30 days prior notice to the other party if (1) we elect to close the hotel as a result of such casualty (except on a temporary basis for repairs or restoration) or (2) we determine in good faith not to proceed with the restoration of the hotel.

Condemnation of a property. Most management agreements may be terminated on 30 days notice to the other party if (1) all or substantially all of the hotel is taken through condemnation or (2) less than all or substantially all of the hotel is taken, but, in the reasonable judgment of the party giving the termination notice, the hotel cannot be profitably operated in the manner the hotel is then being operated. The manager does not have any right to the award from the taking or condemning authority in any such proceeding.

Sale of the hotel. The existing management agreements with Marriott and Hyatt limit our ability to sell, lease or otherwise transfer the hotels unless the transferee is not a competitor of the managers and unless the transferee assumes the related management agreements and meets specified other conditions. Our management agreements with the Management Company will be cancelable upon sale and in certain cases may require payment of a termination fee.

Service marks. During the terms of the respective management agreements with Marriott and Hyatt, the service mark, symbols and logos currently used by the managers may be used in the operation of the applicable hotels. Any right to use the service marks, logo and symbols and related trademarks of a manager at a hotel will terminate with respect to that hotel upon termination of the applicable management agreement with respect to such hotel.

Termination. The management agreements may be terminated as to one or more of the hotels earlier than the stated term if certain events occur, including: (1) upon a default by the manager or us that is not cured prior to the expiration of any applicable cure periods, (2) making an assignment for the benefit of creditors and (3) upon instituting or consenting to any proceeding seeking relief under any federal or state bankruptcy or insolvency laws and which remains undismissed to the applicable period. In certain cases of early termination of the management agreement, not including default by the manager, we must pay the manager a termination fee, plus any amounts otherwise due pursuant to the terms of the management agreement.

Additional termination rights . In addition to the termination rights provided above, the management agreements with the Management Company, for the period commencing on the closing of this offering and ending on December 31, 2005, allow for us to terminate the management agreements for up to 1,000 rooms,

referred to as the Base Rooms, upon the sale of hotels to unaffiliated third parties. During this period, we also have the right to terminate additional rooms so long as we pay the applicable termination fee. Any Base Rooms not terminated during this period, referred to as the Year One Carry Over Rooms, may be carried over and terminated during the Second Year Termination Period defined below or at any time upon the same terms and conditions as if terminated during the First Year Termination Period.

For the period commencing on January 1, 2006 and ending on December 31, 2006, referred to as the Second Year Termination Period, we may terminate the management agreements for up to 300 rooms, referred to as the Year Two Base Rooms plus any Year One Carry Over Rooms upon the sale of hotels to unaffiliated third parties. During this period, we shall have the right to terminate additional rooms so long as we pay the applicable termination fee. Any Year Two Base Rooms not terminated during the Second Year Termination Period and Year One Carry Over Rooms not terminated, referred to collectively as the Carry Over Rooms, may be terminated at any time on the same terms and conditions as if terminated during the Second Year Termination Period.

Commencing on January 1, 2007, we may terminate the management agreements for up to 300 rooms, referred to as the At Will Rooms. Also commencing on January 1 of each year thereafter, 300 of the Carry Over Rooms, if any, shall convert to At Will Rooms.

The above termination rights for Base Rooms, Year Two Base Rooms and At Will Rooms provide for no termination fee or similar compensation so long as all amounts due to the Management Company have been paid in full. The number of rooms for which we may terminate the management agreements under the provisions described above may not exceed an aggregate of 1,600 rooms during the term of the master agreement with the Management Company. All exercise of termination rights must include 30 days prior written notice to the Management Company.

In addition, we may terminate an individual management agreement for a hotel property without the payment of any termination fee so long as all amounts due to the manager under the terminated management agreement have been paid in full and we execute new management agreement(s) with the manager relating to new hotel properties on terms and conditions substantially similar to the terms and conditions of the terminated management agreement.

Indemnification obligations. In connection with the sale to Interstate Hotel & Resorts, Inc., the Management Company, of our corporate subsidiary that manages our hotels prior to the Formation and Structuring Transactions, we have agreed to indemnify the Management Company and its officers, directors, employees, agents and representatives against any losses from any and all liabilities resulting from or related to the ownership of this subsidiary and its assets, liabilities and operations prior to the completion of this offering. The Management Company has agreed to indemnify us and our officers, directors, employees, agents and representatives for any of these liabilities incurred after the completion of this offering.

Tax Status

We intend to elect to be taxed as a REIT under Sections 856 through 859 of the Code, commencing with our taxable year ending December 31, 2004. If we qualify for taxation as a REIT, then under current Federal income tax laws we generally will not be taxed at the corporate level to the extent we distribute at least 90% of our net taxable income to our stockholders. However, even if we qualify for taxation as a REIT, we may be subject to certain Federal, state and local taxes on our income and property and to Federal income and excise tax on our undistributed income.

Taxable REIT Subsidiary

On January 1, 2001, the provisions of the REIT Modernization Act became effective. These provisions allow REITs, subject to certain limitations, to own, directly or indirectly, up to 100% of the stock of a taxable

REIT subsidiary, or TRS, that may engage in businesses previously prohibited to a REIT. In particular, these provisions permit hotel REITs to own a TRS that leases hotels from the REIT, rather than requiring the lessee to be an unaffiliated third party. However, hotels leased to a TRS still must be managed by an unaffiliated third party. The TRS provisions are complex and impose several conditions on the use of TRSs, generally to assure that TRSs are subject to an appropriate level of Federal corporate taxation.

As described above, we may own up to 100% of the stock of one or more taxable REIT subsidiaries, including Sunstone Hotel TRS Lessee, Inc., the TRS Lessee. A TRS is a fully taxable corporation that may earn income that would not be qualifying income if earned directly by us. A TRS may perform activities such as third party management, development, and other independent business activities. However, a TRS may not directly or indirectly operate or manage any hotels or health care facilities or provide rights to any brand name under which any hotel or health care facility is operated.

We and the TRS Lessee must elect for the TRS Lessee to be treated as a TRS. A corporation of which a qualifying TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 20% of the value of our assets may consist of securities of one or more TRSs, and no more than 25% of the value of our assets may consist of the securities of TRSs and other assets that are not qualifying assets for purposes of the 75% asset test.

The rent that we receive from a TRS will qualify as “rents from real property” as long as the property is operated on behalf of the TRS by a person who qualifies as an “independent contractor” and who is, or is related to a person who is, actively engaged in the trade or business of operating “qualified lodging facilities” for any person unrelated to us and the TRS (an “eligible independent contractor”). A “qualified lodging facility” is a hotel, motel or other establishment more than one-half of the dwelling units in which are used on a transient basis, unless wagering activities are conducted at or in connection with such facility by any person who is engaged in the business of accepting wagers and who is legally authorized to engage in such business at or in connection with such facility. A “qualified lodging facility” includes customary amenities and facilities operated as part of, or associated with, the lodging facility as long as such amenities and facilities are customary for other properties of a comparable size and class owned by other unrelated owners.

We have formed the TRS Lessee as a wholly owned TRS. Each of our hotels will be leased by our relevant property-owning subsidiary to the TRS Lessee. As described below, these leases provide for a base rent plus a percentage rent. These leases must contain economic terms which are similar to a lease between unrelated parties because the Code imposes a 100% excise tax on certain transactions between a TRS and us or our tenants that are not conducted on an arm’s-length basis. We believe that all transactions between us and our TRS Lessee will be conducted on an arm’s-length basis. Further, the TRS rules limit the deductibility of interest paid or accrued by a TRS to us to assure that the TRS is subject to an appropriate level of corporate taxation.

The TRS Lessee will engage independent hotel operators to operate the related hotels on its behalf. Furthermore, we have represented, with respect to hotels that we lease to the TRS Lessee in the future, that the TRS Lessee will engage “eligible independent contractors” to manage and operate the hotels leased by the TRS Lessee. Our primary hotel operator, the Management Company, will qualify as an “eligible independent contractor.”

TRS Leases

To qualify as a REIT, neither we nor our operating partnership, Sunstone Hotel Partnership, nor any of our subsidiaries can operate our hotels. Accordingly, Sunstone Hotel Partnership or its subsidiaries, as lessors, will lease our hotels to the TRS Lessee, as lessee, and the TRS Lessee will then enter into hotel management agreements with third party management companies, including the Management Company. The TRS Lessee may enter into leases or agreements through its subsidiaries.

Term. The initial leases for each hotel will have a term of years from the completion of this offering. The leases will be terminable earlier than the stated term if certain events occur, including specified damages to the related hotel, a condemnation of the related hotel or the sale of the related hotel, or an event of default which is not cured within any applicable cure or grace period.

Amounts payable under leases. The leases will provide for the TRS Lessee to pay in each calendar month the base rent plus, in each calendar month, percentage rent, if any. The percentage rent for each hotel will equal the sum of:

•

a percentage of gross room revenue up to a specified threshold;

•

a percentage of gross room revenue in excess of the specified threshold;

•

a percentage of gross food and beverage revenue;

•

a percentage of any gross sublease revenue; and

•

a percentage of all other gross revenue, which include revenue from vending machines, honor bars, movie rentals, concessions and all other such services.

Modifications and alterations. The TRS Lessee will be responsible for all routine repair and maintenance of the hotels. The cost will be borne by us as part of the annual budget. The TRS Lessee, at its own expense, will be permitted to make additions, modifications or improvements to the hotels with our approval, so long as any such additions, modifications or improvements do not significantly alter the character or purposes of the hotels or significantly detract from the value or operating efficiencies of the hotels. Any such additions, modifications or improvements will be subject to the terms and provisions of the applicable leases and will become our property upon the termination of the related lease. The TRS Lessee will own substantially all personal property (other than inventory, linens and other nondepreciable personal property) not affixed to, or deemed a part of, the real estate or improvements on the initial hotels, unless ownership of such personal property would cause the rent under a lease not to qualify as “rents from real property” for REIT income test purposes.

Insurance and property taxes. We will be responsible for paying real estate and personal property taxes with respect to our hotels. In addition, we may be responsible, without reimbursement from the TRS Lessee, for maintaining the types and amounts of insurance required by loan agreements with our lenders. The TRS Lessee will be required to pay for all liability insurance on its respective leased hotels, fidelity bonds, comprehensive casualty insurance, workers’ compensation, vehicle liability and other insurance appropriate and customary for similar properties and naming us, where applicable, as an additional named insured.

Assignment and subleasing. The TRS Lessee will not be permitted to assign or sublet any part of the hotels or assign its interest under any of the leases without our prior written consent. No assignment or subletting permitted by us will release the TRS Lessee from any of its obligations under the leases.

Damage to and destruction of our hotels. If any of our hotels is damaged or destroyed, the TRS Lessee will be required to restore the hotel to substantially the same condition as existed immediately before the damage or destruction in accordance with the terms of the lease. The portion of any insurance policy will be paid out by us from time to time for the reasonable costs of the reconstruction or repair upon satisfaction of reasonable terms and conditions specified by us. Such damage or destruction will not generally terminate the lease.

Condemnation. If any of our hotels is subject to a total condemnation or a partial taking that prevents use of the property as a hotel, we and the TRS Lessee each will have the option to terminate the related lease. We will share in the condemnation award with the TRS Lessee in accordance with the provisions of the related lease. If any partial taking of a hotel does not prevent the use of the property as a hotel, the TRS Lessee will be obligated to restore the untaken portion of the hotel to a complete architectural unit but only to the extent of any available condemnation award. We may ultimately be responsible for restoring the hotel under our obligations under our applicable loan agreements.

REIT requirements. The TRS Lessee will covenant to take the following actions to maintain our status as a REIT:

•

the TRS Lessee will elect to be and operate as a “taxable REIT subsidiary” of us within the meaning of Section 856(l) of the Code;

•

the TRS Lessee, if necessary, will purchase at fair market value any personal property anticipated to be in excess of the 15% personal property limitation on leased property;

•

the TRS Lessee may only assign or sublet the leased property upon or approval if any portion of the rent from the sublessee would fail to qualify as “rents from real property” within the meaning of Section 856(d) of the Code;

•

the TRS Lessee will not sublet the leased property to any person or entity in which we own an interest of 10% or greater; and

•

the TRS Lessee will not operate or manage a lodging facility or a healthcare facility within the meaning of Section 856(d)(9)(D)(ii) and Section 856(e)(6)(D)(ii) of the Code.

Events of default. Events of default under the leases will include, without limitation, the following:

•

the TRS Lessee’s failure to pay base rent within 30 days after the same becomes due and payable;

•

the TRS Lessee’s failure to pay the percentage rent within 30 days after the same becomes due and payable;

•

the TRS Lessee’s failure to observe or perform any other term, covenant or condition of a lease, provided that TRS Lessee has a 30-day grace period after receiving notice from us that a term of the lease has been violated before an event of default would occur. There are certain instances in which the 30-day grace period can be extended to a maximum of 90 days or shortened in the event of gross negligence or fraud;

•

the transfer, assignment, conveyance or attachment of the estate or interest of the TRS Lessee in a hotel in any proceeding;

•

a bankruptcy, reorganization, insolvency, liquidation or dissolution event of which the TRS Lessee is the subject that is not discharged within 60 days; and

•

the termination of the franchise agreement for a hotel by the franchisor because of any action or failure to act by the TRS Lessee.

If an event of default by the TRS Lessee occurs and continues beyond any grace period, we will have the option of terminating the related lease. If we decide to terminate a lease, we will be required to give the TRS Lessee not less than 10 days’ written notice, except in instances giving rise to a termination involving bankruptcy, liquidation or dissolution of the TRS Lessee. Unless the event of default is cured before the termination date we specify in the termination notice, the lease will terminate on the date specified in the termination notice. In that event, the TRS Lessee will be required to surrender to us or our designee, possession of the related hotel.

Termination of leases upon sale. We will have the right to terminate any lease upon a sale of the applicable hotel with not less than 30 days’ prior written notice to the TRS Lessee. If we elect to terminate a lease, we may have to either:

•

pay the TRS Lessee an amount equal to a percentage of the net profit earned by the TRS Lessee with respect to the leased hotel for the twelve-month period ended immediately preceding the termination; or

•

offer to lease to the TRS Lessee one or more substitute hotels on terms with a fair market value equal to the fair market value of the remaining leasehold interest under the terminated lease.

100

Ground Lease Agreements

Immediately prior to the offering, nine of our hotels were subject to ground leases that cover either all or portions of their respective properties. As of June 30, 2004, the terms of these ground leases (including renewal options) range from 27 to 92 years. These ground leases generally require us to make rental payments and payments for all charges, costs, expenses and liabilities, including real and personal property taxes, insurance, and utilities.

Any proposed sale of the property that is subject to a ground lease or any proposed assignment of our leasehold interest as ground lessee under the ground lease may require the consent of the applicable ground lessor. As a result, we may not be able to sell, assign, transfer or convey our ground lessee’s interest in any such property in the future absent the consent of the ground lessor, even if such transaction may be in the best interests of our stockholders. Three of our properties prohibit the sale or conveyance of the hotel by us to another party without first offering the ground lessor the opportunity to acquire the hotel upon the same terms and conditions as offered to the third party.

We have an option to acquire the ground lessor’s interest in the ground lease relating to four of our hotels for specified amounts and exercisable provisions. At the closing of this offering, we intend to exercise the option relating to the Embassy Suites, Chicago, Illinois. At this time, we do not intend to exercise any other options to purchase the ground lessor’s interest in any of our other ground leases.

Insurance

We believe that our properties are adequately insured, subject to the risks described under the “Risk Factors” section and the following. We and the TRS Lessee are responsible for arranging the insurance of most of our hotels, although in certain cases the management company for the applicable hotel will have responsibility for arranging insurance under the relevant management agreement. Our properties are covered by blanket insurance policies which cover multiple properties. Our properties in California are covered by earthquake insurance. In the event that these blanket policies are drawn upon to cover losses on some of our properties, the amount of insurance coverage available under the policies would thereby be reduced and could be insufficient to cover the remaining properties’ insurable risks. Our property insurance is subject to renewal on our annual basis.

When our current insurance policies expire, we may encounter difficulty in obtaining or renewing property or casualty insurance on our properties at the same levels of coverage and under similar terms. This insurance may be more limited and for some catastrophic risks (e.g., earthquake, flood and terrorism) may not be generally available at current levels. Even if we are able to renew our policies or to obtain new policies at levels and with limitations consistent with our current policies, we cannot be sure that we will be able to obtain insurance with the scope of coverage we desire or at premium rates that are commercially reasonable.

We will maintain letters of credit to collateralize our obligations with respect to workers’ compensation claims made by our employees for periods prior to the time that our management operations were assumed by the Management Company and other hotel operators.

Offices

We lease our headquarters located at 903 Calle Amanecer, Suite 100, San Clemente, California 92673 from an unaffiliated third party. We believe that our current facilities are adequate for our present and future operations.

Employees

At June 30, 2004, we had 4,973 full-time and 1,452 part-time employees. We have 6,312 employees at our hotels and 113 employees at our corporate headquarters. We believe that our relations with our employees are

101

good. Immediately after this offering, we will have 28 employees, and most of our other employees are expected to become employees of the Management Company.

Founders

The Contributing Entities, Messrs. Kazilionis, Paul and Alter, who will serve as members of our board of directors, and Messrs. Alter, Kline and Stougaard, who will serve as executive officers, may be considered our founders because they participated in founding and organizing the REIT.

Environmental

All of our hotels have been subjected to environmental reviews. Environmental consultants retained by our lenders recently conducted Phase I environmental site assessments on many of our properties. These Phase I assessments often relied on older environmental assessments prepared in connection with a prior financing. Phase I assessments are designed to evaluate the potential for environmental contamination on properties based generally upon site inspections, facility personnel interviews, historical information and certain publicly- available databases, but Phase I assessments will not necessarily reveal the existence or extent of all environmental conditions, liabilities or compliance concerns at the properties. While some of these assessments have led to further investigation and sampling, none of the environmental assessments have revealed, nor are we aware of any environmental liability (including asbestos-related liability) that we believe would harm our business, financial position, results of operations or cash flow.

Under various Federal, state and local laws and regulations, an owner or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances on the property. These laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of hazardous or toxic substances. Furthermore, a person that arranges for the disposal or transports for disposal or treatment of a hazardous substance at another property may be liable for the costs of removal or remediation of hazardous substances released into the environment at that property. The costs of remediation or removal of such substances may be substantial, and the presence of such substances, or the failure to promptly remediate such substances, may adversely affect the owner’s ability to sell such real estate or to borrow using such real estate as collateral. In connection with the ownership and operation of our properties, we or the TRS Lessee, as the case may be, may be potentially liable for such costs.

Legal Proceedings

We are not involved in any material litigation nor, to our knowledge, is any material litigation threatened against us, other than routine litigation arising in the ordinary course of business or which is expected to be covered by insurance and not expected to harm our business, financial condition or results of operations.

102

MANAGEMENT

Directors and Executive Officers

Upon completion of this offering, our board of directors will consist of seven directors, at least four of whom will be independent directors as provided in the listing standards and rules of the New York Stock Exchange. Our directors will serve one-year terms and thus be subject to election annually. There will be no cumulative voting in the election of directors. Consequently, at each annual meeting of our stockholders, the successors to each of our seven directors will be elected by a plurality of the votes cast at that meeting.

The following table sets forth information concerning the individuals who will be directors and executive officers upon the consummation of this offering. Ages are as of June 30, 2004.


Name	Age	Position
Robert A. Alter	53	Chairman and Chief Executive Officer
Jon D. Kline	37	Executive Vice President and Chief Financial Officer
Gary A. Stougaard	50	Executive Vice President and Chief Investment Officer
Paul D. Kazilionis	47	Director
Jonathan H. Paul	40	Director

The following is a biographical summary of the experience of our directors and executive officers:

Robert A. Alter is our Chairman and Chief Executive Officer. Until our formation, Mr. Alter served as Chief Executive Officer of one of our predecessor companies formed in 1985 and originally taken public in August 1995. The public company, Sunstone Hotel Investors, Inc., began in August 1995 upon its initial public offering. In November 1999, Mr. Alter and one of the Contributing Entities successfully completed a management-led buyout to take the company private. He has been an owner of hotels since 1976 and is a past president of the Holiday Inn Franchise Association and a member of the Marriott Franchise board. Mr. Alter holds a B.S. degree in Hotel Administration from Cornell University.

Jon D. Kline is our Executive Vice President and Chief Financial Officer. From April 2003 to our formation, Mr. Kline served as the Executive Vice President and Chief Financial Officer of Sunstone Hotel Investors, L.L.C. Previously, Mr. Kline spent five years with Merrill Lynch & Co.’s Investment Banking Division, during which time he directed the firm’s Hospitality and Leisure practice. Before that time, he was a member of the Real Estate and Lodging Finance Group of Smith Barney’s Investment Banking Division as well as an attorney with Sullivan & Cromwell LLP. Mr. Kline holds a B.A. degree in Economics from Emory University and a J.D. degree from New York University School of Law.

Gary A. Stougaard is our Executive Vice President and Chief Investment Officer. From October 1997 to our formation, Mr. Stougaard has been employed by Sunstone Hotel Investors, L.L.C. He now serves as the Executive Vice President and Chief Investment Officer of Sunstone Hotel Investors, L.L.C., in which capacity he oversees the company’s acquisition, development and hotel renovation and redevelopment activities. Since 1985 and prior to joining Sunstone, he served as a developer and asset manager of hotel properties and prior to that time he was a certified public accountant in private practice. Mr. Stougaard holds a B.A. degree in Accounting from Michigan State University.

Paul D. Kazilionis has been a Managing Principal of Westbrook Real Estate Partners, L.L.C., a real estate investment management company, since 1994. Prior to co-founding Westbrook Real Estate Partners, L.L.C., Mr. Kazilionis spent 12 years at Morgan Stanley & Co. Incorporated, serving most recently as Managing Director and President of the General Partner of the Morgan Stanley Real Estate Fund, through which Morgan Stanley conducted its principal real estate investment activities. Mr. Kazilionis is a member of the Board of Overseers of Colby College and serves as a member of the Dartmouth College Real Estate Advisory Committee. Mr. Kazilionis holds an A.B. degree from Colby College and an M.B.A. degree from Amos Tuck School of Business Administration at Dartmouth College.

103

Jonathan H. Paul has been a Managing Principal of Westbrook Real Estate Partners, L.L.C. since 1994 and a Managing Principal of Rockpoint Group, L.L.C. since its formation in 2003. Prior to joining Westbrook, Mr. Paul spent six years at Morgan Stanley in the real estate and corporate finance areas, including three years with the Morgan Stanley Real Estate Fund. Mr. Paul holds an A.B. degree from Dartmouth College and an M.B.A. degree from The Amos Tuck School of Business Administration at Dartmouth College.

Vice Presidents

The following is a biographical summary of the experience of our vice presidents:

Olivier Kolpin is our Vice President—Tax. In this capacity he oversees the management of all tax compliance related functions. From July 2003 to our formation, Mr. Kolpin has been employed by Sunstone Hotel Investors, L.L.C. Since 1993 and prior to joining Sunstone, Mr. Kolpin was with PricewaterhouseCoopers as a Senior Tax Manager specializing in the real estate industry, and prior to that time he was a real estate broker. Mr. Kolpin holds a B.A degree from University of California, San Diego, and a M.S. degree in Accounting of Taxation from San Diego State University.

W. Guy Lindsey is our Senior Vice President—Design & Construction. From December 2001 to our formation, Mr. Lindsey has been employed by Sunstone Hotel Investors, L.L.C. He now serves as the Vice President—Design & Construction, in which capacity he oversees all aspects related to hotel renovations, conversions and developments for our owned hotels and acquisition hotels. Since 1986 and prior to joining Sunstone, he served as an Executive Vice President and general contractor for several construction companies specializing in hotel renovation and construction. Mr. Lindsey holds a B.A. degree in Building Science from Auburn University.

Lindsay N. Monge is our Vice President—Treasurer. From July 2000 to our formation, Mr. Monge has been employed by Sunstone Hotel Investors, L.L.C., serving initially as Manager—Acquisitions between 2000 and January 2003. Since 2003, he has served as the Vice President—Treasurer, in which capacity he oversees the management of all treasury and finance-related functions and lender relationships. Since 1995 and prior to joining Sunstone, he has served in various capacities in hotel operations. Mr. Monge holds a B.S. degree in Hotel Administration from Cornell University and a M.B.A. degree from the Peter F. Drucker Graduate School of Management at Claremont Graduate University.

Thomas K. Naughton is our Vice President—Acquisitions. In this capacity he oversees the sourcing and underwriting of new investment opportunities. Mr. Naughton held a similar position since joining Sunstone Hotel Investors, L.L.C. in January 2003. Prior to that time, Mr. Naughton was an acquisitions and asset management executive for ING Realty Partners I and II, two real estate opportunity funds capitalized with $700 million of institutional equity capital. Prior to joining ING in 1999, Mr. Naughton worked for Westmont Hospitality Group in Houston and was an analyst with Goldman Sachs’s Whitehall real estate investment group in Dallas. Mr. Naughton holds an A.B. degree from Stanford University.

Michael J. Sullivan is our Vice President—Asset Management. From December 2002 to our formation, Mr. Sullivan has been employed by Sunstone Hotel Investors, L.L.C. He now serves as the Vice President Asset Management, in which capacity he oversees the management of all third-party managed hotels. Since 1996 and prior to joining Sunstone, he was responsible for the asset management and acquisition of hotel properties at Colony Capital, and prior to that time he managed the audit department for ITT Sheraton and was an auditor at PriceWaterhouse. Mr. Sullivan holds a B.S. degree in Accounting from Boston College.

William M. Wagner is our Vice President—Accounting. From July 2004 to our formation, Mr. Wagner has been employed by Sunstone Hotel Investors, L.L.C., serving as its Vice President of Accounting, in which capacity he oversees all financial accounting and reporting. Since 2001 and prior to joining Sunstone, he was Vice President, Financial Reporting for The TriZetto Group, Inc. where he was responsible for all financial accounting and reporting, including SEC compliance. From 1999 to 2001, Mr. Wagner worked for two years in

104

startup ventures where he was responsible for setting up financial accounting and reporting processes. From 1997 to 1999, he was Director, Financial Reporting of Irvine Apartment Communities, Inc. a NYSE publicly traded real estate investment trust where he was responsible for all financial accounting and reporting including SEC compliance. From 1990 to 1997, he worked for Ernst & Young LLP in their real estate group. Mr. Wagner holds a B.A. degree in Business Administration from the University of Washington and is a Certified Public Accountant in the State of California.

Corporate Governance Profile

We believe that we have organized our corporate structure and governance to align our interests with those of our stockholders. For example:

•

the terms of our board of directors are not staggered, which means that all of our directors are subject to re-election annually;

•

at least four of our seven directors will be independent for purposes of the listing standards and rules of the NYSE;

•

we have provided for a simple majority vote of our common stockholders for all matters requiring a stockholder vote, which means that Westbrook Real Estate Partners, L.L.C. will not have veto

•

power over such voting matters;

•

we have opted out of the Maryland business combination and control share acquisition statutes and have waived the ability to opt back in without a stockholder vote, which means that it may be easier for an interested party or third party to acquire control of us;

•

we do not have a stockholder rights plan;

•

we do not have any agreements or arrangements to provide tax protection to any stockholder or any holder of membership units in Sunstone Hotel Partnership, the operating partnership;

•

we intend to adopt a code of business conduct and ethics which, among other things, will address corporate opportunity issues relevant to directors, officers and employees.

Committees of Our Board of Directors

Upon completion of this offering, our board of directors will have three committees—an audit committee, a compensation committee and a nominating and corporate governance committee—each of which will consist of three directors, all of whom will be independent within the meaning of the listing standards and rules of the NYSE. The members of our compensation committee also will be “non-employee directors” within the meaning of Section 162(m) of the Code and the applicable rules of the SEC. Following completion of this offering, we expect to form an investment committee of our board of directors, which will consist of three directors, a majority of whom will be independent within the meaning of the listing standards and rules of the NYSE.

Audit Committee

Prior to completion of this offering, our board of directors will adopt an audit committee charter, which will define the audit committee’s purposes to be:

•

overseeing (1) the integrity of our financial statements, (2) our compliance with legal and regulatory requirements, (3) the independent auditors’ qualifications and independence, and (4) the performance of the independent auditors and our internal audit function; and

•

preparing an audit committee report as required by the SEC for inclusion in our annual proxy statement.

105

All of the members of the audit committee will be financially literate within the meaning of the listing standards and rules of the NYSE. At least one member will be an audit committee financial expert as that term is defined by applicable rules of the SEC, and at least one member will possess accounting and financial management expertise within the meaning of the listing standards and rules of the NYSE.

Our audit committee is comprised of , and . will be the chair.

Compensation Committee

Prior to completion of this offering, our board of directors will adopt a compensation committee charter that will define the compensation committee’s primary duties to include:

•

reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer;

•

making recommendations to our board of directors with respect to non-CEO compensation, incentive compensation plans and equity-based plans;

•

approving any new equity compensation plan or any material change to an existing plan where stockholder approval has not been obtained;

•

in consultation with management, overseeing regulatory compliance with respect to compensation matters; and

•

preparing a report on executive compensation for inclusion in our proxy statement for our annual meetings.

Our compensation committee is comprised of , and . will be the chair.

Nominating and Corporate Governance Committee

Prior to completion of this offering, our board of directors will establish a nominating and corporate governance committee charter that will define the committee’s primary purpose and responsibilities to include:

•

identifying individuals qualified to become members of the board of directors and recommending director candidates for election or re-election to the board of directors;

•

considering and making recommendations to the board of directors regarding board size and composition, committee composition and structure and procedures affecting directors;

•

developing and recommending to the board of directors a set of corporate governance principles, and to review those principles at least once a year; and

•

reviewing conflicts between the Contributing Entities, directors, officers, employees and us.

Our nominating and corporate governance committee is comprised of , and . will be the chair.

Compensation Committee Interlocks and Insider Participation

During the last completed fiscal year, none of our executive officers served as a member of the governing body or compensation committee of any entity that had one or more executive officers serving as a member of our board of directors or compensation committee.

Upon completion of this offering, the members of the compensation committees of our board of directors will be independent directors as required by the listing standards and rules of the NYSE and will be “non-

106

employee” directors within the meaning of Section 162(m) of the Code and the applicable rules of the SEC. None of these directors, nor any of our executive officers, will serve as a member of the governing body or compensation committee of any entity that has one or more executive officers serving as a member of our board of directors or compensation committee.

Compensation of Directors

Each of our independent directors will receive an annual stock grant of shares having a value equal to $ for serving on our board of directors, and an attendance fee paid in cash of $1,000 per meeting of our board of directors if the meeting is attended in person or $250 if the meeting is attended telephonically.

In addition, each member of our audit committee is entitled to an attendance fee of $750 per meeting of the audit committee or $250 if the meeting is attended telephonically. Each member of our compensation committee and our nominating and corporate governance committee is entitled to an attendance fee of $500 if the meeting is attended in person or $250 if the meeting is attended telephonically.

The chair of our audit committee will receive $5,000, the chair of our compensation committee will receive $4,000 and the chair of our nominating and corporate governance committee will receive $1,000, in each case, on an annual basis.

We intend to implement a deferred compensation program for our directors, allowing them to defer all or a portion of their compensation. Directors will also be entitled to reimbursement for expenses incurred in fulfilling their duties as our directors and will receive complimentary hotel room, food and beverage and related services at our hotels and resorts when on personal travel, including reimbursements for associated taxes.

Executive Compensation

The following table sets forth the compensation paid or accrued in the year ended December 31, 2003, to our Chief Executive Officer and our two other most highly compensated executive officers (our “named executive officers”).


	Summary Compensation Table
	Annual Compensation		Long-Term Compensation	All Other Compensation
Name and principal position	Salary	Bonus	Long-Term Compensation	All Other Compensation
Robert A. Alter, Chairman and Chief Executive Officer
Jon D. Kline, Executive Vice President and Chief Financial Officer
Gary A. Stougaard, Executive Vice President and Chief Investment Officer

Employment Agreements

We expect to enter into new employment agreements with our executive officers that, among other terms, will have customary non-competition provisions.

Long-Term Incentive Plan

We expect to adopt a long-term incentive plan that will become effective upon completion of this offering. The purpose of the plan will be to attract and retain our directors, executive officers and employees. The 2004

107

long-term incentive plan will be administered by our compensation committee or the board of directors, which will have broad powers to interpret and implement the plan.

Types of Awards. The long-term incentive plan will provide for grants of incentive stock options (within the meaning of Section 422 of the Code), nonqualified stock options, stock appreciation rights, dividend equivalent rights, restricted stock, restricted stock units and other stock-based awards such as performance shares.

Shares Subject to the 2004 Long-Term Incentive Plan; Other Limitations on Awards. The number of shares of common stock that may be issued under the plan may not exceed . These shares may be authorized but unissued shares of our common stock or otherwise acquired for the purposes of the plan. If any award is forfeited or is otherwise terminated or canceled without the delivery of shares of our common stock, if shares of our common stock are surrendered or withheld from any award to satisfy a recipient’s income tax or other withholding obligations, or if shares of our common stock owned by a recipient are tendered to pay the exercise price of awards, then such shares will again become available under the long-term incentive plan. No more than shares of our common stock may be available for delivery in connection with the exercise of incentive stock options. The maximum number of shares of our common stock with respect to which options or stock appreciation rights may be granted to an individual in any calendar year is .

The compensation committee will have the authority to adjust the terms of any outstanding awards and the number of shares of our common stock issuable under the plan for any increase or decrease in the number of issued shares of our common stock resulting from a stock split, reverse stock split, stock dividend, spin-off, combination or reclassification of our common stock, or any other event that the compensation committee determines affects our capitalization.

Eligibility. Awards may be made to any director, officer or employee, including any prospective employee, and to any consultant or advisor selected by the compensation committee.

Stock Options and Stock Appreciation Rights. The compensation committee may grant incentive stock options and non-qualified stock options to purchase shares of our common stock from us (at the price set forth in the applicable award agreement), and stock appreciation rights in such amounts, and subject to such terms and conditions, as the compensation committee may determine. No grantee of an option or stock appreciation right will have any of the rights of a stockholder of us with respect to shares subject to their award until the issuance of the shares.

Restricted Stock. The compensation committee may grant restricted shares of common stock in amounts, and subject to terms and conditions, as the compensation committee may determine. The grantee will have the rights of a shareholder with respect to the restricted stock, subject to any restrictions and conditions as the compensation committee may include in the applicable award agreement.

Restricted Stock Units. The compensation committee may grant restricted stock units in amounts, and subject to terms and conditions, as the compensation committee may determine. Recipients of restricted stock units have only the rights of a general unsecured creditor of us and no rights as a stockholder of us until the common stock underlying the restricted stock units is delivered.

Other Equity-Based Awards. The compensation committee may grant other types of equity-based awards, including the grant of unrestricted shares, in amounts, and subject to terms and conditions, as the compensation committee may determine. These awards may involve the transfer of actual shares of our common stock, or the payment in cash or otherwise of amounts based on the value of shares of our common stock.

Change in Control. The compensation committee may provide in any award agreement for provisions relating to a change in control of us or any of its subsidiaries or affiliates, including, without limitation, the acceleration of the exercisability of, or the lapse of restrictions with respect to, the award.

108

Dividend Equivalent Rights. The compensation committee may in its discretion include in the award agreement a dividend equivalent right entitling the grantee to receive amounts equal to the dividends that would be paid, during the time such award is outstanding, on the shares of our common stock covered by such award as if such shares were then outstanding.

Nonassignability. Except to the extent otherwise provided in the applicable award agreement or approved by the compensation committee, no award or right granted to any person under the stock incentive plan will be assignable or transferable other than by will or by the laws of descent and distribution, and all awards and rights will be exercisable during the life of the grantee only by the grantee or the grantee’s legal representative.

Amendment and Termination. The board of directors may from time to time suspend, discontinue, revise or amend the 2004 long-term incentive plan.

109

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The Contributing Entities

Messrs. Alter, Kline and Stougaard directly or indirectly own interests in Sunstone Hotel Investors, L.L.C., WB Hotel Investors, LLC, Sunstone/WB Hotel Investors IV, LLC, and Sunstone/WB Manhattan Beach, LLC. As a result of holding these interests, these individuals will receive cash when the Contributing Entities sell shares of our common stock and distribute the proceeds to their investors.

The allocation of the consideration received in the Formation and Structuring Transactions among the Contributing Entities will be as follows:


	Shares of Common Stock	Membership Units
Sunstone Hotel Investors, L.L.C.
WB Hotel Investors, LLC
Sunstone/WB Hotel Investors IV, LLC
Sunstone/WB Manhattan Beach, LLC

Total

Mr. Alter directly and indirectly owns 100% of Alter SHP LLC, which owns 4.3% of the outstanding Class B membership units, 57.9% of the outstanding Class C membership units and 50.1% of the outstanding Class D units of Sunstone Hotel Investors, L.L.C. In the Formation and Structuring Transactions, the 4.3% interest will be reduced to 1.0% as a result of the distribution of the Embassy Suites, Los Angeles, California. Mr. Stougaard owns 3.1% of the outstanding Class C membership units, 3.0% of the outstanding Class D membership units and an economic interest equivalent to 0.04% of the outstanding Class B membership units in Sunstone Hotel Investors, L.L.C. Class B unitholders receive a first priority distribution equal to a specified return on initial capital contributions, then distributions equal to their initial contributions. It is not expected that the Class C and Class D membership units will receive any distributions. Mr. Kline has an economic interest in Sunstone Hotel Investors, L.L.C. which entitles him to receive 2.0% of any increase in value of Sunstone Hotel Investors, L.L.C. above a specified amount as of the disposition date for the entity.

Mr. Alter owns a 49.0% interest and Mr. Stougaard owns a 9.0% interest in L/S Investors, LLC, which owns a 5.0% interest in WB Hotel Investors, LLC. L/S Investors, LLC receives its pro rata share of all distributions until all contributed capital has been returned and specified returns have been achieved, at which point it then receives 12.5% of the distributions of WB Hotel Investors, LLC with the remainder distributed to all of the members on a pro rata basis until the other members have achieved specified returns, at which point L/S Investors, LLC receives 20% of the distributions of WB Hotel Investors, LLC with the remainder being distributed pro rata among all of the members of WB Hotel Investors, LLC. Mr. Kline has an economic interest in WB Hotel Investors which entitles him to receive 2.0% of any increase in value of WB Hotel Investors, LLC above a specified amount as of the disposition date for the entity. Mr. Kline’s economic interests in WB Hotel Investors, LLC and Sunstone Hotel Investors, L.L.C. are currently capped at an aggregate amount of $1.5 million, with the cap increasing by a fixed amount each year until it reaches a maximum of $3.0 million in 2006.

Mr. Alter owns a 45.004% interest, Mr. Kline owns a 9.0454% interest and Mr. Stougaard owns a 9.0454% interest in Fund IV Sun Investors, LLC, which holds a 1.5% interest in Sunstone/WB Hotel Investors IV, LLC. Fund IV Sun Investors, LLC receives its pro rata share of all distributions until all contributed capital has been returned and specified returns have been achieved, at which point it then receives 12.5% of the distributions of Sunstone/WB Hotel Investors IV, LLC with the remainder distributed to all of the members on a pro rata basis until the other members have achieved specified returns, at which point Fund IV Sun Investors, LLC receives 20% of the distributions of Sunstone/WB Hotel Investors IV, LLC with the remainder being distributed pro rata among all of the members of Sunstone/WB Hotel Investors IV, LLC.

110

Mr. Alter owns a 50.0% interest and Mr. Kline owns a 25.0% interest in AKM Investment, LLC, which owns an 8.5% interest in Sunstone/WB Manhattan Beach, LLC. AKM Investment, LLC receives its pro rata share of all distributions until all contributed capital has been returned and specified returns have been achieved, at which point it then receives 7.5% of the distributions of Sunstone/WB Manhattan Beach, LLC, with the remainder distributed to all of the members on a pro rata basis until the other members have achieved specified returns, at which point AKM Investments, LLC receives 10% of the distributions of Sunstone/WB Manhattan Beach, LLC with the remainder being distributed pro rata among all of the members of Sunstone/WB Manhattan Beach, LLC. As described above, Messrs. Alter, Kline and Stougaard each indirectly own an interest in Sunstone/WB Hotel Investors IV, LLC, the other member of Sunstone/WB Manhattan Beach, LLC.

Excluded Properties

Two hotels included in continuing operations in our historical financial information will not be contributed to us in connection with the Formation and Structuring Transactions. The JW Marriott, Cherry Creek, Colorado will continue to be owned primarily by Sunstone/WB Hotel Investors IV, LLC with a minority interest owned by an entity in which Messrs. Alter, Kline and Stougaard will all continue to have indirect interests. The Embassy Suites, Los Angeles, California will be distributed to an entity controlled by Robert A. Alter. These properties will be managed by the Management Company. Set forth below is information about these properties.

Hotel

City

State

Chain Scale

Service
Category

Rooms

Year Acquired

Date Opened

JW Marriott

Cherry Creek

Colorado

Upper upscale

Full Service

196

2004

June 1, 2004

Embassy Suites

Los Angeles

California

Upper upscale

Full Service

215

2000

October 16, 1990

Other Properties

Our executive officers and affiliates of the Contributing Entities also own interests in other hotels that are not included in our historical financial information, other than to the extent of acquisition or asset management fees paid to us, and that will not contributed to us in connection with this offering. For example:

•

Messrs. Alter, Kline and Stougaard own a minority interest in two limited service Courtyard by Marriott hotels located in Suwanee (78 rooms) and Atlanta (78 rooms), Georgia, the remainder of which are owned by an entity affiliated with Westbrook Real Estate Partners, L.L.C.

•

Messrs. Alter, Kline and Stougaard own a minority interest in the entity that owns the 338 room Doubletree, Nashville, Tennessee, the remainder of which is owned by an entity affiliated with Rockpoint Group, L.L.C., of which Mr. Paul is a Managing Principal.

•

Messrs. Alter, Kline and Stougaard own a minority interest in the entity that owns the 186 room Residence Inn by Marriott, Beverly Hills, California, the remainder of which is owned by an unaffiliated third party.

Some of our executive officers and affiliates of the Contributing Entities owned interests in other hotels from January 1, 2001 to June 30, 2004 that are not included in our historical financial information, other than to the extent of acquisition, asset management or disposition fees paid to us. Information about these hotels, all of which have been sold, is set forth below.


Hotel	Location	Rooms	Acquisition Date	Sale Date
Ritz Carlton	Manalapan, Florida	270	Fourth quarter of 2002	Fourth quarter of 2003
Limited-service portfolio ⁽¹⁾	Various	575	Second quarter of 2002	First quarter of 2004

(1)	Includes seven hotels located in Southeastern United States with the following Marriott brand affiliations: SpringHill Suites (four hotels with 312 rooms), TownePlace Suites (two hotels with 184 rooms) and Fairfield Inn (one hotel with 79 rooms).

111

Franchise Agreements

For franchise agreements relating to 38 of our hotels, an entity controlled by Robert A. Alter, Alter SHP LLC, owned a majority voting, but non-economic, interest in a subsidiary of Sunstone Hotel Investors, L.L.C. that is a party to those franchise agreements. Any distributions on those shares or consideration received in respect of those shares have been contributed and assigned to Sunstone Hotel Investors, L.L.C. In the event that (1) a member of the board of directors of the subsidiary designated by Mr. Alter failed to vote in favor of any action approved by a majority of the board of directors of the subsidiary or (2) Mr. Alter ceased to be an employee of the subsidiary, we would have a right to purchase the shares held by Mr. Alter for $1. Alter SHP LLC’s interest in that subsidiary, which will be transferred or merged to the Management Company in the Formation and Structuring Transactions, will be cancelled for no consideration prior to consummation of this offering.

Investors Agreement

We intend to enter into an investors agreement with the Contributing Entities. This agreement will provide that the Contributing Entities, acting as a group, will have the right to require our board of directors and nominating and corporate governance committee to nominate their designees to our board of directors, based upon their ownership interest in us at that time on a fully converted basis (i.e., the total number of shares of our common stock held by the Contributing Entities, assuming full conversion of all of their membership units in the operating partnership) as follows: (i) one of the seven directors so long as the Contributing Entities hold a more than 10% but less than 20% ownership interest in us; or (ii) two of the seven directors so long as the Contributing Entities hold a 20% or greater ownership interest in us. If the number of directors on our board of directors increases, the number of directors that the Contributing Entities have the right to require us to nominate shall also proportionately increase. These calculations shall not include any shares of our common stock or membership units in our operating partnership acquired by any of the Contributing Entities after this offering. We shall solicit proxies and the Contributing Entities shall vote in favor of the nominees pursuant to this agreement.

This agreement also provides for a waiver of the common stock ownership limit for the Contributing Entities and other limited information and other rights in accordance with applicable ERISA regulations, subject to tax laws applicable to REITs.

Registration Rights Agreement

We intend to enter into a registration rights agreement with the Contributing Entities. The aggregate number of shares of our common stock and securities convertible into or exchangeable into shares of our common stock subject to the registration rights agreement is .

Demand registration. Prior to the first anniversary of this offering and for such additional periods during which we fail to file or maintain a shelf registration statement, the Contributing Entities, acting as a group, will have the right, subject to limitations, on one occasion, to request that we effect a registration of our shares of common stock owned by it. We may postpone the initial filing of that registration for up to 90 days if our independent directors believe that filing would jeopardize a material financing, acquisition or similar transaction. Upon receipt of a request to register shares, we will have a 30-day option to acquire the shares sought to be registered at the then fair market value thereof subject to the right of the requesting party to withdraw its request for registration and our acquisition rights.

Shelf registration. Beginning on the first anniversary of this offering, we will be required to use our reasonable efforts to file and maintain a registration statement for the resale of shares owned by the Contributing Entities, subject to certain limitations. Each stockholder eligible to have shares registered under the shelf registration statement will be entitled to resell shares pursuant to that registration statement, subject to availability. We may postpone a filing of a registration statement or a proposed sale under a shelf registration for

112

up to 90 days if our independent directors believe such registration would adversely affect a material financing, acquisition or similar transaction. We may only exercise our right to postpone an offering pursuant to a demand or shelf registration on two occasions during any twelve month period.

Piggy-back rights. The Contributing Entities will have the right to include their shares in two underwritten offerings of shares by us, subject to availability. We may grant holders of our shares piggy-back registration rights permitting them, subject to availability, to participate in the demand and shelf registrations described above.

Cut back rights. If the managing underwriter for an underwritten offering advises us that the number of shares sought to be included in such registration would create a substantial risk that the sale of some or all of the shares sought to be sold will substantially reduce the proceeds or price per share, then the number of securities to be registered by the investors participating in such registration will be reduced to the number of shares recommended by the managing underwriter.

Expenses. The Contributing Entities will be responsible for paying all underwriters’ discounts, commissions or fees, fees of placement agents and the fees and expenses of counsel for the Contributing Entities. We are obligated to pay all other fees and expenses, including applicable Federal and state filing fees. The Contributing Entities will also be obligated to provide indemnification and opinion letters required by the underwriters or placement agents as well as representations and warranties regarding relevant information pertaining to such entities.

Letters of Credit

An affiliate of Westbrook Real Estate Partners, L.L.C. provides letters of credit on our behalf in the amount of $20.0 million to collateralize our workers’ compensation obligations as required by our insurance carrier and obligations under one of our notes payable. Following this offering, we will replace those letters of credit with new letters of credit under our new revolving credit facility.

Loans

In connection with the purchase of our predecessor public company by one of the Contributing Entities, on October 1, 1999, Sunstone Hotel Properties, Inc., the corporation that will be sold to the Management Company in the Formation and Structuring Transactions, entered into a promissory note in favor of Mr. Alter, due October 1, 2009, in a principal amount of $650,000, with interest payable at the rate of 8% per year. Concurrently, Mr. Alter entered into a promissory note in favor of Sunstone Hotel Properties, Inc., due October 1, 2009, in a principal amount of $650,000, with interest payable at the rate of 8% per year. Neither of these notes has been materially modified since July 30, 2002. At June 30, 2004, the amount of principal outstanding on each note is $650,000. Both of these notes will be cancelled in the Formation and Structuring Transactions.

On July 1, 2003, one of our subsidiaries loaned Mr. Kline $100,000 for relocation expenses pursuant to a promissory note with interest payable at the rate of 6% per year and a maturity of April 21, 2007. The subsidiary agreed to waive 25% of the original principal and accrued interest due to it on each succeeding April 21. In June 2004, the remaining $75,000 principal amount of the note was forgiven.

Transactions with Others

We purchase telecommunications equipment from Gemini Telemanagement Systems, or GTS, a telecommunications equipment provider based in Redwood City, California. Robert A. Alter’s brother, Richard Alter, is the majority stockholder in GTS, and Robert A. Alter is a 5.2% stockholder in GTS. We paid GTS $236,046 in 2003, $6,000 in 2002 and $27,965 in 2001 for equipment provided in the ordinary course of business on arm’s length terms.

113

INVESTMENT POLICIES AND

POLICIES WITH RESPECT TO CERTAIN ACTIVITIES

The following is a discussion of our investment policies and our policies with respect to other activities, including financing matters and conflicts of interest. These policies may be amended or revised from time to time at the discretion of our board of directors without a vote of our stockholders or, in the case of conflicts, by the independent members of our board of directors. Any change to any of these policies would be made by our board of directors, or, in the case of conflicts, by the independent members of our board of directors, however, only after a review and analysis of that change, in light of then existing business and other circumstances, and then only if, in the exercise of their business judgment, they believe that it is advisable to do so in our and our stockholders’ best interest.

Investment Policies

Investments in Real Estate or Interests in Real Estate

In evaluating future acquisitions of upper upscale and upscale hotels, we seek existing properties in markets with strong growth characteristics, substantial demand generators, reasonable barriers to entry and attractive demographics. We will consider future opportunities to acquire hotels on a case-by-case basis. In evaluating future acquisitions of properties other than upper upscale and upscale hotels, we will seek properties that have characteristics which present a compelling case for investment. In particular, our acquisition strategy will focus on hotels where our aggregate investment basis, which includes all acquisition, rebranding and renovation costs, will be below replacement costs. Examples may include properties which have high entry yields, properties that are outside of our target markets but are being sold as part of a portfolio package, properties that are debt-free or properties that provide substantial growth potential. We also may consider investments in other real estate properties, such as land, that are complementary to our hotels or may be developed into hotels or related properties.

Our policy is to acquire assets primarily for current income generation and future value appreciation. In general, our investment objectives are:

•

to enhance stockholder value over time by generating strong returns on invested capital;

•

to increase our value through increases in the cash flow and values of our properties;

•

to achieve long-term capital appreciation, and preserve and protect the value of our interest in our properties; and

•

to pay distributions to our stockholders.

Under our policy, there are no limitations on the amount or percentage of our total assets that may be invested in any one property or on the number or amount of debt that may be placed on any one property. Additionally, no limits have been set on the concentration of investments in any one location or facility type.

We plan to finance investments in real estate or interests in real estate with borrowings, including mortgage loans and mezzanine financings.

Investments in Real Estate Mortgages

Prior to this offering, we have not engaged in any significant investments in mortgages. Although we currently have no specific plans to do so, we may engage in mortgage investments in the future, in particular if such investments lead to the acquisition of the underlying property.

Investments in Securities of or Interests in Persons Primarily Engaged in Real Estate Activities and Other Issuers

We generally have not, prior to this offering, engaged in any significant investment activities in other entities. However, subject to the percentage of ownership limitations and gross income and asset tests necessary

114

for REIT qualification, we may in the future invest in securities of entities engaged in real estate activities or securities of other issuers and we may consider joint venture investments with other investors. We may also invest in the securities of other issuers in connection with acquisitions of indirect interests in properties, which normally would include general or limited partnership interests in special purpose partnerships which own properties. We may in the future acquire some, all or substantially all of the securities or assets of other REITs or similar entities where that investment would be consistent with its investment policies. Subject to the percentage of ownership limitations and asset test referred to above, there are no limitations on the amount or percentage of our total assets that may be invested in any one issuer. However, we do not anticipate investing in other issuers of securities for the purpose of exercising control or acquiring any investments primarily for sale in the ordinary course of business or holding any investments with a view to making short-term profits from their sale. In any event, we do not intend that our investments in securities will require us to register as an “investment company” under the Investment Company Act, and we intend to divest securities before any registration would be required.

We have not in the past acquired loans secured by properties and we have not engaged in trading, underwriting, agency distribution or sales of securities of other issuers. Although we currently have no specific plans to do so, we may engage in such activities in the future if we believe that they will be beneficial to our business as a whole.

Disposition Policies

Generally, we will consider dispositions of properties, subject to REIT qualification rules, if we determine that the sale of a property would be in our best interests based on the price being offered for the property, the operating performance of the property, the possible tax consequences of the sale and other factors and circumstances surrounding the proposed sale. We are more likely to sell properties where:

•

we can realize attractive pricing;

•

demand in the market in which the hotel is located is declining or static;

•

competition in the market requires substantial capital investment into a hotel that will not generate adequate returns; or

•

the hotel was acquired as a part of a portfolio and is not consistent with our business strategy.

Financing Policies

As disclosed elsewhere in this prospectus, we have incurred debt in order to fund operations and acquisitions. Our board of directors will consider a number of factors when evaluating our level of indebtedness and when making decisions regarding the incurrence of indebtedness, including the purchase price of properties to be acquired with debt financing, the estimated market value of our properties upon refinancing and the ability of particular properties, and our company as a whole, to generate cash flow to cover expected debt service. Our financing strategy is to maintain a prudent level of debt with limited recourse if possible and to manage our variable interest rate exposure flexibly. We intend to finance future growth with the most advantageous source of capital available to us at the time of acquisition.

We may incur debt in the form of purchase money obligations to the sellers of properties or in the form of publicly or privately placed debt instruments, financing from banks, institutional investors, or other lenders, any of which indebtedness may be unsecured or may be secured by mortgages or other interests in our properties. This indebtedness may be recourse, non-recourse or cross-collateralized and, if recourse, that recourse may include our general assets and, if non-recourse, may be limited to the particular property to which the indebtedness relates. In addition, we may invest in properties subject to existing loans secured by mortgages or similar liens on the properties, or may refinance properties acquired on a leveraged basis. We may use the proceeds from any borrowings for working capital, to purchase additional interests in partnerships or joint ventures in which we participate, to refinance existing indebtedness or to finance acquisitions, expansion,

115

redevelopment of existing properties or development of new properties. We may also incur indebtedness for other purposes when our board of directors determines it is advisable to do so. In addition, we may need to borrow to meet the taxable income distribution requirements under the Code if we do not have sufficient cash available to meet those distribution requirements.

Lending Policies

We do not have a policy limiting our ability to make loans to other persons. We may consider offering purchase money financing in connection with the sale of properties where the provision of that financing will increase the value to be received by us for the property sold and we may engage in other mortgage or mezzanine lending activities. We may also make loans to joint ventures in which we or they participate or may participate in the future. We have not engaged in any significant lending activities in the past.

Equity Capital Policies

Subject to applicable law and the requirements for listed companies on the NYSE, our board of directors has the authority, without further stockholder approval, to amend our charter to increase or decrease the aggregate number of shares of our stock or the number of shares of any class or series of our stock and to cause us to issue additional authorized shares of common stock and preferred stock or otherwise raise capital, including through the issuance of senior securities, in any manner and on those terms and for that consideration it deems appropriate, including in exchange for property. Existing stockholders will have no preemptive right to shares of common stock or other shares of our stock issued in any offering, and any offering might cause a dilution of a stockholder’s investment in us. Although we have no current plans to do so, and we have not done so in the past, we may in the future issue common stock in connection with acquisitions. We also may issue partnership units in Sunstone Hotel Partnership in connection with acquisitions.

In some circumstances, we may purchase shares of our common stock in the open market or in private transactions with our stockholders, if our board of directors approves those purchases. Our board of directors has no present intention of causing us to repurchase any shares, and any action would only be taken in conformity with applicable Federal and state laws and the applicable requirements for qualifying as a REIT.

In the future we may institute a dividend reinvestment plan, or DRIP, which would allow our stockholders to acquire additional shares of our common stock by automatically reinvesting their cash distributions. Shares of our common stock would be acquired pursuant to the DRIP at a price equal to the then prevailing market price, without payment of brokerage commissions or service charges. Stockholders who do not participate in the plan will continue to receive cash distributions as declared.

Conflict of Interest Policies

Upon completion of this offering, our board of directors will consist of seven directors, at least four of whom will be independent directors within the meaning of the listing standards and rules of the NYSE. We also plan to adopt policies to reduce or eliminate potential conflicts of interest. However, we cannot assure you that these policies or provisions of law will be successful in eliminating the influence of these conflicts.

We plan to adopt a policy that the approval of our nominating and corporate governance committee is required for any transaction involving us and:

•

any of our directors, officers or employees, or any entity in which any of our directors, officers or employees is employed or has an interest of more than 5%; or

•

the Contributing Entities or their affiliates.

116

Corporate Opportunities

We intend to adopt a code of business conduct and ethics, which will provide that directors, officers and employees owe a duty to us to advance our business interests when the opportunity to do so arises. Among other things, our directors, officers and employees will be prohibited from taking (or directing to a third party) a business opportunity that is discovered through the use of corporate property, information or position, unless we have already been offered the opportunity and turned it down, in which case our nominating and corporate governance committee must in any event approve the director, officer or employee interest therein. More generally, our directors, officers and employees will be prohibited from using corporate property, information or position for personal gain and from competing with us.

Reporting Policies

After this offering, we will become subject to the information reporting requirements of the SEC. Pursuant to these requirements, we will file periodic reports, proxy statements and other information, including certified financial statements, with the SEC.

Regulatory Compliance Policies

Regulatory compliance matters will be overseen by one of our officers who is charged with responsibility for implementation of a corporate compliance plan that addresses employee conduct, conflict of interest, disclosure processes, corporate integrity, insider trading and other applicable polices governing business ethics and regulatory compliance.

117

PRINCIPAL STOCKHOLDERS

The following table sets forth information regarding (1) the beneficial ownership of our common stock and membership units in Sunstone Hotel Partnership before this offering, (2) the beneficial ownership of our common stock and membership units in Sunstone Hotel Partnership after this offering, with respect to (a) each person who will be a director after this offering, (b) each executive officer named in the summary compensation table, (c) all of our directors and executive officers as a group and (d) each person known by us to be the beneficial owner of greater than a 5% interest in our common stock and membership units in Sunstone Hotel Partnership. Unless otherwise indicated, all shares of common stock and membership units in Sunstone Hotel Partnership are owned directly and the indicated person has sole voting and investment power.

Unless otherwise indicated, the address of each person is 903 Calle Amanecer, Suite 100, San Clemente, California 92673.

Before Offering

After Offering

Name of Beneficial Owner

Number of
Shares of
Common Stock

Number of
Membership
Units

Percentage of
Common Stock ⁽¹⁾

Number of
Shares of
Common Stock

Number of

Membership
Units

Percentage of
Common Stock ⁽¹⁾

Robert A. Alter ⁽²⁾

—

Jon D. Kline ⁽³⁾

—

Gary A. Stougaard ⁽⁴⁾

—

Paul D. Kazilionis ⁽⁵⁾

100.0

Jonathan H. Paul ⁽⁶⁾

100.0

All executive officers and directors as a group (5 persons)

100.0

Westbrook Real Estate Partners, L.L.C. ⁽⁷⁾

100.0

*	Represents less than 1% of the number of shares of our common stock and membership units in Sunstone Hotel Partnership.

Notes:

(1)	Includes shares of our common stock and membership units in Sunstone Hotel Partnership that may, subject to limits in the operating agreement, be exchanged for cash or, at our option, shares of our common stock on a one for one basis commencing 12 months after this offering.

(2)

Mr. Alter owns interests in members of Sunstone Hotel Investors, L.L.C., Sunstone/WB Hotel Investors IV, LLC, Sunstone/WB Manhattan Beach, LLC and WB Hotel Investors, LLC. Mr. Alter serves on the executive committees of those entities but does not have voting or disposition control over the securities held by those entities.

(3)	Mr. Kline owns interests in Sunstone/WB Hotel Investors IV, LLC and Sunstone/WB Manhattan Beach, LLC. Mr. Kline does not have voting or disposition control over the securities held by these entities.

(4)	Mr. Stougaard owns interests in Sunstone Hotel Investors, L.L.C. and in a member of Sunstone/WB Hotel Investors IV, LLC and WB Hotel Investors, LLC. Mr. Stougaard does not have voting or disposition control over the securities held by these entities.

(5)

Mr. Kazilionis is a Managing Principal of Westbrook Real Estate Partners, L.L.C., which is a managing member of the general partner of an entity with ownership interests in Sunstone Hotel Investors, L.L.C., Sunstone/WB Hotel Investors IV, LLC, Sunstone/WB Manhattan Beach, LLC and WB Hotel Investors, LLC, but disclaims any beneficial interest in the shares held by these entities other than to the extent of his pecuniary interest.

(6)

Mr. Paul is a Managing Principal of Westbrook Real Estate Partners, L.L.C., which is a managing member of the general partner of an entity with ownership interests in Sunstone Hotel Investors, L.L.C., Sunstone/WB Hotel Investors IV, LLC, Sunstone/WB Manhattan Beach, LLC and WB Hotel Investors, LLC, but disclaims any beneficial interest in the shares held by these entities other than to the extent of his pecuniary interest.

(7)

Westbrook Real Estate Partners, L.L.C. is the managing member of the general partners of entities that have the right to appoint a majority of the members of the executive committees of the Contributing Entities (Sunstone Hotel Investors, L.L.C. Sunstone/WB Hotel Investors IV, LLC, Sunstone/WB Manhattan Beach, LLC and WB Hotel Investors, LLC.) Voting and investment control of the securities owned by the Contributing Entities is held by executive committees, of which Robert A. Alter, Paul D. Kazilionis and Jonathan H. Paul, among others, are members. Voting and investment control of the securities owned by Westbrook Real Estate Partners, L.L.C. is held by a committee, of which Paul D. Kazilionis and Jonathan H. Paul, among others, are members. The address for these entities is 13155 Noel Road, LB 54, Suite 700, Dallas, Texas 75240. Prior to the Formation and Structuring Transactions, Sunstone Hotel Investors, L.L.C. owned 100 shares of our common stock, representing all of our common stock.

118

DESCRIPTION OF STOCK

Rights of our stockholders are governed by the Maryland General Corporation Law, or MGCL, our charter and our bylaws. The following is a summary of the provisions of our capital stock and describes certain provisions of our charter and bylaws, copies of which are filed as exhibits to the registration statement of which this prospectus is a part.

General

Our charter provides that we are authorized to issue 500,000,000 shares of common stock, $0.01 par value per share, and 100,000,000 shares of preferred stock, $0.01 par value per share. Our board, without any action by our stockholders, may amend our charter to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that we have authority to issue.

Common Stock

Upon completion of this offering, there will be shares of our common stock issued and outstanding, or shares of common stock if the underwriters’ option to purchase additional shares is exercised in full. We intend to apply to have our common stock listed on the NYSE under the symbol “SHO.”

Distributions. Subject to provisions of law and the preferential rights of any other class or series of stock and the restrictions on transfer of stock as provided in our charter, the holders of our common stock will be entitled to receive distributions when, as and if authorized by our board of directors and declared by us out of assets legally available therefor. We will pay those distributions either in cash, or otherwise, at the rate and on the date or dates declared by our board of directors.

Liquidation preference. Upon the occurrence of any liquidation, dissolution or winding up of our affairs, whether voluntary or involuntary, and subject to the liquidation preferences of any outstanding class or series of stock, the holders of our common stock are entitled to receive their proportionate share of all assets available for distribution.

Voting rights. Subject to the restrictions on transfer of stock in our charter, holders of our common stock are entitled to one vote for each share of our common stock held on every matter submitted to a vote of stockholders. Except as otherwise required by law or the terms of any outstanding class or series of stock, the holders of our common stock have sole voting power. Holders of our common stock do not have cumulative voting rights in the election of directors, which means that the holders of a majority of the shares of our outstanding common stock, voting as a single class, may elect all of the directors and the holders of the remaining shares of our common stock are not able to elect any directors.

Other rights. Holders of shares of our common stock have no conversion, sinking fund, redemption, exchange or appraisal rights and have no preemptive rights to subscribe for any of our securities.

Preferred Stock

Our charter authorizes our board of directors to classify any unissued shares of preferred stock and to reclassify any previously classified but unissued shares of any series. Prior to issuance of shares of each series, our board of directors is required by the MGCL and our charter to set the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each such series. Thus, our board of directors could authorize the issuance of shares of preferred stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or a change of control of our company that might involve a premium price for holders of our common stock or otherwise be in their best interest. As of the date of this prospectus, no shares of preferred stock are outstanding and we have no current plans to issue any preferred stock.

Restrictions on Ownership and Transfer

To qualify as a REIT under Sections 856 through 859 of the Code, we must meet certain requirements concerning the ownership of our outstanding shares of equity stock. Specifically, not more than 50% in value of

119

our outstanding shares of capital stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities). This ownership restriction is commonly referred to as the “5/50 Test”. Additionally, the shares of stock 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. Accordingly, we have various restrictions on the ownership of shares of our capital stock to ensure that these tests are met.

To protect us against the risk of losing our status as a REIT due to a concentration of ownership among our stockholders, and to otherwise address concerns related to a concentrated ownership of capital stock, our charter, subject to certain exceptions, provides that no single person, may “beneficially own” or “constructively own” more than 9.8% (in number or value, whichever is more restrictive) of the aggregate outstanding shares of common stock or more than 9.8% in value of the aggregate outstanding shares of our capital stock. Our board of directors may waive or modify the ownership limits with respect to one or more persons if it is satisfied that ownership in excess of this limit would not jeopardize our status as a REIT for U.S. federal income tax purposes. The board of directors may require that such person provide a ruling from the Internal Revenue Service or an opinion of counsel to determine or ensure our status as a REIT in circumstances where it has received a request for exemption and is unable to satisfy itself that the ownership limitations will not be violated.

Stock owned, deemed to be owned or transferred to a stockholder in excess of the 9.8% ownership limits will be automatically transferred, by operation of law, to a trust, the beneficiary of which shall be a qualified charitable organization.

Each share of stock transferred to the trust will be entitled to the same dividends and distributions (as to both timing and amount) as may be authorized by our board of directors on other shares of the same class or series. The trustee, as record holder of the shares of stock, will be entitled to receive all dividends and distributions and will hold all such dividends or distributions in trust for the benefit of the beneficiary. The “prohibited owner,” with respect to such shares of stock, will be required to repay to the trust the amount of any dividends or distributions received by it that are attributable to any such shares the record date of which was on or after the date that such shares were transferred to the trust. We will take all measures that we determine reasonably necessary to recover the amount of any such dividend or distribution paid to a prohibited owner, including, if necessary, withholding any portion of future dividends or distributions payable on shares beneficially or constructively owned by such person who, but for these provisions, would own the shares of stock that were transferred to the trust, and, as soon as reasonably practicable following our receipt or withholding thereof, shall pay over to the trust for the benefit of the beneficiary the dividends so received or withheld, as the case may be.

In addition to the foregoing transfer restrictions, and as more fully explained in our charter, shares of stock transferred to the 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 (1) the price per share in the transaction that caused such shares to be transferred to the trust, or (2) the market price on the date we, or our designee, accepts such offer. We will have the right to accept such offer for a period of 90 days.

The foregoing restrictions on transferability and ownership will not apply if our board of directors determines that it is no longer in our best interest for us to continue to qualify as a REIT. Furthermore, our board of directors may, in its sole discretion, waive or modify the ownership limits with respect to one or more persons if they are satisfied that ownership in excess of this limit will not jeopardize our qualification as a REIT, and the board of directors otherwise decides that such action is in our stockholders’ best interest.

Our stockholders are required to disclose to us in writing any information with respect to their ownership of our capital stock that we may request to determine our status as a REIT and to ensure compliance with the ownership limits.

The ownership limits may have the effect of delaying, deferring or preventing a change of control of us.

Other Matters

The transfer agent and registrar for our common stock is .

120

CERTAIN PROVISIONS OF MARYLAND LAW AND OF OUR CHARTER AND BYLAWS

The following is a summary of the provisions of Maryland law applicable to us and of our charter and bylaws. For more detail, we refer you to Maryland law, including the MGCL, our charter and our bylaws. We have filed our charter and bylaws as exhibits to the registration statement of which this prospectus is a part.

Amendment of Charter and Bylaws

Under Maryland law, a Maryland corporation generally cannot amend its charter, unless declared advisable by its board of directors and approved by the affirmative vote of stockholders entitled to cast at least two-thirds of the votes entitled to be cast on the matter. However, a Maryland corporation may provide in its charter for approval of amendments by a lesser percentage of the shares entitled to vote on the matter, but not less than a majority of all of the votes entitled to be cast on the matter. Our charter provides for approval of amendments to our charter by a majority of the votes entitled to be cast on the matter. Our board of directors has the exclusive power to adopt, alter or repeal any provisions of our bylaws and make new bylaws, except with respect to amendments to the provisions of our bylaws regarding our opt out of the Maryland business combination and control share acquisition statutes.

Meetings of Stockholders

Under our bylaws, annual meetings of stockholders are to be held each year at a date and time as determined by our board of directors. Special meetings of stockholders may be called only by a majority of our directors, our Chairman, our Chief Executive Officer or our President and must be called by our Secretary upon the written request of the holders of a majority of the shares of our common stock entitled to vote at a meeting. The date, time and place of any special meetings will be set by our board of directors. Our bylaws provide that with respect to special meetings of our stockholders, only the business specified in our notice of meeting may be brought before the meeting.

Advance Notice Provisions for Stockholder Nominations and Stockholder Proposals

Our bylaws provide that, with respect to an annual meeting of stockholders, nominations of individuals for election to our board of directors and the proposal of business to be considered by stockholders may be made only (i) pursuant to our notice of the meeting, (ii) by our board of directors or (iii) by a stockholder who is a stockholder of record both at the time of giving notice by the stockholder as required by the bylaws and at the time of the meeting and who is entitled to vote at the meeting and who has complied with the advance notice procedures of our bylaws. With respect to special meetings of stockholders, only the business specified in our notice of the meeting may be brought before the meeting. Nominations of individuals for election to our board of directors at a special meeting may be made only (x) pursuant to our notice of the meeting, (y) by our board of directors or (z) provided that the board of directors has determined that directors will be elected at the meeting, by a stockholder who is a stockholder of record both at the time of giving notice by the stockholder as required by the bylaws and at the time of the meeting and who is entitled to vote at the meeting and who has complied with the advance notice provisions of our bylaws.

The purpose of requiring stockholders to give advance notice of nominations and other proposals is to afford our board of directors the opportunity to consider the qualifications of the proposed nominees or the advisability of the other proposals and, to the extent considered necessary by our board of directors, to inform stockholders and make recommendations regarding the nominations or other proposals. The advance notice procedures also permit a more orderly procedure for conducting our stockholder meetings. Although our bylaws do not give our board of directors the power to disapprove timely stockholder nominations and proposals, they may have the effect of precluding a contest for the election of directors or proposals for other action if the proper procedures are not followed, and of discouraging or deterring a third party from conducting a solicitation of proxies to elect its own slate of directors to our board of directors or to approve its own proposal.

121

Board of Directors

Upon completion of this offering, our board of directors will consist of seven directors and thereafter the number of directors may be established by our board of directors but may not be fewer than the minimum number required by the MGCL (which currently is one). Under our charter and bylaws, we have elected to be subject to certain provisions of Maryland law which vest in our board of directors the exclusive right to determine the number of directors and the exclusive right, by the affirmative vote of a majority of the remaining directors, to fill vacancies on the board even if the remaining directors do not constitute a quorum.

Our directors will serve for one-year terms and until their successors are elected and qualify and thus be subject to election annually. Holders of shares of our common stock will not have the 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 our common stock will be able to elect all of the successors of the directors.

Any vacancy will be filled, including any vacancy created by an increase in the number of directors, at any regular meeting or at any special meeting called for the purpose, by a majority of the remaining directors in office, even if the remaining directors do not constitute a quorum. Any director appointed to fill a vacancy shall hold office until the next annual meeting and until his or her successor is duly elected and qualified.

Removal of Directors

Our charter provides that a director may be removed, with or without cause, upon the affirmative vote of a majority of the votes entitled to be cast in the election of directors. Absent removal of all of our directors, this provision, when coupled with the provision in our bylaws authorizing our board of directors to fill vacant directorships, precludes stockholders from removing incumbent directors, except upon an affirmative majority vote, and filling the vacancies created by such removal with their own nominees.

Extraordinary Transactions

Under Maryland law, a Maryland corporation generally cannot dissolve, merge, sell all or substantially all of its assets, engage in a share exchange or engage in similar transactions outside the ordinary course of business unless declared advisable by its board of directors and approved by the affirmative vote of stockholders entitled to cast at least two-thirds of the votes entitled to be cast on the matter. However, a Maryland corporation may provide in its charter for approval of these matters by a lesser percentage of the shares entitled to vote on the matter, but not less than a majority of all of the votes entitled to be cast on the matter. Our charter provides for approval of these matters by a majority of the votes entitled to be cast on the matter. Maryland law permits a corporation to transfer all or substantially all of its assets without the approval of the stockholders of the corporation to one or more persons if all of the equity interests of the person or persons are owned, directly or indirectly, by the corporation. Maryland law also does not require approval of the stockholders of a parent corporation to merge or sell all or substantially all of the assets of a subsidiary entity. Because operating assets may be held by a corporation’s subsidiaries, as in our situation, this may mean that a subsidiary may be able to merge or sell all or substantially all of its assets without a vote of the corporation’s stockholders. Maryland law also permits the merger of a 90% or more owned subsidiary with or into its parent corporation without stockholder approval if (1) the charter of the successor in the merger is not amended other than to change its name, the name or other designation or the par value of any class or series of its stock or the aggregate par value of its stock and (2) the contract rights of any stock of the successor issued in the merger in exchange for stock of the other corporation participating in the merger are identical to the contract rights of the stock for which it is exchanged.

Business Combinations

Maryland law prohibits “business combinations” between us and an interested stockholder or an affiliate of an interested stockholder for five years after the most recent date on which the interested stockholder becomes an

122

interested stockholder. These business combinations include a merger, consolidation, share exchange or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. Maryland law defines an interested stockholder as:

•

any person who beneficially owns 10% or more of the voting power of our stock; or

•

an affiliate or associate of ours who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of our then outstanding voting stock.

A person is not an interested stockholder if our board of directors approved in advance the transaction by which the person otherwise would have become an interested stockholder. However, in approving a transaction, our board of directors may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by our board of directors.

After the five-year prohibition, any business combination between us and an interested stockholder generally must be recommended by our board of directors and approved by the affirmative vote of at least:

•

80% of the votes entitled to be cast by holders of our then outstanding shares of voting stock; and

•

two-thirds of the votes entitled to be cast by holders of our voting stock other than stock held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or stock held by an affiliate or associate of the interested stockholder.

These super-majority vote requirements do not apply if our common stockholders receive a minimum price, as defined under Maryland law, for their stock in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its stock.

The statute permits various exemptions from its provisions, including business combinations that are exempted by the board of directors before the time that the interested stockholder becomes an interested stockholder. We have opted out of the business combination provisions of the MGCL by resolution of our board of directors and our bylaws contain a provision providing that we may not opt in without approval of our shareholders.

Control Share Acquisitions

With certain exceptions, 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 acquiring person or by our officers or directors who are our employees. Control shares are voting shares which, if aggregated with all other shares owned or voted by the acquiror, would entitle the acquiror to exercise voting power in electing directors within one of the following ranges of voting power: (i) one-tenth 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 acquiror is then entitled to vote as a result of having previously obtained stockholder approval. A control share acquisition means, subject to certain exceptions, the acquisition by any person of ownership or voting power of issued and outstanding control shares. 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 our board of directors to call a special meeting of stockholders to be held within 50 days of demand to consider the voting rights of the control shares in question. If no request for a meeting is made, we may present the issue at any stockholders’ meeting.

If voting rights are not approved at the stockholders’ meeting or if the acquiring person does not deliver the statement required by Maryland law, then, subject to certain conditions and limitations, we may redeem any or all of the control shares, except those for which voting rights have previously been approved, for fair value. Fair value is determined without regard to the absence of voting rights for the control shares as of the date of the last

123

control share acquisition or of any meeting of stockholders at which the voting rights of the shares were considered and not approved. If voting rights for control shares are approved at a stockholders’ meeting and the acquiror may then vote a majority of the shares entitled to vote, then all other stockholders may exercise appraisal rights. The fair value of the shares for purposes of these appraisal rights may not be less than the highest price per share paid by the acquiror in the control share acquisition. The control share acquisition statute does not apply to shares acquired in a merger, consolidation or share exchange if we are a party to the transaction, nor does it apply to acquisitions approved or exempted by our charter or bylaws.

Our bylaws contain a provision exempting any and all acquisitions of our stock from the control share provisions of Maryland law providing that we may not repeal this provision without approval of our stockholders.

Maryland Unsolicited Takeover Act

The MGCL permits a Maryland corporation with a class of equity securities registered under the Exchange Act and at least three independent directors to elect to be subject, by provision in its charter or bylaws or a resolution of its board of directors and notwithstanding any contrary provision in the charter or bylaws, to any or all of the following provisions:

•

a classified board of directors;

•

a two-thirds vote requirement for removing a director;

•

a requirement that the number of directors be fixed only by vote of the directors;

•

a requirement that a vacancy on the board of directors be filled only by the remaining directors and for the remainder of the full term of the class of directors in which the vacancy occurred; or

•

a majority requirement for the calling of a special meeting of stockholders.

Our charter and bylaws (a) vest in our board of directors the exclusive power to fix the number of directorships and (b) require, unless called by our Chairman, Chief Executive Officer, President or board of directors, the request of holders of a majority of outstanding shares to call a special meeting. We also have elected to be subject to the provisions of Subtitle 8 of the MGCL relating to the filling of vacancies on our board of directors. We do not have a classified board or require a two-thirds vote for removal of any director from our board of directors.

Limitation of Liability and Indemnification

Maryland law permits us to include in our charter a provision limiting the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from (a) actual receipt of an improper benefit or profit in money, property or services or (b) active and deliberate dishonesty established by a final judgment as being material to the cause of action. Our charter contains a provision which eliminates directors’ and officers’ liability to the maximum extent permitted by Maryland law.

Our charter also authorizes us, to the maximum extent permitted by Maryland law, to obligate ourselves us to indemnify (a) any present or former director or officer or (b) any individual who, while a director or officer and, at our request, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise as a director, officer, partner, trustee, employee or agent, against any claim or liability arising from service in any such capacity and to pay or reimburse their reasonable expenses in advance of final disposition of a proceeding. Our bylaws obligate us to provide such indemnification and advance of expenses. Our charter and bylaws also permit us to indemnify and advance expenses to any individual who served our predecessor in any of the capacities described above and any employee or agent of us or our predecessor.

124

Maryland law requires us (unless our charter provides otherwise, which our charter does not) to indemnify a director or officer who has been successful, on the merits or otherwise, against reasonable expenses incurred in the defense of any proceeding to which he or she is made, or threatened to be made, a party by reason of his or her service in that capacity. Maryland law permits us to indemnify our present and former directors and officers, among others, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by them in connection with any proceeding to which they may be made a party by reason of their service in those or other capacities unless it is established that:

•

the act or omission of the director or officer was material to the matter giving rise to the proceeding and (1) was committed in bad faith or (2) was the result of active and deliberate dishonesty;

•

the director or officer actually received an improper personal benefit in money, property or services; or

•

in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful.

A court may order indemnification if it determines that the director or officer is fairly and reasonably entitled to indemnification, even though the director or officer did not meet the prescribed standard of conduct or was adjudged liable on the basis that personal benefit was improperly received. However, indemnification for an adverse judgment in a suit by us or in our right, or for a judgment of liability on the basis that personal benefit was improperly received, is limited to expenses.

In addition, Maryland law permits us to advance reasonable expenses to a director or officer upon receipt of (a) a written affirmation by the director or officer of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification and (b) a written undertaking by him or her or on his or her behalf to repay the amount paid or reimbursed if it is ultimately determined that the standard of conduct was not met.

Anti-Takeover Effect of Certain Provisions of Maryland Law and of our Charter and Bylaws

If the resolution of our board of directors and the applicable provisions in our bylaws exempting us from the business combination provisions and the control share acquisition provisions of the MGCL are rescinded, the business combination provisions and the control share acquisition provisions of the MGCL, the provisions of our charter on removal of directors and the advance notice provisions of our bylaws and certain other provisions of our charter and bylaws and the MGCL could delay, defer or prevent a change in control of us or other transactions that might involve a premium price for holders of our common stock or otherwise be in their best interest.

REIT Status

Our charter provides that our board of directors may revoke or otherwise terminate our REIT election if it determines that it is no longer in our best interest to continue to qualify as a REIT. If our board of directors so determines, the restrictions set forth in the section above entitled “Description of Stock—Restrictions on Ownership and Transfer” will no longer apply.

125

DESCRIPTION OF THE

OPERATING AGREEMENT OF SUNSTONE HOTEL PARTNERSHIP, LLC

The following is a summary of the material provisions of the limited liability company agreement, which we refer to as the operating agreement. For more detail, we refer you to the operating agreement itself, a copy of which is filed as an exhibit to the registration statement of which this prospectus is a part.

Management of Sunstone Hotel Partnership

Sunstone Hotel Partnership is a Delaware limited liability company that was formed in June 2004. We are the sole managing member of Sunstone Hotel Partnership and conduct substantially all of our business in or through it. As sole managing member of Sunstone Hotel Partnership, we exercise exclusive and complete responsibility and discretion in its day-to-day management and control. We can cause Sunstone Hotel Partnership to enter into certain major transactions including acquisitions, dispositions and financings, subject to certain limited exceptions. The non-managing members of Sunstone Hotel Partnership have no right to participate in or exercise control or management power over our business and affairs, except as otherwise expressly provided in the operating agreement and as required by applicable law. Provisions of the operating agreement restrict our ability to engage in a business combination as more fully described in “—Termination Transactions” below.

The non-managing members of our operating partnership expressly acknowledged that we, as managing member of our operating partnership, are acting for the benefit of the operating partnership, the non-managing members and our stockholders collectively. We are under no obligation to give priority to the separate interests of the non-managing members or our stockholders in deciding whether to cause our operating partnership to take or decline to take any actions. If there is a conflict between the interests of our stockholders on the one hand and the non-managing members on the other hand, we will endeavor in good faith to resolve the conflict in a manner not adverse to either our stockholders or the limited partners; provided, however, that for so long as we own a controlling interest in our operating partnership, any conflict that cannot be resolved in a manner not adverse to either our stockholders or the non-managing members will be resolved in favor of our stockholders. We are not liable under the operating agreement to our operating partnership or to any non-managing members for monetary damages or losses sustained, liabilities incurred, or benefits not derived by the non-managing members in connection with such decisions provided that we have acted in good faith.

The operating agreement provides that all our business activities, including all activities pertaining to the acquisition and operation of properties, must be conducted through Sunstone Hotel Partnership, and that Sunstone Hotel Partnership must be operated in a manner that will enable us to satisfy the requirements for being classified as a REIT.

Transferability of Interests

As managing member, we may not voluntarily withdraw from Sunstone Hotel Partnership or transfer or assign all or any portion of our interest in Sunstone Hotel Partnership, except:

•

in the event that we purchase shares of our common stock, then we shall cause Sunstone Hotel Partnership to purchase from us an equal number of membership units; or

•

in connection with a transaction described in “—Termination Transactions” below.

The non-managing members may transfer all or any portion of their interests without our prior written consent, provided that: (1) such transfer would not require filing of a registration agreement under the Securities Act, or otherwise violate any applicable Federal or state securities laws or regulations; (2) such transfer would not result in the sum of the percentage of interests in membership units transferred during Sunstone Hotel Partnership’s taxable year exceeding 2% of the total membership units of Sunstone Hotel Partnership, subject to certain exceptions; and (3) any transferee desiring to become a substituted non-managing member must furnish

126

to us evidence of acceptance of all of the terms and conditions of the operating agreement and such other documents and instruments as we may reasonably require.

Amendments to the Operating Agreement

Amendments to the operating agreement may be proposed by us, as managing member, or by non-managing members owning at least 25% of the membership units held by non-managing members.

Generally, the operating agreement may be amended with the approval of us as managing member and the consent of non-managing members holding a majority of the membership units of the non-managing members. As managing member, we will have the power to unilaterally make certain amendments to the operating agreement without obtaining the consent of the non-managing members as may be required to:

•

add to our obligations as managing member or surrender any right or power granted to us as managing member for the benefit of the non-managing members;

•

set forth the rights, powers, duties, and preferences of the holders of any additional membership units issued pursuant to the operating agreement;

•

reflect the issuance of additional membership units or the admission, substitution, termination or withdrawal of members in accordance with the terms of the operating agreement;

•

reflect a change of an inconsequential nature that does not adversely affect the non-managing members in any material respect, or cure any ambiguity, correct or supplement any provisions of the operating agreement not inconsistent with law or with other provisions of the operating agreement;

•

satisfy any requirements, conditions or guidelines contained in any order, directive, opinion, ruling or regulation of a Federal or state agency or contained in Federal or state law;

•

reflect changes that are reasonably necessary for us, as managing member, to maintain our status as a REIT; or

•

modify the manner in which capital accounts are computed in order to comply with tax regulations.

Amendments that would, among other things, convert a non-managing member’s interest into a managing member’s interest, modify the limited liability of a non-managing member, alter a member’s right to receive any distributions or allocations of profits or losses, alter or modify the redemption rights described below, cause the termination of Sunstone Hotel Partnership prior to the time set forth in the operating agreement, or amend provisions that require the consent of adversely affected members, must be approved by each non-managing member that would be adversely affected by such amendment.

In addition, there are certain other provisions of the operating agreement that we, as managing member, may not amend without the written consent of non-managing members holding two-thirds of the membership units. For example, we may not amend any of the provisions of the operating agreement regarding:

•

our removal;

•

limitations on our outside activities;

•

our liability;

•

transfer of our managing member’s interest;

•

judicial dissolution;

•

when consent of an adversely affected non-managing member is required to amend the operating agreement;

•

when consent by a majority of non-managing membership interests is required for amendment of operating agreement; or

•

meetings of members.

127

Distributions to Members

The operating agreement provides that members are entitled to receive quarterly distributions of available cash as determined by the managing member on a pro rata basis in accordance with their ownership of membership units, subject to distributions made to any class of additional membership interests which are entitled to a preference on the distribution of available cash.

Redemption and Exchange Rights

Non-managing members who acquire units in the Formation and Structuring Transactions have the right, commencing on or after the date which is 12 months after the completion of this offering, to require Sunstone Hotel Partnership to redeem part or all of their membership units for a cash amount based upon the fair market value of a equivalent number of shares of our common stock at the time of the redemption (adjusted for stock splits or combinations and stock dividends or distributions of our common stock). The aggregate number of membership units held by non-managing members is .

As managing member, we may elect to acquire those units in exchange for shares of our common stock. Our acquisition will be on a one-for-one basis, subject to adjustment in the event of stock splits or combination and stock dividends or distributions. We presently anticipate that we will elect to issue shares of our common stock in exchange for units in connection with each redemption request, rather than having Sunstone Hotel Partnership redeem the units for cash. If we issue shares of common stock in exchange for units, the number of shares of our common stock outstanding will increase, although the number of shares of common stock you hold will stay the same, which will cause dilution to your ownership in the REIT. With each redemption or exchange, we increase our percentage ownership interest in Sunstone Hotel Partnership. Commencing on or after the date which is 12 months after the consummation of this offering, non-managing members who hold units may exercise this redemption right from time to time, in whole or in part, except when, as a consequence of shares of our common stock being issued, any person’s actual or constructive stock ownership would exceed our ownership limits, or any other limit as provided in our charter or as otherwise determined by our board of directors as described under the section entitled “Description of Stock—Restrictions on Ownership and Transfer.” If the non-managing members exercised their redemption rights with respect to all membership units held, and we issued common stock in exchange for those membership units we would issue shares of common stock, or shares of common stock if the underwriters’ over-allotment option is exercised in full subject to adjustment in the events discussed above.

Issuance of Additional Units, Common Stock or Convertible Securities

As sole managing member, we have the ability to cause Sunstone Hotel Partnership to issue additional units representing membership interests. These additional units may include preferred membership units. In addition, we may issue additional shares of our common stock or convertible securities, but only if: (1) we cause Sunstone Hotel Partnership to issue to us membership interests or rights, options, warrants or convertible or exchangeable securities of Sunstone Hotel Partnership having designations, preferences and other rights, so that the economic interests of Sunstone Hotel Partnership’s interests issued are substantially similar to the securities that we have issued; and (2) we contribute the net proceeds from, or the property received in consideration for, the securities that we have issued to Sunstone Hotel Partnership.

Tax Matters

We are the tax matters member of Sunstone Hotel Partnership, and we also have authority to make tax elections under the Code on behalf of Sunstone Hotel Partnership.

Allocations of Net Income and Net Losses to Members

The net income or net loss of Sunstone Hotel Partnership generally will be allocated to the members in accordance with their respective percentage interests in Sunstone Hotel Partnership, subject to special allocations relating to compliance with the provisions of Sections 704(b) and 704(c) of the Code and the associated Treasury regulations.

128

Operations

The operating agreement provides that Sunstone Hotel Partnership will assume and pay when due, or reimburse us for payment of all costs and expenses relating to operations of, or for the benefit of, Sunstone Hotel Partnership.

Termination Transactions

The operating agreement provides that we may not engage in any merger, consolidation or other business combination with or into another person, sale of all or substantially all of our assets or any reclassification or any recapitalization or change in outstanding shares of our common stock other than a stock split or combination or stock dividend, which we call a termination transaction, unless as a result of the termination transaction each non-managing member thereafter remains entitled to redeem each membership unit owned by such non-managing member for an amount of cash, securities or other property equal to the greatest amount of cash, securities or other property which such non-managing member would have received from such termination transaction if such non-managing member had exercised its redemption right immediately prior to the termination transaction; provided that, if, in connection with a termination transaction, a purchase, tender or exchange offer is made to and accepted by the holders of more than 50% of the outstanding shares of our common stock, each holder of membership units will receive the greatest amount of cash, securities or other property which such holder would have received had it exercised its redemption right and received shares of our common stock in exchange for its membership units immediately prior to the expiration of such purchase, tender or exchange offer and accepted such purchase, tender or exchange offer. For any termination transaction in which shares were exchanged for securities of the acquiror, the non-managing members shall remain entitled to exercise their redemption rights with respect to the acquiror unless the consent of the non-managing members is obtained.

Term

Sunstone Hotel Partnership will continue in full force and effect until dissolved in accordance with its terms or as otherwise provided by law.

Indemnification and Limitation of Liability

To the extent permitted by applicable law, Sunstone Hotel Partnership will indemnify its members, directors, officers, employees and agents against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement in connection with claims arising from operations of Sunstone Hotel Partnership in which any such person may be involved, or is threatened to be involved, if the person acted in good faith and in a manner that they reasonably believed to be in or not opposed to the best interests of Sunstone Hotel Partnership and, with respect to any criminal action or proceeding, had no reasonable cause to believe that their conduct was unlawful.

As the managing member, we are not liable to Sunstone Hotel Partnership for monetary damages for losses sustained on liabilities incurred as a result of errors in judgment or any act or omission unless:

•

we actually received an improper benefit in money, property or services (in which case, we will be liable for the amount of the benefit in money, property or services actually received); or

•

our action or failure to act was the result of active and deliberate dishonesty, gross negligence or bad faith and was material to the matter giving rise to the proceeding.

129

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this offering, we will have shares of our common stock outstanding, assuming no exercise of the underwriters’ option to purchase additional shares.

Of these shares, shares, or shares if the underwriters exercise their option to purchase additional shares in full, sold in this offering will be freely transferable without restriction or registration under the Securities Act, except for any shares purchased by one of our existing “affiliates,” as that term is defined in Rule 144 under the Securities Act. The remaining shares of our common stock, including any shares purchased by affiliates in this offering, will be “restricted securities” as defined in Rule 144. Restricted securities may be sold in the public market only if registered under the Securities Act or if they qualify for an exemption from registration under Rules 144 or 701 of the Securities Act. As a result of the contractual lock-up periods described below and the provisions of Rules 144 and 701, these restricted shares will become available for sale in the public market at various times beginning 180 days after this offering (subject, in some cases, to volume limitations and applicable holding periods).

Rule 144

In general, under Rule 144 as currently in effect, beginning 90 days after this offering, a person, or persons whose shares are aggregated, who owns shares that were purchased from us or any affiliate at least one year prior to such date is entitled to sell within any three-month period a number of shares that does not exceed the greater of:

•

1% of our then-outstanding shares of our common stock, or approximately shares immediately after this offering; or

•

the average weekly trading volume of our common stock on the NYSE during the four calendar weeks preceding the filing of a notice of the sale on Form 144.

Sales under Rule 144 are also subject to manner of sale provisions, notice requirements and the availability of current public information about us. We are unable to estimate the number of shares that will be sold under Rule 144 since this will depend on the market price for our common stock, the personal circumstances of the stockholder and other factors.

Rule 144(k)

Under Rule 144(k), a person who is not deemed to have been one of our affiliates at any time during the three months preceding a sale, and who owns shares within the definition of “restricted securities” under Rule 144 that were purchased from us or any affiliate at least two years prior to such date, would be entitled to sell shares under Rule 144(k) without regard to the volume limitations, manner of sale provisions, public information requirements or notice requirements described above.

Rule 701

In general, any of our employees, directors, officers, consultants or advisors who purchased shares from us before the effective date of this offering acquired the shares in reliance on the exemption from registration provided by Rule 701.

Securities issued in reliance on Rule 701 are restricted securities but, subject to the contractual “lock-up” restrictions described below, beginning 90 days after the offering, may be sold by:

•

persons other than “affiliates,” as defined in Rule 144, subject only to the manner of sale provisions of Rule 144; and

•

by “affiliates” under Rule 144 without compliance with its one-year minimum holding period requirement.

130

Registration Rights

The aggregate number of shares of our common stock and securities convertible into or exchangeable into shares of our common stock subject to a registration rights agreement is . For a description of the registration rights granted to some holders of our common stock, see “Certain Relationships and Related Transactions—Registration Rights.”

Lock-up Agreements

We, our directors and officers and the Contributing Entities have agreed that, for a period of 180 days from this offering, we and they will not without the prior written consent of the representatives offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, any shares of our common stock or any securities convertible into or exchangeable for shares of our common stock, subject to limited exceptions. Citigroup Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley & Co. Incorporated have no specific criteria with respect to the conditions under which they may release securities subject to lock-up agreements, which waivers are subject to their sole discretion. The total number of shares of our common stock and any securities convertible into or exchangeable into shares of our common stock subject to lock-up agreements is .

131

OUTSTANDING INDEBTEDNESS

As of June 30, 2004, our material indebtedness consisted of the following (the indebtedness that will be repaid with the proceeds from this offering is identified under “Use of Proceeds”):

Massachusetts Mutual Life Insurance Company. We have approximately $320.8 million of debt with Massachusetts Mutual Life Insurance Company. This debt bears interest at LIBOR (with a right to select one, three or six month indices) plus a spread of 3.35% and matures on September 1, 2007. As of June 30, 2004, we have selected one-month LIBOR as the base index. This debt is secured by a first deed of trust/mortgage, assignment of leases and rents, a financing agreement, a security agreement and personal property on 32 hotels, on a cross-collateralized and cross-defaulted basis. Subject to certain operating performance thresholds and portfolio loan-to-value ratios within prescribed time periods, we may be entitled to an increase in the principal amount of the loan up to a maximum of $54.5 million. There is also an option to extend the initial maturity date of the loan for one year. Beginning with the payment due for the 27th month of the loan and on every third payment date thereafter, a mandatory principal prepayment in the amount of $5.0 million will be required if the loan-to-value at the 27th month through the 36th month of the loan is greater than 70.0%. If the loan-to-value as of the 37th month of the loan is greater than 68.0%, a one-time mandatory prepayment of $5.0 million in loan principal will be required. Subject to certain prepayment conditions, the loan may be paid down by up to a maximum of $50.0 million of the allocated loan amount during the first twelve months, with the payment of a 2.0% prepayment fee. The remaining loan balance may be prepaid in whole or in part with the payment of a 1.0% prepayment fee during the 13th through 18th months of the loan term, and the loan may be prepaid without either a prepayment premium or penalty beginning in the 19th month of the loan through the maturity date.

In connection with this offering, we have the option to elect to make a one-time deleveraging prepayment in an amount sufficient to delever the portfolio to 50.0% loan-to-value without releasing any properties. In connection with the deleveraging prepayment, we will be subject to a deleveraging premium of 2.0% in the first year of the loan, 1.5% in the second year of the loan, 1.25% in the third year of the loan, 1.0% in months 37 to 42 of the loan, and 0.5% thereafter. Upon payment of the deleveraging prepayment, the overall pricing on the remaining principal balance of the loan will be reduced to LIBOR plus 2.40%.

Subject to certain exceptions, we may not engage in the following activities relating to the mortgaged properties without the consent of Massachusetts Mutual Life Insurance Company: sell, transfer, convey, mortgage, pledge or assign any interest in any of the mortgaged properties or further encumber any of the mortgaged properties; admit any new general partner, manager or member having the ability to control our affairs; change our organizational documents if such a change would affect control; replace the current manager under the management agreements; engage in any transactions with affiliates other than the management agreements and the operating leases; or make any unscheduled alterations that would cost $250,000 or more. Under the loan agreement, we are required to maintain various escrow accounts which are lender-controlled reserves: (1) a property tax and insurance reserve for the purpose of reserving funds for the payment of annual property taxes and insurance premiums, (2) a capital expenditure reserve for the purpose of reserving funds, as required by the various franchise agreements, for current and future capital renovation projects (3) a ground lease reserve equal to two times the sum of the current monthly ground lease requirement, (4) a deferred maintenance reserve for the purpose of reserving funds for repairs and maintenance noted in the deferred maintenance reports issued at the time of loan closing, and (5) a trapped cash reserve for the purpose of reserving monthly net cash flow, as defined in the loan agreement, for the portfolio if our actual debt service coverage ratio, as defined in the loan agreement, falls below 1.4 to 1.0 until our debt service coverage ratio has improved to either equal or exceed 1.4 to 1.0 for six consecutive months. The aggregate amount of all reserve funds was $2.3 million at June 30, 2004.

Bear Stearns Commercial Mortgage Securities Inc. Commercial Mortgage Pass-Through Certificates, Series 2003-West/Junior Mezzanine Debt/Senior Mezzanine Debt. We have approximately $216.7 million of first mortgage debt financing that was issued in the form of commercial mortgage-backed securities underwritten

132

by Bear Stearns Commercial Mortgage, Inc. In addition, we have $54.5 million in mezzanine debt, structured in two tranches of $44.0 million (junior mezzanine debt) and $10.5 million (senior mezzanine debt). We incurred each of the three components of the debt simultaneously and collectively as one loan on December 5, 2002 in connection with the acquisition of 11 of the Recent Acquisition Hotels. The first mortgage debt is secured by a first deed of trust/mortgage and security agreement on the portfolio, and the mezzanine debt is secured by a promissory note, on a cross-collateralized and cross-defaulted basis. This debt bears interest at the greater of 2.0% or one-month LIBOR plus a spread of 3.45% (the weighted average of the nine loan tranches). The initial maturity date of the loan is January 1, 2006, and subject to not being in default and purchasing an interest rate cap for the extended loan term, we have an option to extend the initial maturity date of the loan for two, one-year extensions, extending the loan through January 1, 2008. Principal amortization began with the first payment due February 1, 2003, and future amortization payments will continue to be made through the maturity date based upon a predetermined schedule. Subject to certain conditions, the loan may, however, be paid down in whole or in part in connection with a release of individual properties through asset sales or a one-time deleveraging event through an offering.

In connection with this offering, we will be entitled to a one-time deleveraging prepayment subject to the payment of a 3.0% deleveraging fee on the principal amount repaid. The deleveraging payment will be calculated as the amount of funds necessary to reduce the outstanding principal balance of each mezzanine debt component to zero and reduce the first mortgage loan to no more than the positive difference between, if any, (a) $177,000,000 and (b) 50.0% of the cumulative amount of all allocated loan amounts of all properties released from the liens of the related mortgages prior to or contemporaneously with the deleveraging prepayment. After the deleveraging prepayment, the amortization schedule will be recalculated, and the amount of principal amortization due each month will also be recalculated. The interest rate after the deleveraging prepayment will be reset to a maximum rate of LIBOR plus a spread of 2.40%.

Under the loan agreement, we are required to maintain various escrow accounts which are controlled by the loan servicer:

•

a capital expenditure reserve fund for the purpose of reserving funds as required by the various franchise agreements for current and future capital renovation projects;

•

a debt service reserve fund of $5.3 million for the term of the loan (currently secured by a letter of credit);

•

a deferred maintenance reserve established for reserving funds for repairs and maintenance noted in the deferred maintenance reports prepared for the loan closing;

•

discrete individual reserve funds for annual ground lease payments, property tax payments, and property insurance premiums;

•

reserve escrow for payments due under the reciprocal easement agreement for the Valley River Inn, Eugene, Oregon; and

•

liquidity reserve funded in the seasonally stronger operating months for the purpose of reserving funds for monthly mezzanine interest payments during the seasonally softer operating months.

The aggregate amount of all reserve funds was $11.6 million at June 30, 2004.

Subject to certain exceptions, we may not engage in the following activities relating to the mortgaged properties without the consent of Wells Fargo Bank, National Association, as servicer, on behalf of LaSalle Bank National Association, as trustee (mortgage note holder), CTMPII FC Westbrook (GCM) (junior mezzanine note holder), and Wells Fargo Real Estate Merchant Bank (senior mezzanine note holder): incur liens or encumber any property; enter into any major operating lease with respect to any mortgaged property; make any alterations to any agreed-upon renovation improvements plans; make material changes to the management and franchise agreements, provided that we may, without consent, replace any manager or franchisor so long as the

133

replacement qualifies pursuant to the respective replacement agreement; surrender, terminate or cancel any liquor license agreement; dissolve, merge or consolidate with any business entity or transfer all or substantially all of its assets; enter into any line of business other than our current operations; cancel or forgive any material claim owed; and consent to any zoning reclassification of any property. However, the lender must consent to a one-time sale, assignment, or other transfer following additional requirements to satisfy the consent.

Citigroup Global Markets Realty Corp. We have approximately $72.9 million of debt with Citigroup Global Markets Realty Corp. We incurred this debt in October 2003 to refinance the outstanding principal of the original portfolio acquisition financing of $95.0 million from Citigroup Global Markets Realty Corp. in August 2000. This debt currently consists of $54.7 million of mortgage notes collateralized by first deeds of trust, assignments of leases and rents, security agreements and fixture filings. There is also $18.2 million of mezzanine notes collateralized by a pledge of membership interests in the entities that own these hotels. The mortgage notes bear interest at one-month LIBOR plus 3.25%, and the mezzanine notes bear interest at the greater of 2.5% or one-month LIBOR plus a spread of 8.00%. The loans, collectively, mature on the October 11, 2005 payment date. Subject to certain conditions, there is an option to extend the maturity date of both loans for one year through the October 11, 2006 payment date. The mortgage notes amortize over a 25-year schedule beginning on the payment date of May 11, 2004 and continuing through the maturity date in October 2005. The mezzanine notes require monthly fixed principal amortization payments of $90,915 beginning on the payment date of May 11, 2004 and continuing through the maturity date in October 2005. We are able to prepay the loans voluntarily either in whole or in part at any time subject to applicable prepayment fees.

Under the loan agreements, we are required to maintain various escrow accounts which are controlled by the loan servicer:

•

a capital expenditure reserve for the purpose of reserving funds for both specific assets classed as “PIP” assets (Holiday Inn, Boise, Idaho and Marriott, Riverside, California) and specific assets classed as “Non-PIP” assets (Holiday Inn, Hollywood, California; Hilton Garden Inn, Lake Oswego, Oregon; and Marriott, Portland, Oregon);

•

discrete individual reserve funds for annual ground lease payments, property tax payments and property insurance premiums;

•

deferred maintenance reserve established for repairs and maintenance noted in the deferred maintenance reports prepared for the loan closing;

•

supplemental reserve for use towards capital renovation programs, with such account funded only during the first six months of the loan with the available cash after debt service and operating expenses; and

•

a revolving working capital reserve of $1.0 million for use throughout the loan term, with drawdowns repaid through available cash after debt service and operating expenses.

The aggregate amount of all reserve funds was $8.2 million at June 30, 2004.

Subject to certain exceptions, we may not engage in the following activities relating to the mortgaged properties or the collateral subject to the mezzanine lien without the consent of Citigroup Global Markets Realty Corp.: incur liens or use the mortgaged property as a collateral; encumber any property with any easement, license or restrictive covenant; transfer the mortgaged properties; dissolve or merge with any other entity; change the nature of our business; cancel or forgive any material claim owed to us; engage in transactions with affiliates except on an arms-length basis on terms at least as favorable to us as we could have obtained from a third party who was not an affiliate; assign, transfer or remove any licenses or permits pertaining to the mortgaged property; transfer our ownership interests or voting rights; make any unscheduled alterations that would cost $250,000 or more; appoint a successor or replacement manager without first having obtained a rating confirmation; assume or guarantee any liabilities except for liabilities relating to the mortgaged property or collateral; or refinance with any entity other than the lender without granting a right of first refusal to the lender.

134

Revolving Credit Facility. We intend to enter into a $ million revolving credit facility with prior to the closing of this offering. The revolving credit facility will mature in . Interest will be payable at % on the credit facility during the previous quarter. We expect that our ability to borrow from time to time under the revolving credit facility will be subject to conditions, including the satisfaction of specified financial covenants.

In addition, we have mortgage debt on the following hotels:

Crowne Plaza, Grand Rapids, Michigan. We have a $14.2 million note payable to State Street Bank and Trust Co., as Trustee for JP Morgan Commercial Mortgage Finance Corp. Mortgage Pass-Through Certificates, Series 1998-C6 that is collateralized by a mortgage, assignment of leases and rents and a fixture filing on this hotel. The loan will mature on September 1, 2007. Interest and principal are payable monthly at a fixed interest rate of 8.51%. The aggregate amount of all reserve funds was $0.6 million at June 30, 2004.

Embassy Suites, Chicago, Illinois and Wyndham, Houston, Texas. We have four individual notes collectively totaling $75.3 million payable to JP Morgan Chase Bank as Trustee for the Registered Holders of Credit Suisse First Boston Mortgage Securities Corp., Commercial Mortgage Pass-Through Certificates, Series 1998-C2 that are collateralized by a leasehold mortgage for the Embassy Suites, Chicago, Illinois and a first deed of trust for the Wyndham, Houston, Texas, as well as assignment of leases and rents, and security agreement and fixture filing on both of these hotels. While the loans have maturity dates on November 11, 2023, the notes have an anticipated repayment date of November 11, 2008. Through the anticipated repayment date, interest and principal are payable monthly at a fixed interest rate of 8.25% and based upon a twenty-five-year amortization schedule. However, after the anticipated repayment date, interest and principal are payable monthly based upon a per annum rate equal to the greater of (a) the initial interest rate of 8.25% plus 5.0% or (b) the Treasury Rate plus 5.0%, provided that for so long as the notes are an asset of the trust, partnership, corporation or other entity formed in connection with a securitization pursuant to which securities rated by any rating agency have been issued, the interest rate after the anticipated repayment date shall be equal to 8.25% plus 2.0%. The aggregate amount of all reserve funds was $5.6 million at June 30, 2004.

Hyatt, Marietta, Georgia. We have a $14.5 million note payable to Deutsche Bank Mortgage Capital, L.L.C. that is collateralized by a first deed of trust and assignment of rents and fixtures on this hotel. The loan will mature on January 9, 2005 after exercising both a one-year option in July 2003 and a six-month option in July 2004 to extend the maturity date. Interest is payable monthly at one-month LIBOR plus a spread of 2.90%. The aggregate amount of all reserve funds was $1.3 million at June 30, 2004.

Marriott, Napa, California. We have a $38.6 million note payable to GE Commercial Finance that is collateralized by a first deed of trust and assignment of rents and fixtures on this hotel. The loan will mature on February 1, 2005 after exercising a one-year option to extend the maturity date. Interest is payable monthly at one-month LIBOR plus a spread of 3.60% and beginning with the first payment during the extension option, we began paying monthly principal amortization payments of $24,159. The aggregate amount of all reserve funds was $0.5 million at June 30, 2004.

Marriott, Ontario, California. We have an $18.6 million note payable to Corus Bank, N.A. that is collateralized by a first deed of trust, assignment of leases and rents, security agreement and fixture filing on this hotel. The loan will mature on January 24, 2006. Interest is payable monthly at the greater of 4.84% or the current three-month LIBOR plus a spread of 3.50% plus monthly principal amortization based upon a twenty-five year amortization schedule, adjusted quarterly to reflect the change in LIBOR index. The aggregate amount of all reserve funds was $0 at June 30, 2004.

Marriott, Park City, Utah and The Kahler Grand, Rochester, Minnesota. We have a $37.8 million note payable to Salomon Brothers Realty Corp. that is collateralized by first deeds of trust and assignment of rents and fixtures on these hotels. The loan will mature on November 11, 2005 with a one-year option to extend the

135

maturity date to November 11, 2006. Interest is payable monthly at one-month LIBOR plus a spread of 2.95%. Under the terms of the loan, monthly principal amortization is due based on an interest rate of 8.75% and a 25-year amortization schedule in the first two years of the loan and a 20-year amortization schedule in the third year of the loan. We have a one-time option to receive an additional loan advance of $10.0 million prior to November 11, 2005, provided that (a) no event of default exists, (b) the Loan DSCR, as defined in the loan agreement, is at least 1.75x, and (c) the loan-to-value ratio, as defined in the loan agreement, of the outstanding loan principal will not exceed 60.0% after taking into account the additional loan advance. The aggregate amount of all reserve funds was $4.5 million at June 30, 2004.

Residence Inn by Marriott, Manhattan Beach, California. We have a $13.7 million note payable to Corus Bank, N.A. that is collateralized by a first deed of trust, assignment of leases and rents, security agreement and fixture filing on this hotel. The loan will mature on August 6, 2006 with the option to extend the maturity date for one year to August 6, 2007. Interest is payable monthly at the greater of 5.0% or the current one-month LIBOR plus a spread of 3.50%, in addition to monthly principal amortization payments of $33,000. The aggregate amount of all reserve funds was $0.2 million at June 30, 2004.

Residence Inn by Marriott, Rochester, Minnesota. We have a $6.3 million note payable to Wells Fargo Bank, National Association that is collateralized by a mortgage and assignment of rents and fixtures on this hotel. The loan will mature in May 22, 2006 with the option to extend the maturity date by one year to May 22, 2007. Interest is payable monthly at one-month LIBOR plus a spread of 3.25%. Commencing with the seventh payment date following the construction completion date, we will pay monthly amortization payments equal to $11,000. The first draw on the loan was February 3, 2004, and as of June 30, 2004, $4.4 million had been drawn down on the loan. The aggregate amount of all reserve funds was $0.1 million at June 30, 2004.

Laundry Facility, Rochester, Minnesota. We have a $6.8 million note payable to The Northwestern Mutual Life Insurance Company that is collateralized by a first deed of trust and assignment of fixtures and other personal property of the textile care laundry facility located in Rochester, Minnesota. The loan matures on June 1, 2013, and fixed interest and principal payments of $95,675 are due monthly, with a fixed interest rate of 9.875%. There are no reserve accounts established for this loan.

136

U.S. FEDERAL INCOME TAX CONSIDERATIONS

The following discussion summarizes our taxation and the Federal income tax consequences to stockholders of their ownership of shares of our common stock. The tax treatment of stockholders will vary depending upon the stockholder’s particular situation, and this discussion addresses only stockholders that hold shares of our common stock as a capital asset and does not address with all aspects of taxation that may be relevant to particular stockholders in light of their personal investment or tax circumstances. This section also does not address with all aspects of taxation that may be relevant to certain types of stockholders to which special provisions of the Federal income tax laws apply, including:

•

dealers in securities or currencies;

•

traders in securities that elect to use a mark-to-market method of accounting for their securities holdings;

•

banks;

•

tax-exempt organizations;

•

certain insurance companies;

•

persons liable for the alternative minimum tax;

•

persons that hold common stock as a hedge against interest rate or currency risks or as part of a straddle or conversion transaction; and

•

stockholders whose functional currency is not the U.S. dollar.

This summary is based on the Code, its legislative history, existing and proposed regulations under the Code, published rulings and court decisions. This summary describes the provisions of these sources of law only as they are currently in effect. All of these sources of law may change at any time, and any change in the law may apply retroactively.

We urge you to consult with your own tax advisors regarding the tax consequences to you of acquiring, owning and selling shares of our common stock including the Federal, state, local and foreign tax consequences of acquiring, owning and selling shares of our common stock in your particular circumstances and potential changes in applicable laws.

Taxation as a REIT

In the opinion of Sullivan & Cromwell LLP, commencing with our taxable year ending December 31, 2004, we will have been organized in conformity with the requirements for qualification and taxation as a REIT under the Code, and our proposed method of operation will enable us to continue to meet the requirements for qualification and taxation as a REIT under the Code. You should be aware, however, that opinions of counsel are not binding upon the IRS or any court.

In providing its opinion, Sullivan & Cromwell LLP is relying as to certain factual matters upon the statements and representations contained in certificates provided to Sullivan & Cromwell LLP by us.

The qualification of Sunstone Hotel Investors as a REIT will depend upon its continuing satisfaction of the requirements of the Internal Revenue Code relating to qualification for REIT status. Some of these requirements depend upon actual operating results, distribution levels, diversity of stock ownership, asset composition, source of income and record keeping. Accordingly, while we intend to continue to qualify to be taxed as a REIT, the actual results of our operations for any particular year might not satisfy these requirements. Sullivan & Cromwell LLP will not monitor our compliance with the requirements for REIT qualification on an ongoing basis.

137

The sections of the Code applicable to REITs are highly technical and complex. The following discussion summarizes some material aspects of the relevant sections of the Code.

As a REIT, we generally will not have to pay Federal corporate income taxes on net income that we currently distribute to our stockholders. This treatment substantially eliminates the “double taxation” at the corporate and stockholder levels that generally results from investment in a regular corporation. Our dividends, however, generally will not be eligible for (i) the reduced tax rates applicable to dividends received by noncorporate stockholders or (ii) the corporate dividends received deduction.

Moreover, we will have to pay Federal income or excise tax as follows:

•

First, we will have to pay tax at regular corporate rates on any undistributed REIT taxable income, including undistributed net capital gains.

•

Second, under certain circumstances, we may have to pay the alternative minimum tax on items of tax preference.

•

Third, if we have (a) net income from the sale or other disposition of “foreclosure property,” as defined in the Code, which is held primarily for sale to customers in the ordinary course of business or (b) other non-qualifying income from foreclosure property, we will have to pay tax at the highest corporate rate on that income.

•

Fourth, if we have net income from “prohibited transactions,” as defined in the Code, we will have to pay a 100% tax on that income. Prohibited transactions 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. As of the date of this prospectus, unless a sale of real property qualifies for a safe harbor, the question of whether the sale of a hotel (or other property) constitutes the sale of property held primarily for sale to customers is generally a question of the facts and circumstances regarding a particular transaction. We and our subsidiaries intend to hold the interests in our hotels for investment with a view to long-term appreciation, to engage in the business of acquiring and owning hotels and to make occasional sales as are consistent with our investment objectives. We do not intend to engage in prohibited transactions. We cannot assure you, however, that we will only make sales that satisfy the requirements of the safe harbors or that the IRS will not successfully assert that one or more of such sales are prohibited transactions.

•

Fifth, if we should fail to satisfy the 75% gross income test or the 95% gross income test, as discussed below under “—Requirements for Qualification as a REIT” and “—Income Tests,” but we have nonetheless maintained our qualification as a REIT because we have satisfied other requirements necessary to maintain REIT qualification, we will have to pay a 100% tax on an amount equal to (a) the gross income attributable to the greater of (i) 75% of our gross income over the amount of gross income that is qualifying income for purposes of the 75% test, and (ii) 90% of our gross income over the amount of gross income that is qualifying income for purposes of the 95% test, multiplied by (b) a fraction intended to reflect our profitability.

•

Sixth, if we should fail to distribute during each calendar year at least the sum of (1) 85% of our real estate investment trust ordinary income for that year, (2) 95% of our real estate investment trust capital gain net income for that year and (3) any undistributed taxable income from prior periods, we would have to pay a 4% excise tax on the excess of that required distribution over the amounts actually distributed.

•

Seventh, if we acquire any asset from a C corporation in certain transactions in which we adopt the basis of the asset or any other property in the hands of the C corporation as our basis of the asset in our hands, and we recognize gain on the disposition of that asset during the 10-year period beginning on the date on which we acquired that asset, then we will have to pay tax on the built-in gain at the highest regular corporate rate. A “C corporation” means generally a corporation that has to pay full corporate-level tax. Because we intend to acquire the assets held by certain C corporations in connection with this offering,

138

we will be subject to corporate income tax with respect to the current built-in gain in the assets currently held by such corporation if we sell any of the assets currently held by such corporation within ten years after the date of this offering.

•

Eighth, if we receive non-arm’s length income from, or non-arm’s length deductions are incurred by the TRS Lessee we will be subject to a 100% tax on the amount of our non-arm’s length income.

Requirements for Qualification as a REIT

The Code defines a REIT as a corporation, trust or association

•

that is managed by one or more trustees or directors;

•

the beneficial ownership of which is evidenced by transferable shares, or by transferable certificates of beneficial interest;

•

that would otherwise be taxable as a domestic corporation, but for Sections 856 through 859 of the Code;

•

that is neither a financial institution nor an insurance company to which certain provisions of the Code apply;

•

the beneficial ownership of which is held by 100 or more persons;

•

that, during the last half of each taxable year, has no more than 50% in value of its outstanding stock owned, directly or constructively, by five or fewer individuals, as defined in the Code to include certain entities; and

•

that meets certain other tests, described below, regarding the nature of its income and assets.

The Code provides that the conditions described in the first through fourth bullet points above must be met during the entire taxable year, and that the condition described in the fifth bullet point above must be met during at least 335 days of a taxable year of 12 months, or during a proportionate part of a taxable year of less than 12 months.

We expect that we will satisfy the conditions described in the first through fifth bullet points of the preceding paragraph and believe that we will also satisfy the condition described in the sixth bullet point of the preceding paragraph. In addition, our charter provides for restrictions regarding the ownership and transfer of our common stock. These restrictions are intended to assist us in continuing to satisfy the share ownership requirements described in the fifth and sixth bullet points of the second preceding paragraph. The ownership and transfer restrictions pertaining to the common stock are described in this prospectus under the heading “Description of Stock—Restrictions on Ownership and Transfer.”

If, as in our case, a REIT is a partner in a partnership, Treasury regulations provide that the REIT will be deemed to own its proportionate capital share of the assets of the partnership and will be deemed to be entitled to the income of the partnership attributable to that share. In addition, the character of the assets and gross income of the partnership will retain the same character in the hands of the REIT for purposes of Section 856 of the Internal Revenue Code, including satisfying the gross income tests and the asset tests. Thus, our proportionate share of the assets, liabilities and items of income of Sunstone Hotel Partnership, which will be our principal and probably only asset, will be treated as assets, liabilities and items of income of ours for purposes of applying the requirements described in this section. In addition, actions taken by Sunstone Hotel Partnership can affect our ability to satisfy the REIT income and assets tests and the determination of whether we have net income from prohibited transactions. (See the fourth bullet point under “—Taxation as a REIT” for a discussion of prohibited transactions.) Accordingly, for purposes of this discussion, when we discuss our actions, income or assets we intend that to include the actions, income or assets of Sunstone Hotel Partnership.

139

Taxable REIT Subsidiaries

A taxable REIT subsidiary, or TRS, is any corporation in which a REIT directly or indirectly owns stock, provided that the REIT and that corporation make a joint election to treat that corporation as a TRS. The election can be revoked at any time as long as the REIT and the TRS revoke such election jointly. In addition, if a TRS holds, directly or indirectly, more than 35% of the securities of any other corporation other than a REIT (by vote or by value), then that other corporation is also treated as a TRS. A corporation can be a TRS with respect to more than one REIT.

A TRS is subject to Federal income tax at regular corporate rates (currently a maximum rate of 35%), and may also be subject to state and local taxation. Any dividends paid or deemed paid by any one of our TRSs will also be subject to tax, either (1) to us if we do not pay the dividends received to our stockholders as dividends, or (2) to our stockholders if we do pay out the dividends received to our stockholders. We may hold more than 10% of the stock of a TRS without jeopardizing our qualification as a REIT notwithstanding the rule described below under “—Asset Tests” that generally precludes ownership of more than 10% of any issuer’s securities. However, as noted below, in order for us to qualify as a REIT, the securities of all of the TRSs in which we have invested either directly or indirectly may not represent more than 20% of the total value of our assets. We expect that the aggregate value of all of our interests in TRSs will represent less than 20% of the total value of our assets; however, we cannot assure that this will always be true. Other than certain activities related to operating or managing a lodging or health care facility as more fully described below under “—Income Tests,” a TRS may generally engage in any business including the provision of customary or non-customary services to tenants of the parent REIT.

As described below, income we receive from operating or managing hotels is not qualified income for either the 75% or 95% income tests described more fully below under “—Income Tests. ” Accordingly, the entity through which we hold an interest in the hotels will lease the hotels to the TRS Lessee, and the TRS Lessee will engage independent third parties to operate the hotels.

A TRS is not permitted to directly or indirectly operate or manage a hotel but a TRS can lease a hotel provided that the TRS meets the following conditions:

•

First, the hotel must be a “qualified lodging facility”. A qualified lodging facility is a hotel, motel or other establishment more than one-half of the dwelling units in which are used on a transient basis, unless wagering activities are conducted at or in connection with such facility by any person who is engaged in the business of accepting wagers and who is legally authorized to engage in such business at or in connection with such facility. Accordingly, we will not be permitted to have gambling or wagering activity on the premises of any of our hotels or to earn income from gambling or wagering activities.

•

Second, the manager must be an “eligible independent contractor.” An eligible independent contractor is an independent contractor that, at the time the management contract is entered into, is actively engaged in the trade or business of operating qualified lodging facilities for any person not related to the REIT or the TRS. For this purpose, an independent contractor means any person (i) that does not own (taking into account relevant attribution rules) more than 35% of the stock of the REIT, and (ii) with respect to which no person or group owning directly or indirectly (taking into account relevant attribution rules) 35% or more of the REIT owns 35% or more directly or indirectly (taking into account relevant attribution rules) of the ownership interest in the contractor. Accordingly, our TRS Lessee will not directly operate or manage the hotels. Rather, our TRS Lessee will enter into management contracts with hotel management companies which will operate and manage the hotels. To the best of our knowledge and belief, such hotel management companies are eligible independent contractors. The TRS Lessee is permitted to bear the expenses of the eligible independent contractor of operating the hotel pursuant to the management contract.

140

Income Tests

In order to maintain our qualification as a REIT, we annually must satisfy two gross income requirements:

•

First, we must generally derive at least 75% of our gross income, excluding gross income from prohibited transactions, for each taxable year directly or indirectly from investments relating to real property or mortgages on real property, including “rents from real property,” as defined in the Code, or from certain types of temporary investments. Rents from real property generally include our expenses that are paid or reimbursed by tenants.

•

Second, at least 95% of our gross income, excluding gross income from prohibited transactions, for each taxable year must generally be derived from real property investments as described in the preceding bullet point, dividends (including dividends from a TRS), interest, gain from the sale or disposition of stock or securities, or from any combination of these types of sources.

Rents that we receive will qualify as rents from real property in satisfying the gross income requirements for a REIT described above only if the rents satisfy several conditions:

•

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 rents from real property solely because it is based on a fixed percentage or percentages of receipts or sales. Accordingly, the leases of our hotels to the TRS Lessee will be based on the gross receipts of the TRS Lessee from the hotels.

•

Second, the Code provides that rents received from a tenant will not qualify as rents from real property in satisfying the gross income tests if the REIT, directly or under the applicable attribution rules, owns a 10% or greater interest in that tenant; except that rents received from a TRS under certain circumstances qualify as rents from real property even if we own a 10% or greater interest in the subsidiary. We refer to a tenant in which we own a 10% or greater interest as a “related party tenant.” As described above, it is our business plan that most or all of our rental income will be from the leases to our TRS Lessee.

•

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 the personal property will not qualify as rents from real property.

•

Finally, for rents received to qualify as rents from real property, the REIT generally must not operate or manage the property or furnish or render services to the tenants of the property, other than through an independent contractor from whom the REIT derives or receives no income or through a TRS. However, we may directly perform certain services that landlords usually or customarily render when renting space for occupancy only or that are not considered rendered to the occupant of the property. In addition, as described more fully below, rent paid by a TRS to a REIT pursuant to a lease of a qualified lodging facility that is managed and operated by an eligible independent contractor can qualify as rents from real property.

The leases to the TRS Lessee will provide for a base rent plus a fixed percentage of the gross revenue from operation of the hotel. Each such lease must be a true lease. If the leases to our TRS Lessee are not respected as true leases we could be disqualified as a REIT. While we intend that each lease will be respected as a true lease, the determination of whether a lease is a true lease is inherently a question of fact and circumstances and we cannot assure you that the IRS will not successfully assert that the leases to the TRS Lessee should not be respected as true leases.

Except as described above with respect to the TRS Lessee, we do not expect to derive significant rents from related party tenants. We also do not intend to derive rental income attributable to personal property.

141

We believe that the leases of the hotels to the TRS Lessee will conform with normal business practice, contain arm’s length terms and that the rent payable under those leases will be treated as rents from real property for purposes of the 75% and 95% gross income tests. However, we cannot assure you that the IRS will not successfully assert a contrary position or that a change in circumstances will not cause a portion of the rent payable under the leases to fail to qualify as “rents from real property.” If such failures were in sufficient amounts, we may not be able to satisfy either or both of the 75% or 95% gross income tests and could lose our REIT status. In addition, if the IRS successfully reapportions or reallocates items of income, deduction, and credit among and between us and our TRS Lessee under the leases or any intercompany transaction because it determines that doing so is necessary to prevent the evasion of taxes or to clearly reflect income, we could be subject to a 100% excise tax on those amounts.

While we will monitor the activities of the eligible independent contractor to maximize the value of our hotel investments, neither we nor our TRS Lessee will directly or indirectly manage our hotels. Similarly, while our tenants may benefit from the services we will provide related to monitoring and, when appropriate, advising the eligible independent contractor regarding the management of the hotel for the purpose of maximizing the value of our investments, we do not believe that these activities will cause gross income attributable to the leases with our TRS Lessee to fail to be treated as rents from real property.

Other than as described in the preceding paragraph, we do not expect to perform any services for our tenants. If we were to provide services to a tenant that are other than those landlords usually or customarily provide when renting space for occupancy only, amounts received or accrued by us for any of these services will not be treated as rents from real property for purposes of the REIT gross income tests. However, the amounts received or accrued for these services will not cause other amounts received with respect to the property to fail to be treated as rents from real property unless the amounts treated as received in respect of the services, together with amounts received for certain management services, exceed 1% of all amounts received or accrued by us during the taxable year with respect to the property. If the sum of the amounts received in respect of the services to tenants and management services described in the preceding sentence exceeds the 1% threshold, then all amounts received or accrued by us with respect to the property will not qualify as rents from real property, even if we provide the impermissible services to some, but not all, of the tenants of the property.

The term “interest” generally does not include any amount received or accrued, directly or indirectly, if the determination of that amount depends 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 interest solely because it is based on a fixed percentage or percentages of receipts or sales.

If we fail to satisfy one or both of the 75% or 95% gross income tests for any taxable year, we may nevertheless qualify as a REIT for that year if we satisfy the requirements of other provisions of the Code that allow relief from disqualification as a REIT. These relief provisions will generally be available if:

•

our failure to meet the income tests was due to reasonable cause and not due to willful neglect;

•

we attach a schedule of the sources of our income to our Federal income tax return; and

•

any incorrect information on the schedule was not due to fraud with intent to evade tax.

We might not be entitled to the benefit of these relief provisions, however. As discussed in the fifth bullet point under “—Taxation as a REIT,” even if these relief provisions apply, we would have to pay a tax on the excess income.

142

Asset Tests

At the close of each quarter of our taxable year, we also must satisfy three tests relating to the nature of our assets:

•

First, at least 75% of the value of our total assets must be represented by real estate assets, including (a) real estate assets held by our qualified REIT subsidiaries, our allocable share of real estate assets held by partnerships in which we own an interest and stock issued by another REIT, (b) for a period of one year from the date of our receipt of proceeds of an offering of its shares of beneficial interest or publicly offered debt with a term of at least five years, stock or debt instruments purchased with these proceeds and (c) cash, cash items and government securities.

•

Second, not more than 25% of our total assets may be represented by securities other than those in the 75% asset class.

•

Third, not more than 20% of our total assets may constitute securities issued by one or more TRSs and of the investments included in the 25% asset class, the value of any one issuer’s securities, other than securities issued by another REIT or by us may not exceed 5% of the value of our total assets, and we may not own more than 10% of the vote or value of any one issuer’s outstanding securities, except in the case of a TRS as described above or certain “straight debt” instruments. As a consequence, if the IRS successfully challenges the partnership status of any of the partnerships in which we maintain an interest, and the partnership is reclassified as a corporation or a publicly traded partnership taxable as a corporation we could lose our REIT status.

Annual Distribution Requirement

We are required to distribute dividends, other than capital gain dividends, to our stockholders in an amount at least equal to (1) the sum of (a) 90% of our “real estate investment trust taxable income,” computed without regard to the dividends paid deduction and our net capital gain, and (b) 90% of the net after-tax income, if any, from foreclosure property minus (2) the sum of certain items of non-cash income.

These distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before we timely file our tax return for the year to which they relate and if paid on or before the first regular dividend payment after the declaration.

To the extent that we do not distribute all of our net capital gain or distribute at least 90%, but less than 100%, of our real estate investment trust taxable income, as adjusted, we will have to pay tax on those amounts at regular ordinary and capital gain corporate tax rates. Furthermore, if we fail to distribute during each calendar year at least the sum of (a) 85% of our ordinary income for that year, (b) 95% of our capital gain net income for that year and (c) any undistributed taxable income from prior periods, we would have to pay a 4% excise tax on the excess of the required distribution over the amounts actually distributed.

We intend to satisfy the annual distribution requirements.

From time to time, we may not have sufficient cash or other liquid assets to meet the 90% distribution requirement due to timing differences between (a) when we actually receive income and when we actually pay deductible expenses and (b) when we include the income and deduct the expenses in arriving at our taxable income. If timing differences of this kind occur, to meet the 90% distribution requirement, we may find it necessary to arrange for short-term, or possibly long-term, borrowings or to pay dividends in the form of taxable stock dividends

Under certain circumstances, we may be able to rectify a failure to meet the distribution requirement for a year by paying “deficiency dividends” to stockholders in a later year, which may be included in our deduction for dividends paid for the earlier year. Thus, we may be able to avoid being taxed on amounts distributed as deficiency dividends; however, we will be required to pay interest based upon the amount of any deduction taken for deficiency dividends.

143

Failure to Qualify as a REIT

If we fail to qualify for taxation as a REIT in any taxable year, and the relief provisions do not apply, we will have to pay tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates. We will not be able to deduct distributions to stockholders in any year in which we fail to qualify, nor will we be required to make distributions to stockholders. In this event, to the extent of current and accumulated earnings and profits, all distributions to stockholders will be taxable to the stockholders as dividend income (which may be subject to tax at preferential rates) and corporate distributees may be eligible for the dividends received deduction if they satisfy the relevant provisions of the Internal Revenue Code. Unless entitled to relief under specific statutory provisions, we will also be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost. We might not be entitled to the statutory relief described in this paragraph in all circumstances.

Tax Basis of Assets

Sunstone Hotel Partnership intends to make an election under Section 754 of the Code. Accordingly, our proportionate share of the basis of the assets held by Sunstone Hotel Partnership will be “stepped up” to fair market value to the extent of the portion of our interest in Sunstone Hotel Partnership that is purchased from the Contributing Entities (as opposed to the portion that is purchased directly from Sunstone Hotel Partnership.) Our remaining share of Sunstone Hotel Partnership’s basis in its assets, however, will not be adjusted in connection with this offering and will generally be less than the fair market value of the hotels as of the date of this offering. Furthermore, we intend to generally use the “traditional” method for making allocations under Section 704(c) of the Code as opposed to the “curative “ or “remedial” method for making such allocations. As a result, (a) our depreciation deductions with respect to our hotels will be less than the depreciation deductions that would have been available to us had our tax basis been equal to the fair market value of the hotels as of the date of this offering and (b) we may recognize income upon a sale of an asset that is attributable to appreciation in the value of the asset that accrued prior to the date of this offering.

Taxation of Stockholders

U.S. Stockholders. As used in this section, the term “U.S. stockholder” means a holder of common stock who, for United States Federal income tax purposes, is:

•

a citizen or resident of the United States;

•

a domestic corporation;

•

an estate whose income is subject to United States Federal income taxation regardless of its source; or

•

a trust if a United States court can exercise primary supervision over the trust’s administration and one or more United States persons have authority to control all substantial decisions of the trust.

As long as we qualify as a REIT, distributions made by us out of our current or accumulated earnings and profits, and not designated as capital gain dividends, will constitute dividends taxable to our taxable U.S. stockholders as ordinary income. Noncorporate U.S. stockholders will generally not be entitled to the tax rate applicable to certain types of dividends except with respect to the portion of any distribution (a) that represents income from dividends we received from a corporation in which we own shares (but only if such dividends would be eligible for the new lower rate on dividends if paid by the corporation to its individual stockholders), or (b) that is equal to our real estate investment trust taxable income (taking into account the dividends paid deduction available to us) and less any taxes paid by us during our previous taxable year, provided that certain holding period and other requirements are satisfied at both the REIT and individual stockholder level. Noncorporate U.S. stockholders should consult their own tax advisors to determine the impact of tax rates on dividends received from us. Distributions of this kind will not be eligible for the dividends received deduction in the case of U.S. stockholders that are corporations. Distributions made by us that we properly designate as capital gain dividends will be taxable to U.S. stockholders as gain from the sale of a capital asset held for more than one

144

year, to the extent that they do not exceed our actual net capital gain for the taxable year, without regard to the period for which a U.S. stockholder has held his common stock. Thus, with certain limitations, capital gain dividends received by an individual U.S. stockholder may be eligible for preferential rates of taxation. U.S. stockholders that are corporations may, however, be required to treat up to 20% of certain capital gain dividends as ordinary income.

To the extent that we make distributions not designated as capital gain dividends in excess of our current and accumulated earnings and profits, these distributions will be treated first as a tax-free return of capital to each U.S. stockholder. Thus, these distributions will reduce the adjusted basis (but not below zero) which the U.S. stockholder has in our common stock for tax purposes by the amount of the distribution. Distributions in excess of a U.S. stockholder’s adjusted basis in his common stock will be taxable as capital gains.

Dividends authorized by us in October, November, or December of any year and payable to a stockholder of record on a specified date in any of these months will be treated as both paid by us and received by the stockholder on December 31 of that year, provided that we actually pay the dividend on or before January 31 of the following calendar year. Stockholders may not include in their own income tax returns any of our net operating losses or capital losses.

U.S. stockholders holding common stock at the close of our taxable year will be required to include, in computing their long-term capital gains for the taxable year in which the last day of our taxable year falls, the amount that we designate in a written notice mailed to our stockholders. We may not designate amounts in excess of our undistributed net capital gain for the taxable year. Each U.S. stockholder required to include the designated amount in determining the stockholder’s long-term capital gains will be deemed to have paid, in the taxable year of the inclusion, the tax paid by us in respect of such stockholder’s undistributed net capital gains. U.S. stockholders to whom these rules apply will be allowed a credit or a refund, as the case may be, for the tax they are deemed to have paid. U.S. stockholders will increase their basis in their common stock by the difference between the amount of the includible gains and the tax deemed paid by the stockholder in respect of these gains.

Distributions made by us and gain arising from a U.S. stockholder’s sale or exchange of our common stock will not be treated as passive activity income. As a result, U.S. stockholders generally will not be able to apply any passive losses against that income or gain.

When a U.S. stockholder sells or otherwise disposes of our common stock, the stockholder will recognize gain or loss for Federal income tax purposes in an amount equal to the difference between (a) the amount of cash and the fair market value of any property received on the sale or other disposition and (b) the holder’s adjusted basis in the common stock for tax purposes. This gain or loss will be capital gain or loss if the U.S. stockholder has held the common stock as a capital asset. The gain or loss will be long-term gain or loss if the U.S. stockholder has held the common stock for more than one year. Long-term capital gain of a noncorporate U.S. stockholder is generally taxed at preferential rates. In general, any loss recognized by a U.S. stockholder when the stockholder sells or otherwise disposes of our common stock that the stockholder has held 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 received by the stockholder from us which were required to be treated as long-term capital gains.

Backup withholding. We will report to our U.S. stockholders and the IRS the amount of dividends paid during each calendar year, and the amount of tax withheld, if any. Under the backup withholding rules, backup withholding may apply to a stockholder with respect to dividends paid unless the holder (a) is a corporation or comes within certain other exempt categories and, when required, demonstrates this fact, or (b) provides a taxpayer identification number, certifies as to no loss of exemption from backup withholding, and otherwise complies with applicable requirements of the backup withholding rules. The IRS may also impose penalties on a U.S. stockholder that does not provide us with its correct taxpayer identification number. A stockholder may credit any amount paid as backup withholding against the stockholder’s income tax liability. In addition, we may be required to withhold a portion of capital gain distributions to any stockholders who fail to certify their non-foreign status to us.

145

Taxation of tax-exempt stockholders. The IRS has ruled that amounts distributed as dividends by a REIT generally do not constitute unrelated business taxable income when received by a tax-exempt entity. Based on that ruling, provided that a tax-exempt stockholder is not one of the types of entity described in the next paragraph and has not held its common stock as “debt financed property” within the meaning of the Code, and the common stock are not otherwise used in a trade or business, the dividend income from the common stock will not be unrelated business taxable income to a tax-exempt stockholder. Similarly, income from the sale of common stock will not constitute unrelated business taxable income unless the tax-exempt stockholder has held the common stock as “debt financed property” within the meaning of the Code or has used the common stock in a trade or business.

Income from an investment in our common stock will constitute unrelated business taxable income for tax-exempt stockholders that are social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts, and qualified group legal services plans exempt from Federal income taxation under the applicable subsections of Section 501(c) of the Code, unless the organization is able to properly deduct amounts set aside or placed in reserve for certain purposes so as to offset the income generated by its common stock. Prospective investors of the types described in the preceding sentence should consult their own tax advisors concerning these “set aside” and reserve requirements.

Notwithstanding the foregoing, however, a portion of the dividends paid by a “pension-held REIT” will be treated as unrelated business taxable income to any trust which:

•

is described in Section 401(a) of the Code;

•

is tax-exempt under Section 501(a) of the Code; and

•

holds more than 10% (by value) of the equity interests in the REIT.

Tax-exempt pension, profit-sharing and stock bonus funds that are described in Section 401(a) of the Code are referred to below as “qualified trusts.” A REIT is a “pension-held REIT” if:

•

it would not have qualified as a REIT but for the fact that Section 856(h)(3) of the Code provides that stock owned by qualified trusts will be treated, for purposes of the “not closely held” requirement, as owned by the beneficiaries of the trust (rather than by the trust itself); and

•

either (a) at least one qualified trust holds more than 25% by value of the interests in the REIT or (b) one or more qualified trusts, each of which owns more than 10% by value of the interests in the REIT, hold in the aggregate more than 50% by value of the interests in the REIT.

The percentage of any REIT dividend treated as unrelated business taxable income to a qualifying trust is equal to the ratio of (a) the gross income of the REIT from unrelated trades or businesses, determined as though the REIT were a qualified trust, less direct expenses related to this gross income, to (b) the total gross income of the REIT, less direct expenses related to the total gross income. A de minimis exception applies where this percentage is less than 5% for any year. We do not expect to be classified as a pension-held REIT.

The rules described above under the heading “U.S. stockholders” concerning the inclusion of our designated undistributed net capital gains in the income of our stockholders will apply to tax-exempt entities. Thus, tax-exempt entities will be allowed a credit or refund of the tax deemed paid by these entities in respect of the includible gains.

Non-U.S. Stockholders.

The rules governing U.S. Federal income taxation of nonresident alien individuals, foreign corporations, foreign partnerships and estates or trusts who own common stock that are not subject to United States Federal income tax on a net income basis, which we call “non-U.S. stockholders,” are complex. The following discussion is only a limited summary of these rules. Prospective non-U.S. stockholders should consult with their own tax advisors to determine the impact of U.S. Federal, state and local income tax laws with regard to an investment in the common stock, including any reporting requirements.

146

Ordinary dividends. Distributions, other than distributions that are treated as attributable to gain from sales or exchanges by us of U.S. real property interests, as discussed below, and other than distributions designated by us as capital gain dividends, will be treated as ordinary income to the extent that they are made out of our current or accumulated earnings and profits. A withholding tax equal to 30% of the gross amount of the distribution will ordinarily apply to distributions of this kind to non-U.S. stockholders, unless an applicable tax treaty reduces that tax. However, if income from the investment in the common stock is treated as effectively connected with the non-U.S. stockholder’s conduct of a U.S. trade or business or is attributable to a permanent establishment that the non-U.S. stockholder maintains in the United States if that is required by an applicable income tax treaty as a condition for subjecting the non-U.S. stockholder to U.S. taxation on a net income basis, tax at graduated rates will generally apply to the non-U.S. stockholder in the same manner as U.S. stockholders are taxed with respect to dividends, and the 30% branch profits tax may also apply if the stockholder is a foreign corporation. We expect to withhold U.S. tax at the rate of 30% on the gross amount of any dividends, other than dividends treated as attributable to gain from sales or exchanges of U.S. real property interests and capital gain dividends, paid to a non-U.S. stockholder, unless (a) a lower treaty rate applies and the required form evidencing eligibility for that reduced rate is filed with us or the appropriate withholding agent or (b) the non-U.S. stockholder files an IRS Form W-8 ECI or a successor form with us or the appropriate withholding agent claiming that the distributions are effectively connected with the non-U.S. stockholder’s conduct of a U.S. trade or business, and in either case other applicable requirements are met.

Distributions to a non-U.S. stockholder that are designated by us at the time of distribution as capital gain dividends which are not attributable to or treated as attributable to the disposition by us of a U.S. real property interest generally will not be subject to U.S. Federal income taxation, except as described below.

Return of capital. Distributions in excess of our current and accumulated earnings and profits, which are not treated as attributable to the gain from our disposition of a U.S. real property interest, will not be taxable to a non-U.S. stockholder to the extent that they do not exceed the adjusted basis of the non-U.S. stockholder’s common stock. Distributions of this kind will instead reduce the adjusted basis of the common stock. To the extent that distributions of this kind exceed the adjusted basis of a non-U.S. stockholder’s common stock, they will give rise to tax liability if the non-U.S. stockholder otherwise would have to pay tax on any gain from the sale or disposition of its common stock, as described below. If it cannot be determined at the time a distribution is made whether the distribution will be in excess of current and accumulated earnings and profits, withholding will apply to the distribution at the rate applicable to dividends. However, the non-U.S. stockholder may seek a refund of these amounts from the IRS if it is subsequently determined that the distribution was, in fact, in excess of our current and accumulated earnings and profits.

Capital gain dividends. For any year in which we qualify as a REIT, distributions that are attributable to gain from sales or exchanges by us of U.S. real property interests will be taxed to a non-U.S. stockholder under the provisions of the Foreign Investment in Real Property Tax Act of 1980, as amended, or FIRPTA. Under FIRPTA, these distributions are taxed to a non-U.S. stockholder as if the gain were effectively connected with a U.S. business. Thus, non-U.S. stockholders will be taxed on the distributions at the normal capital gain rates applicable to U.S. stockholders, subject to any applicable alternative minimum tax and special alternative minimum tax in the case of individuals. We are required by applicable Treasury regulations under this statute to withhold 35% of any distribution that we could designate as a capital gain dividend. However, if we designate as a capital gain dividend a distribution made before the day we actually effect the designation, then although the distribution may be taxable to a non-U.S. stockholder, withholding does not apply to the distribution under FIRPTA. Rather, we must effect the 35% withholding from distributions made on and after the date of the designation, until the distributions so withheld equal the amount of the prior distribution designated as a capital gain dividend. The non-U.S. stockholder may credit the amount withheld against its U.S. tax liability.

Sales of common stock. Gain recognized by a non-U.S. stockholder upon a sale or exchange of our common stock generally will not be taxed under the FIRPTA if we are a “domestically controlled REIT,” defined generally as a REIT, less than 50% in value of whose stock is and was held directly or indirectly by foreign

147

persons at all times during a specified testing period. We believe that we are and will continue to be a domestically controlled REIT, and, therefore, that taxation under FIRPTA generally will not apply to the sale of our common stock. However, gain to which FIRPTA does not apply will be taxable to a non-U.S. stockholder if investment in the common stock is treated as effectively connected with the non-U.S. stockholder’s U.S. trade or business or is attributable to a permanent establishment that the non-U.S. stockholder maintains in the United States if that is required by an applicable income tax treaty as a condition for subjecting the non-U.S. stockholder to U.S. taxation on a net income basis. In this case, the same treatment will apply to the non-U.S. stockholder as to U.S. stockholders with respect to the gain. In addition, gain to which the FIRPTA does not apply will be taxable to a non-U.S. stockholder if the non-U.S. stockholder is a nonresident alien individual who was present in the United States for 183 days or more during the taxable year and has a “tax home” in the United States, or maintains an office or a fixed place of business in the United States to which the gain is attributable. In this case, a 30% tax will apply to the nonresident alien individual’s capital gains and capital gain dividends.

If we were not a domestically controlled REIT, tax under the FIRPTA would apply to a non-U.S. stockholder’s sale of common stock only if the selling non-U.S. stockholder owned more than 5% of the class of common stock sold at any time during a specified period. This period is generally the shorter of the period that the non-U.S. stockholder owned the common stock sold or the five-year period ending on the date when the stockholder disposed of the common stock. If tax under FIRPTA applies to the gain on the sale of common stock, the same treatment would apply to the non-U.S. stockholder as to U.S. stockholders with respect to the gain, subject to any applicable alternative minimum tax and a special alternative minimum tax in the case of nonresident alien individuals.

Backup withholding and information reporting. If you are a non-U.S. stockholder, you are generally exempt from backup withholding and information reporting requirements with respect to:

•

dividend payments; and

•

the payment of the proceeds from the sale of common stock effected at a U.S. office of a broker,

as long as the income associated with these payments is otherwise exempt from U.S. Federal income tax, and:

•

the payor or broker does not have actual knowledge or reason to know that you are a U.S. person and you have furnished to the payor or broker:

•

a valid Internal Revenue Service Form W-8BEN or an acceptable substitute form upon which you certify, under penalties of perjury, that you are a non-U.S. person, or

•

other documentation upon which it may rely to treat the payments as made to a non-U.S. person in accordance with U.S. Treasury regulations, or

•

you otherwise establish an exemption.

Payment of the proceeds from the sale of common stock effected at a foreign office of a broker generally will not be subject to information reporting or backup withholding. However, a sale of common stock that is effected at a foreign office of a broker will be subject to information reporting and backup withholding if:

•

the proceeds are transferred to an account maintained by you in the United States,

•

the payment of proceeds or the confirmation of the sale is mailed to you at a U.S. address or

•

the sale has some other specified connection with the United States as provided in U.S. Treasury regulations,

unless the broker does not have actual knowledge or reason to know that you are a U.S. person and the documentation requirements described above are met or you otherwise establish an exemption.

148

In addition, a sale of common stock will be subject to information reporting if it is effected at a foreign office of a broker that is:

•

a U.S. person,

•

a controlled foreign corporation for U.S. tax purposes,

•

a foreign person 50% or more of whose gross income is effectively connected with the conduct of a U.S. trade or business for a specified three-year period, or

•

a foreign partnership, if at any time during its tax year:

•

one or more of its partners are “U.S. persons,” as defined in U.S. Treasury regulations, who in the aggregate hold more than 50% of the income or capital interest in the partnership, or

•

such foreign partnership is engaged in the conduct of a U.S. trade or business,

unless the broker does not have actual knowledge or reason to know that you are a U.S. person and the documentation requirements described above are met or you otherwise establish an exemption. Backup withholding will apply if the sale is subject to information reporting and the broker has actual knowledge that you are a U.S. person.

You generally may obtain a refund of any amounts withheld under the backup withholding rules that exceed your income tax liability by filing a refund claim with the Service.

Other Tax Consequences

State or local taxation may apply to us and our stockholders in various state or local jurisdictions, including those in which we or they transact business or reside. The state and local tax treatment of us and our 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 shares of our common stock.

149

ERISA CONSIDERATIONS

The following is a summary of certain considerations associated with an investment in us by a pension, profit sharing or other employee benefit plan subject to Title I of ERISA or Section 4975 of the Code. The following is merely a summary, however, and should not be construed as legal advice or as complete in all relevant respects. All investors are urged to consult their legal advisors before investing assets of an employee plan in our company and to make their own independent decisions.

A fiduciary considering investing assets of an employee plan in us should consult its legal advisor about ERISA, fiduciary and other legal considerations before making such an investment. Specifically, before investing in us, any fiduciary should, after considering the employee plan’s particular circumstances, determine whether the investment is appropriate under the fiduciary standards of ERISA or other applicable law including standards with respect to prudence, diversification and delegation of control and the prohibited transaction provisions of ERISA and the Code. In making those determinations, you should take into account, among the other factors described in this prospectus that, as described below, we do not expect that our assets will constitute the “plan assets” of any investing employee plan, so that neither we nor any of our principals, agents, employees, or affiliates will be a fiduciary as to any investing employee plan.

ERISA and the Code do not define “plan assets.” However, regulations promulgated under ERISA by the United States Department of Labor (the “DOL Plan Asset Regulations”) generally provide that when an employee plan acquires an equity interest in an entity that is neither a “publicly-offered security” nor a security issued by an investment company registered under the Investment Company Act of 1940, as amended, the employee plan’s assets include both the equity interest in the entity and an undivided interest in each of the underlying assets of the entity, unless it is established either that equity participation in the entity by “benefit plan investors” is not “significant” or that the entity is an “operating company,” in each case as defined in the DOL Plan Asset Regulations.

Under the DOL Plan Asset Regulations, a security is a “publicly-offered security” if it is freely transferable, part of a class of securities that is widely-held, and either (i) part of a class of securities registered under section 12(b) or 12(g) of the Securities Exchange Act of 1934 or (ii) sold to an employee plan as part of an offering of securities to the public pursuant to an effective registration statement under the Securities Act of 1933 and the class of securities of which that security is a part is registered under the Securities Exchange Act of 1934 within 120 days (or that later time as may be allowed by the Securities and Exchange Commission) after the end of the fiscal year of the issuer during which the offering of those securities to the public occurred. “Widely-held” for this purpose means the security is of a class owned by 100 or more investors independent of the issuer and of one another. “Freely transferable,” again for purposes of the DOL Plan Asset Regulations, is a question to be determined on the basis of all relevant facts and circumstances but, where the minimum investment is $10,000 or less, is ordinarily not adversely affected by some enumerated restrictions including restrictions against any transfer which would result in a termination or reclassification of the issuer for Federal tax purposes.

For purposes of the DOL Plan Asset Regulations, equity participation in an entity by benefit plan investors is not significant if their aggregate interest is less than 25% of the value of each class of equity securities in the entity, disregarding, for purposes of such determination, any interests held by persons, and their affiliates, who have discretionary authority or control with respect to the assets of the entity or who provide investment advice for a fee with respect to such assets. Benefit plan investors, for these purposes, include employee plans and certain other types of plans, such as governmental plans, not subject to Title I of ERISA.

The definition of “operating company” in the DOL Plan Asset Regulations includes, among other things, a “real estate operating company,” or a REOC, and a “venture capital operating company,” or a VCOC. In general, an entity may qualify as a REOC if (i) at least 50% of its assets valued at cost, other than short-term investments pending long-term commitment or distribution to investors’ are invested in real estate which is managed or developed and with respect to which the entity has the right to substantially participate directly in the

150

management or development activities and (ii) such entity in the ordinary course of its business is engaged directly in real estate management or development activities. Similarly, in general, an entity may qualify as a VCOC if (a) at least 50% of its assets valued at cost, other than short-term investments pending long-term commitment or distribution to investors, are invested in “operating companies,” other than other VCOCs, and with respect to which the entity has or obtains direct contractual management rights and (b) such entity in the ordinary course of its business actually exercises such management rights with respect to one or more of the operating companies in which it invests.

If our assets were deemed to be “plan assets” of employee plans whose assets were invested in us, whether as a result of the application of the DOL Plan Asset Regulations or otherwise, Subtitle A and Parts 1 and 4 of Subtitle B of Title I of ERISA and Section 4975 of the Tax Code would extend to our investments. This would result, among other things, in (i) the application of the prudence and other fiduciary standards of ERISA, which impose liability on fiduciaries, to investments made by us, which could materially affect our operations, (ii) potential liability of persons having investment discretion over the assets of the employee plans investing in us should our investments not conform to ERISA’s prudence and fiduciary standards under Part 4 of Subtitle B of Title I of ERISA, unless certain conditions are satisfied, and (iii) the possibility that certain transactions that we might enter into in the ordinary course of our business and operation might constitute “prohibited transactions” under ERISA and the Tax Code. A prohibited transaction, in addition to imposing potential personal liability upon fiduciaries of the employee plans, may also result in the imposition of an excise tax under the Tax Code upon the “party in interest,” as defined in ERISA, or “disqualified person,” as defined in the Tax Code, with whom the employee plan engaged in the transaction, and correction or unwinding of the transaction.

Historically, we have not treated the requirements of Subtitle A and Parts 1 and 4 of Subtitle B of Title I of ERISA and Section 4975 of the Code as applying to our investments. Our stock has not been previously publicly-offered, nor are we an investment company under the 1940 Act, and benefit plan investors’ holdings in us are significant within the meaning of the DOL Plan Asset Regulations because of the Contributing Entities’ interest in us. However, we believe that we have qualified since our formation as an operating company as that term is defined under the DOL Plan Asset Regulations. Further, subject to the following, we believe that after this offering, our stock should qualify as a “publicly offered security” under the DOL Plan Asset Regulations.

While there are restrictions imposed on the transfer of our stock, we believe they are the type of restrictions on transfer generally permitted under the DOL Plan Asset Regulations or are not otherwise material and should not result in the failure of our stock to be “freely transferable” within the meaning of the DOL Plan Asset Regulations. We also believe that certain restrictions on transfer that derive from the securities laws and from contractual arrangements with the underwriters in connection with this offering should not result in the failure of our stock to be “freely transferable.” Furthermore, we are not aware of any other facts or circumstances limiting the transferability of our stock that are not included among those enumerated as not affecting their free transferability under the DOL Plan Asset Regulations, and we do not expect to impose in the future (or to permit any person to impose on its behalf) any other limitations or restrictions on transfer that would not be among the enumerated permissible limitations or restrictions.

Assuming that our stock is “widely held” within the meaning of the DOL Plan Asset Regulations and that no facts and circumstances other than those referred to in the preceding paragraph exist that restrict transferability of our stock, we believe that, under the DOL Plan Asset Regulations, our stock should be considered “publicly offered securities” after this offering, and, therefore, that our underlying assets should not be deemed to be plan assets of any benefit plan investors that choose to invest in us.

151

UNDERWRITING

Subject to the terms and conditions contained in the underwriting agreement dated , 2004, each of the underwriters named below, who are represented by Citigroup Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley & Co. Incorporated, acting as joint bookrunning managers of the offering and acting as representatives of the underwriters named below, has agreed to purchase, and we have agreed to sell to that underwriter, the respective number of shares of our common stock set forth opposite the underwriter’s name.


Underwriter		Number of Shares
Citigroup Global Markets Inc.
Merrill Lynch, Pierce, Fenner & Smith Incorporated
Morgan Stanley & Co. Incorporated

Total

The underwriting agreement provides that the obligations of the underwriters to purchase and accept delivery of the shares included in this offering are subject to approval of certain legal matters by their counsel and to certain other conditions. The underwriters are obligated to purchase and accept delivery of all the shares (other than those covered by the over-allotment option described below) if they purchase any of the shares.

The underwriters propose to initially offer some of the shares directly to the public at the public offering price set forth on the cover page of this prospectus and some of the shares to certain dealers at the public offering price less a concession not to exceed $ per share. The underwriters may allow, and these dealers may reallow, a concession not to exceed $ per share on sales to some other dealers. After the initial offering of the shares to the public, the representatives of the underwriters may change the public offering price and these concessions. The underwriters do not intend to confirm sales to any accounts over which they exercise discretionary authority.

The following table shows the underwriting discounts and commissions that we are to pay to the underwriters in connection with this offering. These amounts are shown assuming both no exercise and full exercise of the underwriters’ option to purchase additional shares of common stock.

We estimate that our portion of the total expenses of this offering will be $ .

We have granted to the underwriters an option, exercisable for 30 days from the date of the underwriting agreement, to purchase up to additional shares of common stock at the public offering price less the underwriting discount. The underwriters may exercise the option solely to cover over-allotments, if any, in connection with this offering. To the extent the option is exercised, each underwriter will become obligated, subject to some conditions, to purchase a number of additional shares approximately proportionate to that underwriter’s initial purchase commitment.

We have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act, or to contribute to payments the underwriters may be required to make because of any of those liabilities.

152

For a period of 180 days after the date of this prospectus, we have agreed that we will not offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, or file with the Securities and Exchange Commission a registration statement (except a registration statement on Form S-8 relating to the 2004 long-term incentive plan) under the Securities Act relating to, any additional shares of our common stock or securities convertible into or exchangeable or exercisable for any shares of our common stock, or publicly disclose the intention to make any offer, sale, pledge, disposition or filing, without the prior written consent of Citigroup Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley & Co. Incorporated.

Our officers and directors and the Contributing Entities have agreed that they will not offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, any shares of our common stock or securities convertible into or exchangeable or exercisable for any shares of our common stock, enter into a transaction that would have the same effect, or enter into any swap, hedge or other arrangement that transfers, in whole or in part, any of the economic consequences of ownership of our common stock, whether any of these transactions are to be settled by delivery of our common stock or other securities, in cash or otherwise, or publicly disclose the intention to make any offer, sale, pledge or disposition, or to enter into any transaction, swap or other arrangement, without, in each case, the prior written consent of Citigroup Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley & Co. Incorporated, for a period of 180 days after the date of this prospectus. In addition, the Contributing Entities has agreed not to make any demand for or exercise any right with respect to, the registration of our common stock or any securities convertible into or exercisable or exchangeable for our common stock without the prior written consent of Citigroup Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley & Co. Incorporated. Citigroup Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley & Co. Incorporated in their sole discretion may release any of the securities subject to lock-up agreements at any time without notice.

At our request, the underwriters have reserved up to 5% of the shares of common stock for sale at the initial public offering price to certain of our employees through a directed share program. Individuals who purchase these shares will be subject to a 30 day lock up period, provided that our directors and officers will remain subject to the 180 day lock up period described above. The number of shares of common stock available for sale to the general public will be reduced by the number of directed shares purchased by participants in the program. Any directed shares not purchased will be offered by the underwriters to the general public on the same basis as all other shares of common stock offered. We have agreed to indemnify the underwriters against certain liabilities and expenses, including liabilities under the Securities Act, in connection with the sales of the directed shares.

Prior to this offering, there has been no public market for our common stock. Consequently, the initial public offering price for the shares was determined by negotiations between us and the representatives. Among the factors considered in determining the initial public offering price were our record of operations, our current financial condition, our future prospects, our markets, the economic conditions in and future prospects for the industry in which we compete, our management, and currently prevailing general conditions in the equity securities markets, including current market valuations of publicly traded companies considered comparable to our company. We cannot assure you, however, that the prices at which the shares will sell in the public market after this offering will not be lower than the initial public offering price or that an active trading market in our common stock will develop and continue after this offering.

We intend to apply to have our common stock listed on the NYSE under the symbol “SHO.”

In connection with the offering, the representatives on behalf of the underwriters, may purchase and sell shares of our common stock in the open market. These transactions may include short sales, syndicate covering transactions and stabilizing transactions. Short sales involve syndicate sales of common stock in excess of the number of shares to be purchased by the underwriters in the offering, which creates a syndicate short position. “Covered” short sales are sales of shares made in an amount up to the number of shares represented by the

153

underwriters’ over-allotment option. In determining the source of shares to close out the covered syndicate short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase share through the over-allotment option. Transactions to close out the covered syndicate short involve either purchases of the common stock in the open market after the distribution has been completed or the exercise of the over-allotment option. The underwriters may also make “naked” short sales of shares in excess of the over-allotment option. The underwriters must close out any naked short position by purchasing shares of common stock in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase in the offering. Stabilizing transactions consist of bids for or purchases of shares in the open market while the offering is in progress.

The underwriters also may impose a penalty bid. Penalty bids permit the underwriters to reclaim a selling concession from a syndicate member when Citigroup Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated or Morgan Stanley & Co. Incorporated repurchase shares originally sold by that syndicate member in order to cover syndicate short positions or make stabilizing purchases.

Any of these activities may have the effect of preventing or retarding a decline in the market price of the common stock. They may also cause the price of the common stock to be higher than the price that would otherwise exist in the open market in the absence of these transactions. The underwriters may conduct these transactions on the NYSE or in the over-the-counter market, or otherwise. If the underwriters commence any of these transactions, they may discontinue them at any time.

Certain of the underwriters have, from time to time, performed, and may in the future perform, various financial advisory and investment banking services for us which they have received or will receive customary fees and expenses. Citicorp Global Markets Realty Corp., an affiliate of Citigroup Global Markets Inc. provided a mortgage loan and mezzanine loan, which we will repay by using a portion of the net proceeds of this offering. Merrill Lynch Capital, an affiliate of Merrill, Lynch, Pierce, Fenner & Smith Incorporated, provided a mortgage loan for the JW Marriott, Cherry Creek, Colorado hotel, which will not be contributed to us in connection with the Formation and Structuring Transactions.

A prospectus in electronic format may be made available on the websites maintained by one or more of the underwriters. The representatives may agree to allocate a number of shares to underwriters for sale to their online brokerage account holders. The representatives will allocate shares to underwriters that may make Internet distributions on the same basis as other allocations. In addition, shares may be sold by the underwriters to securities dealers who resell shares to online brokerage account holders.

154

EXPERTS

The combined financial statements as of December 31, 2003 and 2002, and for each of the three years in the period ended December 31, 2003 of our predecessor companies included in this prospectus and the related financial statement schedules included elsewhere in the registration statement have been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their reports appearing herein and elsewhere in the registration statement, and are included in reliance upon the reports of such firm given upon their authority as experts in accounting and auditing.

The financial statements as of November 30, 2002, December 31, 2001 and for the 11-month period ended November 30, 2002 and the year ended December 31, 2001 of the 13 hotels we acquired in December 2002, referred to as the Wyndham Acquisition Hotels, included in this prospectus and the related financial statement schedules included elsewhere in the registration statement have been audited by PricewaterhouseCoopers LLP, an independent registered accounting firm, as stated in their reports appearing herein and the registration statement, and are included in reliance upon the reports of such firm given upon their authority as experts in accounting and auditing.

VALIDITY OF SECURITIES

The validity of our shares of common stock will be passed upon for us by Venable LLP. Sullivan & Cromwell LLP will provide an opinion relating to tax consequences. Certain legal matters will be passed upon for the underwriters by O’Melveny & Myers LLP.

WHERE YOU CAN FIND MORE INFORMATION

We have filed with the Securities and Exchange Commission a registration statement on Form S-11, including exhibits, schedules and amendments filed with this registration statement, under the Securities Act of 1933, as amended, with respect to the shares to be sold in this offering. This prospectus does not contain all of the information set forth in the registration statement and exhibits and schedules to the registration statement. For further information with respect to us and the shares to be sold in this offering, reference is made to the registration statement, including the exhibits and schedules to the registration statement. Statements contained in this prospectus as to the contents of any contract or other document referred to in this prospectus are not necessarily complete and, where that contract is an exhibit to the registration statement, each statement is qualified in all respects by reference to the exhibit to which the reference relates. Copies of the registration statement, including the exhibits and schedules to the registration statement, may be examined without charge at the public reference room of the Securities and Exchange Commission, 450 Fifth Street, N.W. Washington, DC 20549. Information about operation of the public reference room may be obtained by calling the Securities and Exchange Commission at 1-800-SEC-0300. Copies of all or a portion of the registration statement can be obtained from the public reference room of the Securities and Exchange Commission upon payment of prescribed fees. Our Securities and Exchange Commission filings, including our registration statement, are also available to you on the Securities and Exchange Commission’s web site www.sec.gov.

As a result of this offering, we will become subject to the information and reporting requirements of the Securities Exchange Act of 1934, as amended, and will file periodic reports, proxy statements and will make available to our stockholders quarterly reports for the first three quarters of each fiscal year containing unaudited interim financial information.

155

INDEX TO FINANCIAL STATEMENTS


		Page
Sunstone Hotel Investors, Inc. and Subsidiaries:

Unaudited Pro Forma Financial Data:

Unaudited Pro Forma Combined Balance Sheets as of June 30, 2004		F-3

Unaudited Pro Forma Condensed Combined Income Statement for the year ended December 31, 2003		F-6

Unaudited Pro Forma Condensed Combined Income Statement for the six months ended June 30, 2004		F-8

Sunstone Predecessor Companies:

Report of Independent Registered Public Accounting Firm		F-10

Combined Balance Sheets as of December 31, 2003 and 2002		F-11

Combined Statements of Operations for the years ended December 31, 2003, 2002 and 2001		F-12

Combined Statements of Changes in Members’ Equity for the years ended December 31, 2003, 2002 and 2001		F-13

Combined Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001		F-14

Notes to Combined Financial Statements		F-15

Schedule III—Real Estate and Accumulated Depreciation		F-38

Condensed Combined Balance Sheets as of June 30, 2004 and December 31, 2003		F-42

Condensed Combined Statements of Operations for the three and six months ended June 30, 2004 and 2003		F-43

Condensed Combined Statements of Cash Flows for the six months ended June 30, 2004 and 2003		F-44

Notes to Condensed Combined Financial Statements		F-45

Wyndham Acquisition Hotels:

Report of Independent Auditors		F-54

Combined Balance Sheets As of November 30, 2002 and December 31, 2001		F-55

Combined Statements of Operations for the period from January 1, 2002 through November 30, 2002 and the year ended December 31, 2001		F-56

Combined Statements of Changes in Owners’ Equity for the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001		F-57

Combined Statements of Cash Flows for the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001		F-58

Notes to Combined Financial Statements		F-60

F-1

UNAUDITED PRO FORMA FINANCIAL DATA

The following unaudited pro forma financial data gives effect to (1) hotel acquisitions and hotels held for sale (discontinued operations), (2) the Formation and Structuring Transactions and (3) this offering and the application of the net proceeds.

The historical financial information for the year ended December 31, 2003 has been derived from the audited combined financial statements of the Sunstone Predecessor Companies, which are included elsewhere in this prospectus. The historical financial information as of and for the six months ended June 30, 2004 has been derived from the unaudited combined financial statements of the Sunstone Predecessor Companies, which are included elsewhere in this prospectus. The unaudited pro forma balance sheet data as of June 30, 2004, is presented as if the transactions had occurred as of June 30, 2004. The unaudited pro forma combined statement of operations data for the year ended December 31, 2003 and the six months ended June 30, 2004, is presented as if the transactions had occurred as of the beginning of the periods indicated.

The unaudited pro forma combined financial data and related notes are presented for informational purposes only and do not purport to represent what our financial position or results of operations would actually have been if the transactions had in fact occurred on the dates discussed above. They also do not project or forecast our combined financial position or results of operations for any future date or period.

The unaudited pro forma combined financial data should be read together with our historical combined financial statements and related notes included elsewhere in this prospectus and with the information set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Formation and Structuring Transactions.” The pro forma adjustments are based on available information and upon assumptions that we believe are reasonable; however, we cannot assure you that actual results will not differ from the pro forma information and perhaps in material and adverse ways.

F-2

UNAUDITED PRO FORMA COMBINED BALANCE SHEETS

Historical and Pro Forma as of June 30, 2004

(In thousands)


	Historical			Hotel Eliminations(1)			Management Company(2)			Subtotal			Offering(3)	Pro Forma
ASSETS
Current assets:
Cash and cash equivalents	$	23,789		$	(1,597	) ^(1a)	$			$	22,192		$	$
Restricted cash		35,180			(150	) ^(1b)					35,030
Accounts receivable, net		23,522			(605	) ^(1c)					22,917
Due from affiliates		436			255	^(1d)					691
Inventories		2,761			(367	) ^(1d)					2,394
Prepaid expenses and other current assets		2,982			(83	) ^(1d)					2,899

Total current assets		88,670			(2,547	)		—			86,123

Investment in hotel properties, net		1,194,216			(62,148	) ^(1e)					1,132,068
Hotel properties held for sale, net		22,232			(22,232	) ^(1f)					—
Other real estate, net		7,550			—						7,550
Deferred financing costs, net		9,433			(948	) ^(1g)					8,485
Goodwill		28,493			—						28,493
Other assets, net		4,925			(236	) ^(1h)					4,689

Total assets	$	1,355,519		$	(88,111	)	$	—		$	1,267,408		$	$

LIABILITIES AND MEMBERS’ EQUITY
Current liabilities:
Accounts payable and other accrued expenses	$	22,940		$	(577	) ⁽¹ⁱ⁾	$			$	22,363
Accrued payroll and employee benefits		12,747			(586	) ^(1j)		(5,235	)		6,926
Interest rate swap		—			—						—
Due to management company		—			—			12,924			12,924
Other current liabilities		29,231			(1,377	) ^(1k)		(7,889	)		19,965
Current portion of line of credit		—			—						—
Current portion of notes payable		64,666			(179	) ^(1l)					64,487

Total current liabilities		129,584			(2,719	)		(200	)		126,665

Line of credit, less current portion		—			—						—
Notes payable, less current portion		848,307			(63,186	) ^(1l)					785,121
Deferred income taxes		41,668			(2,612	) ^(1m)(1p)					39,056	^(1p)
Accrued pension liability		1,542			—			(1,542	)		—
Other liabilities		3,159			(15	) ⁽¹ⁿ⁾					3,144

Total liabilities		1,024,260			(68,532	)		(1,742	)		953,986

Minority interests		528			—						528

Members’ equity:
Members’ capital		332,473			(19,579	) ^(1o)					312,894
Accumulated other comprehensive loss		(1,742	)		—			1,742			—

Members’ equity		330,731			(19,579	)		1,742			312,894
Stockholders’ equity
Common stock		—			—						—
Additional paid in capital		—			—						—

Total stockholders’ equity		—			—						—

Total liabilities and equity	$	1,355,519		$	(88,111	)	$	—		$	1,267,408		$	$

F-3

UNAUDITED PRO FORMA COMBINED BALANCE SHEETS—(Continued)

Historical and Pro Forma as of June 30, 2004

(In thousands)

Notes to Unaudited Pro Forma Combined Balance Sheets as of June 30, 2004

(1)

Represents the elimination of the two hotels that will not be contributed to us by the Contributing Entities, and three hotels held for sale at June 30, 2004. The two hotels that will not be contributed are the JW Marriott, Cherry Creek, Colorado and the Embassy Suites, Los Angeles, California. Further discussion of these two hotels is described in the “Certain Relationships and Related Transactions—Excluded Properties” and “—Other Properties.” The three hotels held for sale were the Concord Hotel and Conference Center, Concord, California; the Four Points-Sheraton Silverthorne, Colorado; and the San Marcos Resort, Chandler, Arizona.

1a.

Represents the elimination of cash from the following hotels: JW Marriott, Cherry Creek, Colorado ($1,272); Concord Hotel and Conference Center, Concord, California ($78); Embassy Suites, Los Angeles, California ($120); the Four Points-Sheraton, Silverthorne, Colorado ($37); and the San Marcos Resort, Chandler, Arizona ($90).

1b.

Represents the elimination of restricted cash at JW Marriott, Cherry Creek, Colorado ($150).

1c.

Represents the elimination of accounts receivable, net, from the following hotels: JW Marriott, Cherry Creek, Colorado ($88); Concord Hotel and Conference Center, Concord, California ($59); Embassy Suites, Los Angeles, California ($84); the Four Points-Sheraton, Silverthorne, Colorado ($97); and the San Marcos Resort, Chandler, Arizona ($277).

1d.

Represents the addition in due from affiliates ($255) that was eliminated in the combined financial statements and the elimination of inventories ($367) and prepaid expenses ($83) related to the excluded and held for sale hotels.

1e.

Primarily the elimination of the two hotels that will not be contributed to us by the Contributing Entities (JW Marriott, Cherry Creek, Colorado ($38,227) and Embassy Suites, Los Angeles, California ($23,921)). The distribution of the Embassy Suites, Los Angeles, California will constitute a distribution of the current and accumulated earnings and profits of our corporate subsidiaries.

1f.

Represents the elimination of 3 hotels held for sale as of June 30, 2004: Concord Hotel and Conference Center, Concord, California ($5,844); the Four Points-Sheraton, Silverthorne, Colorado ($2,939); and the San Marcos Resort, Chandler, Arizona ($13,449).

1g.

Represents the elimination of deferred financing costs and interest rate cap agreements from the following hotels: JW Marriott, Cherry Creek, Colorado ($389); Concord Hotel and Conference Center, Concord, California ($90); Embassy Suites, Los Angeles, California ($257); the Four Points-Sheraton, Silverthorne, Colorado ($45); and the San Marcos Resort, Chandler, Arizona ($167).

1h.

Represents the elimination of other assets from the following hotels: JW Marriott, Cherry Creek, Colorado ($150); Concord Hotel and Conference Center, Concord, California ($13); Embassy Suites, Los Angeles, California ($26); and the San Marcos Resort, Chandler, Arizona ($47).

1i.

Represents the elimination of accounts payable and other accrued expenses from the following hotels: JW Marriott, Cherry Creek, Colorado ($307); Concord Hotel and Conference Center, Concord, California ($25); Embassy Suites, Los Angeles, California ($87); the Four Points-Sheraton, Silverthorne, Colorado ($45); and the San Marcos Resort, Chandler, Arizona ($113).

1j.

Represents the elimination of accrued payroll and employee benefits from the following hotels: JW Marriott, Cherry Creek, Colorado, ($142); Concord Hotel and Conference Center, Concord, California ($190); Embassy Suites, Los Angeles, California ($115); the Four Points-Sheraton, Silverthorne, Colorado ($71); and the San Marcos Resort, Chandler, Arizona ($68).

1k.

Represents the elimination of other current liabilities (e.g. sales and use tax, real estate taxes, etc.) from the following hotels: JW Marriott, Cherry Creek, Colorado ($250); Concord Hotel and Conference Center, Concord, California ($196); Embassy Suites, Los Angeles, California ($360); the Four Points-Sheraton, Silverthorne, Colorado ($104); and the San Marcos Resort, Chandler, Arizona ($467).

F-4

UNAUDITED PRO FORMA COMBINED BALANCE SHEETS—(Continued)

Historical and Pro Forma as of June 30, 2004

(In thousands)

1l.

Represents the debt associated with the JW Marriott, Cherry Creek, Colorado ($24,300); and Embassy Suites, Los Angeles, California ($17,530), that will not be contributed by the Contributing Entities and the paydown of debt from the sale of the following hotels: Concord Hotel and Conference Center, Concord, California ($7,027); the Four Points-Sheraton, Silverthorne, Colorado ($3,098); and the San Marcos Resort, Chandler, Arizona ($11,410). Of the $63,365 paydown on notes payable, as of June 30, 2004 $179 is classified as short-term notes payable.

1m.

Represents the elimination of deferred income taxes of Embassy Suites, Los Angeles, California ($2,612).

1n.

Represents the elimination of other liabilities at the San Marcos Resort, Chandler, Arizona ($15).

1o.

Represents the elimination of equity from the following hotels: JW Marriott, Cherry Creek, Colorado ($15,151); Concord Hotel and Conference Center, Concord, California ($(1,234)); Embassy Suites, Los Angeles, California ($3,738); the Four Points-Sheraton, Silverthorne, Colorado ($(193)); and the San Marcos Resort, Chandler, Arizona ($2,117).

1p.

Deferred taxes will be reduced by [$ ] upon formation of the REIT.

(2)

Represents the transfer of employee-related liabilities from the corporation that currently manages 50 of our hotels and employs the employees for those hotels as well as certain corporate personnel involved in hotel management (Step Two of the “Formation and Structuring Transactions”) to the Management Company ($5,235 in employee benefits liabilities, $7,889 in other current liabilities, $1,542 in accrued pension liability and $(1,742) in accumulated other comprehensive loss).

(3)	The effect of the issuance of securities to the Contributing Entities in this offering and the application of the net proceeds as described under “Use of Proceeds.”

F-5

SUNSTONE HOTEL INVESTORS, INC.

PRO FORMA CONDENSED COMBINED INCOME STATEMENT

For the Year Ended December 31, 2003

(Unaudited)

(In thousands, except per share data)


	Historical			Hotel Acquisitions ⁽¹⁾			Hotel Eliminations ⁽²⁾			Management Company ⁽³⁾			Other Adjustments (4)			Subtotal			Offering ⁽⁵⁾		Pro Forma
REVENUES
Room	$	315,812		$	2,840	^(1a)	$	(6,134	) ^(2a)	$			$			$	312,518		$		$
Food and beverage		107,200			326	^(1b)		(996	) ^(2b)								106,530
Other operating		36,985			84	^(1c)		(516	) ^(2c)								36,553
Management and other fees from affiliates		705												(705	) ^(4a)		—

Total revenues		460,702			3,250			(7,646	)		—			(705	)		455,601

OPERATING EXPENSES
Room		74,471			612	^(1d)		(1,291	) ^(2d)								73,792
Food and beverage		76,750			222	^(1e)		(799	) ^(2e)								76,173
Other hotel		148,869			1,149	^(1f)		(3,094	) ^(2f)								146,924
General and administrative		64,229			473	^(1g)		(889	) ^(2g)		(57,844	)		(5,969	) ^(4b)		—
General and administrative—corporate		—												8,169	^(4b)		8,169
General and administrative—property operations		—									45,744						45,744
Management fee expense		—									7,643						7,643
Depreciation and amortization		53,481			275	^(1h)		(1,159	) ^(2h)								52,597
Impairment loss		11,382															11,382

Total operating expenses		429,182			2,731			(7,232	)		(4,457	)		2,200			422,424

Operating income (loss)		31,520			519			(414	)		4,457			(2,905	)		33,177

Interest and other income		712															712
Interest expense		(55,235	)		(410	) ⁽¹ⁱ⁾		1,134	⁽²ⁱ⁾								(54,511	)

Income (loss) from continuing operations before minority interest and income taxes		(23,003	)		109			720			4,457			(2,905	)		(20,622	)
Minority interest		(17	)														(17	)
Income tax benefit		2,017															2,017

Loss from continuing operations		$(21,003)		$	109		$	720		$	4,457			$(2,905)			$(18,622)			$		$

Loss per share from continuing operations:
Basic

Diluted

Common shares outstanding:
Basic

Diluted

Notes to Unaudited Pro Forma Combined Statements of Operations for the Year Ended December 31, 2003

(1)

In 2003, we added two hotels to the portfolio. On January 24, 2003, we acquired the Marriott, Ontario, California (299 rooms) and on June 20, 2003 we acquired the Residence Inn, Manhattan Beach, California (176 rooms). Details of these two acquisitions are described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Acquisition, Sales & Major Redevelopment Activity.” The following pro forma adjustments were made to account for these two 2003 acquisitions as if the acquisitions occurred as of January 1, 2003:

1a.

Represents the addition of room revenue from the Residence Inn, Manhattan Beach, California ($2,343) and the Marriott, Ontario, California ($497).

1b.

Represents the addition of food and beverage revenue from the Marriott, Ontario, California ($326).

1c.

Represents the addition of other operating revenues from the Residence Inn, Manhattan Beach, California ($45) and the Marriott, Ontario, California ($39).

1d.

Represents the addition of room expense from the Residence Inn, Manhattan Beach, California ($446) and the Marriott, Ontario, California ($166).

1e.

Represents the addition of food and beverage expense from the Marriott, Ontario, California ($222).

F-6

1f.

Represents the addition of other expenses from the Residence Inn, Manhattan Beach, California ($15) and the Marriott, Ontario, California ($21); advertising and promotion expenses from the Residence Inn, Manhattan Beach, California ($134) and the Marriott, Ontario, California ($45); repairs and maintenance expense from the Residence Inn, Manhattan Beach, California ($112) and the Marriott, Ontario, California ($39); utilities expense from the Residence Inn, Manhattan Beach, California ($91) and the Marriott, Ontario, California ($24); franchise costs from the Residence Inn, Manhattan Beach, California ($264) and the Marriott, Ontario, California ($56); and property tax, ground lease and insurance from the Residence Inn, Manhattan Beach, California ($326) and the Marriott, Ontario, California ($22); in repairs and maintenance expense; utilities expense; in franchise costs; and in property tax, ground lease and insurance.

1g.

Represents the addition of general and administrative expense from the Residence Inn, Manhattan Beach, California ($326) and the Marriott, Ontario, California ($147).

1h.

Represents the addition of depreciation and amortization expense from the Residence Inn, Manhattan Beach, California ($200) and the Marriott, Ontario, California ($75).

1i.

Represents the addition of interest expense from the Residence Inn, Manhattan Beach, California ($360) and the Marriott, Ontario, California ($50).

(2)

Primarily represents the historical results of the Embassy Suites, Los Angeles, California for the year ended December 31, 2003. Additionally, as described in “Certain Relationships and Related Transactions—Excluded Properties” and “—Other Properties”, we are excluding the JW Marriott Hotel, Cherry Creek, Colorado, and accordingly, operating items related to this hotel are eliminated. Properties sold or held for sale in 2003 or 2004 are included in discontinued operations and, therefore, are not included in this column.

2a.

Represents the reduction of $6,134 million in room revenue from the Embassy Suites, Los Angeles, California.

2b.

Represents the reduction of $996 in food and beverage revenue from the Embassy Suites, Los Angeles, California.

2c.

Represents the reduction of $516 in other/operating revenue from the Embassy Suites, Los Angeles, California.

2d.

Represents the reduction of $1,291 million in room expense from the Embassy Suites, Los Angeles, California.

2e.

Represents the reduction of $799 in food and beverage expense from the Embassy Suites, Los Angeles, California.

2f.

Represents the reduction of $431 in other expense; $749 in advertising and promotion expense; $372 in repairs and maintenance expense; $379 in utilities expense; $607 in franchise costs; and $556 in property tax, ground lease, and insurance expense from the Embassy Suites, Los Angeles, California.

2g.

Represents the reduction of $704 in general and administrative expense from the Embassy Suites, Los Angeles, California, as well as $185 of pre-opening expenses for the JW Marriott, Cherry Creek, Colorado.

2h.

Represents the reduction of $1,159 in depreciation and amortization expense from the Embassy Suites, Los Angeles, California.

2i.

Represents the reduction of $1,134 in interest expense as a result of repayment of the underlying notes payable from the Embassy Suites, Los Angeles, California.

(3)

Represents the transfer of employee-related expenses from the corporation that currently manages 50 of our hotels and employs the employees for those hotels as well as certain corporate personnel involved in hotel management (Step Two of the “Formation and Structuring Transactions”) to the Management Company ($45,744) and the establishment of the management fee expense ($7,643).

(4)	Other adjustments represents:

4a.

The elimination of management and other fees from affiliates as a result of the Formation and Structuring Transactions ($705).

4b.

The estimated continuing general and administrative expenses ($5,969) and the estimated additional costs of being a public company ($2,200).

(5)	The effect of the application of the net proceeds of this offering as described under “Use of Proceeds.”

F-7

SUNSTONE HOTEL INVESTORS, INC.

PRO FORMA CONDENSED COMBINED INCOME STATEMENT

For the Six Months Ended June 30, 2004

(Unaudited)

(In thousands, except per share data)


	Historical			Hotel Eliminations ⁽¹⁾			Management Company ⁽²⁾			Other Adjustments ⁽³⁾			Subtotal			Offering ⁽⁴⁾	Pro Forma
REVENUES
Room	$	166,957		$	(3,958	) ^(1a)	$			$			$	162,999		$	$
Food and beverage		54,849			(766	) ^(1b)								54,083
Other operating		21,576			(326	) ^(1c)								21,250
Management and other fees from affiliates		522									(522	) ^(3a)		—

Total revenues		243,904			(5,050	)		—			(522	)		238,332

OPERATING EXPENSES
Room		37,267			(837	) ^(1d)								36,430
Food and beverage		37,923			(618	) ^(1e)								37,305
Other hotel		76,306			(1,901	) ^(1f)								74,405
General and administrative		32,853			(1,059	) ^(1g)		(28,809	)		(2,985	) ^(3b)		—
General and administrative—corporate		—									4,085	^(3b)		4,085
General and administrative—property operations		—						22,552						22,552
Management fee expense		—						3,822						3,822
Depreciation and amortization		28,444			(893	) ^(1h)								27,551
Impairment loss		7,439												7,439

Total operating expenses		220,232			(5,308	)		(2,435	)		1,100			213,589

Operating income (loss)		23,672			258			2,435			(1,622	)		24,743
Interest and other income		216												216
Interest expense		(26,576	)		688	⁽¹ⁱ⁾								(25,888	)

Income (loss) from continuing operations before minority interest and income taxes		(2,688	)		946			2,435			(1,622	)		(929	)
Minority interest		166												166
Provision for income taxes		(780	)											(780	)

Income (loss) from continuing operations	$	(3,302	)	$	946		$	2,435		$	(1,622	)	$	(1,543	)	$	$

Income (loss) per share from continuing operations:
Basic

Diluted

Common shares outstanding:
Basic

Diluted

F-8

Notes to Unaudited Pro Forma Combined Statements of Operations for the Six Months Ended June 30, 2004

(1)	Represents the historical results of the Embassy Suites, Los Angeles, California for the six months ended June 30, 2004.

Additionally, as is fully described in “Certain Relationships and Related Transactions—Excluded Properties” and “—Other Properties”, we are excluding the JW Marriott, Cherry Creek, Colorado, and accordingly, operating items related to this hotel are eliminated. Properties sold or held for sale in 2003 or 2004 are included in discontinued operations and, therefore, are not included in this column.

1a.

Represents the reduction of $3,958 million in room revenue from the Embassy Suites, Los Angeles, California and the JW Marriott, Cherry Creek, Colorado.

1b.

Represents the reduction of $766 in food and beverage revenue from the Embassy Suites, Los Angeles, California and the JW Marriott, Cherry Creek, Colorado.

1c.

Represents the reduction of $326 in other operating revenue from the Embassy Suites, Los Angeles, California and the JW Marriott, Cherry Creek, Colorado.

1d.

Represents the reduction of $837 in room expense from the Embassy Suites, Los Angeles, California and the JW Marriott, Cherry Creek, Colorado.

1e.

Represents the reduction of $618 in food and beverage expense from the Embassy Suites, Los Angeles, California and the JW Marriott, Cherry Creek, Colorado.

1f.

Represents the reduction of $265 in other expenses from the Embassy Suites, Los Angeles, California; $487 in advertising and promotion expense; $209 in repairs and maintenance expense; $230 in utilities expense; $388 in franchise costs; and $322 in property tax, ground lease, and insurance from the Embassy Suites, Los Angeles, California and the JW Marriott, Cherry Creek, Colorado.

1g.

Represents the reduction of $1,059 in general and administrative expense at the Embassy Suites, Los Angeles, California and the JW Marriott, Cherry Creek, Colorado.

1h.

Represents the reduction of $893 in depreciation and amortization expense from the Embassy Suites, Los Angeles, California and the JW Marriott, Cherry Creek, Colorado.

1i.

Represents the reduction of $688 in interest expense related to the underlying note payable from the Embassy Suites, Los Angeles, California and the JW Marriott, Cherry Creek, Colorado.

(2)

Represents the transfer of employee-related expenses from the corporation that currently manages 50 of our hotels and employs the employees for those hotels as well as certain corporate personnel involved in hotel management hotels (Step Two of the “Formation and Structuring Transactions”) to the Management Company ($22,552) and the establishment of the third party management fee expense ($3,822).

(3)	Other adjustments represents:

3a.

The estimated continuing general and administrative expenses ($2,985) and the estimated additional costs of being a public company ($1,100).

3b.

The elimination of management and other fees from affiliates as a result of the Formation and Structuring Transactions ($522).

(4)	The effect of the application of the net proceeds of this offering as described under “Use of Proceeds.”

F-9

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Members:

Sunstone Hotel Investors, L.L.C.

WB Hotel Investors, LLC

Sunstone/WB Hotel Investors IV, LLC

We have audited the accompanying combined balance sheets of Sunstone Hotel Investors, L.L.C., WB Hotel Investors, LLC, and Sunstone/WB Hotel Investors IV, LLC (collectively, the “Company” or “Sunstone Predecessor Companies”) as of December 31, 2003 and 2002 and the related combined statements of operations, changes in members’ equity and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the Index to Financial Statements. These combined financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these combined financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Company at December 31, 2003 and 2002, and the combined results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic combined financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As described in Note 2, in 2001 the Company changed its method of accounting for derivative instruments and hedging activities upon adoption of Statement of Financial Accounting Standard (“SFAS”) No. 133, “ Accounting for Derivative Instruments and Hedging Activities .” Also as described in Note 2, in 2002 the Company changed its method of accounting for goodwill and intangible assets upon adoption of SFAS No. 142, “ Goodwill and Other Intangible Assets .” As described in Note 2, the Company adopted SFAS No. 144, “ Accounting for the Impairment or Disposal of Long-Lived Assets ” on January 1, 2002.

/s/ E RNST & Y OUNG LLP

Irvine, California

February 2, 2004, except for Note 4 and Note 14, as to which the date is August 3, 2004

F-10

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

COMBINED BALANCE SHEETS

(In thousands)


	December 31,
	2003			2002
ASSETS
Current assets:
Cash and cash equivalents	$	20,229		$	22,302
Restricted cash		37,611			30,200
Accounts receivable, net		19,040			14,632
Due from affiliates		451			47
Inventories		2,690			2,941
Prepaid expenses		2,624			2,536

Total current assets		82,645			72,658

Investment in hotel properties, net		1,227,537			1,316,659
Other real estate, net		7,767			7,270
Deferred financing costs, net		11,921			10,637
Interest rate cap agreements		540			1,255
Goodwill		28,493			31,495
Other assets, net		6,039			5,915

Total assets	$	1,364,942		$	1,445,889

LIABILITIES AND MEMBERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses	$	28,943		$	20,143
Accrued payroll and employee benefits		13,263			11,602
Other current liabilities		25,313			21,389
Current portion of notes payable		25,804			477,141

Total current liabilities		93,323			530,275

Notes payable, less current portion		891,848			465,282
Deferred income taxes		43,612			46,853
Accrued pension liability		1,638			2,142
Other liabilities		3,572			2,595

Total liabilities		1,033,993			1,047,147

Commitments and contingencies (Note 11)

Minority interest		604			—

Members’ equity:
Members’ capital		332,087			400,858
Accumulated other comprehensive loss		(1,742	)		(2,116	)

Total members’ equity		330,345			398,742

Total liabilities and members’ equity	$	1,364,942		$	1,445,889

See accompanying notes to combined financial statements.

F-11

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

COMBINED STATEMENTS OF OPERATIONS

(In thousands)


	Year Ended December 31,
	2003			2002			2001
REVENUES
Room	$	315,812		$	191,794		$	181,284
Food and beverage		107,200			47,700			41,885
Other operating		36,985			21,721			20,311
Management and other fees from affiliates		705			194			—

Total revenues		460,702			261,409			243,480

OPERATING EXPENSES
Room		74,471			43,318			41,288
Food and beverage		76,750			35,010			33,293
Other operating		25,582			14,537			13,744
Advertising and promotion		29,362			15,478			13,670
Repairs and maintenance		21,186			11,081			10,067
Utilities		19,538			11,464			11,243
Franchise costs		24,005			14,984			3,747
Property tax, ground lease, and insurance		29,196			13,143			12,048
General and administrative		64,229			39,122			46,689
Depreciation and amortization		53,481			34,213			30,117
Impairment loss		11,382			6,789			—
Goodwill amortization		—			—			4,925

Total operating expenses		429,182			239,139			220,831

Operating income		31,520			22,270			22,649
Interest and other income		712			2,080			1,070
Interest expense		(55,235	)		(29,186	)		(42,338	)

Loss before minority interest, income taxes, cumulative effect of change in accounting principle and discontinued operations accounting principle and income taxes		(23,003	)		(4,836	)		(18,619	)
Minority interest		(17	)		—			—
Income tax benefit		2,017			4,715			8,770

Loss from continuing operations before cumulative effect of change in accounting principle and discontinued operations		(21,003	)		(121	)		(9,849	)
Cumulative effect of change in accounting principle		—			—			(1,326	)
Income (loss) from discontinued operations		(1,263	)		(10,265	)		(7,632	)

NET LOSS	$	(22,266	)	$	(10,386	)	$	(18,807	)

See accompanying notes to combined financial statements.

F-12

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

COMBINED STATEMENTS OF CHANGES IN MEMBERS’ EQUITY

(In thousands)


	Total Members’ Capital			Accumulated Other Comprehensive Income (Loss)			Total Members’ Equity
Balance at December 31, 2000	$	359,479		$	(363	)	$	359,116
Distributions		(40,920	)		—			(40,920	)
Net loss		(18,807	)		—			(18,807	)
Minimum pension liability adjustment		—			(604	)		(604	)

Comprehensive loss								(19,411	)

Balance at December 31, 2001		299,752			(967	)		298,785
Contributions		135,071			—			135,071
Distributions		(23,579	)		—			(23,579	)
Net loss		(10,386	)		—			(10,386	)
Minimum pension liability adjustment		—			(1,149	)		(1,149	)

Comprehensive loss								(11,535	)

Balance at December 31, 2002		400,858			(2,116	)		398,742
Contributions		25,971			—			25,971
Transfer of members’ interest to minority interest		(470	)		—			(470	)
Distributions		(72,006	)		—			(72,006	)
Net loss		(22,266	)		—			(22,266	)
Minimum pension liability adjustment		—			374			374

Comprehensive loss								(21,892	)

Balance at December 31, 2003	$	332,087		$	(1,742	)	$	330,345

See accompanying notes to combined financial statements

F-13

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

COMBINED STATEMENTS OF CASH FLOWS

(In thousands)


	Year Ended December 31,
	2003			2002			2001
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$	(22,266	)	$	(10,386	)	$	(18,807	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Bad debt expense (recovery)		605			(201	)		553
Minority interest		17			—			—
(Gain) loss on sale of hotel properties		(14,757	)		43			(262	)
Depreciation		60,081			39,621			37,854
Amortization of deferred franchise fees		407			324			286
Amortization of deferred financing costs		7,797			5,381			9,010
Amortization of goodwill		—			—			4,925
Impairment loss—investment in hotel properties and discontinued operations		26,297			7,054			3,445
Impairment loss—goodwill		2,076			9,393			540
(Gain) loss on derivatives		1,423			(4,976	)		5,633
Cumulative effect of change in accounting principle		—			—			2,006
Deferred income taxes		(3,241	)		(5,131	)		(9,070	)
Changes in operating assets and liabilities:
Restricted cash		(7,411	)		(18,303	)		6,214
Accounts receivable		(5,013	)		(6,861	)		4,482
Due from affiliates		(404	)		(47	)		—
Inventories		251			(777	)		(37	)
Prepaid expenses and other assets		(1,060	)		(1,091	)		89
Accounts payable and other liabilities		13,701			11,214			(4,199	)
Accrued payroll and employee benefits		1,661			1,766			289
Accrued pension liability		(130	)		(303	)		366

Net cash provided by operating activities		60,034			26,720			43,317

CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of hotel properties		119,259			6,246			173,637
Acquisitions of hotel properties		(41,925	)		(526,504	)		—
Additions to hotel properties and other real estate		(58,963	)		(21,180	)		(29,253	)

Net cash provided by (used in) investing activities		18,371			(541,438	)		144,384

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes payable		483,883			471,378			61,431
Payments on notes payable		(508,654	)		(44,362	)		(211,181	)
Payments of deferred financing costs		(9,081	)		(6,544	)		(967	)
Proceeds from sale of interest rate cap agreements		—			—			69
Acquisition of interest rate cap agreements		(708	)		(1,249	)		—
Contributions from members		25,971			135,071			—
Distributions to members		(72,006	)		(23,579	)		(40,920	)
Contributions from minority interest holders		164			—			—
Distributions to minority interest holders		(47	)		—			—

Net cash (used in) provided by financing activities		(80,478	)		530,715			(191,568	)

Net (decrease) increase in cash and cash equivalents		(2,073	)		15,997			(3,867	)
Cash and cash equivalents, beginning of year		22,302			6,305			10,172

Cash and cash equivalents, end of year	$	20,229		$	22,302		$	6,305

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest	$	51,713		$	34,944		$	45,496

Income taxes paid	$	1,008		$	468		$	64

NONCASH FINANCING ACTIVITY
Transfer of member’s interest to minority interest	$	470		$	—		$	—

See accompanying notes to combined financial statements.

F-14

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

1. Organization and Proposed Transactions

Sunstone Hotel Investors, L.L.C., a Delaware limited liability company (“SHI”), was formed on April 5, 1999 and commenced operations on November 22, 1999 effective with the acquisitions of Sunstone Hotel Investors, Inc, a former public real estate investment trust; Sunstone Hotel Properties, Inc.; and Sunstone Hotel Management, Inc. (both subchapter S corporations). Its founding members consisted of Westbrook SHP L.L.C.; Westbrook Real Estate Fund III, L.P.; Westbrook Real Estate Co-Investment Partnership III, L.P.; Alter SHP LLC, a company controlled by Robert A. Alter (“Alter”); Biederman SHP LLC, a company controlled by Charles L. Biederman (“Biederman”); and certain other members. SHI owned and operated 38 and 44 hotel properties at December 31, 2003 and 2002, respectively.

WB Hotel Investors, LLC, a Delaware limited liability company (“WB”), was formed on August 11, 2000 and commenced operations on August 31, 2000 effective with the acquisition of ten hotel properties from Lodgian Corporation. The members of WB are Westbrook Real Estate Fund III, L.P., Westbrook Real Estate Co-Investment Partnership III, L.P., and L/S Investors, LLC. WB owned and operated seven hotels at December 31, 2003 and 2002.

Sunstone/WB Hotel Investors IV, LLC, a Delaware limited liability company (“WB IV”), was formed on December 17, 2002 and commenced operations effective with the acquisitions of 15 hotel properties that were wholly owned or substantially owned by Wyndham International, Inc. in December 2002 for $525.3 million. These acquisitions were consummated with new financings in the amount of $421.4 million and cash contributions aggregating $129.5 million from the members. The members of WB IV are Westbrook Real Estate Fund IV, L.P., Westbrook Real Estate Co-Investment Partnership IV, L.P., and Fund IV Sun Investors, LLC. WB IV owned and operated 16 and 15 hotel properties at December 31, 2003 and 2002, respectively, including through its majority interest in Sunstone/WB Manhattan Beach, LLC.

SHI, WB and WB IV will be referred to, collectively, as the “Company” or “Sunstone Predecessor Companies.” Affiliates of Westbrook Partners are referred to collectively as “Westbrook” or “Westbrook Affiliates.”

The Company is currently engaged in owning, acquiring, selling, managing, and renovating hotel properties in the United States. The Company is not a legal entity but rather a combination of the real estate entities described above. Controlling ownership interests in Sunstone Predecessor Companies are held by Westbrook (Note 10). The ultimate owners of the Company are Westbrook and certain others who have minor ownership interests.

The partners and members of Sunstone Predecessor Companies will, concurrently with a proposed public offering, enter into a series of transactions with Sunstone Hotel Investors, Inc., a Maryland corporation, to form a real estate investment trust (the “REIT”) to continue and expand the business of Sunstone Predecessor Companies. All of the properties (the “Properties”) owned by the Sunstone Predecessor Companies have been managed by Sunstone Hotel Properties, Inc., a Colorado corporation and a subsidiary of SHI, since their acquisition by Sunstone Predecessor Companies.

Proposed Transactions

Concurrently with the consummation of an initial public offering of the REIT’s common stock, (the “Offering”), which is expected to be completed in 2004, the REIT and a newly formed limited partnership (the

F-15

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

“Operating Partnership”), together with Sunstone Predecessor Companies will engage in certain formation transactions (the “Formation Transactions”). The Formation Transactions are designed to (i) enable the REIT to raise the necessary capital to acquire the Properties and repay certain mortgage debt relating thereto, (ii) provide a vehicle for future acquisitions, (iii) enable the REIT to comply with certain requirements under the federal income tax laws and regulations relating to real estate investment trusts, (iv) facilitate potential financings and (v) preserve certain tax advantages for Sunstone Predecessor Companies.

The operations of the REIT will be carried on primarily through the Operating Partnership and its subsidiaries in order to assist the REIT and Sunstone Predecessor Companies in forming the REIT under the Internal Revenue Code.

The REIT will be the sole general partner in the Operating Partnership and Sunstone Predecessor Companies will transfer their property and operating interests in the Sunstone Predecessor Companies in exchange for limited partnership interests in the Operating Partnership and/or cash.

The transfer of the properties and operating interests of Sunstone Predecessor Companies for cash or ownership interests in the Operating Partnership will be accounted for at the historical cost of their interests in Sunstone Predecessor Companies similar to a pooling of interests as these entities are all under common control.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying combined financial statements as of and for the year ended December 31, 2003 include the accounts of SHI, WB, and WB IV. The accompanying combined financial statements as of and for the year ended December 31, 2002 include the accounts of SHI and WB for the full year and the accounts of WB IV from December 17, 2002 to December 31, 2002. For the year ended December 31, 2001, the accompanying combined financial statements only include the accounts of SHI and WB. Significant intercompany accounts and transactions have been eliminated for all periods presented. Minority interest represents the outside equity interest of non-controlling owners in certain of the Company’s non-wholly owned consolidated subsidiaries. Certain amounts included in the combined financial statements for prior years have been reclassified to conform with the most recent financial statement presentation, including the comparative presentation of discontinued operations as required by Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (Note 4) .

Use of Estimates

The preparation of combined financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates.

Cash and Cash Equivalents

Cash and cash equivalents are defined as cash on hand and in banks plus all short-term investments with an original maturity of three months or less.

F-16

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

The Company maintains cash and cash equivalents and certain other financial instruments with various financial institutions. These financial institutions are located throughout the country and the Company’s policy is designed to limit exposure to any one institution. The Company performs periodic evaluations of the relative credit standing of those financial institutions that are considered in the Company’s investment strategy. At December 31, 2003 and 2002, the Company had amounts in banks that were in excess of federally insured amounts.

Restricted Cash

Restricted cash is comprised of reserve accounts for debt service, interest reserves, capital replacements, and ground leases, property taxes and insurance impounds. These restricted funds are subject to supervision and disbursement approval by certain of the Company’s lenders.

Accounts Receivable

Accounts receivable primarily represents receivables from hotel guests who occupy hotel rooms and utilize hotel services. Accounts receivable also includes receivables from customers who utilize the Company’s laundry facilities in Salt Lake City, Utah, and Rochester, Minnesota. The Company maintains an allowance for doubtful accounts sufficient to cover potential credit losses. The Company’s accounts receivable at December 31, 2003 and 2002 includes an allowance for doubtful accounts of $847,000 and $995,000, respectively.

Inventories

Inventories, consisting primarily of food and beverages, are stated at the lower of cost or market, with cost determined on a method that approximates first-in, first-out basis.

Investments In Hotel Properties, Other Real Estate and Franchise Fees

Hotel properties and other real estate assets are recorded at cost, less accumulated depreciation. During periods of construction or major renovation, direct construction costs and carrying costs such as interest, property taxes and insurance are capitalized to the real estate project while under development until the project is ready for its intended use. Hotel properties and other completed real estate investments are depreciated using the straight-line method over estimated useful lives ranging from five to 35 years for buildings and improvements and three to 12 years for furniture, fixtures and equipment.

Initial franchise fees are recorded at cost and amortized using the straight-line method over the lives of the franchise agreements ranging from seven to 20 years. All other franchise fees that are based on the Company’s results of operations are expensed as incurred.

Effective January 1, 2002, the Company adopted the requirements of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets . SFAS 144 requires impairment losses to be recorded on long-lived assets to be held and used by the Company when indicators of impairment are present and the future undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. When an impairment loss is required for assets to be held and used by the Company, the related assets are adjusted to their estimated fair values.

F-17

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

As a result of a depressed state in certain markets of the hotel industry, at December 31, 2003 and 2002, the Company determined that the carrying values of certain hotels were no longer recoverable based on estimated future undiscounted cash flows to be generated from these hotels. As a result, the Company recognized an impairment loss, exclusive of impairment of discontinued operations (Note 4) and goodwill, of $9.3 million in 2003, based on the difference between the carrying values and the fair values of the hotels as determined by the Company based on supporting factors such as net operating cash flows, terminal capitalization rates and replacement costs. These hotels continue to be held for use by the Company and, accordingly, the hotel impairment loss is included in continuing operations for the years ended December 31, 2003. There was no related impairment charge in 2002. Based on the Company’s review, management believes that there were no other impairments on its long-lived assets held for use and that the carrying values of its hotel properties and other real estate are recoverable at December 31, 2003.

Fair value represents the amount at which an asset could be bought or sold in a current transaction between willing parties, that is, other than a forced or liquidation sale. The estimation process involved in determining if assets have been impaired and in the determination of fair value is inherently uncertain because it requires estimates of current market yields as well as future events and conditions. Such future events and conditions include economic and market conditions, as well as the availability of suitable financing. The realization of the Company’s investment in hotel properties and other real estate is dependent upon future uncertain events and conditions and, accordingly, the actual timing and amounts realized by the Company may be materially different from their estimated fair values.

Deferred Financing Costs

Deferred financing costs consist of loan fees and other financing costs related to the Company’s notes payable and revolver loans and are amortized to interest expense over the terms of the related debt.

Deferred financing costs have been allocated to the underlying hotel properties based on their relative fair values. Whenever the underlying debt is paid off, any related unamortized deferred financing cost is charged to interest expense. During 2003, 2002, and 2001 the Company incurred and paid approximately $9.1 million, $6.5 million, and $1.0 million respectively, related to debt refinancings for certain hotel properties. Such refinancing costs are being amortized over the related terms of the loans.

Interest expense related to the amortization of deferred financing costs was $7.8 million, $5.4 million, and $9.0 million for the years ended December 31, 2003, 2002, and 2001, respectively.

Goodwill

Goodwill of $67.6 million was originally recorded in connection with the 1999 acquisitions consummated by SHI (Note 1) and was amortized through December 31, 2001. Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). Under SFAS No. 142, goodwill and intangible assets deemed to have indefinite lives are subject to annual impairment tests. As a result, the carrying value of goodwill allocated to the hotel properties and other real estate is reviewed at least annually and when facts and circumstances suggest that it may be impaired. Such review entails comparing the carrying value of the individual hotel property (the reporting unit) including the allocated goodwill to the fair value determined for that hotel property. If the aggregate carrying value of the hotel property exceeds the fair value, the

F-18

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

goodwill of the hotel property is impaired to the extent of the difference between the fair value and the aggregate carrying value, not to exceed the carrying amount of the allocated goodwill. As a result of the depressed state in certain markets of the hotel industry, the Company determined that the carrying values of some of the reporting units were no longer recoverable based on the estimated future cash flows to be generated by these reporting units. The fair values of the reporting units were determined using factors such as net operating cash flows, terminal capitalization rates and replacement costs. Application of SFAS No. 142 resulted in a decrease of amortization expense of approximately $6.8 million for the years ended December 31, 2003 and 2002.

The Company’s review at December 31, 2003 and 2002 indicated that the remaining allocated goodwill for certain hotel properties was impaired resulting in a $2.1 million and $9.4 million of goodwill impairment loss recorded for the years ended December 31, 2003 and 2002, respectively. Prior to January 1, 2002, goodwill was amortized on a straight-line basis over ten years.

Property and Equipment

Property and equipment is stated on the cost basis and includes computer equipment and other corporate office equipment and furniture. Property and equipment is depreciated on a straight-line basis over the estimated useful lives ranging from three to five years. The cost basis of property and equipment amounted to $5.4 million and $4.4 million at December 31, 2003 and 2002, respectively. Accumulated depreciation amounted to $3.0 million and $2.2 million at December 31, 2003 and 2002, respectively. Property and equipment net of related accumulated depreciation is included in other assets.

Derivative Financial Instruments

The Company accounts for derivative financial instruments in accordance with the requirements of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , as amended (“SFAS No. 133”). SFAS No. 133 requires the Company to recognize all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and resulting designation. Derivatives that are not hedges must be adjusted to fair value through income. Gains and losses on sale of derivative instruments are also reported in the statements of operations. The transition adjustment to implement this new standard on January 1, 2001, which presented as a cumulative effect of change in accounting principle, reduced the Company’s earnings by $1.3 million for the year ended December 31, 2001 (Note 6).

Fair Value of Financial Instruments

As of December 31, 2003 and 2002, the carrying amount of certain financial instruments held by the Company, including cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses were representative of their fair values due to the short-term maturity of these instruments. A significant portion of debt has interest rates that fluctuate based on published market rates. The Company’s fixed-rate mortgage debt is at commensurate terms with similar debt instruments based on risk, collateral, and other characteristics. Management believes the carrying value of the mortgage and other debt is a reasonable estimation of its fair value as of December 31, 2003 and 2002. Interest rate cap agreements have been recorded at their estimated fair values.

Revenue Recognition

Room revenue and food and beverage revenue are recognized as earned, which is generally defined as the date upon which a guest occupies a room and/or utilizes the hotel’s services. Additionally, some of the

F-19

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

Company’s hotel rooms are booked through an independent Internet travel intermediary. Revenue for these rooms is booked at the price the Company sold the room to the independent Internet travel intermediary less any discount or commission paid.

Other operating revenues consist of revenues derived from incidental hotel services such as concessions, movie rentals, golf operations, retail sales, fitness services, internet access, telephone, sublease revenues relating to the restaurants and retail shops, and management fees from third-party management agreements. In addition, as an adjunct to the Company’s hotels located in Rochester, Minnesota and Salt Lake City, Utah, the Company operates commercial laundries at those locations providing laundry services to the Company’s hotels and other third parties in the respective locations. Revenues from incidental hotel services, management agreements, and laundry services are recognized in the period the related services are provided. The Company also has an online purchasing platform (“Buy Efficient, L.L.C.”) that offers volume discounts to third parties. Revenues generated by Buy Efficient, L.L.C. include transactions fees, development fees, hardware sales and rebate sales. The Company charges the third party for the installation associated with configuring the third party’s information technology system with the purchasing platform and access rights to the purchasing platform. Fees for the installation are typically based on time and materials and are recognized as the services are performed. Fees associated with access rights are based on a percentage of the price of goods purchased by the third party from the vendor and are recognized as incurred.

Management and other fees from affiliates consist of management fees, acquisition fees, and disposition fees earned from services provided to affiliates of the Company and affiliates of Westbrook (collectively, the “Affiliates”). Management fees and accounting fees are recognized as services are rendered. Acquisition and disposition fees are recognized upon successful closings. Incentive fees are not recognized until earned. No incentive fees were earned for the years ended December 31, 2003, 2002, and 2001 (Note 13).

Advertising and Promotion Costs

Advertising and promotion costs are expensed when incurred. Advertising and promotion costs represent the expense for franchise advertising and reservation systems under the terms of the hotel franchise agreements and general and administrative expenses that are directly attributable to advertising and promotions.

Income Taxes

The Company is treated as a partnership for federal and most state income tax purposes. However, certain states may impose entity level taxes and fees. In addition, the Company owns various corporations included in these combined financial statements which are subject to federal and state income taxes. These corporations are owned through a series of partnerships and limited liability companies and cannot be consolidated for federal and/or state income tax purposes.

With respect to taxable subsidiaries, the Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Accordingly, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse.

F-20

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

Pension Accounting

The Company measures and accounts for its pension obligations under the provisions of SFAS No. 87, Employers’ Accounting for Pensions, and follows the disclosure requirements of SFAS No. 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits . In December 2003, SFAS No. 132 was amended to require additional disclosures including disclosure of the benefits expected to be paid in each of the next five fiscal years, and in the aggregate for the five fiscal years thereafter.

Minority Interest

Minority interests represent the limited partners interest in limited partnerships that are controlled by WB IV. The carrying value of the minority interest has been increased by the minority interests share of WB IV earnings and reduced by WB IV partnership cash distributions as well as return of capital distributions (see Note 13).

Comprehensive Income (Loss)

The Company reports and displays comprehensive income (loss) and its components in accordance with SFAS No. 130, Reporting Comprehensive Income (“SFAS No. 130”). SFAS No. 130 requires that the Company’s minimum pension liability adjustment be included in other comprehensive income (loss).

Segment Reporting

Under the provision of SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information , the Company’s operations are at this time conducted and aggregated under one segment, hotel operations.

New Accounting Standard

In January 2003, the Financial Accounting Standards Boards (“FASB”) issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities , an interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements (“FIN 46”). This interpretation requires an existing unconsolidated variable interest entity to be consolidated by its primary beneficiary if the entity does not effectively disperse risk among all parties involved or if other parties do not have significant capital to finance activities without subordinated financial support from the primary beneficiary. The primary beneficiary is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both as a result of holding variable interests, which are the ownership, contractual, or other pecuniary interests in an entity. FASB Interpretation No. 46 was revised in December 2003 (“FIN 46(R)”) and effectively replaces FIN 46. While retaining a majority of the provisions and concepts of FIN 46, FIN 46(R) provides additional scope exceptions and clarifies the description of variable interests. Public companies are required to apply FIN 46(R) no later than the end of the first reporting period that ends after March 15, 2004. However, prior to the required application of FIN 46(R), public companies are required to apply either FIN 46 or FIN 46(R) to any interests in special purpose entities as of the first interim or annual period ending after December 15, 2003.

Effective January 1, 2004, the Company anticipates consolidating one variable interest entity related to an option agreement to purchase the hotel under development (Note 11). The net impact of adopting FIN 46 is expected to increase hotel properties and liabilities by approximately $38.8 million.

F-21

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

3. Investment in Hotel Properties

Investment in hotel properties consisted of the following (in thousands):


	December 31,
	2003			2002
Land	$	147,554		$	145,035
Buildings and improvements		1,065,991			1,130,738
Fixtures, furniture and equipment		148,708			140,715
Franchise fees		3,087			3,383
Construction in process		17,703			2,005

		1,383,043			1,421,876
Accumulated depreciation and amortization		(155,506	)		(105,217	)

	$	1,227,537		$	1,316,659

During 2003, the Company sold seven hotel properties for net proceeds of $119.3 million and realized net gains of $14.8 million. The gain on sale was included in discontinued operations in the accompanying combined statements of operations, as required by SFAS No. 144.

During 2003, the Company acquired two hotel properties for an aggregate purchase price of $41.9 million.

WB IV was formed on December 17, 2002, and commenced operations effective with the acquisitions of 15 hotel properties that were wholly owned or substantially owned by Wyndham International, Inc. in December 2002 for $525.3 million. These acquisitions were consummated with new financings in the amount of $421.4 million and cash contributions aggregating $129.5 million from its members. The purchase price was recorded in accordance with SFAS Nos. 141 and 142, and did not result in any goodwill or intangible asset.

In March 2002, the Company sold a hotel property held for sale for net proceeds of $6.2 million and realized a loss on disposal of $43,000. The loss on sale was included in discontinued operations in the accompanying combined statements of operations, as required by SFAS No. 144.

During 2001, the Company sold 13 hotel properties for net proceeds of $173.7 million and realized a gain on disposal of $262,000. The gain on sale was included in discontinued operations in the accompanying combined statements of operations, as required by SFAS No. 144.

F-22

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

4. Discontinued Operations

Subsequent to December 31, 2003, as part of the Company’s strategic plan to dispose of non-core hotel assets, management has identified in its disposition plan six hotel properties to be sold during 2004. Three of the hotel properties were sold in April and May 2004 for net proceeds of $29.4 million and a net loss on sale of $280,000 (Note 14). These six hotel properties met the “held for sale” and “discontinued operations” criteria in accordance with SFAS 144 as of March 31, 2004. The following sets forth the Company’s discontinued operations for the years ended December 31, 2003, 2002 and 2001 related to hotel properties held for sale through June 30, 2004 (in thousands):


	Year Ended December 31,
	2003			2002			2001
Operating revenues	$	66,160		$	54,437		$	75,891
Operating expenses		(52,767	)		(43,766	)		(55,630	)
Interest expense		(6,262	)		(5,172	)		(15,767	)
Depreciation and amortization		(7,007	)		(5,732	)		(8,023	)
Impairment loss		(16,991	)		(9,658	)		(3,985	)
Gain (loss) on disposal		14,757			(43	)		262
Cumulative effect of change in accounting principle		—			—			(680	)
Benefit from (provision for) income taxes		847			(331	)		300

Loss from discontinued operations	$	(1,263	)	$	(10,265	)	$	(7,632	)

5. Other Real Estate

Other real estate consisted of the following (in thousands):


	December 31,
	2003			2002
Laundry facilities:
Land	$	1,600		$	1,600
Buildings and improvements		4,428			4,428
Fixtures, furniture and equipment		3,220			2,288

		9,248			8,316
Accumulated depreciation		(1,731	)		(1,296	)

		7,517			7,020
Land held for future development or sale		250			250

	$	7,767		$	7,270

F-23

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

6. Derivative Financial Instruments

At December 31, 2003 and 2002, the Company held interest rate cap agreements (“derivatives”) to manage its exposure to the interest rate risks related to its floating rate debt. The fair values of the Company’s derivatives are recorded as interest rate cap agreements assets on the consolidated balance sheets for the years ended December 31, 2003 and 2002. During 2001, in speculation that the interest rates may rise, the Company entered into interest rate swaps, in which the Company agreed to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to agreed-upon notional principal amounts. The interest rate swaps matured in 2002, and as a result, the Company recorded a valuation change of approximately $5.4 million as a result of the changes in fair value of the interest rate swaps from December 31, 2001 to the maturity dates. None of the Company’s derivatives held at December 31, 2003 and 2002 qualify for effective hedge accounting treatment under SFAS No. 133. Accordingly, changes in the fair value of the Company’s derivatives at December 31, 2003 and 2002 resulted in a net loss of $1.4 million and a net increase of $5.0 million (including the valuation change realized at maturity of the interest rate swaps of $5.4 million), respectively. The changes in fair value have been reflected as an increase in interest expense for the year ended December 31, 2003 and a decrease in interest expense for the year ended December 31, 2002.

The following table summarizes the Company’s interest rate cap agreements at December 31 (dollars in thousands):


	2003			2002
Notional amount of variable rate debt	$	775,500		$	902,500
Fair value of interest rate caps	$	540		$	1,255
Interest rate cap rates		4.45% - 7.19	%		4.96% - 8.40	%
Maturity dates		July 2004 - May 2006			July 2003 - January 2006

7. Other Current Liabilities

Other current liabilities consisted of the following (in thousands):


	December 31,
	2003		2002
Property, sales, and use taxes payable	$	8,930	$	9,488
Worker’s compensation		7,769		4,959
Accrued interest mortgage		2,763		2,094
Advanced deposits		2,781		2,664
Other current liabilities		3,070		2,184

	$	25,313	$	21,389

F-24

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

8. Notes Payable

Notes payable consisted of the following at December 31 (in thousands):


	2003			2002
Notes payable requiring payments of interest and principal, with interest at rates ranging from variable of one-month LIBOR plus 2.80% to 3.60% to fixed rates ranging from 8.51% to 9.88%; maturing at dates ranging from July 2004 through June 2013. The notes are collateralized by first deeds of trust on 59 hotel properties and one laundry facility	$	822,733		$	852,649

Unsecured revolving line of credit in the amount of $7.0 million requiring monthly payments of interest only at one-month LIBOR plus 3.75% on the drawn portion of the line of credit and quarterly payments of 0.50% on the average unused portion of the line of credit during the previous quarter. The revolving line of credit matures in September 2004 and is collateralized by a repayment guarantee		800			500

Industrial development bonds requiring monthly payments of principal and interest at a variable rate which averaged 1.10% during 2003 and were redeemed and paid in full in 2003		—			12,125

Notes payable requiring monthly payments of principal and interest at 8.25%. The notes mature in November 2023 and are collateralized by a leasehold mortgage, assignment of leases and rents, and security agreement and fixture filing on two hotel properties		75,936			77,149

Mezzanine note payable requiring monthly payments of interest only through March 2004, and thereafter, principal at $90,915 per month plus interest at the greater of 2.50% or one-month LIBOR plus 8.00%. The note matures in October 2005 and is collateralized by a pledge agreement granting a security interest in the Company’s assets		18,183			—

		917,652			942,423
Less: current portion		(25,804	)		(477,141	)

	$	891,848		$	465,282

At December 31, 2003, the Company has a construction loan outstanding in the committed amount of $6.3 million related to a hotel under construction. No amount has yet been drawn on the loan as of December 31, 2003. The loan is collateralized by the hotel under construction and when drawn requires monthly payments of interest only at one-month LIBOR plus 3.25%. The loan has a maturity date of May 2006.

At December 31, 2003, the Company had a loan forward commitment of $24.3 million dated September 2003, with monthly payments of principal and interest at the greater of 5% or the sum of the borrower-selected LIBOR-based index (1.12% at December 31, 2003) plus 3.50% with amortization at a fixed payment amount of $28,000 per month beginning in the thirteenth month after loan funding. The loan will mature four years from loan funding, and is to be collateralized by a first deed of trust on one hotel. No amounts were funded at December 31, 2003. The purpose of the loan forward commitment was to provide funds to acquire a hotel located in Cherry Creek, Colorado (Note 11).

F-25

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

Total interest incurred and expensed on the notes payable is as follows (in thousands):


	Year Ended December 31,
	2003		2002		2001
Interest expense—continuing operations	$	45,237	$	27,988	$	33,844
Interest expense—discontinued operations		4,761		6,185		9,552
Prepayment penalty paid—continuing operations		2,099		—		—
Prepayment penalty paid—discontinued operations		179		—		—

	$	52,276	$	34,173	$	43,396

Aggregate future principal maturities of notes payable at December 31, 2003, are as follows (in thousands):


2004	$	25,804
2005		168,952
2006		315,964
2007		319,474
2008		2,746
Thereafter		84,712

	$	917,652

9. Income Taxes

The income tax benefit (provision) included in the combined statements of operations is as follows (in thousands):


	Year Ended December 31,
	2003			2002			2001
Current:
Federal	$	(271	)	$	(12	)	$	—
State		(105	)		(724	)		—

		(376	)		(736	)		—

Deferred:
Federal		4,356			1,805			14,275
State		952			595			2,404

		5,308			2,400			16,679

Valuation allowance		(2,068	)		2,720			(7,609	)

Income tax benefit	$	2,864		$	4,384		$	9,070

F-26

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

Benefit from (provision for) income taxes applicable to continuing operations and discontinued operations is as follows (in thousands):


	Year Ended December 31,
	2003			2002			2001
Benefit from (provision for) continuing operations:
Current	$	(329	)	$	(718	)	$	—
Deferred		2,346			5,433			8,770

Benefit from continuing operations		2,017			4,715			8,770


Benefit from (provision for) discontinued operations:
Current		(47	)		(18	)		—
Deferred		894			(313	)		300

Benefit from (provision for) discontinued operations		847			(331	)		300

Benefit from income taxes	$	2,864		$	4,384		$	9,070

Income tax benefits primarily arose as a result of certain intercompany transactions that resulted in the reduction of deferred income tax liability that was recorded in connection with the November 22, 1999 going private transaction (Note 1).

For the years ended December 31, 2003, 2002 and 2001, the provision for income taxes differs from the federal statutory rate primarily because (i) a significant portion of the Company’s income is earned in partnerships, and, as such, is not subject to federal or most state income tax; and (ii) the goodwill associated with impairment losses is not deductible.

The tax effects of temporary differences giving rise to the Company’s deferred tax assets (liabilities) are as follows (in thousands):


	December 31,
	2003			2002
Deferred tax assets:
NOL carryover	$	13,898		$	9,800
State taxes and other		2,727			3,493
Other reserves		3,337			2,914

Current deferred tax asset before valuation allowance		19,962			16,207


Deferred tax liabilities:
Depreciation		(50,028	)		(51,576	)
Other		(21	)		(27	)

		(50,049	)		(51,603	)

Net deferred tax liabilities		(30,087	)		(35,396	)
Valuation allowance		(13,525	)		(11,457	)

	$	(43,612	)	$	(46,853	)

Substantially all of the Company’s deferred tax liabilities at December 31, 2003 and 2002 were due to the lower tax bases of its hotel assets in comparison to the book bases as a result of the structure used by SHI in the

F-27

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

November 22, 1999 transaction (Note 1). The November 22, 1999 transaction was accounted for using the purchase method of accounting, which resulted in the carrying value of the Company’s assets held by the Company’s taxable subsidiaries to be significantly higher than their related carry over tax bases.

The Company maintains a valuation allowance to offset a portion of its deferred tax assets due to uncertainties surrounding their realization.

At December 31, 2003 and 2002, the Company had federal net operating loss carryforwards of $35.2 million and $24.6 million, respectively, which begin to expire in 2019.

As of December 31, 2003 and 2002, the Company had state net operating loss carryforwards of $19.9 million and $12.0 million, respectively, which begin to expire in 2011.

10. Members’ Equity

Members’ capital account balances consisted of the following:


	December 31,
	2003			2002
SHI	$	173,159		$	237,953
WB		29,534			32,100
WB IV		131,517			132,780
Eliminations		(2,123	)		(1,975	)

Combined total	$	332,087		$	400,858

SHI Capital Accounts

SHI has four classes of membership equity units. WB and WB IV have only one class of equity units. The SHI classes’ respective distribution rights are as follows:

•

Class A Units —Former OP unitholders not electing to receive cash in the November 22, 1999 transaction (Note 1) could have elected to receive Class A units or Class B units. None elected Class A units and, accordingly, none were issued.

•

Class B Units —These units were issued to (i) Westbrook, Alter, Biederman and electing OP unitholders in exchange for their initial capital contributions. Since there are no Class A units issued, Class B unitholders receive a first priority distribution equal to a 15% cumulative, compounded quarterly return on initial capital contributions, then distributions equal to their initial contributions. All of these distributions are to be pro rata based on the number of Class B units outstanding. Through December 31, 2003 and 2002, the 15% cumulative priority distribution for the Class B unitholders amounted to $258.8 million and $186.7 million, respectively, of which $112.2 million and $76.8 million, respectively, had been paid.

•

Class C Units —These are nonvoting units that were issued to Messrs. Alter and Biederman and certain SHI management members and represent rights to participate in future income and loss allocations and distributions. These unitholders are to receive an aggregate $12.5 million in distributions after the Class B unitholders have received 100% of their accrued preferred return and initial capital contributions.

F-28

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

•

Class D Units —Similar to the Class C units, these are nonvoting units that were issued to Messrs. Alter and Biederman and certain SHI management members and represent rights to participate in future income and loss allocations and distributions only. After the Class B and Class C unitholders have received the distributions specified above, the remaining income and distributions will be allocated pro rata 12.5% to the Class D unitholders and 87.5% to the Class B unitholders on a pro rata basis.

The SHI’s capital account balances at December 31, 2003 are as follows (dollars in thousands):


	Class B			Class C			Class D
	Units	Amount		Units	Amount		Units	Amount
Westbrook SHP L.L.C.	15,450,954	$	78,268	—	$	—	—	$	—
Westbrook Real Estate Fund III, L.P.	16,248,343		82,250	—		—	—		—
Westbrook Real Estate Co-Investment Partnership III, L.P.	617,469		3,117	—		—	—		—
Alter SHP LLC	1,469,909		7,446	697,095		—	501.0		—
Biederman SHP LLC	382,647		1,905	96,375		—	100.0		—
Other members	38,156		173	411,222		—	399.0		—

Total SHI members’ capital	34,207,478	$	173,159	1,204,692	$	—	1,000.0	$	—

The SHI members’ capital account balances at December 31, 2002 are as follows (dollars in thousands):


	Class B			Class C			Class D
	Units	Amount		Units	Amount		Units	Amount
Westbrook SHP L.L.C.	15,450,954	$	107,554	—	$	—	—	$	—
Westbrook Real Estate Fund III, L.P.	16,248,343		113,028	—		—	—		—
Westbrook Real Estate Co-Investment Partnership III, L.P.	617,469		4,283	—		—	—		—
Alter SHP LLC	1,469,909		10,232	697,095		—	501.0		—
Biederman SHP LLC	382,647		2,617	96,375		—	100.0		—
Other members	38,156		239	411,222		—	399.0		—

Total SHI members’ capital	34,207,478	$	237,953	1,204,692	$	—	1,000.0	$	—

The SHI members’ capital accounts are increased for the members’ contributions of cash or fair market value of other property contributed and for the SHI members’ allocable share of Net Income, as defined, and decreased with distributions of cash or fair market value of other property and the SHI members’ allocable share of Net Loss, as defined (Note 1). Pursuant to the Operating Agreement, no SHI member shall have any obligation to restore any negative balance in the SHI member’s capital account.

Other SHI member’s capital at December 31, 2003 and 2002 has been reduced by approximately $230,000 and $241,000, respectively, representing the outstanding balance of a note receivable plus unpaid accrued interest related to financing provided to a unitholder by SHI.

The founding SHI members are required to make Additional Capital Contributions, as defined, only to the extent additional funds are required by SHI in connection with Emergency Expenses, as defined in the Operating Agreement.

F-29

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

WB Capital Accounts

The WB capital account balances are as follows (in thousands):


	December 31,
	2003		2002
Westbrook Real Estate Fund III, L.P.	$	27,029	$	29,378
Westbrook Real Estate Co-Investment Partnership III, L.P.		1,027		1,116
L/S Investors, L.L.C.		1,478		1,606

	$	29,534	$	32,100

WB IV Capital Accounts

The WB IV capital account balances are as follows:


	December 31,
	2003		2002
Westbrook Real Estate IV, L.P.	$	124,810	$	126,008
Westbrook Real Estate Co-Investment Partnership IV, L.P.		4,735		4,780
Fund IV Sun Investors, L.L.C.		1,972		1,992

	$	131,517	$	132,780

11. Commitments and Contingencies

Franchise Agreements

The Company entered into various license and franchise agreements related to certain hotel properties. The franchise agreements require the Company to, among other things, pay various monthly fees that are calculated based on specified percentages of certain specified revenues. The franchise agreements generally contain specific standards for, and restrictions and limitations on, the operation and maintenance of the hotels which are established by the franchisors to maintain uniformity in the system created by each such franchisor. Such standards generally regulate the appearance of the hotel, quality and type of goods and services offered, signage and protection of trademarks. Compliance with such standards may from time to time require significant expenditures for capital improvements which will be borne by the Company.

Total franchise costs incurred by the Company during the years ended December 31, 2003, 2002 and 2001 were $25.7 million, $17.3 million and $19.0 million, of which $14.2 million, $9.6 million and $10.2 million, respectively, were for franchise royalties. The remaining franchise costs include advertising, reservation and priority club assessments.

In connection with the 1999 acquisition by SHI (Note 1), the Company obtained franchisor consents from the Company’s various franchisors, which, among other things, required the Company to execute new franchise agreements and pay certain fees. One of the Company’s franchisors stipulates in the franchise agreement that in the event certain membership interests are acquired by the Company, the Company will be liable to that

F-30

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

franchisor in the amount of $961,000, plus accrued interest. The Company does not currently contemplate acquiring such membership interest held by that certain member and, accordingly, did not accrue such amount at December 31, 2003 and 2002.

Renovation and Construction Commitments

At December 31, 2003 and 2002, the Company has various contracts outstanding with third parties in connection with the renovation of certain of the Company’s hotel properties. The Company’s remaining commitments under these contracts at December 31, 2003 and 2002 totaled $17.8 million and $1.1 million, respectively.

During 2002, the Company entered into an agreement with an unrelated third-party contractor to develop and construct a hotel located in Cherry Creek, Colorado. In June 2004, upon completion of the construction phase and prior to the end of the inspection contingency phase, the Company will purchase the completed hotel from the contractor for approximately $38.8 million. (Note 14)

Operating Leases

At December 31, 2003, the Company was obligated under the terms of nine ground leases and a lease on the corporate facility, which mature from dates ranging from 2005 through 2096. Future minimum payments under the terms of the operating leases in effect at December 31, 2003 are as follows (in thousands):


2004	$	4,549
2005		4,120
2006		3,793
2007		3,793
2008		3,759
Thereafter		205,323

	$	225,337

Rent expense incurred pursuant to these operating lease agreements totaled $4.9 million, $3.1 million and $2.7 million for the years ended December 31, 2003, 2002 and 2001, respectively, and was included in real estate and personal property taxes and insurance in the accompanying statements of operations.

Employment Agreements

The Company has employment agreements with certain executive employees, which expire through January 2008. The terms of the agreements stipulate payments of base salaries, bonuses and certain phantom equity awards. The holders of the phantom equity units are entitled to compensation payments on a per unit basis equal to distributions that are made to Class B unitholders of SHI. Total distributions to the holders of the phantom equity units amounted to $181,000, $90,000 and $91,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Such distributions were included as salaries and wages, which were included in general and administrative expenses in the accompanying statements of operations.

Loans

In connection with the November 22, 1999 transaction (Note 1), the Company entered into a promissory note in favor of one of its executives, due October 1, 2009, in a principal amount of $650,000, with interest

F-31

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

payable at the rate of 8% per year. Concurrently, the executive entered into a promissory note in favor of a subsidiary of the Company, due October 1, 2009, in a principal amount of $650,000, with interest payable at the rate of 8% per year. Neither of these notes has been materially modified since the inception date.

On July 1, 2003, the Company loaned one of its executives $100,000 for relocation expenses pursuant to a promissory note with interest payable at the rate of 6% per year and a maturity of April 21, 2007. The Company has agreed to waive 25% of the original principal and accrued interest due to it on each succeeding April 21. In June 2004, the remaining $75,000 principal amount of the note was forgiven.

SHI’s other members’ capital at December 31, 2003 and 2002 includes a reduction of approximately $230,000 and $241,000, respectively, representing the outstanding balance of a note receivable plus unpaid accrued interest related to financing provided to a unitholder (also a former executive of the Company).

Approximate minimum future obligations under employment agreements are as follows as of December 31, 2003 (in thousands):


2004	$	1,553
2005		1,386
2006		1,437
2007		964

	$	5,340

Litigation

During 2003, a suit against the Company was filed for $6.0 million by a hotel guest who became ill and alleged the illness resulted from exposure to a Legionella bacteria during a stay at one of the Company’s hotels. The Company has liability insurance to potentially cover this claim subject to certain insurance deductibles. The litigation has just commenced and the Company and the insurance company’s lawyers have not been able to assess the exposure, if any, to the Company associated with this litigation.

Additionally, the Company is involved from time to time in various claims and other legal actions in the ordinary course of business. Management does not believe that the resolution of such additional matters will have a material adverse effect on the Company’s financial position or results of operations when resolved.

Collective Bargaining Agreements

The Company is subject to collective bargaining agreements at certain hotels it operates. At December 31, 2003 and 2002, the percentage of employees covered by such collective bargaining agreements represent approximately 13% and 12%, respectively, of the total number of employees.

12. Retirement Plans

Defined Benefit Retirement Plan

The Company sponsors a defined benefit retirement plan covering union employees at certain properties located in Rochester, Minnesota. Pension contributions and expenses for this plan are determined based on the actuarial cost of current service. In December 2003, the FASB issued SFAS No. 132 (revised December 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits” (SFAS 132-R). This statement

F-32

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

amends the disclosure requirements of SFAS 132 to require more details about retirement plan assets, benefit obligations, cash flows and other relevant information. SFAS 132-R is effective for years ending after December 15, 2003, except certain benefit payment and international plan disclosures that are effective for fiscal years after June 15, 2004. The adoption of the disclosure provisions of SFAS 132-R did not have a material effect on the Company’s combined financial statements.

The Company’s funding policy with respect to its qualified pension plan is to contribute annually not less than the minimum required by applicable law and regulations. The Company made pension contributions of $507,000 in 2003, $552,000 in 2002, and $414,000 in 2001. The Company does not have any contributions due in 2004 for its pension plan to meet ERISA minimum funding requirements or to avoid paying variable rate premiums to the Pension Benefit Guaranty Corporation. The Company expects to contribute approximately $571,000 to its pension plan during 2004. The Company uses a December 31 measurement date for its pension plan.

The accumulated benefit obligation (“ABO”), the projected benefit obligation (“PBO”), the fair value of plan assets, and related pension balance sheet accounts at December 31 are as follows (in thousands):


	2003			2002
ABO	$	5,792		$	5,311

Change in the PBO
PBO at beginning of period	$	5,311		$	4,505
Service cost		178			150
Interest cost		336			323
Benefits paid		(233	)		(264	)
Actuarial loss		200			597

PBO at end of period	$	5,792		$	5,311

Change in the fair value of plan assets
Fair value of assets at beginning of period	$	3,169		$	3,209
Employer contributions		507			552
Benefits paid		(233	)		(264	)
Actual return on assets		711			(328	)

Fair value of assets at end of period ⁽¹⁾	$	4,154		$	3,169

Components of prepaid (accrued) pension cost
Funded status	$	(1,638	)	$	(2,142	)
Unrecognized net actuarial loss		1,742			2,116

Prepaid (accrued) pension cost	$	104		$	(26	)

Amounts recognized in the statement of financial position
Accrued pension cost	$	(1,638	)	$	(2,142	)
Accumulated other comprehensive loss		1,742			2,116

Net amount recognized in balance sheet	$	104		$	(26	)

Key economic assumptions Discount rate		6.00	%		6.25	%

(1)	Plan assets consist primarily of equity and fixed-income securities.

F-33

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

Net periodic pension cost for the defined benefit plan and the change in other comprehensive loss for the years ended December 31, 2003, 2002, and 2001 are as follows (in thousands):


	2003			2002			2001
Components of the net periodic pension cost
Service cost	$	178		$	150		$	150
Interest cost		336			323			312
Expected return on plan assets		(267	)		(272	)		(285	)
Amortization of unrecognized net actuarial loss		130			48			—

Net periodic pension cost	$	377		$	249		$	177

Decrease (increase) adjustment to accumulated other comprehensive loss from change in minimum pension liability	$	374		$	(1,149	)	$	(604	)

Key economic assumptions
Discount rate		6.25	%		7.00	%		7.00	%
Expected long-term return on plan assets		8.00	%		8.00	%		8.00	%

The Company sets the discount rate assumption annually for its plan at its measurement date to reflect the yield of a portfolio of high quality, fixed-income debt instruments matched against the timing and amounts of projected future benefits.

The Company’s expected return on assets assumption is derived from a detailed periodic study conducted by the Company’s actuaries. The study includes a review of the asset allocation strategy, anticipated future long-term performance of individual asset classes, risks (standard deviations) and correlations for each of the asset classes that comprise the funds and asset mix. While the study gives appropriate consideration to recent fund performance and historical returns, the assumption is primarily a long-term, prospective rate.

The following table sets forth the actual and target allocation of plan assets (in thousands):


	Target Allocation	2003		2002
Equity securities	45% - 70%	56	%	53	%
Debt securities	30% - 50%	38		39
Other	0% - 10%	6		8

		100	%	100	%

The Company’s investments policy is to maintain the plan assets within the target asset allocation to ensure the plan assets are adequately diversified. Pension plan asset performance and allocations are reviewed quarterly.

F-34

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

The benefits expected to be paid in each of the next five years, and in the aggregate for the five years thereafter as of December 31, 2003 are as follows (in thousands):


2004	$	283
2005		265
2006		269
2007		276
2008		290
Thereafter		1,732

	$	3,115

401(k) Savings and Retirement Plan

The Company’s employees may participate, subject to eligibility, in the Company’s 401(k) Savings and Retirement Plan (the “401(k) Plan”). Employees are eligible to participate in the 401(k) Plan after attaining 21 years of age and performing one year of service and working at least 1,000 hours. Up to three percent of employee contributions are matched by the Company at 50 percent. Matching contributions made by the Company totaled $567,000 and $283,000 for the years ended December 31, 2003 and 2002, respectively.

13. Transactions With Affiliates

Minority Interest

During 2003, the members of WB IV transferred a portion of their interest to a minority for $470,000 in a transaction outside of the Company. In addition, the members of WB IV received a $164,000 contribution from a minority interest for an investment in one of the WB IV hotels. Minority interest at December 31, 2003 consisted of an 8.5% ownership interest by AKM Investment, LLC in one of the WB IV hotels and a 15.32% ownership interest by ABM Investment, LLC in another WB IV hotel.

Management Fees

On May 22, 2002, the Company entered into a management agreement with a Westbrook affiliate to provide management services for the hotel property located in Nashville, Tennessee owned by the Westbrook affiliate. The agreement expires on May 22, 2007 and includes successive one-year renewal options. Pursuant to the agreement, the Company is to receive from the Westbrook affiliate a base management fee of 4.0% of gross operating revenues, as defined. This agreement was terminated in February 2004 following the sale of the hotel.

On May 29, 2002, the Company entered into eight asset management agreements with a Westbrook affiliate to provide asset management services for the hotel properties owned by the Westbrook affiliate. The agreements expire on May 29, 2007 and include successive one-year renewal options. Pursuant to the agreements, the Company is to receive an asset management fee of 1.0% of gross operating revenues, as defined. Only two of the agreements remain in effect due to the sale of six hotel properties in February 2004.

On October 17, 2002, the Company entered into an asset management agreement with a Westbrook affiliate to provide asset management services for the hotel property owned by the Westbrook affiliate. The agreement

F-35

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

shall continue through the earlier of i) the date the lease with the Westbrook affiliate is terminated or ii) the date the asset management agreement is terminated, as defined. Pursuant to the agreement, the Company is to receive from the Westbrook affiliate an asset management fee of 0.25% of gross revenues, as defined. This agreement was terminated in November 2003 following the sale of Palm Beach Ritz Carlton.

For the years ended December 31, 2003, 2002 and 2001, aggregate management fees and asset management fees earned from affiliates totaled $245,000, $116,000 and $0, respectively.

Acquisition Fees

During the year ended December 31, 2002, in connection with successful acquisitions of hotel properties by a Westbrook affiliate, the Company received aggregate acquisition fees in the amount of $78,000, in exchange for rendering services in connection with such acquisitions. Such acquisition fees were recognized as revenue and were included in management and other fees from affiliates. No acquisition fees were earned in 2003 or 2001.

Disposition Fees

During the year ended December 31, 2003, in connection with the successful disposition of a hotel property by a Westbrook affiliate, the Company received a disposition fee in the amount of $460,000, in exchange for rendering services in connection with such disposition. Such disposition fees were recognized as revenue and were included in management and other fees from affiliates. No disposition fees were earned in 2002 or 2001.

Other Reimbursements

From time to time, the Company paid for certain expenses such as payroll, insurance and other costs on behalf of certain affiliates. The affiliates generally reimburse such amounts on a monthly basis. At December 31, 2003 and 2002, amounts owed to the Company by its affiliates amounted to $451,000 and $47,000, respectively, and are included in due from affiliates.

At December 31, 2002, the Company owed a reimbursement to Westbrook affiliates for costs and expenses aggregating $326,000 paid by Westbrook affiliates on the Company’s behalf related to the acquisition of certain hotels. Such amount was was included in accounts payable and accrued expenses at December 31, 2002 and paid in 2003.

14. Subsequent Events (Unaudited)

On April 15, 2004, the Company sold the Hawthorne Suites Hotel located in Anaheim, California, to an unrelated third party. The hotel was sold for net proceeds of $4.5 million, resulting in a loss on the sale of $392,000. The operating results of the hotel were included in discontinued operations in the accompanying combined statements of operations during the years ended December 31, 2003, 2002, and 2001, as required by SFAS No. 144.

On April 28, 2004, the Company purchased the JW Marriott hotel, located in Cherry Creek, Colorado, from an unrelated third party. The hotel was purchased for an aggregate purchase price of $38.8 million.

F-36

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

YEARS ENDED DECEMBER 31, 2003, 2002, and 2001

On May 18, 2004, the Company sold the Holiday Inn Select hotel located in La Mirada, California, to an unrelated third party. The hotel was sold for net proceeds of $17.2 million, resulting in a gain on the sale of $347,000. The operating results of the hotel were included in discontinued operations in the accompanying combined statements of operations during the years ended December 31, 2003, 2002, and 2001, as required by SFAS No. 144.

On May 27, 2004, the Company sold the Holiday Inn hotel located in Anchorage, Alaska, to an unrelated third party. The hotel was sold for net proceeds of $7.7 million, resulting in a loss on the sale of $234,000. The operating results of the hotel were included in discontinued operations in the accompanying combined statements of operations during the years ended December 31, 2003, 2002, and 2001, as required by SFAS No. 144.

On July 2, 2004, Sunstone Hotel Investors, Inc. (“SHI”), that was formed on June 28, 2004, filed Form S-11 with the Securities and Exchange Commission for an initial public offering of its common stock. As further described in the S-11, upon the initial public offering’s closing, SHI plans to contribute a significant portion of its hotel portfolio to an entity controlled by SHI in exchange for an ownership interest in this entity. SHI has had no material operations for the period June 28, 2004 through June 30, 2004.

On August 3, 2004, the Company entered into an agreement to sell the Four Points by Sheraton hotel located in Silverthorne, Colorado, to an unrelated third party for $3.4 million. The operating results of the hotel were included in discontinued operations in the accompanying combined statements of operations during the years ended December 31, 2003, 2002, and 2001, as required by SFAS No. 144.

F-37

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION

DECEMBER 31, 2003

(IN THOUSANDS)


	Encumbrances			Initial costs				Cost Capitalized Subsequent to Acquisition						Gross Amount at December 31, 2003
	Encumbrances			Land		Building and Improvements		Land			Building and Improvements			Land		Building and Improvements		Totals		Accumulated Depreciation		Date of Construction	Date Acquired	Depreciation Life
Crowne Plaza—Grand Rapids	$	14,384		$	1,488	$	15,698	$	—		$	292		$	1,488	$	15,990	$	17,478	$	633	N/A	2002	5-35
Courtyard by Marriott—Fresno		(	c)		950		4,834		(12	)*		391			938		5,225		6,163		751	N/A	1999	5-35
Courtyard by Marriott—Los Angeles		(	c)		—		8,446		—			7,701			—		16,147		16,147		2,375	N/A	1999	5-35
Courtyard by Marriott—Lynnwood		(	c)		1,900		8,864		—			318			1,900		9,182		11,082		1,373	N/A	1999	5-35
Courtyard by Marriott—Riverside		(	c)		395		8,483		—			181			395		8,664		9,059		1,294	N/A	1999	5-35
Courtyard by Marriott—San Diego		(	c)		1,569		15,336		—			1,041			1,569		16,377		17,946		2,375	N/A	1999	5-35
Courtyard by Marriott—Santa Fe		(	c)		2,296		10,412		—			821			2,296		11,233		13,529		1,636	N/A	1999	5-35
Doubletree—Minneapolis		(	d)		1,150		9,953		—			2,208			1,150		12,161		13,311		409	N/A	2002	5-35
Four Points by Sheraton—Silverthorne		(	c)		1,340		7,095		—			(3,212	)*		1,340		3,883		5,223		777	N/A	1999	5-35
Embassy Suites—Chicago		(	e)		79		46,886		—			284			79		47,170		47,249		1,867	N/A	2002	5-35
Embassy Suites—Los Angeles		(	c)		—		21,455		—			2,959			—		24,414		24,414		2,650	N/A	2000	5-35
Hawthorn Suites—Anaheim		(	c)		—		6,234		—			(767	)*		—		5,467		5,467		963	N/A	1999	5-35
Hawthorn Suites—Kent		(	c)		1,744		10,142		—			290			1,744		10,432		12,176		1,562	N/A	1999	5-35
Hawthorn Suites—Sacramento		(	c)		3,517		19,023		—			386			3,517		19,409		22,926		2,912	N/A	1999	5-35
Hilton—Carson		(	c)		1,830		9,969		—			388			1,830		10,357		12,187		1,515	N/A	1999	5-35
Hilton—Del Mar		(	d)		4,106		22,353		—			3,899			4,106		26,252		30,358		895	N/A	2002	5-35
Hilton—Huntington		(	d)		6,730		41,198		—			2,496			6,730		43,694		50,424		1,654	N/A	2002	5-35
Hilton Garden Inn—Lake Oswego		18,183	(g)		2,534		9,400		—			135			2,534		9,535		12,069		1,173	N/A	2000	5-35
Holiday Inn—Anchorage		(	g)		2,510		10,924		—			244			2,510		11,168		13,678		1,495	N/A	2000	5-35
Holiday Inn—Boise		(	g)		2,120		10,314		—			1,298			2,120		11,612		13,732		1,175	N/A	2000	5-35
Holiday Inn—Craig		(	c)		277		5,136		—			1,014			277		6,150		6,427		931	N/A	1999	5-35
Holiday Inn—Flagstaff		(	c)		1,148		5,812		—			189			1,148		6,001		7,149		885	N/A	1999	5-35
Holiday Inn—Hollywood		(	g)		2,880		6,554		—			144			2,880		6,698		9,578		827	N/A	2000	5-35
Holiday Inn—La Mirada		(	c)		3,001		19,958		—			(4,088	)*		3,001		15,870		18,871		3,044	N/A	1999	5-35
Holiday Inn—Mesa		(	c)		1,721		11,356		—			(1,449	)*		1,721		9,907		11,628		1,472	N/A	1999	5-35

F-38

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION—(Continued)

DECEMBER 31, 2003

(IN THOUSANDS)


	Encumbrances		Initial costs		Cost Capitalized Subsequent to Acquisition			Gross Amount at December 31, 2003
	Encumbrances		Land	Building and Improvements	Land	Building and Improvements		Land	Building and Improvements	Totals	Accumulated Depreciation	Date of Construction	Date Acquired	Depreciation Life
Holiday Inn—Price	(	c)	476	6,744	—	47		476	6,791	7,267	1,018	N/A	1999	5-35
Holiday Inn—Provo	(	c)	855	2,345	—	270		855	2,615	3,470	373	N/A	1999	5-35
Holiday Inn—Renton	(	c)	2,120	16,593	—	(7,187	)*	2,120	9,406	11,526	2,101	N/A	1999	5-35
Holiday Inn—Rochester	(	c)	1,100	7,502	—	(504	)*	1,100	6,998	8,098	1,018	N/A	1999	5-35
Holiday Inn—San Diego (Harbor View)	(	c)	875	15,648	—	6,790		875	22,438	23,313	3,353	N/A	1999	5-35
Holiday Inn—San Diego (Mission Valley)	(	c)	—	11,206	—	510		—	11,716	11,716	1,663	N/A	1999	5-35
Holiday Inn Express—San Diego (Old Town)	(	c)	2,070	10,005	—	461		2,070	10,466	12,536	1,527	N/A	1999	5-35
Hyatt—Atlanta	14,500		2,700	15,359	—	(3,338	)*	2,700	12,021	14,721	2,041	N/A	2000	5-35
Hyatt—Newport Beach	(	d)	—	30,549	—	(103	)*	—	30,446	30,446	1,194	N/A	2002	5-35
Kahler Hotel—Rochester	(	f)	3,411	45,349	—	2,812		3,411	48,161	51,572	6,883	N/A	1999	5-35
Kahler Inn & Suites—Rochester	(	c)	1,666	21,582	—	249		1,666	21,831	23,497	3,262	N/A	1999	5-35
Marriott—Houston	(	d)	4,167	19,155	—	(241	)*	4,167	18,914	23,081	793	N/A	2002	5-35
Marriott—Napa Valley	38,699		5,845	21,975	3,000	23,888		8,845	45,863	54,708	5,240	N/A	1999	5-35
Marriott—Ontario	18,819		5,057	18,481	—	223		5,057	18,704	23,761	629	N/A	2003	5-35
Marriott—Ogden	(	c)	1,482	14,416	—	426		1,482	14,842	16,324	2,191	N/A	1999	5-35
Marriott—Park City	(	f)	2,260	17,778	—	1,241		2,260	19,019	21,279	2,898	N/A	1999	5-35
Marriott—Philadelphia	(	d)	3,297	29,710	—	(427	)*	3,297	29,283	32,580	1,159	N/A	2002	5-35
Marriott—Portland	(	g)	5,341	20,705	—	678		5,341	21,383	26,724	2,601	N/A	2000	5-35
Marriott—Provo	(	c)	1,117	18,676	—	247		1,117	18,923	20,040	2,816	N/A	1999	5-35
Marriott—Pueblo	(	c)	—	10,396	—	82		—	10,478	10,478	1,564	N/A	1999	5-35
Marriott—Riverside	(	g)	2,145	8,689	—	2,938		2,145	11,627	13,772	1,226	N/A	2000	5-35
Marriott—Rochester	(	c)	1,851	39,714	—	2,269		1,851	41,983	43,834	6,170	N/A	1999	5-35
Marriott—Salt Lake City	(	c)	—	19,918	—	292		—	20,210	20,210	3,006	N/A	1999	5-35
Marriott—Troy	(	d)	2,701	45,814	—	1,409		2,701	47,223	49,924	1,801	N/A	2002	5-35
Marriott—Tyson’s Corner	(	d)	3,897	43,528	—	1,443		3,897	44,971	48,868	1,720	N/A	2002	5-35

F-39

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION—(Continued)

DECEMBER 31, 2003

(IN THOUSANDS)


	Encumbrances			Initial costs				Cost Capitalized Subsequent to Acquisition						Gross Amount at December 31, 2003						Accumulated Depreciation		Date of Construction	Date Acquired	Depreciation Life
	Encumbrances			Land		Building and Improvements		Land			Building and Improvements			Land		Building and Improvements		Totals		Accumulated Depreciation		Date of Construction	Date Acquired	Depreciation Life
Radisson—Englewood		(d	)		—		7,347		—			249			—		7,596		7,596		301	N/A	2002	5-35
Radisson—Oxnard		(c	)		1,637		8,041		—			330			1,637		8,371		10,008		1,240	N/A	1999	5-35
Radisson—Williamsburg		(d	)		2,768		10,250		—			358			2,768		10,608		13,376		421	N/A	2002	5-35
Residence Inn—Manhattan Beach		13,868			7,990		8,024		—			(601	)*		7,990		7,423		15,413		139	N/A	2003	5-35
Residence Inn—Oxnard		(c	)		2,894		19,386		—			173			2,894		19,559		22,453		2,922	N/A	1999	5-35
Residence Inn—Sacramento		(c	)		2,020		13,050		—			58			2,020		13,108		15,128		1,963	N/A	1999	5-35
San Marcos Resort—Chandler		(c	)		8,782		15,222		1,250			(9,607	)*		10,032		5,615		15,647		2,353	N/A	1999	5-35
Sheraton—Concord		(g	)		3,888		7,546		—			1,145			3,888		8,691		12,579		1,014	N/A	2000	5-35
Sheraton—Salt Lake City		(c	)		5,629		30,964		—			(5,331	)*		5,629		25,633		31,262		3,771	N/A	1999	5-35
Valley River Inn—Eugene		(d	)		1,806		14,113		—			201			1,806		14,314		16,120		566	N/A	2002	5-35
Wyndham—Houston		(e	)		6,184		35,628		—			135			6,184		35,763		41,947		1,420	N/A	2002	5-35

				$	143,316	$	1,027,243	$	4,238		$	38,748		$	147,554	$	1,065,991	$	1,213,545	$	111,000

Investments in Other Real Estate

TCS—Rochester	$	7,029		$	1,600	$	4,400	$	—		$	28		$	1,600	$	4,428	$	6,028	$	662	N/A	1999	5-35
Land held for future development or sale		—			4,500		—		(4,250	)		—			250		—		250		—	N/A	1999	5-35

	$	7,029		$	6,100	$	4,400	$	(4,250	)	$	28		$	1,850	$	4,428	$	6,278	$	662

*	Net of dispositions, impairment write-downs and other items totaling ($50,947).

F-40

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION—(Continued)

DECEMBER 31, 2003

(IN THOUSANDS)


	Hotel Properties									Other Real Estate Investments
	2003			2002			2001			2003		2002			2001
(a) Reconciliation of land and buildings and improvements:
Balance at the beginning of the year	$	1,275,773		$	783,623		$	937,259		$	6,278	$	10,558		$	10,554
Additions during year:											—
Acquisitions		39,700			480,399			—			—		—			—
Improvements		19,066			25,869			7,555			—		20			4
Impairment loss		(26,297	)		(7,054	)		(3,445	)		—		—			—
Disposals during the year		(94,549	)		(5,749	)		(157,086	)		—		(4,300	)		—
Eliminate acquisition fees		(148	)		(1,315	)		(660	)		—		—			—

Balance at the end of the year	$	1,213,545		$	1,275,773		$	783,623		$	6,278	$	6,278		$	10,558

(b) Reconciliation of accumulated depreciation:
Balance at the beginning of the year	$	76,014		$	49,490		$	1,104		$	500	$	339		$	—
Depreciation for the year		36,945			26,880			54,254			162		161			339
Retirement		(1,959	)		(356	)		(5,868	)		—		—			—

Balance at the end of the year	$	111,000		$	76,014		$	49,490		$	662	$	500		$	339

(c)	Property is pledged as collateral by the note payable secured by deed of trust dated August 23, 2003 with a current balance at December 31, 2003 of $343,460.

(d)	Property is pledged as collateral by the note payable secured by deed of trust dated December 5, 2002 with a current balance at December 31, 2003 of $274,010.

(e)	Property is pledged as collateral by the note payable secured by deed of trust dated December 18, 2002 with a current balance at December 31, 2003 of $75,935.

(f)	Property is pledged as collateral by the note payable secured by deed of trust dated November 4, 2002 with a current balance at December 31, 2003 of $37,965.

(g)

Property is pledged as collateral by the note payable secured by deed of trust dated October 16, 2003 with a current balance at December 31, 2003 of $60,000. Additionally, $18,183 of encumbrances are cross-collateralized by the Concord Sheraton, Riverside Marriott, Portland Marriott, Hollywood Holiday Inn, Boise Holiday Inn, Anchorage Holiday Inn, Lake Oswego Hilton Garden Inn.

F-41

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

CONDENSED COMBINED BALANCE SHEETS

(In thousands)


	June 30, 2004			December 31, 2003
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	23,789		$	20,229
Restricted cash		35,180			37,611
Accounts receivable, net		23,522			19,040
Due from affiliates		436			451
Inventories		2,761			2,690
Prepaid expenses		2,982			2,624

Total current assets		88,670			82,645

Investment in hotel properties, net		1,194,216			1,227,537
Hotel properties held for sale, net		22,232			—
Other real estate, net		7,550			7,767
Deferred financing costs, net		9,344			11,921
Interest rate cap agreements		89			540
Goodwill		28,493			28,493
Other assets, net		4,925			6,039

Total assets	$	1,355,519		$	1,364,942


LIABILITIES AND MEMBERS’ EQUITY
Current liabilities:
Accounts payable and other accrued expenses	$	22,940		$	28,943
Accrued payroll and employee benefits		12,747			13,263
Other current liabilities		29,231			25,313
Current portion of notes payable		64,666			25,804

Total current liabilities		129,584			93,323

Notes payable, less current portion		848,307			891,848
Deferred income taxes		41,668			43,612
Accrued pension liability		1,542			1,638
Other liabilities		3,159			3,572

Total liabilities		1,024,260			1,033,993

Commitments and contingencies (Note 8)

Minority interest		528			604

Members’ equity:
Members’ capital		332,473			332,087
Accumulated other comprehensive loss		(1,742	)		(1,742	)

Total members’ equity		330,731			330,345

Total liabilities and members’ equity	$	1,355,519		$	1,364,942

See accompanying notes to condensed combined financial statements (unaudited).

F-42

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

CONDENSED COMBINED STATEMENTS OF OPERATIONS (UNAUDITED)

(In thousands)


	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
REVENUES
Room	$	87,958		$	79,280		$	166,957		$	151,531
Food and beverage		28,548			27,230			54,849			51,670
Other operating		10,369			9,488			21,576			17,548
Management and other fees from affiliates		145			93			522			132

Total revenues		127,020			116,091			243,904			220,881

OPERATING EXPENSES
Room		19,238			18,362			37,267			35,338
Food and beverage		19,731			19,272			37,923			37,300
Other operating		7,191			6,157			14,320			11,534
Advertising and promotion		7,583			7,490			14,743			14,287
Repairs and maintenance		5,430			5,244			10,675			10,194
Utilities		4,932			4,508			10,129			9,110
Franchise costs		6,738			6,037			12,814			11,317
Property taxes, ground lease and insurance		6,817			6,883			13,625			14,472
General and administrative		17,963			15,747			32,853			30,156
Depreciation and amortization		14,249			13,463			28,444			26,398
Impairment loss		—			—			7,439			—

Total operating expenses		109,872			103,163			220,232			200,106

Operating income		17,148			12,928			23,672			20,775

Interest and other income		114			101			216			328
Interest expense		(12,985	)		(12,951	)		(26,576	)		(26,202	)

Income (loss) before minority interest, income taxes and discontinued operations		4,277			78			(2,688	)		(5,099	)

Minority interest		158			—			166			—
Benefit from (provision for) income taxes (Note 7)		784			401			(780	)		(359	)

Income (loss) from continuing operations before discontinued operations		5,219			479			(3,302	)		(5,458	)
Loss from discontinued operations (Note 3)		(1,364	)		(586	)		(18,188	)		(1,207	)

NET INCOME (LOSS)	$	3,855		$	(107	)	$	(21,490	)	$	(6,665	)

See accompanying notes to condensed combined financial statements (unaudited).

F-43

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

CONDENSED COMBINED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)


	Six Months Ended June 30,
	2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES	$	28,628		$	26,190
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of hotel properties		29,370			—
Acquisitions of hotel properties		(38,820	)		(41,925	)
Additions to hotel properties and other real estate		(32,964	)		(17,155	)

Net cash used in investing activities		(42,414	)		(59,080	)

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes payable		31,413			52,700
Payments on notes payable		(36,092	)		(25,433	)
Refunds (payments) of deferred financing costs, net		67			(594	)
Acquisition of interest rate cap agreements		(8	)		(37	)
Contributions from members		25,322			14,133
Distributions to members		(3,446	)		(3,761	)
Contributions from minority interest holders		105			—
Distributions to minority interest holders		(15	)		—

Net cash provided by financing activities		17,346			37,008

Net increase in cash and cash equivalents		3,560			4,118
Cash and cash equivalents, beginning of period		20,229			22,302

Cash and cash equivalents, end of period	$	23,789		$	26,420

See accompanying notes to condensed combined financial statements (unaudited).

F-44

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED)

1. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed combined financial statements as of June 30, 2004 (unaudited) and December 31, 2003 (audited) and for the three and six months ended June 30, 2004 and 2003 (unaudited) include the accounts of Sunstone Hotel Investors, L.L.C. (“SHI”), WB Hotel Investors, LLC (“WB”) and Sunstone/WB Hotel Investors IV, LLC (“WB IV”). Significant intercompany accounts and transactions have been eliminated for all periods presented. Certain amounts included in the combined financial statements for prior periods have been reclassified to conform with the current financial statement presentation, including the comparative presentation of discontinued operations as required by Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets .

SHI, WB and WB IV will be referred to, collectively, as the “Company” or “Sunstone Predecessor Companies”. Affiliates of Westbrook Partners are referred to collectively as “Westbrook” or “Westbrook Affiliates”.

Interim Combined Financial Statements

The accompanying condensed combined balance sheet as of June 30, 2004 and the related condensed combined statements of operations and cash flows for the six months ended June 30, 2004 and 2003 are unaudited and have been prepared pursuant to rules and regulations of the Securities and Exchange Commission and, therefore, do not include all information and footnote disclosures normally included in audited financial statements. The interim condensed combined financial statements reflect all adjustments (consisting only of normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim periods should not be considered indicative of results to be expected for the full year. These interim condensed combined financial statements should be read in conjunction with the audited combined financial statements as of December 31, 2003 and 2002, and the three years in the period ended December 31, 2003.

Use of Estimates

The preparation of condensed combined financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates.

Seasonality

The hotel industry is seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in the Company’s operating results.

Deferred Financing Costs

Interest expense related to the amortization of deferred financing costs was $1.4 million and $1.8 million for the three months ended June 30, 2004 and 2003, respectively, and $2.5 million and $3.6 million for the six months ended June 30, 2004 and 2003, respectively.

F-45

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

New Accounting Standard

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, Consolidation of Variable Interest Entities , as amended (“FIN 46”). As of June 30, 2004, the Company was not considered to be the primary beneficiary in any arrangements. See Note 10 for further information regarding the acquisition of a previously considered variable interest entity.

2. Investment in Hotel Properties

Investment in hotel properties consisted of the following at June 30, 2004 and December 31, 2003 (in thousands):


	June 30, 2004			December 31, 2003
	(Unaudited)
Land	$	133,951		$	147,554
Buildings and improvements		1,064,372			1,065,991
Fixtures, furniture and equipment		157,998			148,708
Franchise fees		2,921			3,087
Construction in process		3,484			17,703

		1,362,726			1,383,043
Accumulated depreciation and amortization		(168,510	)		(155,506	)

	$	1,194,216		$	1,227,537

3. Discontinued Operations

As part of the Company’s strategic plan to dispose of non-core hotel assets, management has identified in its disposition plan six hotel properties to be sold during 2004. Three of the hotel properties were sold in April and May 2004 for net proceeds of $29.4 million and a net loss on sale of $280,000. Also included in loss on disposal is $102,000 related to the sale of a hotel in December 2003. Additionally, an impairment loss of $17.0 million was recorded for the six months ended June 30, 2004 related to hotel properties in the disposition plan, representing the amount in excess of the carrying values over the related sales prices less estimated selling costs. The remaining three hotel properties met the “held for sale” and “discontinued operations” criteria as required by SFAS 144, at June 30, 2004.

F-46

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

The following is a summary of the Company’s discontinued operations for the three and six months ended June 30, 2004 and the comparative operating information for the three and six months ended June 30, 2003 related to hotel properties sold or held for sale through June 30, 2004 (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
	(Unaudited)
Operating revenues	$	5,785		$	17,660		$	14,204		$	35,581
Operating expenses		(6,030	)		(14,584	)		(13,341	)		(29,369	)
Interest expense		(702	)		(1,558	)		(1,288	)		(3,106	)
Depreciation and amortization		(475	)		(1,996	)		(1,346	)		(4,094	)
Impairment loss		—			—			(16,954	)		—
Loss on disposal		(280	)		—			(382	)		—
Income tax benefit (provision)		338			(108	)		919			(219	)

Loss from discontinued operations	$	(1,364	)	$	(586	)	$	(18,188	)	$	(1,207	)

The assets and liabilities of the discontinued operations consisted of the following at June 30, 2004 (in thousands):


Assets:
Total current assets	$	1,175
Hotel properties held for sale, net		22,232
Deferred financing costs, net		299
Interest rate cap agreements		6
Other assets, net		237

Total assets of discontinued operations	$	23,949

Liabilities:
Total current liabilities	$	1,839
Notes payable		21,535
Deferred income taxes		258
Other liabilities		15

Total liabilities of discontinued operations	$	23,647

F-47

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

4. Other Real Estate

Other real estate consisted of the following (in thousands):


	June 30, 2004			December 31, 2003
	(Unaudited)
Laundry facilities:
Land	$	1,600		$	1,600
Buildings and improvements		4,428			4,428
Fixtures, furniture and equipment		3,353			3,220

		9,381			9,248
Accumulated depreciation		(2,081	)		(1,731	)

		7,300			7,517
Land held for future development or sale		250			250

	$	7,550		$	7,767

5. Derivative Financial Instruments

At June 30, 2004 and December 31, 2003, the Company held various interest rate cap agreements to manage its exposure to the interest rate risks related to its floating rate debt. None of the Company’s derivatives held at June 30, 2004 and December 31, 2003 qualify for hedge accounting treatment under SFAS No. 133. Accordingly, changes in the fair value of the Company’s derivatives for the three months ended June 30, 2004 and 2003 resulted in a net loss of $23,000 and $290,000, respectively, and for the six months ended June 30, 2004 and 2003 resulted in a net loss of $459,000 and $1.1 million, respectively. The changes in fair value have been reflected as an increase in interest expense for the three and six months ended June 30, 2004 and 2003.

At June 30, 2004 and December 31, 2003, the total notional amount of the underlying variable-rate debt being hedged was $775.5 million, which caps the applicable LIBOR variable rate at fixed rates ranging from 2.65% to 7.19%. The interest rate cap agreements terminate between January 2005 and May 2006. The fair value of the interest rate cap agreements at June 30, 2004 and December 31, 2003 was $89,000 and $540,000, respectively.

F-48

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

6. Notes Payable

Notes payable consisted of the following (in thousands):


	June 30, 2004			December 31, 2003
	(Unaudited)
Notes payable requiring payments of interest and principal, with interest at rates ranging from variable of one-month LIBOR plus 2.90% to 3.60% to fixed rates ranging from 8.51% to 9.88%; maturing at dates ranging from July 2004 through June 2013. The notes are collateralized by first deeds of trust on 59 hotel properties and one laundry facility	$	815,177		$	822,733

Unsecured revolving line of credit in the amount of $7.0 million requiring monthly payments of interest only at one-month LIBOR plus 3.75% on the drawn portion of the line of credit and quarterly payments of 0.50% on the average unused portion of the line of credit during the previous quarter. The revolving line of credit had its maturity extended to October 2004 and is collateralized by a repayment guarantee		—			800

Construction loan requiring monthly payments of interest only at one-month LIBOR plus 3.25%. The loan matures in May 2006 and is collateralized by the hotel under construction when drawn		4,362			—

Notes payable requiring monthly payments of principal and interest at 8.25%. The notes mature in November 2023 and are collateralized by a leasehold mortgage, assignment of leases and rents, and security agreement and fixture filing on the two hotel properties		75,251			75,936

Mezzanine note payable requiring monthly payments of interest only through March 2004, and thereafter, principal at $90,915 per month plus interest at the greater of 2.50% or one-month LIBOR plus 8.00%. The note matures in October 2005 and is collateralized by a pledge agreement granting a security interest in the Company’s assets		18,183			18,183

		912,973			917,652
Less: current portion		(64,666	)		(25,804	)

	$	848,307		$	891,848

Total interest incurred on the notes payable was $12.3 million and $12.4 million for the three months ended June 30, 2004 and 2003, respectively, and $24.9 million and $24.6 million for the six months ended June 30, 2004 and 2003, respectively.

F-49

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

7. Income Taxes

The benefit from (provision for) income taxes included in the condensed combined statements of operations is as follows (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Current:
Federal	$	(469	)	$	(99	)	$	(1,456	)	$	(200	)
State		99			(36	)		(349	)		(72	)

		(370	)		(135	)		(1,805	)		(272	)

Deferred:
Federal		1,942			807			1,910			1,602
State		589			130			831			286

		2,531			937			2,741			1,888
Valuation allowance		(1,039	)		(509	)		(797	)		(2,194	)

Benefit from (provision for) income taxes	$	1,122		$	293		$	139		$	(578	)

The provision for income taxes applicable to continuing operations and discontinued operations is as follows (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Benefit from (provision for) continuing operations:
Current	$	(370	)	$	(50	)	$	(1,805	)	$	(102	)
Deferred		1,154			451			1,025			(257	)

Benefit from (provision for) continuing operations		784			401			(780	)		(359	)

Benefit from (provision for) discontinued operations:
Current		—			(83	)		—			(170	)
Deferred		338			(25	)		919			(49	)

Benefit from (provision for) discontinued operations		338			(108	)		919			(219	)

Benefit from (provision for) income taxes	$	1,122		$	293		$	139		$	(578	)

For the three and six months ended June 30, 2004 and 2003, the provision for income taxes differs from the federal statutory rate primarily because (i) a significant portion of the Company’s income is earned in partnerships, and, as such, is not subject to federal or most state income tax; and (ii) the goodwill associated with impairment losses is not deductible.

F-50

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

The tax effects of temporary differences giving rise to the Company’s deferred tax assets and liabilities are as follows (in thousands):


	June 30, 2004			December 31, 2003
	(Unaudited)
Deferred tax assets:
NOL carryover	$	14,440		$	13,898
State taxes and other		2,645			2,727
Other reserves and accruals		3,562			3,337

Current deferred tax asset before valuation allowance		20,647			19,962

Deferred tax liabilities:
Depreciation		(47,857	)		(50,028	)
Other		(17	)		(21	)

		(47,874	)		(50,049	)

Net deferred tax liabilities		(27,227	)		(30,087	)
Valuation allowance		(14,441	)		(13,525	)

	$	(41,668	)	$	(43,612	)

Deferred income taxes reflect the net effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

Substantially all of the Company’s deferred tax liabilities at June 30, 2004 and December 31, 2003 were due to the lower tax bases of its hotel assets in comparison to the book bases.

The Company maintains a valuation allowance to offset a portion of its deferred tax assets due to uncertainties surrounding their realization.

At June 30, 2004 and December 31, 2003, the Company had federal net operating loss carryforwards of $35.9 million and $35.2 million, respectively, which begin to expire in 2019.

At June 30, 2004 and December 31, 2003, the Company had state net operating loss carryforwards of $24.5 million and $19.9 million, respectively, which begin to expire in 2011.

8. Commitments and Contingencies

Franchise Agreements

Total franchise costs incurred by the Company for both continuing operations and discontinued operations during the three months ended June 30, 2004 and 2003 were $7.0 million and $7.2 million, respectively, of which $3.8 million and $3.9 million, respectively, were for franchise royalties and for the six months ended June 30, 2004 and 2003 were $13.4 million and $13.6 million, of which $7.4 million and $7.4 million, respectively, were for franchise royalties. The remaining franchise costs include advertising, reservation and priority club assessments.

F-51

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

Renovation and Construction Commitments

At June 30, 2004 and December 31, 2003, the Company has various contracts outstanding with third parties in connection with the renovation of certain of the Company’s hotel properties. The Company’s remaining commitments under these contracts at June 30, 2004 and December 31, 2003 totaled $9.9 million and $17.8 million, respectively.

Operating Leases

At June 30, 2004, the Company was obligated under the terms of nine ground leases and a lease on the corporate facility, which mature from dates ranging from 2005 through 2096.

Rent expense incurred pursuant to these ground lease agreements totaled $1.0 million for both the three months ended June 30, 2004 and 2003, and $1.9 million and $2.0 million for the six months ended June 30, 2004 and 2003, respectively, and was included in property taxes, ground lease and insurance in the accompanying statements of operations. Rent expense incurred pursuant to the lease on the corporate facility totaled $189,000 and $183,000 for the three months ended June 30, 2004 and 2003, respectively, and $378,000 and $363,000 for the six months ended June 30, 2004 and 2003, respectively, and was included in general and administrative expenses in the accompanying statements of operations.

9. Transactions With Affiliates

Management Fees

On January 30, 2004, the Company entered into a management agreement with an affiliate to provide management services for the hotel located in Beverly Hills, California owned by the affiliate. The agreement expires January 30, 2009 and includes successive one-year renewal options. Pursuant to the agreement, the Company is to receive from the affiliate a base management fee of 2.5% of gross operating revenues, as defined.

On March 30, 2004, the Company entered into a management agreement with an affiliate to provide management services for the hotel located in Nashville, Tennessee owned by a Westbrook affiliate. The agreement expires on March 30, 2009 and includes successive one-year renewal options. Pursuant to the agreement, the Company is to receive from the Westbrook affiliate a base management fee of 2.5% of gross operating revenues, as defined.

On May 29, 2002, the Company entered into asset management agreements to provide asset management services for two hotels located in Lithia Springs and Suwanee, Georgia owned by a Westbrook affiliate. The agreements expire on May 29, 2007 and include successive one-year renewal options. Pursuant to the agreements, the Company is to receive an asset management fee of 1.0% of gross operating revenues, as defined.

Aggregate management fees and asset management fees earned from affiliates totaled $129,000 and $93,000, for the three months ended June 30, 2004 and 2003, respectively, and $184,000 and $132,000 for the six months ended June 30, 2004 and 2003, respectively.

Accounting Fees

The Company receives an accounting fee from certain affiliates equal to $10 per available room per month. Aggregate accounting fees earned from affiliated totaled $16,000 and $20,000 for the three and six months ended June 30, 2004, respectively. The Company did not earn any accounting fees for the three and six months ended June 30, 2003.

F-52

SUNSTONE HOTEL INVESTORS, L.L.C.

WB HOTEL INVESTORS, LLC

SUNSTONE/WB HOTEL INVESTORS IV, LLC

NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

Acquisition Fees

During the six months ended June 30, 2004, in connection with successful acquisitions of hotel properties by certain affiliated companies, the Company received aggregate acquisition fees in the amount of $318,000 in exchange for rendering services in connection with such acquisitions. Such acquisition fees were recognized as revenue and were included in management and other fees from affiliates. The Company did not earn any acquisition fees for the three months ended June 30, 2004 or the three and six months ended June 30, 2003.

Other Reimbursements

From time to time, the Company paid for certain expenses such as payroll, insurance and other costs on behalf of the Affiliates. The Affiliates generally reimburse such amounts on a monthly basis. At June 30, 2004 and December 31, 2003, amounts owed to the Company by Affiliates amounted to $436,000 and $451,000, respectively, and are included in due from affiliates.

10. Acquisitions and Dispositions of Hotel Properties

On May 27, 2004, the Company sold the Holiday Inn hotel located in Anchorage, Alaska, to an unrelated third party. The hotel was sold for net proceeds of $7.7 million, resulting in a loss on the sale of $234,000. The operating results of the hotel were included in discontinued operations in the accompanying combined statements of operations during three and the six months ended June 30, 2004 and 2003.

11. Subsequent Events

On July 2, 2004, Sunstone Hotel Investors, Inc. (“SHI”), that was formed on June 28, 2004, filed Form S-11 with the Securities and Exchange Commission for an initial public offering of its common stock. As further discussed in the S-11, upon the initial public offering’s closing, SHI plans to contribute a significant portion of its hotel portfolio to an entity controlled by SHI in exchange for an ownership interest in this entity. SHI has had no material operations for the period June 28, 2004 through June 30, 2004.

F-53

Report of Independent Auditors

To the Members and Partners of

Wyndham Acquisition Hotels:

In our opinion, the accompanying combined balance sheets and the related combined statements of operations, owners’ equity and cash flows present fairly, in all material respects, the financial position of the Wyndham Acquisition Hotels (the “Hotels”) at November 30, 2002 and December 31, 2001, and the results of its operations and its cash flows for the period from January 1, 2002 through November 30, 2002 and the year then ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Hotels’ management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Dallas, Texas

April 15, 2004

F-54

Wyndham Acquisition Hotels

Combined Balance Sheets

As of November 30, 2002 and December 31, 2001


	2002		2001
Assets
Current assets
Cash and cash equivalents	$	7,630,934	$	6,055,339
Restricted cash		14,890,018		14,694,474
Accounts receivable, net of allowance of $83,068 and $100,318, respectively		7,406,362		3,319,332
Inventories		918,710		1,149,201
Due from affiliates		6,021,898		—
Prepaid expenses and other		586,576		646,252
Assets held for sale, net of accumulated depreciation of $101,172,117 and $20,234,207, respectively		380,567,812		65,459,809

Total current assets		418,022,310		91,324,407
Investments in hotels, net of accumulated depreciation of $ and $58,940,657 respectively		—		330,895,152
Deferred expense, net of accumulated amortization of $3,688,810 and $2,984,382, respectively		2,467,899		3,327,205

Total assets	$	420,490,209	$	425,546,764

Liabilities and Owners’ Equity
Current liabilities
Accounts payable and accrued expenses	$	18,375,545	$	25,071,310
Due to affiliates		—		14,118,968
Borrowings associated with assets held for sale		141,825,568		—
Current portion of notes payable		—		2,496,374

Total current liabilities		160,201,113		41,686,652
Notes payable, less current portion		—		140,714,725
Minority interest		2,620,385		2,500,957
Owners’ equity		257,668,711		240,644,430

Total liabilities and owners’ equity	$	420,490,209	$	425,546,764

The accompanying notes are an integral part of these financial statements.

F-55

Wyndham Acquisition Hotels

Combined Statements of Operations

For the Period from January 1, 2002 through November 30, 2002

and the Year Ended December 31, 2001


	2002		2001
Revenues:
Rooms	$	111,425,281	$	130,010,312
Food and beverage		54,510,807		64,110,897
Other		8,428,268		10,883,903

Total revenues		174,364,356		205,005,112

Operating costs and expenses:
Departmental expenses:
Rooms		26,122,612		30,267,494
Food and beverage		38,917,559		45,255,911
Other		4,207,307		4,822,908
Operating expenses:
Administrative and general		15,038,015		17,426,250
Management and tradename fees		7,273,241		8,357,079
Sales and marketing		14,612,675		16,271,895
Property operating costs		14,917,826		17,415,679
Property insurance, rent and taxes		12,458,774		13,015,711
Depreciation		14,675,746		7,072,816
Interest expense		8,919,011		11,473,781

Total operating costs and expenses		157,142,766		171,379,524

Operating income		17,221,590		33,625,588

Minority interest		119,428		219,892
Impairment loss		—		6,099,071

Net income	$	17,102,162	$	27,306,625

The accompanying notes are an integral part of these financial statements.

F-56

Wyndham Acquisition Hotels

Combined Statements of Changes in Owners’ Equity

For the Period from January 1, 2002 through November 30, 2002 and

for the Year Ended December 31, 2001


	Total
Balance at January 1, 2001	$	222,274,745
Distribution of net assets		(236,542	)
Intercompany		(8,700,398	)
Net income		27,306,625

Balance at December 31, 2001		240,644,430
Distribution of net assets		(77,881	)
Net income		17,102,162

Balance at November 30, 2002	$	257,668,711

The accompanying notes are an integral part of these financial statements.

F-57

Wyndham Acquisition Hotels

Combined Statements of Cash Flows

For the Period from January 1, 2002 through November 30, 2002 and

for the Year Ended December 31, 2001


	2002			2001
Cash flows from operating activities:
Net income	$	17,102,162		$	27,306,625
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		14,675,746			7,072,816
Impairment loss		—			6,099,071
Amortization of deferred loan costs		859,306			773,498
Provision for bad debt		(17,170	)		206,273
Minority interest		119,428			—
Changes in assets and liabilities, net effects of business acquisitions:
Accounts receivable		(4,069,860	)		12,378,955
Inventories		230,491			655,404
Prepaid expenses and other		59,676			(459,379	)
Accounts payable and accrued expenses		(6,610,247	)		6,569,570
Due to affiliates		(16,188,673	)		(18,979,410	)

Net cash provided by operating activities		6,160,859			41,623,423

Cash flows from investing activities:
Additions to hotel properties		(2,840,790	)		(34,407,053	)
Change in restricted cash		(195,544	)		(344,885	)

Net cash used in investing activities		(3,036,334	)		(34,751,938	)

Cash flows from financing activities:
Payments on notes payable		(1,385,531	)		(2,503,283	)
Distributions to partners		(77,881	)		—
Due from Parent					(8,700,398	)
Net cash from change in ownership
Capital Lease Obligation		(85,518	)		(194,777	)
Distributions to minority interest in other partnerships		—			(236,543	)

Net cash used in financing activities		(1,548,930	)		(11,635,001	)

Change in cash and cash equivalents		1,575,595			(4,763,516	)
Cash and cash equivalents at the beginning of the period		6,055,339			10,818,855

Cash and cash equivalents at the end of the period	$	7,630,934		$	6,055,339

Supplemental disclosure of cash flow information:
Cash paid for interest	$	8,076,442		$	10,544,929

The accompanying notes are an integral part of these financial statements.

F-58

WYNDHAM ACQUISITION HOTELS

NOTES TO COMBINED FINANCIAL STATEMENTS

1.	Organization

Wyndham Acquisition Hotels (“Hotels”) represents the combined operations and financial position of certain proprietary and non-proprietary branded hotels as of November 30, 2002 and December 31, 2001. Prior to their acquisition by Sunstone Hotel Investors, LLC (“Sunstone”), the Hotels were wholly owned or substantially owned by Wyndham International, Inc. (“Wyndham”). Wyndham managed seven of the Hotels and third parties managed six of the Hotels.

At the dates of acquisition (see footnote 9), the name under which the Hotel is operated, the location of the Hotels and the number of rooms in each Hotel are as follows:


Acquired December 5, 2002:
Marriott Tyson’s Corner #	Vienna, VA	390
Marriott Houston North at Greenspoint	Houston, TX	391
Marriott Philadelphia West #	West Conshohocker, PA	286
Marriott Troy #	Troy, MI	350
Hilton Del Mar	Del Mar, CA	251
Hilton Huntington	Melville, NY	302
Doubletree Suites Minneapolis # *	Minneapolis, MN	230
Radisson Englewood	Englewood, NJ	194
Radisson Ft. Magruder	Williamsburg, VA	303
Hyatt Newporter #	Newport Beach, CA	403
Valley River Inn #	Eugene, OR	257

Acquired December 18, 2002:
Embassy Suites Chicago	Chicago, IL	358
Wyndham Greenspoint Houston	Houston, TX	472

#	Hotel was third party managed at December 31, 2001

*	Wyndham owned a 90% interest in this hotel and Sunstone acquired both Wyndham’s interest and the third party’s 10% interest in December 2002 (see footnote 9).

2.	Summary of Significant Accounting Policies

Principles of Combination and Basis of Presentation

The accompanying combined financial statements reflect the combined balance sheets and the related combined statements of operations, owners’ equity and cash flows of the Hotels subject to the acquisition by Sunstone and under common control and ownership by Wyndham for the years ended November 30, 2002 and December 31, 2001. These combined statements have been prepared in accordance with accounting principles generally accepted in the United States of America.

The accompanying combined financial statements have been prepared for the purpose of a filing by Sunstone with the Securities and Exchange Commission, as required by Regulation S-X, Rule 3-05.

Cash and Cash Equivalents

All highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents.

F-59

WYNDHAM ACQUISITION HOTELS

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

Restricted Cash

In connection with the mortgage loan agreement, the Hotels are required to set aside funds to pay costs of real estate and personal property taxes, property insurance and capital expenditures related to periodic replacement of furniture, fixtures and equipment. The funds are on deposit with the Hotels’ lenders.

Accounts Receivable

Accounts receivable primarily represents receivables from hotel guests who occupy hotel rooms and utilize hotel services. The Hotel’s management maintains an allowance for doubtful accounts sufficient to cover potential credit losses. The Hotels’ accounts receivable at November 30, 2002 and December 31, 2001 includes an allowance for doubtful accounts of $83,068 and $100,318.

Inventories

Inventories, consisting primarily of food, beverages, china, linen, glassware and silverware and are stated at cost which approximates market.

Investment in Hotels

Investment in hotels is stated at cost and is depreciated using the straight-line method over the estimated useful life of 35 years. Furniture, fixtures and equipment are depreciated using a method that approximates straight-line over the estimated useful lives of five to seven years.

Maintenance and repairs are charged to operations as incurred; major renewals and betterments are capitalized. Upon the sale or disposition of a fixed asset, the asset and related accumulated depreciation are removed from the accounts, and the related gain or loss is included in operations.

In accordance with Financial Accounting Standards Board Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the owners of the Hotels periodically reviews the carrying value of its investment in hotels held for use to determine if circumstances exist indicating an impairment in the carrying value of the investment in the hotels or that the depreciation periods should be modified. If facts or circumstances support the possibility of impairment, the owners of the Hotels will prepare a projection of the undiscounted future operating cash flows. In cases when the owners of the Hotels do not expect to recover its carrying value, the owners of the Hotels recognize an impairment loss.

At December 31, 2000, Wyndham identified six of the Hotels as held for sale and reduced the holding period for two of the hotels, and as a result Wyndham recorded impairment for the difference between the fair market value and the carrying value of $97,413,237. In addition, Wyndham ceased depreciation on these Hotels identified as held for sale. During the year ended December 31, 2001, Wyndham transferred four of the hotels from held for sale to held for use at the lower of fair value or depreciated value (considering depreciation during that holding period). In addition, Wyndham reviewed the carrying value of the two remaining held for sale Hotels and determined that additional impairment of $6,099,071, due to a change in the assessed fair value of the properties. During the period from January 1, 2002 and November 30, 2002, Wyndham identified all of the Hotels as held for sale. No additional impairment was recorded and depreciation ceased on these Hotels.

F-60

WYNDHAM ACQUISITION HOTELS

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

Franchise Fees

Initial franchise fees are recorded at cost and amortized using the straight-line method over the lives of the franchise agreements. All other franchise fees that are based on the Hotels’ results of operations are expensed as incurred.

Deferred Expenses

Deferred expenses consist primarily of unamortized deferred financing costs, which are being amortized on a straight-line basis, which approximates the effective interest method over the term of the related debt. For the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001, amortization expense related to these deferred financing costs was $859,306 and $773,498 respectively. These amounts were included in interest expense.

Due to Affiliate

Due to affiliate represents net amounts due to Wyndham or its affiliates. The amounts are attributable primarily to the contribution of assets and liabilities by Wyndham into the Properties, salaries payable to affiliates, and the processing of normal day to day cash receipts and disbursements on behalf of the Properties by Wyndham through a central cash account.

Receivable from Parent

Receivable from parent is recorded in equity and primarily represents the proceeds of the mortgage debt, which were advanced to Wyndham of approximately $0 and $8,700,398, respectively, as of November 30, 2002 and December 31, 2001.

Revenue Recognition

Rooms, food and beverage and other revenues are recognized when earned.

Advertising Expense

All advertising costs are expensed as incurred. The Properties recognized advertising expense of $1,436,794 and $1,553,274, respectively, for the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001.

Fair Value of Financial Instruments

Financial Accounting Standards Board Statement of Financial Accounting Standards No. 107 requires all entities to disclose the fair value of certain financial instruments in their financial statements. The carrying amount of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximates fair value due to the short maturity of these instruments. The carrying amount of the Properties’ borrowings approximates fair value due to the Properties’ ability to obtain such borrowings at comparable interest rates.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

F-61

WYNDHAM ACQUISITION HOTELS

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

Income Taxes

The Hotels are included in limited liability corporations or limited partnerships which are not taxable entities. The results of operations are included in the tax returns of the partners or members. Accordingly, the combined statements of operations do not contain provision for federal income taxes.

3.	Investment in Hotels

Investment in hotels at November 30, 2002 and December 31, 2001 consisted of the following:


	2002			2001
Land	$	24,044,835		$	24,044,835
Building and improvements		469,457,542			467,850,071
Furniture and equipment		87,922,669			82,046,796
WIP		3,827,191			5,100,431

Total cost		585,252,237			579,042,133
Impairment		(103,512,308	)		(103,512,308	)
Accumulated depreciation		(101,172,117	)		(79,174,864	)

Net investment in hotels	$	380,567,812		$	396,354,961

4.	Notes Payable

Notes payable consisted of the following at November 30, 2002 and December 31, 2001:


	2002		2001
Notes payable dated October 16, 1988; monthly payments of principal and interest at 8.25%; maturing in October 2023; collateralized by a leasehold mortgage, assignment of leases and rents, and security agreement and fixture filing on Embassy Suites Chicago and Wyndham Greenspoint.		77,354,550		78,445,015
Note payable dated June 30, 1999; monthly payments of principal at one-month LIBOR (1.88% at December 31, 2001) plus 3.25%, maturing in July 1, 2004; collateralized by a first deeds of trust on the Hilton Del Mar, Hilton Huntington and Marriott Troy. On November 5, 1999, the loan was modified to bear interest at the LIBOR rate plus spreads of .82% through 4.50%		64,471,018		64,766,084

Less current portion		1,683,277		2,496,374

	$	140,142,291	$	140,714,725

Total interest incurred on the notes payable was $8,076,442 and $10,544,929 for the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001, respectively.

F-62

WYNDHAM ACQUISITION HOTELS

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

Aggregate future principal maturities of notes payable at November 30, 2002, are as follows:


2003	$	1,683,277
2004		65,734,229
2005		1,525,826
2006		1,656,577
2007		1,656,577
Thereafter		69,569,082

	$	141,825,568

5.	Related Party Transactions

Management Fees

Six of the Hotels are operated by subsidiaries of Wyndham under management agreements with expiration dates ranging from December 31, 2004 through December 31, 2016, that require payment of various percentage fees based on certain revenue components. The percentages assessed reflect rates comparable to those available from non-related entities. Fees incurred for the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001 were $2,118,684 and $2,474,185 respectively. No Wyndham fees were owed at November 30, 2002 and December 31, 2001 for these Hotels.

Seven of the Properties are operated by a third party under management agreements with expiration dates ranging from September 30, 2006 through February 28, 2020, that require payment of various percentage fees based on certain revenue components. The Hotel’s management has also entered into various license and franchise agreements related to these hotel properties. Total management and franchise fees paid for the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001 were $5,608,026 and $6,340,415 respectively. Amounts due under these agreements of $2,020,336 and $1,241,565 are recorded in accrued expenses in the accompanying balance sheets in 2002 and 2001, respectively.

In addition, one Hotel is operated under the Wyndham proprietary brand name, which requires the payment of tradename fees to a subsidiary of Wyndham. These fees are based on percentages of revenue components and were $49,912 and $60,511 for the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001. No Wyndham fees were owed at November 30, 2002 and December 31, 2001.

6.	Employee Benefit Plans

The Hotels participated in a 401(k) retirement savings plan sponsored by Wyndham until December 2002. Employees who are over 21 years of age and have completed one year of service are eligible to participate in the plan. The Hotels can elect to match up to fifty percent of employee contributions of the first four percent of an employee’s salary. The Hotels recognized $94,427 and $117,734 of expense for the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001, respectively.

The Hotels participated in a self-insured group health plan through a Voluntary Employee Benefit Association (“VEBA”) for its employees until December 2002. This plan is funded to the limits provided in the Internal Revenue Code, and liabilities have been recorded for unpaid claims. Aggregate and stop loss insurance exists at amounts which limit exposure to the Hotels. The Hotels have recognized expenses related to the plan of $2,418,452 and $2,704,936 for the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001, respectively.

F-63

WYNDHAM ACQUISITION HOTELS

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

7.	Franchise Agreements

The Hotels have entered into various license and franchise agreements related to certain hotel properties. The franchise agreement require the Hotels to, among other things, pay various monthly fees that are calculated based on specified percentages of certain specified revenues. The franchise agreements generally contain specific standards for, and restrictions and limitations on, the operation and maintenance of the hotels which are established by the franchisors to maintain uniformity in the system created by each such franchisor. Such standards generally regulate the appearance of the hotel, quality and type of goods and services offered, signage and protection of trademarks. Compliance with such standards may from time to time require significant expenditures for capital improvements which will be borne by the Hotels.

Total franchise costs incurred by the Hotels during the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001 were $2,711,511 and $3,016,119, respectively.

8.	Commitments and Contingencies

From time to time, the Properties have been and may in the future be involved as a party in various legal proceedings, both as plaintiff and defendant. Management regularly analyzes current information and, as necessary, provides accruals for probable liabilities on the eventual disposition of these matters. As of the dates of the combined balance sheets, there were no threatened or pending legal matters of which management was aware which would, in the opinion of management and legal counsel, have a material impact on the Properties’ combined results of operations, financial position or cash flows.

The Properties are subject to environmental regulations related to the ownership of real estate. The cost of complying with the environmental regulations was not material to the Properties’ results of operations for the period from January 1, 2002 through November 30, 2002 and for the year ended December 31, 2001. The Properties are not aware of any environmental condition on any of its properties, which is likely to have a material adverse effect on the combined financial statements.

9.	Subsequent Events

In December 2002, Sunstone acquired Wyndham’s interest and a third party’s interest in the Hotels. Eight of the hotels are managed by Sunstone Hotel Properties, Inc. (“SHP”), an affiliate of Sunstone, and five hotels are managed by third party managers pursuant to certain management agreements dated December 2002.

F-64

Shares

Sunstone Hotel Investors, Inc.

Common Stock

Through and including , 2004 (the 25th day after the offering), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable by the company in connection with the sale of securities being registered. All amounts shown are estimates except the SEC registration fee and the NASD filing fee.


SEC registration fee	$	63,350
NASD filing fee		30,500
NYSE listing fee		200,000
Printing and engraving expenses		500,000
Legal fees and expenses		*
Accounting fees and expenses		*
Blue sky fees and expenses		10,000
Transfer agent and registrar fees		*
Miscellaneous		*

Total	$	*

*	To be filed by amendment.

ITEM 32. SALES TO SPECIAL PARTIES

See Item 33.

ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES

Upon our formation in June 2004, Sunstone Hotel Investors, L.L.C. was issued 100 shares of common stock of Sunstone Hotel Investors, Inc. for total consideration of $100.00 in cash in order to provide our initial capitalization. The issuance of such shares was effected in reliance upon an exemption from registration provided by Section 4(2) under the Securities Act.

In connection with the Formation and Structuring Transactions, Sunstone Hotel Partnership, LLC will issue shares of common stock and membership units that are exchangeable for shares of our common stock to Sunstone Hotel Investors, L.L.C., WB Hotel Investors, LLC, Sunstone/WB Hotel Investors IV, LLC and Sunstone/WB Manhattan Beach, LLC in exchange for the contribution of assets by them. Sunstone Hotel Partnership, LLC, Sunstone Hotel Investors, L.L.C., WB Hotel Investors, LLC, Sunstone/WB Hotel Investors IV, LLC and Sunstone/WB Manhattan Beach, LLC committed to this issuance prior to the filing of this Registration Statement. The issuance of such units will be effected in reliance upon an exemption from registration provided by Section 4(2) under the Securities Act.

ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS

Maryland law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its stockholders for money damages except for liability resulting from (a) actual receipt of an improper benefit or profit in money, property or services or (b) active and deliberate dishonesty which is established by a final judgment as being is material to the cause of action. Our charter contains such a provision which eliminates directors’ and officers’ liability to the maximum extent permitted by Maryland law.

Our charter authorizes us, to the maximum extent permitted by Maryland law, to obligate the Company to indemnify any present or former director or officer or any individual who, while a director or officer of the

II-1

Company and at the request of the Company, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise as a director, officer, partner, trustee, employee or agent from and against any claim or liability to which that individual may become subject or which that individual may incur by reason of his or her service in any such capacity and to pay or reimburse his or her reasonable expenses in advance of final disposition of a proceeding. Our bylaws obligate us, to the maximum extent permitted by Maryland law, to indemnify any present or former director or officer or any individual who, while a director or officer of the Company and at the request of the Company, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise as a director, officer, partner, trustee, employee or agent and who is made, or threatened to be made, a party to the proceeding by reason of his or her service in any such capacity from and against any claim or liability to which that individual may become subject or which that individual may incur by reason of his or her service in any such capacity and to pay or reimburse his or her reasonable expenses in advance of final disposition of a proceeding. The charter and bylaws also permit the Company to indemnify and advance expenses to any individual who served a predecessor of the Company in any of the capacities described above and any employee or agent of the Company or a predecessor of the Company. Maryland law requires a corporation (unless its charter provides otherwise, which the Company’s charter does not) to indemnify a director or officer who has been successful in the defense of any proceeding to which he is made a party by reason of his service in that capacity.

Maryland law permits a corporation to indemnify its present and former directors and officers, among others, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by them in connection with any proceeding to which they may be made a party by reason of their service in those or other capacities unless it is established that (a) the act or omission of the director or officer was material to the matter giving rise to the proceeding and (i) was committed in bad faith or (ii) was the result of active and deliberate dishonesty, (b) the director or officer actually received an improper personal benefit in money, property or services or (c) in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. However, under Maryland law, a Maryland corporation may not indemnify for an adverse judgment in a suit by or in the right of the corporation or for a judgment of liability on the basis that personal benefit was improperly received, unless in either case a court orders indemnification and then only for expenses. In addition, Maryland law permits a corporation to advance reasonable expenses to a director or officer upon the corporation’s receipt of (a) a written affirmation by the director or officer of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification by the corporation and (b) a written undertaking by him or her or on his or her behalf to repay the amount paid or reimbursed by the corporation if it is ultimately determined that the standard of conduct was not met.

ITEM 35. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED

None of the proceeds will be credited to an account other than the appropriate capital share account.

II-2

ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS

(a) Financial Statements. See page F-1 for an index of the financial statements included in this registration statement.

(b) Exhibits. The following exhibits are filed as part of, or incorporated by reference into, this registration statement on Form S-11:


1.1*		Form of Underwriting Agreement among Sunstone Hotel Investors, Inc. and the underwriters named therein.
3.1		Form of Articles of Amendment and Restatement of Sunstone Hotel Investors, Inc.
3.2		Form of Bylaws of Sunstone Hotel Investors, Inc.
4.1*		Specimen Certificate of Common Stock of Sunstone Hotel Investors, Inc.
5.1*		Opinion of Venable LLP.
8.1*		Tax Opinion of Sullivan & Cromwell LLP.
10.1		Structuring and Contribution Agreement, dated as of July 2, 2004, by and among Sunstone Hotel Partnership, LLC, Sunstone Hotel Investors, Inc., Sunstone Hotel Investors, L.L.C., Sunstone/WB Hotel Investors IV, LLC, WB Hotel Investors, LLC, Sunstone/WB Manhattan Beach, LLC and Alter SHP LLC.
10.2		Form of Master Agreement with Management Company.
10.3		Form of Hotel Management Agreement.
10.4**		Loan Agreement, dated August 28, 2003, among the borrowers named therein, the Senior Lenders, Junior Lenders and Massachusetts Mutual Life Insurance Company, as Administrative Agent.
10.5**		Amended and Restated Loan Agreement, dated January 31, 2003, between the borrowers named therein and Bear Stearns Commercial Mortgage, Inc., as Lender.
10.5.1**		First Amendment to Amended and Restated Loan Agreement, dated February 25, 2003, between the borrowers named therein and LaSalle Bank National Association, as Trustee, in trust for the Holders of Bear Stearns Commercial Mortgage Securities Inc. Commercial Mortgage Pass-Through Certificates, Series 2003-West, as Lender.
10.6**		Junior Mezzanine Loan Agreement, dated December 5, 2002, among the borrowers named therein and Bear Stearns Commercial Mortgage, Inc., as Lender.
10.6.1**		First Amendment to Junior Mezzanine Loan Agreement, dated January 7, 2003, among the borrowers named therein and CTMPII FC Westbrook (GCM), as Lender.
10.7**		Mezzanine Loan Agreement, dated December 5, 2002, among the borrowers named therein and Bear Stearns Commercial Mortgage, Inc., as Lender.
10.7.1**		First Amendment to Mezzanine Loan Agreement, dated January 7, 2003, among the borrowers named therein and Bear Stearns Commercial Mortgage, Inc., as Lender.
10.8		Form of Registration Rights Agreement among Sunstone Hotel Investors, Inc. and the persons named therein.
10.9*		Form of 2004 Long-term Incentive Plan of Sunstone Hotel Investors, Inc.
10.10*		Form of TRS Lease.
10.11*		Form of Limited Liability Company Agreement of Sunstone Hotel Partnership, LLC.
10.12*		Revolving Credit Agreement.
10.13		Form of Investors Agreement among Sunstone Hotel Investors, Inc. and the persons named therein.
10.14*		Form of Annual Bonus Plan.
10.15*		Form of Employment Agreement.
21.1*		Subsidiaries of Sunstone Hotel Investors, Inc.

II-3


23.1		Consent of Ernst & Young LLP.
23.2		Consent of PricewaterhouseCoopers LLP.
23.3*		Consent of Venable LLP (included as part of Exhibit 5.1).
23.4*		Consent of Sullivan & Cromwell LLP (included in Exhibit 8.1).
24.1		Power of Attorney (included on the signature page at page II-5 hereof).
99.1**		Consent of Paul D. Kazilionis.
99.2**		Consent of Jonathan H. Paul.

*	To be filed by amendment

**	Previously filed

ITEM 37. UNDERTAKINGS

The undersigned registrant hereby undertakes to provide to the underwriter at the closing specified in the underwriting agreements, certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser.

The undersigned registrant further hereby undertakes that:

(1) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in opinion of its counsel the matter has been settle by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.

(2) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in the form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective.

(3) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.

II-4

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-11 and has duly caused this amendment to registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Clemente, State of California on this 19th day of August, 2004.


SUNSTONE HOTEL INVESTORS, INC.

By:	/s/ J ON D. K LINE
	Name:	Jon D. Kline
	Title:	Executive Vice President and Chief Financial Officer

POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature appears below constitutes and appoints Robert A. Alter and Jon D. Kline his true and lawful attorney-in-fact and agent, with the full power of substitution for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this registration statement, and any registration statement pursuant to Rule 462(b) under the Securities Act, and to file the same, with all exhibits thereto, and all documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may do or cause to be done by virtue thereof.

Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and as on the dates indicated.


SIGNATURE	TITLE	DATE

/ S / R OBERT A. A LTER Robert A. Alter	Chairman, Chief Executive Officer and President	August 19, 2004

/ S / J ON D. K LINE Jon D. Kline	Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)	August 19, 2004

/ S / P AUL D. K AZILIONIS Paul D. Kazilionis	Director	August 19, 2004

Jonathan H. Paul	Director	August , 2004

II-5

INDEX TO EXHIBITS


1.1*		Form of Underwriting Agreement among Sunstone Hotel Investors, Inc. and the underwriters named therein.
3.1		Form of Articles of Amendment and Restatement of Sunstone Hotel Investors, Inc.
3.2		Form of Bylaws of Sunstone Hotel Investors, Inc.
4.1*		Specimen Certificate of Common Stock of Sunstone Hotel Investors, Inc.
5.1*		Opinion of Venable LLP.
8.1*		Tax Opinion of Sullivan & Cromwell LLP.
10.1		Structuring and Contribution Agreement, dated as of July 2, 2004, by and among Sunstone Hotel Partnership, LLC, Sunstone Hotel Investors, Inc., Sunstone Hotel Investors, L.L.C., Sunstone/WB Hotel Investors IV, LLC, WB Hotel Investors, LLC, Sunstone/WB Manhattan Beach, LLC and Alter SHP LLC.
10.2		Form of Master Agreement with Management Company.
10.3		Form of Hotel Management Agreement.
10.4**		Loan Agreement, dated August 28, 2003, among the borrowers named therein, the Senior Lenders, Junior Lenders and Massachusetts Mutual Life Insurance Company, as Administrative Agent.
10.5**		Amended and Restated Loan Agreement, dated January 31, 2003, between the borrowers named therein and Bear Stearns Commercial Mortgage, Inc., as Lender.
10.5.1**		First Amendment to Amended and Restated Loan Agreement, dated February 25, 2003, between the borrowers named therein and LaSalle Bank National Association, as Trustee, in trust for the Holders of Bear Stearns Commercial Mortgage Securities Inc. Commercial Mortgage Pass-Through Certificates, Series 2003-West, as Lender.
10.6**		Junior Mezzanine Loan Agreement, dated December 5, 2002, among the borrowers named therein and Bear Stearns Commercial Mortgage, Inc., as Lender.
10.6.1**		First Amendment to Junior Mezzanine Loan Agreement, dated January 7, 2003, among the borrowers named therein and CTMPII FC Westbrook (GCM), as Lender.
10.7**		Mezzanine Loan Agreement, dated December 5, 2002, among the borrowers named therein and Bear Stearns Commercial Mortgage, Inc., as Lender.
10.7.1**		First Amendment to Mezzanine Loan Agreement, dated January 7, 2003, among the borrowers named therein and Bear Stearns Commercial Mortgage, Inc., as Lender.
10.8		Form of Registration Rights Agreement among Sunstone Hotel Investors, Inc. and the persons named therein.
10.9*		Form of 2004 Long-term Incentive Plan of Sunstone Hotel Investors, Inc.
10.10*		Form of TRS Lease.
10.11*		Form of Limited Liability Company Agreement of Sunstone Hotel Partnership, LLC.
10.12*		Revolving Credit Agreement.
10.13		Form of Investors Agreement among Sunstone Hotel Investors, Inc. and the persons named therein.
10.14*		Form of Annual Bonus Plan.
10.15*		Form of Employment Agreement.
21.1*		Subsidiaries of Sunstone Hotel Investors, Inc.
23.1		Consent of Ernst & Young LLP.
23.2		Consent of PricewaterhouseCoopers LLP.
23.3*		Consent of Venable LLP (included as part of Exhibit 5.1).
23.4*		Consent of Sullivan & Cromwell LLP (included in Exhibit 8.1).
24.1		Power of Attorney (included on the signature page at page II-5 hereof).
99.1**		Consent of Paul D. Kazilionis.
99.2**		Consent of Jonathan H. Paul.

*	To be filed by amendment

**	Previously filed

II-6

Exhibit 3.1

SUNSTONE HOTEL INVESTORS, INC.

ARTICLES OF AMENDMENT AND RESTATEMENT

FIRST : Sunstone Hotel Investors, Inc., a Maryland corporation (the “Corporation”), desires to amend and restate the charter of the Corporation as currently in effect and as hereinafter amended.

SECOND: The following provisions are all the provisions of the charter currently in effect and as hereinafter amended:

ARTICLE I

INCORPORATOR

The undersigned, Patricia McGowan, whose address is c/o Venable LLP, 1800 Mercantile Bank & Trust Bldg., 2 Hopkins Plaza, Baltimore, Maryland 21201, being at least 18 years of age, does hereby form a corporation under the general laws of the State of Maryland.

ARTICLE II

NAME

The name of the corporation (the “Corporation”) is:

Sunstone Hotel Investors, Inc.

ARTICLE III

PURPOSE

The purposes for which the Corporation is formed are to engage in any lawful act or activity (including, without limitation or obligation, engaging in business as a real estate investment trust under the Internal Revenue Code of 1986, as amended, or any successor statute (the “Code”)) for which corporations may be organized under the general laws of the State of Maryland as now or hereafter in force. For purposes of the charter (the “Charter”), the term “REIT” shall mean a corporation that elects to be taxed as a “real estate investment trust” under Sections 856 through 859 of the Code.

ARTICLE IV

PRINCIPAL OFFICE IN STATE AND RESIDENT AGENT

The address of the principal office of the Corporation in the State of Maryland is c/o The Corporation Trust Incorporated, 300 East Lombard Street, Baltimore, Maryland 21202. The name and address of the resident agent of the Corporation in the State of Maryland are The Corporation Trust Incorporated, 300 East Lombard Street, Baltimore, Maryland 21202. The resident agent is a Maryland corporation.

ARTICLE V

PROVISIONS FOR DEFINING, LIMITING

AND REGULATING CERTAIN POWERS OF THE

CORPORATION AND OF THE STOCKHOLDERS AND DIRECTORS

Section 5.1 Number of Directors . The business and affairs of the Corporation shall be managed under the direction of the Board of Directors. The number of directors of the Corporation initially shall be seven, which number may be increased or decreased only by the Board of Directors pursuant to the Bylaws, but shall never be less than the minimum number required by the Maryland General Corporation Law (the “MGCL”). The names of the directors who shall serve until the first annual meeting of stockholders and until their successors are duly elected and qualify are:

Robert A. Alter

Paul D. Kazilionis

Jonathan H. Paul

The Corporation elects, at such time as it becomes eligible to make the election provided for under Section 3-802(b) of the MGCL, that, except as may be provided by the Board of Directors in setting the terms of any class or series of stock, pursuant to Section 3-804(c) of the MGCL, any and all vacancies on the Board of Directors may be filled only by the affirmative vote of a majority of the remaining directors in office, even if the remaining directors do not constitute a quorum, and any director elected to fill a vacancy shall serve for the remainder of the full term of the directorship in which such vacancy occurred.

Section 5.2 Extraordinary Actions . Notwithstanding any provision of the MGCL requiring any action to be taken or approved by the affirmative vote of the holders of shares entitled to cast a greater number of votes, any such action shall be effective and valid if declared advisable by the Board of Directors and taken or approved by the affirmative vote of holders of shares entitled to cast a majority of all the votes entitled to be cast on the matter.

Section 5.3 Authorization by Board of Stock Issuance . The Board of Directors may authorize the issuance from time to time of shares of stock of the Corporation of any class or series, whether now or hereafter authorized, or securities or rights convertible into shares of its stock of any class or series, whether now or hereafter authorized, for such consideration as the Board of Directors may deem advisable (or without consideration in the case of a stock split or stock dividend), subject to such restrictions or limitations, if any, as may be set forth in the Charter or the Bylaws.

Section 5.4 Preemptive Rights and Appraisal Rights . Except as may be provided by the Board of Directors in setting the terms of classified or reclassified shares of stock pursuant to Section 6.4 or as may otherwise be provided by contract, no holder of shares of stock of the Corporation shall, as such holder, have any preemptive right to purchase or subscribe for any additional shares of stock of the Corporation or any other security of the Corporation which it may issue or sell. Holders of shares of stock shall not be entitled to exercise any rights of an objecting stockholder provided for under Title 3, Subtitle 2 of the Maryland General Corporation Law or any successor statute unless the Board of Directors, upon the affirmative vote of a majority of the Board of Directors, shall determine that such rights apply, with respect to all or any classes or series of stock, to one or more transactions occurring after the date of such determination in connection with which holders of such shares would otherwise be entitled to exercise such rights.

Section 5.5 Indemnification . The Corporation shall have the power, to the maximum extent permitted by Maryland law in effect from time to time, to obligate itself to indemnify, and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to, (a) any individual who is a present or former director or officer of the Corporation or (b) any individual who, while a director or officer of the Corporation and at the request of the Corporation, serves or has served as a director, officer, partner or trustee of another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or any other enterprise from and against any claim or liability to which such person may become subject or which such person may incur by reason of his or her service in such capacity. The Corporation shall have the power, with the approval of the Board of Directors, to provide such indemnification and advancement of expenses to a person who served a predecessor of the Corporation in any of the capacities described in (a) or (b) above and to any employee or agent of the Corporation or a predecessor of the Corporation.

Section 5.6 Determinations by Board . The determination as to any of the following matters, made in good faith by or pursuant to the direction of the Board of Directors consistent with the Charter, shall be final and conclusive and shall be binding

upon the Corporation and every holder of shares of its stock: the amount of the net income of the Corporation for any period and the amount of assets at any time legally available for the payment of dividends, redemption of its stock or the payment of other distributions on its stock; the amount of paid-in surplus, net assets, other surplus, annual or other cash flow, funds from operations, net profit, net assets in excess of capital, undivided profits or excess of profits over losses on sales of assets; the amount, purpose, time of creation, increase or decrease, alteration or cancellation of any reserves or charges and the propriety thereof (whether or not any obligation or liability for which such reserves or charges shall have been created shall have been paid or discharged); any interpretation of the terms, preferences, conversion or other rights, voting powers or rights, restrictions, limitations as to dividends or distributions, qualifications or terms or conditions of redemption of any class or series of stock of the Corporation; the fair value, or any sale, bid or asked price to be applied in determining the fair value, of any asset owned or held by the Corporation or of any shares of stock of the Corporation; the number of shares of stock of any class of the Corporation; any matter relating to the acquisition, holding and disposition of any assets by the Corporation; or any other matter relating to the business and affairs of the Corporation or required or permitted by applicable law, the Charter or Bylaws or otherwise to be determined by the Board of Directors.

Section 5.7 REIT Qualification . If the Corporation elects to qualify for federal income tax treatment as a REIT, the Board of Directors shall use its reasonable best efforts to take such actions as are necessary or appropriate to preserve the status of the Corporation as a REIT; however, if the Board of Directors determines that it is no longer in the best interests of the Corporation to continue to be qualified as a REIT, the Board of Directors may revoke or otherwise terminate the Corporation’s REIT election pursuant to Section 856(g) of the Code. The Board of Directors also may determine that compliance with any restriction or limitation on stock ownership and transfers set forth in Article VII is no longer required for REIT qualification.

Section 5.8 Removal of Directors . Subject to the rights of holders of one or more classes or series of Preferred Stock to elect or remove one or more directors, any director, or the entire Board of Directors, may be removed from office at any time, with or without cause, by the affirmative vote of at least a majority of the votes entitled to be cast generally in the election of directors.

ARTICLE VI

STOCK

Section 6.1 Authorized Shares . The Corporation has authority to issue 600,000,000 shares of stock, consisting of 500,000,000 shares of Common Stock, $.01 par value per share (“Common Stock”), and 100,000,000 shares of Preferred Stock, $.01 par value per share (“Preferred Stock”). The aggregate par value of all authorized shares of stock having par value is $6,000,000. If shares of one class of stock are classified or reclassified into shares of another class of stock pursuant to Section 6.2, 6.3 or 6.4 of this

Article VI, the number of authorized shares of the former class shall be automatically decreased and the number of shares of the latter class shall be automatically increased, in each case by the number of shares so classified or reclassified, so that the aggregate number of shares of stock of all classes that the Corporation has authority to issue shall not be more than the total number of shares of stock set forth in the first sentence of this paragraph. The Board of Directors, with the approval of a majority of the entire Board and without any action by the stockholders of the Corporation, may amend the Charter from time to time to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that the Corporation has authority to issue.

Section 6.2 Common Stock . Subject to the provisions of Article VII and except as may otherwise be specified in the terms of any class or series of Common Stock, each share of Common Stock shall entitle the holder thereof to one vote. The Board of Directors may reclassify any unissued shares of Common Stock from time to time in one or more classes or series of stock.

Section 6.3 Preferred Stock . The Board of Directors may classify any unissued shares of Preferred Stock and reclassify any previously classified but unissued shares of Preferred Stock of any series from time to time in one or more classes or series of stock.

Section 6.4 Classified or Reclassified Shares . Prior to issuance of classified or reclassified shares of any class or series, the Board of Directors by resolution shall: (a) designate that class or series to distinguish it from all other classes and series of stock of the Corporation; (b) specify the number of shares to be included in the class or series; (c) set or change, subject to the provisions of Article VII and subject to the express terms of any class or series of stock of the Corporation outstanding at the time, the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms and conditions of redemption for each class or series; and (d) cause the Corporation to file articles supplementary with the State Department of Assessments and Taxation of Maryland (“SDAT”). Any of the terms of any class or series of stock set or changed pursuant to clause (c) of this Section 6.4 may be made dependent upon facts or events ascertainable outside the Charter (including determinations by the Board of Directors or other facts or events within the control of the Corporation) and may vary among holders thereof, provided that the manner in which such facts, events or variations shall operate upon the terms of such class or series of stock is clearly and expressly set forth in the articles supplementary or other Charter document.

Section 6.5 Stockholders’ Consent in Lieu of Meeting . Any action required or permitted to be taken at any meeting of the stockholders may be taken without a meeting by consent, in writing or by electronic transmission, in any manner permitted by the MGCL and (a) set forth in the Bylaws or (b) set forth in the terms of any class or series of Preferred Stock.

Section 6.6 Charter and Bylaws . The rights of all stockholders and the terms of all stock are subject to the provisions of the Charter and the Bylaws.

ARTICLE VII

RESTRICTION ON TRANSFER AND OWNERSHIP OF SHARES

Section 7.1 Definitions . For the purpose of this Article VII, the following terms shall have the following meanings:

Aggregate Stock Ownership Limit . The term “Aggregate Stock Ownership Limit” shall mean not more than 9.8 percent in value of the aggregate of the outstanding shares of Capital Stock.

Beneficial Ownership . The term “Beneficial Ownership” shall mean ownership of Capital Stock by a Person, whether the interest in the shares of Capital Stock is held directly or indirectly (including by a nominee), and shall include interests that would be treated as owned through the application of Section 544 of the Code, as modified by Section 856(h)(1)(B) of the Code. The terms “Beneficial Owner,” “Beneficially Owns” and “Beneficially Owned” shall have the correlative meanings.

Business Day . The term “Business Day” shall mean any day, other than a Saturday or Sunday, that is neither a legal holiday nor a day on which banking institutions in California are authorized or required by law, regulation or executive order to close.

Capital Stock . The term “Capital Stock” shall mean all classes or series of stock of the Corporation, including, without limitation, Common Stock and Preferred Stock.

Charitable Beneficiary . The term “Charitable Beneficiary” shall mean one or more beneficiaries of the Trust as determined pursuant to Section 7.3.6, provided that each such organization must be described in Section 501(c)(3) of the Code and contributions to each such organization must be eligible for deduction under each of Sections 170(b)(1)(A), 2055 and 2522 of the Code.

Code . The term “Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

Common Stock Ownership Limit . The term “Common Stock Ownership Limit” shall mean not more than 9.8 percent (in value or in number of shares, whichever is more restrictive) of the aggregate of the outstanding shares of Common Stock of the Corporation.

Constructive Ownership . The term “Constructive Ownership” shall mean ownership of Capital Stock by a Person, whether the interest in the shares of Capital Stock is held directly or indirectly (including by a nominee), and shall include interests

that would be treated as owned through the application of Section 318(a) of the Code, as modified by Section 856(d)(5) of the Code. The terms “Constructive Owner,” “Constructively Owns” and “Constructively Owned” shall have the correlative meanings.

Excepted Holder . The term “Excepted Holder” shall mean a stockholder of the Corporation for whom an Excepted Holder Limit is created by this Charter or by the Board of Directors pursuant to Section 7.2.7.

Excepted Holder Limit . The term “Excepted Holder Limit” shall mean, provided that the affected Excepted Holder agrees to comply with the requirements established by the Board of Directors pursuant to Section 7.2.7 and subject to adjustment pursuant to Section 7.2.8, the percentage limit established by the Board of Directors pursuant to Section 7.2.7.

Initial Date . The term “Initial Date” shall mean the date upon which the Articles of Amendment and Restatement containing this Article VII are accepted for record by the SDAT.

Market Price . The term “Market Price” on any date shall mean, with respect to any class or series of outstanding shares of Capital Stock, the Closing Price for such Capital Stock on such date. The “Closing Price” on any date shall mean the last sale price for such Capital Stock, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, for such Capital Stock, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the NYSE or, if such Capital Stock is not listed or admitted to trading on the NYSE, as reported on the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which such Capital Stock is listed or admitted to trading or, if such Capital Stock is not listed or admitted to trading on any national securities exchange, the last quoted price, or, if not so quoted, the average of the high bid and low asked prices in the over-the-counter market, as reported by the National Association of Securities Dealers, Inc. Automated Quotation System or, if such system is no longer in use, the principal other automated quotation system that may then be in use or, if such Capital Stock is not quoted by any such organization, the average of the closing bid and asked prices as furnished by a professional market maker making a market in such Capital Stock selected by the Board of Directors of the Corporation or, in the event that no trading price is available for such Capital Stock, the fair market value of the Capital Stock, as determined in good faith by the Board of Directors of the Corporation.

MGCL . The term “MGCL” shall mean the Maryland General Corporation Law, as amended from time to time.

NYSE . The term “NYSE” shall mean the New York Stock Exchange.

Person . The term “Person” shall mean an individual, corporation, partnership, estate, trust (including a trust qualified under Sections 401(a) or 501(c)(17) of the Code), a portion of a trust permanently set aside for or to be used exclusively for

the purposes described in Section 642(c) of the Code, association, private foundation within the meaning of Section 509(a) of the Code, joint stock company or other entity and also includes a group as that term is used for purposes of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, and a group to which an Excepted Holder Limit applies.

Prohibited Owner . The term “Prohibited Owner” shall mean, with respect to any purported Transfer, any Person who, but for the provisions of Section 7.2.1, would Beneficially Own or Constructively Own shares of Capital Stock, and if appropriate in the context, shall also mean any Person who would have been the record owner of the shares that the Prohibited Owner would have so owned.

Restriction Termination Date . The term “Restriction Termination Date” shall mean the first day after the Initial Date on which the Corporation determines pursuant to Section 5.7 of the Charter that it is no longer in the best interests of the Corporation to attempt to, or continue to, qualify as a REIT or that compliance with the restrictions and limitations on Beneficial Ownership, Constructive Ownership and Transfers of shares of Capital Stock set forth herein is no longer required in order for the Corporation to qualify as a REIT.

Transfer . The term “Transfer” shall mean any issuance, sale, transfer, gift, assignment, devise or other disposition, as well as any other event that causes any Person to acquire Beneficial Ownership or Constructive Ownership, or any agreement to take any such actions or cause any such events, of Capital Stock or the right to vote or receive dividends on Capital Stock, including (a) the granting or exercise of any option (or any disposition of any option), (b) any disposition of any securities or rights convertible into or exchangeable for Capital Stock or any interest in Capital Stock or any exercise of any such conversion or exchange right and (c) Transfers of interests in other entities that result in changes in Beneficial or Constructive Ownership of Capital Stock; in each case, whether voluntary or involuntary, whether owned of record, Constructively Owned or Beneficially Owned and whether by operation of law or otherwise. The terms “Transferring” and “Transferred” shall have the correlative meanings.

Trust . The term “Trust” shall mean any trust provided for in Section 7.3.1.

Trustee . The term “Trustee” shall mean the Person unaffiliated with the Corporation and a Prohibited Owner, that is appointed by the Corporation to serve as trustee of the Trust.

Section 7.2 Capital Stock .

Section 7.2.1 Ownership Limitations . During the period commencing on the Initial Date and prior to the Restriction Termination Date, but subject to Section 7.4:

(a) Basic Restrictions .

(i) (1) No Person, other than an Excepted Holder, shall Beneficially Own or Constructively Own shares of Capital Stock in excess of the Aggregate Stock Ownership Limit, (2) no Person, other than an Excepted Holder, shall Beneficially Own or Constructively Own shares of Common Stock in excess of the Common Stock Ownership Limit and (3) no Excepted Holder shall Beneficially Own or Constructively Own shares of Capital Stock in excess of the Excepted Holder Limit for such Excepted Holder.

(ii) No Person shall Beneficially or Constructively Own shares of Capital Stock to the extent that such Beneficial or Constructive Ownership of Capital Stock would result in the Corporation being “closely held” within the meaning of Section 856(h) of the Code (without regard to whether the ownership interest is held during the last half of a taxable year), or otherwise failing to qualify as a REIT (including, but not limited to, Beneficial or Constructive Ownership that would result in the Corporation owning (actually or Constructively) an interest in a tenant that is described in Section 856(d)(2)(B) of the Code if the income derived by the Corporation from such tenant would cause the Corporation to fail to satisfy any of the gross income requirements of Section 856(c) of the Code or that would result in the Corporation owning more than a 35% interest in any person which manages properties owned by the Corporation).

(iii) Any Transfer of shares of Capital Stock that, if effective, would result in the Capital Stock being beneficially owned by less than 100 Persons (determined under the principles of Section 856(a)(5) of the Code) shall be void ab initio , and the intended transferee shall acquire no rights in such shares of Capital Stock.

(b) Transfer in Trust . If any Transfer of shares of Capital Stock occurs which, if effective, would result in any Person Beneficially Owning or Constructively Owning shares of Capital Stock in violation of Section 7.2.1(a)(i) or (ii),

(i) then that number of shares of the Capital Stock the Beneficial or Constructive Ownership of which otherwise would cause such Person to violate Section 7.2.1(a)(i) or (ii)(rounded to the nearest whole share) shall be automatically transferred to a Trust for the benefit of a Charitable Beneficiary, as described in Section 7.3, effective as of the close of business on the Business Day prior to the date of such Transfer, and such Person shall acquire no rights in such shares; or

(ii) if the transfer to the Trust described in clause (i) of this sentence would not be effective for any reason to prevent the violation of Section 7.2.1(a)(i) or (ii), then the Transfer of that number of shares of Capital Stock that otherwise would cause any Person to violate Section 7.2.1(a)(i) or (ii) shall be void ab initio , and the intended transferee shall acquire no rights in such shares of Capital Stock.

Section 7.2.2 Remedies for Breach . If the Board of Directors of the Corporation or any duly authorized committee thereof shall at any time determine in good faith that a Transfer or other event has taken place that results in a violation of Section 7.2.1 or that a Person intends to acquire or has attempted to acquire Beneficial or Constructive Ownership of any shares of Capital Stock in violation of Section 7.2.1 (whether or not such violation is intended), the Board of Directors or a committee thereof shall take such action as it deems advisable to refuse to give effect to or to prevent such Transfer or other event, including, without limitation, causing the Corporation to redeem shares, refusing to give effect to such Transfer on the books of the Corporation or instituting proceedings to enjoin such Transfer or other event; provided , however , that any Transfer or attempted Transfer or other event in violation of Section 7.2.1 shall automatically result in the transfer to the Trust described above, and, where applicable, such Transfer (or other event) shall be void ab initio as provided above irrespective of any action (or non-action) by the Board of Directors or a committee thereof.

Section 7.2.3 Notice of Restricted Transfer . Any Person who acquires or attempts or intends to acquire Beneficial Ownership or Constructive Ownership of shares of Capital Stock that will or may violate Section 7.2.1(a) or any Person who would have owned shares of Capital Stock that resulted in a transfer to the Trust pursuant to the provisions of Section 7.2.1(b) shall immediately give written notice to the Corporation of such event or, in the case of such a proposed or attempted transaction, give at least 15 days prior written notice, and shall provide to the Corporation such other information as the Corporation may request in order to determine the effect, if any, of such Transfer on the Corporation’s status as a REIT.

Section 7.2.4 Owners Required To Provide Information . From the Initial Date and prior to the Restriction Termination Date:

(a) every owner of five percent or more (or such lower percentage as required by the Code or the Treasury Regulations promulgated thereunder) of the outstanding shares of Capital Stock, within 30 days after the end of each taxable year, shall give written notice to the Corporation stating the name and address of such owner, the number of shares of Capital Stock and other shares of the Capital Stock Beneficially Owned and a description of the manner in which such shares are held. Each such owner shall provide to the Corporation such additional information as the Corporation may request in order to determine the effect, if any, of such Beneficial Ownership on the Corporation’s status as a REIT and to ensure compliance with the Aggregate Stock Ownership Limit; and

(b) each Person who is a Beneficial or Constructive Owner of Capital Stock and each Person (including the stockholder of record) who is holding Capital Stock for a Beneficial or Constructive Owner shall provide to the Corporation such information as the Corporation may request, in good faith, in order to determine the Corporation’s status as a REIT and to comply with requirements of any taxing authority or governmental authority or to determine such compliance.

Section 7.2.5 Remedies Not Limited . Subject to Section 5.7 of the Charter, nothing contained in this Section 7.2 shall limit the authority of the Board of Directors of the Corporation to take such other action as it deems necessary or advisable to protect the Corporation and the interests of its stockholders in preserving the Corporation’s status as a REIT.

Section 7.2.6 Ambiguity . In the case of an ambiguity in the application of any of the provisions of this Section 7.2, Section 7.3, or any definition contained in Section 7.1, the Board of Directors of the Corporation shall have the power to determine the application of the provisions of this Section 7.2 or Section 7.3 or any such definition with respect to any situation based on the facts known to it. In the event Section 7.2 or 7.3 requires an action by the Board of Directors and the Charter fails to provide specific guidance with respect to such action, the Board of Directors shall have the power to determine the action to be taken so long as such action is not contrary to the provisions of Sections 7.1, 7.2 or 7.3. Absent a decision to the contrary by the Board of Directors (which the Board may make in its sole and absolute discretion), if a Person would have (but for the remedies set forth in Section 7.2.2) acquired Beneficial or Constructive Ownership of Stock in violation of Section 7.2.1, such remedies (as applicable) shall apply first to the shares of Stock which, but for such remedies, would have been Beneficially Owned or Constructively Owned (but not actually owned) by such Person, pro rata among the Persons who actually own such shares of Stock based upon the relative number of the shares of Stock held by each such Person.

Section 7.2.7 Exceptions .

(a) Subject to Section 7.2.1(a)(ii), the Board of Directors of the Corporation, in its sole discretion, may waive or exempt (prospectively or retroactively) a Person from the Aggregate Stock Ownership Limit and the Common Stock Ownership Limit, as the case may be, and may establish or increase an Excepted Holder Limit for such Person if:

(i) the Board of Directors obtains such representations and undertakings from such Person as are reasonably necessary to ascertain that no individual’s Beneficial or Constructive Ownership of such shares of Capital Stock will violate Section 7.2.1(a)(ii);

(ii) such Person does not and represents that it will not own, actually or Constructively, an interest in a tenant of the Corporation (or a tenant of any entity owned or controlled by the Corporation) that would cause the Corporation to own, actually or Constructively, more than a 9.9% interest (as set forth in Section 856(d)(2)(B) of the Code) in such tenant and the Board of Directors obtains such representations and undertakings from such Person as are reasonably necessary to ascertain this fact (for this purpose, a tenant from whom

the Corporation (or an entity owned or controlled by the Corporation) derives (and is expected to continue to derive) a sufficiently small amount of revenue such that, in the opinion of the Board of Directors of the Corporation, rent from such tenant would not adversely affect the Corporation’s ability to qualify as a REIT shall not be treated as a tenant of the Corporation); and

(iii) such Person agrees that any violation or attempted violation of such representations or undertakings (or other action which is contrary to the restrictions contained in Sections 7.2.1 through 7.2.6) will result in such shares of Capital Stock being automatically transferred to a Trust in accordance with Sections 7.2.1(b) and 7.3.

(b) Prior to granting any waiver or exception pursuant to Section 7.2.7(a), the Board of Directors of the Corporation may require that such person provide a ruling from the Internal Revenue Service, or an opinion of counsel, in either case in form and substance satisfactory to the Board of Directors in its sole discretion, as it may deem necessary or advisable in order to determine or ensure the Corporation’s status as a REIT. Notwithstanding the receipt of any ruling or opinion, the Board of Directors may impose such conditions or restrictions as it deems appropriate in connection with granting such exception.

(c) Subject to Section 7.2.1(a)(ii), an underwriter which participates in a public offering or a private placement of Capital Stock (or securities convertible into or exchangeable for Capital Stock) may Beneficially Own or Constructively Own shares of Capital Stock (or securities convertible into or exchangeable for Capital Stock) in excess of the Aggregate Stock Ownership Limit, the Common Stock Ownership Limit, or both such limits, but only to the extent necessary to facilitate such public offering or private placement.

(d) The Board of Directors may only reduce the Excepted Holder Limit for an Excepted Holder: (1) with the written consent of such Excepted Holder at any time, or (2) pursuant to the terms and conditions of the agreements and undertakings entered into with such Excepted Holder in connection with the establishment of the Excepted Holder Limit for that Excepted Holder. No Excepted Holder Limit shall be reduced to a percentage that is less than the Common Stock Ownership Limit.

Section 7.2.8 Increase in Aggregate Stock Ownership and Common Stock Ownership Limits . Subject to Section 7.2.2 (a)(ii), the Board of Directors may from time to time increase the Common Stock Ownership Limit and the Aggregate Stock Ownership Limit for one or more Persons and decrease the Common Stock Ownership Limit and the Aggregate Stock Ownership Limit for all other Persons; provided, however, that the decreased Common Stock Ownership Limit and/or Aggregate Stock Ownership Limit will not be effective for any Person whose percentage ownership in Stock is in excess of such decreased Common Stock Ownership Limit and/or Aggregate Stock Ownership Limit until such time as such Person’s percentage of Stock

equals or falls below the decreased Common Stock Ownership Limit and/or Aggregate Stock Ownership Limit, but any further acquisition of Stock in excess of such percentage ownership of Stock will be in violation of the Common Stock Ownership Limit and/or Aggregate Stock Ownership Limit and, provided further, that the new Common Stock Ownership Limit and/or Aggregate Stock Ownership Limit would not allow five or fewer Persons to Beneficially Own more than 49.9% in value of the outstanding Stock.

Section 7.2.9 Legend . Each certificate for shares of Capital Stock shall bear substantially the following legend:

The shares represented by this certificate are subject to restrictions on Beneficial and Constructive Ownership and Transfer for the purpose, among others, of the Corporation’s maintenance of its status as a Real Estate Investment Trust under the Internal Revenue Code of 1986, as amended, or any successor statute (the “Code”). Subject to certain further restrictions and except as expressly provided in the Corporation’s Charter, (i) no Person may Beneficially or Constructively Own shares of the Corporation’s Common Stock in excess of 9.8 percent (in value or number of shares) of the outstanding shares of Common Stock of the Corporation unless such Person is an Excepted Holder (in which case the Excepted Holder Limit shall be applicable); (ii) no Person may Beneficially or Constructively Own shares of Capital Stock of the Corporation in excess of 9.8 percent of the value of the total outstanding shares of Capital Stock of the Corporation, unless such Person is an Excepted Holder (in which case the Excepted Holder Limit shall be applicable); (iii) no Person may Beneficially or Constructively Own Capital Stock that would result in the Corporation being “closely held” under Section 856(h) of the Code or otherwise cause the Corporation to fail to qualify as a REIT; and (iv) no Person may Transfer shares of Capital Stock if such Transfer would result in the Capital Stock of the Corporation being owned by fewer than 100 Persons. Any Person who Beneficially or Constructively Owns or attempts to Beneficially or Constructively Own shares of Capital Stock which causes or will cause a Person to Beneficially or Constructively Own shares of Capital Stock in excess or in violation of the above limitations must immediately notify the Corporation. If any of the restrictions on transfer or ownership are violated, the shares of Capital Stock represented hereby will be automatically transferred to a Trustee of a Trust for the benefit of one or more Charitable Beneficiaries. In addition, the Corporation

may redeem shares upon the terms and conditions specified by the Board of Directors in its sole discretion if the Board of Directors determines that ownership or a Transfer or other event may violate the restrictions described above. Furthermore, upon the occurrence of certain events, attempted Transfers in violation of the restrictions described above may be void ab initio . All capitalized terms in this legend have the meanings defined in the Charter of the Corporation, as the same may be amended from time to time, a copy of which, including the restrictions on transfer and ownership, will be furnished to each holder of Capital Stock of the Corporation on request and without charge. Requests for such a copy may be directed to the Secretary of the Corporation at its Principal Office.

Instead of the foregoing legend, the certificate may state that the Corporation will furnish a full statement about certain restrictions on transferability to a stockholder on request and without charge.

Section 7.3 Transfer of Capital Stock in Trust .

Section 7.3.1 Ownership in Trust . Upon any purported Transfer or other event described in Section 7.2.1(b) that would result in a transfer of shares of Capital Stock to a Trust, such shares of Capital Stock shall be deemed to have been transferred to the Trustee as trustee of a Trust for the exclusive benefit of one or more Charitable Beneficiaries. Such transfer to the Trustee shall be deemed to be effective as of the close of business on the Business Day prior to the purported Transfer or other event that results in the transfer to the Trust pursuant to Section 7.2.1(b). The Trustee shall be appointed by the Corporation and shall be a Person unaffiliated with the Corporation and any Prohibited Owner. Each Charitable Beneficiary shall be designated by the Corporation as provided in Section 7.3.6.

Section 7.3.2 Status of Shares Held by the Trustee . Shares of Capital Stock held by the Trustee shall be issued and outstanding shares of Capital Stock of the Corporation. The Prohibited Owner shall have no rights in the shares held by the Trustee. The Prohibited Owner shall not benefit economically from ownership of any shares held in trust by the Trustee, shall have no rights to dividends or other distributions and shall not possess any rights to vote or other rights attributable to the shares held in the Trust.

Section 7.3.3 Dividend and Voting Rights . The Trustee shall have all voting rights and rights to dividends or other distributions with respect to shares of Capital Stock held in the Trust, which rights shall be exercised for the exclusive benefit of the Charitable Beneficiary. Any dividend or other distribution paid prior to the discovery by the Corporation that the shares of Capital Stock have been transferred to the

Trustee shall be paid by the recipient of such dividend or distribution to the Trustee upon demand and any dividend or other distribution authorized but unpaid shall be paid when due to the Trustee. Any dividend or distribution so paid to the Trustee shall be held in trust for the Charitable Beneficiary. The Prohibited Owner shall have no voting rights with respect to shares held in the Trust and, subject to Maryland law, effective as of the date that the shares of Capital Stock have been transferred to the Trustee, the Trustee shall have the authority (at the Trustee’s sole discretion) (i) to rescind as void any vote cast by a Prohibited Owner prior to the discovery by the Corporation that the shares of Capital Stock have been transferred to the Trustee and (ii) to recast such vote in accordance with the desires of the Trustee acting for the benefit of the Charitable Beneficiary; provided, however, that if the Corporation has already taken irreversible corporate action, then the Trustee shall not have the authority to rescind and recast such vote. Notwithstanding the provisions of this Article VII, until the Corporation has received notification that shares of Capital Stock have been transferred into a Trust, the Corporation shall be entitled to rely on its share transfer and other stockholder records for purposes of preparing lists of stockholders entitled to vote at meetings, determining the validity and authority of proxies and otherwise conducting votes of stockholders.

Section 7.3.4 Sale of Shares by Trustee . Within 20 days of receiving notice from the Corporation that shares of Capital Stock have been transferred to the Trust, the Trustee of the Trust shall sell the shares held in the Trust to a person, designated by the Trustee, whose ownership of the shares will not violate the ownership limitations set forth in Section 7.2.1(a). Upon such sale, the interest of the Charitable Beneficiary in the shares sold shall terminate and the Trustee shall distribute the net proceeds of the sale to the Prohibited Owner and to the Charitable Beneficiary as provided in this Section 7.3.4. The Prohibited Owner shall receive the lesser of (1) the price paid by the Prohibited Owner for the shares or, if the Prohibited Owner did not give value for the shares in connection with the event causing the shares to be held in the Trust ( e.g. , in the case of a gift, devise or other such transaction), the Market Price of the shares on the day of the event causing the shares to be held in the Trust and (2) the price per share received by the Trustee (net of any commissions and other expenses of sale) from the sale or other disposition of the shares held in the Trust. The Trustee may reduce the amount payable to the Prohibited Owner by the amount of dividends and distributions which have been paid to the Prohibited Owner and are owed by the Prohibited Owner to the Trustee pursuant to Section 7.3.3 of this Article VII. Any net sales proceeds in excess of the amount payable to the Prohibited Owner shall be immediately paid to the Charitable Beneficiary. If, prior to the discovery by the Corporation that shares of Capital Stock have been transferred to the Trustee, such shares are sold by a Prohibited Owner, then (i) such shares shall be deemed to have been sold on behalf of the Trust and (ii) to the extent that the Prohibited Owner received an amount for such shares that exceeds the amount that such Prohibited Owner was entitled to receive pursuant to this Section 7.3.4, such excess shall be paid to the Trustee upon demand.

Section 7.3.5 Purchase Right in Stock Transferred to the Trustee . Shares of Capital Stock transferred to the Trustee shall be deemed to have been offered for sale to the Corporation, or its designee, at a price per share equal to the lesser of (i)

the price per share in the transaction that resulted in such transfer to the Trust (or, in the case of a devise or gift, the Market Price at the time of such devise or gift) and (ii) the Market Price on the date the Corporation, or its designee, accepts such offer. The Corporation may reduce the amount payable to the Prohibited Owner by the amount of dividends and distributions which has been paid to the Prohibited Owner and are owed by the Prohibited Owner to the Trustee pursuant to Section 7.3.3 of this Article VII. The Corporation may pay the amount of such reduction to the Trustee for the benefit of the Charitable Beneficiary. The Corporation shall have the right to accept such offer until the Trustee has sold the shares held in the Trust pursuant to Section 7.3.4. Upon such a sale to the Corporation, the interest of the Charitable Beneficiary in the shares sold shall terminate and the Trustee shall distribute the net proceeds of the sale to the Prohibited Owner.

Section 7.3.6 Designation of Charitable Beneficiaries . By written notice to the Trustee, the Corporation shall designate one or more nonprofit organizations to be the Charitable Beneficiary of the interest in the Trust such that (i) the shares of Capital Stock held in the Trust would not violate the restrictions set forth in Section 7.2.1(a) in the hands of such Charitable Beneficiary and (ii) each such organization must be described in Section 501(c)(3) of the Code and contributions to each such organization must be eligible for deduction under each of Sections 170(b)(1)(A), 2055 and 2522 of the Code.

Section 7.4 NYSE Transactions . Nothing in this Article VII shall preclude the settlement of any transaction entered into through the facilities of the NYSE or any other national securities exchange or automated inter-dealer quotation system. The fact that the settlement of any transaction occurs shall not negate the effect of any other provision of this Article VII and any transferee in such a transaction shall be subject to all of the provisions and limitations set forth in this Article VII.

Section 7.5 Enforcement . The Corporation is authorized specifically to seek equitable relief, including injunctive relief, to enforce the provisions of this Article VII.

Section 7.6 Non-Waiver . No delay or failure on the part of the Corporation or the Board of Directors in exercising any right hereunder shall operate as a waiver of any right of the Corporation or the Board of Directors, as the case may be, except to the extent specifically waived in writing.

ARTICLE VIII

AMENDMENTS

The Corporation reserves the right from time to time to make any amendment to its Charter, now or hereafter authorized by law, including any amendment altering the terms or contract rights, as expressly set forth in the Charter, of any shares of outstanding stock. All rights and powers conferred by the Charter on stockholders,

directors and officers are granted subject to this reservation. Except for those amendments permitted to be made without stockholder approval under Maryland law or by specific provision in the Charter, any amendment to the Charter shall be valid only if declared advisable by the Board of Directors and approved by the affirmative vote of a majority of all the votes entitled to be cast on the matter. However, any amendment to Article VII or to this sentence of the Charter shall be valid only if declared advisable by the Board of Directors and approved by the affirmative vote of a majority of all the votes entitled to be cast on the matter.

ARTICLE IX

LIMITATION OF LIABILITY

To the maximum extent that Maryland law in effect from time to time permits limitation of the liability of directors and officers of a corporation, no present or former director or officer of the Corporation shall be liable to the Corporation or its stockholders for money damages. Neither the amendment nor repeal of this Article IX, nor the adoption or amendment of any other provision of the Charter or Bylaws inconsistent with this Article IX, shall apply to or affect in any respect the applicability of the preceding sentence with respect to any act or failure to act which occurred prior to such amendment, repeal or adoption.

THIRD : The amendment to and restatement of the charter as hereinabove set forth have been duly advised by the Board of Directors and approved by the stockholders of the Corporation as required by law.

FOURTH : The current address of the principal office of the Corporation is as set forth in Article IV of the foregoing amendment and restatement of the charter.

FIFTH : The name and address of the Corporation’s current resident agent is as set forth in Article IV of the foregoing amendment and restatement of the charter.

SIXTH : The number of directors of the Corporation and the names of those currently in office are as set forth in Article V of the foregoing amendment and restatement of the charter.

SEVENTH : The total number of shares of stock which the Corporation had authority to issue immediately prior to this amendment and restatement was 1000 shares of Common Stock, $0.01 par value per share. The aggregate par value of all shares of stock having par value was $10.

EIGHTH : The total number of shares of stock which the Corporation has authority to issue pursuant to the foregoing amendment and restatement of the charter is 600,000,000, consisting of 500,000,000 shares of Common Stock, $0.01 par value per share, and 100,000,000 shares of Preferred Stock, $0.01 par value per share. The aggregate par value of all authorized shares of stock having par value is $6,000,000.

NINTH : The undersigned officer acknowledges these Articles of Amendment and Restatement to be the corporate act of the Corporation and as to all matters or facts required to be verified under oath, the undersigned officer acknowledges that, to the best of his knowledge, information and belief, these matters and facts are true in all material respects and that this statement is made under the penalties for perjury.

IN WITNESS WHEREOF, the Corporation has caused these Articles of Amendment and Restatement to be signed in its name and on its behalf by its and attested to by its Secretary on this day of , 2004.


ATTEST:		SUNSTONE HOTEL INVESTORS, INC.

		By: (SEAL)

Secretary

Exhibit 3.2

SUNSTONE HOTEL INVESTORS, INC.

BYLAWS

ARTICLE I

OFFICES

Section 1.1 Principal Office . The principal office of the Corporation in the State of Maryland shall be located at such place as provided in the charter of the Corporation or as the Board of Directors may otherwise designate.

Section 1.2 Additional Offices . The Corporation may have additional offices, including a principal executive office, at such places as the Board of Directors may from time to time determine or the business of the Corporation may require.

ARTICLE II

MEETINGS OF STOCKHOLDERS

Section 2.1 Place . All meetings of stockholders shall be held at the principal executive office of the Corporation or at such other place as shall be set by the Board of Directors and stated in the notice of the meeting.

Section 2.2 Annual Meeting . An annual meeting of the stockholders for the election of directors and the transaction of any business within the powers of the Corporation shall be held on a date and at the time set by the Board of Directors during the month of May in each year.

Section 2.3 Special Meetings .

(a) General . The chairman of the board, president, chief executive officer or Board of Directors may call a special meeting of the stockholders. Subject to subsection (b) of this Section 2.3, a special meeting of stockholders shall also be called by the secretary of the Corporation upon the written request of stockholders entitled to cast not less than a majority of all the votes entitled to be cast at such meeting.

(b) Stockholder Requested Special Meetings .

(i) Any stockholder of record seeking to have stockholders request a special meeting shall, by sending written notice to the secretary (the “Record Date Request Notice”) by registered mail, return receipt requested, request the Board of Directors to fix a record date to determine the stockholders

entitled to request a special meeting (the “Request Record Date”). The Record Date Request Notice shall set forth the purpose of the meeting and the matters proposed to be acted on at it, shall be signed by one or more stockholders of record as of the date of signature (or their agents duly authorized in a writing accompanying the Record Date Request Notice), shall bear the date of signature of each such stockholder (or such agent) and shall set forth all information relating to each such stockholder that must be disclosed in solicitations of proxies for election of directors in an election contest (even if an election contest is not involved), or is otherwise required, in each case pursuant to Regulation 14A (or any successor provision) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Upon receiving the Record Date Request Notice, the Board of Directors may fix a Request Record Date. The Request Record Date shall not precede and shall not be more than ten days after the close of business on the date on which the resolution fixing the Request Record Date is adopted by the Board of Directors. If the Board of Directors, within ten days after the date on which a valid Record Date Request Notice is received, fails to adopt a resolution fixing the Request Record Date, the Request Record Date shall be the close of business on the tenth day after the first date on which the Record Date Request Notice is received by the secretary.

(ii) In order for any stockholder to request a special meeting, one or more written requests for a special meeting signed by stockholders of record (or their agents duly authorized in a writing accompanying the request) as of the Request Record Date entitled to cast not less than a majority (the “Special Meeting Percentage”) of all of the votes entitled to be cast at such meeting (the “Special Meeting Request”) shall be delivered to the secretary. In addition, the Special Meeting Request (A) shall set forth the purpose of the meeting and the matters proposed to be acted on at it (which shall be limited to those lawful matters set forth in the Record Date Request Notice received by the secretary), (B) shall bear the date of signature of each such stockholder (or such agent) signing the Special Meeting Request, (C) shall set forth the name and address, as they appear in the Corporation’s books, of each stockholder signing such request (or on whose behalf the Special Meeting Request is signed), the class, series and number of all shares of stock of the Corporation which are owned by each such stockholder, and the nominee holder for, and number of, shares owned by such stockholder beneficially but not of record, (D) shall be sent to the secretary by registered mail, return receipt requested, and (E) shall be received by the secretary within 60 days after the Request Record Date. Any requesting stockholder (or agent duly authorized in a writing accompanying the revocation or the Special Meeting Request) may revoke his, her or its request for a special meeting at any time by written revocation delivered to the secretary.

(iii) The secretary shall inform the requesting stockholders of the reasonably estimated cost of preparing and mailing the notice of meeting

(including the Corporation’s proxy materials). The secretary shall not be required to call a special meeting upon stockholder request and such meeting shall not be held unless, in addition to the documents required by paragraph (ii) of this Section 2.3(b), the secretary receives payment of such reasonably estimated cost prior to the mailing of any notice of the meeting.

(iv) Except as provided in the next sentence, any special meeting shall be held at such place, date and time as may be designated by the chairman of the board, chief executive officer, president or Board of Directors, whoever has called the meeting. In the case of any special meeting called by the secretary upon the request of stockholders (a “Stockholder Requested Meeting”), such meeting shall be held at such place, date and time as may be designated by the Board of Directors; provided , however, that the date of any Stockholder Requested Meeting shall be not more than 90 days after the record date for such meeting (the “Meeting Record Date”); and provided further that if the Board of Directors fails to designate, within ten days after the date that a valid Special Meeting Request is actually received by the secretary (the “Delivery Date”), a date and time for a Stockholder Requested Meeting, then such meeting shall be held at 2:00 p.m. local time on the 90 ^th day after the Meeting Record Date or, if such 90 ^th day is not a Business Day (as defined below), on the first preceding Business Day; and provided further that in the event that the Board of Directors fails to designate a place for a Stockholder Requested Meeting within ten days after the Delivery Date, then such meeting shall be held at the principal executive office of the Corporation. In fixing a date for any special meeting, the chairman of the board, chief executive officer, president or Board of Directors may consider such factors as he, she or it deems relevant within the good faith exercise of business judgment, including, without limitation, the nature of the matters to be considered, the facts and circumstances surrounding any request for the meeting and any plan of the Board of Directors to call an annual meeting or a special meeting. In the case of any Stockholder Requested Meeting, if the Board of Directors fails to fix a Meeting Record Date that is a date within 30 days after the Delivery Date, then the close of business on the 30 ^th day after the Delivery Date shall be the Meeting Record Date. The Board of Directors may revoke the notice for any Stockholder Requested Meeting in the event that the requesting stockholders fail to comply with the provisions of paragraph (iii) of this Section 2.3(b).

(v) If written revocations of requests for the special meeting have been delivered to the secretary and the result is that stockholders of record (or their agents duly authorized in writing), as of the Request Record Date, entitled to cast less than the Special Meeting Percentage have delivered, and not revoked, requests for a special meeting to the secretary, the secretary shall: (A) if the notice of meeting has not already been mailed, refrain from mailing the notice of the meeting and send to all requesting stockholders who have not revoked such

requests written notice of any revocation of a request for the special meeting, or (B) if the notice of meeting has been mailed and if the secretary first sends to all requesting stockholders who have not revoked requests for a special meeting written notice of any revocation of a request for the special meeting and written notice of the secretary’s intention to revoke the notice of the meeting, revoke the notice of the meeting at any time before ten days before the commencement of the meeting. Any request for a special meeting received after a revocation by the secretary of a notice of a meeting shall be considered a request for a new special meeting.

(vi) The chairman of the board, chief executive officer, president or Board of Directors may appoint regionally or nationally recognized independent inspectors of elections to act as the agent of the Corporation for the purpose of promptly performing a ministerial review of the validity of any purported Special Meeting Request received by the secretary. For the purpose of permitting the inspectors to perform such review, no such purported request shall be deemed to have been delivered to the secretary until the earlier of (A) five Business Days after receipt by the secretary of such purported request and (B) such date as the independent inspectors certify to the Corporation that the valid requests received by the secretary represent at least a majority of the issued and outstanding shares of stock that would be entitled to vote at such meeting. Nothing contained in this paragraph (vi) shall in any way be construed to suggest or imply that the Corporation or any stockholder shall not be entitled to contest the validity of any request, whether during or after such five Business Day period, or to take any other action (including, without limitation, the commencement, prosecution or defense of any litigation with respect thereto, and the seeking of injunctive relief in such litigation).

(vii) For purposes of these Bylaws, “Business Day” shall mean any day other than a Saturday, a Sunday or a day on which banking institutions in the State of California are authorized or obligated by law or executive order to close.

Section 2.4 Notice . Not less than ten nor more than 90 days before each meeting of stockholders, the secretary shall give to each stockholder entitled to vote at such meeting and to each stockholder not entitled to vote who is entitled to notice of the meeting written or printed notice stating the time and place of the meeting and, in the case of a special meeting or as otherwise may be required by any statute, the purpose for which the meeting is called, either by mail, by presenting it to such stockholder personally, by leaving it at the stockholder’s residence or usual place of business or by any other means permitted by Maryland law. If mailed, such notice shall be deemed to be given when deposited in the United States mail addressed to the stockholder at the stockholder’s address as it appears on the records of the Corporation, with postage thereon prepaid.

Subject to Section 2.11(a) of this Article II, any business of the Corporation may be transacted at an annual meeting of stockholders without being specifically designated in the notice, except such business as is required by any statute to be stated in such notice. No business shall be transacted at a special meeting of stockholders except as specifically designated in the notice.

Section 2.5 Organization And Conduct . Every meeting of stockholders shall be conducted by an individual appointed by the Board of Directors to be chairman of the meeting or, in the absence of such appointment, by the chairman of the board or, in the case of a vacancy in the office or absence of the chairman of the board, by one of the following officers present at the meeting: the vice chairman of the board, if there is one, the president, the vice presidents in their order of rank and seniority, or, in the absence of such officers, a chairman chosen by the stockholders by the vote of a majority of the votes cast by stockholders present in person or by proxy. The secretary, or, in the secretary’s absence, an assistant secretary, or in the absence of both the secretary and assistant secretaries, a person appointed by the Board of Directors or, in the absence of such appointment, a person appointed by the chairman of the meeting shall act as secretary. In the event that the secretary presides at a meeting of the stockholders, an assistant secretary, or in the absence of assistant secretaries, an individual appointed by the Board of Directors or the chairman of the meeting, shall record the minutes of the meeting. The order of business and all other matters of procedure at any meeting of stockholders shall be determined by the chairman of the meeting. The chairman of the meeting may prescribe such rules, regulations and procedures and take such action as, in the discretion of such chairman, are appropriate for the proper conduct of the meeting, including, without limitation, (A) restricting admission to the time set for the commencement of the meeting; (B) limiting attendance at the meeting to stockholders of record of the Corporation, their duly authorized proxies and other such individuals as the chairman of the meeting may determine; (C) limiting participation at the meeting on any matter to stockholders of record of the Corporation entitled to vote on such matter, their duly authorized proxies and other such individuals as the chairman of the meeting may determine; (D) limiting the time allotted to questions or comments by participants; (E) determining when the polls should be opened and closed; (F) maintaining order and security at the meeting; (G) removing any stockholder or any other individual who refuses to comply with meeting procedures, rules or guidelines as set forth by the chairman of the meeting; and (H) concluding a meeting or recessing or adjourning the meeting to a later date and time and at a place announced at the meeting. Unless otherwise determined by the chairman of the meeting, meetings of stockholders shall not be required to be held in accordance with the rules of parliamentary procedure.

Section 2.6 Quorum . At any meeting of stockholders, the presence in person or by proxy of stockholders entitled to cast a majority of all the votes entitled to be cast at such meeting on any matter shall constitute a quorum; but this section shall not affect any requirement under any statute or the charter of the Corporation for the vote necessary for the adoption of any measure. If, however, such quorum shall not be present

at any meeting of the stockholders, the chairman of the meeting shall have the power to adjourn the meeting from time to time to a date not more than 120 days after the original record date without notice other than announcement at the meeting. At such adjourned meeting at which a quorum shall be present, any business may be transacted which might have been transacted at the meeting as originally notified.

The stockholders present either in person or by proxy, at a meeting which has been duly called and convened, may continue to transact business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum.

Section 2.7 Voting . A plurality of all the votes cast at a meeting of stockholders duly called and at which a quorum is present shall be sufficient to elect a director. Each share may be voted for as many individuals as there are directors to be elected and for whose election the share is entitled to be voted. A majority of the votes cast at a meeting of stockholders duly called and at which a quorum is present shall be sufficient to approve any other matter which may properly come before the meeting, unless more than a majority of the votes cast is required by statute or by the charter of the Corporation. Unless otherwise provided by statute or by the charter, each outstanding share, regardless of class, shall be entitled to one vote on each matter submitted to a vote at a meeting of stockholders. Voting on any question or in any election may be viva voce unless the chairman of the meeting shall order that voting be by ballot.

Section 2.8 Proxies . A stockholder may cast the votes entitled to be cast by the shares of stock owned of record by the stockholder in person or by proxy executed by the stockholder or by the stockholder’s duly authorized agent in any manner permitted by law. Such proxy or evidence of authorization of such proxy shall be filed with the secretary of the Corporation before or at the meeting. No proxy shall be valid more than eleven months after its date unless otherwise provided in the proxy.

Section 2.9 Voting Of Stock By Certain Holders . Stock of the Corporation registered in the name of a corporation, partnership, trust or other entity, if entitled to be voted, may be voted by the president or a vice president, a general partner or trustee thereof, as the case may be, or a proxy appointed by any of the foregoing individuals, unless some other person who has been appointed to vote such stock pursuant to a bylaw or a resolution of the governing body of such corporation or other entity or agreement of the partners of a partnership presents a certified copy of such bylaw, resolution or agreement, in which case such person may vote such stock. Any director or other fiduciary may vote stock registered in his or her name as such fiduciary, either in person or by proxy.

Shares of stock of the Corporation directly or indirectly owned by it shall not be voted at any meeting and shall not be counted in determining the total number of outstanding shares entitled to be voted at any given time, unless they are held by it in a fiduciary capacity, in which case they may be voted and shall be counted in determining the total number of outstanding shares at any given time.

The Board of Directors may adopt by resolution a procedure by which a stockholder may certify in writing to the Corporation that any shares of stock registered in the name of the stockholder are held for the account of a specified person other than the stockholder. The resolution shall set forth the class of stockholders who may make the certification, the purpose for which the certification may be made, the form of certification and the information to be contained in it; if the certification is with respect to a record date or closing of the stock transfer books, the time after the record date or closing of the stock transfer books within which the certification must be received by the Corporation; and any other provisions with respect to the procedure which the Board of Directors considers necessary or desirable. On receipt of such certification, the person specified in the certification shall be regarded as, for the purposes set forth in the certification, the stockholder of record of the specified stock in place of the stockholder who makes the certification.

Section 2.10 Inspectors . The Board of Directors, in advance of any meeting, may, but need not, appoint one or more individual inspectors or one or more entities that designate individuals as inspectors to act at the meeting or any adjournment thereof. If an inspector or inspectors are not appointed, the person presiding at the meeting may, but need not, appoint one or more inspectors. In case any person who may be appointed as an inspector fails to appear or act, the vacancy may be filled by appointment made by the Board of Directors in advance of the meeting or at the meeting by the chairman of the meeting. The inspectors, if any, shall determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, the validity and effect of proxies, and shall receive votes, ballots or consents, hear and determine all challenges and questions arising in connection with the right to vote, count and tabulate all votes, ballots or consents, determine the result, and do such acts as are proper to conduct the election or vote with fairness to all stockholders. Each such report shall be in writing and signed by him or her or by a majority of them if there is more than one inspector acting at such meeting. If there is more than one inspector, the report of a majority shall be the report of the inspectors. The report of the inspector or inspectors on the number of shares represented at the meeting and the results of the voting shall be prima facie evidence thereof.

Section 2.11 Advance Notice of Stockholder Nominees For Director and Other Stockholder Proposals .

(a) Annual Meetings of Stockholders .

(i) Nominations of individuals for election to the Board of Directors and the proposal of other business to be considered by the stockholders may be made at an annual meeting of stockholders (A) pursuant to the Corporation’s notice of meeting, (B) by or at the direction of the Board of Directors or (C) by any stockholder of the Corporation who was a stockholder of record both at the time of giving of notice by the stockholder as provided for in

this Section 2.11(a) and at the time of the annual meeting, who is entitled to vote at the meeting and who has complied with this Section 2.11(a).

(ii) For nominations or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (C) of paragraph (a)(i) of this Section 2.11, the stockholder must have given timely notice thereof in writing to the secretary of the Corporation and such other business must otherwise be a proper matter for action by the stockholders. To be timely, a stockholder’s notice shall set forth all information required under this Section 2.11 and shall be delivered to the secretary at the principal executive office of the Corporation not earlier than the 150 ^th day nor later than 5:00 p.m., Pacific Time, on the 120 ^th day prior to the first anniversary of the date of mailing of the notice for the preceding year’s annual meeting; provided, however, that in the event that the date of the annual meeting is advanced or delayed by more than 30 days from the first anniversary of the date of the preceding year’s annual meeting, notice by the stockholder to be timely must be so delivered not earlier than the 150 ^th day prior to the date of such annual meeting and not later than 5:00 p.m., Pacific Time, on the later of the 120 ^th day prior to the date of such annual meeting or the tenth day following the day on which public announcement of the date of such meeting is first made. The public announcement of a postponement or adjournment of an annual meeting shall not commence a new time period for the giving of a stockholder’s notice as described above. Such stockholder’s notice shall set forth (A) as to each individual whom the stockholder proposes to nominate for election or reelection as a director, (1) the name, age, business address and residence address of such individual, (2) the class, series and number of any shares of stock of the Corporation that are beneficially owned by such individual, (3) the date such shares were acquired and the investment intent of such acquisition and (4) all other information relating to such individual that is required to be disclosed in solicitations of proxies for election of directors in an election contest (even if an election contest is not involved), or is otherwise required, in each case pursuant to Regulation 14A (or any successor provision) under the Exchange Act and the rules thereunder (including such individual’s written consent to being named in the proxy statement as a nominee and to serving as a director if elected); (B) as to any other business that the stockholder proposes to bring before the meeting, a description of such business, the reasons for proposing such business at the meeting and any material interest in such business of such stockholder and any Stockholder Associated Person (as defined below), individually or in the aggregate, including any anticipated benefit to the stockholder and the Stockholder Associated Person therefrom; (C) as to the stockholder giving the notice and any Stockholder Associated Person, the class, series and number of all shares of stock of the Corporation which are owned by such stockholder and by such Stockholder Associated Person, if any, and the nominee holder for, and number of, shares owned beneficially but not of record by such stockholder and by any such Stockholder Associated Person; (D) as to the

stockholder giving the notice and any Stockholder Associated Person covered by clauses (B) or (C) of this paragraph (ii) of this Section 2.11(a), the name and address of such stockholder, as they appear on the Corporation’s stock ledger and current name and address, if different, and of such Stockholder Associated Person; and (E) to the extent known by the stockholder giving the notice, the name and address of any other stockholder supporting the nominee for election or reelection as a director or the proposal of other business on the date of such stockholder’s notice.

(iii) Notwithstanding anything in this subsection (a) of this Section 2.11 to the contrary, in the event the Board of Directors increases or decreases the maximum or minimum number of directors in accordance with Section 3.2 of these Bylaws, and there is no public announcement of such action at least 130 days prior to the first anniversary of the date of mailing of the notice of the preceding year’s annual meeting, a stockholder’s notice required by this Section 2.11(a) shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if it shall be delivered to the secretary at the principal executive office of the Corporation not later than 5:00 p.m., Pacific Time, on the tenth day following the day on which such public announcement is first made by the Corporation.

(iv) For purposes of this Section 2.11, “Stockholder Associated Person” of any stockholder shall mean (A) any person controlling, directly or indirectly, or acting in concert with, such stockholder, (B) any beneficial owner of shares of stock of the Corporation owned of record or beneficially by such stockholder and (C) any person controlling, controlled by or under common control with such Stockholder Associated Person.

(b) Special Meetings of Stockholders . Only such business shall be conducted at a special meeting of stockholders as shall have been brought before the meeting pursuant to the Corporation’s notice of meeting. Nominations of individuals for election to the Board of Directors may be made at a special meeting of stockholders at which directors are to be elected (i) pursuant to the Corporation’s notice of meeting, (ii) by or at the direction of the Board of Directors or (iii) provided that the Board of Directors has determined that directors shall be elected at such special meeting, by any stockholder of the Corporation who is a stockholder of record both at the time of giving of notice provided for in this Section 2.11 and at the time of the special meeting, who is entitled to vote at the meeting and who complied with the notice procedures set forth in this Section 2.11. In the event the Corporation calls a special meeting of stockholders for the purpose of electing one or more individuals to the Board of Directors, any such stockholder may nominate an individual or individuals (as the case may be) for election as a director as specified in the Corporation’s notice of meeting, if the stockholder’s notice required by paragraph (ii) of this Section 2.11(a) shall be delivered to the secretary at the principal executive office of the Corporation not earlier than the 120 ^th day prior to such special meeting and not later than 5:00 p.m ., Pacific Time on the later of the 90 ^th

day prior to such special meeting or the tenth day following the day on which public announcement is first made of the date of the special meeting and of the nominees proposed by the Board of Directors to be elected at such meeting. The public announcement of a postponement or adjournment of a special meeting shall not commence a new time period for the giving of a stockholder’s notice as described above.

(i) Upon written request by the secretary or the Board of Directors or any committee thereof, any stockholder proposing a nominee for election as a director or any proposal for other business at a meeting of stockholders shall provide, within five Business Days of delivery of such request (or such other period as may be specified in such request), written verification, satisfactory, in the discretion of the Board of Directors or any committee thereof or any authorized officer of the Corporation, to demonstrate the accuracy of any information submitted by the stockholder pursuant to this Section 2.11. If a stockholder fails to provide such written verification within such period, the information as to which written verification was requested may be deemed not to have been provided in accordance with this Section 2.11.

(ii) Only such individuals who are nominated in accordance with this Section 2.11 shall be eligible for election by stockholders as directors, and only such business shall be conducted at a meeting of stockholders as shall have been brought before the meeting in accordance with this Section 2.11. The chairman of the meeting shall have the power to determine whether a nomination or any other business proposed to be brought before the meeting was made or proposed, as the case may be, in accordance with this Section 2.11.

(iii) For purposes of this Section 2.11, (A) the “date of mailing of the notice” shall mean the date of the proxy statement for the solicitation of proxies for election of directors and (B) “public announcement” shall mean disclosure (1) in a press release reported by the Dow Jones News Service, Associated Press, Business Wire, PR Newswire or comparable news service or (2) in a document publicly filed by the Corporation with the Securities and Exchange Commission pursuant to the Exchange Act.

(iv) Notwithstanding the foregoing provisions of this Section 2.11, a stockholder shall also comply with all applicable requirements of state law and of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section 2.11. Nothing in this Section 2.11 shall be deemed to affect any right of a stockholder to request inclusion of a proposal in, nor the right of the Corporation to omit a proposal from, the Corporation’s proxy statement pursuant to Rule 14a-8 (or any successor provision) under the Exchange Act.

Section 2.12 Telephone Meetings . The Board of Directors or chairman of the meeting may permit stockholders to participate in meetings of the stockholders by means of a conference telephone or other communications equipment by which all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means constitutes presence in person at the meeting.

Section 2.13 Stockholders’ Consent In Lieu Of Meeting . Any action required or permitted to be taken at any meeting of stockholders may be taken without a meeting (a) if a unanimous consent setting forth the action is given in writing or by electronic transmission by each stockholder entitled to vote on the matter and filed with the minutes of proceedings of the stockholders, (b) if the action is advised, and submitted to the stockholders for approval, by the Board of Directors and a consent in writing or by electronic transmission of stockholders entitled to cast not less than the minimum number of votes that would be necessary to authorize or take the action at a meeting of stockholders is delivered to the Corporation in accordance with the MGCL or (c) in any manner set forth in the terms of any class of series of preferred stock of the corporation. The Corporation shall give notice of any action taken by less than unanimous consent to each stockholder not later than ten days after the effective time of such action.

Section 2.14 Control Share Acquisition Act . Notwithstanding any other provision of the charter of the Corporation or these Bylaws, Title 3, Subtitle 7 of the Maryland General Corporation Law (or any successor statute) shall not apply to any acquisition by any person of shares of stock of the Corporation. Any amendment, alteration or repeal of this section shall be valid only if approved by the affirmative vote of a majority of votes cast by stockholders entitled to vote generally in the election of directors.

Section 2.15 Business Combination Act . The Board of Directors has adopted a resolution exempting all business combinations between the Corporation and any person from the provisions of Title 3, Subtitle 6 of the Maryland General Corporation Law (or any successor statute). Pursuant to such resolution, any rescission, amendment, alteration or repeal of such resolution by the Board of Directors shall be valid only if approved by the affirmative vote of a majority of votes cast by stockholders entitled to vote generally in the election of directors. Any amendment, alteration or repeal of this section shall be valid only if approved by the affirmative vote of a majority of votes cast by stockholders entitled to vote generally in the election of directors.

ARTICLE III

DIRECTORS

Section 3.1 General Powers . The business and affairs of the Corporation shall be managed under the direction of its Board of Directors.

Section 3.2 Number, Tenure And Qualifications . At any regular meeting or at any special meeting called for that purpose, a majority of the entire Board of Directors may establish, increase or decrease the number of directors, provided that the number thereof shall never be less than the minimum number required by the Maryland General Corporation Law, nor more than 15, and further provided that the tenure of office of a director shall not be affected by any decrease in the number of directors.

Section 3.3 Annual And Regular Meetings . An annual meeting of the Board of Directors shall be held immediately after and at the same place as the annual meeting of stockholders, no notice other than this Bylaw being necessary. In the event such meeting is not so held, the meeting may be held at such time and place as shall be specified in a notice given as hereinafter provided for special meetings of the Board of Directors. The Board of Directors may provide, by resolution, the time and place for the holding of regular meetings of the Board of Directors without other notice than such resolution.

Section 3.4 Special Meetings . Special meetings of the Board of Directors may be called by or at the request of the chairman of the board, the chief executive officer, the president or by a majority of the directors then in office. The person or persons authorized to call special meetings of the Board of Directors may fix any place as the place for holding any special meeting of the Board of Directors called by them. The Board of Directors may provide, by resolution, the time and place for the holding of special meetings of the Board of Directors without other notice than such resolution.

Section 3.5 Notice . Notice of any special meeting of the Board of Directors shall be delivered personally or by telephone, electronic mail, facsimile transmission, United States mail or courier to each director at his or her business or residence address. Notice by personal delivery, telephone, electronic mail or facsimile transmission shall be given at least 24 hours prior to the meeting. Notice by United States mail shall be given at least three days prior to the meeting. Notice by courier shall be given at least two days prior to the meeting. Telephone notice shall be deemed to be given when the director or his or her agent is personally given such notice in a telephone call to which the director or his or her agent is a party. Electronic mail notice shall be deemed to be given upon transmission of the message to the electronic mail address given to the Corporation by the director. Facsimile transmission notice shall be deemed to be given upon completion of the transmission of the message to the number given to the Corporation by the director and receipt of a completed answer-back indicating receipt. Notice by United States mail shall be deemed to be given when deposited in the United States mail properly addressed, with postage thereon prepaid. Notice by courier shall be deemed to be given when deposited with or delivered to a courier properly addressed. Neither the business to be transacted at, nor the purpose of, any annual, regular or special meeting of the Board of Directors need be stated in the notice, unless specifically required by statute or these Bylaws.

Section 3.6 Quorum . A majority of the directors shall constitute a quorum for transaction of business at any meeting of the Board of Directors, provided that, if less than a majority of such directors are present at said meeting, a majority of the directors present may adjourn the meeting from time to time without further notice, and provided further that if, pursuant to applicable law, the charter of the Corporation or these Bylaws, the vote of a majority of a particular group of directors is required for action, a quorum must also include a majority of such group.

The directors present at a meeting which has been duly called and convened may continue to transact business until adjournment, notwithstanding the withdrawal of enough directors to leave less than a quorum.

Section 3.7 Voting . The action of the majority of the directors present at a meeting at which a quorum is present shall be the action of the Board of Directors, unless the concurrence of a greater proportion is required for such action by applicable law, the charter or these Bylaws. If enough directors have withdrawn from a meeting to leave less than a quorum but the meeting is not adjourned, the action of the majority of that number of directors necessary to constitute a quorum at such meeting shall be the action of the Board of Directors, unless the concurrence of a greater proportion is required for such action by applicable law, the charter or these Bylaws.

Section 3.8 Organization . At each meeting of the Board of Directors, the chairman of the board or, in the absence of the chairman, the vice chairman of the board, if any, shall act as chairman of the meeting. In the absence of both the chairman and vice chairman of the board, the chief executive officer or in the absence of the chief executive officer, the president or in the absence of the president, a director chosen by a majority of the directors present, shall act as chairman of the meeting. The secretary or, in his or her absence, an assistant secretary of the Corporation, or in the absence of the secretary and all assistant secretaries, a person appointed by the Chairman, shall act as secretary of the meeting.

Section 3.9 Telephone Meetings . Directors may participate in a meeting by means of a conference telephone or other communications equipment if all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means shall constitute presence in person at the meeting.

Section 3.10 Consent By Directors Without A Meeting . Any action required or permitted to be taken at any meeting of the Board of Directors may be taken without a meeting, if a consent in writing or by electronic transmission to such action is given by each director and is filed with the minutes of proceedings of the Board of Directors.

Section 3.11 Vacancies . If for any reason any or all the directors cease to be directors, such event shall not terminate the Corporation or affect these Bylaws or the powers of the remaining directors hereunder (even if fewer than three directors

remain). Except as may be provided by the Board of Directors in setting the terms of any class or series of preferred stock, any vacancy on the Board of Directors may be filled only by a majority of the remaining directors, even if the remaining directors do not constitute a quorum. Any director elected to fill a vacancy shall serve until the next annual meeting of stockholders and until a successor is elected and qualifies.

Section 3.12 Compensation . Directors shall not receive any stated salary for their services as directors but, by resolution of the Board of Directors, may receive compensation per year and/or per meeting and/or per visit to real property or other facilities owned or leased by the Corporation and for any service or activity they performed or engaged in as directors. Directors may be reimbursed for expenses of attendance, if any, at each annual, regular or special meeting of the Board of Directors or of any committee thereof and for their expenses, if any, in connection with each property visit and any other service or activity they performed or engaged in as directors; but nothing herein contained shall be construed to preclude any directors from serving the Corporation in any other capacity and receiving compensation therefor.

Section 3.13 Loss Of Deposits . No director shall be liable for any loss which may occur by reason of the failure of the bank, trust company, savings and loan association, or other institution with whom moneys or stock have been deposited.

Section 3.14 Surety Bonds . Unless required by law, no director shall be obligated to give any bond or surety or other security for the performance of any of his or her duties.

Section 3.15 Reliance . Each director, officer, employee and agent of the Corporation shall, in the performance of his or her duties with respect to the Corporation, be fully justified and protected with regard to any act or failure to act in reliance in good faith upon the books of account or other records of the Corporation, upon an opinion of counsel or upon reports made to the Corporation by any of its officers or employees or by the adviser, accountants, appraisers or other experts or consultants selected by the Board of Directors or officers of the Corporation, regardless of whether such counsel or expert may also be a director.

Section 3.16 Certain Rights Of Directors, Officers, Employees And Agents . The directors shall have no responsibility to devote their full time to the affairs of the Corporation. Any director or officer, employee or agent of the Corporation, in his or her personal capacity or in a capacity as an affiliate, employee, or agent of any other person, or otherwise, may have business interests and engage in business activities similar to, in addition to or in competition with those of or relating to the Corporation.

ARTICLE IV

COMMITTEES

Section 4.1 Number, Tenure And Qualifications . The Board of Directors may appoint from among its members an Executive Committee, an Audit Committee, a Compensation Committee, a Nominating and Corporate Governance Committee and other committees, composed of one or more directors, to serve at the pleasure of the Board of Directors.

Section 4.2 Powers . The Board of Directors may delegate to committees appointed under Section 1 of this Article any of the powers of the Board of Directors, except as prohibited by law.

Section 4.3 Meetings . Notice of committee meetings shall be given in the same manner as notice for special meetings of the Board of Directors. A majority of the members of the committee shall constitute a quorum for the transaction of business at any meeting of the committee. The act of a majority of the committee members present at a meeting shall be the act of such committee. The Board of Directors may designate a chairman of any committee, and such chairman or, in the absence of a chairman, any two members of any committee (if there are at least two members of the Committee) may fix the time and place of its meeting unless the Board shall otherwise provide. In the absence of any member of any such committee, the members thereof present at any meeting, whether or not they constitute a quorum, may appoint another director to act in the place of such absent member. Each committee shall keep minutes of its proceedings.

Section 4.4 Telephone Meetings . Members of a committee of the Board of Directors may participate in a meeting by means of a conference telephone or other communications equipment if all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means shall constitute presence in person at the meeting.

Section 4.5 Consent By Committees Without A Meeting . Any action required or permitted to be taken at any meeting of a committee of the Board of Directors may be taken without a meeting, if a consent in writing or by electronic transmission to such action is given by each member of the committee and is filed with the minutes of proceedings of such committee.

Section 4.6 Vacancies . Subject to the provisions hereof, the Board of Directors shall have the power at any time to change the membership of any committee, to fill all vacancies, to designate alternate members to replace any absent or disqualified member or to dissolve any such committee.

ARTICLE V

OFFICERS

Section 5.1 General Provisions . The officers of the Corporation shall include a president, a secretary and a treasurer and may include a chairman of the board, a vice chairman of the board, a chief executive officer, one or more vice presidents, a chief operating officer, a chief financial officer, a chief investment officer and one or more assistant secretaries and one or more assistant treasurers. In addition, the Board of Directors may from time to time elect such other officers with such powers and duties as they shall deem necessary or desirable. The officers of the Corporation shall be elected annually by the Board of Directors, except that the chief executive officer or president may from time to time appoint one or more vice presidents, assistant secretaries and assistant treasurers or other officers. Each officer shall hold office until his or her successor is elected and qualifies or until his or her death, or his or her resignation or removal in the manner hereinafter provided. Any two or more offices except president and vice president may be held by the same person. Election of an officer or agent shall not of itself create contract rights between the Corporation and such officer or agent.

Section 5.2 Removal And Resignation . Any officer or agent of the Corporation may be removed, with or without cause, by the Board of Directors if in its judgment the best interests of the Corporation would be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. Any officer of the Corporation may resign at any time by giving written notice of his or her resignation to the Board of Directors, the chairman of the board, the president or the secretary. Any resignation shall take effect immediately upon its receipt or at such later time specified in the notice of resignation. The acceptance of a resignation shall not be necessary to make it effective unless otherwise stated in the resignation. Such resignation shall be without prejudice to the contract rights, if any, of the Corporation.

Section 5.3 Vacancies . A vacancy in any office may be filled by the Board of Directors for the balance of the term.

Section 5.4 Chief Executive Officer . The Board of Directors may designate a chief executive officer. In the absence of such designation, the chairman of the board shall be the chief executive officer of the Corporation. The chief executive officer shall have general responsibility for implementation of the policies of the Corporation, as determined by the Board of Directors, and for the management of the business and affairs of the Corporation. He or she may execute any deed, mortgage, bond, contract or other instrument, except in cases where the execution thereof shall be expressly delegated by the Board of Directors or by these Bylaws to some other officer or agent of the Corporation or shall be required by law to be otherwise executed; and in general shall perform all duties incident to the office of chief executive officer and such other duties as may be prescribed by the Board of Directors from time to time.

Section 5.5 Chief Operating Officer . The Board of Directors may designate a chief operating officer. The chief operating officer shall have the responsibilities and duties as set forth by the Board of Directors or the chief executive officer.

Section 5.6 Chief Financial Officer . The Board of Directors may designate a chief financial officer. The chief financial officer shall have the responsibilities and duties as set forth by the Board of Directors or the chief executive officer.

Section 5.7 Chairman Of The Board . The Board of Directors shall designate a chairman of the board. The chairman of the board shall preside over the meetings of the Board of Directors and of the stockholders at which he shall be present. The chairman of the board shall perform such other duties as may be assigned to him or her by the Board of Directors.

Section 5.8 President . In the absence of a chief executive officer, the president shall in general supervise and control all of the business and affairs of the Corporation. In the absence of a designation of a chief operating officer by the Board of Directors, the president shall be the chief operating officer. He or she may execute any deed, mortgage, bond, contract or other instrument, except in cases where the execution thereof shall be expressly delegated by the Board of Directors or by these Bylaws to some other officer or agent of the Corporation or shall be required by law to be otherwise executed; and in general shall perform all duties incident to the office of president and such other duties as may be prescribed by the Board of Directors from time to time.

Section 5.9 Chief Investment Officer . The Board of Directors may designate a chief investment officer. The chief investment officer shall have the responsibilities and duties as set forth by the Board of Directors or the chief executive officer.

Section 5.10 Vice Presidents . In the absence of the president or in the event of a vacancy in such office, the vice president (or in the event there be more than one vice president, the vice presidents in the order designated at the time of their election or, in the absence of any designation, then in the order of their election) shall perform the duties of the president and when so acting shall have all the powers of and be subject to all the restrictions upon the president; and shall perform such other duties as from time to time may be assigned to such vice president by the president or by the Board of Directors. The Board of Directors may designate one or more vice presidents as executive vice president, senior vice president, or as vice president for particular areas of responsibility.

Section 5.11 Secretary . The secretary shall (a) keep the minutes of the proceedings of the stockholders, the Board of Directors and committees of the Board of Directors in one or more books provided for that purpose; (b) see that all notices are duly

given in accordance with the provisions of these Bylaws or as required by law; (c) be custodian of the corporate records and of the seal of the Corporation; (d) keep a register of the post office address of each stockholder which shall be furnished to the secretary by such stockholder; (e) have general charge of the stock transfer books of the Corporation; and (f) in general perform such other duties as from time to time may be assigned to him by the chief executive officer, the president or by the Board of Directors.

Section 5.12 Treasurer . The treasurer shall have the custody of the funds and securities of the Corporation and shall keep full and accurate accounts of receipts and disbursements in books belonging to the Corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such depositories as may be designated by the Board of Directors. In the absence of a designation of a chief financial officer by the Board of Directors, the treasurer shall be the chief financial officer of the Corporation.

The treasurer shall disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the president and Board of Directors, at the regular meetings of the Board of Directors or whenever it may so require, an account of all his or her transactions as treasurer and of the financial condition of the Corporation.

If required by the Board of Directors, the treasurer shall give the Corporation a bond in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for the faithful performance of the duties of his or her office and for the restoration to the Corporation, in case of his or her death, resignation, retirement or removal from office, of all books, papers, vouchers, moneys and other property of whatever kind in his or her possession or under his or her control belonging to the Corporation.

Section 5.13 Assistant Secretaries And Assistant Treasurers . The assistant secretaries and assistant treasurers, in general, shall perform such duties as shall be assigned to them by the secretary or treasurer, respectively, or by the president or the Board of Directors. The assistant treasurers shall, if required by the Board of Directors, give bonds for the faithful performance of their duties in such sums and with such surety or sureties as shall be satisfactory to the Board of Directors.

Section 5.14 Salaries . The salaries and other compensation of the officers shall be fixed from time to time by the Board of Directors or determined by procedures approved from time to time by the Board of Directors and no officer shall be prevented from receiving such salary or other compensation by reason of the fact that he is also a director.

ARTICLE VI

CONTRACTS, LOANS, CHECKS AND DEPOSITS

Section 6.1 Contracts . The Board of Directors, the Executive Committee or another committee of the Board of Directors within the scope of its delegated authority may authorize any officer or agent to enter into any contract or to execute and deliver any instrument in the name of and on behalf of the Corporation and such authority may be general or confined to specific instances. Any agreement, deed, mortgage, lease or other document shall be valid and binding upon the Corporation when duly authorized or ratified by action of the Board of Directors or the Executive Committee or such other committee and executed by an authorized person.

Section 6.2 Checks And Drafts . All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the Corporation shall be signed by such officer or agent of the Corporation in such manner as shall from time to time be determined by the Board of Directors.

Section 6.3 Deposits . All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositories as the Board of Directors may designate.

ARTICLE VII

STOCK

Section 7.1 Certificates . Except as otherwise provided in these Bylaws, this Section shall not be interpreted to limit the authority of the Board of Directors to issue some or all of the shares of any or all of the Corporation’s classes or series without certificates. Each stockholder, upon written request to the secretary of the Corporation, shall be entitled to a certificate or certificates which shall represent and certify the number of shares of each class of stock held by him in the Corporation. Each certificate shall be signed by the chairman of the board, the vice chairman of the board, the president, the chief executive officer, the chief operating officer, the chief financial officer or a vice president and countersigned by the secretary or an assistant secretary or the treasurer or an assistant treasurer and may be sealed with the seal, if any, of the Corporation. The signatures may be either manual or facsimile. Certificates shall be consecutively numbered; and if the Corporation shall, from time to time, issue several classes of stock, each class may have its own number series. A certificate is valid and may be issued whether or not an officer who signed it is still an officer when it is issued. Each certificate representing shares which are restricted as to their transferability or voting powers, which are preferred or limited as to their dividends or as to their allocable portion of the assets upon liquidation or which are redeemable at the option of the Corporation, shall have a statement of such restriction, limitation, preference or

redemption provision, or a summary thereof, plainly stated on the certificate. If the Corporation has authority to issue stock of more than one class, the certificate shall contain on the face or back a full statement or summary of the designations and any preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications and terms and conditions of redemption of each class of stock and, if the Corporation is authorized to issue any preferred or special class in series, the differences in the relative rights and preferences between the shares of each series to the extent they have been set and the authority of the Board of Directors to set the relative rights and preferences of subsequent series. In lieu of such statement or summary, the certificate may state that the Corporation will furnish a full statement of such information to any stockholder upon request and without charge. If any class of stock is restricted by the Corporation as to transferability, the certificate shall contain a full statement of the restriction or state that the Corporation will furnish information about the restrictions to the stockholder on request and without charge.

Section 7.2 Transfers . Upon surrender to the Corporation or the transfer agent of the Corporation of a stock certificate duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, the Corporation shall issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books.

The Corporation shall be entitled to treat the holder of record of any share of stock as the holder in fact thereof and, accordingly, shall not be bound to recognize any equitable or other claim to or interest in such share or on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of the State of Maryland.

Notwithstanding the foregoing, transfers of shares of any class of stock will be subject in all respects to the charter of the Corporation and all of the terms and conditions contained therein.

Section 7.3 Replacement Certificate . Any officer designated by the Board of Directors may direct a new certificate to be issued in place of any certificate previously issued by the Corporation alleged to have been lost, stolen or destroyed upon the making of an affidavit of that fact by the person claiming the certificate to be lost, stolen or destroyed. When authorizing the issuance of a new certificate, an officer designated by the Board of Directors may, in his or her discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or the owner’s legal representative to advertise the same in such manner as he shall require and/or to give bond, with sufficient surety, to the Corporation to indemnify it against any loss or claim which may arise as a result of the issuance of a new certificate.

Section 7.4 Closing Of Transfer Books Or Fixing Of Record Date . The Board of Directors may set, in advance, a record date for the purpose of determining

stockholders entitled to notice of or to vote at any meeting of stockholders or determining stockholders entitled to receive payment of any dividend or the allotment of any other rights, or in order to make a determination of stockholders for any other proper purpose. Such date, in any case, shall not be prior to the close of business on the day the record date is fixed and shall be not more than 90 days and, in the case of a meeting of stockholders, not less than ten days, before the date on which the meeting or particular action requiring such determination of stockholders of record is to be held or taken.

In lieu of fixing a record date, the Board of Directors may provide that the stock transfer books shall be closed for a stated period but not longer than 20 days. If the stock transfer books are closed for the purpose of determining stockholders entitled to notice of or to vote at a meeting of stockholders, such books shall be closed for at least ten days before the date of such meeting.

If no record date is fixed and the stock transfer books are not closed for the determination of stockholders, (a) the record date for the determination of stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day on which the notice of meeting is mailed or the 30th day before the meeting, whichever is the closer date to the meeting; and (b) the record date for the determination of stockholders entitled to receive payment of a dividend or an allotment of any other rights shall be the close of business on the day on which the resolution of the directors, declaring the dividend or allotment of rights, is adopted.

When a determination of stockholders entitled to vote at any meeting of stockholders has been made as provided in this section, such determination shall apply to any adjournment thereof, except when (a) the determination has been made through the closing of the transfer books and the stated period of closing has expired or (b) the meeting is adjourned to a date more than 120 days after the record date fixed for the original meeting, in either of which case a new record date shall be determined as set forth herein.

Section 7.5 Stock Ledger . The Corporation shall maintain at its principal office or at the office of its counsel, accountants or transfer agent, an original or duplicate share ledger containing the name and address of each stockholder and the number of shares of each class held by such stockholder.

Section 7.6 Fractional Stock; Issuance Of Units . The Board of Directors may issue fractional stock or provide for the issuance of scrip, all on such terms and under such conditions as they may determine. Notwithstanding any other provision of the charter or these Bylaws, the Board of Directors may issue units consisting of different securities of the Corporation. Any security issued in a unit shall have the same characteristics as any identical securities issued by the Corporation, except that the Board of Directors may provide that for a specified period securities of the Corporation issued in such unit may be transferred on the books of the Corporation only in such unit.

ARTICLE VIII

ACCOUNTING YEAR

The Board of Directors shall have the power, from time to time, to fix the fiscal year of the Corporation by a duly adopted resolution.

ARTICLE IX

DISTRIBUTIONS

Section 9.1 Authorization . Dividends and other distributions upon the stock of the Corporation may be authorized by the Board of Directors, subject to the provisions of law and the charter of the Corporation. Dividends and other distributions may be paid in cash, property or stock of the Corporation, subject to the provisions of law and the charter.

Section 9.2 Contingencies . Before payment of any dividends or other distributions, there may be set aside out of any assets of the Corporation available for dividends or other distributions such sum or sums as the Board of Directors may from time to time, in its absolute discretion, think proper as a reserve fund for contingencies, for equalizing dividends or other distributions, for repairing or maintaining any property of the Corporation or for such other purpose as the Board of Directors shall determine to be in the best interest of the Corporation, and the Board of Directors may modify or abolish any such reserve.

ARTICLE X

INVESTMENT POLICY

Subject to the provisions of the charter of the Corporation, the Board of Directors may from time to time adopt, amend, revise or terminate any policy or policies with respect to investments by the Corporation as it shall deem appropriate in its sole discretion.

ARTICLE XI

SEAL

Section 11.1 Seal . The Board of Directors may authorize the adoption of a seal by the Corporation. If adopted, the seal shall contain the name of the Corporation and the year of its incorporation and the words “Incorporated Maryland.” The Board of Directors may authorize one or more duplicate seals and provide for the custody thereof.

Section 11.2 Affixing Seal . Whenever the Corporation is permitted or required to affix its seal to a document, it shall be sufficient to meet the requirements of any law, rule or regulation relating to a seal to place the word “(SEAL)” adjacent to the signature of the person authorized to execute the document on behalf of the Corporation.

ARTICLE XII

INDEMNIFICATION AND ADVANCE OF EXPENSES

To the maximum extent permitted by Maryland law in effect from time to time, the Corporation shall indemnify and, without requiring a preliminary determination of the ultimate entitlement to indemnification, shall pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (a) any individual who is a present or former director or officer of the Corporation and who is made or threatened to be made a party to the proceeding by reason of his or her service in that capacity or (b) any individual who, while a director or officer of the Corporation and at the request of the Corporation, serves or has served as a director, officer, partner, trustee, employee or agent of such corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise and who is made or threatened to be made a party to the proceeding by reason of his or her service in that capacity. The Corporation may, with the approval of its Board of Directors or any duly authorized committee thereof, provide such indemnification and advance for expenses to a person who served a predecessor of the Corporation in any of the capacities described in (a) or (b) above and to any employee or agent of the Corporation or a predecessor of the Corporation. The indemnification and payment of expenses provided in these Bylaws shall not be deemed exclusive of or limit in any way other rights to which any person seeking indemnification or payment of expenses may be or may become entitled under any bylaw, regulation, insurance, agreement or otherwise.

Neither the amendment nor repeal of this Article, nor the adoption or amendment of any other provision of the Bylaws or charter of the Corporation inconsistent with this Article, shall apply to or affect in any respect the applicability of the preceding paragraph with respect to any act or failure to act which occurred prior to such amendment, repeal or adoption.

ARTICLE XIII

WAIVER OF NOTICE

Whenever any notice is required to be given pursuant to the charter of the Corporation or these Bylaws or pursuant to applicable law, a waiver thereof in writing, signed by the person or persons entitled to such notice, whether before or after the time stated therein, shall be deemed equivalent to the giving of such notice. Neither the business to be transacted at nor the purpose of any meeting need be set forth in the waiver

of notice, unless specifically required by statute. The attendance of any person at any meeting shall constitute a waiver of notice of such meeting, except where such person attends a meeting for the express purpose of objecting to the transaction of any business on the ground that the meeting is not lawfully called or convened.

ARTICLE XIV

AMENDMENT OF BYLAWS

Except as otherwise provided in Sections 2.14 and 2.15 of these Bylaws, the Board of Directors shall have the exclusive power to adopt, alter or repeal any provision of these Bylaws and to make new Bylaws.

Exhibit 10.1

STRUCTURING AND CONTRIBUTION AGREEMENT

THIS STRUCTURING AND CONTRIBUTION AGREEMENT (the “ Agreement ”) is made as of July 2, 2004 by and among SUNSTONE HOTEL PARTNERSHIP, LLC, a Delaware limited liability company (“ SUNSTONE HOTEL PARTNERSHIP ”); SUNSTONE HOTEL INVESTORS, INC., a Maryland corporation (“ SUNSTONE HOTEL REIT ”); SUNSTONE HOTEL INVESTORS, L.L.C., a Delaware limited liability company (“ SUNSTONE HOTEL INVESTORS ”); SUNSTONE/WB HOTEL INVESTORS IV, LLC., a Delaware limited liability company (“ SUNSTONE/WB HOTEL INVESTORS IV ”); WB HOTEL INVESTORS, LLC, a Delaware limited liability company (“ WB HOTEL INVESTORS ”); SUNSTONE/WB MANHATTAN BEACH, LLC, a Delaware limited liability company (“ SUNSTONE/WB MANHATTAN BEACH ”); and ALTER SHP LLC, a Delaware limited liability company (“ ALTER SHP LLC ”); (Sunstone Hotel Investors, Sunstone/WB Hotel Investors IV, WB Hotel Investors, Sunstone/WB Manhattan Beach, Alter SHP, each, an “ Interested Party ” and collectively, “ Interested Parties ”).

WHEREAS, in connection with the initial public offering (the “ IPO ”) of the common stock, par value $.01 per share (the “ Common Stock ”), of Sunstone Hotel REIT pursuant to a registration statement to be filed on Form S-11 with the Securities and Exchange Commission, the parties hereto desire to effect certain formation and structuring transactions outlined in Exhibit A hereto (the “ Formation and Structuring Transactions ”) under the terms and conditions set forth herein;

NOW, THEREFORE, in consideration of the mutual covenants and conditions set forth herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Sunstone Hotel Partnership, Sunstone Hotel REIT and the Interested Parties agree as follows:

ARTICLE I.

STRUCTURING TRANSACTIONS

1.1 Consent and Waiver . Subject to the terms and conditions of this Agreement, Sunstone Hotel Partnership and each of the Interested Parties hereby (i) consent to each of the Formation and Structuring Transactions, (ii) waive any restrictions set forth under any agreement to which it is party and rights that it may have to object to any of the Formation and Structuring Transactions and (iii) agree to take all actions reasonably necessary or advisable to consummate the Formation and Structuring Transactions.

1.2 Unit Transactions . Subject to the terms and conditions of this Agreement, Sunstone Hotel Partnership, Sunstone Hotel REIT and each of the Interested Parties hereby agree to perform the following transactions (the “ Unit and Stock Transactions ”) with respect to the issuance, distribution, exchange or purchase of membership units of Sunstone Hotel Partnership

(“ Partnership Units ”) and Common Stock as an integral part of the Formation and Structuring Transactions:

(a) Formation and Structuring. Each of the Interested Parties agrees to take or cause to be taken the actions set forth on steps (1) through (8) of Exhibit A .

(b) Purchase Transaction. Sunstone Hotel REIT will use the net proceeds from the sale of Common Stock in the IPO in excess of amounts that the board of directors of Sunstone Hotel REIT in its sole discretion determines Sunstone Hotel REIT needs for debt repayment, payment of expenses and other items associated with the offering and other general corporate purposes to purchase Partnership Units from the Interested Parties. The net proceeds from any exercise of any over-allotment option granted to the underwriters in the IPO will be used to purchase additional Partnership Units from the Interested Parties. In each case, the purchase will be at a price per Partnership Unit equal to the net price per share to Sunstone Hotel Investors of the Common Stock in the IPO and the purchases shall be made on a pro rata basis as set forth on Exhibit B .

(c) Allocation . The allocation of the total Partnership Units and shares of Common Stock to be issued among the Interested Parties is set forth on Exhibit B . The exact numbers of Partnership Units and shares of Common Stock to be issued and purchased shall be made by the board of directors of Sunstone Hotel REIT in its sole discretion at the time of the IPO in accordance with the allocations set forth in this Agreement with no further action on the part of any Interested Party. If any Interested Party purchases or sells a hotel prior to the IPO, the allocations shall be adjusted as agreed prior to the date hereof with no further action on the part of any Interested Party. Unless an Interested Party notifies Sunstone Hotel REIT otherwise prior to the IPO, 67.0% of the total Partnership Units and Common Stock to be received by each Interested Party shall be Partnership Units and 33.0% shall be Common Stock. If the tax consequences of the Unit and Stock Transactions change prior to the IPO, the steps on Exhibit A shall be adjusted to preserve the intended consequences as agreed prior to the date hereof.

1.3 Simultaneous Closing. The Unit and Stock Transactions shall close simultaneously with the closing of the IPO (the “ Closing ”).

1.4 Further Acts . Sunstone Hotel Partnership, Sunstone Hotel REIT and the Interested Parties shall perform, execute, and deliver or cause to be performed, executed, and delivered at the Closing or after the Closing, any and all further acts, instruments, and agreements and provide such further assurances as the other parties may reasonably require to consummate the Formation and Structuring Transactions contemplated hereunder. Sunstone Hotel REIT agrees to enter into a registration rights agreement with the Interested Parties in connection with the Closing that provides the Interested Parties with demand, piggyback and shelf registration rights in a form approved by the directors of Sunstone Hotel REIT.

1.5 Management Company . Sunstone Hotel Investors shall sell the assets and operations related to the management of the hotels to a third party management company prior to or in connection with the consummation of the Formation and Structuring Transactions and shall be entitled to keep the consideration, if any, from such sale.

ARTICLE II.

CONDITIONS TO CLOSING

2.1 Conditions to Closing . The obligations of each Interested Party, Sunstone Hotel Partnership and Sunstone Hotel REIT hereunder are subject to the satisfaction of the conditions set forth below on or before the Closing. If for any reason any of the conditions set forth in this Section 2.1 are not satisfied or waived by each party entitled to the benefit of such conditions at or prior to the Closing, or if the Closing shall not have occurred by December 31, 2004, then each party hereto by written notice given to the other parties hereto shall have the right to elect to terminate this Agreement and each party shall be released from their obligations hereunder and shall have no further liability hereunder except that nothing herein shall relieve any party from liability for any breach of this Agreement prior to such termination.

(a) Representations and Warranties True and Correct . The representations and warranties of each other party hereto shall be true and correct in all material respects as of the date of the Closing;

(b) Closing of Unit and Stock Transactions . The closing of each of the Unit and Stock Transactions applicable to each other party hereto shall occur simultaneously therewith and all obligations of each other party hereto shall have been performed or complied with in all material respects; and

(c) Closing of IPO . The IPO shall have been consummated simultaneously with the closing of the Unit and Stock Transactions therewith.

2.2 Abandonment of IPO . If at any time Sunstone Hotel REIT determines in good faith to abandon the IPO, Sunstone Hotel REIT shall so advise each Interested Party in writing and thereupon each party shall be released from its obligations hereunder and shall have no further liability hereunder. The decision by Sunstone Hotel REIT to proceed with or abandon the IPO shall be made by the board of directors of Sunstone Hotel REIT in its sole discretion taking into account the best interests of Sunstone Hotel REIT and all its stockholders.

ARTICLE III.

REPRESENTATIONS AND WARRANTIES

3.1 Representations by Sunstone Hotel Partnership and Sunstone Hotel REIT . Each of Sunstone Hotel Partnership and Sunstone Hotel REIT hereby represents and warrants to the Interested Parties as follows:

(a) Organization and Power . It is duly organized, validly existing, and in good standing under the laws of the State of Delaware (in the case of Sunstone Hotel Partnership) or the State of Maryland (in the case of Sunstone Hotel REIT), and has full right, power, and authority to enter into and perform all of its obligations under this Agreement. Sunstone Hotel REIT is, and upon consummation of the IPO will be, the sole managing member of Sunstone Hotel Partnership. The execution, delivery and performance of this Agreement have been duly authorized by it, and this Agreement constitutes the legal, valid and binding obligation

of it, enforceable against it in accordance with its terms, subject to bankruptcy, reorganization, insolvency and other similar laws affecting the enforcement of creditors’ rights generally and to general principles of equity.

(b) Litigation . There is no action, suit, or proceeding, pending or known to be threatened, against it in any court or before any arbitrator or before any federal, state, municipal, or other governmental department, commission, board, bureau, agency or instrumentality that could materially and adversely affect the ability of it to perform its obligations hereunder or otherwise delay consummation of any of the transactions contemplated hereby.

(c) Consents . Each consent, approval, authorization, order, license, certificate, permit, registration, designation, or filing by or with any governmental agency or other person or entity necessary for the execution, delivery, and performance of this Agreement or the transactions contemplated hereby by it will be obtained as of Closing.

(d) Valid Issuance . The Partnership Units issued as part of the Formation and Structuring Transactions will represent duly and validly issued limited partnership interests in Sunstone Hotel Partnership and the Common Stock issued as part of the Formation and Structuring Transactions will be duly authorized and validly issued and fully paid and non-assessable when issued.

3.2 Representations by Interested Parties . Each Interested Party hereby severally and not jointly represents and warrants to Sunstone Hotel Partnership and Sunstone Hotel REIT as follows:

(a) Organization and Power . Such Interested Party is duly organized, validly existing and in good standing under the laws of the state of its formation and has full right, power, and authority to enter into and perform all of its obligations under this Agreement. The execution, delivery and performance of this Agreement have been duly authorized by such Interested Party, and this Agreement constitutes the legal, valid and binding obligation of such Interested Party, enforceable against such Interested Party in accordance with its terms, subject to bankruptcy, reorganization, insolvency and other similar laws affecting the enforcement of creditors’ rights generally and to general principles of equity.

(b) Litigation . There is no action, suit, claim, or proceeding pending or, to the Interested Party’s knowledge, threatened against such Interested Party or such Interested Party’s interests in any court, before any arbitrator, or before or by any governmental body or other regulatory authority that would materially and adversely affect the ability of such Interested Party to perform its obligations hereunder or otherwise delay the consummation of any of the transactions contemplated hereby.

(d) Securities Law Matters . (i) In acquiring Partnership Units and/or Common Stock, such Interested Party is not relying upon any representations made to it by Sunstone Hotel

Partnership or Sunstone Hotel REIT, or any of their officers, employees, or agents that are not contained herein. The Interested Party is aware of the risks involved in investing in Partnership Units and/or Common Stock. Such Interested Party has had an opportunity to ask questions of, and to receive answers from Sunstone Hotel Partnership and Sunstone Hotel REIT, or a person or persons authorized to act on their behalf, concerning the terms and conditions of this investment and the financial condition, affairs, and business of Sunstone Hotel REIT, including Sunstone Hotel REIT’s intent to qualify as a real estate investment trust under federal income tax laws and the associated restrictions that will apply to holders of the Common Stock under federal tax laws and under Sunstone Hotel REIT’s charter and bylaws. Such Interested Party confirms that all documents, records, and information pertaining to its investment in Partnership Units and/or Common Stock that have been requested by it, have been made available or delivered to it prior to the date hereof.

(ii) Such Interested Party understands that Partnership Units and/or Common Stock issuable to such Interested Party hereunder has not been registered under the Securities Act of 1933, as amended (the “ Securities Act ”), or any state securities laws and is instead being offered and sold in reliance on an exemption from such registration requirements. Partnership Units and/or Common Stock issuable to such Interested Party is being acquired solely for the Interested Party’s own account, for investment, and is not being acquired with a view to, or for resale in connection with, any distribution, subdivision, or fractionalization thereof, in violation of such laws, and such Interested Party does not have any present intention to enter into any contract, undertaking, agreement, or arrangement with respect to any such resale. The Interested Parties understand that the Partnership Units and/or Common Stock issuable to such Interested Party will contain appropriate legends reflecting the requirement that the Partnership Units and/or Common Stock not be resold by such Interested Party without registration under such laws or the availability of an exemption from such registration.

(iii) Such Interested Party is an “accredited investor” within the meaning of Rule 501(a) under Regulation D under the Securities Act.

(e) Investment Decision . Such Interested Party is capable of making an informed investment decision based on its knowledge, sophistication and experience in financial and business matters together with the business and financial experience of those persons, if any, retained by it, and other relevant information it may have received with respect to the matters set forth in this Agreement.

(f) Brokers . Such Interested Party has not engaged the services of any agent, broker, finder or any other person or entity for any brokerage or finder’s fee, commission or other amount with respect to the transactions described herein.

(g) Good Title . Such Interested Party holds the equity interests in the assets it is contributing as part of the Formation and Structuring Transactions free and clear of all liens, encumbrances, security interests, prior assignments or conveyances, conditions, restrictions, and any other adverse right, interest, charge or claim of any kind whatsoever (collectively “ Restrictions ”) other than any Restriction for which an Interested Party will receive the necessary consent, approval or authorization to effect the Formation and Structuring Transactions prior to the Closing.

ARTICLE IV.

MISCELLANEOUS

4.1 Survival and Indemnity . The representations and warranties contained herein shall survive the Closing. Each Interested Party, severally and not jointly, agrees to indemnify, defend and hold harmless Sunstone Hotel Partnership, Sunstone Hotel REIT and each other party hereto and Sunstone Hotel Partnership and Sunstone Hotel REIT agrees to indemnify, defend and hold harmless each Interested Party from and against all costs, expenses, losses and damages (including, without limitation, reasonable attorney’s fees and expenses, but excluding consequential damages) incurred by Sunstone Hotel Partnership and Sunstone Hotel REIT or such other party resulting from any misrepresentation or breach of warranty made by it. The total liability and indemnity obligation of each Interested Party shall be limited to the aggregate value of the Partnership Units and Common Stock received by such party in the Unit and Stock Transactions.

4.2 Entire Agreement; Modifications and Waivers; Cumulative Remedies . This Agreement supersedes any existing letter of intent between the parties, constitutes the entire agreement among the parties hereto and may not be modified or amended except by instrument in writing signed by the parties hereto, and no provisions or conditions may be waived other than by a writing signed by the party waiving such provisions or conditions. No delay or omission in the exercise of any right or remedy accruing to Sunstone Hotel Partnership, Sunstone Hotel REIT or an Interested Party upon any breach under this Agreement shall impair such right or remedy or be construed as a waiver of any such breach theretofore or thereafter occurring. The waiver by Sunstone Hotel Partnership, Sunstone Hotel REIT or an Interested Party of any breach of any term, covenant, or condition herein stated shall not be deemed to be a waiver of any other breach, or of a subsequent breach of the same or any other term, covenant, or condition herein contained. All rights, powers, options, or remedies afforded to Sunstone Hotel Partnership, Sunstone Hotel REIT or an Interested Party either hereunder or by law shall be cumulative and not alternative, and the exercise of one right, power, option, or remedy shall not bar other rights, powers, options, or remedies allowed herein or by law, unless expressly provided to the contrary herein.

4.3 Notices . Any notice provided for by this Agreement and any other notice, demand, or communication which any party may wish to send to another shall be in writing and either delivered in person (including by confirmed facsimile transmission) or sent by registered or certified mail or overnight courier, return receipt requested, in a sealed envelope, postage prepaid, and addressed to the party for which such notice, demand or communication is intended at such party’s address as set forth in this Section. Sunstone Hotel Partnership and Sunstone Hotel REIT’s address for all purposes under this Agreement shall be as follows:

Suite 100

903 Calle Amanecer

San Clemente, CA 92673-6212

Attention: Jon D. Kline

Copy: Legal Department

Fax No: (949) 369-3179

The address of each of the Interested Parties for all purposes under this Agreement shall be as follows:

Sunstone Hotel Investors:

LB 54, Suite 700

13155 Noel Road

Dallas, TX 75240

Attention: Patrick K. Fox

Fax No: (972) 934-8333

Sunstone/WB Hotel Investors IV:

LB 54, Suite 700

13155 Noel Road

Dallas, TX 75240

Attention: Patrick K. Fox

Fax No: (972) 934-8333

WB Hotel Investors:

LB 54, Suite 700

13155 Noel Road

Dallas, TX 75240

Attention: Patrick K. Fox

Fax No: (972) 934-8333

Sunstone/WB Manhattan Beach:

LB 54, Suite 700

13155 Noel Road

Dallas, TX 75240

Attention: Patrick K. Fox

Fax No: (972) 934-8333

Alter SHP LLC:

Suite 100

903 Calle Amanecer

San Clemente, CA 92673-6212

Attention: Robert A. Alter

Fax No: (949) 369-4210

Any address or name specified above may be changed by a notice given by the addressee to the other parties. Any notice, demand or other communication shall be deemed given and effective as of the date of delivery in person or receipt set forth on the return receipt.

The inability to deliver because of changed address of which no notice was given, or rejection or other refusal to accept any notice, demand or other communication, shall be deemed to be receipt of the notice, demand or other communication as of the date of such attempt to deliver or rejection or refusal to accept.

4.4 Exhibits . All exhibits referred to in this Agreement and attached hereto are hereby incorporated in this Agreement by reference.

4.5 Governing Law . This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, without regard to its conflicts of laws principles.

4.6 Waiver of Trial by Jury . Each party to this Agreement hereby waives any right to a trial by jury.

4.7 Severability. In case any one or more of the provisions contained in this Agreement shall for any reason be held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality, or unenforceability shall not affect any other provision hereof, and this Agreement shall be construed as if such invalid, illegal, or unenforceable provision had never been contained herein.

4.8 Successors and Assigns. This Agreement may not be assigned by Sunstone Hotel Partnership, Sunstone Hotel REIT or any Interested Party without the prior approval of Sunstone Hotel Partnership, Sunstone Hotel REIT or the other Interested Parties, as applicable. This Agreement shall be binding upon, and inure to the benefit of, Sunstone Hotel Partnership, Sunstone Hotel REIT, the Interested Parties, and their respective legal representatives, successors, and permitted assigns.

4.9 Headings. Article headings and article and section numbers are inserted herein only as a matter of convenience and in no way define, limit, or prescribe the scope or intent of this Agreement or any part hereof and shall not be considered in interpreting or construing this Agreement.

4.10 Recitals. The recital and introductory paragraphs hereof are a part hereof, form a basis for this Agreement and shall be considered prima facie evidence of the facts and documents referred to therein.

4.11 Counterparts. This Agreement may be executed in any number of counterparts and by any party hereto on a separate counterpart, each of which when so executed and delivered shall be deemed an original and all of which taken together shall constitute but one and the same instrument. Copies of executed counterparts transmitted by telecopy, telefax or other electronic transmission service shall be considered original executed counterparts.

4.12 Specific Performance . Each party to this Agreement agrees that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. Each party to this Agreement agrees that each other party hereto will be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the provisions of this Agreement

in any federal or state court located in the State of California (as to which each party to this Agreement agrees to submit to jurisdiction for purposes of such action), this being in addition to any other remedies to which such party may be entitled under this Agreement or otherwise at law or in equity.

4.13 Time of the Essence . Time is of the essence with respect to all obligations of each party under this Agreement.

[Signature pages follow.]

IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written.


SUNSTONE HOTEL PARTNERSHIP, LLC

By:		/s/ R OBERT A. A LTER
		Name: Robert A. Alter Title:President and Chief Executive Officer of its sole member


SUNSTONE HOTEL INVESTORS, INC.

By:		/s/ R OBERT A. A LTER
		Name: Robert A. Alter Title: President and Chief Executive Officer


SUNSTONE HOTEL INVESTORS, L.L.C.

By:		/s/ J ON D. K LINE
		Name: Jon D. Kline Title: Vice President


SUNSTONE/WB HOTEL INVESTORS IV, LLC

By:		/s/ P ATRICK K. F OX
		Name: Patrick K. Fox Title: Secretary


WB HOTEL INVESTORS, LLC

By:		/s/ P ATRICK K. F OX
		Name: Patrick K. Fox Title: Vice President


SUNSTONE/WB MANHATTAN BEACH, LLC

By:		/s/ P ATRICK K. F OX
		Name: Patrick K. Fox Title: Executive Committee Member


ALTER SHP LLC

By:		/s/ R OBERT A. A LTER
		Name: Robert A. Alter Title: Managing Member

EXHIBIT A ¹

1.	Each of the following corporations that are directly or indirectly owned by Sunstone Hotel Investors will convert into a Delaware limited liability company:

•

Park SH Hotels Corp., a Delaware corporation

•

Sunstone E&P Corporation I, a Delaware corporation

•

Sunstone Hotels Sub Corp., a Delaware corporation

•

Sunstone SH Hotels Corp., a Delaware corporation

Sunstone Hotel Investors, WB Hotel Investors, Sunstone/WB Hotel Investors IV and Sunstone/WB Manhattan Beach will contribute all of their assets, other than (i) the hotel management assets and employees for the hotels, (ii) interests in the Embassy Suites, Los Angeles, California and WB Cherry Creek Hotel Investors, LLC, WB Cherry Creek Investors Inc., WB Cherry Creek, LLC, WB Cherry Creek Hotels, Inc., and WB Cherry Creek Lessee, Inc., (iii) interests in SHP Investors, SHP Properties Corp, Sunstone Properties Sub Corp, Sunstone OP Properties Corp and SHP Ogden Inc. and (iv) interests in the hotels listed on Schedule I, to Sunstone Hotel Partnership in return for Partnership Units.

3.	Each of SHP Investors, SHP Properties Corp, Sunstone Properties Sub Corp, Sunstone OP Properties Corp and SHP Ogden Inc. will distribute all of its current and accumulated earnings and profits to its shareholders.

4.	All of the lessee or management companies, which will be subsidiaries of Sunstone Hotel Partnership, will merge into a single surviving lessee corporation (the “TRS Lessee”).

5.	Sunstone Hotel Partnership will contribute all of its membership interests in Buy Efficient, L.L.C. to the TRS Lessee.

6.	Sunstone Hotel Investors will distribute the interests in the Embassy Suites, Los Angeles, California to Alter SHP LLC in redemption of its interests in Sunstone Hotel Investors.

7.	Sunstone Hotel Investors will sell the hotel management assets and employees for the hotels to a third party management company (the “Management Company”) and the TRS Lessee will enter into a management agreement with the Management Company.

8.	Simultaneously with both (i) the contribution by each of Sunstone Hotel Investors, WB Hotel Investors and Sunstone/WB Hotel Investors of their interests in the hotels listed on Schedule I to Sunstone Hotel REIT in exchange for Common Stock and (ii) the merger of

¹	Except as otherwise indicated, each transaction shall be consummated in the order set forth above on the closing date for the IPO of the Common Stock.

each of SHP Investors, SHP Properties Corp, Sunstone Properties Sub Corp, Sunstone OP Properties Corp and SHP Ogden Inc. with and into Sunstone Hotel REIT, with Sunstone Hotel REIT surviving, in exchange for Common Stock, Sunstone Hotel REIT will consummate the IPO.

EXHIBIT B


Name	Percentage
Sunstone Hotel Investors, L.L.C.	45.1	%
WB Hotel Investors, LLC	9.5
Sunstone/WB Hotel Investors IV, LLC	42.6
Sunstone/WB Manhattan Beach, LLC	2.8

	100.0	%

SCHEDULE I

Sunstone Hotel Investors

Sheraton Four Points, Silverthorne, Colorado

Holiday Inn Select, Renton, Washington

Holiday Inn, Provo, Utah

Holiday Inn, Price, Utah

Courtyard Marriott, Lynnwood, Washington

Holiday Inn, Mesa, Arizona

Holiday Inn, Flagstaff, Arizona

Holiday Inn, Craig, Colorado

Courtyard Marriott, Fresno, California

WB Hotel Investors

Hilton Garden Inn, Lake Oswego, Oregon

Holiday Inn, Boise, Idaho

Holiday Inn, Hollywood, California

Sunstone/WB Hotel Investors IV

Marriott, West Conshohocken, Pennsylvania

Radisson, Englewood, New Jersey

Valley River Inn, Eugene, Oregon

Crowne Plaza, Grand Rapids, Michigan

Radisson, Williamsburg, Virginia

Hilton, Del Mar, California

Hilton, Melville, New York

Doubletree, Minneapolis, Minnesota

Marriott, Troy, Michigan

Embassy Suites, Chicago, Illinois

Marriott, Ontario, California

Exhibit 10.2

MASTER AGREEMENT

This Master Agreement (this “ Agreement ”) is made and entered into as of this [Date of Sunstone IPO] , 2004, by and between SUNSTONE HOTEL PROPERTIES, INC., a Delaware limited liability company (“ Operator ”), and [Sunstone Hotel Investors, Inc., Sunstone Hotel TRS Lessee, Inc., SUNSTONE Lessee/Ownership Entities] (collectively, “ Owner ”).

Recitals:

A. WHEREAS, Owner and Operator have entered into certain Hotel Management Agreements (together with any other Hotel Management Agreements now or hereafter entered into between Owner (or any of Owner’s affiliates) and Operator with respect to one or more Portfolio Properties (as hereinafter defined), the “ Management Agreements ”) with respect to the hotel properties more particularly set forth on Schedule A attached hereto and made a part hereof (as modified from time to time as a result of the termination or addition of Management Agreements) between Owner or Owner’s Affiliates and Operator (individually, a “ Portfolio Property ” and collectively, the “ Portfolio Properties ”);

B. Owner and Operator desire to set forth their agreement regarding certain matters that relate to, and affect, the Portfolio Properties as more particularly set forth herein; and

NOW THEREFORE, for and in consideration of the premises, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Owner and Operator hereby supplement and amend each of the Management Agreements and agree as follows:

1. Definitions . Any capitalized terms used herein which are not defined herein shall have the same meanings given to such terms in the Management Agreements.

2. Term . This Agreement shall have a term commencing on the effective date of the initial public stock offering of shares of capital stock of Sunstone Hotel Investors, Inc. (“ Sunstone ”) (the “ Effective Date ”) and expiring on the date on which the last of the Management Agreements in effect between Owner and Operator expires or terminates. Upon the termination or expiration of a Management Agreement, the Owner thereunder shall no longer be bound by the terms of this Agreement unless and to the extent (a) such entity is a guarantor under the provisions of Section 3 hereof, (b) such entity is a party to another Management Agreement or (c) of those obligations that expressly survive the termination or expiration of the Management Agreement or this Agreement.

3. Guaranty of Portfolio Properties Fees . With respect to payment of fees (including the Incentive Fee) for services rendered by Operator relating to the Portfolio Properties, Owner shall deliver to Operator a guaranty or guarantees of payment from entities reasonably satisfactory to Operator.

4. Incentive Fee .

(A) Commencing January 1, 2005, and in addition to the fees set forth in, and subject to the terms of, the Management Agreements, Owner shall pay to Operator on an annual basis ten percent (10%) of the amount by which aggregate Net Operating Income for all of the Portfolio Properties exceeds the Incentive Fee Threshold for the Portfolio Properties for such Fiscal Year or partial Fiscal Year (the “ Incentive Fee ”). For 2005, the Incentive Fee Threshold shall mean the aggregate projected Net Operating Income for all of the Portfolio Properties as set forth in the Operating Budgets for the Portfolio Properties and shall increase each subsequent Fiscal Year by the greater of (i) three percent (3%), or (ii) the actual percentage change in average REVPAR for all of the Portfolio Properties over the previous year multiplied by 1.5. The Incentive Fee Threshold shall be subject to adjustment for increases and decreases in the number of Portfolio Properties. If a Portfolio Property leaves during a Fiscal Year, for purposes of the Incentive Fee calculation (y) such Portfolio Property ’ s Incentive Fee Threshold for such Fiscal Year shall be removed from the aggregate Incentive Fee Threshold for all of the Portfolio Properties for such Fiscal Year and (z) the actual Net Operating Income of such Portfolio Property for such Fiscal Year through the date of termination shall be removed from the aggregate year-end Net Operating Income for all of the Portfolio Properties. In addition, beginning with Fiscal Year 2006, the Incentive Fee Threshold shall be adjusted annually by the amount by which the actual cumulative capital expenditures for all of the Portfolio Properties from the Effective Date exceeds or falls short of four percent (4%) of Total Revenues for all of such Portfolio Properties (on a cumulative basis) from the Effective Date. Notwithstanding the foregoing, the total Incentive Fee payable to Operator for all of the Portfolio Properties for any Fiscal Year (or partial Fiscal Year) shall not exceed one and one half percent (1.5%) of Total Revenues (as defined in the Management Agreements) of all of the Portfolio Properties for such Fiscal Year (or partial Fiscal Year). Narrative and numeric examples of the foregoing calculations are attached hereto as Schedule B .

(B) If the Management Agreement with respect to any Portfolio Property encumbered by a mortgage or deed of trust shall limit the maximum management fee payable to Operator with respect to such Portfolio Property, then notwithstanding anything to the contrary set forth in this Agreement, the individual entity included within Owner which is the owner or lessee of such Portfolio Property shall not be liable, with respect to such encumbered Portfolio Property only, for any portion of the Portfolio Management Fee in excess of such maximum fee; provided, however, that such limitation on the liability of such entity shall not reduce the total fee for all of the Portfolio Properties payable by Owner or any guarantor hereunder or under any Management Agreement (calculated as if no such limitation on liability existed) or, if such individual entity also owns or leases Portfolio Properties not encumbered by a mortgage or deed of trust, the liability of any such individual entity in its capacity as owner or lessee of any Portfolio Property not so encumbered.

5. Centralized Services . In addition to the fees and reimbursements set forth in the Management Agreements for Centralized Services, attached hereto as Schedule C is a list of all of the types of services (including Centralized Services) and the corresponding fees and reimbursements payable to Operator for such services (including Centralized Services) rendered with respect to the Portfolio Properties as of the date of this Agreement. The amounts of such

fees applicable to each respective Portfolio Property shall be set forth in the Operating Budget for each Portfolio Property. Owner shall have the right to approve a Portfolio Property ’ s participation in any additional Centralized Services provided by Operator which are not listed on Schedule B .

6. Termination Rights . (A) (i) In addition to the other termination rights provided in the Management Agreements and notwithstanding anything contained therein to the contrary, for the period commencing on the Effective Date and ending on December 31, 2005 (the “ First Year Termination Period ”), Owner may terminate the Management Agreements for up to one thousand (1,000) rooms upon the sale to unaffiliated third parties of the Hotels comprised by such rooms (the “ Year One Rooms ”) with no termination fee or similar compensation to Operator so long as (1) all other amounts due the Operator under the terminated Management Agreement(s) have been paid in full, and (2) Operator is given by Owner at least thirty (30) days prior written notice. During the First Year Termination Period Owner shall have the right to terminate additional rooms (in excess of one thousand (1,000) so long as (a) all amounts due the Operator under the terminated Management Agreement(s) have been paid in full, (b) Owner pays to Operator a termination fee equal to the product of two percent (2%) of Total Revenues projected for the terminated Portfolio Property in calendar year 2005 multiplied by two and one-half (2.5) and (c) Operator is given by Owner at least thirty (30) days prior written notice. Any of the Year One Rooms not terminated during the First Year Termination Period (the “ Year One Carry-Over Rooms ”) may be terminated during the Second Year Termination Period or at any time thereafter upon the same terms and conditions as if terminated during the First Year Termination Period.

(ii) In addition, and notwithstanding anything contained in the Management Agreements to the contrary, for the period commencing on January 1, 2006 and ending on December 31, 2006 (the “ Second Year Termination Period ”), Owner may terminate the Management Agreements for up to three hundred (300) rooms plus any Year One Carry-Over Rooms upon the sale to unaffiliated third parties of the Hotels comprised by such rooms (“ Year Two Rooms ”) with no termination fee or similar compensation to Operator so long as (1) all other amounts due the Operator under the terminated Management Agreement(s) have been paid in full, and (2) Operator is given by Owner at least thirty (30) days prior written notice. During the Second Year Termination Period Owner shall have the right to terminate additional rooms (in excess of the Year Two Rooms) so long as (x) all amounts due the Operator under the terminated Management Agreement(s) (other than termination fees) have been paid in full, (y) Owner pays to Operator a termination fee equal to the product of the Basic Fee for the terminated Portfolio Property in calendar year 2006 multiplied by two (2.0) and (z) Operator is given by Owner at least thirty (30) days prior written notice. Any of the Year Two Rooms not terminated during the Second Year Termination Period may be terminated after the Second Year Termination Period on the same terms and conditions as if terminated during the Second Year Termination Period (the “ Year Two Carry-Over Rooms ”). The Year Two Carry-Over Rooms and any Year One Carry-Over Rooms not terminated during the Second Year Termination Period are sometimes hereinafter collectively referred to as the “ Carry-Over Rooms ”.

(iii) In addition, and notwithstanding anything contained in the management Agreement to the contrary, commencing on January 1, 2007, Owner may terminate the Management Agreements for up to three hundred (300) rooms with no termination fee or similar

compensation to Operator (the “ At-Will Rooms ”) so long as (1) all other amounts due the Operator under the terminated Management Agreement(s) have been paid in full, and (2) Operator is given by Owner at least thirty (30) days prior written notice. Commencing on January 1 of each year thereafter, three hundred (300) of the Carry-Over Rooms, if any, shall convert to At-Will Rooms.

(iv) Notwithstanding the foregoing, the number of rooms for which Owner shall have the right to terminate Management Agreements pursuant to this Section 6(A) shall under no circumstances exceed an aggregate of one thousand six hundred (1,600) rooms during the Term of this Agreement.

(B) In addition, Owner shall have the right to terminate an individual Management Agreement for a Portfolio Property without the payment of any termination fee so long as (1) all amounts due to Operator under the terminated Management Agreement have been paid in full and (2) prior to such termination, Owner executes new Management Agreement(s) with Operator relating to new Portfolio Property(ies) to be covered by this Agreement on terms and conditions substantially similar to the terms and conditions of the terminated Management Agreement, and with projected Basic Fees equal to or greater than the budgeted Basic Fee for the then current Fiscal Year for the terminated Portfolio Property. Projected Basic Fees for a specific Portfolio Property shall mean the Basic Fees generated by that Portfolio Property reasonably projected and agreed to by Owner and Operator. To the extent that Owner enters into new Management Agreements with projected Basic Fees greater than the Basic Fees for the terminated Management Agreement, Owner shall receive a credit in the amount of such excess that Owner may use with respect to replacement of any other Management Agreements subsequently terminated following the execution of such new Management Agreement. In addition, to the extent that Owner executes new Management Agreements with Operator with projected annual Basic Fees less than the budgeted Basic Fees for the then current Fiscal Year for the terminated Portfolio Property, the Termination Fee for such terminated Portfolio Property shall be reduced by a percentage equal to the quotient of (a) the amount of projected annual Basic Fees generated by the new Management Agreement divided by (b) the amount of budgeted Basic Fees for the terminated Management Agreement.

(C) In addition, if Operator acquires or is acquired by, an entity that owns and operates a major hotel industry brand name and, as a result, a default occurs (beyond any applicable cure periods) under the Franchise Agreement for a Hotel, Owner shall have the right to terminate the Management Agreement so long as (a) Owner provides to Operator at least thirty (30) days prior written notice of termination and (b) if such termination occurs (i) prior to, or on, December 31, 2005, Owner pays to Operator an amount equal to the Basic Fee for the first full Fiscal Year multiplied by one and one-half (1.5) (and if such termination occurs prior to the end of the first full Fiscal Year, the budgeted Basic Fee for the first full Fiscal Year will be used to calculate the amount due to Operator under this Section 6(C)) or (ii) on or after January 1, 2006 but prior to or on December 31, 2006, Owner shall pay to Operator an amount equal to the Basic Fee for the first full Fiscal Year of this Agreement.

7. Dedicated Staff . Operator and/or its affiliates shall establish and maintain a dedicated operational staff to oversee the operations, sales and marketing, revenue management and

centralized accounting for the Portfolio Properties (the “ Staff ”). The Staff will initially consist of personnel filling the positions and numbers thereof set forth on Schedule C which shall also summarize the approximate costs of such personnel. With respect to any changes to the Staff prior to December 31, 2005, the parties agree to act in good faith to negotiate changes to the number of personnel filling the positions and the numbers thereof based upon increases or decreases in the number of Portfolio Properties. From and after January 1, 2006, the Operator may make increases or decreases in the Overhead (as such term is defined below) proportionately with changes in the number of Portfolio Properties; provided, however, Owner shall have approval rights over the change in identity of any person filling the Staff positions which approval shall not be unreasonably withheld or delayed. The Staff shall initially primarily consist of current Owner staff. The Staff shall be based in Southern California in the offices maintained by Owner unless otherwise agreed to by Owner and Operator shall bear the portion of the expenses (rent, CAM charges, utilities, IT maintenances costs and such other matters set forth on Schedule C ) that are expressly set forth on Schedule C as allocable to Operator (the portion of the expenses expressly set forth on Schedule C as allocable to Operator and the salaries, benefits and related employment expenses of the Staff are referred to herein as the “Overhead”). Commencing January 1, 2007, the Operator shall have the right to reduce the Overhead that existed as of December 31, 2006 by an aggregate amount of up to ten percent (10%) as a result of achieving synergies with the hotel operations of other hotels managed by Operator Affiliates which reduction shall be exclusive of, and in addition to, any reductions in Overhead as a result of proportionate decreases in the number of Portfolio Properties as described above. Operator shall have the sole discretion and control in the supervision of the Staff, including, but not limited to, the recruitment, dismissal and determination of wages, benefit and severance policies. Notwithstanding the foregoing, Operator shall not make any change in the identity of the persons filling the following positions: Executive Vice Presidents of Operations or the Regional Directors of Operations, Executive and Regional Vice Presidents of Sales and Marketing, Directors of Regional Sales, Directors of Hotel Accounting and/or certain mutually agreed upon key Revenue Management personnel overseeing the Portfolio Properties without the prior written consent of Owner, which consent shall not be unreasonably withheld or delayed. Operator shall cause a “Leadership Conference” to be held in Fiscal Year 2005 which is specific to the Staff.

8. Changes to Policies . Operator shall not make any material changes to the Budgets for any Portfolio Property (except as set forth in the Management Agreements), bonus calculations or methodology and payments, brand management and/or any corporate programs or policies in which the Portfolio Properties participate without the prior written consent of Owner, such consent not to be unreasonably withheld or delayed.

9. The Four Hotels . On or prior to the Effective Date, Sunstone shall cause the owners of the hotels set forth on Exhibit D (the “Four Hotels”) to enter into hotel management agreements on the same terms and conditions as set forth in the Management Agreement; provided, however, the hotel management agreements for each of the Four Hotels shall provide for an incentive fee for 2005 equal to ten percent (10%) of the amount by which Net Operating Income for such hotel exceeds the amount of projected Net Operating Income set forth in the Operating Budget for such hotel (the “Initial Threshold”) and the Initial Threshold for each hotel shall increase each subsequent Fiscal Year by the greater of (i) three percent (3%) or (ii) the actual percentage

change in REVPAR for such hotel over the previous year multiplied by 1.5. In addition, the owners of the Four Hotels may terminate with no termination fee or similar compensation to Operator one of the management agreements for the Four Hotels during each of the following time periods (the “Annual Termination Right”): (a) January 1, 2005 through December 31, 2005, (b) January 1, 2006 through December 31, 2006, (c) January 1, 2007 through December 31, 2007 and (d) after January 1, 2008 so long as (1) all amounts due the Operator under the terminated management agreement have been paid in full and (2) Operator is given at least thirty (30) days prior written notice by the owner of the terminated hotel. In addition, the management agreements for any or all of the Four Hotels may be terminated at any time upon the sale of such hotel(s) to unaffiliated third parties with no termination fee or similar compensation to Operator so long as (1) all amounts due the Operator under the terminated management agreement have been paid in full and (2) Operator is given at least thirty (30) days prior written notice by the owner of the terminated hotel; provided, however, the termination of a management agreement for any of the Four Hotels as a result of a sale to an unaffiliated third party shall exhaust the next available Annual Termination Right.

10. Subordination of Management Agreement . Operator acknowledges and agrees that its rights under this Agreement are subject and subordinate to the lien of any first mortgage or deed of trust loan, or any junior mortgage or deed of trust loan held by an institutional investor or lender, encumbering any Hotel which is subject to a Management Agreement whether now or hereafter existing; provided, however, that (i) Operator shall not be obligated to waive or forbear from receiving, on a current basis and as and when due under this Agreement any and all fees due to it under this Agreement and allocable to such Hotel and (ii) Operator shall not be obligated to waive, or to forbear from exercising (unless and to the extent Operator receives reasonable assurance, in Operator ’ s good faith business judgment, that it will be paid or reimbursed for any and all amounts due to Operator under this Agreement and allocable to such Hotel during the period of any such forbearance, which period will not exceed 60 days in any event) any right it may have to terminate this Agreement in relation to such Hotel in accordance with the terms hereof. The provisions of this Section shall be self-operative but Operator agrees to execute and deliver promptly within ten (10) days after receipt thereof by Operator any document or certificate containing such other terms as may be customary and reasonable confirming such subordination as Owner or the holder of any such lien may reasonably request.

11. Estoppels . Owner and Operator agree that from time to time upon the request of the other party or a party to a Major Agreement, it shall execute and deliver within ten (10) days after the request a certificate confirming that this Agreement is in full force and effect, stating whether this Agreement has been modified or if any defaults exist hereunder and supplying such other information as the requesting party may reasonably require.

12. REIT Status . Operator acknowledges the status of Owner as a “taxable REIT subsidiary” of Sunstone Hotel Investors, Inc., a real estate investment trust (the “ REIT ”), all within the meaning of the Internal Revenue Code of 1986, as amended, and all of the regulations thereunder (the “ Code ”), and agrees to act in good faith at all times to protect both Owner ’ s and the REIT ’ s status under the Code, including but not limited to entering into reasonably necessary modifications to the Management Agreements to the extent of changes to the Code or any judicial or administrative determinations thereunder.

13. Notices . Any notice, statement or demand required to be given under this Agreement shall be in writing, sent by certified mail, postage prepaid, return receipt requested, or by facsimile transmission, receipt electronically or verbally confirmed, or by nationally-recognized overnight courier, receipt confirmed, addressed if to:


Owner:		[Sunstone] c/o Sunstone Hotel Investors, Inc. 903 Calle Amanecer, Suite 100 San Clemente, CA 92673 Attention: Gary A. Stougaard and Jon Kline Facsimile No.: (949) 369-4230

and Operator:		Interstate Management Company, L.L.C. c/o Interstate Hotels & Resorts, Inc. 4501 N. Fairfax Drive, Suite 800 Arlington, VA 22203 Attention: Senior Vice President and General Counsel Facsimile No.: (703) 387-3389

or to such other addresses as Operator and Owner shall designate in the manner provided in this Section 12. Any notice or other communication shall be deemed given (a) on the date three (3) business days after it shall have been mailed, if sent by certified mail, (b) on the business day it shall have been sent by facsimile transmission (unless sent on a non-business day or after business hours in which event it shall be deemed given on the following business day), or (c) on the date received if it shall have been given to a nationally-recognized overnight courier service.

14. Governing Law . This Agreement shall be subject to, and governed by, the laws of the State of Maryland, without giving effect to its conflict of laws provisions.

15. Amendment . This Agreement may not be amended except by the express written agreement duly executed by all parties hereto.

16. Waiver . The failure of either party, at any time, to enforce any of the provisions of this Agreement shall in no way constitute, or be construed as, a waiver of such provision, nor in any way affect the validity of, or the right thereafter to enforce, each and every provision of this Agreement.

17. Severability . The invalidity or unenforceability of any provision(s) of this Agreement shall not affect the other provisions hereof, and this Agreement shall be construed in all respects as if such invalid or unenforceable provision(s) were omitted.

18. Headings . The section headings in this Agreement are for convenience of reference only and in no way define or limit the scope and content of this Agreement or in any way affect its provisions.

19. Assignment . Neither Owner nor Operator may assign without the prior written consent of the other party unless such assignment complies with the assignment provisions contained in the Management Agreements.

20. Further Acts . The parties shall execute and deliver all other appropriate supplemental agreements and other instruments, and take any other action necessary to make this Agreement fully and legally effective, binding, and enforceable as between them and as against third parties.

21. Counterparts . This Agreement may be executed in several counterparts, each of which shall be deemed an original, and all such counterparts together constitute one and the same instrument. For the purpose of this Agreement, facsimile signatures shall be deemed originals.

[ Remainder of page intentionally left blank ]

IN WITNESS WHEREOF, Operator and Owner have duly executed this Agreement the day and year first above written.


SUNSTONE HOTEL TRS LESSEE, INC.

By:
Name:
Title:

SUNSTONE HOTEL INVESTORS, INC.

By:
Name:
Title:

SUNSTONE HOTEL PROPERTIES, INC.

By:
Name:
Title:

SCHEDULE A

LIST OF PROPERTIES

SCHEDULE B

EXAMPLE OF CALCULATION OF INCENTIVE FEE THRESHOLD

If:

2005 Incentive Fee threshold = $140 million

and

2005 REVPAR Percentage Change over 2004 = 1.5%

Then for 2006:

2006 Incentive Fee Threshold shall increase by the greater of (a) three percent (3%) or (b) the product of 1.5 multiplied by the REVPAR Percentage Change over 2004 (i.e., 1.5 x 1.5% = 2.25%).

Since 3% is greater than 2.25%, the 2006 Incentive Fee Threshold shall be an amount equal to the 2005 Incentive Fee Threshold increased by 3% (i.e., $140 million increased by 3%) which will result in a 2006 Incentive Fee Threshold equal to $144.20 million.

SCHEDULE C

LIST OF CENTRALIZED POSITIONS, FEES AND REIMBURSEMENTS

SCHEDULE D

THE FOUR HOTELS

EXHIBIT 10.3

HOTEL MANAGEMENT AGREEMENT

THIS HOTEL MANAGEMENT AGREEMENT (this “Agreement” ) is made as of the day of [ IPO Date ], between SUNSTONE HOTEL TRS, LESSEE, INC. (“ Owner” ), and SUNSTONE HOTEL PROPERTIES, INC. ( “Operator” ), a Colorado corporation company.

RECITALS

A. Owner is the lessee of a hotel (the “Hotel” ) known as the [Name of Hotel] located at [Address of Hotel] .

B. Owner and certain affiliates thereof (collectively, “ Owner Affiliate ”) and Operator have entered into that certain Master Agreement, dated as of [ IPO Date ] (the “ Master Agreement ”) in which the parties have set forth certain agreements that affect all of the hotels (including the Hotel) managed by Operator on behalf of Owner and such Owner Affiliate; and

C. Owner and Operator desire to evidence their agreement with respect to the operation, direction, management, and supervision of the Hotel as more particularly set forth below.

NOW, THEREFORE , for and in consideration of the premises, and other good and valuable consideration, Owner and Operator agree as follows:

ARTICLE I

THE HOTEL

1.1. Owner and Operator acknowledge that the Hotel consists of and contains:

Building (the “Building” ) with ___ guest rooms, restaurant(s), lounge(s), and conference and meeting rooms together with the parcel of land on which the Building is located and any outdoor parking areas or other facilities located on such land;

Mechanical systems and built-in installations (the “Installations” ) of the Building including, but not limited to, heating, ventilation, air conditioning, electrical and plumbing systems, elevators and escalators, and built-in laundry, refrigeration and kitchen equipment;

Furniture, furnishings, wall coverings, floor coverings, window treatments, fixtures and hotel equipment and vehicles (the “FF&E” );

Chinaware, glassware, silverware, linens, and other items of a similar nature (the “Operating Equipment” );

Stock and inventories of paper supplies, cleaning materials and similar consumable items and food and beverage (the “Operating Supplies” ); and

[Specify recreational facilities and/or parking garage, as appropriate.]

ARTICLE II

OPERATING TERM

2.1. This Agreement shall have a term (the “Operating Term” ) commencing on the effective date of the initial public stock offering of shares of capital stock of Sunstone Hotel Investors, Inc. (“ Sunstone” ) (the “Commencement Date” ) and expiring on the twentieth (20 ^th ) anniversary of the Commencement Date (the “Initial Term” ), unless sooner terminated in accordance with the provisions of this Agreement or unless extended as provided by the terms of this Agreement or as otherwise provided by the written agreement of Owner and Operator. Owner shall have the right, in its sole discretion, to elect to renew this Agreement for up to two (2) additional renewal terms of five (5) years each (each a “Renewal Term” ) by giving to Operator written notice of such election at least ninety (90) days prior to the end of the Initial Term or the first Renewal Term (as the case may be). Any and all reference contained herein to Term shall be deemed to include the Operating Term, the Initial Term and the Renewal Term(s).

ARTICLE III

APPOINTMENT AND ENGAGEMENT OF OPERATOR

3.1. Owner hereby engages Operator as the exclusive operator of the Hotel during the Term as agent for and on behalf of Owner, and Operator hereby accepts such engagement.

3.2. Subject to the terms of this Agreement (including without limitation, the limitations of Article XXIII below) and the applicable Budgets, Operator shall have control and discretion in the operation, direction, management and supervision of the Hotel including, without limitation, the determination of credit policies (including entering into agreements with credit card organizations), terms of admittance, charges for rooms, food and beverage policies, employee wage, benefits and severance policies, entertainment and amusement policies, leasing, licensing and granting of concessions for commercial space at the Hotel, and all phases of advertising, promotion and publicity relating to the Hotel.

3.3. Operator shall manage and operate the Hotel and all of its facilities and activities in a manner consistent with past practices of the previous Manager of the Hotel, but in all events in accordance with the standards and specifications set forth in any applicable franchise agreement as directed by Owner, so long as Owner provides sufficient capital to enable Operator to operate the Hotel in good standing under such franchise agreement, and in accordance with the Budgets.

3.4. Operator will be available to consult with and advise Owner, at Owner’s reasonable request, concerning all policies and procedures affecting all phases of the conduct of business at the Hotel. Subject to the terms of the Master Agreement, Operator shall in all events obtain Owner’s prior

written approval before implementing any material changes in policies and procedures relating to the Hotel, such approval not to be unreasonably withheld or delayed.

3.5. Operator shall maintain and make available to Owner upon request invoices or other evidence reasonably acceptable to Owner supporting all Operating Expenses described in Section 10.2A(ix) hereof.

3.6. Operator shall not enter into any “barter” arrangements with respect to any Hotel facilities or services, or enter into equipment leases, whether or not the same would be characterized as a capital lease under the Uniform System, without the prior written approval of Owner.

3.7. Owner shall have the right to close the Hotel from time to time on a temporary basis to perform such renovations or other work in the Hotel as Owner may determine in its sole discretion. During any such period of closure Operator shall provide the services set forth in Section 3.8 below, to the extent applicable during such period and Owner shall, in lieu of any management fee, pay to Operator reasonable compensation for such services as Operator may actually render.

3.8. During the Term, Operator, as agent and for the account of Owner, shall in accordance with the Budgets (as defined in Section 8.4) and the other applicable provisions of this Agreement, and only to the extent Owner has provided sufficient funds therefor, either through Hotel operations or directly from Owner:

Recruit, train, direct, supervise, employ and dismiss all personnel employed at or by the Hotel (the “Hotel Employees” ) for the operation of the Hotel, and in connection therewith, if one does not already exist for the Hotel, establish and maintain an affirmative action plan for the Hotel; provided, however, and subject to the terms of the Master Agreement, Operator will not make any change in the General Manager, Director of Finance and/or Director of Hotel Sales for the Hotel without the prior written consent of Owner, such consent not to be unreasonably withheld or delayed;

Develop and implement advertising, marketing, promotion, publicity and other similar programs for the Hotel;

Negotiate and enter into leases, licenses and concession agreements (collectively, the “Leases” ) for stores, office space and lobby space at the Hotel, collect the rent under such Leases and otherwise administer the Leases; provided, however, that without Owner’s prior written approval, Operator shall not enter into any new Lease, amend any Lease, terminate any Lease, grant any material waiver or consent under any Lease or renew or allow to renew automatically any existing Lease (unless such renewal is not optional on the part of Owner) unless:

(i)

The Lease has a term of one (1) year or less (including any renewal term or extension period); provided that any renewal of any Lease otherwise not requiring Owner’s consent under this clause (i) shall require the prior written consent of Owner;

(ii)

The annual rent (including, without limitation, any reasonably anticipated percentage rent) payable under such Lease is less than Ten Thousand Dollars ($10,000) (as increased (but not decreased) by the same percentage as the percentage increase in the CPI from the first day of the calendar month in which the effective date of this Agreement occurs through the first day of the first month of the then current Fiscal Year);

(iii)

Owner is not required to contribute any amounts on account of landlord work or to perform any landlord work unless the same is specified in an approved Capital Budget;

(iv)

The Lease does not provide for more than one (1) month’s free rent;

(v)

The tenant, licensee, concessionaire or occupant under the Lease is not an Operator Affiliate;

(vi)

The Lease does not demise billboard space or space for the purpose of or otherwise permit erecting and/or using antennas, microwave transmission or other telecommunications facilities;

(vii)

The Lease is not a “barter” arrangement in whole or in part; and

(viii)

The Lease is not otherwise a Major Lease. As used herein, “Major Lease” means any Lease (x) in excess of five hundred (500) square feet, (y) the annual rental under which is equal to or in excess of two percent (2%) of Total Revenues for the corresponding Fiscal Year as set forth in the then applicable Budgets or (z) the execution or amendment of which requires the consent of a party other than Owner under any Major Agreement.

(D)

Negotiate, enter into and, at Owner’s discretion, enforce contracts for the provision of services to the Hotel; provided, however, that without Owner’s prior written consent, Operator shall not enter into any such contract, amend any such contract, grant any material waiver or consent under any such contract or terminate any such contract unless:

(i)

The contract is not a “barter” arrangement in whole or in part;

(ii)

The contract is not an equipment lease, whether or not the same would be characterized as a capital lease under the Uniform System;

(iii)

The contract is not with an Operator Affiliate (as defined herein). For purposes of this Agreement, the term “Operator Affiliate” shall mean any person or entity that, directly or indirectly, controls or is controlled by or is under common control with such person or entity. For the purposes of this

definition, “control” (including the correlative meanings of the terms “controlled by” and “under common control with”), as used with respect to any person or entity, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of such person or entity, through the ownership of voting securities, partnership interests, by contract or otherwise;

(iv)

The contract has a term of one (1) year or less (including any renewal term or extension period) or is terminable by Owner upon not more than thirty (30) days notice without the payment of any fee or premium; and

(v)

The contract requires an annual payment of less than Fifteen Thousand Dollars ($15,000) (as increased (but not decreased) by the same percentage as the percentage increase in the CPI from the first day of the calendar month in which the effective date of this Agreement occurs through the first day of the first month of the then current Fiscal Year).

Apply for, process and take all necessary steps to procure and keep in effect in Owner’s name (or, if required by the licensing authority, in Operator’s name or both) all licenses, permits and other governmental authorizations required for the operation of the Hotel;

Subject to the Competitive Bidding Requirements (as such term is defined below) and unless otherwise directed by Owner, purchase FF&E, Operating Equipment and Operating Supplies necessary for the operation of the Hotel. All contracts for repairs, renewals and replacement of FF&E, all fixed asset supplies, inventories, provisions, Operating Supplies and capital renewals which exceed Fifteen Thousand and No/100 Dollars ($15,000.00) individually or other projects managed by Operator pursuant to Section 3.10 hereof shall be awarded on the basis of the following “Competitive Bidding Requirements” and solicited in the following manner: (i) a minimum of three (3) bids shall be obtained; (ii) Operator may choose the low bid without Owner’s approval if the expenditure is for an amount which is not greater than five percent (5%) in excess of a budgeted amount; and (iii) if Operator wishes to engage a contractor who provides a bid other than the low bid, Operator shall provide Owner with a written recommendation and other additional support as to why Operator wishes to engage such contractor. Notwithstanding anything set forth herein, Owner shall have the authority to accept or reject any and all bids. Further, the foregoing requirements shall not apply to purchases made through the BuyEfficient Program;

Subject to the terms of the Master Agreement, provide routine accounting services as required in the ordinary course of business;

Cause the Hotel to comply with all applicable laws, ordinances, regulations, rulings and orders of governmental authorities affecting or issued in connection with the Hotel, as well as with orders and requirements of any board of fire underwriters or

any other body which may exercise similar functions and in accordance with all Major Agreements and insurance policies with respect to the Hotel. Each party shall promptly deliver to the other any notice of violation thereof received by such party;

Cause all needed repairs and maintenance to the Hotel of which Operator is aware to be made;

Subject to the Budgets, the other applicable provisions of this Agreement and the availability of funds, Operator shall operate the Hotel in accordance with the terms of any applicable mortgage, deed of trust, ground lease and/or hotel franchise agreement (collectively, “Major Agreements”);

At Owner’s direction and with Owner’s prior written approval, institute, defend and settle any legal or administrative proceedings relating to the Hotel without Owner’s direction so long as the resolution of such matter involves less than Two Thousand Dollars ($2,000); provided, that the foregoing shall not apply to accounts receivables which Operator may handle without Owner’s involvement;

Owner’s direction or with Owner’s prior written approval and subject to Section 3.10 hereof, represent Owner in connection with the making of any Capital Improvements which are not Major Renovations. As used herein, the term “Major Renovations” shall mean any alteration or renovation or related series of alterations or renovations of the Hotel which is (i) not in the ordinary course of business at the Hotel and (ii) a material addition of rooms or other facilities at the Hotel, or a material change in the layout of such rooms or other facilities at the Hotel having a material impact upon the Hotel’s structure or infrastructure systems;

Operate with Owner and any prospective purchasers or lenders in all reasonable respects in connection with any actual proposed sale or refinancing of the Hotel; and

Provide such other services as are required under the terms of this Agreement or as are customarily performed by management companies of similar properties in the area of the Hotel or as are necessary for the day-to-day operation, management and supervision of the Hotel.

3.9. Notwithstanding any other provision of this Agreement to the contrary, Operator’s obligations with respect to any Major Agreement shall be limited to the extent (i) complete and accurate summaries of the relevant provisions thereof have been delivered to Operator sufficiently in advance to allow Operator to perform such obligations and (ii) the provisions thereof and/or compliance with such provisions by Operator (1) are applicable to the day-to-day operation, maintenance and non-capital repair and replacement of the Hotel or any portion thereof, (2) do not require contribution of capital or payments of Operator’s own funds, (3) do not materially increase Operator’s obligations hereunder or materially decrease Operator’s rights hereunder, (4) do not limit or purport to limit any corporate activity or transaction with respect to Operator or any Operator Affiliate or any other activity, transfer, transaction, property or other matter involving Operator or any Operator Affiliate other than at the site of the Hotel, and (5) are otherwise within the scope of

Operator’s duties under this Agreement. Owner acknowledges and agrees, without limiting the foregoing, that any failure of Operator or the Hotel to comply with the provisions of any Major Agreement arising out of (A) the condition of the Hotel, and/or the failure of the Hotel to comply with the provisions of such Major Agreement, prior to Operator’s assuming the day-to-day management thereof, (B) construction activities at the Hotel (except to the extent arising from Operator’s or any Operator Affiliate’s management of same pursuant to Section 3.10 hereof), (C) inherent limitations in the design and/or construction of, location of and/or parking at the Hotel, and/or (D) instructions from Owner to operate the Hotel in a manner inconsistent with the Major Agreements shall not be deemed a breach by Operator of its obligations under this Agreement. Operator shall be entitled to rely on the copies of the franchise agreement provided by Owner.

3.10. On a per project basis and at the written request of Owner from time to time, provided that Owner and Operator have agreed upon an additional construction management fee payable to Operator therefor (which fee shall be reflected in the applicable Capital Budget) and pursuant to a written project management services agreement with respect thereto reasonably acceptable to Operator and Owner, Operator or any Operator Affiliate will provide project management services as Owner’s agent in connection with the making of Major Renovations at the Hotel, which project management services may, at Owner’s request, include without limitation Operator negotiating and entering into third party agreements as agent on behalf of Owner for architectural, engineering, testing, consulting and construction services. Project management services with respect to any matters which are not Major Renovations shall be part of Operator’s services under Article III. In the event Owner does not retain Operator to provide project management services with respect to any Major Renovation, Operator shall cooperate in all reasonable respects with Owner and/or any third party project manager retained by Owner with respect to such Major Renovation.

ARTICLE IV

AGENCY; HOTEL EMPLOYEES

4.1. In the performance of its duties as Operator of the Hotel, Operator shall act solely as agent of Owner in a fiduciary capacity. Nothing in this Agreement shall constitute or be construed to be or create a partnership or joint venture between Owner and Operator or create any interest in, lease of real estate or a lien or security interest of any nature against the Hotel or any portion thereof. Except as otherwise provided in this Agreement, (a) all debts and liabilities to third persons incurred by Operator in the course of its operation and management of the Hotel in accordance with the provisions of this Agreement shall be the debts and liabilities of Owner only and (b) Operator shall not be liable for any such obligations by reason of its management, supervision, direction and operation of the Hotel as agent for Owner. Operator may so inform third parties with whom it deals on behalf of Owner and may take any other reasonable steps to carry out the intent of this paragraph.

4.2. All Hotel Employees at all times from and after the Commencement Date shall be employees of Operator. All compensation (including without limitation all wages, fringe benefits and severance payments) of the Hotel Employees shall be an Operating Expense (as defined in Section 10.2) and shall be borne by Owner and paid or reimbursed to Operator out of the Agency Account (as hereinafter defined) or if the amounts therein are insufficient by Owner upon demand therefor by

Operator. Owner acknowledges and agrees that Operator shall have the right to institute severance payment policies and bonus programs for the Hotel Employees so long as such policies are reasonable, consistent with past practices of the previous manager of the Hotel and in accordance with the Budgets.

4.3. Operator, with Owner’s prior written approval, may enroll the Hotel Employees in retirement, health and welfare employee benefit plans substantially similar to corresponding plans implemented in other hotels with similar service levels managed by Operator or similar hotels in the area of the Hotel, provided that Owner may require such plans to be consistent with past practices of the previous manager of the Hotel. Such plans may, with Owner’s prior written approval, be joint plans for the benefit of employees at more than one hospitality property owned, leased or managed by Operator or any Operator Affiliate. To the extent so approved by Owner, employer contributions to such plans (including any withdrawal liability incurred upon termination of this Agreement) and reasonable administrative fees which Operator may expend in connection therewith shall be the financial responsibility of Owner and shall be an Operating Expense. The administrative expenses of any joint plans shall be set forth in the applicable Operating Budget. Owner hereby acknowledges and agrees that compliance with the provisions of the Worker Adjustment and Retraining Notification Act and/or any similar state or local laws (together with all rules and regulations promulgated thereunder and including without limitation any such state or local laws, the “ WARN Act ”) upon any disposition of the Hotel, upon any termination of this Agreement or upon the occurrence of any other event giving rise to the application of the WARN Act is the responsibility and obligation of Owner if and to the extent Owner fails to provide Operator at least seventy (70) days’ prior written notice of such disposition, termination or occurrence to permit Operator to comply with the WARN Act. In the event Owner fails to give Operator at least seventy (70) days prior written notice, Owner hereby agrees to indemnify, defend and hold Operator harmless from and against any cost, expense, obligation, claim or other liability which Operator may incur arising out of or in connection with any breach or claimed breach of the WARN Act in connection with any such disposition, termination or other occurrence.

4.4. Operator may (i) in its discretion, provide lodging for Operator’s executive employees visiting the Hotel in connection with the performance of Operator’s services and allow them the use of Hotel facilities and (ii) with Owner’s prior written approval, provide the General Manager of the Hotel and other Hotel Employees temporary living quarters within the Hotel and the use of all Hotel facilities, in either case at a discounted price or without charge as the case may be.

4.5. Operator shall not be liable for any failure of the Hotel to comply prior to the Commencement Date with any federal, state, local and foreign statutes, laws, ordinances, regulations, rules, permits, judgments, orders and decrees affecting labor union activities, civil rights or employment in the United States, including, without limitation, the Civil Rights Act of 1870, 42 U.S.C. §1981, the Civil Rights Acts of 1871, 42 U.S.C. §1983 the Fair Labor Standards Act, 29 U.S.C. §201, et seq ., the Civil Rights Act of 1964, 42 U.S.C. §2000e, et seq ., as amended, the Age Discrimination in Employment Act of 1967, 29 U.S.C. §621, et seq ., the Rehabilitation Act, 29 U.S.C. §701, et seq ., the Americans With Disabilities Act of 1990, 29 U.S.C. §706, 42 U.S.C. §12101, et seq ., the Employee Retirement Income Security Act of 1974, 29 U.S.C. § 301, et seq ., the Equal Pay Act, 29 U.S.C. §201, et seq ., the National Labor Relations Act, 29 U.S.C. §151, et seq .,

and any regulations promulgated pursuant to such statutes (collectively, as amended from time to time, and together with any similar laws now or hereafter enacted, the “Employment Laws” ).

4.6. Operator shall from time to time develop and implement policies, procedures and programs for the Hotel (collectively, the “Employment Policies” ) reasonably designed to effect compliance with the Employment Laws.

ARTICLE V

PROVISION OF FUNDS

5.1. In performing its services under this Agreement, Operator shall act solely as agent and for the account of Owner. Operator shall not be deemed to be in default of its obligations under this Agreement to the extent it is unable to perform any obligation due to the lack of available funds from the operation of the Hotel or as otherwise provided by Owner.

5.2. Operator shall in no event be required (i) to advance any of its funds (whether by waiver or deferral of its management fees or otherwise) for the operation of the Hotel or (ii) to incur any liability unless Owner shall have furnished Operator with funds necessary for the discharge thereof prior to incurring such liability.

ARTICLE VI

CENTRALIZED SERVICES; WIDE AREA NETWORK

6.1. In accordance with the provisions of the Master Agreement, Operator shall provide to the Hotel certain centralized services including accounting, revenue management, sales and marketing, operations supervision and oversight and other similar related services more efficiently provided on a group and centralized basis (collectively, the “Centralized Services” ). In addition, Operator may, subject to the Budgets or other prior written approval of Owner, provide or cause any Operator Affiliate to provide for the Hotel other group benefits and services as are made available generally to similar properties managed by Operator.

6.2. Unless otherwise directed by Owner, Operator will utilize the Owner’s BuyEfficient program to enable the Hotel to participate in certain purchasing or other contracts with respect to the Hotel (collectively, “BuyEfficient Program” ).

6.3. From the Commencement Date through December 31, 2005, Operator shall continue to use the Hotel’s existing wide area network. Thereafter, Owner and Operator shall mutually agree upon whether to continue utilization of the Hotel’s wide area network or to utilize Operator’s wide area network on terms and conditions to be mutually agreed upon by Owner and Operator. Unless otherwise expressly agreed upon, Operator shall continue to use the Hotel’s existing wide area network.

6.4. The fees and reimbursements payable to Operator under this Article VI shall be subject to the terms and conditions of the Master Agreement.

ARTICLE VII

WORKING CAPITAL AND BANK ACCOUNTS

7.1. The following special accounts shall be established in connection with the operation of the Hotel:

The Deposit Account . All cash (other than cash needed to maintain a reasonable and customary petty cash fund at the Hotel) and checks received by Operator in the operation of the Hotel shall be deposited in a special account or accounts bearing the name of the Hotel (the “ Deposit Account ”), in such federally insured banks, savings and loans or trust companies as may be designated from time to time by Owner and reasonably approved by Operator. The Deposit Account shall be in the name of Operator as agent for Owner and shall be under the control of Operator. Amounts in the Deposit Account shall not be commingled with other funds of Operator or funds from other properties owned, leased or managed by Operator. Excluding amounts deposited by Operator into the Agency Account sufficient to maintain the Working Capital Reserve (as such term is hereinafter defined), all amounts deposited into the Deposit Account shall be paid into the Owner Account (as hereinafter defined) as set forth in Section 7.1(B). For purposes of this Agreement, the term Working Capital Reserve shall be an amount sufficient to cover any cash shortfalls based upon the monthly cash forecast of projected operating revenues and expenses for the next month (the “ Cash Forecast ”). To the extent that the Cash Forecast indicates (i) a cash excess, such excess will be transferred to the Owner Account or (ii) a cash shortfall, Owner shall fund such cash shortfall into the Agency Account within five (5) days after receipt by Owner of the Cash Forecast.

The Owner Account . Owner shall establish, in Owner’s name and under the sole control of Owner, a master account or accounts in such federally insured banks, savings and loans or trust companies as may be designated from time to time by Owner (the “ Owner Account ”). All amounts deposited into the Deposit Account shall be paid into the Owner Account on a weekly basis, or on such other basis as may be determined by Owner from time to time upon written notice to Operator. All credit card receipts shall be deposited directly into the Owner Account. Amounts in the Owner Account may be commingled with funds from other properties owned or leased by Owner, at Owner’s discretion. Owner shall be responsible for paying Fixed Charges and debt service, ground rent and capital costs with respect to the Hotel from the Owner Account or from other funds of Owner, except to the extent Owner has designated Operator in writing to pay such amounts from the Agency Account (as hereinafter defined).

The Agency Account . Operator shall establish, in Operator’s name as agent for Owner and under the control of Operator as hereinafter set forth, a special account or accounts in such federally insured banks, savings and loans or trust companies as may be designated from time to time by Owner (the “ Agency Account ”). Owner shall deposit into the Agency Account sufficient working capital on an as-needed basis to pay all Operating Expenses and other amounts which are the responsibility of Operator to pay under this Agreement (including without limitation any Fixed Charges and debt service, ground rent and capital costs with respect to the Hotel which Owner may have designated Operator to pay from the Agency Account) (collectively, “ Operator Paid Amounts ”). From the Agency Account, Operator shall pay all Operating Expenses and other Operator Paid Amounts required to be paid by Operator on Owner’s behalf under this Agreement (to the extent, in each case, such amounts are permitted or required to be paid under this Agreement). Interest on the Agency Account shall accrue to the benefit of Owner but shall be available to pay any Operator Paid Amounts. Checks or other documents of withdrawal from the Agency Account shall be signed only by representatives of Operator, provided that such representatives shall be bonded or otherwise insured in a manner reasonably satisfactory to Owner. The identity of such authorized representatives shall be disclosed to Owner from time to time. The premiums for bonding or other insurance shall be an Operating Expense except for premiums for bonding off-site executive employees of Operator. Upon the expiration or termination of this Agreement all remaining amounts in the Agency Account shall be transferred to Owner.

The FF&E Reserve Account . Owner may, at its election, establish an account or accounts in Owner’s name for a reserve for replacements, substitutions and additions to the FF&E in such federally insured banks, savings and loans or trust companies as may be designated from time to time by Owner (the “ FF&E Reserve Account ”). The FF&E Reserve Account shall be under the sole control of Owner. If and to the extent directed by Owner, Operator shall make deposits to be made to the FF&E Reserve Account directly out of the Agency Account.

7.2. If and to the extent that there are insufficient funds in the Agency Account to pay compensation due to Hotel Employees (including all related payroll and withholding taxes) and if Owner shall fail to deposit such funds in the Agency Account within two (2) business days after written notice from Operator, then Operator may use funds in the Deposit Accounts only to the extent necessary to pay such compensation (not in any event to exceed the amount of such compensation accrued or payable with respect to the two calendar weeks preceding the date of any such draw upon the Deposit Accounts by Operator) and shall immediately advise Owner as to the use of such funds.

7.3. Any security deposit held under a Lease shall be held in a separate account if required by law or the terms of such Lease or if otherwise required by Owner.

7.4. Notwithstanding anything to the contrary set forth in this Article VII, Operator agrees that it will comply with any reasonable requirement or request of the holder of any first mortgage or deed of trust loan encumbering the Hotel to change the manner in which bank and other accounts are held, provided the same does not materially increase Operator’s obligations or liabilities under this Agreement.

ARTICLE VIII

BOOKS, RECORDS AND STATEMENTS; BUDGETS

8.1. Utilizing the Hotel’s existing accounting systems, Operator shall keep full and accurate books of account and other records reflecting the results of the operation of the Hotel in accordance with the “Uniform System of Accounts” (Ninth Revised Edition 1996, as further revised from time to time) as adopted by the American Hotel and Motel Association of the United States and Canada (the “Uniform System” ) with such exceptions as may be required by the provisions of this Agreement; provided, however, that Operator may, with prior notice to Owner, make such modifications to the methodology in the Uniform System as are consistent with Operator’s standard practice in accounting for its operations under management contracts generally, so long as such modifications do not affect the determination of Total Revenues, Operating Expenses or Fixed Charges under Article X. Except for the books and records which may be kept in Operator’s home office located in Southern California or such other location approved from time to time by Owner, the books of account and all other records relating to or reflecting the operation of the Hotel shall be kept at the Hotel and shall be available to Owner and its representatives at all reasonable times for examination, audit, inspection and transcription. All of such books and records including, without limitation, books of account, guest records and front office records, shall be the property of Owner. Upon any termination of this Agreement, all of such books and records shall thereafter be available to Operator at all reasonable times for inspection, audit, examination and transcription for a period of three (3) years.

8.2. Operator shall deliver to Owner within ten (10) days after the end of each month or as otherwise indicated below, the following items (collectively, the “Monthly Reports” ):

A balance sheet as of the last day of such month;

A source and use of funds statement for such month;

An income and expense statement for such month;

Detailed departmental income and expense statements for such month;

Such other monthly reports as Owner may reasonably request and to which Operator agrees in writing;

A reforecast of projected revenues and expenses for the next month by the 1 ^st of each month; and

A market share analysis based upon STR reports.

The Monthly Reports shall be prepared in accordance with the Uniform System to the extent applicable and shall otherwise be prepared in accordance with Operator’s standard financial reporting and budgeting practices, and shall be certified by the Regional Vice President of Operations and the Director of Hotel Accounting with supervisory responsibility for the Hotel. In addition to the Monthly Reports, Operator shall deliver to Owner within thirty (30) days after the end of each calendar quarter a reforecast of revenues and expenses for the remainder of the current Fiscal Year taking into account the actual results of all prior quarters in such Fiscal Year.

8.3. Year-end financial statements for the Hotel (including a balance sheet, income statement and statement of sources and uses of funds) shall be prepared and delivered by Operator to Owner within ten (10) days after the end of such Fiscal Year and certified by the Director of Hotel Accounting with supervisory responsibilities for the preparation of the Hotel’s financial statements. In addition and in the sole discretion of Owner, such year-end financial statements shall be audited and certified by an independent certified public accountant selected by Owner. Such accountant shall address any findings, reports or opinions that concern Operator’s work under this Agreement to both Operator and Owner. Operator shall provide reasonable assistance with such accountant in the preparation of such statements.

8.4. On or before each October 15 ^th during the Term, Operator shall submit to Owner for the next Fiscal Year the following items (collectively, the “Budgets” ):

An operating budget (the “Operating Budget” ) setting forth in reasonable line-item detail the projected income from and expenses of all aspects of the operations of the Hotel;

A capital budget (the “Capital Budget” ) setting forth in reasonable line-item detail proposed capital projects and expenditures for the Hotel including but not limited to FF&E expenditures;

A market share analysis based upon STR reports; and

Such other reports or projections as Owner may reasonably request and to which Operator agrees in writing.

The Budgets shall be prepared in accordance with the Uniform System to the extent applicable and shall otherwise be prepared in accordance with Operator’s standard financial reporting and budgeting practices, and shall be in the form attached to this Agreement as Exhibit A . Owner shall notify Operator in writing of its approval or disapproval of the Budgets not later than thirty (30) days after the delivery of the Budgets to Owner and, if Owner disapproves any such Budget, Owner shall state in such notice the reasons therefor with reasonable particularity. In the event Owner fails to notify Operator in writing of its approval or disapproval of any Budget on or before the expiration of such thirty (30) day approval period, then such Budget shall be deemed disapproved by Owner.

Notwithstanding anything to the contrary contained in this Agreement, Operator is not warranting or guaranteeing in any respect that the actual operating results of the Hotel during the period covered by the Budgets will not materially vary from the Budgets. The Budgets are a good faith estimate only and unforeseen circumstances, including but not limited to, cost of labor, material, services and supplies, casualty, law, economic or market conditions may make adherence to the Budgets impracticable.

8.5. Upon approval of the Budgets by Owner, Operator shall use diligent and commercially reasonable efforts to operate the Hotel substantially in accordance with the Budgets. Operator shall not, without Owner’s prior written approval, incur any expense for any departmental line-item in the Operating Budget which causes the aggregate expenditures for such departmental line-item to exceed the budgeted amount by more than five percent (5%) for the applicable Fiscal Year set forth in the Operating Budget, provided that Operator may at Owner’s cost and expense, without Owner’s approval, (x) pay any non-capital expenses (the “Necessary Expenses” ) regardless of amount, which are necessary for the continued operation of the Hotel in accordance with the requirements of any Major Agreement and the operational standards set forth in this Agreement and which are not within the reasonable control of Operator (including, but not limited to, those for insurance, taxes, utility charges and debt service), (y) pay any expenses (the “Emergency Expenses” ) regardless of amount which, in Operator’s good faith judgment, are immediately necessary to protect the physical integrity or lawful operation of Hotel or the health or safety of its occupants, and/or (z) pay any third-party operating expenses which are commercially desirable to be incurred in order to obtain unbudgeted Hotel revenue in the ordinary course of operating the Hotel in accordance with the then current business plan provided that such unbudgeted revenue is sufficient in Operator’s professional judgment to offset such expenses ( “Opportunity Expenses” ) not to exceed Ten Thousand Dollars ($10,000) annually.

8.6. If the Operating Budget (or any component of such Budget) with respect to any Fiscal Year are disapproved by Owner as provided in Section 8.4 then, until approval of the Operating Budget (or such components) by Owner, Operator until the resolution of such dispute shall cause the Hotel to be operated substantially in accordance with most recent approved Operating Budget, except for, or as modified by, (a) those components of such Operating Budget for the applicable Fiscal Year approved by Owner, (b) an adjustment to the disputed Operating Budget so as to increase (but not decrease) disputed expense items by the same percentage as any percentage increase in the Consumer Price Index—All Urban Consumers (U.S. City Average) (1982-1984 =100), or any successor index thereto appropriately adjusted (the “ CPI ”), from the CPI in effect on the first day of the first month of the Fiscal Year applicable to such last approved Budget to the CPI in effect on the first day of the first month of the Fiscal Year applicable to the disputed Operating Budget, (c) Necessary Expenses which shall be paid as required, (d) Emergency Expenses which shall be paid as required and (d) Opportunity Expenses.

8.7. Within ten (10) days after the end of Fiscal Year 2005 and each Fiscal Year thereafter, year-end financial statements for the Hotel (including a balance sheet, income statement and statement of cash flows) shall be certified by the person responsible for accounting and financial reporting for the Portfolio Properties (as defined in the Master Agreement). The year-end statements shall include computations of Total Revenue, Operating Expenses, Fixed Charges and the fees payable to Operator

hereunder. If requested by the Owner, such year-end statements will be audited by an independent certified public accountant selected by Owner. Operator shall cooperate in all respects with such accountant in the preparation of such statements and shall use its diligent efforts to enable such statements to be delivered to Owner on or before the date sixty (60) days after the end of each Fiscal Year. Owner shall bear the cost of any audit prepared pursuant to this Section 8.7 unless Gross Operating Profit for the year in question, as certified by Operator, varies by more than four percent (4.0%) from that determined by such audit, in which event the cost thereof shall be borne by Operator.

8.8. Operator shall at all times during the Operating Term of this Agreement, at no cost or expense to Operator, cooperate with Owner’s accountants and provide them with access to all financial and other information relating to the Hotel, and access to Operator’s accountants, work papers and to otherwise assist in minimizing the cost of the audit, sufficient to enable Owner to prepare audited financial statements in conformity with Regulation S-X of the Securities and Exchange Commission ( “SEC” ) and to enable Owner to satisfy its reporting obligations under the Securities Exchange Act of 1934, as amended, or to prepare a registration statement, report or disclosure statement for filing with the SEC on behalf of Owner and/or any Owner Affiliate or to enable Owner to prepare and file their tax returns and Operator shall execute any representation letters reasonably requested by Owner’s accountants in connection with the foregoing.

ARTICLE IX

MANAGEMENT FEES

AND PAYMENTS TO OPERATOR AND OWNER

9.1. Owner shall pay to Operator, on a monthly basis, for services rendered under this Agreement a management fee (the “Basic Fee” ) equal to: (i) for the period commencing on the Commencement Date and ending on June 30, 2005, [$ ] per month; (ii) for the period commencing on July 1, 2005 and ending on December 31, 2005, [ percent ( %)] of Total Revenues; and (iii) for the period commencing on January 1, 2006 and for the remainder of the Term thereafter, [ percent ( %)] of Total Revenues.

9.2. In addition to the Basic Fee, Owner shall pay to Operator, on a monthly basis, for its centralized accounting services a fee (the “Accounting Fee” ) equal to Ten Dollars ($10) per room per month during the Term and for one (1) month after the termination of this Agreement. During the one (1) month following the termination of this Agreement, Operator shall perform such services as are reasonably necessary to transition the accounting process to the new owner and/or operator and to prepare final accounting reports consistent with the reports described in Article VII hereof. The Accounting Fee shall be increased (but not decreased) annually on each anniversary of the Opening Date by the same percentage as any percentage increase in the CPI from the first day of the calendar month in which the Commencement Date occurs through the first day of the calendar month in which such anniversary of the Commencement Date occurs.

9.3. In each month during the Term, Operator shall be paid out of the Agency Account the Basic Fee and the Accounting Fee for the preceding month, as determined from the monthly income and

expense statement. Such payment shall be due and made within ten (10) days following delivery of the income and expense statement for such month showing the computation of Total Revenues and the Basic Fee for such month.

9.4. On a weekly basis, or on such other basis as may be determined by Owner from time to time upon written notice to Operator in accordance with the provisions of Article VII of this Agreement, after (a) payment of Operating Expenses, Fixed Charges and, to the extent the same are to be paid by Operator under this Agreement, debt service, ground rent, capital costs and other amounts, (b) deposits to the FF&E Reserve Account in accordance with the Budget, (c) any required payment to Operator pursuant to Section 9.5 below and (d) retention of the Working Capital Reserve, all remaining funds in the Agency Account shall be paid to Owner.

9.5. At the end of each Fiscal Year and following receipt by Owner of the annual audit, if requested by Owner, as set forth in Section 8.3, an adjustment will be made, if necessary, based on the audit so that Operator shall have received the accurate Basic Fee for such Fiscal Year. Within thirty (30) days of receipt by Owner and Operator of such audit, Operator shall either (a) place in the Agency Account or remit to Owner, as appropriate, any excess amounts Operator may have received for such fees during such calendar year or (b) be paid out of the Agency Account or by Owner, as appropriate, any deficiency in the amounts due Operator for the Basic Fee.

ARTICLE X

CERTAIN DEFINITIONS

10.1. A. The term “Total Revenues” shall mean all income, revenue and proceeds resulting from the operation of the Hotel and all of its facilities (net of refunds and credits to guests and other items deemed “Allowances” under the Uniform System) which are properly attributable under the Uniform System to the period in question. Subject to Section 10.1(B), Total Revenues shall include, without limitation, all amounts derived from:

(i)

The rentals of rooms, banquet facilities and conference facilities;

(ii)

The sale of food and beverage whether sold in a bar, lounge or restaurant, delivered to a guest room, sold through an in-room facility or vending machines, provided in meeting or banquet rooms or sold through catering operations;

(iii)

Charges for admittance to or the use of any parking facilities, if included as part of the Hotel, recreational facilities, if included as part of the Hotel, or any entertainment events at the Hotel;

(iv)

Rentals paid under Leases to the extent such Leases cover premises used as newsstands, restaurants, bars, lounges, gift and sundries shops, health clubs and spas, barber shops and beauty salons, car rental agencies, concierge operations, ticket sales, vacation club rentals or otherwise to provide services

and merchandise to Hotel guests or which are customarily provided to guests at hotels similar in character to the Hotel (it being agreed that, with respect to other Leases, Operator shall be compensated in amounts agreed upon by Owner and Operator, which amounts shall fairly reflect the time and effort expended by Operator in connection with such Leases);

(v)

Charges for other Hotel services or amenities, including, but not limited to, telephone service, in-room movies, and laundry services; and

(vi)

The gross revenue amount on which the proceeds of business interruption or similar insurance are determined, with respect to any period for which such proceeds are received.

Total Revenues shall not include:

(i)

Sales or use taxes or similar governmental impositions collected by Owner or Operator;

(ii)

Tips, service charges and other gratuities received by Hotel Employees;

(iii)

Proceeds of insurance except as set forth in Section 10.1(A);

(iv)

Proceeds of the sale or condemnation of the Hotel, any interest therein or any other asset of Owner not sold in the ordinary course of business, or the proceeds of any loans or financings;

(v)

Capital contributed by Owner to the Hotel;

(vi)

The receipts of any tenant, licensee or concessionaire under a Lease;

(vii)

Repayments on any loans, including interest thereon, made by Owner;

(viii)

The proceeds of any judgments, awards or settlements;

(ix)

Interest earned on any and all accounts; and

(x)

Any and all security deposits made under any Leases.

10.2. A. The term “Operating Expenses” shall mean all costs and expenses of maintaining, conducting and supervising the operation of the Hotel and all of its facilities which are properly attributable under the Uniform System to the period in question. Operating Expenses shall include, without limitation:

(i)

The cost of all Operating Equipment and Operating Supplies;

(ii)

Salaries and wages of Hotel personnel, including costs of payroll taxes, employee benefits and severance payments. The salaries or wages of off-site employees or off-site executives of Operator shall not be Operating Expenses, provided that if it becomes necessary for an off-site employee or executive of Operator to temporarily perform services at the Hotel of a nature normally performed by Hotel Employees, his salary (including payroll taxes and employee benefits) for such period only as well as his traveling expenses shall, subject to the Budgets or as otherwise agreed upon in writing by Operator, be Operating Expenses and reimbursed to Operator;

(iii)

The cost of all other goods and services obtained in connection with the operation of the Hotel including, without limitation, heat and utilities, laundry, landscaping and exterminating services and office supplies;

(iv)

The cost of all non-capital repairs to and maintenance of the Hotel;

(v)

Insurance premiums (or the allocable portion thereof in the case of blanket policies) for all insurance maintained under Article XIII (other than insurance against physical damage to the Hotel) and losses incurred on any self-insured risks (including deductibles);

(vi)

All taxes, assessments, permit fees, inspection fees, and water and sewer charges and other charges (other than income or franchise taxes) payable by or assessed against Owner with respect to the operation of the Hotel, excluding Property Taxes (as defined in Section 10.3);

(vii)

Legal fees and fees of any independent certified public accountant for services directly related to the operation of the Hotel and its facilities;

(viii)

All expenses for advertising the Hotel and all expenses of sales promotion and public relations activities;

(ix)

To the extent same are specifically provided for in an approved Budget or otherwise approved in writing by Owner, all out-of-pocket expenses and disbursements reasonably incurred by Operator, pursuant to, in the course of, and directly related to, the management and operation of the Hotel under this Agreement, which fees and disbursements shall be paid by out of the Agency Account or paid or reimbursed by Owner to Operator upon demand. Without limiting the generality of the foregoing, but only to the extent specifically set forth in an approved Budget or otherwise approved in writing by Owner, such charges may include all reasonable travel, telephone, telegram, facsimile, air express and other incidental expenses, but, except as otherwise provided in this Agreement, shall not include any of the regular expenses of the central offices maintained by Operator, other than offices maintained at the Hotel for the management of the Hotel. Operator shall maintain and make available to Owner invoices or other evidence supporting such charges;

(x)

The Basic Fee and the Accounting Fee;

(xi)

Periodic payments made in the ordinary course of business under any applicable franchise agreement;

(xii)

Any other item specified as an Operating Expense in this Agreement;

(xiii)

The amount of operating expenses used to determine the proceeds of business interruption or similar insurance; and

(xiv)

Any other cost or charge classified as an Operating Expense or an Administrative and General Expense under the Uniform System unless specifically excluded under the provisions of this Agreement.

Operating Expenses shall not include:

(i)

Amortization and depreciation;

(ii)

The making of or the repayment of any loans or any interest thereon;

(iii)

The costs of any alterations, additions or improvements which for Federal income tax purposes must be capitalized and amortized over the life of such alteration addition or improvement;

(iv)

Payments on account of any equipment lease that is to be capitalized under generally accepted accounting principles;

(v)

Payments under any ground lease, space lease or easement agreement;

(vi)

Payments into or out of the FF&E Reserve Account; or

(vii)

Any item defined as a Fixed Charge in Section 10.3.

10.3. “Fixed Charges” shall mean the cost of the following items relating to the Hotel or its facilities which are properly attributable under the Uniform System to the period in question:

(i)

Real estate taxes, assessments, personal property taxes and any other ad valorem taxes imposed on or levied in connection with the Hotel, the Installations and the FF&E (collectively, “Property Taxes” );

(ii)

Insurance against physical damage to the Hotel; and

(iii)

Payments made under any ground lease covering land on which the Hotel is situated.

10.4. “ Net Operating Income” for any period shall mean the amount, if any, by which Total Revenues for such period exceed the sum of (a) Operating Expenses and (b) Fixed Charges for such period.

10.5. “Fiscal Year” shall mean each twelve (12) consecutive calendar month period or partial twelve (12) consecutive calendar month period within the Term commencing on January 1st (or, with respect to the first year of the Term, the Commencement Date) and ending on December 31 ^st (or, with respect to the last year of the Term, the expiration or earlier termination of the Term) unless Owner and Operator otherwise agree.

10.6. “ Operating Loss ” shall mean the amount, if any, by which Operating Expenses exceed Total Revenues.

10.7. “Gross Operating Profit” shall mean the amount, if any, by which Total Revenues exceed Operating Expenses.

ARTICLE XI

FF&E RESERVE

11.1. If and to the extent directed by Owner, during each Fiscal Year there shall be allocated and paid on a monthly basis to the FF&E Reserve Account from Total Revenues or other funds provided by Owner an amount equal to a minimum of four percent (4%) of Total Revenues for such month.

11.2. All funds in the FF&E Reserve Account, together with any interest earned thereon and the proceeds of any sale of FF&E (which proceeds shall be deposited in the FF&E Reserve Account) shall be used solely for purposes of replacing or refurbishing the FF&E in accordance with the applicable Capital Budget. At Owner’s direction, any funds remaining in the FF&E Reserve Account at the end of a Fiscal Year shall be carried forward to the next Fiscal Year or paid to Owner.

ARTICLE XII

INSURANCE

12.1. Except for the insurances described in Sections 12.1(D), (E) and (G) which shall be obtained by Operator (to the extent such insurances are commercially available) in Operator’s name as an Operating Expense, and the insurance described in Section 12.1(C) which may (at Owner’s discretion) be obtained by Operator in Operator’s name as an Operating Expense, the following insurance with respect to the Hotel, to the extent such insurance is commercially available, shall be obtained by Owner (or, at Owner’s Request, Operator) and maintained throughout the Term at Owner’s sole cost and expense in the amounts as set forth on Exhibit B :

Insurance covering the Building, the Installations and the FF&E on an all-risk, broad form basis, against such risks as are customarily covered by such insurance (including, without limitation, boiler and machinery insurance, but excluding damage resulting from earthquake, war, and nuclear energy), in aggregate amounts which shall be not less than the full replacement cost of the Building, the Installations and the FF&E (exclusive of foundations, footings and land);

Commercial general liability insurance (including broad form endorsement and coverage against liability arising out of the ownership or operation of motor vehicles) with a combined single limit of not less than $25,000,000 for each occurrence for liability for (i) bodily injury, (ii) death, (iii) property damage, (iv) assault and battery, (v) false arrest, detention or imprisonment or malicious prosecution, (vi) libel, slander, defamation or violation of the right of privacy, (vii) wrongful entry or eviction, or (viii) liquor law or dram shop liability;

Worker’s compensation insurance or insurance required by similar employee benefit acts having a minimum per occurrence limit as Owner may deem advisable against all claims which may be brought for personal injury or death of Hotel employees, but in any event not less than amounts prescribed by applicable state law;

Fidelity insurance, in such amounts and with such deductibles as Owner may require, covering Operator’s employees at the Hotel (other than executive employees of Operator) or in job classifications normally bonded in other hotels it manages in the United States or otherwise required by law;

Employee crime insurance in such amounts and with such deductibles as Owner may require;

Business interruption insurance covering loss of income for a minimum period of six (6) months resulting from interruption of business resulting from physical damage caused by the occurrence of any of the risks affecting the Hotel insured against under “all-risk” policy referred to in Section 12.1(A);

Employment Practices Liability Insurance ( “Employment Insurance” ) with reasonable limits and deductibles;

If the Hotel is located within an area designated “flood prone” pursuant to the National Flood Insurance Act of 1968 and the Flood Disaster Protection Act of 1973, as the same may be amended from time to time, flood insurance in such amount as Owner may reasonably require; and

Such other or additional insurance as may be (i) required under the provisions of any applicable Major Agreement (provided Operator has been given detailed written notice of such requirements) or (ii) requested by Owner in writing and customarily carried by prudent operators of first-class, full-service hotels in the geographic area of the Hotel including, but not limited to, earthquake insurance.

12.2. All insurance policies obtained by Operator shall name Operator as the insured party and shall name as additional insureds Owner, [name of fee owner], and such other parties as may be required by the terms of any applicable Major Agreements. as appropriate. Owner understands that coverage afforded the Owner as an additional insured is solely for liability arising out of Operator’s activities performed by Operator by or on behalf of Owner and that it may be necessary for Owner to purchase separate policies to cover Owner activities not performed by or on behalf of Operator. In the event that Owner shall obtain any such insurance other than through the program established by Operator, such insurance policy shall name Operator as an additional insured party All insurance policies obtained by Owner shall name Owner as the insured party and shall name as additional insureds Operator, [name of fee owner] and such other parties as may be required with respect to such insurance by the terms of any applicable Major Agreement.

12.3. All insurance policies shall be in such form and with such companies as shall be reasonably satisfactory to Owner and provided Owner has given Operator detailed written notice of such requirements, shall comply with the requirements of any Major Agreement. Insurance may be provided under blanket or master policies covering one or more other hotels operated by Operator or owned by Owner. The portion of the premium for any blanket or master policy which is allocated to the Hotel as an Operating Expense or Fixed Charge shall be determined in an equitable manner by Operator and, subject to verification by Owner of the method used to determine such allocation, reasonably approved by Owner and paid out of the Agency Account or if the funds therein are insufficient by Owner upon demand therefor by Operator. Such amount shall be determined by a suitable and customary formula applying the specific hotel exposures against appropriate rates to determine the premium allocation for the Hotel.

12.4. All insurance policies shall specify that they cannot be canceled or modified on less than twenty (20) days prior written notice to both Owner and Operator and any additional insureds (or such longer period as may be required under a Major Agreement, provided that Operator has been advised in writing of such period) and shall provide that claims shall be paid notwithstanding any act or negligence of Owner, or Operator unilaterally or on behalf of Owner, including without limitation their respective agents or employees.

12.5. All insurance policies shall provide, to the extent customarily obtainable from the insurance company providing such insurance, that the insurance company will have no right of subrogation against Owner, Operator any party to a Major Agreement or any of their respective agents, employees, partners, members, officers, directors or beneficial owners.

12.6. Owner and Operator hereby release one another from any and all liability, to the extent of the waivers of subrogation obtained under Section 12.5, associated with any damage, loss or liability with respect to which property insurance coverage is provided pursuant to this Article or otherwise.

12.7. The proceeds of any insurance claim (other than proceeds payable to third parties under the terms of the applicable policy) shall be paid into the Owner Account to the extent of Owner’s interest therein unless otherwise required by the terms of a Major Agreement.

12.8. Operator shall have the right to pay for, or reimburse itself for, insurance required under this Article XII out of the Agency Account. Notwithstanding anything to the contrary set forth in this Agreement, Operator shall have no obligation to obtain or maintain any insurance set forth in this Article if funds from Total Revenues or funds otherwise provided by Owner are not made available to Operator to purchase the same.

12.9. Subject to the prior written approval of Owner, Operator may act, directly or indirectly, in a brokerage capacity with respect to the insurance required under this Article or as a direct insurer or reinsurer with respect to the same.

ARTICLE XIII

PROPERTY TAXES

13.1. Unless Owner instructs Operator in writing that Owner will pay the Property Taxes, Operator shall pay all Property Taxes on behalf of Owner not less than ten (10) days prior to the applicable due dates so long as (a) funds from Total Revenues or funds otherwise provided by Owner are available, and (b) Operator has received written notice thereof sufficiently in advance to make such payments. Upon Owner’s request, Operator shall promptly furnish Owner with proof of payment of Property Taxes.

13.2. Upon Owner’s request, Operator shall from time to time advise Owner of the desirability of contesting the validity or amount of any Property Tax (a “Tax Contest” ). Owner may, whether or not Operator so recommends, pursue a Tax Contest, and Operator agrees to cooperate with Owner in a Tax Contest and execute any documents or pleadings required for such purpose, provided that the facts set forth in such documents or pleadings are accurate and that such cooperation or execution does not impose any liability on Operator. All out-of-pocket costs and expenses incurred by Owner and Operator in connection with a Tax Contest shall be Operating Expenses.

ARTICLE XIV

REPAIRS AND MAINTENANCE

14.1. Operator shall perform ordinary repairs and maintenance at the Hotel, subject to the Budgets and Owner providing sufficient funding. Ordinary repairs shall include only those which are normally expenses under generally accepted accounting principles. The cost of ordinary repairs shall be paid from Total Revenues and shall be treated as an Operating Expense.

14.2. As part of the annual budgeting process, Operator shall prepare an annual estimate of non-Routine Capital Expenditures to the Hotel, including without limitation the structure, the exterior façade, the mechanical, electrical, heating, ventilating, air conditioning, or plumbing systems.

14.3. After notice to Owner, if practicable, Operator may take appropriate remedial action without Owner consent in the event of: (i) an emergency threatening the health and safety of the Hotel or its guests or employees; or (ii) if the expenditures are necessary to avoid Operator’s exposure to any civil or criminal liability. Operator shall have the right to participate in any decisions that affect any conditions as described in this Section 14.3.

14.4. If Owner directly performs or contracts for repair, maintenance, refurbishing, construction or renovations at the Hotel, Owner shall exercise commercially reasonable efforts to coordinate, and require its contractors and subcontractors to coordinate, with Operator including, but not limited to, exercising commercially reasonable efforts to cause any Owner employees, contractors or subcontractors to comply with safety and security rules of the Hotel and communicate on a regular basis the activities being performed at the Hotel to assure the health, safety and efficient operation of the Hotel and its guests and employees.

ARTICLE XV

OWNER COVENANTS AND REPRESENTATIONS

15.1. Owner represents and warrants that it holds good and marketable either (a) fee title to the Hotel or (b) leasehold interest in the Hotel.

15.2. Owner represents and warrants that neither it, nor any Owner Affiliate (nor any of their respective principals, partners or funding sources but excluding any owner of publicly traded shares of Sunstone, or other interests convertible into such shares, is nor will become (i) a person designated by the U.S. Department of Treasury’s Office of Foreign Asset Control as a “specially designated national or blocked person” or similar status, (ii) a person described in Section 1 of U.S. Executive Order 13224 issued on September 23, 2001; (iii) a person otherwise identified by a government or legal authority as a person with whom Owner or Operator is prohibited from transacting business; (iv) directly or indirectly owned or controlled by the government of any country that is subject to an embargo by the United States government; or (v) a person acting on behalf of a government of any country that is subject to an embargo by the United States government. Owner agrees that it will notify Operator in writing immediately upon the occurrence of any event which would render the foregoing representations and warranties contained in this Section 15.2 incorrect.

ARTICLE XVI

DAMAGE OR DESTRUCTION; CONDEMNATION

16.1. If the Hotel is damaged by fire or other casualty, Operator shall promptly notify Owner, but no later than five (5) days following such occurrence. Operator shall cooperate with and assist Owner in evaluating the extent of the damage, filing and pursuing insurance claims, developing plans for the restoration of the Hotel and modifying the applicable Budgets to reflect the effect of the casualty on operations. This Agreement shall remain in full force and effect subsequent to such

casualty provided that either party may terminate this Agreement upon thirty days prior notice to the other party if (a) Owner shall elect to close the Hotel as a result of such casualty (except on a temporary basis for repairs or restoration) or (b) Owner shall determine in good faith not to proceed with the restoration of the Hotel.

16.2. If all or any portion of the Hotel becomes the subject of a condemnation proceeding or if Operator learns that any such proceeding may be commenced, Operator shall promptly notify Owner, but no later than five (5) days following the date Operator learns of such proceeding. Operator shall cooperate with and assist Owner in evaluating the effect of the condemnation, pursuing any negotiation, litigation, administrative action or appeal relating to the condemnation award, developing plans for the restoration of the Hotel and modifying the applicable Budgets to reflect the effect of the condemnation on operations. Either party may terminate this Agreement on thirty (30) days notice to the other party if (a) all or substantially all of the Hotel is taken through condemnation or (b) less than all or substantially all of the Hotel is taken, but, in the reasonable judgment of the party giving the termination notice, the Hotel cannot, after giving effect to any restoration as might be reasonably accomplished through available funds from the condemnation award, be profitably operated in the manner the Hotel is then being operated pursuant to this Agreement.

16.3. Any condemnation award or similar compensation shall be the property of Owner, provided that Operator shall have the right to bring a separate proceeding against the condemning authority for any damages and expenses specifically incurred by Operator as a result of such condemnation.

16.4. Operator shall not be entitled to any Termination Fee or similar compensation by reason of any termination of this Agreement pursuant to this Article XVI; provided, however, if this Agreement terminates pursuant to this Article 16 (i) prior to, or on December 31, 2005, Owner shall pay to Operator an amount equal to the Basic Fee for the first full Fiscal Year hereunder multiplied by one and one-half (1.5) (and if such termination occurs prior to the end of the first full Fiscal Year, the budgeted Basic Fee for the first full Fiscal Year shall be used to calculate the amount due to Operator under this Article 16) or (ii) on or after January 1, 2006 but prior to, or on December 31, 2006, Owner shall pay to Operator an amount equal to the Basic Fee for the first full Fiscal Year of this Agreement.

ARTICLE XVII

EVENTS OF DEFAULT AND TERMINATION RIGHTS

17.1. The following shall constitute events of default:

If either party shall be in default on the payment of any amount required to be paid under the terms of this Agreement, and such default continues for a period of ten (10) days after written notice from the other party;

If either party shall be in material default on the performance of its other obligations under this Agreement, and such default continues for a period of thirty (30) days after written notice from the other party, or if Operator shall consistently and willfully

refuse to follow instructions of Owner with respect to the operation of the Hotel (provided such instructions are not materially inconsistent with the provisions of this Agreement, the Major Agreements or applicable law) provided that if such default cannot by its nature reasonably be cured within such thirty (30) day period, an event of default shall not occur if and so long as the defaulting party promptly commences and diligently pursues the curing of such default, unless such default remains uncured for a period of ninety (90) days after receipt of such notice (or, in the event a default of the type set forth in this subsection B shall result in a default under any Major Agreement, such shorter cure period (if any) with respect to such default as shall be provided for therein);

If either party shall (i) make an assignment for the benefit of creditors, (ii) institute any proceeding seeking relief under any federal or state bankruptcy or insolvency laws, (iii) institute any proceeding seeking the appointment of a receiver, trustee, custodian or similar official for its business or assets or (iv) consent to the institution against it of any such proceeding by any other person or entity (an “Involuntary Proceeding” );

If an Involuntary Proceeding shall be commenced against either party and shall remain undismissed for a period of sixty (60) days; or

If Owner violates Section 15.2 hereof in which case Operator may terminate this Agreement immediately.

17.2. Unless otherwise stated in Section 17.1 hereof, if any event of default shall occur, the non-defaulting party may terminate this Agreement on five (5) days prior notice to the defaulting party.

17.3. The right of termination set forth in Section 17.2 shall not be in substitution for, but shall be in addition to, any and all rights and remedies for breach of contract available in law or at equity.

17.4. Neither party shall be deemed to be in default of its obligations under this Agreement if and to the extent that such party is unable to perform such obligation as a result of fire or other casualty, act of God, strike or other labor unrest, unavailability of materials, war, terrorist activity, riot or other civil commotion or any other cause beyond the reasonable control of such party (which shall not include the inability of such party to meet its financial obligations), provided that any such occurrence is an extraordinary (as opposed to a routine or cyclical) material event that was not reasonably foreseeable when the then applicable Budget was prepared.

17.5. Each of the parties hereto irrevocably waives any right such party may have against the other party hereto at law, in equity or otherwise to any consequential damages, punitive damages or exemplary damages.

17.6. Notwithstanding anything to the contrary contained in this Agreement, if within thirty (30) days after receiving Operator’s written request Owner fails to approve any changes, repairs, alterations, improvements, renewals or replacements to the Hotel which Operator determines in its

reasonable judgment are necessary (i) to protect the Hotel, Owner and/or Operator from innkeeper liability exposure, (ii) to ensure material compliance with any applicable code requirements pertaining to life safety systems requirements or (iii) to ensure material compliance with any applicable state, local or federal employment law, including without limitation the Americans with Disabilities Act, then Operator may terminate this Agreement upon thirty (30) days’ written notice to Owner delivered at any time after the expiration of Owner’s thirty (30) day approval period. In such event Operator shall not be entitled to receive any Termination Fee or similar compensation; provided, however, if this Agreement is so terminated (i) prior to, or on December 31, 2005, Owner shall pay to Operator an amount equal to the Basic Fee for the first full Fiscal Year hereunder multiplied by one and one-half (1.5) (and if such termination occurs prior to the end of the first full Fiscal Year, the budgeted Basic Fee for the first full Fiscal Year shall be used to calculate the amount due to Operator under this Section 17.6) or (ii) on or after January 1, 2006 but prior to, or on December 31, 2006, Owner shall pay to Operator an amount equal to the Basic Fee for the first full Fiscal Year of this Agreement.

17.7. At any time, Owner may terminate this Agreement, with or without cause, upon thirty (30) days prior written notice so long as (i) all amounts due Operator under this Agreement have been paid in full, (ii) subject to the last sentence of this Section 17.7 or any other provision of this Agreement to the contrary, Owner pays Operator the Termination Fee and (iii) Owner fully and unconditionally indemnifies, holds harmless and defends Operator from any and all claims, damages, costs, expenses (including reasonable attorney’s fees) arising under or relating to the WARN Act to the extent required under Section 4.3. For purposes of this Agreement, the “ Termination Fee ” shall be equal to: (A) if the termination occurs prior to the end of the first full Fiscal Year of the Term, an amount equal to the budgeted Basic Fee for the first full Fiscal Year multiplied by two and one-half (2.5), (B) if the termination occurs in the second full Fiscal Year of the Term, an amount equal to the prior Fiscal Year’s Basic Fee multiplied by two (2.0), (C) if the termination occurs in either of the third or fourth full Fiscal Years of the Term, an amount equal to the prior Fiscal Year’s Basic Fee multiplied by one and one half (1.5), (D) if the termination occurs in the fifth full Fiscal Year of the Term, an amount equal to the prior Fiscal Year’s Basic Fee, (E) if the termination occurs in the sixth full Fiscal Year of the Term, an amount equal to the prior Fiscal Year’s Basic Fee multiplied by one half (.5), and (F) if the termination occurs after the sixth full Fiscal Year of the Term, there shall be no Termination Fee. For purposes of this Section 17.7, the Basic Fee shall be calculated as an amount equal to two percent (2%) of Total Revenues. For the avoidance of doubt, no Termination Fee shall be payable to Operator in connection with Owner’s election to terminate this Agreement pursuant to Sections 17.8, 17.9 (unless such termination occurs on or prior to December 31, 2005 and then only to the extent specifically provided in Section 17.9), 17.10 (except as otherwise set forth in the Master Agreement), 23.2 or pursuant to any other provision allowing Owner to terminate this Agreement upon the occurrence of an Event of Default.

17.7. Beginning with Fiscal Year 2006, if the Hotel fails to achieve in any Fiscal Year (i) the Incentive Fee Threshold for the Hotel for such Fiscal Year, and (ii) ninety-five percent (95%) of the Hotel’s REVPAR Penetration Index (relative to the Hotel’s Competitive Set) achieved during the immediately preceding Fiscal Year (collectively, a “Performance Failure” ), Owner may terminate this Agreement upon thirty (30) days prior written notice to Operator with no termination fee or similar compensation. As an example, if the Hotel’s REVPAR Penetration Index for a Fiscal Year is

one hundred and ten percent (110%), the Hotel must achieve a REVPAR Penetration Index of at least one hundred and four and one half percent (104.5%) during the next succeeding Fiscal Year to satisfy the requirements of Section 17.8(ii) above. For purposes hereof, the Competitive Set shall mean the competitive set for the Hotel as determined by the Hotel’s then current STR Report prepared by Smith Travel Research, or if such report is no longer being prepared, a similar third party report to be mutually agreed to by Owner and Operator (the “STR Report” ). Notwithstanding the foregoing, if Owner notifies Operator that Owner elects to terminate this Agreement for a Performance Failure, Operator shall have a one time right, in its sole discretion, to cure the Performance Failure by making a payment to Owner equal to the amount by which the Incentive Fee Threshold exceeds actual Net Operating Income for such Fiscal Year. Upon the occurrence of a second Performance Failure, Owner shall have the right to terminate this Agreement without the payment of a termination fee upon thirty (30) days prior written notice to Operator so long as (a) Owner has paid Operator all amounts due and owing under this Agreement and (b) Owner fully and unconditionally indemnifies, holds harmless and defends Operator from any and all claims, damages, costs, expenses (including reasonable attorney’s fees) arising under or relating to the WARN Act to the extent required under Section 4.3 hereof. Notwithstanding the foregoing, Owner and Operator will negotiate in good faith each year during the process of approving the Budgets (as described in Article VIII hereof) whether the provisions of this Section 17.8 shall apply in the event that (x) the Hotel will undergo, in whole or in part, a Major Renovation during such Fiscal Year that will affect the Operator’s ability to comply with the provisions of this Section 17.8 or (y) Operator demonstrates that the failure to make capital improvements proposed by Operator to the Hotel will affect the Operator’s ability to comply with the provisions of this Section 17.8.

17.9. In addition, Owner shall have the right to terminate this Agreement without the payment of any termination fee in the event that Operator acquires an equity interest in a hotel which is in the Hotel’s Competitive Set (as defined in Section 17.8 hereof), so long as (i) all amounts due to Operator under this Agreement have been paid in full and (ii) Owner provides to Operator at least thirty (30) days prior written notice of termination at any time after Owner receives notice that Operator has acquired an equity interest in a hotel in the Hotel’s Competitive Set. In addition, Owner shall have the right to terminate this Agreement in the event Operator commences management of a hotel within the Hotel’s Competitive Set, so long as (i) all amounts due to Operator under this Agreement have been paid in full, (ii) Owner provides to Operator at least thirty (30) days prior written notice of termination, (iii) Owner fully and unconditionally indemnifies, holds harmless and defends Operator from any and all claims, damages, costs, expenses (including reasonable attorney’s fees) arising under or relating to the WARN Act to the extent required under Section 4.3 hereof, (iv) if such termination occurs prior to or on December 31, 2005, Owner pays to Operator an amount equal to the Basic Fee for the first full Fiscal Year of this Agreement (and if such termination occurs prior to the end of the first full Fiscal Year, the budgeted Basic Fee for the first full Fiscal Year shall be used to calculate the amount due to Operator under this Section 17.9) and (v) Operator is still continuing to manage such other hotel on the proposed effective date of termination set forth in the Owner’s notice of termination.

17.10. Either party may terminate this Agreement in accordance with the terms of the Master Agreement.

ARTICLE XVIII

TERMINATION OF AGREEMENT

18.1. Upon termination of this Agreement for any reason, Operator and Owner agree to sign any documents reasonably necessary to effect such termination or change in management for the Hotel.

18.2. Operator and Owner agree that upon termination, there may be certain adjustments to the final accounting for which information may not be available at the time of the final accounting and the parties agree to readjust such amounts and make the required cash adjustments when such information becomes available; provided, however, but subject to the provisions of Article XXII hereof, all accounts shall be deemed final two (2) years after termination of the Agreement.

18.3. Operator shall release to Owner any of Owner’s funds and accounts controlled by Operator, except as stated herein.

18.4. With the exception of employment records to the extent Operator has a legal obligation or duty of confidentiality with respect to such records, Operator shall provide or make available to Owner all books and records with respect to the Hotel upon termination of this Agreement.

18.5. To the extent permitted by applicable laws, Operator shall cooperate with Owner to assign any permits or licenses to Owner or the subsequent manager or owner; provided that (i) Owner give Operator sufficient time to effect such transfers; (ii) Owner shall cooperate and require that the new manager and/or owner to cooperate with Operator with respect to such transfers; (iii) Owner shall pay or reimburse any costs or expenses, including reasonable attorney fees, incurred by Operator in connection with these efforts.

18.6. All software used at the Hotel which is owned or licensed by Operator or any Operator Affiliate shall remain the exclusive property of Operator. Operator shall have the right to remove such software without compensation to Owner.

18.7. In the event this Agreement terminates, the parties agree that, on and after the effective date of such termination, Hotel personnel employed by Operator immediately prior to the effective date of termination will either be employed by Owner, or Owner will take such other action with respect to their employment, which may include at least seventy (70) days’ prior notification by Owner to Operator of the prospective termination of the employment of such personnel, so as, in any case, to ensure that Operator may avoid any liability pursuant to the WARN Act. Owner hereby agrees to defend, indemnify and hold harmless Operator from and against any and all manner of claims, actions, liabilities, costs and expenses (including, without limitation, reasonable attorneys’ fees and disbursements) relating to or arising from Owner’s breach of the foregoing covenant. Further, Owner agrees to assume all severance pay, accrued vacation or personal leave, COBRA and similar liabilities and obligations to the Hotel’s personnel, which Operator shall or may incur in connection with such termination of this Agreement, and Owner hereby agrees to defend, indemnify and hold harmless Operator from and against any and all manner of claims, actions, liabilities, costs and expenses (including, without limitation, reasonable attorneys’ fees and disbursements) relating to or

resulting from Owner’s breach of the foregoing covenant. Upon Owner’s request to Operator, Operator shall take all prudent and proper actions as operator, to notify, advise and cooperate with Owner in order to mitigate any such liability or expense of Owner.

ARTICLE XIX

ASSIGNMENT

19.1. Operator shall not assign or pledge this Agreement (including as a result of a Change in Control (as defined below) of Operator) without the prior consent of Owner, which may be withheld in Owner’s sole discretion; provided, however, so long as an assignment does not result in either a Change in Control of Operator (including a direct or indirect parent company) or Interstate Hotels & Resorts, Inc. (“IHR”) or a tangible material adverse economic effect upon Owner, Operator may, without the consent of Owner, assign this Agreement to (a) any Operator Affiliate, (b) any entity which is the successor by merger, consolidation or reorganization of Operator or Operator’s general partner, managing member or parent corporation or (c) the purchaser of all or substantially all of the hotel management business of Operator or Operator’s general partner, managing member or parent corporation. For purposes of this Agreement, a “Change in Control” of Operator or IHR shall mean (i) a change of more than fifty percent (50%) of the voting control of Operator or IHR (or another direct or indirect parent company), or another direct or indirect parent company of Operator, in a single transaction or series of transactions constituting a single transaction (unless arising from the issuance in an underwritten public offering by IHR of additional voting stock or instruments convertible into voting stock) coupled with (ii) two (2) or more of Messrs. Morse, Studer or Elston leaving their management positions with Operator. Nothing in this Agreement shall prohibit or be deemed to prohibit any pledge by Operator of the Basic Fee or any other amounts received by Operator under this Agreement to any lender as collateral security for debt of Operator and/or Operator’s Affiliates. Owner shall have the right as its sole and exclusive remedy, to terminate this Agreement if a Change in Control of Operator occurs. In the event that Owner terminates this Agreement as a result of a Change in Control of Operator, Owner shall (x) provide to Operator at least thirty (30) days prior written notice of termination and (y) if such termination occurs (i) on or prior to December 31, 2005, pay to Operator an amount equal to the Basic Fee for the first full Fiscal Year multiplied by one and one-half (1.5) (and if such termination occurs prior to the end of the end of the first full Fiscal Year, the budgeted Basic Fee for the first full Fiscal Year shall be used to calculate the amount due to Operator under this Section 19.1) or (ii) on or after January 1, 2006 but prior to, or on December 31, 2006, Owner shall pay to Operator an amount equal to the Basic Fee for the first full Fiscal Year of this Agreement.

19.2. Owner shall not assign this Agreement without the prior consent of Operator, provided that, Owner may assign this Agreement without Operator’s consent to (a) any person or entity acquiring the fee or leasehold interest in the Hotel if as of the effective date of such acquisition such assignee agrees in writing to be bound by this Agreement and assumes in writing all of Owner’s obligations under this Agreement accruing from and after the effective date of such assignment or (b) any Owner Affiliate so long as such Owner Affiliate is, or simultaneously with such assignment becomes, the fee owner or lessee of the Hotel.

19.3. Upon any permitted assignment of this Agreement and the assumption of this Agreement by the assignee, the assignor shall be relieved of any obligation or liability under this Agreement arising after the effective date of the assignment.

ARTICLE XX

NOTICES

20.1. Any notice, statement or demand required to be given under this Agreement shall be in writing, sent by certified mail, postage prepaid, return receipt requested, or by facsimile transmission, receipt electronically or verbally confirmed, or by nationally-recognized overnight courier, receipt confirmed, addressed if to:


Owner:		c/o Sunstone Hotel Investors, Inc.
		903 Calle Amanecer, Suite 100
		San Clemente, CA 92673
		Attention: Gary A. Stougaard and Jon Kline
		Facsimile No.: (949) 369-4230

and Operator:		c/o Interstate Hotels & Resorts, Inc.
		4501 N. Fairfax Drive, Suite 800
		Arlington, VA 22203
		Attention: Senior Vice President and General Counsel
		Facsimile No.: (703) 387-3389

or to such other addresses as Operator and Owner shall designate in the manner provided in this Section 20.1. Any notice or other communication shall be deemed given (a) on the date three (3) business days after it shall have been mailed, if sent by certified mail, (b) on the business day it shall have been sent by facsimile transmission (unless sent on a non-business day or after business hours in which event it shall be deemed given on the following business day), or (c) on the date received if it shall have been given to a nationally-recognized overnight courier service.

ARTICLE XXI

SUBORDINATION; ESTOPPELS; RECOGNITION

21.1. Operator acknowledges and agrees that its rights under this Agreement are subject and subordinate to the lien of any first mortgage or deed of trust loan, or any junior mortgage or deed of trust loan held by an institutional investor, encumbering the Hotel whether now or hereafter existing; provided, however, that (i) Operator shall not be obligated to waive or forbear from receiving, on a current basis and as and when due under this Agreement, any and all fees due to it under this Agreement and (ii) Operator shall not be obligated to waive, or to forbear from exercising (unless and to the extent Operator receives reasonable assurance that it will be paid or reimbursed for any and all amounts due to Operator under this Agreement during the period of any such forbearance, which period will not exceed sixty (60) days in any event) any right it may have to terminate this

Agreement. The provisions of this Section 21.1 shall be self-operative but Operator agrees to execute and deliver promptly within ten (10) days after receipt thereof by Operator any document or certificate containing such other terms as may be customary and reasonable confirming such subordination as Owner or the holder of any such lien may reasonably request.

21.2. If any person or entity making or holding a loan to be secured by a mortgage or deed of trust encumbering the Hotel shall request that Operator agree to modifications of this Agreement, Operator shall enter into an agreement setting forth such modifications provided that the same do not materially and adversely affect the rights or obligations of Operator under this Agreement. Such modifications may include, but shall not be limited to, Operator’s agreement to give notice of, and the opportunity to cure, any defaults on the part of Owner to such person or entity.

21.3. Owner and Operator agree that from time to time upon the request of the other party or a party to a Major Agreement, it shall execute and deliver within ten (10) days after the request a certificate confirming that this Agreement is in full force and effect, stating whether this Agreement has been modified or if any defaults exist hereunder and supplying such other information as the requesting party may reasonably require.

21.4. Owner shall execute and deliver to Operator, simultaneously with the execution of this Agreement and as a condition precedent to Operator’s obligations under this Agreement, a recognition agreement, in form and content reasonably acceptable to Operator, pursuant to which the fee owner shall recognize this Agreement or agree to enter into (or cause its successor lessee to enter into) a new management agreement with Operator for the balance of the Operating Term, together with any renewal rights, with respect to the Hotel upon substantially the same terms and conditions as contained in this Agreement, in the event that the [Main Lease] [Define] shall expire or terminate prior to the expiration of the Term; provided, however, that the fee Owner shall have no such obligation if Owner shall have terminated (or, simultaneously with such termination, shall terminate) this Agreement pursuant to the provisions of this Agreement or other applicable provision of this Agreement.

ARTICLE XXII

INDEMNIFICATION

22.1. Operator hereby agrees to indemnify, defend and hold Owner (and Owner’s agents, principals, shareholders, partners, members, officers, directors and employees) harmless from and against all liabilities, losses, claims, damages, costs and expenses (including, but not limited to, reasonable attorneys’ fees and expenses) that may be incurred by or asserted against any such party and that arise from (a) the willful misconduct or gross negligence of the Hotel’s General Manager, (b) the fraud, willful misconduct or negligence of the off-site employees of Operator, (c) the breach by Operator of any provision of this Agreement or (d) any action taken by Operator which is beyond the scope of Operator’s authority under this Agreement. Owner shall promptly provide Operator with written notice of any claim or suit brought against it by a third party which might result in such indemnification. Owner shall cooperate with the Operator or its counsel in the preparation and conduct of any defense to any such claim or suit.

22.2. Except as provided in Section 22.1, Owner hereby agrees to indemnify, defend and hold Operator (and Operator’s agents, principals, shareholders, partners, members, officers, directors and employees) harmless from and against all liabilities, losses, claims, damages, costs and expenses (including, but not limited to, reasonable attorneys’ fees and expenses) that may be incurred by or asserted against such party and that arise from or in connection with (a) the performance of Operator’s services under this Agreement (including compliance with Section 3.3 hereof), (b) any act or omission (whether or not willful, tortious, or negligent) of Owner or any third party or (c) or any other occurrence related to the Hotel (including but not limited to environmental or life-safety matters) and/or Operator’s duties under this Agreement whether arising before, during or after the Term. Operator shall promptly provide Owner with written notice of any claim or suit brought against it by a third party which might result in such indemnification. Operator shall cooperate with the Owner or its counsel in the preparation and conduct of any defense to any such claim or suit.

22.3. Supplementing the provisions of Sections 22.1 and 22.2, if any claim shall be made against Owner and/or Operator which is based upon a violation or alleged violation of the Employment Laws (an “Employment Claim” ), the Employment Claim shall fall within Operator’s indemnification obligations under Section 22.1 only if it is based upon (a) the willful misconduct or gross negligence of the Hotel’s General Manager, (b) the willful misconduct or negligence of Operator’s off-site employees or (c) Operator’s breach of its obligations under Section 5.5, 4.6 and shall otherwise fall within Owner’s indemnification obligations under Section 22.2.

22.4. If any action, lawsuit or other proceeding shall be brought against any party (the “Indemnified Party” ) hereunder arising out of or based upon any of the matters for which such party is indemnified under this Agreement, such Indemnified Party shall promptly notify the party required to provide indemnification hereunder (the “Obligor” ) in writing thereof and Obligor shall promptly assume the defense thereof (including without limitation the employment of counsel selected by Obligor), such defense to be subject to the consent of the Indemnified Party, which consent shall not be unreasonably withheld (provided, however, by way of illustration and not limitation, it shall be reasonable for the Indemnified Party to deny consent to any settlement that requires the Indemnified Party to admit guilt or liability). The Indemnified Party shall cooperate with the Obligor in the defense of any such action, lawsuit or proceeding, on the condition that the Obligor shall reimburse the Indemnified Party for any out-of-pocket costs and expenses incurred in connection therewith. The Obligor shall have the right to negotiate settlement or consent to the entry of judgment with respect to the matters indemnified hereunder; provided, however, that if any such settlement or consent judgment contemplates any action or restraint on the part of the Indemnified Party, then such settlement or consent judgment shall require the written consent of the Indemnified Party, which consent shall not be unreasonably withheld. In addition to the foregoing, the Indemnified Party shall have the right, at the expense of the Indemnified Party, to employ separate counsel in any such action and to participate in the defense thereof. An Indemnified Party may settle any action for which it is Indemnified hereunder on behalf of itself only (i.e., with respect to its own liability and with no requirement of Obligor to admit guilt or liability) with the prior written consent of Obligor, which consent shall not be unreasonably withheld (provided, however, by way of illustration and not limitation, it shall be reasonable for Obligor to deny consent to any settlement that requires Obligor to expend funds in an amount Obligor determines in good faith is inappropriate

so long as the Indemnified Party remains adequately protected at all times). In the event that Obligor fails to use reasonable efforts to defend or compromise any action, lawsuit or other proceeding for which an Indemnified Party is indemnified hereunder, the Indemnified Party may, at Obligor’s expense and without limiting Obligor’s liability under the applicable indemnity, assume the defense of such action and the Obligor shall pay the charges and expenses of such attorneys and other persons on a current basis within thirty (30) days of submission of invoices or bills therefor. In the event the Obligor is Owner and Owner neglects or refuses to pay such charges, Operator may pay such charges out of the Agency Account and deduct such charges from any amounts due Owner, or add such charges to any amounts due Operator from Owner under this Agreement. If Operator is the Obligor and Operator neglects or refuses to pay such charges, the amount of such charges shall be deducted from any amounts due Operator under this Agreement.

22.5. The provisions of this Article shall survive the termination of this Agreement with respect to acts, omissions and occurrences arising during the Operating Term.

ARTICLE XXIII

REIT LAW COMPLIANCE

23.1. Operator acknowledges that Owner is a subsidiary of Sunstone, a real estate investment trust ( “REIT” ) and that Owner is a “taxable REIT subsidiary” within the meaning of Section 856(1) of the Internal Revenue Code of 1986, as amended, together with all regulations promulgated thereunder (the “Code” ). Operator agrees to enter into such modifications of this Agreement as Owner may reasonably request from time to time in order to comply with the requirements of the Code applicable to a REIT and taxable REIT subsidiary so long as such modifications do not materially and adversely affect the rights or obligations of Operator under this Agreement.

23.2. Operator hereby acknowledges that in order for Sunstone to qualify as a REIT, and Owner to qualify as a taxable REIT subsidiary, Operator must be an “eligible independent contractor” within the meaning of that term under the Code and agrees not to knowingly engage in any activity that would prevent it from being an “eligible independent contractor” at any time during the Operating Term of this Agreement, or would otherwise jeopardize the REIT status of Sunstone, including but not limited to the following: (1) permit wagering activities to be conducted at or in connection with the Hotel by a person who is legally authorized to engage in such business, (2) stop being actively engaged in the trade or business of operating hotels for parties unrelated to Sunstone or the Owner, (3) own (directly or indirectly) more than 35% of the shares of Sunstone or the Owner, or (4) permit a person who owns (directly or indirectly) 35% of Sunstone or the Owner to also own 35% (directly or indirectly) of Operator; provided, however, Owner’s sole and exclusive remedy for violation of subsection (4) above shall be to terminate this Agreement. In the event of a violation of the foregoing, this Agreement shall be deemed to have been terminated at a time immediately prior to such violation.

ARTICLE XXIV

MISCELLANEOUS

24.1. Owner and Operator shall execute and deliver all other appropriate supplemental agreements and other instruments, and take any other action necessary to make this Agreement fully and legally effective, binding, and enforceable as between them and as against third parties.

24.2. This Agreement constitutes the entire agreement between the parties relating to the subject matter hereof, superseding all prior agreements or undertakings, oral or written. Owner acknowledges that in entering into this Agreement Owner has not relied on any projection of earnings, statements as to the possibility of future success or other similar matter which may have been prepared by Operator.

24.3. The headings of the titles to the several articles of this Agreement are inserted for convenience only and are not intended to affect the meaning of any of the provisions hereof.

24.4. A waiver of any of the terms and conditions of this Agreement may be made only in writing and shall not be deemed a waiver of such terms and conditions on any future occasion.

24.5. This Agreement shall be binding upon and inure to the benefit of Owner and Operator and their respective successors and permitted assigns.

24.6. This Agreement shall be construed, both as to its validity and as to the performance of the parties, in accordance with the laws of the State of Maryland, without reference to its conflict of laws provisions.

24.7. This Agreement may be executed in any number of counterparts each of which shall, when executed, be deemed to be an original and all of which shall be deemed to be one and the same instrument. Signatures on this Agreement shall be deemed to be original signatures for all purposes of this Agreement.

[Remainder of page intentionally left blank]

IN WITNESS WHEREOF , Operator and Owner have duly executed this Agreement the day and year first above written.


SUNSTONE HOTELS TRS LESSEE, INC.

By:
Name:
Title:

SUNSTONE HOTELS PROPERTIES, INC.

By:
Name:
Title:

EXHIBIT A

Form of Budgets

EXHIBIT B

Insurance Amounts

Glossary of Terms


Accounting Fee		Section 9.2

Agency Account		Section 7.1(C)

Agreement		Preamble

Basic Fee		Section 9.1

Budgets		Section 8.4

Building		Section 1.1(A)

BuyEfficient Program		Section 6.2

Capital Budget		Section 8.4(B)

Cash Forecast		Section 7.1(A)

Centralized Services		Section 6.1

Change in Control		Section 19.1

Code		Section 23.1

Commencement Date		Section 2.1

CPI		Section 8.6

Deposit Account		Section 7.1(A)

Emergency Expenses		Section 8.5

Employment Claim		Section 22.3

Employment Insurance		Section 12.1(F)

Employment Laws		Section 4.5

Employment Policies		Section 4.6

FF&E		Section 1.1(C)

FF&E Reserve Account		Section 7.1(D)

Fiscal Year		Section 10.5

Fixed Charges		Section 10.3

Gross Operating Profit		Section 10.7

Hotel		Recital A


Hotel Employees		Section 3.8(A)

Indemnified Party		Section 22.4

Initial Term		Section 2.1

Installations		Section 1.1(B)

Involuntary Proceeding		Section 17.1(C)

Leases		Section 3.8(C)

Major Agreements		Section 3.8(J)

Major Lease		Section 3.8(C)(viii)

Major Renovations		Section 3.8(L)

Master Agreement		Recital B

Monthly Reports		Section 8.2

Necessary Expenses		Section 8.5

Net Operating Income		Section 10.4

Obligor		Section 22.4

Operating Budget		Section 8.4(A)

Operating Equipment		Section 1.1(D)

Operating Expenses		Section 10.2(A)

Operating Loss		Section 10.6

Operating Supplies		Section 1.1(E)

Operating Term		Section 2.1

Operator		Preamble

Operator Affiliate		Section 3.8(D)(iii)

Operator Paid Amounts		Section 7.1(C)

Opportunity Expenses		Section 8.5

Owner		Preamble

Owner Account		Section 7.1(B)

Owner Affiliate		Recital B


Performance Failure		Section 17.8

Property Taxes		Section 10.3(i)

REIT		Section 23.1

Renewal Term		Section 2.1

SEC		Section 8.8

STR Report		Section 17.8

Tax Contest		Section 13.2

Term		Section 2.1

Termination Fee		Section 17.7

Total Revenues		Section 10.1(A)

Uniform System		Section 8.1

WARN Act		Section 4.3

EXHIBIT 10.8

REGISTRATION RIGHTS AGREEMENT

This REGISTRATION RIGHTS AGREEMENT (this “ Agreement ”), is made and entered into as of , 2004, among Sunstone Hotel Investors, Inc., a Delaware corporation (the “ Company ”), Sunstone Hotel Investors, L.L.C. a Delaware limited liability company (“ Sunstone Hotel Investors ”), Sunstone/WB Hotel Investors IV, LLC, a Delaware limited liability company (“ Sunstone/WB Hotel Investors IV ”), WB Hotel Investors, LLC, a Delaware limited liability company (“ WB Hotel Investors ”) and Sunstone/WB Manhattan Beach, LLC, a Delaware limited liability company (“ Sunstone/WB Manhattan Beach ”). Each of Sunstone Hotel Investors, Sunstone/WB Hotel Investors IV, WB Hotel Investors and Sunstone/WB Manhattan Beach is referred to as an “ Investor ” and they are collectively referred to as the “ Investors ”.

WHEREAS, concurrently with the execution of this Agreement, the Company will effect an initial public offering of shares of its common stock; and

WHEREAS, the parties desire to provide the Investors with certain registration rights.

NOW, THEREFORE, in consideration of the foregoing, the parties hereto agree as follows:

1.	DEFINITIONS.

As used in this Agreement, the following terms shall have the following respective meanings:

“ Affiliate ”: with regard to a Person, a Person that controls, is controlled by, or is under common control with, such original Person. For purposes of this definition, “control” when used with respect to any Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms “affiliated,” “controlling” and controlled” have meanings correlative to the foregoing.

“ Closing Price ”: the reported last sale price of the Shares on the New York Stock Exchange Composite Tape.

“ Commission ”: the Securities and Exchange Commission or any other applicable Federal agency at the time administering the Securities Act.

“ Company ”: as defined in the preamble, and shall include, where the context requires any Person into which the Company is merged or with which the Company is consolidated.

“ Demand Registration ”: an effective registration pursuant to a request made by the Investors pursuant to Section 2.1.

“ Exchange Act ”: the Securities Exchange Act of 1934, as amended.

“ Membership Units ”: any membership interests in Sunstone Hotel Partnership, LLC, a Delaware limited liability company.

“ Overhang Risk ”: a substantial risk that the sale of some or all of the Shares sought to be sold will substantially reduce the proceeds or price per Share to be derived from the sale.

“ Person ”: an individual, partnership, corporation, company (including a limited liability company), trust or unincorporated organization, or a government or agency or political subdivision thereof.

“ Resale Rules ”: as defined in Section 3.3.

“ Securities Act ”: the Securities Act of 1933, as amended.

“ Shares ”: the shares of common stock of the Company owned or issuable upon conversion of Membership Units owned by the Investors on the date of this Agreement, and any other securities that subsequently may be issued or issuable by the Company as a result of a stock split or dividend or other similar transaction involving the Shares and any securities into which the Shares may thereafter be changed or exchanged as a result of the reincorporation of the Company or merger, consolidation, recapitalization or other similar transaction.

“ Shelf Registration ”: an effective registration under Rule 415 of the Securities Act pursuant to Section 2.3.

“ Violation ”: as defined in Section 3.2(a).

2.	REGISTRATION RIGHTS.

2.1 Demand Registration . Subject to any applicable lockup or standstill agreement to which the Company or any Investor is a party, from and after the date hereof and until , 2005 (and for such additional period during which the Company fails to file or maintain a Shelf Registration pursuant to Section 2.3), the Investors may request the Company to register the resale of the Investors’ Shares pursuant to an underwritten offering. The Investors shall be entitled to one Demand Registration, provided that the Investors continue to own at least $50 million of Shares (based on the Closing Price) on the date the registration is requested.

2.2 Option to Acquire . In the event that the Company has received a request for a Demand Registration pursuant to Section 2.1, the Company shall have the option, for a period of 30 days from the date of the request, to acquire all of the Shares sought to be included in the Demand Registration at a per share price equal to the average Closing Price of the Shares during the 20-day period beginning 10 days prior to receipt of the request and ending 10 days thereafter. The Investors shall have the absolute right to withdraw their request for a Demand Registration at any time prior to the expiration of such 20-day period. In the event that the Company elects not to purchase all of the Shares covered by the request, the Company shall proceed with the registration of the Shares pursuant to this Article 2.

2.3 Shelf Registration . From and after , 2005, the Company shall register the resale of the Investors’ Shares pursuant to Rule 415 under the Securities Act. Following the

effectiveness of the registration statement, the Investors shall be entitled, upon at least 30 days’ (in the case of an underwritten offering) or 2 business days’ (in all other cases) prior written notice to the Company, to sell such number of Shares as are then registered pursuant to such registration statement. The Investors shall also give the Company prompt written notice of the consummation of such sale. The Investors shall not have the right to cause the Company to register their Shares under this Section 2.3 if the number of Shares requested to be so registered may be immediately sold pursuant to the Resale Rules. The Company’s obligation to maintain the effectiveness of such registration statement shall terminate at such time as the Investors’ Shares are freely tradeable pursuant to the Resale Rules.

2.4 Company’s Ability to Postpone . The Company shall have the privilege to postpone the filing or effectiveness of a registration statement under Section 2.1 and 2.3 and each proposed sale of Shares by the Investors under an effective registration statement, for a reasonable period of time (not exceeding 90 days) if the Company furnishes the Investors with a certificate signed by the Chief Executive Officer of the Company stating that the Company’s board of directors (not including directors affiliated with the Investors), in its good faith judgment, has determined that effecting the registration or sale at such time would adversely affect a material financing, acquisition, disposition of assets or stock, merger or other comparable transaction or would require the Company to make public disclosure of information the public disclosure of which would have a material adverse effect upon the Company; provided , however , that notwithstanding anything herein to the contrary, the Company shall only be entitled to exercise its rights under this Section 2.4 on two occasions during any 12-month period.

2.5 Registration Procedures . If and whenever the Company is required by any of the provisions of this Article 2 to effect the registration of any of the Shares under the Securities Act, the Company shall:

(a) prepare and file with the Commission a registration statement with respect to such Shares and use its reasonable efforts to cause such registration statement to become effective and remain effective for as long as shall be necessary to complete the distribution of the Shares so registered;

(b) prepare and file with the Commission such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective and to comply with the provisions of the Securities Act with respect to the sale or other disposition of all Shares covered by such registration statement whenever the Investors shall desire to sell or otherwise dispose of the same;

(c) furnish to the Investors such numbers of copies of a summary prospectus or other prospectus, including a preliminary prospectus or any amendment or supplement to any prospectus, in conformity with the requirements of the Securities Act, and such other documents, as the Investors may reasonably request in order to facilitate the public sale or other disposition of the Shares covered by such registration statement;

(d) use its reasonable efforts to register and qualify the Shares covered by such registration statement under such other securities or blue sky laws of such jurisdictions as the Investors shall reasonably request, and do any and all other acts and things reasonably requested by the Investors to assist them to consummate the public sale or other disposition in such jurisdictions of the Shares owned by the Investors, except that the Company shall not for any such purpose be required to qualify to do business as a foreign corporation in any jurisdiction wherein it is not so qualified or to file therein any general consent to service of process;

(e) otherwise use its reasonable efforts to comply with all applicable rules and regulations of the Commission, and make available to its security holders, as soon as reasonably practicable, an earnings statement covering the period of at least twelve months, beginning with the first fiscal quarter beginning after the effective date of the registration statement, which earnings statement shall satisfy the provisions of Section 11(a) of the Securities Act;

(f) use its reasonable efforts to list such Shares on any securities exchange or interdealer quotation system on which the shares of common stock of the Company are then listed, if the listing or quotation of such Shares is then permitted under the rules of such exchange or interdealer quotation system;

(g) if the Investors intend to dispose of their Shares through an underwritten public offering, enter into and perform its obligations under an underwriting agreement, in customary and usual form, with the managing underwriter of such underwritten offering, including, without limitation, to obtain an opinion of counsel to the Company and a “comfort letter” from the independent public accountants to the Company in the usual and customary form for such underwritten offering;

(h) notify the Investors, at any time when a prospectus relating thereto covered by such registration statement is required to be delivered under the Securities Act, of the happening of any event of which it has knowledge as a result of which the prospectus included in such registration statement, as then in effect, contains an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing;

(i) make the Company’s executive officers available for presentations to investors to discuss the affairs of the Company at times that may be mutually and reasonably agreed upon; and

(j) upon the request of the Investors, take any and all other actions which may be reasonably necessary to complete the registration and thereafter to complete the distribution of the Shares so registered.

2.6 Underwritten Offering .

(a) If the proposed sale by the Investors in a Demand Registration or Shelf Registration is an underwritten offering, the Investors shall (together with the Company

as provided in Section 2.5(g)), enter into an underwriting agreement in customary and usual form with the managing underwriter selected for such underwriting by the Company or selected by the Investors and approved by the Company. Each Investor hereby agrees that it may not participate in any underwritten offering hereunder unless it (i) agrees to sell its Shares on the basis provided in the underwriting agreement and (ii) completes and executes all questionnaires, powers of attorney and other documents reasonably required under the terms of the underwriting agreement or by the Company

(b) If the managing underwriter in an underwritten offering advises that the number of Shares sought to be included in such offering would create an Overhang Risk, then the number of Shares to be sold by the Investors participating in such offering shall be reduced to the number of Shares recommended by the managing underwriter, and the amount of Shares to be offered by the Investors shall be allocated pro rata among the Investors on the basis of the number of Shares owned by such Investors.

(c) The Investors may not make more than four underwritten offerings pursuant to a Demand Registration, Shelf Registration or Section 3.5. For this purpose, “underwritten offerings” do not include block purchases from the Investors by brokers or dealers without any marketing efforts by the Company or the Investors.

3.	PROVISIONS APPLICABLE TO REGISTRATION RIGHTS.

3.1 Expenses .

(a) Except as set forth in Section 3.1(b), the expenses specified in the following sentence incurred in any Shelf Registration or Demand Registration (or any attempted Shelf Registration or Demand Registration that is not consummated) of the Investors’ Shares under this Agreement shall be paid by the Investors pro rata on the basis of the number of Shares registered or attempted to be registered. The expenses referred to in the preceding sentence shall be limited to underwriters’ discounts or commissions or fees or fees of placement agents and fees and disbursements of one counsel for the Investors.

(b) All other expenses incurred in any Shelf Registration or Demand Registration (or any attempted Shelf Registration or Demand Registration that is not consummated) shall be paid by the Company, including, without limitation, (i) the expenses of its counsel, including fees and expenses related to the preparation, printing and distribution of the registration statement and the prospectus used in connection therewith and any amendment or supplement thereto, (ii) any necessary accounting expenses, including any special audits which shall be necessary to comply with governmental requirements in connection with any such registration, including the expense related to any comfort letters and (iii) expenses of complying with the securities or blue sky laws of any jurisdictions.

3.2 Indemnification . In the event the Investors’ Shares are included in a registration statement under Article 2:

(a) Indemnity by Company . Without limitation of any other indemnity provided to an Investor, to the extent permitted by law, the Company will indemnify and hold harmless each Investor, the Affiliates, officers, directors and partners of each Investor, each underwriter (as defined in the Securities Act), and each Person, if any, who controls an Investor or underwriter (within the meaning of the Securities Act), against any losses, claims, damages, liabilities and expenses (joint or several) to which they may become subject under the Securities Act, the Exchange Act or other federal or state law, insofar as such losses, claims, damages, liabilities and expenses (or actions in respect thereof) arise out of or are based upon any of the following statements, omissions or violations (collectively a “ Violation ”): (i) any untrue statement or alleged untrue statement of a material fact contained in such registration statements (including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto), (ii) the omission or alleged omission to state therein a material fact required to be stated therein, or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, or (iii) any other violation or alleged violation by the Company of the Securities Act, the Exchange Act, any state securities law or any rule or regulation promulgated under the Securities Act, the Exchange Act or any state securities law, and the Company will reimburse each Investor and its Affiliates, officers, directors or partners, underwriter and controlling person for any reasonable legal or other expenses incurred by them in connection with investigating or defending any such loss, claim, damage, liability, expense or action; provided , however , that the Company shall not be liable to any Investor in any such case for any such loss, claim, damage, liability, expense or action to the extent that it arises out of or is based upon a Violation which occurs in reliance upon and in conformity with written information furnished expressly for use in connection with such registration by such Investor or any Affiliate, officer, director, partner or controlling person thereof.

(b) Indemnity by Investors . In connection with any registration statement in which the Investors are participating, the Investors will furnish to the Company in writing such reasonably necessary information as the Company reasonably requests for use in connection with any such registration statement or prospectus and, to the extent permitted by law, will indemnify the Company, its directors and officers and each Person who controls the Company (within the meaning of the Securities Act or Exchange Act) against any losses, claims, damages, liabilities and expenses resulting from any Violation, but only to the extent that such Violation is contained in any information furnished in writing to the Company by the Investors stated to be specifically for use in such registration statement or prospectus (the furnishing of such reasonably necessary information by the Investors being a condition precedent to the Company’s obligation to cause the registration statement to become effective); provided , that the obligation to indemnify will be several and not joint with any other Person and will be limited to the net amount received by the Investor from the sale of Shares, pursuant to such registration statement.

(c) Notice; Right to Defend . Promptly after receipt by an indemnified party under this Section 3.2 of notice of the commencement of any action (including any governmental action), such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this Section 3.2, deliver to the indemnifying

party a written notice of the commencement thereof and the indemnifying party shall have the right to participate in, and, if the indemnifying party agrees in writing that it will be responsible for any costs, expenses, judgments, damages and losses incurred by the indemnified party with respect to such claim, jointly with any other indemnifying party similarly noticed, to assume the defense thereof with counsel mutually satisfactory to the parties; provided , however , that an indemnified party shall have the right to retain its own counsel, with the fees and expenses to be paid by the indemnifying party, if the indemnified party reasonably believes that representation of such indemnified party by the counsel retained by the indemnifying party would be inappropriate due to actual or potential differing interests between such indemnified party and any other party represented by such counsel in such proceeding. The failure to deliver written notice to the indemnifying party within a reasonable time of the commencement of any such action shall relieve such indemnifying party of any liability to the indemnified party under this Section 3.2 only if and to the extent that such failure is prejudicial to its ability to defend such action, and the omission so to deliver written notice to the indemnifying party will not relieve it of any liability that it may have to any indemnified party other than under this Section 3.2.

(d) Contribution . If the indemnification provided for in this Section 3.2 is held by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any loss, liability, claim, damage or expense referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party thereunder, shall contribute to the amount paid or payable by such indemnified party as a result of such loss, liability, claim, damage or expense in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and of the indemnified party on the other hand in connection with the statements or omissions which resulted in such loss, liability, claim, damage or expense as well as any other relevant equitable considerations. The relative fault of the indemnifying party and the indemnified party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party and the parties’ relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. Notwithstanding the foregoing, the amount an Investor shall be obligated to contribute pursuant to this Section 3.2(d) shall be limited to an amount equal to the proceeds to the Investor of the Shares sold pursuant to the registration statement which gives rise to such obligation to contribute (less the aggregate amount of any damages which the Investor has otherwise been required to pay in respect of such loss, claim, damage, liability or action or any substantially similar loss, claim, damage, liability or action arising from the sale of such Shares).

(e) Survival of Indemnity . The indemnification provided by this Section 3.2 shall be a continuing right to indemnification and shall survive the registration and sale of any securities by any Person entitled to indemnification hereunder and the expiration or termination of this Agreement.

3.3 Rule 144 . In order to permit each Investor to sell the Shares it holds, if it so desires, from time to time pursuant to Rule 144 promulgated by the Commission or any

successor to such rule or any other rule or regulation of the Commission that may at any time permit each Investor to sell its Shares to the public without registration (“ Resale Rules ”), the Company will:

(a) comply with all rules and regulations of the Commission applicable in connection with use of the Resale Rules;

(b) make and keep adequate and current public information available, as those terms are understood and defined in the Resale Rules, at all times;

(c) file with the Commission in a timely manner all reports and other documents required of the Company under the Securities Act and the Exchange Act;

(d) furnish to each Investor so long as it owns any Shares, forthwith upon request (i) a written statement by the Company that it has complied with the reporting requirements of the Resale Rules, the Securities Act and the Exchange Act, (ii) a copy of the most recent annual or quarterly report of the Company and any other reports and documents so filed by the Company, and (iii) such other information as may be reasonably requested in availing an Investor of any rule or regulation of the Commission which permits the selling of any such Shares without registration; and

(e) take any action (including cooperating with each Investor to cause the transfer agent to remove any restrictive legend on certificates evidencing the Shares) as shall be reasonably requested by the Investor or which shall otherwise facilitate the sale of Shares from time to time by the Investor pursuant to the Resale Rules.

3.4 Investor Status and Responsibilities . Each Investor acknowledges the limitations that may be imposed upon the Investor under Section 10 of the Exchange Act and the rules and regulations thereunder in connection with the Investor’s sale or transfer of Shares and agrees to sell or transfer any such Shares only subject to any such applicable limitations.

3.5 Piggyback Registration Rights . If the Company proposes to make an underwritten offering of its common stock, the Investors shall be entitled to sell Shares in such offering subject to compliance with Sections 2.6(a), (b) and (c). The Investors may not include Shares in more than two underwritten offerings pursuant to this Section 3.5. The Company may grant other holders of its shares of common stock the right to include any or all of such holders’ shares in any registration statement filed on behalf of the Investors, subject in the case of an underwritten offering to there not being an Overhang Risk.

4.	MISCELLANEOUS.

4.1 Amendment; Termination . This Agreement may be amended, modified or supplemented but only in writing signed by each of the parties hereto. This Agreement shall terminate when the Investors no longer own any Shares.

4.2 Notices . Any notice, request, instruction or other document to be given hereunder by a party hereto shall be in writing and shall be deemed to have been given, (a) when received if given in person or by courier or a courier service, (b) on the date of transmission if sent by

facsimile or (c) three business days after being deposited in the U.S. mail, certified or registered mail, postage prepaid:

If to the Company, addressed as follows:

903 Calle Amanecer, Suite 100

San Clemente, California 92673

Attention: Jon D. Kline

Facsimile No.: (949) 369-4110

with a copy to:

Sullivan & Cromwell LLP

1888 Century Park East

Los Angeles, California 90067

Attention: Alison S. Ressler and Steven B. Stokdyk

Facsimile No.: (310) 712-8800

If to the Investors, addressed as follows:

LB 54, Suite 2400

13155 Noel Road

Dallas, Texas 75240

Attention: Patrick K. Fox

Facsimile No: (972) 934-8333

or to such other individual or address as a party hereto may designate for itself by notice given as herein provided.

Unless otherwise specified, the Company may presume that any notice provided by any Investor is made on behalf of all Investors and, unless otherwise agreed by the Company, all actions and obligations of the Investors shall be jointly as a group on a pro rata basis based on the number of Shares owned by such Investors.

4.3 Waivers . The failure of a party hereto at any time or times to require performance of any provision hereof shall in no manner affect its right at a later time to enforce the same. No waiver by a party of any condition or of any breach of any term, covenant, representation or warranty contained in this Agreement shall be effective unless in writing, and no waiver in any one or more instances shall be deemed to be a further or continuing waiver of any such condition or breach in other instances or a waiver of any other condition or breach of any other term, covenant, representation or warranty.

4.4 Counterparts . This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.

4.5 Interpretation . The headings preceding the text of Articles and Sections included in this Agreement are for convenience only and shall not be deemed part of this Agreement or be

given any effect in interpreting this Agreement. The use of the masculine, feminine or neuter gender herein shall not limit any provision of this Agreement. The use of the terms “including” or “include” shall in all cases herein mean “including, without limitation” or “include, without limitation,” respectively. Underscored references to Articles, Sections or Subsections shall refer to those portions of this Agreement.

4.6 Governing Law . THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF CALIFORNIA, WITHOUT REGARD TO ITS CONFLICTS OF LAWS PRINCIPLES.

4.7 Assignment . This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. In the event that any transferee of any Investor shall acquire Shares of that Investor, in any manner, whether by gift, bequest, purchase, operation of law or otherwise, such transferee shall, without any further writing or action of any kind, be entitled to receive the benefits of and, if applicable, be conclusively deemed to have agreed to be bound by and to perform all of the terms and provisions of this Agreement.

4.8 No Third Party Beneficiaries . This Agreement is solely for the benefit of the parties hereto and no provision of this Agreement shall be deemed to confer upon any third parties any remedy, claim, liability, reimbursement, cause of action or other right.

4.9 Severability . If any provision of this Agreement shall be held invalid, illegal or unenforceable, the validity, legality or enforceability of the other provisions hereof shall not be affected thereby, and there shall be deemed substituted for the provision at issue a valid, legal and enforceable provision as similar as possible to the provision at issue.

4.10 Entire Understanding . This Agreement sets forth the entire agreement and understanding of the parties hereto with respect to the matters set forth herein and supersedes any and all prior agreements, arrangements and understandings among the parties.

4.11 Specific Performance . Each of the parties acknowledges that the obligations undertaken by it pursuant to this Agreement are unique and that the other parties will not have an adequate remedy at law if it shall fail to perform any of its obligations hereunder, and each party therefore confirms that the right of each other party hereto to specific performance of the terms of this Agreement is essential to protect the rights and interests of such parties. Accordingly, in addition to any other remedies that the parties may have at law or in equity, each party shall have the right to have all obligations, covenants, agreements and other provisions of this Agreement specifically performed by each other party, and shall have the right to obtain preliminary and permanent injunctive relief to secure specific performance and to prevent a breach or contemplated breach of this Agreement by each other party.

4.12 Reorganization . In connection with any merger, consolidation, sale of all or substantially all of the Company’s assets, the Company will use its best efforts to take such actions, or to cause the other party to such transaction to take such actions, to ensure that the parties hereto have, immediately after consummation of such transaction, substantially the same rights in respect of such other Person or the Company, as applicable, as they may have immediately prior to consummation of such transaction in respect of the Company under this Agreement.

* * * * *

IN WITNESS WHEREOF, the undersigned has executed this Agreement as of the date and year first above written.


S UNSTONE H OTEL I NVESTORS , I NC .

By:
		Name:
		Title:

S UNSTONE H OTEL I NVESTORS , L.L.C.

By:
		Name:
		Title:

S UNSTONE /WB H OTEL I NVESTORS IV, LLC

By:
		Name:
		Title:

WB H OTEL I NVESTORS , LLC

By:
		Name:
		Title:

S UNSTONE /WB M ANHATTAN B EACH , LLC

By:
		Name:
		Title:

EXHIBIT 10.13

INVESTORS AGREEMENT

This INVESTORS AGREEMENT (this “Agreement”), is made and entered into as of , 2004, among Sunstone Hotel Investors, Inc., a Delaware corporation (the “Company”), Sunstone Hotel Investors, L.L.C. a Delaware limited liability company (“Sunstone Hotel Investors”), Sunstone/WB Hotel Investors IV, LLC, a Delaware limited liability company (“Sunstone/WB Hotel Investors IV”), WB Hotel Investors, LLC, a Delaware limited liability company (“WB Hotel Investors”) and Sunstone/WB Manhattan Beach, LLC, a Delaware limited liability company (“Sunstone/WB Manhattan Beach”). Each of Sunstone Hotel Investors, Sunstone/WB Hotel Investors IV, WB Hotel Investors and Sunstone/WB Manhattan Beach is referred to as an “Investor” and they are collectively referred to as the “Investors”.

WHEREAS, concurrently with the execution of this Agreement, the Company will effect an initial public offering of shares of its common stock; and

WHEREAS, the Company and the Investors desire to establish in this Agreement certain terms and conditions concerning the corporate governance of the Company.

NOW, THEREFORE, in consideration of the foregoing, the parties hereto agree as follows:

ARTICLE I

DEFINITIONS

As used in this Agreement, the following terms shall have the following respective meanings:

“Aggregate Stock Ownership Limit” has the meaning set forth in the Charter.

“Board of Directors” means the Board of Directors of the Company.

“Capital Stock” has the meaning set forth in the Charter.

“Charter” means the Amended and Restated Charter of the Company.

“Common Stock Ownership Limit” has the meaning set forth in the Charter.

“Director” means a member of the Board of Directors.

“Excepted Holder Limit” has the meaning set forth in the Charter.

“Investor Director” means a Director who is designated for such position by the Investors in accordance with Section 2.1.

“Investors’ Percentage Interest” means the percentage determined by dividing (i) the Shares by (ii) the outstanding shares of common stock of the Company, including shares of

common stock owned by the Investors, and the shares of common stock issuable upon conversion of Membership Units.

“Membership Units” means membership units in the Partnership.

“Nominating and Corporate Governance Committee” means the Nominating and Corporate Governance Committee of the Board of Directors or the Board of Directors or other committee of the Board of Directors who has the authority to nominate directors for election.

“Partnership” means Sunstone Hotel Partnership, LLC, a Delaware limited liability company.

“Shares” means the shares of common stock owned or issuable upon conversion of Membership Units owned by the Investors. Shares do not include shares of common stock or Membership Units acquired after the date of this Agreement other than upon conversion of Membership Units owned by the Investors on the date of this Agreement. Shares do include any other securities that subsequently may be issued or issuable by the Company as a result of a stock split or dividend or similar transaction involving the Shares and any securities into which the Shares may thereafter be changed or exchanged as a result of the reincorporation of the Company or merger, consolidation, recapitalization or similar transaction.

“Transfer” has the meaning set forth in the Charter.

ARTICLE II

CORPORATE GOVERNANCE

Section 2.1 Composition of the Board of Directors . The composition of the Board of Directors and manner of selecting members thereof shall be as follows:

(a) The Board of Directors shall be comprised of seven Directors. Such number of Directors shall be increased only in accordance with the Charter and the bylaws of the Company and Section 2.1(h) hereunder.

(b) Except as otherwise provided herein, the Directors shall be nominated as follows (it being understood that such nomination shall include any nomination of any incumbent Director for reelection to the Board of Directors):

(i) the Investors shall have the right to designate two Investor Directors, each of whom shall be nominated by the Nominating and Corporate Governance Committee; and

(ii) the Nominating and Corporate Governance Committee shall nominate the remaining Directors.

(c) Notwithstanding anything in the foregoing paragraph (b) to the contrary, (i) if at any time the Investors’ Percentage Interest is less than 20% but at least 10%, the

Directors shall be nominated as set forth in such paragraph (b) except the Investors shall have the right to designate one Investor Director and (ii) if at any time the Investors’ Percentage Interest is less than 10%, the Investors shall have no right to designate any Investor Directors and the Nominating and Corporate Governance Committee shall nominate all the Directors.

(d) Each Director nominated as provided above shall be included in the Company’s Notice of Meeting and Nominees for any election of Directors, which shall include only one nominee for each Director position subject to election, and shall be deemed nominated by or at the direction of the Board of Directors pursuant to the bylaws of the Company.

(e) The Investors and the Nominating and Corporate Governance Committee, respectively, shall have the right to designate any replacement for a Director designated for nomination or nominated in accordance with this Section 2.1 by the Investors or the Nominating Committee, respectively, upon the death, resignation, retirement, disqualification or removal from office of such Director. The Board of Directors shall elect each person so designated to fill the vacancy.

(f) In the event that the number of Investor Directors on the Board of Directors is less than the number that the Investors have the right (and wish) to designate pursuant to this Section 2.1, the Company shall take all necessary action to create sufficient vacancies on the Board of the Company to permit the Investors to designate the full number of Investor Directors which they are entitled (and wish) to designate pursuant to this Section 2.1 (such action to include seeking the resignation or removal of Directors, expanding the size of the Board of Directors or, at the request of the Investors, calling a special meeting of the shareholders of the Company for the purpose of removing Directors to create such vacancies to the extent permitted by applicable law). Upon the creation of any vacancy pursuant to the preceding sentence, the Investors shall designate the person to fill such vacancy in accordance with this Section 2.1 and the Board of Directors shall elect each person so designated.

(g) In the event that the number of Investor Directors on the Board of Directors exceeds the number that the Investors have the right (and wish) to designate pursuant to this Section 2.1, the Investors shall, if requested by the Board of Directors (not including the Investor Directors), take all appropriate action to cause to resign that number of Investor Directors as is required to make the remaining number of such Investor Directors conform to this Section 2.1.

(h) In the event the number of Directors on the Board of Directors is increased, the number of Directors that the Investor Directors shall have the right to designate pursuant to Section 2.1(b) shall be the total number of Directors on the Board of Directors multiplied by 0.2857, rounded to the nearest whole number, and the number of Directors that the Investor Directors shall have the right to designate pursuant to Section 2.1(c)(i) shall be the total number of Directors on the Board of Directors multiplied by 0.1429, rounded to the nearest whole number. In the event the number of Directors on the Board of Directors is decreased, the number of Directors that the Investor Directors shall have the right to designate pursuant to Section 2.1(b) and Section 2.1(c) shall not change.

Section 2.2 Solicitation and Voting of Shares .

(a) The Company shall use its best efforts, consistent with the fiduciary duties of the Directors, to solicit from the stockholders of the Company eligible to vote for the election of Directors proxies (i) in favor of the nominees selected in accordance with Section 2.1, (ii) in favor of removal of any Director as contemplated by Section 2.1(g) and (iii) otherwise against the removal of any Director designated in accordance with Section 2.1.

(b) In any election of Directors or any meeting of the stockholders of the Company called expressly for the removal of Directors, so long as the Board of Directors includes (and will include after any such removal) the number of Investor Directors contemplated by Section 2.1, the Investors shall be present for purposes of establishing a quorum and shall vote all their shares of common stock (i) in favor of the nominees selected in accordance with Section 2.1, (ii) in favor of removal of any Director as contemplated by Section 2.1(g) and (iii) otherwise against the removal of any Director designated in accordance with Section 2.1. In any other matter submitted to a vote of the stockholders of the Company, the Investors may vote any or all of their shares in their sole discretion.

(c) The Company and the Investors, as stockholders of the Company, agree that they will take all actions reasonably within their control as necessary to effect the provisions of this Agreement and will not take any actions, including amending the Charter or bylaws of the Company, that would affect the ability or process for Investors to nominate directors pursuant to this Agreement.

Section 2.3 Investor Director Information . Each Investor Director shall provide to the Company (a) the name, age, business address and residence address of such individual, (b) the class, series and number of any shares of stock of the Company that are beneficially owned by such individual and (c) all other information relating to such individual that is required to be disclosed in solicitations of proxies for election of directors in an election contest (even if a contest is not involved), or otherwise required, in each case pursuant to Regulation 14A (or any successor provision) under the Securities Exchange Act of 1934 and the rules thereunder (including such individual’s written consent to being named in the proxy statement as a nominee and to serving as a director if elected).

ARTICLE III

EXCEPTED HOLDER LIMIT

Section 3.1 Excepted Holder Limit . The Company, acting through its board of directors, has approved an exemption from the Aggregate Stock Ownership Limit and the Common Stock Ownership Limit set forth in the Charter for the Investors. Effective as of the date hereof, the Investors shall be treated as an Excepted Holder, and shall be subject in the aggregate to an Excepted Holder Limit of percent.

Section 3.2 Modification of Excepted Holder Limit . Subject to the limitations provided in Sections 7.2.1(a)(ii) and 7.2.8 of the Charter, the Excepted Holder Limit for the Investors shall be modified as follows:

(a) The Excepted Holder Limit for the Investors shall be reduced after any Transfer permitted in Article VII of the Charter by the Investors by the percentage of the outstanding shares of Capital Stock so Transferred, but the Excepted Holder Limit for the Investors shall not be reduced to a percentage which is less than the Common Stock Ownership Limit.

(b) Upon the issuance by the Company of any Capital Stock, the Excepted Holder Limit for the Investors shall be reduced to the percentage of the outstanding shares of Capital Stock held by the Investors immediately after such issuance, but the Excepted Holder Limit for the Investors shall not be reduced to a percentage which is less than the Common Stock Ownership Limit.

(c) Upon the repurchase by the Company of any Capital Stock, the Excepted Holder Limit for the Investors shall be increased to the percentage of the outstanding shares of Capital Stock held by the Investors immediately after such repurchase.

(d) Prior to the modification of the Excepted Holder Limit for the Investors pursuant to this Section 3.2, the Board of Directors may require such opinions of counsel, affidavits, undertakings or agreements as it may deem necessary or advisable in order to determine or ensure the Company’s status as a REIT (as defined in the Charter).

Section 3.3 Representations . The exception described in Section 3.1 above is subject to the present and continuing accuracy of the following facts and representations:

(a) No individual, within the meaning of Section 542(a)(2) of the Internal Revenue Code of 1986, as amended, or any successor statute (the “Code”), as modified for purposes of the REIT ownership requirements by Section 856(h)(3)(A) of the Code (an “Individual”), directly, indirectly or constructively owns, applying the constructive ownership rules contained in Section 544 of the Code, as modified for REIT purposes by Section 856(h)(1) of the Code (“Owns”), an interest of more than 9.8 percent in the Investors.

(b) No Individual Owns, through the Investors, an interest in any or all classes or series of capital stock of the Company of more than 9.8 percent.

(c) To the knowledge and belief of the Investors, the Investors do not Own more than a 9.8 percent interest in any tenant of a property in which the Company holds any direct or indirect equity interest.

In addition, as a condition to the Investors’ continued treatment as an Excepted Holder subject to an Excepted Holder Limit, the Investors agree to confirm, from time to time, their ownership interests, if any, upon request, in (i) tenants of properties in which the Company holds a direct or indirect interest, (ii) any entity that directly, beneficially or constructively owns any interest in the Company, and (iii) any entity directly, beneficially or constructively owned or controlled by the Company.

The exception described in this Article III: (i) relates solely to the Aggregate Stock Ownership Limit and Common Stock Ownership Limit for purposes of applying Section 7.2.1(a)(i) of the Charter, and does not affect the application of any other limitations contained in the Charter, and (ii) relates only to shares of stock of the Company that are owned directly by the Investors, and does not affect the application of the Aggregate Stock Ownership Limit or the Common Stock Ownership Limit to shares of stock of the Company that are owned through any other chain. To the extent that any of the representations set forth above cease to be true at any time, shares of the Company’s stock Owned by the Investors may be automatically transferred to a trust to the extent provided by Sections 7.2.1(b), 7.2.7(a)(iii), and 7.3 of the Charter.

ARTICLE IV

OTHER MANAGEMENT RIGHTS

Section 4.1 General . In order to ensure that the Investors may substantially participate in, or substantially influence the conduct of, the management of the Company and the Partnership, and are therefore considered to have “management rights” within the meaning of United States Department of Labor Regulation 29 C.F.R. Section 2510.3-101(d)(3)(ii) with respect to their investments in the Shares and the Membership Units, the parties hereby agree as provided in this Article IV.

Section 4.2 Management Rights . The Company agrees that for so long as the Investors’ Percentage Interest is at least 10%, the Company shall:

(a) Provide each Investor or its designated representative with:

(i) as soon as available and in any event within forty-five (45) days after the end of the first three quarters of each fiscal year of the Company, consolidated balance sheets of the Company and its subsidiaries as of the end of such period, and consolidated statements of income and cash flows of the Company and its subsidiaries for such period, prepared in conformity with generally accepted accounting principles in the United States applied on a consistent basis, except as otherwise noted therein, and subject to the absence of footnotes and to year-end adjustments;

(ii) as soon as available and in any event within one hundred and twenty (120) days after the end of each fiscal year of the Company, a consolidated balance sheet of the Company and its subsidiaries as of the end of such year, and consolidated statements of income and cash flows of the Company and its subsidiaries for the year then ended, prepared in conformity with generally accepted accounting principles in the United States applied on a consistent basis, except as otherwise noted therein, together with an auditor’s report thereon of a firm of established national reputation;

(iii) to the extent the Company is required by law or pursuant to the terms of any outstanding indebtedness of the Company to prepare such reports, any annual reports, quarterly reports and other periodic reports pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934 actually prepared by the Company as soon as available, which shall be deemed to satisfy clauses (i) and (iii); and

(iv) true and correct copies of all other documents, reports, financial data and other information as the Investor may reasonably request with respect to the business and operations of the Company and the Partnership.

(b) Permit each Investor or its designated representative to visit and inspect any of the offices or other properties of the Company or any of its subsidiaries, to inspect the books of account of the Company or any subsidiary, and to discuss the affairs, finances and accounts of the Company or any subsidiary with its officers, all at such times during normal business hours as the Investor may reasonably request and upon reasonable notice.

(c) Permit each Investor or its designated representative to consult with appropriate officers and/or directors of the Company and its subsidiaries, at such times as reasonably requested by the Investor from time to time upon reasonable notice, with respect to all matters relating to the business and operations of the Company and its subsidiaries, and to make recommendations with respect thereto.

Section 4.3 Company Retains Discretion . The Company agrees to consider, in good faith, the recommendations of the Investor or its designated representative in connection with the matters on which it is consulted as described above, recognizing that the ultimate discretion with respect to all such matters shall be retained by the Company.

Section 4.4 Confidentiality . The Investor agrees, and will require each designated representative of the Investor to agree, to hold in confidence and not use or disclose to any third party (other than its legal counsel and accountants) any confidential information provided to or learned by such party in connection with the Investor’s rights under this Agreement.

ARTICLE V

MISCELLANEOUS

Section 5.1 Amendment; Termination . This Agreement may be amended, modified or supplemented but only in writing signed by each of the parties hereto. This Agreement shall terminate when the Investors no longer own any Shares.

Section 5.2 Notices . Any notice, request, instruction or other document to be given hereunder by a party hereto shall be in writing and shall be deemed to have been given, (a) when received if given in person or by courier or a courier service, (b) on the date of transmission if sent by facsimile or (c) three business days after being deposited in the U.S. mail, certified or registered mail, postage prepaid:

If to the Company, addressed as follows:

903 Calle Amanecer, Suite 100

San Clemente, California 92673

Attention: Jon D. Kline

Facsimile No.: (949) 369-4110

with a copy to:

Sullivan & Cromwell LLP

1888 Century Park East

Los Angeles, California 90067

Attention: Alison S. Ressler and Steven B. Stokdyk

Facsimile No.: (310) 712-8800

If to the Investors, addressed as follows:

LB 54, Suite 2400

13155 Noel Road

Dallas, Texas 75240

Attention: Patrick K. Fox

Facsimile No: (972) 934-8333

or to such other individual or address as a party hereto may designate for itself by notice given as herein provided.

Section 5.3 Waivers . The failure of a party hereto at any time or times to require performance of any provision hereof shall in no manner affect its right at a later time to enforce the same. No waiver by a party of any condition or of any breach of any term, covenant, representation or warranty contained in this Agreement shall be effective unless in writing, and no waiver in any one or more instances shall be deemed to be a further or continuing waiver of any such condition or breach in other instances or a waiver of any other condition or breach of any other term, covenant, representation or warranty.

Section 5.4 Counterparts . This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.

Section 5.5 Interpretation . The headings preceding the text of Articles and Sections included in this Agreement are for convenience only and shall not be deemed part of this Agreement or be given any effect in interpreting this Agreement. The use of the masculine, feminine or neuter gender herein shall not limit any provision of this Agreement. The use of the terms “including” or “include” shall in all cases herein mean “including, without limitation” or

“include, without limitation,” respectively. Underscored references to Articles, Sections or Subsections shall refer to those portions of this Agreement.

Section 5.6 Governing Law . THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF CALIFORNIA, WITHOUT REGARD TO ITS CONFLICTS OF LAWS PRINCIPLES.

Section 5.7 Assignment . This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. In the event that any transferee of any Investor shall acquire Shares of that Investor, in any manner, whether by gift, bequest, purchase, operation of law or otherwise, such transferee shall, without any further writing or action of any kind, be entitled to receive the benefits of and, if applicable, be conclusively deemed to have agreed to be bound by and to perform all of the terms and provisions of this Agreement.

Section 5.8 No Third Party Beneficiaries . This Agreement is solely for the benefit of the parties hereto and no provision of this Agreement shall be deemed to confer upon any third parties any remedy, claim, liability, reimbursement, cause of action or other right.

Section 5.9 Severability . If any provision of this Agreement shall be held invalid, illegal or unenforceable, the validity, legality or enforceability of the other provisions hereof shall not be affected thereby, and there shall be deemed substituted for the provision at issue a valid, legal and enforceable provision as similar as possible to the provision at issue.

Section 5.10 Entire Understanding . This Agreement sets forth the entire agreement and understanding of the parties hereto with respect to the matters set forth herein and supersedes any and all prior agreements, arrangements and understandings among the parties.

Section 5.11 Specific Performance . Each of the parties acknowledges that the obligations undertaken by it pursuant to this Agreement are unique and that the other parties will not have an adequate remedy at law if it shall fail to perform any of its obligations hereunder, and each party therefore confirms that the right of each other party hereto to specific performance of the terms of this Agreement is essential to protect the rights and interests of such parties. Accordingly, in addition to any other remedies that the parties may have at law or in equity, each party shall have the right to have all obligations, covenants, agreements and other provisions of this Agreement specifically performed by each other party, and shall have the right to obtain preliminary and permanent injunctive relief to secure specific performance and to prevent a breach or contemplated breach of this Agreement by each other party.

Section 5.12 Reorganization . In connection with any merger, consolidation, sale of all or substantially all of the Company’s assets, the Company will use its best efforts to take such actions, or to cause the other party to such transaction to take such actions, to ensure that the parties hereto have, immediately after consummation of such transaction, substantially the same rights in respect of such other Person or the Company, as applicable, as they may have immediately prior to consummation of such transaction in respect of the Company under this Agreement.

* * * * *

IN WITNESS WHEREOF, the undersigned has executed this Agreement as of the date and year first above written.


S UNSTONE H OTEL I NVESTORS , I NC .

By:

		Name:
		Title:

S UNSTONE H OTEL I NVESTORS , L.L.C.

By:

		Name:
		Title:

S UNSTONE /WB H OTEL I NVESTORS IV, LLC

By:

		Name:
		Title:

WB H OTEL I NVESTORS , LLC

By:

		Name:
		Title:

S UNSTONE /WB M ANHATTAN B EACH , LLC

By:

		Name:
		Title:

EXHIBIT 23.1

Consent of Independent Registered Accounting Firm

We consent to the reference to our firm under the caption “Experts” and to the use of our report dated February 2, 2004 (except Notes 4 and 14, as to which the date is August 3, 2004) with respect to the combined financial statements and the schedule of Sunstone Hotel Investors, L.L.C., WB Hotel Investors, LLC and Sunstone/WB Hotel Investors IV, LLC, as of December 31, 2003 and 2002 and for each of the three years in the period ended December 31, 2003, included in the Registration Statement (Form S-11 No. 333-117141) and the related Prospectus of Sunstone Hotel Investors, Inc. for the registration of _______ shares of its common stock.

/s/ E RNST & Y OUNG LLP

Irvine, California

August 18, 2004

EXHIBIT 23.2

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to use in this Registration Statement on Form S-11 of our report dated April 15, 2004, relating to the financial statements of Wyndham Acquisition Hotels, included in the Registration Statement on Form S-11 (No. 333- 117141) and related Prospectus of Sunstone Hotel Investors, Inc. We also consent to the references to us under the heading “Experts” in such Registration Statement.

/s/ PricewaterhouseCoopers LLP

Dallas, Texas

August 19, 2004