Sunstone Hotel Investors, Inc. (Form: S-11/A, Received: 10/07/2004 16:53:52)

Paid by Us

No Exercise

Full Exercise

As filed with the Securities and Exchange Commission on October 7, 2004

Registration No. 333-117141

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Amendment No. 3

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 Registrant’s 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 OCTOBER 7, 2004.

PROSPECTUS

21,100,000 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 21,100,000 shares of our common stock in this offering. In addition, we are concurrently selling 194,737 shares of our common stock to Robert A. Alter, our Chief Executive Officer and a Director, at the initial public offering price per share for approximately $3.7 million.

We have applied 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 $18.00 and $20.00 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 19 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 will have approximately $714.9 million of debt, approximately 51.6% of which will be variable rate 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 in Sunstone Hotel Partnership 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 $219.0 million of the net proceeds of this offering to be paid to entities affiliated with Westbrook Real Estate Partners, L.L.C. to purchase membership units in Sunstone Hotel Partnership, and those entities will distribute or pay approximately $1.7 million to Robert A. Alter, our Chief Executive Officer and a Director, of which he will receive approximately $1.6 million after partially repaying a loan from one of the Contributing Entities, $374,300 to Jon D. Kline, our Chief Financial Officer, and $477,400 to Gary A. Stougaard, our Chief Investment Officer, of which he will receive approximately $237,300 after partially repaying loans from two of the Contributing Entities, as a result of their interests in those entities and disposition fees from those entities to which they are entitled pursuant to Sunstone Hotel Investors, L.L.C.’s disposition fee incentive plan. The Contributing Entities will own shares of our common stock and membership units in Sunstone Hotel Partnership with a value of approximately $320.3 million based on an initial public offering price of $19.00 per share, the midpoint of the price range set forth above.

•

The use of the net proceeds from this offering to repay $79.9 million of indebtedness, including approximately $1.0 million of prepayment and exit fees, that has been extended by affiliates of two of our underwriters, Citigroup Global Markets Inc. and Deutsche Bank Securities Inc., creates a conflict of interest because these underwriters will have an interest in the successful completion of this offering beyond the underwriting discounts and commissions they 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 3,165,000 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

Deutsche Bank Securities

Bear, Stearns & Co. Inc.

UBS Investment Bank

A.G. Edwards

Calyon Securities (USA) Inc.

Prospectus dated , 2004

LOGO

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		3
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		9
Conflicts of Interest		10
Restrictions on Ownership of Our Stock		11
Tax Status		11
Distribution Policy		11
Corporate Information		12
THE OFFERING		13
SUMMARY HISTORICAL AND PRO FORMA FINANCIAL AND OPERATING DATA		15
RISK FACTORS		19
Risks Related to Our Business		19
Risks Related to This Offering		27
Risks Related to Our Organization and Structure		31
Risks Related to the Lodging and Real Estate Industries		33
Tax and Employee Benefit Plan Risks		37
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS		39
USE OF PROCEEDS		40
DISTRIBUTION POLICY		41
DILUTION		44
Net Tangible Book Value		44
Dilution After This Offering		44
Differences Between New and Existing Stockholders in Number of Shares of Common Stock and Amount Paid		45
FORMATION AND STRUCTURING TRANSACTIONS		46
CAPITALIZATION		51
SELECTED FINANCIAL AND OPERATING DATA		52
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		57
Overview		57
Operations		57
Factors Affecting Our Results of Operations		58
Acquisition, Sale and Major Redevelopment Activity		60


		Page
Operating Results		64
Comparison of First Half of 2004 to 2003		64
Comparison of 2003 to 2002		67
Comparison of 2002 to 2001		70
Liquidity and Capital Resources		72
Contractual Obligations		75
Capital Expenditures and Reserve Funds		75
Derivative Financial Instruments		76
Off-Balance Sheet Arrangements		76
Critical Accounting Policies		77
Quantitative and Qualitative Disclosures About Market Risk		78
Seasonality		78
Inflation		79
New Accounting Standards and Accounting Changes		79
LODGING INDUSTRY		81
OUR BUSINESS		86
Our Company		86
Competitive Strengths		86
Business and Growth Strategy		87
Hotel Properties		94
Geographic Diversity		95
Competition		96
Franchise Agreements		96
Portfolio by Chain Scale Segment		99
Management Company		100
Management Agreements		100
Tax Status		104
Taxable REIT Subsidiary		104
TRS Leases		105
Ground Lease Agreements		107
Insurance		108
Offices		108
Employees		108
Founders		108
Environmental		108
Legal Proceedings		109
MANAGEMENT		110
Directors and Executive Officers		110
Vice Presidents		112
Management Company Employees		113
Corporate Governance Profile		113
Committees of Our Board of Directors		114
Compensation Committee Interlocks and Insider Participation		115
Compensation of Directors		115
Executive Compensation		116
Employment Agreements		116
Long-Term Incentive Plan		118
Senior Management Incentive Plan		119


		Page
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS		120
The Contributing Entities		120
Excluded Properties		121
Other Properties		122
Franchise Agreements		122
Investors Agreement		123
Registration Rights Agreement		123
Letters of Credit		124
Loans		124
Insurance Arrangements		124
Transactions with Others		124
INVESTMENT POLICIES AND POLICIES WITH RESPECT TO CERTAIN ACTIVITIES		125
Investment Policies		125
Disposition Policies		126
Financing Policies		126
Lending Policies		127
Equity Capital Policies		127
Conflict of Interest Policies		127
Corporate Opportunities		128
Reporting Policies		128
Regulatory Compliance Policies		128
PRINCIPAL STOCKHOLDERS		129
DESCRIPTION OF STOCK		130
General		130
Common Stock		130
Preferred Stock		130
Restrictions on Ownership and Transfer		131
Other Matters		132
CERTAIN PROVISIONS OF MARYLAND LAW AND OF OUR CHARTER AND BYLAWS		133
Amendment of Charter and Bylaws		133
Meetings of Stockholders		133
Advance Notice Provisions for Stockholder Nominations and Stockholder Proposals		133
Board of Directors		134
Removal of Directors		134
Extraordinary Transactions		134
Business Combinations		134
Control Share Acquisitions		135
Maryland Unsolicited Takeover Act		136
Limitation of Liability and Indemnification		136
Anti-Takeover Effect of Certain Provisions of Maryland Law and of our Charter and Bylaws		137
REIT Status		137
DESCRIPTION OF THE OPERATING AGREEMENT OF SUNSTONE HOTEL PARTNERSHIP, LLC		138
Management of Sunstone Hotel Partnership		138
Transferability of Interests		138
Amendments to the Operating Agreement		139
Distributions to Members		140
Redemption and Exchange Rights		140
Issuance of Additional Units, Common Stock or Convertible Securities		140
Tax Matters		140
Allocations of Net Income and Net Losses to Members		140
Operations		141

iii


		Page
Termination Transactions		141
Term		141
Indemnification and Limitation of Liability		141
SHARES ELIGIBLE FOR FUTURE SALE		142
Rule 144		142
Rule 144(k)		142
Rule 701		142
Registration Rights		143
Lock-up Agreements		143
OUTSTANDING INDEBTEDNESS		144
U.S. FEDERAL INCOME TAX CONSIDERATIONS		151
Taxation as a REIT		151
Requirements for Qualification as a REIT		153
Taxable REIT Subsidiaries		154
Income Tests		155
Asset Tests		157
Annual Distribution Requirement		157
Failure to Qualify as a REIT		158
Tax Basis of Assets		158
Taxation of Stockholders		158
Non-U.S. Stockholders		161
Other Tax Consequences		163
ERISA CONSIDERATIONS		164
UNDERWRITING		166
EXPERTS		170
VALIDITY OF SECURITIES		170
WHERE YOU CAN FIND MORE INFORMATION		170
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 Hotels ^® , 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 these trademarks 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. None of the owners of these trademarks, or any of their officers, directors, agents or employees will receive any proceeds from the sale of the shares in this offering, other than the application fees paid to our franchisors as part of the Formation and Structuring Transactions, and the purchasers of shares will not receive any interest in the trademarks of such owners.

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 Hotels, 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 by Marriott 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 $19.00 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 54 hotels, comprising 13,183 rooms, located in 17 states in the United States. Our portfolio also includes midscale hotels. The terms upper upscale, upscale and midscale 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 $797.2 million of hotels and sold $380.3 million of hotels, which increased the percentage of our upper upscale and upscale hotel revenue from 65.0% in 1999 to 88.4% in 2003 on a pro forma basis. Additionally, since November 1999, we increased our room count by 25.3% to 13,183 rooms and our average rooms per hotel by 36.9% to 244 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 49 of our 54 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, our management agreements with the Management Company will align its incentives with ours and 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 54 hotels we will own following the Formation and Structuring Transactions increased over the prior year’s comparable period by 1.7% in the third quarter of 2003, 4.8% in the fourth quarter of 2003, 5.7% in the first quarter of 2004 and 8.4% 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 through June 30, 2004, 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 88.4% 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 32.4% 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 1.5% in 2003. Smith Travel Research projects that it will increase by 4.0% in 2004 and 3.0% in 2005.

•

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 and 1.3% in 2005, 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 6.2% in 2004 and 5.5% in 2005.

Our Portfolio

The charts below show the franchise affiliations, hotel chain scale segments and geographic regions of the 54 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 six of our nine directors will be independent for purposes of the listing standards and rules of the NYSE, and our board of directors will make an affirmative determination of the independence of each of these six directors on an annual basis;

•

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 19, 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 will have approximately $714.9 million of debt, approximately 51.6% of which will be variable rate 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 in Sunstone Hotel Partnership 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 $219.0 million of the net proceeds of this offering to be paid to entities affiliated with Westbrook Real Estate Partners, L.L.C. to purchase membership units in Sunstone Hotel Partnership, and those entities will distribute or pay approximately $1.7 million to Robert A. Alter, our Chief Executive Officer, of which he will receive $1.6 million after partially repaying a loan from one of the Contributing Entities, $374,300 to Jon D. Kline, our Chief Financial Officer, and $477,400 to Gary A. Stougaard, our Chief Investment Officer, of which he will receive $237,300 after partially repaying loans from two of the Contributing Entities, as a result of their interests in those entities and disposition fees to which they are entitled pursuant to Sunstone Hotel Investors, L.L.C.’s disposition fee incentive plan. The Contributing Entities will own shares of our common stock and membership units in Sunstone Hotel Partnership with a value of approximately $320.3 million based on an initial public offering price of $19.00 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 $79.9 million of indebtedness, including approximately $1.0 million of prepayment and exit fees, that has been extended by affiliates of two of our underwriters, Citigroup Global Markets Inc. and Deutsche Bank Securities Inc., creates a conflict of interest because these underwriters will have an interest in the successful completion of this offering beyond the underwriting discounts and commissions they 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 beginning on page 46 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 54 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 9,990,932 shares of our common stock and 19,112,556 membership units in Sunstone Hotel Partnership;

•

Sunstone Hotel Investors, L.L.C. will distribute its interests in the Embassy Suites Hotel, Los Angeles, California to Alter SHP LLC, an entity affiliated with Robert A. Alter, in consideration for the redemption of a 3.6% interest in Sunstone Hotel Investors, L.L.C. held by Alter SHP LLC;

•

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 21,100,000 shares of our common stock for cash, or 24,265,000 shares if the underwriters fully exercise their option to purchase additional shares of our common stock, and 194,737 shares of our common stock to Robert A. Alter. Sunstone Hotel Investors, Inc. will use $219.0 million of the net proceeds of this offering, the concurrent sale of shares of our common stock to Robert A. Alter and borrowings under our new term loan facility to purchase from the Contributing Entities 12,247,984 membership units in Sunstone Hotel Partnership and reimburse certain expenses of the Contributing Entities and will contribute the remaining net proceeds and assets held by us to Sunstone Hotel Partnership in exchange for 9,046,753 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 3,165,000 additional Sunstone Hotel Partnership membership units for $56.5 million in cash from the Contributing Entities and reimburse certain of their expenses.

In the Formation and Structuring Transactions, Alter SHP LLC will receive the interests in the Embassy Suites Hotel, 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. As of June 30, 2004, this hotel had a book value of approximately $900,000 in excess of the debt required to be repaid on the property. Following the distribution, Alter SHP LLC will have a 0.66% 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 Messrs. Alter and Kline served as officers 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 our executive officers following the Formation and Structuring Transactions.

In connection with this offering, pursuant to our 2004 long-term incentive plan, we will grant 210,526 restricted stock units to Mr. Alter, 118,421 restricted stock units to Mr. Kline and 92,105 restricted stock units to Mr. Stougaard. Twenty-five percent of Messrs. Alter’s, Kline’s and Stougaard’s units will vest at the closing of this offering and 15% will vest on the second anniversary of the closing of this offering. With respect to Mr. Alter, 20% of his units will vest on the third anniversary of this offering and 1.67% will vest monthly thereafter so long as Mr. Alter remains employed by us. With respect to Messrs. Kline and Stougaard, the remaining units will vest in equal installments on the third, fourth and fifth anniversaries of the closing of this offering. As a result of tax withholding obligations on the 105,263 restricted stock units that vest on the closing of this offering, we expect to issue only 67,947 shares of our common stock to those individuals for the vested units. In addition, each of Messrs. Kline and Stougaard will receive a one-time cash bonus of $100,000 at the closing of this offering.

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

If the underwriters’ over-allotment option is exercised, the purchasers in this offering would own 70.3% of our common stock, our officers would own 0.8% of our common stock, we would own 90.3% of Sunstone Hotel Partnership and the Contributing Entities would own 28.9% of our common stock and 9.7% of Sunstone Hotel Partnership.

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 9,990,932 shares of our common stock and 6,864,572 membership units in Sunstone Hotel Partnership after the purchase by us described below. The membership units 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. These interests include ownership by (1) Mr. Alter of approximately 0.66% of Sunstone Hotel Investors, L.L.C., 2.45% of WB Hotel Investors, LLC, 0.675% of Sunstone/WB Hotel Investors IV, LLC and 4.25% of Sunstone/WB Manhattan Beach, LLC; (2) Mr. Kline of approximately 0.136% of Sunstone/WB Hotel Investors IV, LLC and 2.125% of Sunstone/WB Manhattan Beach, LLC; and (3) Mr. Stougaard of approximately 0.54% of WB Hotel Investors, LLC and 0.136% of Sunstone/WB Hotel Investors IV, LLC, and are more fully described under “Certain Relationships and Related Transactions—The Contributing Entities;”

•

$219.0 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, $275.5 million of the net proceeds of this offering will be paid to the Contributing Entities to purchase membership units in Sunstone Hotel Partnership and reimburse certain of the Contributing Entities’ expenses;

•

as a result of their interests in the Contributing Entities, including disposition fees, Mr. Alter will receive approximately $1.7 million, of which he will receive $1.6 million after partially repaying a loan from one of the Contributing Entities, Mr. Kline will receive $374,300 and Mr. Stougaard will receive $477,400, of which he will receive $237,300 after partially repaying loans from two of the Contributing Entities, 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 approximately $2.1 million, of which he will receive approximately $1.9 million after partially repaying such loan, Mr. Kline will receive approximately $447,700 and Mr. Stougaard will receive approximately $550,000, of which he will receive approximately $250,400 after partially repaying such loans;

•

Mr. Kline may receive cash payments of up to $200,000 from two of the Contributing Entities upon the closing of this offering as partial payment of economic interests he has in those entities pursuant to the terms of his previous employment agreement;

•

the Embassy Suites Hotel, Los Angeles, California and promissory notes between us and Mr. Alter, each in the amount of $650,000, 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 $19.8 million provided by Westbrook Real Estate Fund III, L.P. and Westbrook Real Estate Co-Investment Partnership III, L.P., affiliates of Westbrook Real Estate Partners, L.L.C., with new letters of credit provided by us under our new revolving credit facility; 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, less the membership units in Sunstone Hotel Partnership purchased by us, will have an aggregate value of $320.3 million, based on an assumed initial public offering price of $19.00 per share, 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 Messrs. Alter, Kline and Stougaard, our executive officers, served as officers of the Contributing Entities prior to this offering and the Formation and Structuring Transactions. 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 9,990,932 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 exchange their membership units in Sunstone Hotel Partnership for up to 6,864,572 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.

•

Four of our directors are actively involved in the management of entities that invest in real estate, including hotels. Accordingly, these directors may have a conflict of interest in evaluating acquisition opportunities in which we and those entities both have a potential interest.

•

Three of our directors are employed by entities that have relationships with Westbrook Real Estate Partners, L.L.C. Accordingly, these directors may have conflicts of interest in evaluating situations in which we and Westbrook Real Estate Partners, L.L.C. or its affiliates have a conflicting interest.

•

The Contributing Entities and their 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 $0.285 per share. On an annualized basis, this distribution would be $1.14 per share, or an annual distribution rate of approximately 6.0% based on an initial public offering price of $19.00 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⁾

10,058,879 shares

Membership units outstanding prior to this offering ⁽²⁾

19,112,556 units

Common stock offered by us

21,100,000 shares

Common stock concurrently sold by us to Robert A. Alter

194,737 shares

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

38,218,188 shares and units

Use of proceeds

We will use the net proceeds of this offering, the concurrent sale of shares of our common stock to Mr. Alter and the incurrence of $75.0 million of debt under our new term loan facility as follows:

•

$219.0 million to purchase membership units in Sunstone Hotel Partnership held by the Contributing Entities;

•

$216.6 million to repay a portion of and to pay prepayment penalties on 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 Hotel, Chicago, Illinois and pay related expenses; and

•

$2.0 million to pay franchise application fees.

Risk factors

See “Risk Factors” beginning on page 19 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 $0.285 per share, or an annual distribution rate of approximately 6.0% based on an initial public offering price of $19.00 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 have applied 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. Includes 9,990,932 shares issued to the Contributing Entities in the Formation and Structuring Transactions and 67,947 shares to be issued in respect of 105,263 vested restricted stock units after tax withholding.

(2)	Includes 12,247,984 membership units in Sunstone Hotel Partnership that will be purchased by us from the Contributing Entities with the net proceeds of this offering, the concurrent sale of shares of our common stock to Robert A. Alter and borrowings under our new term loan facility.

(3)

Consists of 31,353,616 shares of our common stock and 6,864,572 membership units in Sunstone Hotel Partnership, but excludes membership units in Sunstone Hotel Partnership owned by us. We will use all of the net proceeds from the exercise of the underwriters’ over-allotment option to purchase additional membership units in Sunstone Hotel Partnership from the Contributing Entities. Accordingly, if the underwriters’ over-allotment option is exercised, the aggregate number of shares and units will still be 38,218,188, consisting of 34,518,616 shares of our common stock and 3,699,572 membership units in Sunstone Hotel Partnership, but excluding membership units in Sunstone Hotel Partnership owned by us. Includes 67,947 shares to be issued in respect of vested restricted stock units under our 2004 long-term incentive plan, but does not include 2,032,053 additional shares of our common stock available for future issuance under our 2004 long-term incentive plan, of which approximately 436,579 will be granted to our employees and unvested at the closing of this offering. As a result of tax withholding, we expect to issue only 281,812 of the 436,579 shares.

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, hotels held for sale (discontinued operations) and a hotel under contract to sell and classified as held for sale after June 30, 2004, (2) the Formation and Structuring Transactions and (3) this offering and the application of the net proceeds from this offering, the concurrent sale of shares of our common stock to Robert A. Alter and borrowings under our new term loan facility. 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-15 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		$	452,835		$	220,881		$	243,904		$	236,982
Operating costs and expenses:
Hotel operating expenses		139,100			159,015			300,090			294,464			143,552			151,496			146,966
General and administrative		46,689			39,122			64,229			62,853			30,156			32,853			31,108
Depreciation and amortization		30,117			34,213			53,481			55,009			26,398			28,444			28,756
Impairment loss		—			6,789			11,382			11,382			—			7,439			7,439
Goodwill amortization		4,925			—			—			—			—			—			—

Total operating expenses		220,831			239,139			429,182			423,708			200,106			220,232			214,269

Operating income (loss)		22,649			22,270			31,520			29,127			20,775			23,672			22,713
Interest and other income		1,070			2,080			712			712			328			216			216
Interest expense		(42,338	)		(29,186	)		(55,235	)		(45,186	)		(26,202	)		(26,576	)		(21,204	)

Income (loss) before minority interest, income taxes, cumulative effect of change in accounting principle and discontinued operations		(18,619	)		(4,836	)		(23,003	)		(15,347	)		(5,099	)		(2,688	)		1,725
Minority interest		—			—			(17	)		2,757			—			166			(310	)
Income tax benefit (provision) ⁽¹⁾		8,770			4,715			2,017			—			(359	)		(780	)		—

Income (loss) from continuing operations before cumulative effect of change in accounting principle and discontinued operations		(9,849	)		(121	)		(21,003	)		(12,590	)		(5,458	)		(3,302	)		1,415
Cumulative effect of change in accounting principle		(1,326	)		—			—			—			—			—			—
Loss from discontinued operations		(7,632	)		(10,265	)		(1,263	)		—			(1,207	)		(18,188	)		—

Net income (loss)	$	(18,807	)	$	(10,386	)	$	(22,266	)	$	(12,590	)	$	(6,665	)	$	(21,490	)	$	1,415

EBITDA	$	73,293		$	59,533		$	96,855		$	87,605		$	53,713		$	36,025		$	51,375
FFO		19,071			29,602			23,482			36,906			23,827			8,516			29,103
Cash flows from operating activities		43,317			26,720			60,034			NA			26,190			28,422			NA

Balance sheet data:
Investment in hotel properties, net	$	821,588		$	1,316,659		$	1,227,537					$	1,345,143		$	1,194,216		$	1,131,612
Hotel properties held for sale, net		—			—			—						—			22,232			—
Total assets		915,654			1,445,889			1,364,942						1,487,807			1,355,519			1,278,523
Total debt		515,407			942,423			917,652						969,690			912,973			714,871
Total liabilities		616,869			1,047,147			1,033,993						1,085,358			1,024,260			779,981
Equity		298,785			398,742			330,345						402,449			330,731			409,092

Common stock/membership unit information:
Common stock outstanding											31,354									31,354
Membership units outstanding											6,864									6,864
Unvested restricted stock issuable ⁽³⁾											282									282

Total diluted common stock, membership units and unvested restricted stock units outstanding											38,500									38,500


Statistical data:
Number of hotels		52			66			61			54			68			60			54
Number of rooms		10,804			15,664			14,901			13,183			15,664			14,529			13,183
Occupancy ⁽²⁾		66.2	%		68.0	%		68.1	%		68.2	%		66.4	%		70.2	%		70.1	%
Average daily rate ⁽²⁾	$	88.36		$	87.40		$	95.09		$	95.32		$	95.59		$	96.51		$	96.84
RevPAR ⁽²⁾	$	58.49		$	59.43		$	64.76		$	65.01		$	63.47		$	67.75		$	67.88

(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.

(3)	Shares of common stock issuable related to unvested restricted stock units.

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	)	$	(12,590	)	$	(6,665	)	$	(21,490	)	$	1,415
Depreciation and amortization—continuing operations		35,042			34,213			53,481			55,009			26,398			28,444			28,756
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			45,186			26,202			26,576			21,204
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		$	87,605		$	53,713		$	36,025		$	51,375


(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. This information relates to gains or losses on hotels that we have sold and impairment losses, and we have included this information since we do not consider these items in evaluating the operating performance of our hotels.

	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			11,382			—			7,439			7,439
Impairment loss—discontinued operations		3,985			9,658			16,991			—			—			16,954			—

Total	$	3,723		$	16,490		$	13,616		$	11,382		$	—		$	24,775		$	7,439

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	)	$	(12,590	)	$	(6,665	)	$	(21,490	)	$	1,415
Minority interest		—			—			17			(2,757	)		—			(166	)		310
Real estate depreciation and amortization—continuing operations ⁽¹⁾		30,117			34,213			53,481			52,253			26,398			28,444			27,378
Real estate 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		$	23,482		$	36,906		$	23,827		$	8,516		$	29,103


(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. This information relates to impairment losses, and we have included this information since we do not consider these items in evaluating the operating performance of our hotels.



	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	$	11,382	$	—	$	7,439	$	7,439
Impairment loss—discontinued operations		3,985		9,658		16,991		—		—		16,954		—

Total	$	3,985	$	16,447	$	28,373	$	11,382	$	—	$	24,393	$	7,439

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 54 hotels decreased 2.1% in 2002. 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 $714.9 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, $368.6 million, or 51.6% of our outstanding debt, will bear interest at a variable rate. In addition, we expect to enter into a $150.0 million revolving credit facility, which also will bear interest at a variable rate. Although we have interest rate caps for all of our existing variable rate 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 $3.7 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 June 30, 2005, on a pro forma basis, $6.7 million, or 0.9% of our outstanding debt, will be amortized. 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 and term loan facility will contain financial covenants that could harm our financial condition.

Our new revolving credit facility and term loan facility will contain financial and operating covenants, including net worth requirements, fixed charge coverage and debt ratios and other limitations on our ability to

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, the incurrence of debt or changes in general economic conditions. Advances under the revolving credit facility are subject to borrowing base requirements based on the hotels securing the facility. 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 or term loan 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.

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

Four of our directors, Messrs. Kazilionis, Paul, Wolff and Dona, are actively involved in the management of entities that invest in real estate, including hotels. Accordingly, these directors may have a conflict of interest in evaluating acquisition opportunities in which we and those entities both have a potential interest. In addition, our executive officers, Messrs. Alter, Kline and Stougaard, have economic interests in other hotel investments and, therefore, may have competing demands on their time.

Some of our directors will have conflicts of interest involving Westbrook Real Estate Partners, L.L.C.

Two of our directors, Messrs. Kazilionis and Paul, are Managing Principals of Westbrook Real Estate Partners, L.L.C. In addition, two of our directors, Ms. Behar and Ms. Brown, are employed by entities that have investments in funds managed by Westbrook Real Estate Partners, L.L.C. that own interests in the Contributing Entities, and one of our directors, Mr. Dona, is employed by an entity that is a partner in a joint venture with a fund managed by Westbrook Real Estate Partners, L.L.C. that has no interest in the Contributing Entities. Accordingly, these directors may have conflicts of interest in evaluating situations in which we and Westbrook Real Estate Partners, L.L.C. or its affiliates have a conflicting interest.

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 which Messrs. Alter, Kline and Stougaard have interests, will 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 our 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 31% 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.

The results of some of our individual hotels are significantly impacted by group contract business and other large customers, and the loss of such customers for any reason could harm our operating results.

Group contract business and other large customers, or large events, can significantly impact the results of operations of our hotels. These contracts and customers vary from hotel to hotel and change from time to time. The impact and timing of large events, such as the 2002 Winter Olympics, are not always easy to predict and are often episodic in nature. As a result, the operating results for our individual hotels can fluctuate as a result of these factors, possibly in adverse ways, and these fluctuations can affect our overall operating results.

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 94% 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. 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.

Prior to the Formation and Structuring Transactions we intend to cause the TRS Lessee or its subsidiaries to enter into new franchise agreements with the franchisors, however, if we are unsuccessful in obtaining such agreements, we may be unable to continue to operate those hotels under the franchisor’s name, which could harm our business.

Prior to the Formation and Structuring Transactions our franchise agreements were entered into by subsidiaries of the Contributing Entities. We intend to cause the TRS Lessee or its subsidiaries to enter into new franchise agreements for all of the hotels the Management Company will operate under franchise agreements following the completion of this offering. Our entry into new franchise agreements is subject to approval by the applicable franchisor and our compliance with the terms of the new agreements. If we are unsuccessful in obtaining new franchise agreements for any of our hotels, however, we may be unable to continue to operate that hotel under the franchisor’s brand name and may lose the benefits associated with the use of that brand name, which may harm our business and the results of those hotels.

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 or its subsidiaries. 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 49 of our 54 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 operating 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 this 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

Immediately after this offering, there will be 17,118,188 shares restricted from immediate resale or issuable upon exchange of membership units in Sunstone Hotel Partnership, but these shares may be sold into the market in the near future. These sales 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 31,353,616 shares of our common stock outstanding, or 34,518,616 shares if the underwriters exercise their over-allotment option. Of these shares, the 21,100,000 shares, or 24,625,000 shares if the underwriters exercise their over-allotment option, 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 10,253,616 shares, including the 194,737 shares concurrently purchased by Robert A. Alter, our Chief Executive Officer and a Director, who is an “affiliate,” and the 6,864,572 shares of common stock issuable to the Contributing Entities upon exchange of their membership units in Sunstone Hotel Partnership, 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 9,990,932 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 6,864,572 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 9,990,932 shares of our common stock (with an aggregate value of approximately $189.8 million, based on an assumed initial public offering price of $19.00 per share, which is the midpoint of the price range set forth on the cover of this prospectus), $219.0 million in cash in exchange for our purchase of 12,247,984 membership units and 6,864,572 membership units net of such purchase (with an aggregate value of approximately $130.4 million, based on an assumed initial public offering price of $19.00 per share, 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 and disposition fees to which they are entitled pursuant to Sunstone Hotel Investors, L.L.C.’s disposition fee incentive plan, Mr. Alter will receive approximately $1.7 million, of which he will receive approximately $1.6 million after partially repaying a loan from one of the Contributing Entities, Mr. Kline will receive approximately $374,300 and Mr. Stougaard will receive approximately $477,400, of which he will receive approximately $237,300 after partially repaying loans from two of the Contributing Entities, from the Contributing Entities’ contribution and sale to us of certain hotel assets, our purchase from the Contributing Entities of the membership units and the distribution of the proceeds to the holders of interests in the Contributing Entities. In addition, 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. Furthermore, upon the closing of this offering, two of the Contributing Entities may make cash payments of up to $200,000 to Mr. Kline as partial payment of economic interests he has in those entities pursuant to the terms of his previous employment agreement.

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 or establish any values 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. Depending on the price per share in this offering, the value of the consideration received by the Contributing Entities for the hotels may be more or less than the value of the hotels.

The use of the net proceeds from this offering to repay indebtedness that has been extended by affiliates of our underwriters creates a conflict of interest because these underwriters will have an interest in the successful completion of this offering beyond the underwriting discounts and commissions they will receive.

We intend to use $79.9 million, including approximately $1.0 million of prepayment and exit fees, or 18.0%, of the net proceeds of this offering, the concurrent sale of shares of our common stock to Robert A. Alter and borrowings under our term loan facility to pay down indebtedness owed to affiliates of two of our underwriters, Citigroup Global Markets Inc. and Deutsche Bank Securities Inc. Accordingly, these underwriters will have interests that are different from us and the other underwriters in the successful completion of this offering. These payments could affect actions and decisions by these underwriters, including their due diligence activities under the Securities Act.

Some of our underwriters may have an interest in the successful completion of this offering beyond the underwriting discounts and commissions.

In addition to the underwriting discounts and commissions to be received by our underwriters upon the successful completion of this offering, we have received commitments for a new $150.0 million senior secured revolving credit facility and $75.0 million subordinate term loan facility from our lead managing underwriters or their affiliates, and we expect that some of our underwriters or their affiliates also will participate in the facilities. In the event that we enter into these facilities, we expect that these underwriters and/or their affiliates will receive fees, interest payments and expense reimbursements. Accordingly, these underwriters may have an interest in the successful completion of this offering beyond the underwriting discounts and commissions.

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 have applied to have our common stock listed 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:

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

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

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

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the trading volumes of our stock;

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the reputation and performance of our franchisors;

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

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

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the addition or departure of key personnel or board members;

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

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

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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 pay a quarterly distribution of $0.285 per share to holders of our common stock. We established this distribution amount based upon our estimated cash available for distribution. 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 $7.02 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 be our largest stockholders 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 31.9% of our common stock and 18.0% of Sunstone Hotel Partnership. 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 constructively own approximately 44.1% of the outstanding shares of our common stock, which exceeds the ownership limit. 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.

Our insurance arrangements with affiliates of Westbrook Real Estate Partners, L.L.C. expose us to expense and coverage risks.

Our excess liability and environmental insurance coverage also relates to affiliates of Westbrook Real Estate Partners, L.L.C. and other hotels owned by them and our executive officers. We expect to obtain our own insurance following this offering, which we expect to be more expensive. In addition, if claims or losses are experienced under the current policy that do not relate to us, the amount of coverage available to us would be reduced.

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:

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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;

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increased competition from other hotels in our markets;

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

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

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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;

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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;

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

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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;

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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

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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, third party Internet travel intermediaries such as Travelocity.com, Expedia.com, Orbitz.com and Hotels.com. For the first half of 2004, 1.8% of our room revenues were attributable to bookings through these intermediaries. As we may continue to selectively use these third party 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

In addition to the 21,100,000 shares of our common stock offered pursuant to this prospectus, we are selling 194,737 shares of our common stock to Robert A. Alter, our Chief Executive Officer and a Director, for $3.7 million in net proceeds and borrowing $75.0 million under our new term loan facility. We estimate that the net cash proceeds to us from this offering, the concurrent sale of shares of our stock to Mr. Alter and the borrowing under our new term loan facility will be approximately $443.9 million, assuming an initial public offering price of $19.00 per share, which is the midpoint of the price range set forth on the cover of this prospectus, and after deducting the underwriting discount, estimated offering expenses of $5.2 million and expenses associated with the credit facilities of approximately $5.4 million. If the underwriters’ over-allotment option is exercised in full, we will sell an additional 3,165,000 shares in this offering and receive additional net proceeds of approximately $56.5 million, before reimbursing certain of the Contributing Entities’ expenses. We do not expect to incur any debt under our revolving credit facility at the closing of this offering. However, if the net proceeds from this offering are less than estimated, we may borrow under our revolving credit facility.

Sunstone Hotel Investors will use $219.0 million of the net proceeds from this offering, the concurrent sale of shares of our common stock to Mr. Alter and the borrowing under our new term loan facility to purchase from the Contributing Entities 12,247,984 membership units in Sunstone Hotel Partnership and pay certain expenses of the Contributing Entities, and will contribute the remaining net proceeds to Sunstone Hotel Partnership in exchange for an additional 9,046,753 membership units in Sunstone Hotel Partnership. In addition, all net proceeds from the exercise of the underwriters’ over-allotment 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 $210.4 million to retire or pay down outstanding principal and an additional $6.2 million of prepayment penalties on the following indebtedness, with such principal paydowns based upon the outstanding principal as of June 30, 2004:

•

approximately $93.0 million of debt 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 $46.8 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 $17.6 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 $14.5 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 $38.5 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 Hotel, Chicago, Illinois; and

•

approximately $2.0 million to pay application fees to our franchisors related to the execution of franchise agreements with the TRS Lessee or its subsidiaries as part of the Formation and Structuring Transactions.

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).

We intend to pay a quarterly distribution of $0.285 per share to our stockholders. On an annualized basis, this distribution would be $1.14 per share, or an annualized distribution rate of approximately 6.0% based on an initial public offering price of $19.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus. 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. In addition, our ability to pay quarterly distributions is limited pursuant to our new revolving credit and term loan facilities to 95% of our funds from operations-adjusted (as defined in the facilities), which limit would have been $62.4 million for the twelve months ended June 30, 2004. Those facilities also contain financial covenants that limit our ability to sell assets or borrow funds.

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, and we cannot assure you that the intended initial distributions will be made or sustained. 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. The calculations include the following material assumptions:

•

loss and cash flows from operations for the twelve months ended June 30, 2004 will be the same for the twelve months ending June 30, 2005;

•

cash flows used in investing activities will be the contractually committed and planned amounts for the twelve months ending June 30, 2005; and

•

cash flows used in financing activities will be the contractually committed amounts for the twelve months ending June 30, 2005.

These calculations do not assume any changes to our operations or any acquisitions or sales, which would affect our operating results and cash flows. We cannot assure you that our actual results will be as indicated in the calculations below. All dollar amounts are in thousands.


Pro forma for the twelve months ended June 30, 2004:

Loss from continuing operations ⁽¹⁾	$	(8,341	)

Add: Minority interest ⁽²⁾		(1,826	)
Add: Loan prepayment penalties ⁽³⁾		2,099
Add: Amortization of deferred financing costs ⁽⁴⁾		7,233
Add: Impairment loss ⁽⁵⁾		18,821
Add: Depreciation and amortization		56,460
Add: Franchise fee ⁽⁶⁾		961
Add: Loss on derivatives ⁽⁴⁾		759
Add: Bad debt expense ⁽⁷⁾		648

Estimated for the twelve months ending June 30, 2005:

Cash flows from operations		76,814

Cash flows used in investing activities—required capital expenditures ⁽⁸⁾		(20,862	)
Cash flows used in financing activities—scheduled principal amortization payments on notes payable ⁽⁹⁾		(6,708	)

Cash available for distribution	$	49,244


Cash available for distribution to:
Common stock ⁽¹⁰⁾	$	39,942

Membership units ⁽¹⁰⁾	$	8,745

Unvested restricted stock units ⁽¹⁰⁾	$	556


Intended initial distribution ^(10)(11)	$	44,066
Ratio of intended initial distribution to cash available for distribution ⁽¹²⁾		89.5	%

(1)	Pro forma loss from continuing operations is as follows:


For the year ended December 31, 2003	$	(12,590	)
Less: For the six months ended June 30, 2003		(2,834	)
Add: For the six months ended June 30, 2004		1,415

	$	(8,341	)

Our operating lease obligations in our pro forma statement of operations for the twelve months ended June 30, 2004 are the same as our contractual commitments for the twelve months ending June 30, 2005 described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations.” In addition, our pro forma statement of operations for the twelve months ended June 30, 2004 reflects all changes we expect regarding our historical contractual commitments with respect to franchise obligations and employment obligations for the twelve months ending June 30, 2005 described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations.” Accordingly, no adjustments have been made in the table above for these items.

(2)	Pro forma amount represents ownership of membership units in Sunstone Hotel Partnership held by the Contributing Entities.

(3)	Pro forma amount represents non-recurring cash payment made in the third quarter of 2003 recorded as interest expense.

(4)	Pro forma amount represents non-cash item recorded as interest expense.

(5)	Pro forma amount represents impairment loss recorded on investment in hotels and goodwill.

(6)	Pro forma amount represents non-cash item recorded as franchise costs.

(7)	Pro forma amount represents non-cash valuation allowance on accounts receivable recorded in other hotel operating expenses.

(8)

Estimated amount based on the amount of capital expenditures or reserves required pursuant to our management, franchise and loan agreements, which range from 4.0% to 5.0% of the revenues of each hotel. These capital expenditures include the remaining $10,043 in our full year 2004 renovation budget for the 13 hotels that are undergoing renovations. This budget includes our $9,920 of contractual construction commitments as of June 30, 2004.

(9)	Estimated amount based on our pro forma notes payable as of June 30, 2004. A reconciliation to our historical payment obligations and commitments as of June 30, 2004 is as follows:


Historical contractual obligation	$	64,666
Notes payable repaid with net proceeds from this offering		(57,902	)
Notes payable related to excluded hotel		(56	)

Pro forma contractual obligation	$	6,708

(10)

Based on 31,353,616 shares of our common stock, 6,864,572 membership units in Sunstone Hotel Partnership outstanding and not owned by us and 436,579 unvested restricted stock units following this offering. The intended initial distribution 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.

(11)	Estimated portion of distributions expected to represent a tax-free return of capital is 10%.

(12)	Calculated by dividing the intended initial distribution by the cash available for distribution.

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 $277.1 million, or $9.50 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 shares of our common stock offered by this prospectus and the concurrent sale of shares of our common stock to Robert A. Alter;

•

the issuance of 6,864,572 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 $457.8 million, or $11.98 per share of common stock. This amount represents an immediate dilution in pro forma net tangible book value of $7.02 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			$	19.00

Net tangible book value per share before this offering ⁽¹⁾	$	9.50

Increase in pro forma net tangible book value per share to existing stockholders attributable to this offering		2.48

Pro forma net tangible book value per share after this offering ⁽²⁾				11.98


Dilution in pro forma net tangible book value per share to new investors ⁽³⁾			$	7.02

(1)

Net tangible book value per share of common stock before this offering is determined by dividing tangible book value of $277.1 million (total tangible assets less total liabilities) on a pro forma basis after giving effect to the Formation and Structuring Transactions by 10,058,879 shares of our common stock outstanding and 19,112,556 shares of our common stock issuable upon conversion of membership units in Sunstone Hotel Partnership. Tangible assets is defined as total assets less goodwill and deferred financing costs, net.

(2)	Based on pro forma net tangible book value after this offering of approximately $457.8 million divided by 31,353,616 shares of our common stock outstanding and 6,864,572 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 and by Mr. Alter for the 194,737 shares of common stock purchased from us concurrently with this offering. We used the initial public offering price of $19.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus, and we have not deducted estimated underwriting discounts and commissions and estimated offering expenses in our calculations.


	Shares/ Units Issued			Cash/Tangible Book Value
	Number	Percentage		Amount			Per Share
Existing stockholders	10,058,879	26.3	%	$	174,529	⁽¹⁾	$	17.35
Units of our operating partnership	6,864,572	18.0	%		119,106	⁽²⁾		17.35
New investors ⁽³⁾	21,294,737	55.7	%		404,600	⁽⁴⁾		19.00

Total	38,218,188	100.0	%

(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 6,864,572 units of Sunstone Hotel Partnership owned by the Contributing Entities.

(3)	Includes the purchasers in this offering of 21,100,000 shares of our common stock and 194,737 shares of our common stock concurrently sold to Mr. Alter.

(4)	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) Sunstone Hotel Properties, Inc., the corporation that currently manages our hotels and employs the employees for our hotels, (2) interests in the Embassy Suites Hotel, 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 19,112,556 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 Hotel, 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 or become subsidiaries of 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 Hotel, Los Angeles, California to Alter SHP LLC, an entity affiliated with Robert A. Alter, in consideration for the redemption of a 3.6% interest in Sunstone Hotel Investors, L.L.C. held by Alter SHP LLC.

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 9,990,932 shares of our common stock; and

•

we will complete this offering by issuing 21,100,000 shares of our common stock for cash, or 24,265,000 shares if the underwriters fully exercise their option to purchase additional shares of our common stock, and concurrently selling 194,737 shares of our common stock to Robert A. Alter.

Sunstone Hotel Investors, Inc. will use $219.0 million of the net proceeds of this offering, the concurrent sale of shares of our common stock to Robert A. Alter and borrowings under our new term loan facility to purchase from the Contributing Entities 12,247,984 membership units in Sunstone Hotel Partnership and reimburse certain expenses of the Contributing Entities, and will contribute the remaining net proceeds and assets held by us to Sunstone Hotel Partnership in exchange for 9,046,753 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 3,165,000 additional Sunstone Hotel Partnership membership units for $56.5 million in cash from the Contributing Entities and reimburse certain of their expenses.

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 relative 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. The shares of common stock and membership units received by the Contributing Entities will be tax-free, other than the shares of common stock received for assets held other than in corporate subsidiaries. Accordingly, for the shares of common stock received in a taxable transaction, the Contributing Entities generally contributed assets in which it had a higher relative tax basis to reduce the amount of taxes that might be due at the time of this offering.

In the Formation and Structuring Transactions:

•

Sunstone Hotel Investors, L.L.C. will contribute or sell 33 hotels, two hotels held for sale and Buy Efficient, L.L.C. to us for 4,516,702 shares of our common stock and 8,636,329 membership units in Sunstone Hotel Partnership, of which 5,535,354 will be purchased by us for approximately $99.0 million in cash; the remaining 7,617,676 shares and units will have a value of approximately $144.7 million based on an assumed initial public offering price of $19.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus;

•

WB Hotel Investors, LLC will contribute or sell five hotels to us for 889,469 shares of our common stock and 1,709,764 membership units in Sunstone Hotel Partnership, of which 1,093,868 will be purchased by us for approximately $19.6 million in cash; the remaining 1,505,365 shares and units will have a value of approximately $28.6 million based on an assumed initial public offering price of $19.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus;

•

Sunstone/WB Hotel Investors IV, LLC will contribute or sell 15 hotels to us for 4,584,761 shares of our common stock and 7,831,659 membership units in Sunstone Hotel Partnership, of which 5,225,357 units will be purchased by us for approximately $93.4 million in cash; the remaining 7,191,063 shares and units will have a value of approximately $136.6 million based on an assumed initial public offering price of $19.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus; and

•

Sunstone/WB Manhattan Beach, LLC will contribute or sell one hotel to us for no shares of our common stock and 934,804 membership units in Sunstone Hotel Partnership, of which 393,405 units will be purchased by us for approximately $7.0 million in cash; the remaining 541,399 units will have a value of approximately $10.3 million based on an assumed initial public offering price of $19.00 per share, which is the midpoint of the price range set forth on the cover page of this prospectus.

In connection with the Formation and Structuring Transactions, we did not obtain any independent third party appraisals or establish any values for any of the hotels owned by the Contributing Entities. The percentage allocation of the aggregate consideration among the Contributing Entities was negotiated among the Contributing Entities on an aggregate basis for each Contributing Entity and no shares or units correspond to a particular hotel. Depending on the price per share in this offering, the value of the consideration received by the Contributing Entities for the hotels may be more or less than the value of the hotels.

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. Messrs. Alter and Kline served as officers 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 our executive officers 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., WB Hotel Investors, LLC, Sunstone/WB Hotel Investors IV, LLC and Sunstone/WB Manhattan Beach, LLC. Each of the Contributing Entities is controlled by Westbrook Real Estate Partners, L.L.C. and has the following ownership structure:

•

funds managed by entities owned by Westbrook Real Estate Partners, L.L.C. own approximately 94.47% of Sunstone Hotel Investors, L.L.C., 95.0% of WB Hotel Investors, LLC and 98.5% of Sunstone/WB Hotel Investors IV, LLC;

•

the remaining ownership of Sunstone Hotel Investors, L.L.C. consists of 4.3% (0.66% after the Formation and Structuring Transactions) owned by Alter SHP LLC, an entity controlled by Mr. Alter, and 1.23% owned by other individual investors;

•

the remaining ownership of WB Hotel Investors, LLC consists of 2.45% indirectly owned by Mr. Alter, 0.54% indirectly owned by Mr. Stougaard and 2.01% indirectly owned by other individual investors, including employees of the Management Company;

•

the remaining ownership of Sunstone/WB Hotel Investors IV, LLC consists of approximately 0.675% indirectly owned by Mr. Alter, 0.136% indirectly owned by Mr. Kline, 0.136% indirectly owned by Mr. Stougaard and 0.554% indirectly owned by other individual investors, including employees of the Management Company; and

•

Sunstone/WB Manhattan Beach, LLC is directly owned 91.5% by Sunstone/WB Hotel Investors IV, LLC and indirectly owned 4.25% by Mr. Alter, 2.125% by Mr. Kline and 2.125% by another individual investor.

Messrs, Alter, Kline and Stougaard also have non-ownership interests in the Contributing Entities. The interests in the Contributing Entities are discussed in more detail under “Certain Relationships and Related Transactions— The Contributing Entities.” Other than the reduction of Alter SHP LLC’s interest in Sunstone Hotel Investors, L.L.C. from 4.3% to 0.66% in connection with the distribution of the Embassy Suites Hotel, Los Angeles, California, and a corresponding increase in the percentage ownership of the other members of Sunstone Hotel Investors, L.L.C., the Formation and Structuring Transactions will have no effect on the ownership of the Contributing Entities.

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, the concurrent sale of shares of our common stock to Robert A. Alter and borrowings under our new term loan facility as described in “Use of Proceeds.”


	June 30, 2004
	Historical		Pro Forma for Formation and Structuring Transactions		Pro Forma
			(unaudited)		(unaudited)
	(dollars in thousands)
Cash	$	23,583	$	32,713	$	40,410

Long-term debt:
Revolving credit facility ⁽¹⁾	$	—	$	—	$	—
Term loan facility ⁽¹⁾		—		—		75,000
Secured notes payable, less current portion ⁽¹⁾⁽²⁾		826,894		785,789		633,163

Total long-term debt		826,894		785,789		708,163
Minority interests		528		528		89,450
Members’ equity		330,731		313,440		—
Preferred stock, $0.01 par value, no shares authorized, issued and outstanding, historical; 100,000,000 shares authorized, no shares issued and outstanding, pro forma		—		—		—
Common stock, $0.01 par value, 100 shares authorized, issued and outstanding, historical; 500,000,000 shares authorized, 31,353,616 shares issued and outstanding, pro forma ⁽³⁾		—		—		314
Additional paid-in capital		—		—		408,778

Total equity		330,731		313,440		409,092

Total capitalization	$	1,158,153	$	1,099,757	$	1,206,705

(1)	See “Outstanding Indebtedness” for a description of our new revolving credit facility, our new term loan facility and our notes payable.

(2)	Excludes current portion of long-term debt as of June 30, 2004 of $64,543 for the Historical, $64,487 for the Pro Forma for Formation and Structuring Transactions and $6,708 for the Pro Forma.

(3)

The common stock outstanding as shown includes shares of our common stock to be issued in this offering, the concurrent sale of shares of our common stock to Robert A. Alter, the common stock to be issued to the Contributing Entities as part of the Formation and Structuring Transactions and the 67,947 shares to be issued in respect of vested restricted stock units under our 2004 long-term incentive plan and excludes:

•

3,165,000 shares of our common stock issuable upon exercise of the underwriters’ over-allotment option to purchase additional shares;

•

2,032,053 additional shares of our common stock available for future issuance under our 2004 long-term incentive plan, of which 436,579 will be issued to our employees and unvested at the closing of this offering; and

•

6,864,572 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, hotels held for sale (discontinued operations) and a hotel under contract to sell and classified as held for sale after June 30, 2004, (2) the Formation and Structuring Transactions and (3) this offering and the application of the net proceeds, the concurrent sale of shares of our common stock to Robert A. Alter and borrowings under our new term loan facility. 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-15 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 helps investors evaluate and compare the results of our operations from period to period by removing the impact of our capital structure (primarily interest expense) and 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 operations without regard to specified non-cash items, such as real estate depreciation and amortization and gain or loss on sale of assets. We believe that these items are more representative of our asset base and our acquisition and disposition activities than our ongoing operations. We also use FFO as one measure in determining our results after taking into account the impact of our capital structure.

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		$	310,126		$	151,531		$	166,957		$	161,834
Food and beverage		31,227			38,373			41,885			47,700			107,200			106,245			51,670			54,849			53,947
Other operating		20,783			18,206			20,311			21,721			36,985			36,464			17,548			21,576			21,201
Management and other fees from affiliates		—			—			—			194			705			—			132			522			—

Total revenues		192,017			222,327			243,480			261,409			460,702			452,835			220,881			243,904			236,982

Operating expenses:
Room		31,519			35,886			41,288			43,318			74,471			73,232			35,338			37,267			36,155
Food and beverage		25,024			30,233			33,293			35,010			76,750			75,887			37,300			37,923			37,173
Other operating		13,548			13,312			13,744			14,537			25,582			25,119			11,534			14,320			14,019
Advertising and promotion		17,033			11,448			13,670			15,478			29,362			28,652			14,287			14,743			14,170
Repairs and maintenance		7,492			8,578			10,067			11,081			21,186			20,796			10,194			10,675			10,380
Utilities		7,399			8,807			11,243			11,464			19,538			19,105			9,110			10,129			9,810
Franchise costs		4,137			12,090			3,747			14,984			24,005			23,495			11,317			12,814			12,323
Property tax, ground lease and insurance		4,508			9,765			12,048			13,143			29,196			28,178			14,472			13,625			12,936
General and administrative		27,470			30,523			46,689			39,122			64,229			62,853			30,156			32,853			31,108
Depreciation and amortization		31,535			26,245			30,117			34,213			53,481			55,009			26,398			28,444			28,756
Impairment loss		—			—			—			6,789			11,382			11,382			—			7,439			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			423,708			200,106			220,232			214,269

Operating income (loss)		7,599			28,643			22,649			22,270			31,520			29,127			20,775			23,672			22,713
Interest and other income		881			658			1,070			2,080			712			712			328			216			216
Interest expense		(23,812	)		(43,345	)		(42,338	)		(29,186	)		(55,235	)		(45,186	)		(26,202	)		(26,576	)		(21,204	)

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	)		(15,347	)		(5,099	)		(2,688	)		1,725
Minority interest		569			(424	)		—			—			(17	)		2,757			—			166			(310	)
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	)		(12,590	)		(5,458	)		(3,302	)		1,415
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) income	$	(6,695	)	$	(8,734	)	$	(18,807	)	$	(10,386	)	$	(22,266	)	$	(12,590	)	$	(6,665	)	$	(21,490	)	$	1,415

EBITDA	$	72,772		$	101,027		$	73,293		$	59,533		$	96,855		$	87,605		$	53,713		$	36,025		$	51,375
FFO		36,599			29,999			19,071			29,602			23,482			36,906			23,827			8,516			29,103
Cash flows from operating activities		31,060			45,510			43,317			26,720			60,034			N/A			26,190			28,422			N/A


	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		$	1,131,612
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			1,278,523
Total debt		583,842			665,157			515,407			942,423			917,652						969,690			912,973			714,871
Total liabilities		679,999			773,196			616,869			1,047,147			1,033,993						1,085,358			1,024,260			779,981
Equity		346,306			359,116			298,785			398,742			330,345						402,449			330,731			409,092
Common stock/membership unit information:
Common stock outstanding																	31,354									31,354
Membership units outstanding																	6,864									6,864
Unvested restricted stock issuable ⁽⁴⁾																	282									282

Total diluted common stock, membership units and unvested restricted stock units outstanding																	38,500									38,500


Statistical data:
Number of hotels		59			65			52			66			61			54			68			60			54
Number of rooms		10,525			12,502			10,804			15,664			14,901			13,183			15,664			14,529			13,183
Occupancy ⁽³⁾		65.0	%		68.0	%		66.2	%		68.0	%		68.1	%		68.2	%		66.4	%		70.2	%		70.1	%
Average daily rate ⁽³⁾	$	86.54		$	89.17		$	88.36		$	87.40		$	95.09		$	95.32		$	95.59		$	96.51		$	96.84
RevPAR ⁽³⁾	$	56.25		$	60.64		$	58.49		$	59.43		$	64.76		$	65.01		$	63.47		$	67.75		$	67.88

(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.

(4)	Shares of common stock issuable related to unvested restricted stock units.

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	)	$	(12,590	)	$	(6,665	)	$	(21,490	)	$	1,415

Depreciation and amortization —continuing operations		32,288			33,042			35,042			34,213			53,481			55,009			26,398			28,444			28,756
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			45,186			26,202			26,576			21,204
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		$	87,605		$	53,713		$	36,025		$	51,375

(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. This information relates to gains or losses on hotels that we have sold and impairment losses, and we have included this information since we do not consider these items in evaluating the operating performance of our hotels.


	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			11,382		—		7,439		7,439
Impairment loss—discontinued operations		—		—		3,985			9,658		16,991			—		—		16,954		—

Total	$	—	$	—	$	3,723		$	16,490	$	13,616		$	11,382	$	—	$	24,775	$	7,439

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	)	$	(12,590	)	$	(6,665	)	$	(21,490	)	$	1,415
Minority interest		(569	)		424			—			—			17			(2,757	)		—			(166	)		310
Real estate depreciation and amortization—continuing operations ⁽²⁾		31,535			26,245			30,117			34,213			53,481			52,253			26,398			28,444			27,378
Real estate 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⁾	$	36,599		$	29,999		$	19,071		$	29,602		$	23,482		$	36,906		$	23,827		$	8,516		$	29,103

(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. This information relates to impairment losses and we have included this information since we do not consider these items in evaluating the operating performance of our hotels.


	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	$	11,382	$	—	$	7,439	$	7,439
Impairment loss—discontinued operations		—		—		3,985		9,658		16,991		—		—		16,954		—

Total	$	—	$	—	$	3,985	$	16,447	$	28,373	$	11,382	$	—	$	24,393	$	7,439

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 two hotels that will not be contributed to us, three hotels that are held for sale as of June 30, 2004 and one hotel that we entered into a contract to sell after 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 Hotel, 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 consist 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 Hotel, 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 54 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 $618.0 million, or $108 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*
Holiday Inn, Flagstaff, Arizona ⁽¹⁾	156	Pending
San Marcos Resort, Chandler, Arizona ⁽²⁾	295	Pending
Concord Hotel and Conference Center, Concord, California	324	September 30, 2004
Four Points—Sheraton, Silverthorne, Colorado	160	August 27, 2004

*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	4,679

(1)	Excluded from our total of 54 hotels following the Formation and Structuring Transactions. This hotel is held under a contract to sell.

(2)	Excluded from our total of 54 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.

The aggregate net sale proceeds for the 24 closed hotel dispositions through June 30, 2004 was $328.5 million, or $88 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 include 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		4	⁽²⁾
Less: Assets not included	—	—	—	—	—		2	⁽³⁾

Number of hotels—end of period	52	66	61	61	60		54
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		935	⁽²⁾
Less: Assets not included	—	—	—	—	—		411	⁽³⁾

Number of rooms—end of period	10,804	15,664	14,901	14,901	14,529		13,183

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

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

(2)	Also reflects Holiday Inn, Flagstaff, Arizona, which is under contract to sell, and San Marcos Resort, Chandler, Arizona, which is held for sale.

(3)	Reflects the exclusion of the JW Marriott, Cherry Creek, Colorado (196 rooms) and the Embassy Suites Hotel, 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 half 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	)	17257.9
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 $214.5 million of hotel operating revenue generated by the Recent Acquisition Hotels. Offsetting this increase was a decline of $15.2 million, or 5.8%, 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 $11.9 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 0.7%, 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 68.6% 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 . Our cash provided by or used in investment activities fluctuates primarily based on acquisitions, sales and renovations of hotels. 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. The change to net cash provided by investing activities in 2003 from net cash used in investing activities in 2002 resulted from the acquisition of fewer hotels and the sale of more hotels in 2003 than in 2002. These and other significant investing activities during the periods discussed are summarized below.

•

In the first half of 2004, we developed and acquired two hotels (an aggregate of 276 rooms) for $49.6 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 $41.9 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 $526.5 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 commercial mortgage-backed notes 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 $312.5 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 Hotel, 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 $150.0 million senior secured revolving credit facility and a $75.0 million subordinate term loan 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 $150.0 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 59.2%. In addition, we have interest rate protection agreements covering all of our total variable rate debt, which accounts for 51.6% 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 Financial 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.

Capital Expenditures and Reserve Funds

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. Our capital expenditures primarily relate to the ongoing maintenance of our hotels and are budgeted in the reserve accounts described in the following paragraph. We also incur capital expenditures following the acquisition of hotels for renovation and development. Our capital expenditures for the twelve months following June 30, 2004 are expected to include the remaining $10.0 million on our full year renovation budget for the 13 hotels that are currently undergoing renovations. This renovation budget includes our $9.9 million of contractual construction commitments. All of these amounts are expected to be funded out of our reserve accounts. Our capital expenditures could increase if we determine to acquire, renovate or redevelop additional hotels in the future. Our capital expenditures also fluctuate from year to year, since we are not required to spend the entire amount in the reserve accounts each year.

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
Commercial Mortgage-Backed Notes	$	224.5	6.75	% ⁽¹⁾	3.5	%	1/3/2006
Mezzanine Debt	$	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

Total	$	775.5

(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. Westbrook Real Estate Fund III L.P. and Westbrook Real Estate Co-Investment Partnership III, L.P., affiliates of Westbrook Real Estate Partners, L.L.C., provide 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 provided by us 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.

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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.

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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.

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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.

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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.

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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 $714.9 million, of which approximately $368.6 million, or 51.6%, 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 $3.7 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 $3.7 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 1.5%, while GDP increased by 2.2% and 3.1%. Smith Travel Research projects GDP growth of 4.6% and an increase in lodging demand of 4.0% in 2004 and GDP growth of 3.8% and an increase in lodging demand of 3.0% in 2005. Our occupancy rates for the 54 hotels we will own following the Formation and Structuring Transactions, which reflect demand for our rooms, increased 1.2% in 2002, 0.4% in 2003 and 5.2% 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 2.7% 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 and 1.3% in 2005, 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 3.7%, 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 6.2% in 2004 and 5.5% in 2005 for the U.S. lodging industry. RevPAR for the 54 hotels we will own following the Formation and Structuring Transactions decreased 2.1% in 2002 and 1.8% in 2003 and increased 6.3% 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 6.2% 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 14 consecutive months of RevPAR growth, averaging 5.5% per month.

U.S. Lodging Industry - Last Fourteen 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 54 hotels, comprising 13,183 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:

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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 88.4% of our 2003 pro forma revenues. 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 32.4% of our 2003 pro forma revenues.

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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 $618.0 million. In addition, during this period, we sold 24 hotels with 3,744 rooms for net sales proceeds of $328.5 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.

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Strategic Relationship with the Management Company. Our agreements with Interstate Hotels & Resorts, Inc., the Management Company, will 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.

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

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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 59.2%. In addition, we expect to enter into a new $150.0 million revolving credit facility. 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

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active asset management;

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opportunistic hotel redevelopment, renovation and expansion;

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franchise rebranding;

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selective hotel acquisition and development;

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capital redeployment; and

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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 49 of our 54 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 ⁽²⁾
*2004—Ongoing Renovations*
Embassy Suites Hotel, Chicago, Illinois ⁽³⁾	365	$	6,034	$	16.5	$	6,269	$	17.2
Hyatt Regency, Newport Beach, California	403		5,890		14.6		8,288		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	$	50,590		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 Hotel, 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 Revenues. We have set forth below a summary regarding investments in renovations we have made in 12 of our hotels between 2001 and 2003, along with operating results of the hotels following the investments. Although we believe that the investments had a meaningful impact on the changes in revenues 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.

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 aggregate renovation investment as of December 31, 2003, revenues for both first half 2003 and 2004 and the corresponding change in revenues in the two periods (dollars in thousands).


2003	2003 Renovation Investment		First Half of 2003 Revenues		First Half of 2004 Revenues		Change in Revenues
Hilton, Del Mar, California	$	5,218	$	4,104	$	4,764	16.1	%
Hilton, Huntington, New York		3,377		8,981		9,610	7.0
Doubletree Suites, Minneapolis, Minnesota		3,017		2,846		3,308	16.2
Hyatt, Marietta, Georgia		2,804		3,026		3,504	15.8
The Kahler Grand, Rochester, Minnesota		2,520		7,847		8,467	7.9
Holiday Inn, Boise, Idaho		2,172		2,874		2,917	1.5
Valley River Inn, Eugene, Oregon		1,349		4,610		5,410	17.4
Wyndham, Houston, Texas		1,141		10,358		15,863	53.1
Marriott, Rochester, Minnesota		1,131		5,004		5,659	13.1

Total	$	22,729	$	49,650	$	59,502	19.8	%

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


2002	2002 Renovation Investment		2002 Revenues		2003 Revenues		Change in Revenues
Marriott, Riverside, California	$	4,320	$	7,717	$	10,234	32.6	%

2001	2001 Renovation Investment		2001 Revenues		2002 Revenues		Change in Revenues
Marriott, Napa, California	$	20,604	$	9,009	$	13,861	53.9	%
Holiday Inn, San Diego (Stadium), California		2,265		5,190		5,051	(2.7	)

Total	$	22,869	$	14,199	$	18,912	33.2	%

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 increases in revenues from the improvements in redevelopments and renovations, we have also generated additional revenues 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 revenues 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 additional revenues attributable to the installations. Installation investment is the amount of capital expenditures made by us for the installations. 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 Revenues		First Half of 2004 Revenues
Starbucks Installations
Wyndham, Houston, Texas	November 2003	$	239,626		N/A	$	173,958
The Kahler Grand, Rochester, Minnesota	April 2002		232,686	$	499,000		256,847
Sheraton, Salt Lake City, Utah	January 2002		255,660		230,973		137,504

Total		$	727,972	$	729,973	$	568,309

Renovations—Guest Parking Installations . We have generated additional revenues 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 additional revenues attributable to the installations. 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 Revenues
Guest Parking Installations
Marriott, Riverside, California	June 2004	$	83,995	$	24,945
Holiday Inn Express, San Diego, California	March 2004		10,503		25,015
Courtyard by Marriott, San Diego, California	January 2004		3,100		122,108

Total		$	97,598	$	172,068

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 $618.0 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 by Marriott, Rochester, Minnesota that we developed and which opened in June 2004 and the JW Marriott, Cherry Creek, Colorado, that we acquired in April 2004 and 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)	—	$	526,504	$	41,925	$	49,582	$	618,011

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
Net sale proceeds (thousands)	$	173,637	$	6,246	$	119,259	$	29,370	$	328,512

From January 1, 2001 through June 30, 2004, we incurred impairment charges of $20.7 million on six of the hotels we sold for a net loss of $0.2 million. We sold the other 18 hotels for a net gain of $14.9 million.

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 $4.9 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 sold two hotels with an aggregate of 484 rooms in the third quarter of 2004 and currently have two hotels with an aggregate of 451 rooms (San Marcos Resort, Chandler, Arizona and Holiday Inn, Flagstaff, Arizona) 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 by Marriott	Manhattan Beach	California	Upscale	Extended Stay	176	2003	1986	2004
Residence Inn by Marriott ⁽³⁾	Oxnard	California	Upscale	Extended Stay	252	1996	1987	2004
Residence Inn by Marriott	Rochester	Minnesota	Upscale	Extended Stay	80	2004	2004	N/A
Residence Inn by Marriott	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 Hotel ⁽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	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)	Upon closing of this offering, we expect to exercise an option to acquire the ground lessor’s interest in the ground lease under this hotel property 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.

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 revenues for the 54 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	32.4	%
Other West ⁽²⁾	16	3,440	19.8
Midwest ⁽³⁾	9	2,696	20.7
Middle Atlantic ⁽⁴⁾	3	782	9.0
South ⁽⁵⁾	3	895	7.8
Southwest ⁽⁶⁾	4	1,322	10.3

Total	54	13,183	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 54 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	75.3	%	$	97.14	$	73.15	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			144.09		102.30	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	68.0			89.22		60.67	62.5			85.66		53.54	73.4			78.85		57.88	79.4			83.09		65.97
Total	67.2	%	$	100.61	$	67.61	68.0	%	$	97.32	$	66.18	68.2	%	$	95.32	$	65.01	70.1	%	$	96.84	$	67.88

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 agreements for 13 of our Marriott hotels require that we deposit 5.0% of the gross revenues of the hotels into a reserve fund for capital expenditures and the agreement for the other Marriott is 3.0% in 2004, 4.0% in 2005 and 5.0% in 2006.

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. Prior to the Formation and Structuring Transactions, our franchise agreements were entered into by subsidiaries of the Contributing Entities. We expect that the TRS Lessee or its subsidiaries will enter into new franchise agreements with the franchisors for all of the hotels the Management Company will operate following the closing of this offering and, accordingly, the TRS Lessee will be responsible for making all payments under those franchise agreements to the franchisors. Approximately $2.0 million will be paid in application fees to our franchisors related to the execution of these new franchise agreements with the TRS Lessee or its subsidiaries as part of the Formation and Structuring Transactions. Our entry into new franchise agreements is subject to approval by the applicable franchisor and our compliance with the terms of the new agreements.

The following table sets forth certain information with respect to the franchise affiliations we expect to have in place after closing of this offering for the 54 hotels that we will own following the Formation and Structuring Transactions.


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	$	161,549		36.6	%	5.0-6.6%	1.0%		2024
Courtyard by Marriott	7	1,178		32,075		7.3		5.0-5.5%	2.0%		2024
Residence Inn by Marriott	4	634		17,262		3.9		5.0-8.5%	2.5%		2024

Subtotal	25	5,741		210,886		47.8


Hilton
Hilton	3	783		32,789		7.4		5.0%	4.0%		2005-2014
Doubletree	1	230		6,455		1.5		4.0%	4.0%		2024
Embassy Suites Hotel	1	365		18,238		4.1		4.0%	4.0%		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	9	1,617		37,971		8.6		5.0%	2.5%		2009-2014
Holiday Inn Select	1	226		3,772		0.8		5.0%	2.5%		2014
Crowne Plaza	1	320		8,016		1.8		5.0%	3.0%		2014
Holiday Inn Express	1	125		3,322		0.8		5.0%	3.0%		2014

Subtotal	12	2,288		53,081		12.0


Hyatt
Hyatt ⁽³⁾	2	605		27,782		6.3		4.0%	—		2039-2040
Hawthorn Suites	2	424		9,150		2.1		2.0%	1.25%		2014

Subtotal	4	1,029		36,932		8.4


Other franchise affiliations ⁽⁴⁾	4	1,331		47,275		10.7		2.0-5.0%	1.0-4.0%		2010-2022

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

Total	54	13,183	$	441,494	⁽⁵⁾	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 revenues 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 revenues is payable to Hyatt Corporation as a management fee.

(4)	Includes Radisson, Sheraton and Wyndham.

(5)	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).

Three of our hotels, The Kahler Grand and the Economy Inn & Suites, both located in Rochester, Minnesota, and the Valley River Inn, 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 54 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	70.4	%	$	102.62	$	72.24	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	66.5			78.93		52.49	69.4			74.80		51.91	67.8			74.12		50.25	69.8			74.56		52.04
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	67.2	%	$	100.61	$	67.61	68.0	%	$	97.32	$	66.18	68.2	%	$	95.32	$	65.01	70.1	%	$	96.84	$	67.88

(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 54 hotels that we will own following the Formation and Structuring Transactions and may include periods prior to when we owned the hotels.


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	56.7	%
Upscale ⁽²⁾	21	4,900	31.7
Midscale with food and beverage ⁽³⁾	11	2,114	10.8
Midscale without food and beverage ⁽⁴⁾	1	125	0.8

Total	54	13,183	100.0	%

(1)	Upper upscale hotels include Marriott, Hilton, Embassy Suites Hotel, 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	68.0	%	$	111.01	$	75.49	70.0	%	$	113.23	$	79.26
Upscale	68.0			90.29		61.40	66.5			87.52		58.20	67.6			85.97		58.12	69.2			87.15		60.31
Midscale with food and beverage	68.5			75.61		51.79	71.7			72.71		52.13	70.0			72.53		50.77	71.8			73.31		52.64
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	67.2	%	$	100.61	$	67.61	68.0	%	$	97.32	$	66.18	68.2	%	$	95.32	$	65.01	70.1	%	$	96.84	$	67.88

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

Forty-nine of our 54 hotels will be managed and operated by the Management Company pursuant to management agreements with the TRS Lessee or its subsidiaries. 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 to the Management Company, 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, 1.75% of our gross revenues from the hotels, (2) for the period commencing on July 1, 2005 and ending on December 31, 2005, 1.85% of our gross revenues from the hotels and (3) for the period commencing on January 1, 2006 and thereafter, 2.1% of our gross revenues from the hotels. In addition, during the term of the management agreements and for one month thereafter, we will pay to the Management Company an accounting fee of $10 per room per month, subject to an annual increase based on a consumer price index. Commencing January 1, 2005, we will be required to pay to the Management Company, on an annual basis, an incentive fee of 10.0% of the excess of net operating income over a threshold, which will be increased each fiscal year by the greater of 3.0% or 1.5 times the actual percentage change in RevPAR for all of the hotels managed by the Management Company during the previous year. The incentive fee, however, will not exceed 1.5% of the total revenues for all the hotels managed by the Management Company for that fiscal year. The TRS Lessee must deliver to the Management Company a guarantee or guarantees of payment with respect to all fees payable to the Management Company.

The initial term of these management agreements will be 20 years, and we will have the right to renew each management agreement for up to two additional terms of five years each, 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 our prior written consent, the Management Company may not replace certain key personnel in operations, sales and marketing, accounting and finance and other agreed upon personnel. All of these key personnel will initially be our former employees. In addition, without our prior written consent, 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.

Hyatt. Our Hyatt hotels are operated under management agreements with Hyatt Corporation. The agreement with respect to the Hyatt, Newport Beach, California hotel 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 hotel 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 our net profit at the hotel above the achievement of certain net profit thresholds. The management agreements with Hyatt may be terminated earlier than the contract 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 the hotel and upon a default by Hyatt or us that is not cured prior to the expiration of any applicable cure period.

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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.

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.

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. The Management Company will use Buy Efficient, L.L.C. to enable the hotels it manages to participate in certain purchasing or other contracts.

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 any change in the general manager and other key employees at each hotel.

Working capital and fixed asset supplies. The management agreements will typically require us to maintain property-level working capital for each hotel based on a monthly cash forecast 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 proposed 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

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manager in an escrow account held by the respective first-mortgage note holders. This percentage is 4.0% under our agreements with the Management Company, 5.0% under our agreement with Marriott for three of our hotels and 4.0% and 5.0% with Hyatt for the Marietta, Georgia and Newport Beach, California 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, including earthquake 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. Upon a termination of the management agreements with the Management Company as a result of damage or destruction or condemnation of a hotel, we will generally not be required to pay a termination or similar fee. However, if we terminate a management agreement for these reasons prior to December 31, 2005, we must pay the Management Company an amount equal to up to 1.5 times the management fee for the first fiscal year of the management agreement.

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 contract term if certain events occur, including: (1) upon a default on payment of an amount due or other material default by the manager or us that is not cured prior to the expiration of any applicable cure periods; (2) an assignment for the benefit of creditors by either party; and (3) either party’s instituting or consenting to any proceeding seeking relief under any federal or state bankruptcy or insolvency laws and which remains undismissed for a period of 60 days.

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Additional Management Company termination rights . In addition, if, prior to December 31, 2006, we do not approve a necessary repair or alteration required to avoid innkeeper liability exposure, life safety system requirements or local, state and federal law after receiving a request from the Management Company, the Management Company may terminate the management agreement, and we will be required to pay to the Management Company up to 1.5 times the management fee for the first fiscal year of the management agreement. In addition, we may terminate a management agreement, with or without cause, upon 30 days’ prior written notice so long as we have paid all amounts due the Management Company and a termination fee. The termination fee for the first fiscal year of the hotel will be equal to a multiplier of 2.5 times an amount equal to 2% of the total revenues of the hotel. For each fiscal year thereafter, the multiplier to determine the termination fee will decrease by 0.5. No termination fee is payable if we terminate the management agreement upon the occurrence of an event of default by the Management Company.

We also have the right to terminate the management agreement without the payment of a termination fee if (1) the hotel fails to achieve its incentive fee threshold and a 95% RevPAR penetration index relative to the hotel’s competitive set or (2) the Management Company acquires an equity interest in a hotel which is in our hotel’s competitive set; however, if we terminate the management agreement prior to December 31, 2005 for either of these reasons, we must pay to the Management Company the management fee budgeted for the first full fiscal year.

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. In addition, 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. The exercise of any termination rights by us 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.

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Management Company indemnification obligations. Under the management agreements, the Management Company will indemnify the TRS Lessee and its agents, principals, shareholders, partners, members, officers, directors and employees from liabilities that may be incurred by or asserted against any of those persons that arise from (1) the willful misconduct or gross negligence of the hotel’s general manager, (2) the fraud, willful misconduct or negligence of the Management Company’s off-site employees, (3) the breach of the management agreements by the Management Company or (4) any action taken by the Management Company outside the scope of its authority under the management agreement. Except as provided above, the TRS Lessee will indemnify the Management Company and its agents, principals, shareholders, partners, members, officers, directors and employees from liabilities that may be incurred by or asserted against any of those persons that arise from (1) the performance of the Management Company’s services under the management agreement, (2) any act or omission of the TRS Lessee, whether or not willful, tortious or negligent, or any third party or (3) any other occurrence related to the hotel (including, without limitation, environmental or life-safety matters) and/or the Management Company’s duties under the management agreement, whether arising before, during or after the term of the management agreements.

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, its affiliates and their respective officers, directors, employees, agents and representatives from and against any and all losses and liabilities resulting from or related to the ownership of this subsidiary or its assets, liabilities and operations prior to the completion of this offering. The Management Company has agreed to indemnify us, our affiliates and our respective 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.

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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 or one of its subsidiaries. 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 five 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;

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a percentage of gross food and beverage revenue;

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a percentage of any gross sublease revenue; and

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a percentage of all other gross revenue, which include revenue from vending machines, honor bars, movie rentals, concessions and all other such services.

Improvements, maintenance 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

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expense, will generally be permitted to make additions, modifications or improvements to the hotels with our approval. 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 subletting. 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:

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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;

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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 our 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;

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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.

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Events of default. Events of default under the leases will include, without limitation, the following:

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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:

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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

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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.

Ground Lease Agreements

Immediately prior to this 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.

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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 Hotel, 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 had 6,312 employees at our hotels and 113 employees at our corporate headquarters. We believe that our relations with our employees are 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

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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.

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MANAGEMENT

Directors and Executive Officers

Upon completion of this offering, our board of directors will consist of nine directors, at least six 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 nine 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	Chief Executive Officer and Director
Jon D. Kline	37	Executive Vice President and Chief Financial Officer
Gary A. Stougaard	50	Executive Vice President and Chief Investment Officer
Lewis N. Wolff	68	Chairman
Z. Jamie Behar	47	Director
Barbara S. Brown	46	Director
Anthony W. Dona	45	Director
Paul D. Kazilionis	47	Director
Jonathan H. Paul	40	Director
Keith P. Russell	58	Director
David M. Siegel	62	Director

The following is a biographical summary of the experience of our directors and executive officers:

Robert A. Alter is our Chief Executive Officer and a Director. Until our formation, Mr. Alter served as Chief Executive Officer of one of our predecessor companies formed in 1985, which became a public company in August 1995. The public company, Sunstone Hotel Investors, Inc., commenced doing business in August 1995 upon its initial public offering. In November 1999, Mr. Alter and one of the Contributing Entities 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.

Lewis N. Wolff will become our Chairman upon the closing of this offering. Mr. Wolff has been Chairman of Wolff DiNapoli LLC since 1994 and Wolff Urban Management, Inc. since 1980, both of which are real estate acquisition, investment, development and management firms. Mr. Wolff is also a co-founder and, since 1994, has

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served as Chairman of Maritz, Wolff & Co., a privately held hotel investment group that has acquired, in cooperation with other persons, 18 luxury hotel properties. From 1999 to 2004, Mr. Wolff also served as Co-Chairman of Fairmont Hotels & Resorts, a hotel management company formed by Fairmont Hotel Management Company and Canadian Pacific Hotels & Resorts, Inc. Mr. Wolff also serves on the boards of Grill Concepts, Inc. and First Century Bank. Mr. Wolff holds a B.A. degree in Business Administration from the University of Wisconsin, Madison, and an M.B.A. degree from Washington University in St. Louis, Missouri.

Z. Jamie Behar will become a Director upon the closing of this offering. Ms. Behar has been a Portfolio Manager with General Motors Investment Management Corporation (together with its predecessors, GMIMCo) since 1986. Ms. Behar manages GMIMCo clients’ real estate investment portfolios, a number of which have interests in funds managed by Westbrook Real Estate Partners, L.L.C. that own interests in the Contributing Entities; however, Ms. Behar does not have voting or investment control over such interests in the Contributing Entities. Ms. Behar serves on the boards of directors of Desarrolladora Homex, S.A. de C.V., a publicly-listed home development company located in Mexico, as well as Hospitality Europe BV, a private European hotel company, and FountainGlen Properties, LLC, a private senior housing company. Ms. Behar holds a B.S.E. degree from The Wharton School of the University of Pennsylvania and an M.B.A. degree from the Columbia University Graduate School of Business. Ms. Behar is a Chartered Financial Analyst.

Barbara S. Brown will become a Director upon the closing of this offering. Ms. Brown has been a Senior Portfolio Manager of Allstate Investments, LLC since 1995. Allstate Investments, LLC is a wholly owned subsidiary of The Allstate Corporation, which has interests in funds managed by Westbrook Real Estate Partners, L.L.C. that own interests in the Contributing Entities and other entities not affiliated with us; however, Ms. Brown does not have voting or investment control over those interests. Ms. Brown holds a B.S. degree in Accountancy from the University of Illinois and an M.B.A. degree from DePaul University.

Anthony W. Dona will become a Director upon the closing of this offering. Mr. Dona is the Chief Executive Officer of Crow Holdings, the holding company for the Trammell Crow family’s investments. He has been with Trammell Crow affiliated entities since 1985 and oversees a diversified investment portfolio that includes real estate private equity funds, real estate assets, marketable securities and other investments and operating companies. Crow Holdings is a partner in a real estate joint venture with a fund managed by Westbrook Real Estate Partners, L.L.C. that has no interests in the Contributing Entities but does have interests in other entities not affiliated with us. Mr. Dona is a member of the boards of Crow Holdings, Trammell Crow Residential, the Real Estate Council Foundation, the Dallas Chamber of Commerce, the American Red Cross Endowment Fund and other charitable and civic organizations. Mr. Dona holds a B.A. degree in Political Science and a B.B.A. degree in Business Administration from Southern Methodist University and an M.B.A. degree from Harvard University.

Paul D. Kazilionis is a Director and 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 The Amos Tuck School of Business Administration at Dartmouth College.

Jonathan H. Paul is a Director and 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.

Keith P. Russell will become a Director upon the closing of this offering. Mr. Russell is President of Russell Financial, Inc., a strategic and financial consulting firm serving businesses and high net worth individuals. Mr.

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Russell is retired as the Chairman of Mellon West and the Vice Chairman of Mellon Financial Corporation, in which capacities he served from May 1996 until March 2001. From September 1991 through April 1996, Mr. Russell served in various positions at Mellon, including Vice Chairman and Chief Risk Officer of Mellon Bank Corporation and Chairman of Mellon Bank Corporation’s Credit Policy Committee. From 1983 to 1991, Mr. Russell served as President and Chief Operating Officer, and a director of, Glenfed/Glendale Federal Bank. Mr. Russell also serves on the boards of Nationwide Health Properties, Inc. and Countrywide Financial Corporation. Mr. Russell holds a B.A. degree in Economics from the University of Washington and an M.A. degree in Economics from Northwestern University.

David M. Siegel will become a Director upon the closing of this offering and has been the principal of DMS Financial Services, which provides financial consulting to the real estate industry, since 2000. Prior to forming DMS Financial, Mr. Siegel served as Senior Vice President and Chief Financial Officer of the Presley Companies from 1985 to 2000 and served on its board of directors. Before that time, Mr. Siegel was employed by the public accounting firm of Kenneth Leventhal & Company for 14 years, where he served as a Managing Partner of its Newport Beach, California office. Mr. Siegel holds a B.S. degree in Accounting and Business Administration from the University of California, Los Angeles.

Vice Presidents

The following is a biographical summary of the experience of our vice presidents:

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 Senior 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 1997 and prior to joining Sunstone, he served as an Executive Vice President of a general contractor specializing in hotel renovation and construction. From 1992 to 1996, he was a project manager for Holiday Inn Worldwide responsible for capital improvements on a portfolio of hotels. Mr. Lindsey holds a B.A. degree in Building Science from Auburn University.

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 LLP 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 Accountancy from San Diego State 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 a B.A. degree from Stanford University.

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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, 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 start-up 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. 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.

Management Company Employees

The employees of ours who will become employees of the Management Company following this offering include a management team of 11 vice presidents with an average of 26 years in the hospitality or service industry.

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:

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

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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;

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we do not have a stockholder rights plan;

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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;

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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.

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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 be comprised of directors who 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 include:

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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

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preparing an audit committee report as required by the SEC for inclusion in our annual proxy statement.

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 will be comprised of David M. Siegel, Anthony W. Dona and Keith P. Russell. Mr. Siegel 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:

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reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer;

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making recommendations to our board of directors with respect to non-CEO compensation, incentive compensation plans and equity-based plans;

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approving any new equity compensation plan or any material change to an existing plan where stockholder approval has not been obtained;

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in consultation with management, overseeing regulatory compliance with respect to compensation matters; and

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preparing a report on executive compensation for inclusion in our proxy statement for our annual meetings.

Our compensation committee will be comprised of Anthony W. Dona and David M. Siegel. Mr. Dona will be the chair.

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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:

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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;

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considering and making recommendations to the board of directors regarding board size and composition, committee composition and structure and procedures affecting directors;

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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

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reviewing conflicts between the Contributing Entities, directors, officers, employees and us.

Our nominating and corporate governance committee will be comprised of Lewis N. Wolff, Z. Jamie Behar and Keith P. Russell. Mr. Russell will be the chair. Ms. Behar will not participate in reviewing conflicts between the Contributing Entities or other matters involving Westbrook Real Estate L.L.C. and us.

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- 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 $50,000 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.

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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	$	707,023	$	—	$	—	$	285,757	⁽¹⁾
Jon D. Kline, Executive Vice President and Chief Financial Officer ⁽²⁾		168,269		175,960		—		16,674	⁽³⁾
Gary A. Stougaard, Executive Vice President and Chief Investment Officer		210,000		105,000		—		140,884	⁽⁴⁾

(1)	Includes $247,035 of fees related to the sale of hotels, $32,146 of split dollar life insurance premiums and $6,576 of health insurance premiums.

(2)	Mr. Kline commenced employment on April 21, 2003.

(3)	Includes $11,970 of fees related to the sale of hotels and $4,704 of health insurance premiums.

(4)	Includes $100,000 of fees related to the acquisition of hotels in December 2002, $25,935 of fees related to the sale of hotels and $14,949 related to economic interests in Sunstone Hotel Investors, L.L.C.

Employment Agreements

Each of Robert A. Alter, Jon D. Kline and Gary A. Stougaard will enter into an employment agreement with us. These agreements will be effective upon the closing of this offering and supersede their prior employment agreements.

Robert A. Alter. We will enter into an employment agreement with Mr. Alter that provides that Mr. Alter will serve as our Chief Executive Officer. The agreement will have an initial term of three years and be automatically extended for additional one-year periods, unless terminated by either party upon 90 days’ notice prior to the renewal date. A decision by us or Mr. Alter not to renew his employment agreement will not trigger any severance payments. The agreement provides for an annual base salary of $550,000 and an annual incentive bonus in a target amount of between 40% and 125% of his base salary. Mr. Alter will receive a bonus of $365,000 for 2004. Mr. Alter will also be granted 210,526 restricted stock units at the closing of this offering, 25.0% of which vest at the closing of this offering, 15.0% on the second anniversary of the closing of this offering, 20.0% on the third anniversary of the closing of this offering and 1.67% monthly thereafter so long as Mr. Alter remains employed by us. He is also entitled to receive all employee benefits and participate in all insurance programs generally available to similarly situated employees. In the event we terminate Mr. Alter without cause or he terminates his employment for good reason, Mr. Alter will receive all of the following amounts: (1) salary and accrued vacation through the date of termination; (2) bonus for any completed fiscal year elapsed prior to the date of termination; (3) a lump sum payment equal to one times Mr. Alter’s salary plus a bonus severance amount (which will be equal to the bonus set forth in the agreement for 2004 if the termination occurs on or prior to December 31, 2004, the target annual bonus if the termination occurs in 2005 or the lesser of the target annual bonus for the year in which the termination occurs or the actual bonus earned in the prior calendar year, if the termination occurs during the remainder of the employment term); (4) 18 months of continued health insurance coverage for Mr. Alter and his dependents; and (5) all outstanding and then unvested equity awards due to vest in the succeeding 12 months will become fully vested and exercisable. If following a change in control, we terminate Mr. Alter’s employment without cause or Mr. Alter terminates his employment for good reason, then he will be entitled to the same amounts as specified above within 180 days after the effective date of the change in control, except that the severance amount will be calculated using a multiple of two rather than one.

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Jon D. Kline. We will enter into an employment agreement with Mr. Kline that provides that Mr. Kline will serve as our Executive Vice President and Chief Financial Officer. The agreement will have an initial term of five years and be automatically extended for additional one-year periods, unless terminated by either party upon 90 days’ notice prior to the renewal date. A decision by us or Mr. Kline not to renew his employment agreement will not trigger any severance payments. The agreement provides for an annual base salary of $375,000 and an annual incentive bonus in a target amount of between 40% and 125% of his base salary. Mr. Kline will receive a bonus of $294,000 for 2004. Mr. Kline will also be granted 118,421 restricted stock units at the closing of this offering, 25.0% of which vest at the closing of this offering, 15.0% on the second anniversary of the closing of this offering and 20.0% on each of the third, fourth and fifth anniversaries of the closing of this offering. He is also entitled to receive all employee benefits and participate in all insurance programs generally available to similarly situated employees. In the event we terminate Mr. Kline without cause or he terminates his employment for good reason, Mr. Kline will receive all of the following amounts: (1) salary and accrued vacation through the date of termination; (2) bonus for any completed fiscal year elapsed prior to the date of termination; (3) a lump sum payment equal to one times Mr. Kline’s salary plus a bonus severance amount (which will be equal to the bonus set forth in the agreement for 2004 if the termination occurs on or prior to December 31, 2004, the target annual bonus if the termination occurs in 2005 or the lesser of the target annual bonus for the year in which the termination occurs or the actual bonus earned in the prior calendar year, if the termination occurs during the remainder of the employment term); (4) 18 months of continued health insurance coverage for Mr. Kline and his dependents; and (5) all outstanding and then unvested equity awards due to vest in the succeeding 12 months will become fully vested and exercisable. If following a change in control, we terminate Mr. Kline without cause or Mr. Kline terminates his employment for good reason, then he will be entitled to the same amounts as specified above within 180 days after the effective date of the change in control, except that the severance amount will be calculated using a multiple of two rather than one, and all outstanding and then unvested equity awards will become fully vested and exercisable. In addition, Mr. Kline will receive a cash bonus of $100,000 upon the closing of this offering.

Gary A. Stougaard. We will enter into an employment agreement with Mr. Stougaard that provides that Mr. Stougaard will serve as our Executive Vice President and Chief Investment Officer. The agreement will have an initial term of five years and be automatically extended for additional one-year periods, unless terminated by either party upon 90 days’ notice prior to the renewal date. A decision by us or Mr. Stougaard not to renew his employment agreement will not trigger any severance payments. The agreement provides for an annual base salary of $350,000 and an annual incentive bonus in a target amount of between 40% and 125% of his base salary. Mr. Stougaard will receive a bonus of $263,500 for 2004. Mr. Stougaard will also be granted 92,105 restricted stock units at the closing of this offering, 25.0% of which vest at the closing of this offering, 15.0% on the second anniversary of the closing of this offering and 20.0% on each of the third, fourth and fifth anniversaries of the closing of this offering. He is also entitled to receive all employee benefits and participate in all insurance programs generally available to similarly situated employees. In the event we terminate Mr. Stougaard without cause or he terminates his employment for good reason, Mr. Stougaard will receive all of the following amounts: (1) salary and accrued vacation through the date of termination; (2) bonus for any completed fiscal year elapsed prior to the date of termination; (3) a lump sum payment equal to one times Mr. Stougaard’s salary plus a bonus severance amount (which will be equal to the bonus set forth in the agreement for 2004 if the termination occurs on or prior to December 31, 2004, the target annual bonus if the termination occurs in 2005 or the lesser of the target annual bonus for the year in which the termination occurs or the actual bonus earned in the prior calendar year, if the termination occurs during the remainder of the employment term); (4) 18 months of continued health insurance coverage for Mr. Stougaard and his dependents; and (5) all outstanding and then unvested equity awards due to vest in the succeeding 12 months will become fully vested and exercisable. If following a change in control, we terminate Mr. Stougaard’s employment without cause or Mr. Stougaard terminates his employment for good reason, then he will be entitled to the same amounts as specified above within 180 days after the effective date of the change in control, except that the severance amount will be calculated using a multiple of two rather than one, and all outstanding and then unvested equity awards will become fully vested and exercisable. In addition, Mr. Stougaard will receive a cash bonus of $100,000 upon the closing of this offering.

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Each of the above named executives will also enter into non-competition agreements with us that restrict him from engaging in any business that is, directly or indirectly, competitive with our business and/or having ownership interests in any business that is, directly or indirectly, competitive with our business during the term of his employment, with exceptions for existing investments and direct or indirect ownership of up to 3% of the outstanding equity interests of any public company, and soliciting our employees for one year following the date of termination of his employment.

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 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 2,100,000. A total of 541,842 restricted stock units will be granted under the long-term incentive plan at the closing of this offering. 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.

The compensation committee will 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 stockholder 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, which occurs within a period following vesting of the restricted stock units and is subject to tax withholding.

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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.

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.

Senior Management Incentive Plan

We expect to adopt a senior management incentive plan which will become effective on the closing of this offering. The plan is designed to attract, retain and motivate selected employees in order to promote our long term growth and profitability. Our compensation committee or the board of directors will have sole discretion in implementing the plan. The amount of any bonus paid under the plan may, but need not, be based on objective performance goals and a targeted level or levels of performance with respect to each goal as specified by the compensation committee or the board of directors. At the compensation committee’s discretion, bonuses shall be payable in cash and/or equity awards of equivalent value. Any equity-based awards shall be subject to such terms and conditions, including vesting requirements, as the committee administering the long-term incentive plan may determine. No rights under the plan may be assigned or transferred. The board of directors may from time to time modify, alter, amend, suspend, discontinue or terminate the senior management incentive plan.

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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 Purchased by Us	Membership Units After Purchase by Us
Sunstone Hotel Investors, L.L.C.	4,516,702	5,535,354	3,100,975
WB Hotel Investors, LLC	889,469	1,093,868	615,896
Sunstone/WB Hotel Investors IV, LLC	4,584,761	5,225,357	2,606,302
Sunstone/WB Manhattan Beach, LLC	—	393,405	541,399

Total	9,990,932	12,247,984	6,864,572

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 0.66% as a result of the distribution of the Embassy Suites Hotel, 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. In addition, pursuant to Sunstone Hotel Investors, L.L.C.’s disposition fee incentive plan, Messrs. Alter, Kline and Stougaard are entitled to receive disposition fees upon sales of hotels owned by this entity and its affiliates, including as a result of the Formation and Structuring Transactions, a sale of the JW Marriott, Cherry Creek, Colorado and a sale of the properties described below under “—Other Properties.” Pursuant to the terms of his previous employment agreement, 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. Upon the closing of this offering, Sunstone Hotel Investors, L.L.C. may make cash payments to Mr. Kline as partial payment of this economic interest.

Mr. Alter owns a 48.9% interest and Mr. Stougaard owns a 10.708% 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. Pursuant to the terms of his previous employment agreement, Mr. Kline has an economic interest in WB Hotel Investors, LLC 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. Together with his economic interests in Sunstone Hotel Investors, L.L.C., Mr. Kline’s economic interests in WB Hotel Investors, LLC 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. Upon the closing of this offering, WB Hotel Investors, LLC may make cash payments to Mr. Kline as partial payment of this economic interest, which together with the payments for his economic interests in Sunstone Hotel Investors, L.L.C., will not exceed $200,000. Messrs. Alter and Stougaard incurred debt to Westbrook Real

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Estate Fund III, L.P. and Westbrook Real Estate Co-Investment Partnership III, L.P., in connection with their purchases of interests in WB Hotel Investors, LLC. As of June 30, 2004, the principal amount outstanding for Mr. Alter was $563,816 and for Mr. Stougaard was $269,779. Those notes have an interest rate of 8.5% and mature on August 31, 2007, and a portion of distributions paid to Messrs. Alter and Stougaard will be used to repay amounts due on the notes.

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. Mr. Stougaard incurred debt to Westbrook Real Estate Fund IV, L.P. and Westbrook Real Estate Co-Investment Partnership IV, L.P. in connection with his purchase of interests in Sunstone/WB Hotel Investors IV, LLC. As of June 30, 2004, the principal amount outstanding was $165,244. This note has an interest rate of 6.0% per annum and matures on September 15, 2008, and a portion of distributions paid to him will be used to repay amounts due on the note.

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.

The Contributing Entities will grant an aggregate of 103,684 shares of our common stock to employees who will become employees of the Management Company. These shares will vest ratably and be expensed by us over five years. These grants will not affect the ownership interests or the calculations of returns for the Contributing Entities described above.

Excluded Properties

Two hotels included in continuing operations in our historical financial information, the JW Marriott, Cherry Creek, Colorado and the Embassy Suites Hotel, Los Angeles, California, 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 an entity owned by Sunstone/WB Hotel Investors IV, LLC, with a minority interest in such entity owned by ABM Investment, LLC, an entity in which Mr. Alter will continue to have an indirect interest, although he will resign as a managing member, director and officer of both that entity and ABM Investment, LLC. Messrs. Alter, Kline and Stougaard have interests in an entity that owns a minority interest in Sunstone/WB Hotel Investors IV, LLC. ABM Investment, LLC has entered into a non-binding letter of intent to purchase the JW Marriott, Cherry Creek, Colorado for $51.0 million. This option is exercisable for 120 days after the closing date of this offering. If ABM Investment, LLC exercises this option, Mr. Alter will not be involved in the decision by ABM Investment, LLC to proceed with the purchase and will not use any of his funds for the purchase. If ABM Investment, LLC does not exercise its option, the letter of intent provides that we will have an option to purchase the JW Marriott, Cherry Creek, Colorado that will be exercisable from May 15, 2005 to January 31, 2006. The purchase price will be the greater of (1) $52.0 million and (2) the unleveraged free cash flow of the hotel for the preceding twelve months divided by 8.5%. If we exercise our option to purchase the hotel, ABM Investment, LLC may elect to: (1) retain its minority ownership in the entity that owns the hotel for up to three years, with the right during that period to convert its interest in that entity into a fixed number of

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membership units in Sunstone Hotel Partnership equal to the number of membership units described in (3) below, (2) receive its allocated portion, as a member of the entity that owns the hotel, of the cash consideration payable to the owner or (3) receive a number of membership units in Sunstone Hotel Partnership equal to the amount of its allocated portion of the cash consideration payable to the owner, divided by the average closing price of our common stock for the 30 trading days prior to the date the hotel is sold. The letter of intent is subject to the negotiation of definitive agreements. The Embassy Suites Hotel, Los Angeles, California will be distributed to an entity controlled by Robert A. Alter. Both of 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 Hotel

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. These hotels are under contract to sell.

•

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).

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.

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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: (1) one of the nine directors so long as the Contributing Entities hold a more than 5% but less than 20% ownership interest in us; or (2) two of the nine 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 16,855,504.

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 them. 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 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.

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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

Westbrook Real Estate Fund III, L.P. and Westbrook Real Estate Co-Investment Partnership III, L.P., affiliates of Westbrook Real Estate Partners, L.L.C., provide letters of credit on our behalf in the amount of $19.8 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 provided by us 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 distributed with the Embassy Suites Hotel, Los Angeles, California to Alter SHP LLC 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.

Insurance Arrangements

We participate in insurance arrangements with affiliates of Westbrook Real Estate Partners, L.L.C. These arrangements include our excess liability and environmental policies, which also cover the hotels not contributed to us and the other hotels in which our executive officers and affiliates of the Contributing Entities own interests. We made payments of $250,000 in 2003, $150,000 in 2002 and $100,000 in 2001 to the insurance companies for costs under these arrangements. We expect to obtain our own insurance following this offering, which we expect will be more expensive than our historical experience.

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 $234,842 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.

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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.

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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 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

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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, 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 nine directors, at least six 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.

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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.

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.

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.

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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⁾	33,974	—	*	228,711	—	*
Jon D. Kline ⁽³⁾	19,110	—	*	19,110	—	*
Gary A. Stougaard ⁽⁴⁾	14,863	—	*	14,863	—	*
Lewis N. Wolff	—	—	*	—	—	*
Z. Jamie Behar	—	—	*	—	—	*
Barbara S. Brown	—	—	*	—	—	*
Anthony W. Dona	—	—	*	—	—	*
Paul D. Kazilionis ⁽⁵⁾	9,990,932	19,112,556	99.8	9,990,932	6,864,572	44.1
Jonathan H. Paul ⁽⁶⁾	9,990,932	19,112,556	99.8	9,990,932	6,864,572	44.1
Keith P. Russell	—	—	*	—	—	*
David M. Siegel	—	—	*	—	—	*
All executive officers and directors as a group (11 persons)	10,058,879	19,112,556	100.0	10,253,616	6,864,572	44.8
Westbrook Real Estate Partners, L.L.C. ⁽⁷⁾	9,990,932	19,112,556	99.8	9,990,932	6,864,572	44.1

*	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)

Shares of common stock before and after this offering include vested restricted stock units granted under our 2004 long-term incentive plan, less shares to be withheld for tax obligations. Shares of common stock after this offering include shares purchased in a concurrent sale with this offering. 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 does not have voting or disposition control over the securities held by those entities.

(3)

Shares of common stock consist of vested restricted stock units granted under our 2004 long-term incentive plan, less shares to be withheld for tax obligations. 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)

Shares of common stock consist of vested restricted stock units granted under our 2004 long-term incentive plan, less shares to be withheld for tax obligations. 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 Messrs. Alter, Kazilionis and 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 Messrs. Kazilionis and 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.

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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 31,353,616 shares of our common stock issued and outstanding, or 34,518,616 shares of common stock if the underwriters’ over-allotment option to purchase additional shares is exercised in full. We have applied 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.

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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 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.

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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 American Stock Transfer & Trust Company.

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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 (1) pursuant to our notice of the meeting, (2) by our board of directors or (3) 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.

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Board of Directors

Upon completion of this offering, our board of directors will consist of nine 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

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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: (1) one-tenth or more but less than one-third, (2) one-third or more but less than a majority or (3) 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

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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 (1) vest in our board of directors the exclusive power to fix the number of directorships and (2) 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 (1) actual receipt of an improper benefit or profit in money, property or services or (2) 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 (1) any present or former director or officer or (2) 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.

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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:

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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;

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the director or officer actually received an improper personal benefit in money, property or services; or

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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.

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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:

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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

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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 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.

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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:

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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;

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set forth the rights, powers, duties, and preferences of the holders of any additional membership units issued pursuant to the operating agreement;

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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;

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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;

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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;

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reflect changes that are reasonably necessary for us, as managing member, to maintain our status as a REIT; or

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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:

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our removal;

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limitations on our outside activities;

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our liability;

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transfer of our managing member’s interest;

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judicial dissolution;

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when consent of an adversely affected non-managing member is required to amend the operating agreement;

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when consent by a majority of non-managing membership interests is required for amendment of operating agreement; or

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meetings of members.

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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 6,864,572.

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 6,864,572 shares of common stock, or 3,699,572 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

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relating to compliance with the provisions of Sections 704(b) and 704(c) of the Code and the associated Treasury regulations.

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:

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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

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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.

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SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this offering, we will have 31,353,616 shares of our common stock outstanding, or 34,518,616 shares if the underwriters exercise their over-allotment option.

Of these shares, 21,100,000 shares, or 24,265,000 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 our “affiliates,” as that term is defined in Rule 144 under the Securities Act. The remaining 10,253,616 shares of our common stock, including the 194,737 shares purchased from us by Robert A. Alter, 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).

In addition, we will have 6,864,572 shares of common stock issuable upon exchange of membership units in Sunstone Hotel Partnership. Those shares, when issued, may be sold pursuant to Rule 144 or the registration rights described below.

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:

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1% of our then-outstanding shares of our common stock, or approximately 313,536 shares immediately after this offering; or

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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 or officers who were granted shares from us before the effective date of this offering acquired the shares in reliance on the exemption from registration provided by Rule 701.

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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:

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persons other than “affiliates,” as defined in Rule 144, subject only to the manner of sale provisions of Rule 144; and

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by “affiliates” under Rule 144 without compliance with its one-year minimum holding period requirement.

Registration Rights

The aggregate number of shares of our common stock and securities exchangeable for shares of our common stock subject to a registration rights agreement is 16,855,504. 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 Citigroup Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley & Co. Incorporated, offer, sell, contract to sell, pledge (subject to certain limited exceptions approved by the representatives) 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 17,118,188.

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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 a group of lenders, including Massachusetts Mutual Life Insurance Company, which serves as administrative agent. 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 on such payment date is greater than the maximum loan to value ratio, which is set at 75% during the third loan year and 68% from the first day of the fourth loan year to maturity. 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.

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.

We expect to enter into a commitment letter with Massachusetts Mutual Life Insurance Company that provides for the modification of certain terms of our loan. The modification is conditioned on, and will occur simultaneously with, the closing of this offering. As part of the modification, the loan will be separated into a fixed rate note and a floating rate note of equal priority. The amount of the fixed rate note will be $250.0 million and the amount of the floating rate note will be equal to $4.5 million plus the difference between the remaining principal balance of the loan at the time of the closing of the modification and $250.0 million. The fixed rate loan will bear interest at a rate of 2.50% plus the interpolated rate of U.S. Treasuries having a maturity co-extensive with the weighted average life of the fixed rate loan and will mature 6.5 years from the loan modification date. The floating rate loan will bear interest at the one-month LIBOR rate plus a spread of 2.35% and will mature three years from the loan modification date. Payments on the floating rate note will be interest only. Payments on

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the fixed rate note will be interest only for two years and thereafter payments of principal and interest based on a 25-year amortization schedule. In addition to the existing one-year extension option with respect to the floating rate note, we will be granted a second one-year option to extend the maturity date of the floating rate note. We will have the right to prepay the fixed rate note on any payment date after the 30th month after the closing of the loan modification subject to meeting certain financial tests and the payment of a prepayment premium. The prepayment provisions in the existing loan documents will continue to apply to the floating rate note. The loan will be amended to delete the provisions allowing us to increase the principal amount of the loan up to a maximum of $54.5 million and there will be no other disbursements that the lender will be required to make. As part of the modification, the lenders will release their mortgages on the Embassy Suites Hotel, Los Angeles, California for a payment equal to 125% of its allocated loan amount in connection with its distribution and we will grant security interests in the entities owning the 30 hotels securing the loan.

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. 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 2.0% 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:

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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;

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a debt service reserve fund of $5.3 million for the term of the loan (currently secured by a letter of credit);

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a deferred maintenance reserve established for reserving funds for repairs and maintenance noted in the deferred maintenance reports prepared for the loan closing;

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discrete individual reserve funds for annual ground lease payments, property tax payments, and property insurance premiums;

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•

reserve escrow for payments due under the reciprocal easement agreement for the Valley River Inn, Eugene, Oregon; and

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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 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:

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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);

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discrete individual reserve funds for annual ground lease payments, property tax payments and property insurance premiums;

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deferred maintenance reserve established for repairs and maintenance noted in the deferred maintenance reports prepared for the loan closing;

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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

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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.

Credit Facilities. We have obtained commitments for the provision to Sunstone Hotel Partnership of a $150.0 million senior secured revolving credit facility and a $75.0 million subordinate term loan facility from Citigroup Global Markets Inc., Citicorp North America, Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Merrill Lynch Capital Corporation and Morgan Stanley Senior Funding, Inc., which we intend to enter into concurrently with the closing of this offering. These entities or their affiliates will serve as the joint lead arrangers and joint book running managers for the facilities. Citicorp North America, Inc. will act as the sole administrative agent and sole collateral agent for the facilities. We expect some of our other underwriters and/or their affiliates to participate in the facilities. The lenders and the collateral agent under the term loan facility will enter into an intercreditor agreement with the lenders and collateral agent under the revolving credit facility.

We expect to use the proceeds of the credit facilities to, among other things, purchase membership units in Sunstone Hotel Partnership held by the Contributing Entities, fund acquisitions, refinance existing mortgage indebtedness and for general corporate purposes. Completion of the credit facilities will be subject to several conditions, including, the consummation of the Formation and Structuring Transactions and this offering, the absence of any material adverse change and the satisfactory completion of the lenders’ legal and financial due diligence.

The senior revolving credit facility and the subordinate term loan facility will both be subject to the following financial covenants:

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a minimum tangible net worth equal to 85% of the tangible net worth as of the end of the fiscal quarter most recently ended prior to the closing of the facility plus 75% of the net proceeds of primary equity issuances not used to purchase membership units in Sunstone Hotel Partnership;

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a minimum ratio of EBITDA less a capital expenditure reserve to fixed charges of 1.5;

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maximum REIT dividend payouts of 95% of funds from operations, as adjusted (subject to dividend payments to preserve our REIT status);

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a maximum ratio of total debt to EBITDA of 7.0 to 1.0 through December 30, 2006 and 6.5 thereafter; and

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a maximum ratio of senior debt to EBITDA of 6.5 to 1.0 through December 30, 2006 and 6.0 to 1.0 thereafter.

The credit facilities also will contain customary provisions regarding events of default, including, among others, the failure to pay principal and interest when due, and failure to comply with covenants and bankruptcy or insolvency. In addition, the facilities will contain provisions for cross-default to payment defaults on principal

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aggregating $10 million or more for indebtedness that is recourse to the operating partnership or $100 million ($50 million with respect to the term loan facility) or more for any other indebtedness of the operating partnership or its subsidiaries, or to other events if the effect is to accelerate or permit the acceleration of the debt of the operating partnership or its subsidiaries, subject to the expiration of applicable cure periods.

Revolving Credit Facility. The revolving credit facility will initially be secured by first priority mortgage liens on the following seven hotels: Holiday Inn, Boise, Idaho; Holiday Inn, Hollywood, California; Hilton Garden Inn, Lake Oswego, Oregon; Marriott, Portland, Oregon; Marriott, Riverside, California; Hyatt Regency, Atlanta, Georgia; and Marriott, Napa, California. The amount borrowed under the facility may not exceed 65% of the appraised value of the hotels in the collateral package, and we must maintain a ratio of net operating income less certain specified fees of the hotels in the collateral package to annual interest payments under the facility of 2.0 to 1.0.

We must maintain a minimum of six hotels in the collateral package, and no single hotel, other than the Marriott, Napa, California hotel, may account for more than 25% of the collateral package (determined on the basis of adjusted net operating income). We may add hotels to the collateral package only if the hotel has been operating for at least a year, is rated at least “upscale” by Smith Travel Research and in addition results in the collateral package meeting a minimum debt service coverage ratio of 1.4 to 1.0. We may remove hotels from the collateral package only if the average RevPAR of the hotels remaining in the collateral package is at least 95% of the collateral package’s average RevPAR prior to the hotel’s removal from the collateral package.

The revolving credit facility will be guaranteed by certain of the operating partnership’s existing and future subsidiaries, including those subsidiaries which hold the hotels securing the revolving credit facility. The lenders’ commitment under the revolving credit facility will terminate on the third anniversary of the closing of this offering, subject to a one-year extension, which requires the payment of a facility extension fee on the commitment amount. All borrowings under the revolving credit facility are subject to the satisfaction of customary conditions, including the absence of a default and accuracy of representations and warranties. We may prepay advances without penalty.

Provided that no default or event of default has occurred and is continuing under the revolving credit facility, we may increase the size of the facility once a year in minimum increments of $5 million, up to a maximum available amount of $225 million. We also have the right to terminate or cancel, in whole or in part, the unused portion of the revolving credit facility as long as we terminate in increments of at least $1 million. Once terminated, the commitment may not be reinstated.

Borrowings under the revolving credit facility will be subject to an interest rate equal to either, at our option, a fluctuating rate equal to Citibank, N.A.’s base rate or a periodic fixed rate equal to one-, two-, three- or six-month LIBOR, plus, in each case, an applicable margin based upon our leverage. The applicable margin is a percentage rate per annum that ranges from 0.50% to 1.00% for base rate loans and 1.50% to 2.00% for LIBOR loans. We will pay a quarterly fee of 0.50% on the average unused commitment on the revolving credit facility and a 0.125% fee upon the issuance of each letter of credit.

Subordinate Term Loan Facility. The term loan facility will initially be secured by a first priority pledge of 100% of the ownership interests of certain of Sunstone Hotel Partnership’s subsidiaries and may be guaranteed by Sunstone Hotel Investors, Inc. and certain existing and future subsidiaries of Sunstone Hotel Partnership.

The lenders’ commitment under the term loan facility is for a single advance upon the closing of this offering, and will terminate on the fourth anniversary of the closing of this offering. All borrowings under the term loan facility are subject to the satisfaction of customary conditions, including the absence of a default and accuracy of representations and warranties. We may prepay advances, in whole or in part, without penalty

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beginning in the 19th month after the closing of this offering. Before that time, we may prepay advances (1) within six months of the closing of this offering, upon payment of 1.50% of the principal amount of the amount being prepaid, (2) during months seven through 12, upon payment of 1.00% of the principal amount of the amount being prepaid and (3) during months 13 through 18, upon payment of 0.50% of the principal amount of the amount being prepaid.

In addition, if the operating partnership or its subsidiaries issue debt, the operating partnership must offer to prepay the advances under the term loan facility in an amount equal to the net proceeds of any such issuance, other than amounts borrowed under the revolving credit facility and other specified indebtedness that is non-recourse to the operating partnership. Amounts prepaid under the term loan facility may not be reborrowed.

Advances under the term loan facility will be subject to an interest rate equal to either, at our option, a fluctuating rate equal to Citibank, N.A.’s base rate or a periodic fixed rate equal to one-, two-, three- or six-month LIBOR, plus, in each case, a margin of 3.00% for base rate loans and 4.00% for LIBOR loans.

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%. Our deposit of 4.0% of the revenues of the hotel in a reserve fund for capital expenditures is pledged to the lender under the loan agreement. The aggregate amount of all reserve funds was $0.6 million at June 30, 2004.

Embassy Suites Hotel, 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 Hotel, 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 loan agreements require that we deposit 5.0% of the revenues of the hotels in a reserve fund for capital expenditures. 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 loan agreement requires that we deposit 4.0% of the revenues of the hotel in a reserve fund for capital expenditures. 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 loan agreement requires that we deposit

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4.0% of the revenues of the hotel in a reserve fund for capital expenditures. 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 loan agreement requires that we deposit 5.0% of the revenues of the hotel in a reserve fund for capital expenditures. 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 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 loan agreement requires that we deposit 5.0% of the revenues of the hotels in a reserve fund for capital expenditures. 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 loan agreement requires that we deposit 5.0% of the revenues of the hotel in a reserve fund for capital expenditures. 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. This loan agreement requires that we deposit a percentage of the revenues of the hotel in a reserve fund for capital expenditures equal to 3.0% in 2005 and 4.0% beginning in 2006. 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.

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U.S. FEDERAL INCOME TAX CONSIDERATIONS

In the opinion of Sullivan & Cromwell LLP, 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:

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dealers in securities or currencies;

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traders in securities that elect to use a mark-to-market method of accounting for their securities holdings;

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banks;

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tax-exempt organizations;

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certain insurance companies;

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persons liable for the alternative minimum tax;

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persons that hold common stock as a hedge against interest rate or currency risks or as part of a straddle or conversion transaction; and

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stockholders whose functional currency is not the U.S. dollar.

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 underwriters and O’Melveny & Myers LLP may rely on this certificate.

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

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.

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.

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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:

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First, we will have to pay tax at regular corporate rates on any undistributed REIT taxable income, including undistributed net capital gains.

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Second, under certain circumstances, we may have to pay the alternative minimum tax on items of tax preference.

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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.

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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. 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.

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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.

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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.

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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.

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Because we intend to acquire the assets held by certain C corporations in connection with this offering, 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.

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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

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that is managed by one or more trustees or directors;

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the beneficial ownership of which is evidenced by transferable shares, or by transferable certificates of beneficial interest;

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that would otherwise be taxable as a domestic corporation, but for Sections 856 through 859 of the Code;

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that is neither a financial institution nor an insurance company to which certain provisions of the Code apply;

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the beneficial ownership of which is held by 100 or more persons;

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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

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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.

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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:

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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.

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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.

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Income Tests

In order to maintain our qualification as a REIT, we annually must satisfy two gross income requirements:

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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.

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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:

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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.

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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.

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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.

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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.

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

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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:

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our failure to meet the income tests was due to reasonable cause and not due to willful neglect;

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we attach a schedule of the sources of our income to our Federal income tax return; and

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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.

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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:

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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.

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Second, not more than 25% of our total assets may be represented by securities other than those in the 75% asset class.

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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.

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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:

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a citizen or resident of the United States;

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a domestic corporation;

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an estate whose income is subject to United States Federal income taxation regardless of its source; or

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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

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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

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be required to withhold a portion of capital gain distributions to any stockholders who fail to certify their non-foreign status to us.

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:

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is described in Section 401(a) of the Code;

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is tax-exempt under Section 501(a) of the Code; and

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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:

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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

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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.

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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.

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

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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 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:

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dividend payments; and

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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:

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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:

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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

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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

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you otherwise establish an exemption.

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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:

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the proceeds are transferred to an account maintained by you in the United States,

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the payment of proceeds or the confirmation of the sale is mailed to you at a U.S. address or

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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.

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:

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a U.S. person,

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a controlled foreign corporation for U.S. tax purposes,

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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

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a foreign partnership, if at any time during its tax year:

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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

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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.

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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

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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.

165

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
Deutsche Bank Securities Inc.
Bear, Stearns & Co. Inc.
UBS Securities LLC
A.G. Edwards & Sons, Inc.
Calyon Securities (USA) Inc.

Total		21,100,000

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 $5.2 million. The underwriters have agreed to reimburse us for certain expenses.

We have granted to the underwriters an option, exercisable for 30 days from the date of the underwriting agreement, to purchase up to 3,165,000 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.

166

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.

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 (subject to certain limited exceptions approved by the representatives) 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 have 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 persons who are our officers, our employees or who are otherwise associated with us through a directed share program. Individuals who purchase these shares will be subject to a 25-day lock up period, provided that our 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.

We have been advised by the underwriters that:

•

they have not offered or sold and, prior to the expiration of a period of six months from the date of this prospectus, will not offer or sell any shares of common stock offered hereby to persons in the United Kingdom except to persons whose ordinary activities involve them in acquiring, holding, managing or disposing of investments (as principal or agent) for the purposes of their businesses or otherwise in circumstances which have not resulted and will not result in an offer to the public in the United Kingdom within the meaning of the Public Offers at Securities Regulations 1995;

•

they have only communicated or caused to be communicated and will only communicate or cause to be communicated any invitation or inducement to engage in investment activity (within the meaning of section 21 of the Financial Services and Markets Act 2000, or FSMA, received by them in connection with the issue or sale of any shares of common stock offered hereby in circumstances in which section 21(1) of the FSMA does not apply to us;

167

•

they have complied and will comply with all applicable provisions of the FSMA with respect to anything done by them in relation to the shares of common stock offered hereby in, from or otherwise involving the United Kingdom; and

•

the shares of common stock offered by means of this prospectus are not, may not and will not be offered, distributed, sold, transferred or delivered, directly or indirectly, in or from the Netherlands, to any person other than our employees and/or our subsidiaries, or individuals or legal entities which trade or invest in securities in the conduct of their profession or business within the meaning of article 2 of the Exemption Regulation issued pursuant to the Securities Transactions Supervision Act 1995 (“Vrijstellingsregeling Wet toezicht effectenverkeer 1995”), which includes, but is not limited to banks, brokers, dealers, pension funds, insurance companies, securities institutions, investment institutions and other institutional investors, including, among others, treasuries of large enterprises.

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 have applied to have our common stock listed on the NYSE under the symbol “SHO.” In order to meet the NYSE distribution requirements for trading, the underwriters have undertaken to sell shares of our common stock to a minimum of 2,000 beneficial owners in lots of 100 or more shares and for there to be at least 1,100,000 publicly held shares outstanding in the United States, an aggregate market value of publicly held shares of at least $60 million in the United States and a global market capitalization of at least $500 million.

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 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

168

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 for which they have received or will receive customary fees and expenses. Citigroup 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, which will not be contributed to us in connection with the Formation and Structuring Transactions. Deutsche Bank Mortgage Capital, L.L.C., an affiliate of Deutsche Bank Securities Inc., provided a mortgage loan for the Hyatt, Marietta, Georgia hotel which we will repay using a portion of the net proceeds of this offering. In addition, we have received commitments for a new $150.0 million senior secured credit facility and $75.0 million subordinate term loan facility from our lead managing underwriters and/or their affiliates, and we expect that some of our other underwriters and/or their affiliates also will participate in the facilities. In the event that we enter into these facilities, we expect that these underwriters and/or their affiliates will receive fees, interest payments and expense reimbursements.

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.

169

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.

170

INDEX TO FINANCIAL STATEMENTS


		Page
Sunstone Hotel Investors, Inc. and Subsidiaries:

Unaudited Pro Forma Financial Data:

Unaudited Pro Forma Combined Balance Sheet as of June 30, 2004		F-3

Unaudited Pro Forma Condensed Combined Income Statement for the year ended December 31, 2003		F-8

Unaudited Pro Forma Condensed Combined Income Statement for the six months ended June 30, 2004		F-12

Sunstone Predecessor Companies:

Report of Independent Registered Public Accounting Firm		F-16

Combined Balance Sheets as of December 31, 2003 and 2002		F-17

Combined Statements of Operations for the years ended December 31, 2003, 2002 and 2001		F-18

Combined Statements of Changes in Members’ Equity for the years ended December 31, 2003, 2002 and 2001		F-19

Combined Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001		F-20

Notes to Combined Financial Statements		F-21

Schedule III—Real Estate and Accumulated Depreciation		F-44

Condensed Combined Balance Sheets as of June 30, 2004 and December 31, 2003		F-48

Condensed Combined Statements of Operations for the three and six months ended June 30, 2004 and 2003		F-49

Condensed Combined Statements of Cash Flows for the six months ended June 30, 2004 and 2003		F-50

Notes to Condensed Combined Financial Statements		F-51

Wyndham Acquisition Hotels:

Report of Independent Auditors		F-60

Combined Balance Sheets as of November 30, 2002 and December 31, 2001		F-61

Combined Statements of Operations for the period from January 1, 2002 through November 30, 2002 and the year ended December 31, 2001		F-62

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-63

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-64

Notes to Combined Financial Statements		F-65

F-1

UNAUDITED PRO FORMA FINANCIAL DATA

The following unaudited pro forma financial data gives effect to (1) hotel acquisitions, hotels held for sale (discontinued operations) and one hotel property under contract to sell and classified as held for sale after June 30, 2004, (2) the Formation and Structuring Transactions and (3) this offering, the concurrent sale of shares to Robert A. Alter, the incurrence of debt under our new term loan facility 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 contribution or sale to us of hotels and interests in entities by the Contributing Entities in the Formation and Structuring Transactions will be accounted for at the historical cost of such assets similar to a pooling of interests as the Contributing Entities are all under common control.

Westbrook Real Estate Partners, L.L.C. is the owner of the entity that is the general partner of the entities that own 95.7% of the interests in Sunstone Hotel Investors, L.L.C., 95.0% of the interests in WB Hotel Investors, LLC and 98.5% of the interests in Sunstone/WB Hotel Investors IV, LLC., which owns 91.5% of the interests in Sunstone/WB Manhattan Beach, LLC. In addition, Westbrook Real Estate Partners, L.L.C., as owner of the entity that is the general partner, has the right to appoint a majority of the executive committees of the Contributing Entities, which makes all major decisions on behalf of such entities. The other partners of the Contributing Entities do not have any substantive participating rights or other important rights, other than the ability to appoint one or two members of the executive committees.

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

SUNSTONE HOTEL INVESTORS, INC.

PRO FORMA CONDENSED COMBINED BALANCE SHEET

June 30, 2004

(Unaudited)

(In thousands)


	Historical		Hotel Eliminations ⁽¹⁾			Management Company ⁽²⁾		Other Adjustments ⁽³⁾		Subtotal		Offering ⁽⁴⁾			Pro Forma
ASSETS
Current assets:
Cash and cash equivalents	$	23,583	$	(5,997	) ^(1a)
				28,913	^(1b)
				(30,761	) ^(1b)
				2,534	^(1b)
				(59	) ^(1d)			$	14,500	$	32,713	$	366,096	^(4a)
													(218,971	) ^(4b)
													69,575	^(4c)
													(6,300	) ^(4d)
													(210,405	) ^(4e)
													7,702	^(4f)	$	40,410
Restricted cash		35,180		(150	) ^(1a)
				(2,534	) ^(1b)						32,496		(7,702	) ^(4f)		24,794
Accounts receivable, net		23,089		(172	) ^(1a)
				(147	) ^(1d)						22,770					22,770
Due from related parties		436		255	^(1a)						691					691
Inventories		2,530		(136	) ^(1a)
				(10	) ^(1d)						2,384					2,384
Prepaid expenses and other current assets		2,927		(27	) ^(1a)
				(10	) ^(1d)						2,890					2,890
Current assets of discontinued operations		925		(925	) ^(1c)						—					—

Total current assets		88,670		(9,226	)		—		14,500		93,944		(5	)		93,939
Investment in hotel properties, net		1,194,216		(62,148	) ^(1a)
				(6,756	) ^(1b)						1,125,312		6,300	^(4d)		1,131,612
Hotel properties held for sale, net		22,232		(22,232	) ^(1b)						—					—
Other real estate, net		7,550									7,550					7,550
Deferred financing costs, net		9,131		(646	) ^(1a)
				(63	) ^(1d)						8,422		5,425	^(4c)
													(1,607	) ^(4g)		12,240
Goodwill		28,493									28,493					28,493
Other assets, net		4,865		(176	) ^(1a)						4,689					4,689
Other assets, net, of discontinued operations		362		(362	) ^(1c)						—					—

Total assets	$	1,355,519	$	(101,609	)	$	—	$	14,500	$	1,268,410	$	10,113		$	1,278,523

F-3

SUNSTONE HOTEL INVESTORS, INC.

PRO FORMA CONDENSED COMBINED BALANCE SHEET—(Continued)

June 30, 2004

(Unaudited)

(In thousands)


	Historical			Hotel Eliminations ⁽¹⁾			Management Company ⁽²⁾			Other Adjustments ⁽³⁾		Subtotal		Offering ⁽⁴⁾			Pro Forma
LIABILITIES AND MEMBERS’ EQUITY
Current liabilities:
Accounts payable and other accrued expenses	$	22,757		$	(394	) ^(1a)
					(54	) ^(1d)						$	22,309				$	22,309
Accrued payroll and employee benefits		12,418			(257	) ^(1a)
					(47	) ^(1d)	$	(5,235	)				6,879					6,879
Due to Management Company								12,924					12,924					12,924
Other current liabilities		28,464			(610	) ^(1a)
					(112	) ^(1d)		(7,889	)				19,853					19,853
Current portion of secured notes payable		64,543			(56	) ^(1a)							64,487	$	(57,779	) ^(4e)		6,708
Current liabilities of discontinued operations		1,402			(123	) ^(1b)
					(1,279	) ^(1c)							—					—

Total current liabilities		129,584			(2,932	)		(200	)		—		126,452		(57,779	)		68,673
Unsecured term loan facility													—		75,000	^(4c)		75,000
Secured notes payable, less current portion		826,894			(46,379	) ^(1a)
					(9,226	) ^(1b)				$	14,500		785,789		(152,626	) ^(4e)		633,163
Deferred income taxes		41,668			(2,612	) ^(1a)							39,056		(39,056	) ^(4h)		—
Accrued pension liability		1,542						(1,542	)				—					—
Other liabilities		3,145											3,145					3,145
Other liabilities of discontinued operations		21,427			(21,412	) ^(1b)
					(15	) ^(1c)							—					—

Total liabilities		1,024,260			(82,576	)		(1,742	)		14,500		954,442		(174,461	)		779,981
Minority interests		528											528		88,922	^(4j)		89,450
Members’ equity:
Members’ capital		332,473			(18,889	) ^(1a)
					(75	) ^(1b)
					7	^(1c)
					(76	) ^(1d)							313,440		(218,971	) ^(4b)
															39,056	^(4h)
															(133,525	) ⁽⁴ⁱ⁾		—
Accumulated other comprehensive loss		(1,742	)					1,742					—					—

Total members’ equity		330,731			(19,033	)		1,742			—		313,440		(313,440	)		—

Stockholders’ equity
Common stock															314	^(4a)		314
Additional paid in capital															365,782	^(4a)
															(1,607	) ^(4g)
															133,525	⁽⁴ⁱ⁾
															(88,922	) ^(4j)		408,778

Total stockholders’ equity		—			—			—			—		—		409,092			409,092

Total liabilities and equity	$	1,355,519		$	(101,609	)	$	—		$	14,500	$	1,268,410	$	10,113		$	1,278,523

F-4

SUNSTONE HOTEL INVESTORS, INC.

PRO FORMA CONDENSED COMBINED BALANCE SHEET

June 30, 2004

(Unaudited)

(In thousands)

Notes to Unaudited Pro Forma Condensed Combined Balance Sheet as of June 30, 2004

(1)	Represents the elimination of the two hotels that will not be contributed to us by the Contributing Entities, one hotel that is under contract to sell and three hotels held for sale at June 30, 2004.

The two hotels that will not be contributed are:

JW Marriott, Cherry Creek, Colorado

Embassy Suites Hotel, Los Angeles, California

One hotel that is under contract to sell is:

Holiday Inn, Flagstaff, Arizona

The three hotels held for sale were:

Concord Hotel and Conference Center, Concord, California

Four Points-Sheraton, Silverthorne, Colorado

San Marcos Resort, Chandler, Arizona


1a.	Represents the elimination of two hotels that will not be contributed:
	Cash	$	5,997
	Restricted cash		150
	Accounts receivable, net		172
	Due from affiliates		(255	)
	Inventories		136
	Prepaid expenses and other current assets		27
	Investment in hotel properties, net		62,148
	Deferred financing costs, net		646
	Other assets, net		176

		$	69,197

	Accounts payable and other accrued expenses	$	394
	Accrued payroll and employee benefits		257
	Current portion of secured notes payable		56
	Other current liabilities		610
	Secured notes payable, less current portion		46,379
	Deferred income taxes		2,612
	Equity		18,889

		$	69,197

1b.	Represents the effect of the sales of one hotel under contract to sell and three hotels held for sale:
	Cash proceeds from sales, net of fees	$	28,913
	Hotel properties held for sale, net:
	Concord Hotel and Conference Center, Concord, California		(5,844	)
	Four Points-Sheraton, Silverthorne, Colorado		(2,939	)
	San Marcos Resort, Chandler, Arizona		(13,449	)

			(22,232	)

	Hotel properties held for investment, net:
	Holiday Inn, Flagstaff, Arizona		(6,756	)

	Equity effect of sales of the four hotel properties	$	(75	)

F-5


		Repayment of debt associated with the four hotels:
		Concord Hotel and Conference Center, Concord, California	$	(7,027	)
		Four Points-Sheraton, Silverthorne, Colorado		(3,887	)
		San Marcos Resort, Chandler, Arizona		(14,408	)

				(25,322	)

		Holiday Inn, Flagstaff, Arizona		(5,439	)

			$	(30,761	)

		Current liabilities of discontinued operations	$	(123	)
		Secured notes payable, less current portion		(9,226	)
		Other liabilities of discontinued operations		(21,412	)

			$	(30,761	)

		Represents the release of restricted cash to cash and cash equivalents as a result of the properties	$	2,534

	1c.	Represents the elimination of three hotels held for sale:
		Current assets of discontinued operations	$	925
		Other assets, net, of discontinued operations		362

			$	1,287

		Other current liabilities of discontinued operations	$	1,279
		Other liabilities of discontinued operations		15
		Equity of discontinued operations		(7	)

			$	1,287

	1d.	Represents the elimination of one hotel under contract to sell:
		Cash	$	59
		Accounts receivable, net		147
		Inventories		10
		Prepaid expenses and other current assets		10
		Deferred financing costs, net		63

				289

		Accounts payable and other accrued expenses	$	54
		Accrued payroll and employee benefits		47
		Other current liabilities		112
		Equity		76

			$	289

(2)	Represents the transfer of employee-related liabilities from the corporation that currently manages 49 of our hotels and employs the employees for those hotels as well as certain corporate personnel involved in hotel management to the Management Company:
		Accrued payroll and employee benefits	$	5,235
		Other current liabilities		7,889
		Accrued pension liability		1,542
		Accumulated other comprehensive loss		(1,742	)

			$	12,924


(3)	Represents additional debt owed to Massachusetts Mutual Life Insurance Company		$	14,500

F-6


(4)	The effect of the issuance of shares in this offering, the concurrent sale of shares to Robert A. Alter and the incurrence of debt under our new term loan facility and the application of the net proceeds as described under “Use of Proceeds”:
	(4a	)	Sale of shares of common stock in this offering
			Proceeds from this offering								$	400,900
			Proceeds from sale of shares to Robert A. Alter									3,700
			Underwriting fees									(25,056	)
			Franchise transfer costs									(2,000	)
			Debt prepayment penalties									(6,248	)
			Other costs associated with this offering									(5,200	)

											$	366,096

			Par value of common stock to be issued								$	314
			Additional paid in capital from proceeds of sale of common stock									365,782

											$	366,096

	(4b	)	Acquisition of membership units in Sunstone Hotel Partnership held by the Contributing Entities for cash								$	218,971

	(4c	)	Unsecured term loan facility, revolving credit facility and debt amendment
			Proceeds from unsecured term loan facility								$	75,000
			Costs associated with revolving credit facility, unsecured term loan facility and Massachusetts Mutual Life Insurance debt amendment									(5,425	)

											$	69,575

	(4d	)	Purchase of the ground lessor’s interest in the ground lease relating to the Embassy Suites Hotel, Chicago, Illinois								$	6,300

	(4e	)	Repayment of secured notes payable:
			Current portion of secured notes payable								$	57,779
			Secured notes payable, less current portion									152,626

											$	210,405

	(4f	)	Represents the release of restricted cash from the properties held for sale and under contract to sell								$	7,702

	(4g	)	Write-off of unamortized loan fees								$	1,607

	(4h	)	Write-off of deferred income taxes								$	39,056

	(4i	)	Elimination of members’ equity								$	133,525

	(4j	)	To establish minority interest in Sunstone Hotel Partnership based on membership units issued								$	88,922

				Minority membership units	6,864	18.0	%
				REIT membership units	31,354	82.0	%

					38,218	100.0	%

			Total equity before percentage allocable to minority interests					$	498,014
			Percentage allocable to minority interests						18.0	%

								$	89,450

F-7

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)	$	(8,526	) ^(2a)							$	310,126						310,126
Food and beverage		107,200			326	^(1b)		(1,281	) ^(2b)								106,245						106,245
Other operating		36,985			84	^(1c)		(605	) ^(2c)								36,464						36,464
Management and other fees from related parties		705											$	(705	) ^(4a)		—						—

Total revenues		460,702			3,250			(10,412	)		—			(705	)		452,835			—			452,835

OPERATING EXPENSES
Room		74,471			612	^(1d)		(1,851	) ^(2d)								73,232						73,232
Food and beverage		76,750			222	^(1e)		(1,085	) ^(2e)								75,887						75,887
Other hotel		148,869			1,149	^(1f)		(4,041	) ^(2f)								145,977			(632	) ^(5a)		145,345
General and administrative		64,229			473	^(1g)		(1,158	) ^(2g)	$	(57,575	)		(5,969	) ^(4b)		—						—
General and administrative—corporate		—												8,169	^(4b)
														1,297	^(4c)		9,466						9,466
General and administrative—property operations		—									45,744						45,744						45,744
Management fee expense		—									7,643						7,643						7,643
Depreciation and amortization		53,481			275	^(1h)		(1,503	) ^(2h)					2,756	^(4c)		55,009						55,009
Impairment loss		11,382															11,382						11,382

Total operating expenses		429,182			2,731			(9,638	)		(4,188	)		6,253			424,340			(632	)		423,708

Operating income (loss)		31,520			519			(774	)		4,188			(6,958	)		28,495			632			29,127
Interest and other income		712															712						712
Interest expense		(55,235	)		(410	) ⁽¹ⁱ⁾		1,406	⁽²ⁱ⁾								(54,239	)		9,053	^(5b)		(45,186	)

Income (loss) from continuing operations before minority interest and income taxes		(23,003	)		109			632			4,188			(6,958	)		(25,032	)		9,685			(15,347	)
Minority interest		(17	)														(17	)		2,774	^(5c)		2,757
Income tax benefit		2,017												(2,017	) ^(4d)		—						—

Income (loss) from continuing operations	$	(21,003	)	$	109		$	632		$	4,188		$	(8,975	)	$	(25,049	)	$	12,459		$	(12,590	)

Income (loss) per share from continuing operations:
Basic																						$	(0.40	)

Diluted																						$	(0.40	)

Common shares outstanding:
Basic																							31,354

Diluted																							31,354

F-8

SUNSTONE HOTEL INVESTORS, INC.

PRO FORMA CONDENSED COMBINED INCOME STATEMENT

For the Year Ended December 31, 2003

(Unaudited)

(In thousands, except per share data)


Notes to Unaudited Pro Forma Condensed Combined Statements of Operations for the Year Ended December 31, 2003

(1)		In 2003, we acquired the following hotels:
		Marriott, Ontario, California
		Residence Inn, Manhattan Beach, California



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 following hotels:
Marriott, Ontario, California	$	497
Residence Inn, Manhattan Beach, California		2,343

	$	2,840

1b. Represents the addition of food and beverage revenue from the following hotels:
Marriott, Ontario, California	$	326
Residence Inn, Manhattan Beach, California		—

	$	326

1c. Represents the addition of other operating revenue from the following hotels:
Marriott, Ontario, California	$	39
Residence Inn, Manhattan Beach, California		45

	$	84

1d. Represents the addition of room expense from the following hotels:
Marriott, Ontario, California	$	166
Residence Inn, Manhattan Beach, California		446

	$	612

1e. Represents the addition of food and beverage expense from the following hotels:
Marriott, Ontario, California	$	222
Residence Inn, Manhattan Beach, California		—

	$	222

1f. Represents the addition of other hotel expenses from the following hotels:
Marriott, Ontario, California	$	207
Residence Inn, Manhattan Beach, California		942

	$	1,149

1g. Represents the addition of general and administrative expense from the following hotels:
Marriott, Ontario, California	$	147
Residence Inn, Manhattan Beach, California		326

	$	473

F-9


	1h. Represents the addition of depreciation and amortization expense from the following hotels:
	Marriott, Ontario, California	$	75
	Residence Inn, Manhattan Beach, California		200

		$	275

	1i. Represents the addition of interest expense from the following hotels:
	Marriott, Ontario, California	$	50
	Residence Inn, Manhattan Beach, California		360

		$	410

(2)	Represents the elimination of the Embassy Suites Hotel, Los Angeles, California, which will not be contributed to us by the Contributing Entities, and the hotel that is subject to a contract to sell. The other hotels sold in 2003 or 2004 or held for sale at June 30, 2004 are included in discontinued operations and, therefore, are not included in this column.

	2a. Represents the elimination of room revenue from the following hotels:
	Holiday Inn, Flagstaff, Arizona	$	2,392
	Embassy Suites Hotel, Los Angeles, California		6,134

		$	8,526


	2b. Represents the elimination of food and beverage revenue from the following hotels:
	Holiday Inn, Flagstaff, Arizona	$	285
	Embassy Suites Hotel,, Los Angeles, California		996

		$	1,281


	2c. Represents the elimination of other operating revenue from the following hotels:
	Holiday Inn, Flagstaff, Arizona	$	89
	Embassy Suites Hotel, Los Angeles, California		516

		$	605


	2d. Represents the elimination of room expense from the following hotels:
	Holiday Inn, Flagstaff, Arizona	$	560
	Embassy Suites Hotel, Los Angeles, California		1,291

		$	1,851


	2e. Represents the elimination of food and beverage expense from the following hotels:
	Holiday Inn, Flagstaff, Arizona	$	286
	Embassy Suites Hotel, Los Angeles, California		799

		$	1,085


	2f. Represents the elimination of other hotel expenses from the following hotels:
	Holiday Inn, Flagstaff, Arizona	$	947
	Embassy Suites Hotel, Los Angeles, California		3,094

		$	4,041


	2g. Represents the elimination of general and administrative expense from the following hotels:
	JW Marriott, Cherry Creek, Colorado	$	185
	Holiday Inn, Flagstaff, Arizona		269
	Embassy Suites Hotel, Los Angeles, California		704

		$	1,158

F-10


	2h. Represents the elimination of depreciation and amortization expense from the following hotels:
	Holiday Inn, Flagstaff, Arizona	$	344
	Embassy Suites Hotel, Los Angeles, California		1,159

		$	1,503

	2i. Represents the elimination of interest expense from the following hotels:
	Holiday Inn, Flagstaff, Arizona	$	272
	Embassy Suites Hotel, Los Angeles, California		1,134

		$	1,406

(3)	Represents the transfer of employee-related expenses from the corporation that currently manages 49 of our hotels and employs the employees for those hotels as well as certain corporate personnel involved in hotel management to the Management Company:
	Transfer of employee-related expenses	$	45,744
	Management fee expense		7,643

		$	53,387

(4)	Other adjustments represents:
	4a. Elimination of management and other fees from affiliates as a result of the Formation and Structuring Transactions	$	705

	4b. Estimated continuing and additional costs of being a public company:
	Continuing costs	$	5,969
	Additional costs		2,200

		$	8,169

	4c. Reflects the grants of restricted stock unit awards:
	Compensation expense associated with restricted stock unit awards	$	1,297
	Non-cash amortization expense associated with restricted stock units awards		2,756

		$	4,053

	4d. As a result of its leases with Sunstone Hotel Partnership, the TRS Lessee would not have had any taxable income on a pro forma basis. Accordingly, the historical income tax benefit has been eliminated.	$	2,017

(5)	The effect of the application of the net proceeds of this offering, the concurrent sale of shares to Robert A. Alter and the incurrence of debt under our new term loan facility as described under “Use of Proceeds.”
	5a. Reflects the reduction of ground lease expense as a result of the acquisition of the ground lessor’s interest in the ground lease relating to the Embassy Suites Hotel, Chicago, Illinois.	$	632

	5b. Reflects the change in interest expense for the following items:
	Decrease in interest expense for the repayment of debt with the net proceeds of this offering	$	12,901
	Increase in interest expense for debt under the term loan facility		(3,848	)

		$	9,053

	5c. Represents the membership units in Sunstone Hotel Partnership owned by the Contributing Entities following the Formation and Structuring Transactions.	$	(2,757	)
			(17	)

		$	(2,774	)

F-11

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		$	(5,123	) ^(1a)							$	161,834					$	161,834
Food and beverage		54,849			(902	) ^(1b)								53,947						53,947
Other operating		21,576			(375	) ^(1c)								21,201						21,201
Management and other fees from related parties		522								$	(522	) ^(3a)		—						—

Total revenues		243,904			(6,400	)		—			(522	)		236,982			—			236,982

OPERATING EXPENSES
Room		37,267			(1,112	) ^(1d)								36,155						36,155
Food and beverage		37,923			(750	) ^(1e)								37,173						37,173
Other hotel		76,306			(2,382	) ^(1f)								73,924		$	(286	) ^(4a)		73,638
General and administrative		32,853			(1,169	) ^(1g)	$	(28,699	)		(2,985	) ^(3b)		—						—
General and administrative—corporate		—									4,085	^(3b)
											649	^(3c)		4,734						4,734
General and administrative—property operations		—						22,552						22,552						22,552
Management fee expense		—						3,822						3,822						3,822
Depreciation and amortization		28,444			(1,066	) ^(1h)					1,378	^(3c)		28,756						28,756
Impairment loss		7,439												7,439						7,439

Total operating expenses		220,232			(6,479	)		(2,325	)		3,127			214,555			(286	)		214,269

Operating income (loss)		23,672			79			2,325			(3,649	)		22,427			286			22,713
Interest and other income		216												216						216
Interest expense		(26,576	)		801	⁽¹ⁱ⁾								(25,775	)		4,571	^(4b)		(21,204	)
Income (loss) from continuing operations before minority interest and income taxes		(2,688	)		880			2,325			(3,649	)		(3,132	)		4,857			1,725
Minority interest		166												166			(476	) ^(4c)		(310	)
Provision for income taxes		(780	)								780	^(3d)		—						—

Income (loss) from continuing operations	$	(3,302	)	$	880		$	2,325		$	(2,869	)	$	(2,966	)	$	4,381		$	1,415

Income (loss) per share from continuing operations:
Basic																			$	0.05

Diluted																			$	0.04

Common shares outstanding:
Basic																			$	31,354

Diluted																			$	31,635

F-12

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)


Notes to Unaudited Pro Forma Condensed Combined Statements of Operations for the Six Months Ended June 30, 2004

(1)	Represents the elimination of the JW Marriott, Cherry Creek, Colorado and the Embassy Suites Hotel, Los Angeles, California, which will not be contributed to us by the Contributing Entities, and the hotel that is subject to a contract to sell. The other hotels sold in 2003 or 2004 or held for sale at June 30, 2004 are included in discontinued operations and, therefore, are not included in this column.

	1a.	Represents the elimination of room revenue from the following hotels:
		JW Marriott, Cherry Creek, Colorado	$	325
		Holiday Inn, Flagstaff, Arizona		1,165
		Embassy Suites Hotel, Los Angeles, California		3,633

			$	5,123

	1b.	Represents the elimination of food and beverage revenue from the following hotels:
		JW Marriott, Cherry Creek, Colorado	$	184
		Holiday Inn, Flagstaff, Arizona		136
		Embassy Suites Hotel, Los Angeles, California		582

			$	902

	1c.	Represents the elimination of other operating revenue from the following hotels:
		JW Marriott, Cherry Creek, Colorado	$	45
		Holiday Inn, Flagstaff, Arizona		49
		Embassy Suites Hotel, Los Angeles, California		281

			$	375

	1d.	Represents the elimination of room expense from the following hotels:
		JW Marriott, Cherry Creek, Colorado	$	169
		Holiday Inn, Flagstaff, Arizona		275
		Embassy Suites Hotel, Los Angeles, California		668

			$	1,112

	1e.	Represents the elimination of food and beverage expense from the following hotels:
		JW Marriott, Cherry Creek, Colorado	$	211
		Holiday Inn, Flagstaff, Arizona		132
		Embassy Suites Hotel, Los Angeles, California		407

			$	750

	1f.	Represents the elimination of other hotel expenses from the following hotels:
		JW Marriott, Cherry Creek, Colorado	$	316
		Holiday Inn, Flagstaff, Arizona		481
		Embassy Suites Hotel, Los Angeles, California		1,585

			$	2,382

F-13


	1g.	Represents the elimination of general and administrative expense from the following hotels:
		JW Marriott, Cherry Creek, Colorado	$	680
		Holiday Inn, Flagstaff, Arizona		110
		Embassy Suites Hotel, Los Angeles, California		379

			$	1,169

	1h.	Represents the elimination of depreciation and amortization expense from the following hotels:
		JW Marriott, Cherry Creek, Colorado	$	281
		Holiday Inn, Flagstaff, Arizona		173
		Embassy Suites Hotel, Los Angeles, California		612

			$	1,066

	1i.	Represents the elimination of interest expense from the following hotels:
		JW Marriott, Cherry Creek, Colorado	$	230
		Holiday Inn, Flagstaff, Arizona		113
		Embassy Suites Hotel, Los Angeles, California		458

			$	801

(2)	Represents the transfer of employee-related expenses from the corporation that currently manages 49 of our hotels and employs the employees for those hotels as well as certain corporate personnel involved in hotel management to the Management Company:
		Transfer of employee-related expenses	$	22,552
		Management fee expense		3,822

			$	26,374

(3)	Other adjustments represents:
	3a.	Elimination of management and other fees from affiliates as a result of the Formation and Structuring Transactions	$	522

	3b.	Estimated continuing and additional costs of being a public company:
		Continuing costs	$	2,985
		Additional costs		1,100

			$	4,085

	3c.	Reflects the grants of restricted stock unit awards:
		Compensation expense associated with restricted stock unit awards	$	649
		Non-cash amortization expense associated with restricted stock unit		1,378

			$	2,027

	3d.	As a result of its leases with Sunstone Hotel Partnership, the TRS Lessee would not have had any taxable income on a pro forma basis. Accordingly, the historical provision for income taxes has been eliminated.	$	(780	)

(4)	The effect of the application of the net proceeds of this offering, the concurrent sale of shares to Robert A. Alter and the incurrence of debt under our new term loan facility as described under “Use of Proceeds.”
	4a.	Reflects the reduction of ground lease expense as a result of the acquisition of the ground lessor’s interest in the ground lease relating to the Embassy Suites Hotel, Chicago, Illinois.	$	286

F-14


4b.	Reflects the change in interest expense for the following items:
	Decrease in interest expense for the repayment of debt with the net proceeds of this offering	$	6,495
	Increase in interest expense for debt under the new term loan facility	$	(1,924	)

		$	4,571

4c.	Represents the membership units in Sunstone Hotel Partnership owned by the Contributing Entities following the Formation and Structuring Transactions.	$	310
			166

		$	476

F-15

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-16

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 related parties		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-17

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 related parties		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-18

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-19

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-20

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 SHI, WB and WB IV are as follows:

Westbrook SHP L.L.C.

Westbrook Real Estate Fund III, L.P.

Westbrook Real Estate Co-Investment Partnership III, L.P.

Westbrook Real Estate Fund IV, L.P.

Westbrook Real Estate Co-Investment Partnership IV, L.P.

The above affiliates of SHI, WB and WB IV, which are all controlled by Westbrook Real Estate Partners, L.L.C., are referred to, collectively, as “Westbrook” or the “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

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

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 “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) .

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

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.

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

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

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.

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.

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

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 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).

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

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 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.

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

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.

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

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

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.

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.

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

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.

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-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

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-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

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-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

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-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

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	)

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

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 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-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

•

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	$	78,213	—	$	—	—	$	—
Westbrook Real Estate Fund III, L.P.	16,248,343		82,249	—		—	—		—
Westbrook Real Estate Co-Investment Partnership III, L.P.	617,469		3,126	—		—	—		—
Alter SHP LLC	1,469,909		7,441	697,095		—	501.0		—
Biederman SHP LLC	382,647		1,937	96,375		—	100.0		—
Other members	38,156		193	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	$	107,480	—	$	—	—	$	—
Westbrook Real Estate Fund III, L.P.	16,248,343		113,026	—		—	—		—
Westbrook Real Estate Co-Investment Partnership III, L.P.	617,469		4,295	—		—	—		—
Alter SHP LLC	1,469,909		10,225	697,095		—	501.0		—
Biederman SHP LLC	382,647		2,662	96,375		—	100.0		—
Other members	38,156		265	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-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

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 franchisor in the amount of $961,000, plus accrued interest. The Company does not currently contemplate

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

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-37

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),

F-38

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

“Employers’ Disclosures about Pensions and Other Postretirement Benefits” (SFAS 132-R). This statement 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-39

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-40

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 Related Parties

Minority Interest

During 2003, the members of WB IV transferred a portion of their interest to a minority interest 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 related party to provide management services for the hotel property located in Nashville, Tennessee owned by the Westbrook related party. 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 related party 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 related party to provide asset management services for the hotel properties owned by the Westbrook related party. 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 related party to provide asset management services for the hotel property owned by the Westbrook related party. The

F-41

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

agreement shall continue through the earlier of i) the date the lease with the Westbrook related party 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 related party 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 related parties 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 related party, 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 related parties. 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 related party, 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 related parties. 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 related parties. The related parties generally reimburse such amounts on a monthly basis. At December 31, 2003 and 2002, amounts owed to the Company by its related parties amounted to $451,000 and $47,000, respectively, and are included in due from related parties.

At December 31, 2002, the Company owed a reimbursement to Westbrook related parties for costs and expenses aggregating $326,000 paid by Westbrook related parties 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.

F-42

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 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.

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-43

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 Hotel—Chicago		(	e)		79		46,886		—			284			79		47,170		47,249		1,867	N/A	2002	5-35
Embassy Suites Hotel—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-44

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-45

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-46

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-47

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	$	23,583		$	20,229
Restricted cash		35,180			37,611
Accounts receivable, net		23,089			19,040
Due from related parties		436			451
Inventories		2,530			2,690
Prepaid expenses		2,927			2,624
Current assets of discontinued operations		925			—

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		9,045			11,921
Interest rate cap agreements		86			540
Goodwill		28,493			28,493
Other assets, net		4,865			6,039
Other assets, net, of discontinued operations		362			—

Total assets	$	1,355,519		$	1,364,942


LIABILITIES AND MEMBERS’ EQUITY
Current liabilities:
Accounts payable and other accrued expenses	$	22,757		$	28,943
Accrued payroll and employee benefits		12,418			13,263
Other current liabilities		28,464			25,313
Current portion of notes payable		64,543			25,804
Current liabilities of discontinued operations		1,402			—

Total current liabilities		129,584			93,323

Notes payable, less current portion		826,894			891,848
Deferred income taxes		41,668			43,612
Accrued pension liability		1,542			1,638
Other liabilities		3,145			3,572
Other liabilities of discontinued operations		21,427			—

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-48

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 related parties		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-49

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	$	28,422		$	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		3,354			4,118
Cash and cash equivalents, beginning of period		20,229			22,302

Cash and cash equivalents, end of period	$	23,583		$	26,420

See accompanying notes to condensed combined financial statements (unaudited).

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)

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-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)

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-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)

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	$	925
Hotel properties held for sale, net		22,232
Deferred financing costs, net		299
Interest rate cap agreements		4
Other assets, net		59

Total assets of discontinued operations	$	23,519

Liabilities:
Total current liabilities	$	1,402
Notes payable		21,413
Other liabilities		14

Total liabilities of discontinued operations	$	22,829

F-53

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-54

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-55

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-56

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-57

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-58

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 April 15, 2004, the Company sold the Hawthorn 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 three and six months ended June 30, 2004 and 2003.

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-59

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-60

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-61

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
Impairment loss		—		6,099,071

Total operating costs and expenses		157,142,766		177,478,595

Operating income		17,221,590		27,526,517

Minority interest		119,428		219,892

Net income	$	17,102,162	$	27,306,625

The accompanying notes are an integral part of these financial statements.

F-62

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-63

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-64

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 Hotel 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-65

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-66

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-67

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 Hotel 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-68

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-69

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-70

LOGO

21,100,000 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		2,000,000
Accounting fees and expenses		1,350,000
Blue sky fees and expenses		10,000
Transfer agent and registrar fees		15,000
Miscellaneous		1,031,150

Total	$	5,200,000

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 Investors, Inc. will issue 9,990,932 shares of common stock and Sunstone Hotel Partnership, LLC will issue 19,112,556 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. We will receive substantially all of the hotels and other assets we will own at the time of this offering as consideration for these issuances of common stock and membership units. We have not obtained any independent valuation of the consideration received by us, and the value of the securities issued by us and Sunstone Hotel Partnership, LLC will depend on the initial public offering price. Sunstone Hotel Investors, Inc., 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 these issuances prior to the filing of this Registration Statement. The issuances of such shares and 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.

II-1

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 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**		Form of Opinion of Venable LLP.
8.1		Form of 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		Commitment Letter for $150,000,000 Senior Secured Revolving Credit Facility and $75,000,000 Subordinate Term Loan Facility, dated September 14, 2004, among Citigroup Global Markets Inc., Citicorp North America, Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Merrill Lynch Capital Corporation, Morgan Stanley Senior Funding, Inc., and Sunstone Hotel Investors, L.L.C.
10.13**		Form of Investors Agreement among Sunstone Hotel Investors, Inc. and the persons named therein.
10.14		Form of Senior Management Incentive Plan of Sunstone Hotel Investors, Inc.
10.15		Form of Employment Agreement with Robert A. Alter.

II-3


10.16		Form of Employment Agreement with Jon D. Kline.
10.17		Form of Employment Agreement with Gary A. Stougaard.
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 to Amendment No. 1 to Registration Statement on Form S-11).
99.1**		Consent of Paul D. Kazilionis.
99.2**		Consent of Jonathan H. Paul.
99.3		Consent of Lewis N. Wolff.
99.4		Consent of Z. Jamie Behar.
99.5		Consent of Barbara S. Brown.
99.6		Consent of Anthony W. Dona.
99.7		Consent of David M. Siegel.
99.8		Consent of Keith P. Russell.

*	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 6 ^th day of October, 2004.


SUNSTONE HOTEL INVESTORS, INC.

By:	/s/ J ON D. K LINE
	Name:	Jon D. Kline
	Title:	Executive Vice President and Chief Financial Officer

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	Chief Executive Officer, President and Director	October 6, 2004

/ S / J ON D. K LINE Jon D. Kline	Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)	October 6, 2004

* Paul D. Kazilionis	Director	October 6, 2004

/ S / J ONATHAN H. P AUL Jonathan H. Paul	Director	October 6, 2004

*	By Jon D. Kline, as attorney-in-fact pursuant to written power of attorney.

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**		Form of Opinion of Venable LLP.
8.1		Form of 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		Commitment Letter for $150,000,000 Senior Secured Revolving Credit Facility and $75,000,000 Subordinate Term Loan Facility, dated September 14, 2004, among Citigroup Global Markets Inc., Citicorp North America, Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Merrill Lynch Capital Corporation, Morgan Stanley Senior Funding, Inc., and Sunstone Hotel Investors, L.L.C.
10.13**		Form of Investors Agreement among Sunstone Hotel Investors, Inc. and the persons named therein.
10.14		Form of Senior Management Incentive Plan of Sunstone Hotel Investors, Inc.
10.15		Form of Employment Agreement with Robert A. Alter.
10.16		Form of Employment Agreement with Jon D. Kline.
10.17		Form of Employment Agreement with Gary A. Stougaard.
21.1		Subsidiaries of Sunstone Hotel Investors, Inc.
23.1		Consent of Ernst & Young LLP.
23.2		Consent of PricewaterhouseCoopers LLP.

II-6


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 to Amendment No. 1 to Registration Statement on Form S-11).
99.1**		Consent of Paul D. Kazilionis.
99.2**		Consent of Jonathan H. Paul.
99.3		Consent of Lewis N. Wolff.
99.4		Consent of Z. Jamie Behar.
99.5		Consent of Barbara S. Brown.
99.6		Consent of Anthony W. Dona.
99.7		Consent of David M. Siegel.
99.8		Consent of Keith P. Russell.

*	To be filed by amendment

**	Previously filed

II-7

EXHIBIT 4.1


COMMON STOCK				COMMON STOCK
Number SHO-				Shares
				CUSIP 867892 10 1
INCORPORATED UNDER THE LAWS OF THE STATE OF MARYLAND				SEE REVERSE FOR IMPORTANT NOTICE ON TRANSFER RESTRICTIONS AND OTHER INFORMATION

THIS CERTIFIES THAT

is the owner of

FULLY PAID AND NONASSESSABLE SHARES OF COMMON STOCK, $.01 PAR VALUE, PER SHARE OF

SUNSTONE HOTEL INVESTORS, INC.

(the “Corporation”) transferable on the books of the Corporation by the holder hereof in person or by its duly authorized attorney upon the surrender of this certificate properly endorsed. This Certificate and the shares represented hereby are issued and shall be held subject to all of the provisions of the charter of the Corporation (the “Charter”) and the Bylaws of the Corporation and any amendments thereto. This certificate is not valid until countersigned by the Transfer Agent and registered by the Registrar.


[SEAL]	Dated:

		/s/ J ON D. K LINE	/s/ R OBERT A. A LTER
		Secretary	President and Chief Executive Officer


COUNTERSIGNED AND REGISTERED: AMERICAN STOCK TRANSFER & TRUST COMPANY TRANSFER AGENT AND REGISTRAR,

BY
		AUTHORIZED SIGNATURE

SUNSTONE HOTEL INVESTORS, INC.

IMPORTANT NOTICE

The Corporation will furnish to any stockholder, on request and without charge, a full statement of the information required by Section 2-211(b) of the Corporations and Associations Article of the Annotated Code of Maryland with respect to 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 the stock of each class which the Corporation has authority to issue and, if the Corporation is authorized to issue any preferred or special class in series, (i) the differences in the relative rights and preferences between the shares of each series to the extent set, and (ii) the authority of the Board of Directors to set such rights and preferences of subsequent series. The foregoing summary does not purport to be complete and is subject to and qualified in its entirety by reference to the Charter, a copy of which will be sent without charge to each stockholder who so requests. Such request must be made to the Secretary of the Corporation at its principal office or to the Transfer Agent.

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.

The following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations:


TEN COM-	as tenants in common	UNIF GIFT MIN ACT-		Custodian

TEN ENT-	as tenants by the entireties		(Cust)		(Minor)

JT TEN-	as joint tenants with right of survivorship and not as tenants in common		under Uniform Gifts to Minors
			Act
			(State)
		UNIF TRF MIN ACT-		Custodian (until age )
			(Cust)

					under Uniform Transfers
			(Minor)
			to Minors Act
			(State)

Additional abbreviations may also be used though not in the above list.

For Value received, hereby sell, assign and transfer unto

PLEASE INSERT SOCIAL SECURITY OR

OTHER IDENTIFYING NUMBER OF ASSIGNEE

PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE

Shares of the Common Stock represented by the within Certificate, and do(es) hereby irrevocably constitute and appoint

Attorney to transfer the said stock on the books of the within named Corporation with full power of substitution in the premises.


	X

Dated	X
	NOTICE:	THE SIGNATURE(S) TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME(S) AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATEVER.

Signature(s) Guaranteed:




By
		THE SIGNATURE(S) MUST BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15.

KEEP THIS CERTIFICATE IN A SAFE PLACE. IF IT IS LOST, STOLEN OR DESTROYED, THE CORPORATION WILL REQUIRE A BOND OF INDEMNITY AS A CONDITION TO THE ISSUANCE OF A REPLACEMENT CERTIFICATE.

EXHIBIT 8.1

October , 2004

Sunstone Hotel Investors, Inc.,

903 Calle Amenecer, Suite 100,

San Clemente, California 92673.

Ladies and Gentlemen:

We have acted as your counsel in connection with the registration of up to shares of common stock, par value $ 0.01 per share, of Sunstone Hotel Investors, Inc. (“Sunstone”), on the Registration Statement on Form S-11 under the Securities Act of 1933, as amended (the “Registration Statement”). We hereby confirm our opinion set forth in the Registration Statement under the caption “U.S. Federal Income Tax Considerations.”

For purposes of this opinion, we have reviewed documents and matters of law and fact as we have considered necessary or appropriate, and we have assumed, with your consent, that the factual representations contained in the letters of representation from Sunstone to us dated September , 2004 will be true and complete on the effective date without regard to any qualifications with respect to knowledge, belief or intention that may be set forth therein or elsewhere.

We hereby expressly consent to the discussion of the tax consequences included in the Registration Statement and the filing with the Securities and Exchange Commission of this letter as an exhibit to the Registration Statement. In giving such consent, we do not thereby admit that we are within the category of persons whose consent is required under Section 7 of the Securities Act.

Very truly yours,

EXHIBIT 10.9

SUNSTONE HOTEL INVESTORS, INC.

2004 LONG-TERM INCENTIVE PLAN

Table of Contents


ARTICLE I

GENERAL

1.1	Purpose	1
1.2	Definitions of Certain Terms	1
1.3	Administration	2
1.4	Persons Eligible for Awards	4
1.5	Types of Awards Under the Plan	4
1.6	Shares Available for Awards	4

ARTICLE II

AWARDS UNDER THE PLAN

2.1	Award Agreements	5
2.2	No Rights as a Shareholder	5
2.3	Grant of Stock Options, Stock Appreciation Rights and Additional Options	5
2.4	Exercise of Stock Options and Stock Appreciation Rights	6
2.5	Cancellation and Termination of Stock Options and Stock Appreciation Rights	7
2.6	Termination of Employment	8
2.7	Grant of Restricted Stock	8
2.8	Grant of Restricted Stock Units	9
2.9	Grant of Performance Shares and Share Units	9
2.10	Other Stock-Based Awards	10
2.11	Grant of Dividend Equivalent Rights	10

ARTICLE III

MISCELLANEOUS

3.1	Amendment of the Plan; Modification of Awards	10
3.2	Tax Withholding	11
3.3	Restrictions	11
3.4	Nonassignability	12
3.5	Requirement of Notification of Election Under Section 83(b) of the Code	12
3.6	Requirement of Notification Upon Disqualifying Disposition Under Section 421(b) of the Code	12


3.7	Change in Control	13
3.8	No Right to Employment	16
3.9	Nature of Payments	16
3.10	Non-Uniform Determinations	16
3.11	Other Payments or Awards	16
3.12	Section Headings	17
3.13	Effective Date and Term of Plan	17
3.14	Governing Law	17
3.15	Severability; Entire Agreement	17
3.16	No Third Party Beneficiaries	17
3.17	Successors and Assigns	17

ARTICLE I

GENERAL

1.1

Purpose

The purpose of the Sunstone Hotel Investors, Inc. 2004 Long-Term Incentive Plan (the “ Plan ”) is to provide an incentive for officers, other employees, prospective employees and directors of, and consultants to, Sunstone Hotel Investors, Inc. (the “ Company ”) and its subsidiaries and affiliates to acquire a proprietary interest in the success of the Company, to enhance the long-term performance of the Company and to remain in the service of the Company and its subsidiaries and affiliates.

1.2

Definitions of Certain Terms

(a) “ Award ” means an award under the Plan as described in Section 1.5 and Article II.

(b) “ Award Agreement ” means a written agreement entered into between the Company and a Grantee in connection with an Award.

(d) “ Code ” means the Internal Revenue Code of 1986, as amended.

(e) “ Committee ” means the Compensation Committee of the Board and shall consist of not less than two directors. However, if a member of the Compensation Committee is not an “outside director” within the meaning of Section 162(m) of the Code or is not a “non-employee director” within the meaning of Rule 16b-3 under the Exchange Act, the Compensation Committee may from time to time delegate some or all of its functions under the Plan to a committee or subcommittee composed of members that meet the relevant requirements. The term “Committee” includes any such committee or subcommittee, to the extent of the Compensation Committee’s delegation.

(f) “ Common Stock ” means the common stock of the Company.

(g) “ Exchange Act ” means the Securities Exchange Act of 1934, as amended.

(h) The “ Fair Market Value ” of a share of Common Stock on any date shall be (i) the closing sale price per share of Common Stock during normal trading hours on the national securities exchange on which the Common Stock is principally traded for such date or the last preceding date on which there was a sale of such Common Stock on such exchange or (ii) if the shares of Common Stock are then traded in an over-the-counter market, the average of the closing bid and asked prices for the shares of Common Stock during normal trading hours in such over-the-counter market for such date or the last preceding date on which there was a sale of such Common Stock in such market, or (iii) if the shares of Common Stock are not then listed

on a national securities exchange or traded in an over-the-counter market, such value as the Committee, in its sole discretion, shall determine.

(i) “ Grantee ” means a person who receives an Award.

(j) “ Incentive Stock Option ” means a stock option that is intended to qualify for special federal income tax treatment pursuant to Sections 421 and 422 of the Code (or a successor provision thereof) and which is so designated in the applicable Award Agreement. Under no circumstances shall any stock option that is not specifically designated as an Incentive Stock Option be considered an Incentive Stock Option.

(k) “ IPO Date ” means the date on which there is an initial public offering of the Company’s shares of Common Stock.

(l) “ Key Persons ” means directors, officers and other employees (including prospective employees) of the Company or of a Related Entity, and consultants and advisors to the Company or a Related Entity.

(m) “ Option Exercise Price ” means the amount payable by a Grantee on the exercise of a stock option.

(n) “ Related Entity ” means any parent or subsidiary corporation of the Company or any business, corporation, partnership, limited liability company or other entity in which the Company or a parent or a subsidiary corporation holds a controlling ownership interest, directly or indirectly.

(o) “ Rule 16b-3 ” means Rule 16b-3 under the Exchange Act.

(p) Unless otherwise determined by the Committee, a Grantee shall be deemed to have a “ Termination of Employment ” upon ceasing employment with the Company and all Related Entities (or, in the case of a Grantee who is not an employee, upon ceasing association with the Company and all Related Entities as a director, consultant or otherwise). The Committee in its discretion may determine (i) whether any leave of absence constitutes a Termination of Employment for purposes of the Plan, (ii) the impact, if any, of any such leave of absence on Awards theretofore made under the Plan, and (iii) when a change in a Grantee’s association with the Company constitutes a Termination of Employment for purposes of the Plan. The Committee may also determine whether a Grantee’s Termination of Employment is for cause and the date of termination in such case.

1.3

Administration

(a) The Plan shall be administered by the Committee, which shall consist of not less than two directors.

(b) The Committee or a subcommittee thereof (which hereinafter shall also be referred to as the Committee) shall have the authority (i) to exercise all of the powers granted to it under the Plan, (ii) to construe, interpret and implement the Plan and any Award Agreements,

(iii) to prescribe, amend and rescind rules and regulations relating to the Plan, including rules governing its own operations, (iv) to make all determinations necessary or advisable in administering the Plan, (v) to correct any defect, supply any omission and reconcile any inconsistency in the Plan, (vi) to amend the Plan to reflect changes in applicable law, (vii) to determine whether, to what extent and under what circumstances Awards may be settled or exercised in cash, shares of Common Stock, other securities, other Awards or other property, or canceled, forfeited or suspended and the method or methods by which Awards may be settled, canceled, forfeited or suspended, and (viii) to determine whether, to what extent and under what circumstances cash, shares of Common Stock, other securities, other Awards or other property and other amounts payable with respect to an Award shall be deferred either automatically or at the election of the holder thereof or of the Committee.

(c) Actions of the Committee shall be taken by the vote of a majority of its members. Any action may be taken by a written instrument signed by a majority of the Committee members, and action so taken shall be fully as effective as if it had been taken by a vote at a meeting.

(d) The determination of the Committee on all matters relating to the Plan or any Award Agreement shall be final, binding and conclusive.

(e) No member of the Board or the Committee or any employee of the Company or any of its subsidiaries or affiliates (each such person a “ Covered Person ”) shall have any liability to any person (including, without limitation, any Participant) for any action taken or omitted to be taken or any determination made in good faith with respect to the Plan or any Award. Each Covered Person shall be indemnified and held harmless by the Company against and from any loss, cost, liability or expense (including attorneys’ fees) that may be imposed upon or incurred by such Covered Person in connection with or resulting from any action, suit or proceeding to which such Covered Person may be a party or in which such Covered Person may be involved by reason of any action taken or omitted to be taken under the Plan and against and from any and all amounts paid by such Covered Person, with the Company’s approval, in settlement thereof, or paid by such Covered Person in satisfaction of any judgment in any such action, suit or proceeding against such Covered Person, provided that the Company shall have the right, at its own expense, to assume and defend any such action, suit or proceeding and, once the Company gives notice of its intent to assume the defense, the Company shall have sole control over such defense with counsel of the Company’s choice. The foregoing right of indemnification shall not be available to a Covered Person to the extent that a court of competent jurisdiction in a final judgment or other final adjudication, in either case, not subject to further appeal, determines that the acts or omissions of such Covered Person giving rise to the indemnification claim resulted from such Covered Person’s bad faith, fraud or willful criminal act or omission. The foregoing right of indemnification shall not be exclusive of any other rights of indemnification to which Covered Persons may be entitled under the Company’s Certificate of Incorporation or Bylaws, as a matter of law, or otherwise, or any other power that the Company may have to indemnify such persons or hold them harmless.

(f) Notwithstanding anything to the contrary contained herein: (i) until the Board shall appoint the members of the Committee, the Plan shall be administered by the Board

and (ii) the Board may, in its sole discretion, at any time and from time to time, grant Awards or resolve to administer the Plan. In either of the foregoing events, the Board shall have all of the authority and responsibility granted to the Committee herein.

1.4

Persons Eligible for Awards

Awards under the Plan may be made to such Key Persons as the Committee shall select in its discretion.

1.5

Types of Awards Under the Plan

Awards may be made under the Plan in the form of stock options, including Incentive Stock Options, stock appreciation rights, restricted stock, restricted stock units, performance shares and share units and other stock-based Awards, as set forth in Article II.

1.6

Shares Available for Awards

(a) Total shares available . The total number of shares of Common Stock, which may be transferred pursuant to Awards granted under the Plan shall not exceed two million (2,000,000) shares. Such shares may be authorized but unissued Common Stock or authorized and issued Common Stock held in the Company’s treasury or acquired by the Company for the purposes of the Plan. The Committee may direct that any stock certificate evidencing shares issued pursuant to the Plan shall bear a legend setting forth such restrictions on transferability as may apply to such shares pursuant to the Plan. If any Award is forfeited or otherwise terminates or is canceled without the delivery of shares of Common Stock, shares of Common Stock are surrendered or withheld from any Award to satisfy a Grantee’s income tax withholding obligations, or shares of Common Stock owned by a Grantee are tendered to pay the exercise price of options granted under the Plan, then the shares covered by such forfeited, terminated or canceled Award or which are equal to the number of shares surrendered, withheld or tendered shall again become available for transfer pursuant to Awards granted or to be granted under this Plan. Any shares of Common Stock delivered by the Company, any shares of Common Stock with respect to which Awards are made by the Company and any shares of Common Stock with respect to which the Company becomes obligated to make Awards, through the assumption of, or in substitution for, outstanding awards previously granted by an acquired entity, shall not be counted against the shares available for Awards under this Plan.

(b) Adjustments . The number of shares of Common Stock covered by each outstanding Award, the number of shares available for Awards and the price per share of Common Stock covered by each such outstanding Award shall be proportionately adjusted, as determined in the sole discretion of the Committee, for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, recapitalization, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company or to reflect any distributions to holders of Common Stock other than regular cash dividends; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been “effected without receipt of consideration.” Except as expressly provided herein, no issuance by the Company of shares of stock of any class,

or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Award. After any adjustment made pursuant to this paragraph, the number of shares subject to each outstanding Award shall be rounded to the nearest whole number.

ARTICLE II

AWARDS UNDER THE PLAN

2.1

Award Agreements

Each Award granted under the Plan shall be evidenced by an Award Agreement which shall contain such provisions as the Committee in its discretion deems necessary or desirable. The Committee may grant Awards in tandem with or in substitution for any other Award or Awards granted under this Plan or any award granted under any other plan of the Company. ¹ Payments or transfers to be made by the Company upon the grant, exercise or payment of an Award may be made in such form as the Committee shall determine, including cash, shares of Common Stock, other securities, other Awards or other property and may be made in a single payment or transfer, in installments or on a deferred basis. A Grantee shall have no rights with respect to an Award unless such Grantee accepts the Award within such period as the Committee shall specify by executing an Award Agreement in such form as the Committee shall determine and, if the Committee shall so require, makes payment to the Company in such amount as the Committee may determine.

2.2

No Rights as a Shareholder

No Grantee of an Award (or other person having rights pursuant to such Award) shall have any of the rights of a shareholder of the Company with respect to shares subject to such Award until the issuance of a stock certificate to such person for such shares. Except as otherwise provided in Section 1.6(b), no adjustment shall be made for dividends, distributions or other rights (whether ordinary or extraordinary, and whether in cash, securities or other property) for which the record date is prior to the date such stock certificate is issued.

2.3

Grant of Stock Options, Stock Appreciation Rights and Additional Options

(a) The Committee may grant stock options, including Incentive Stock Options to purchase shares of Common Stock from the Company, to such Key Persons, in such amounts and subject to such terms and conditions, as the Committee shall determine in its discretion.

Note, grants of performance awards intended to comply with Section 162(m) should be granted under a separate Company plan (in order to avoid having to get shareholder approval every 5 years for this Plan). However, the actual delivery of Shares under such Section 162(m) plan may be made under this Plan.

(b) The Committee may grant stock appreciation rights to such Key Persons, in such amounts and subject to such terms and conditions, as the Committee shall determine in its discretion. Stock appreciation rights may be granted in connection with all or any part of, or independently of, any stock option granted under the Plan. A stock appreciation right may be granted at or after the time of grant of such option.

(c) The Grantee of a stock appreciation right shall have the right, subject to the terms of the Plan and the applicable Award Agreement, to receive from the Company an amount equal to (i) the excess of the Fair Market Value of a share of Common Stock on the date of exercise of the stock appreciation right over (ii) the exercise price of such right as set forth in the Award Agreement (or over the option exercise price if the stock appreciation right is granted in connection with a stock option), multiplied by (iii) the number of shares with respect to which the stock appreciation right is exercised. Payment to the Grantee upon exercise of a stock appreciation right shall be made in cash or in shares of Common Stock (valued at their Fair Market Value on the date of exercise of the stock appreciation right) or both, as the Committee shall determine in its discretion. Upon the exercise of a stock appreciation right granted in connection with a stock option, the number of shares subject to the option shall be correspondingly reduced by the number of shares with respect to which the stock appreciation right is exercised. Upon the exercise of a stock option in connection with which a stock appreciation right has been granted, the number of shares subject to the stock appreciation right shall be correspondingly reduced by the number of shares with respect to which the option is exercised.

(d) Each Award Agreement with respect to a stock option shall set forth the Option Exercise Price, which shall be at least 100% of the Fair Market Value of a share of Common Stock on the date the option is granted (except as permitted in connection with the assumption or issuance of options in a transaction to which Section 424(a) of the Code applies).

(e) Each Award Agreement with respect to a stock option or stock appreciation right shall set forth the periods during which the Award evidenced thereby shall be exercisable, whether in whole or in part. Such periods shall be determined by the Committee in its discretion; provided , however , that no Incentive Stock Option (or a stock appreciation right granted in connection with an Incentive Stock Option) shall be exercisable more than ten (10) years after the date of grant.

(f) To the extent that the aggregate Fair Market Value (determined as of the time the option is granted) of the stock with respect to which Incentive Stock Options granted under this Plan and all other plans of the Company are first exercisable by any Grantee during any calendar year shall exceed the maximum limit (currently, $100,000), if any, imposed from time to time under Section 422 of the Code, such options shall be treated as nonqualified stock options.

2.4

Exercise of Stock Options and Stock Appreciation Rights

Each stock option or stock appreciation right granted under the Plan shall be exercisable as follows:

(a) A stock option or stock appreciation right shall become exercisable at such time or times as determined by the Committee.

(b) Unless the applicable Award Agreement otherwise provides, a stock option or stock appreciation right may be exercised from time to time as to all or part of the shares as to which such Award is then exercisable (but, in any event, only for whole shares). A stock appreciation right granted in connection with an option may be exercised at any time when, and to the same extent that, the related option may be exercised. A stock option or stock appreciation right shall be exercised by written notice to the Company, on such form and in such manner as the Committee shall prescribe.

(c) Any written notice of exercise of a stock option shall be accompanied by payment of the Option Exercise Price for the shares being purchased. Such payment shall be made (i) in cash (by certified check or as otherwise permitted by the Committee), or (ii) to the extent specified in the Award Agreement (A) by delivery of shares of Common Stock (which, if acquired pursuant to the exercise of a stock option or under an Award made under this Plan or any other compensatory plan of the Company, were acquired at least six (6) months prior to the option exercise date) having a Fair Market Value (determined as of the exercise date) equal to all or part of the Option Exercise Price and cash for any remaining portion of the Option Exercise Price, or (B) to the extent permitted by law, by such other method as the Committee may from time to time prescribe, including a cashless exercise procedure through a broker-dealer.

(d) Promptly after receiving payment of the full Option Exercise Price, or after receiving notice of the exercise of a stock appreciation right for which payment will be made partly or entirely in shares of Common Stock, the Company shall, subject to the provisions of Section 3.3 (relating to certain restrictions), deliver to the Grantee or to such other person as may then have the right to exercise the Award, a certificate or certificates for the shares of Common Stock for which the Award has been exercised. If the method of payment employed upon option exercise so requires, and if applicable law permits, a Grantee may direct the Company to deliver the certificate(s) to the Grantee’s broker-dealer.

2.5

Cancellation and Termination of Stock Options and Stock Appreciation Rights

The Committee may, at any time and in its sole discretion, determine that any outstanding stock options and stock appreciation rights granted under the Plan, whether or not exercisable, will be canceled and terminated and that in connection with such cancellation and termination the holder of such options (and stock appreciation rights not granted in connection with an option) may receive for each share of Common Stock subject to such Award a cash payment (or the delivery of shares of stock, other securities or a combination of cash, stock and securities equivalent to such cash payment) equal to the difference, if any, between the amount determined by the Committee to be the fair market value of the Common Stock and the exercise price per share multiplied by the number of shares of Common Stock subject to such Award; provided that if such product is zero or less or to the extent that the Award is not then exercisable, the stock options and stock appreciation rights will be canceled and terminated without payment therefor.

2.6

Termination of Employment

(a) Except to the extent otherwise provided in paragraphs (b) and (c) below or in the applicable Award Agreement, all stock options and stock appreciation rights not theretofore exercised shall terminate upon the Grantee’s Termination of Employment for any reason.

(b) If a Grantee’s Termination of Employment is for any reason other than death or dismissal for cause, the Grantee may exercise any outstanding stock option or stock appreciation right on the following terms and conditions: (i) exercise may be made only to the extent that the Grantee was entitled to exercise the Award on the date of the Termination of Employment; and (ii) exercise must occur within ninety (90) days after the Termination of Employment, except that this ninety (90) day period shall be increased to one (1) year if the Termination of Employment is by reason of disability, but in no event after the expiration date of the Award as set forth in the Award Agreement. In the case of an Incentive Stock Option, the term “disability” for purposes of the preceding sentence shall have the meaning given to it by Section 422(c)(6) of the Code.

(c) If a Grantee dies while employed by the Company or a Related Entity, or after a Termination of Employment but during the period in which the Grantee’s stock options or stock appreciation rights are exercisable pursuant to paragraph (b) above, any outstanding stock option or stock appreciation right shall be exercisable on the following terms and conditions: (i) exercise may be made only to the extent that the Grantee was entitled to exercise the Award on the date of death and (ii) exercise must occur by the earlier of the first anniversary of the Grantee’s death or the expiration date of the Award. Any such exercise of an Award following a Grantee’s death shall be made only by the Grantee’s executor or administrator, unless the Grantee’s will specifically disposes of such Award, in which case such exercise shall be made only by the recipient of such specific disposition. If a Grantee’s personal representative or the recipient of a specific disposition under the Grantee’s will shall be entitled to exercise any Award pursuant to the preceding sentence, such representative or recipient shall be bound by all the terms and conditions of the Plan and the applicable Award Agreement which would have applied to the Grantee.

2.7

Grant of Restricted Stock

(a) The Committee may grant restricted shares of Common Stock to such Key Persons, in such amounts, and subject to such terms and conditions as the Committee shall determine in its discretion, subject to the provisions of the Plan. Restricted stock Awards may be made independently of or in connection with any other Award.

(b) The Company shall issue in the Grantee’s name a certificate or certificates for the shares of Common Stock covered by the Award. Upon the issuance of such certificate(s), the Grantee shall have the rights of a shareholder with respect to the restricted stock, subject to the transfer restrictions and the Company repurchase rights described in paragraphs (d) and (e) below and to such other restrictions and conditions as the Committee in its discretion may include in the applicable Award Agreement.

(c) Unless the Committee shall otherwise determine, any certificate issued evidencing shares of restricted stock shall remain in the possession of the Company until such shares are free of any restrictions specified in the applicable Award Agreement.

(d) Shares of restricted stock may not be sold, assigned, transferred, pledged or otherwise encumbered or disposed of except as specifically provided in this Plan or the applicable Award Agreement. The Committee at the time of grant shall specify the date or dates (which may depend upon or be related to the attainment of performance goals and other conditions) on which the nontransferability of the restricted stock shall lapse. Unless the applicable Award Agreement provides otherwise, additional shares of Common Stock or other property distributed to the Grantee in respect of shares of restricted stock, as dividends or otherwise, shall be subject to the same restrictions applicable to such restricted stock.

(e) During the ninety (90) days following the Grantee’s Termination of Employment for any reason, the Company shall have the right to require the return of any shares to which restrictions on transferability apply, in exchange for which the Company shall repay to the Grantee (or the Grantee’s estate) in cash any amount paid by the Grantee for such shares.

2.8

Grant of Restricted Stock Units

(a) The Committee may grant Awards of restricted stock units to such Key Persons, in such amounts, and subject to such terms and conditions as the Committee shall determine in its discretion, subject to the provisions of the Plan. Restricted stock units may be awarded independently of or in connection with any other Award under the Plan.

(b) At the time of grant, the Committee shall specify the date or dates on which the restricted stock units shall become vested, and may specify such conditions to vesting as it deems appropriate. Unless otherwise determined by the Committee, in the event of the Grantee’s Termination of Employment for any reason, restricted stock units that have not vested shall be forfeited and canceled. The Committee at any time may accelerate vesting dates and otherwise waive or amend any conditions of an Award of restricted stock units.

(c) At the time of grant, the Committee shall specify the maturity date applicable to each grant of restricted stock units, which may be determined at the election of the Grantee. Such date may be later than the vesting date or dates of the Award. On the maturity date, the Company shall transfer to the Grantee one unrestricted, fully transferable share of Common Stock for each vested restricted stock unit scheduled to be paid out on such date and as to which all other conditions to the transfer have been fully satisfied. The Committee shall specify the purchase price, if any, to be paid by the Grantee to the Company for such shares of Common Stock.

2.9

Grant of Performance Shares and Share Units

The Committee may grant performance shares in the form of actual shares of Common Stock or share units having a value equal to an identical number of shares of Common Stock to such Key Persons, in such amounts, and subject to such terms and conditions as the Committee shall determine in its discretion, subject to the provisions of the Plan. In the event

that a stock certificate is issued in respect of performance shares, such certificates shall be registered in the name of the Grantee but shall be held by the Company until the time the performance shares are earned. The performance conditions and the length of the performance period shall be determined by the Committee. The Committee shall determine in its sole discretion whether performance shares granted in the form of share units shall be paid in cash, Common Stock, or a combination of cash and Common Stock.

2.10

Other Stock-Based Awards

The Committee may grant other types of stock-based Awards to such Key Persons, in such amounts and subject to such terms and conditions, as the Committee shall in its discretion determine, subject to the provisions of the Plan. Such Awards may entail the transfer of actual shares of Common Stock, or payment in cash or otherwise of amounts based on the value of shares of Common Stock.

2.11

Grant of Dividend Equivalent Rights

The Committee may in its discretion include in the Award Agreement with respect to any Award a dividend equivalent right entitling the Grantee to receive amounts equal to the ordinary dividends that would be paid, during the time such Award is outstanding and unexercised, on the shares of Common Stock covered by such Award if such shares were then outstanding. In the event such a provision is included in an Award Agreement, the Committee shall determine whether such payments shall be made in cash, in shares of Common Stock or in another form, whether they shall be conditioned upon the exercise or vesting of the Award to which they relate, the time or times at which they shall be made, and such other terms and conditions as the Committee shall deem appropriate.

ARTICLE III

MISCELLANEOUS

3.1

Amendment of the Plan; Modification of Awards

(a) The Board may from time to time suspend, discontinue, revise or amend the Plan in any respect whatsoever, except that no such amendment shall materially impair any rights or materially increase any obligations of the Grantee under any Award theretofore made under the Plan without the consent of the Grantee (or, after the Grantee’s death, the person having the right to exercise or receive payment of the Award). For purposes of the Plan, any action of the Board or the Committee that alters or affects the tax treatment of any Award shall not be considered to materially impair any rights of any Grantee.

(b) Shareholder approval of any amendment shall be obtained to the extent necessary to comply with Section 422 of the Code (relating to Incentive Stock Options) or any other applicable law, regulation or stock exchange listing requirements.

(c) The Committee may amend any outstanding Award Agreement, including, without limitation, by amendment which would accelerate the time or times at which the Award

becomes unrestricted or may be exercised, or waive or amend any goals, restrictions or conditions set forth in the Award Agreement. However, any such amendment (other than an amendment pursuant to paragraphs (a) or (d) of this Section or an amendment to effect an assumption or other action consistent with Section 3.7(b)) that materially impairs the rights or materially increases the obligations of a Grantee under an outstanding Award shall be made only with the consent of the Grantee (or, upon the Grantee’s death, the person having the right to exercise the Award).

(d) Notwithstanding anything to the contrary in this Section, the Board or the Committee shall have full discretion to amend the Plan to the extent necessary to preserve fixed accounting treatment with respect to any Award and any outstanding Award Agreement shall be deemed to be so amended to the same extent, without obtaining the consent of any Grantee (or, after the Grantee’s death, the person having the right to exercise or receive payment of the affected Award), without regard to whether such amendment adversely affects a Grantee’s rights under the Plan or such Award Agreement.

3.2

Tax Withholding

(a) As a condition to the receipt of any shares of Common Stock pursuant to any Award or the lifting of restrictions on any Award, or in connection with any other event that gives rise to a federal or other governmental tax withholding obligation on the part of the Company relating to an Award (including, without limitation, FICA tax), the Company will require that the Grantee remit to the Company an amount sufficient in the opinion of the Company to satisfy such withholding obligation.

(b) If the event giving rise to the withholding obligation is a transfer of shares of Common Stock, then, to the extent specified in the applicable Award Agreement and unless otherwise permitted by the Committee, the Grantee may satisfy only the minimum statutory withholding obligation imposed under paragraph (a) by electing to have the Company withhold shares of Common Stock having a Fair Market Value equal to the amount of tax to be withheld. For this purpose, Fair Market Value shall be determined as of the date on which the amount of tax to be withheld is determined (and any fractional share amount shall be settled in cash).

3.3

Restrictions

(a) If the Committee shall at any time determine that any consent (as hereinafter defined) is necessary or desirable as a condition of, or in connection with, the granting of any Award, the issuance or purchase of shares of Common Stock or other rights thereunder, or the taking of any other action thereunder (a “ Plan Action ”), then no such Plan Action shall be taken, in whole or in part, unless and until such consent shall have been effected or obtained to the full satisfaction of the Committee.

(b) The term “ consent ” as used herein with respect to any action referred to in paragraph (a) means (i) any and all listings, registrations or qualifications in respect thereof upon any securities exchange or under any federal, state or local law, rule or regulation, (ii) any and all written agreements and representations by the Grantee with respect to the disposition of shares, or with respect to any other matter, which the Committee shall deem necessary or desirable to

comply with the terms of any such listing, registration or qualification or to obtain an exemption from the requirement that any such listing, qualification or registration be made, (iii) any and all consents, clearances and approvals in respect of a Plan Action by any governmental or other regulatory bodies, and (iv) any and all consents or authorizations required to comply with, or required to be obtained under, applicable local law or otherwise required by the Committee. Nothing herein shall require the Company to list, register or qualify the shares of Common Stock on any securities exchange.

3.4

Nonassignability

Except to the extent otherwise provided in the applicable Award Agreement, no Award or right granted to any person under the Plan shall be assignable or transferable other than by will or by the laws of descent and distribution, and all such Awards and rights shall be exercisable during the life of the Grantee only by the Grantee or the Grantee’s legal representative. Notwithstanding the immediately preceding sentence, the Committee may permit a Grantee to transfer any stock option which is not an Incentive Stock Option to one or more of the Grantee’s immediate family members or to trusts established in whole or in part for the benefit of the Grantee and/or one or more of such immediate family members. For purposes of the Plan, (i) the term “ immediate family ” shall mean the Grantee’s spouse and issue (including adopted and step children) and (ii) the phrase “immediate family members or to trusts established in whole or in part for the benefit of the Grantee and/or one or more of such immediate family members” shall be further limited, if necessary, so that neither the transfer of a nonqualified stock option to such immediate family member or trust, nor the ability of a Grantee to make such a transfer shall have adverse consequences to the Company or the Grantee by reason of Section 162(m) of the Code.

3.5

Requirement of Notification of Election Under Section 83(b) of the Code

If a Grantee, in connection with the acquisition of shares of Common Stock under the Plan, is permitted under the terms of the Award Agreement to make the election permitted under Section 83(b) of the Code ( i.e. , an election to include in gross income in the year of transfer the amounts specified in Section 83(b) of the Code notwithstanding the continuing transfer restrictions) and the Grantee makes such an election, the Grantee shall notify the Company of such election within ten (10) days of filing notice of the election with the Internal Revenue Service, in addition to any filing and notification required pursuant to regulations issued under Section 83(b) of the Code.

3.6

Requirement of Notification Upon Disqualifying Disposition Under Section 421(b) of the Code

If any Grantee shall make any disposition of shares of Common Stock issued pursuant to the exercise of an Incentive Stock Option under the circumstances described in Section 421(b) of the Code (relating to certain disqualifying dispositions), such Grantee shall notify the Company of such disposition within ten (10) days thereof.

3.7

Change in Contro l

(a) A “ Change in Control ” means the occurrence of any one of the following events:

(i) any person is or becomes a “ beneficial owner ” (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing more than 50% of the total voting power of the Company’s then outstanding securities generally eligible to vote for the election of directors (the “ Company Voting Securities ”); provided , however , that any of the following acquisitions shall not be deemed to be a Change in Control: (1) by the Company or any subsidiary or affiliate, (2) by any employee benefit plan (or related trust) sponsored or maintained by the Company or any subsidiary or affiliate, (3) by any underwriter temporarily holding securities pursuant to an offering of such securities, or (4) pursuant to a Non-Qualifying Transaction (as defined in paragraph (ii));

(ii) the consummation of a merger, consolidation, statutory share exchange or similar form of corporate transaction involving the Company or any of its subsidiaries or affiliates that requires the approval of the Company’s stockholders whether for such transaction or the issuance of securities in the transaction (a “ Business Combination ”), unless immediately following such Business Combination:

(A) more than 50% of the total voting power of (x) the corporation resulting from such Business Combination (the “ Surviving Corporation ”), or (y) if applicable, the ultimate parent corporation that directly or indirectly has beneficial ownership of 95% of the voting securities eligible to elect directors of the Surviving Corporation (the “ Parent Corporation ”), is represented by Company Voting Securities that were outstanding immediately prior to such Business Combination (or, if applicable, is represented by shares into which such Company Voting Securities were converted pursuant to such Business Combination), and such voting power among the holders thereof is in substantially the same proportion as the voting power of such Company Voting Securities among the holders thereof immediately prior to the Business Combination,

(B) no person (other than any employee benefit plan (or any related trust) sponsored or maintained by the Surviving Corporation or the Parent Corporation), is or becomes the beneficial owner, directly or indirectly, of securities of the Parent Corporation (or, if there is no Parent Corporation, the Surviving Corporation) representing 50% of the total voting power of the

securities then outstanding generally eligible to vote for the election of directors of the Parent Corporation (or the Surviving Corporation), and

(C) at least a majority of the members of the board of directors of the Parent Corporation (or, if there is no Parent Corporation, the Surviving Corporation) following the consummation of the Business Combination were Incumbent Directors at the time of the Board’s approval of the execution of the initial agreement providing for such Business Combination;

(any Business Combination which satisfies all of the criteria specified in (A), (B) and (C) above shall be deemed to be a “ Non-Qualifying Transaction ”);

(iii) individuals who, on the IPO Date, constitute the Board (the “ Incumbent Directors ”) cease for any reason to constitute at least a majority of the Board, provided that any person becoming a director subsequent to the IPO Date whose election or nomination for election was approved by a vote of at least two-thirds of the Incumbent Directors then on the Board (either by a specific vote or by approval of the proxy statement of the Company in which such person is named as a nominee for director, without written objection to such nomination) shall be an Incumbent director; provided , however , that no individual initially elected or nominated as a director of the Company as a result of an actual or threatened election contest with respect to directors or as a result of any other actual or threatened solicitation of proxies or consents by or on behalf of any person other than the Board shall be deemed to be an Incumbent Director;

(iv) the shareholders of the Company approve a plan of complete liquidation or dissolution of the Company; or

(v) the consummation of a sale of all or substantially all of the Company’s assets to an entity that is not an affiliate of the Company (other than pursuant to a Non-Qualifying Transaction).

Notwithstanding the foregoing, a Change in Control of the Company shall not be deemed to occur solely because any person acquires beneficial ownership of more than 50% of Company Voting Securities as a result of the acquisition of Company Voting Securities by the Company which reduces the number of Company Voting Securities outstanding; provided , that if after such acquisition by the Company such person becomes the beneficial owner of additional Company Voting Securities that increases the percentage of outstanding Company Voting Securities beneficially owned by such person, a Change in Control of the Company shall then occur.

(b) Upon the occurrence of a Change in Control specified in paragraph (a)(i) or (a)(iii) above and immediately prior to the occurrence of a Change in Control specified in

paragraph (a)(ii) or (a)(v) above, unless the applicable Award Agreement expressly provides otherwise, Awards shall Fully Vest.

(c) Upon the occurrence of a Change in Control specified in paragraph (a)(iv) above, all outstanding Awards will terminate upon consummation of the liquidation or dissolution of the Company. The Committee may, in the exercise of its sole discretion in such instances, (i) provide that Awards shall Fully Vest as of any specified date prior to such liquidation or dissolution and/or (ii) declare that any Award shall terminate as of any specified date.

(d) The following shall occur if Awards “ Fully Vest ”: (i) any stock options and stock appreciation rights granted under the Plan shall become fully vested and immediately exercisable, (ii) any restricted stock, restricted stock units and other stock-based Awards granted under the Plan will become fully vested, any restrictions applicable to such Awards shall lapse and such Awards denominated in stock will be immediately paid out, and (iii) any performance goals applicable to Awards will be deemed to be fully satisfied.

(e) Upon the occurrence of any Change in Control or upon the occurrence of a Non-Qualifying Transaction where Awards are not assumed (or substituted) by the Surviving Corporation or Parent Corporation, the Committee may, in its sole discretion, (i) Fully Vest Awards, (ii) determine that any or all outstanding Awards granted under the Plan, whether or not exercisable, will be canceled and terminated and that in connection with such cancellation and termination the holder of such Award may receive for each share of Common Stock subject to such Awards a cash payment (or the delivery of shares of stock, other securities or a combination of cash, stock and securities equivalent to such cash payment) equal to the difference, if any, between the consideration received by shareholders of the Company in respect of a share of Common Stock in connection with such transaction and the purchase price per share, if any, under the Award multiplied by the number of shares of Common Stock subject to such Award; provided that if such product is zero or less or to the extent that the Award is not then exercisable, the Awards will be canceled and terminated without payment therefor or (iii) provide that the period to exercise stock options or stock appreciation rights granted under the Plan shall be extended (but not beyond the expiration of such option or stock appreciation right).

(f) The Committee shall determine in its sole discretion whether an Award shall be considered “ assumed ” or “ substituted ”. Without limiting the foregoing, for the purposes of Section 3.7, a stock option or stock appreciation right shall be considered “ assumed ” or “ substituted ” if in the reasonable determination of the Committee (i) the aggregate intrinsic value (the difference between the then fair market value as reasonably determined by the Committee and the exercise price per share of Common Stock multiplied by the number of shares of Common Stock subject to such award) of the assumed (or substituted) Award immediately after the Change in Control is substantially the same as the aggregate intrinsic value of such Award immediately before such transaction, (ii) the ratio of the exercise price per assumed (or substituted) Award to the fair market value per share of successor corporation stock immediately after the Change in Control is substantially the same as such ratio for such Award immediately before such transaction and (iii) the Award is exercisable for the consideration approved by the

Committee (including shares of stock, other securities or property or a combination of cash, stock, securities and other property).

(g) Where the successor corporation assumes (or substitutes for) any outstanding Awards, if within twelve (12) months of the consummation of such Change in Control, Grantee’s employment with the successor corporation is terminated by the successor corporation other than for cause or the Grantee terminates employment with the successor corporation for good reason, then all outstanding Awards owned by such Participant shall Fully Vest. For purposes hereof, the term “cause” shall have the meaning specified in the Grantee’s Award agreement or as otherwise determined by the Committee in its discretion and the term “good reason” shall have the meaning specified in the Grantee’s Award agreement or as otherwise determined by the Committee in its discretion.

3.8

No Right to Employment

Nothing in the Plan or in any Award Agreement shall confer upon any Grantee the right to continue in the employ of or association with the Company or affect any right which the Company may have to terminate such employment or association at any time (with or without cause).

3.9

Nature of Payments

Any and all grants of Awards and issuances of shares of Common Stock under the Plan shall constitute a special incentive payment to the Grantee and shall not be taken into account in computing the amount of salary or compensation of the Grantee for the purpose of determining any benefits under any pension, retirement, profit-sharing, bonus, life insurance or other benefit plan of the Company or under any agreement with the Grantee, unless such plan or agreement specifically provides otherwise.

3.10

Non-Uniform Determinations

The Committee’s determinations under the Plan need not be uniform and may be made by it selectively among persons who receive, or are eligible to receive, Awards (whether or not such persons are similarly situated). Without limiting the generality of the foregoing, the Committee shall be entitled, among other things, to make non-uniform and selective determinations, and to enter into non-uniform and selective Award Agreements, as to the persons to receive Awards under the Plan, and the terms and provisions of Awards under the Plan.

3.11

Other Payments or Awards

Nothing contained in the Plan shall be deemed in any way to limit or restrict the Company from making any Award or payment to any person under any other plan, arrangement or understanding, whether now existing or hereafter in effect.

3.12

Section Headings

The section headings contained herein are for the purpose of convenience only and are not intended to define or limit the contents of the sections.

3.13

Effective Date and Term of Plan

(a) Unless sooner terminated by the Board, the Plan, including the provisions respecting the grant of Incentive Stock Options, shall terminate the day before the tenth anniversary of the adoption of the Plan by the Board. All Awards made under the Plan prior to its termination shall remain in effect until such Awards have been satisfied or terminated in accordance with the terms and provisions of the Plan and the applicable Award Agreements.

3.14

Governing Law

All rights and obligations under the Plan shall be construed and interpreted in accordance with the laws of the State of California, without giving effect to principles of conflict of laws.

3.15

Severability; Entire Agreement

If any of the provisions of this Plan or any Award Agreement is finally held to be invalid, illegal or unenforceable (whether in whole or in part), such provision shall be deemed modified to the extent, but only to the extent, of such invalidity, illegality or unenforceability and the remaining provisions shall not be affected thereby; provided , that if any of such provisions is finally held to be invalid, illegal, or unenforceable because it exceeds the maximum scope determined to be acceptable to permit such provision to be enforceable, such provision shall be deemed to be modified to the minimum extent necessary to modify such scope in order to make such provision enforceable hereunder. The Plan and any Award Agreements contain the entire agreement of the parties with respect to the subject matter thereof and supersede all prior agreements, promises, covenants, arrangements, communications, representations and warranties between them, whether written or oral with respect to the subject matter thereof.

3.16

No Third Party Beneficiaries

Except as expressly provided therein, neither the Plan nor any Award Agreement shall confer on any person other than the Company and the grantee of any Award any rights or remedies thereunder.

3.17

Successors and Assigns

The terms of this Plan shall be binding upon and inure to the benefit of the Company and its successors and assigns.

Exhibit 10.10

LEASE AGREEMENT

BETWEEN

__________________________

AS LESSOR

AND

___________________________,

AS LESSEE

DATED AS OF , 20

TABLE OF CONTENTS


		Page

ARTICLE 1	LEASED PROPERTY; TERM	1

ARTICLE 2	DEFINITIONS	3

ARTICLE 3	RENT	14

ARTICLE 4	IMPOSITIONS	19

ARTICLE 5	ABATEMENT	21

ARTICLE 6	PERSONAL PROPERTY; LESSOR'S LIEN	22

ARTICLE 7	CONDITION OF LEASED PROPERTY; USE	23

ARTICLE 8	COMPLIANCE WITH LAWS	25

ARTICLE 9	IMPROVEMENTS; MAINTENANCE	28

ARTICLE 10	ALTERATIONS	29

ARTICLE 11	LIENS	30

ARTICLE 12	PERMITTED CONTESTS	31

ARTICLE 13	INSURANCE	31

ARTICLE 14	DAMAGE AND DESTRUCTION	33

ARTICLE 15	EMINENT DOMAIN	35

ARTICLE 16	DEFAULT; REMEDIES	36

ARTICLE 17	LESSOR'S RIGHT TO CURE	39

ARTICLE 18	REIT REQUIREMENTS	40

ARTICLE 19	COMPLIANCE WITH SPECIAL PURPOSE PROVISIONS	41

ARTICLE 20	HOLDING OVER	44

ARTICLE 21	RISK OF LOSS	44

ARTICLE 22	INDEMNIFICATION	44

ARTICLE 23	SUBLETTING AND ASSIGNMENT	45

ARTICLE 24	ESTOPPEL CERTIFICATES; FINANCIAL REPORTS	46

(i)


		Page

ARTICLE 25	LESSOR’S RIGHT TO INSPECT	47

ARTICLE 26	NO WAIVER	47

ARTICLE 27	REMEDIES CUMULATIVE	47

ARTICLE 28	ACCEPTANCE OF SURRENDER	48

ARTICLE 29	NO MERGER OF TITLE	48

ARTICLE 30	TRANSFER OF LEASED PROPERTY; SUBORDINATION	48

ARTICLE 31	QUIET ENJOYMENT	49

ARTICLE 32	NOTICES	49

ARTICLE 33	[RESERVED]	49

ARTICLE 34	LESSOR LIENS; LESSEE RIGHTS TO CURE	49

ARTICLE 35	MISCELLANEOUS	50

ARTICLE 36	MEMORANDUM OF LEASE	52

ARTICLE 37	[RESERVED]	52

ARTICLE 38	LESSOR'S OPTION TO TERMINATE UPON SALE	52

ARTICLE 39	FRANCHISE AGREEMENT	53

ARTICLE 40	ROOM SET-ASIDE; CAPITAL EXPENDITURES	53

ARTICLE 41	CHANGE IN REIT STATUS OR REIT REGULATIONS	54

ARTICLE 42	ADDITIONAL COVENANTS	54


EXHIBIT A	-	PROPERTY DESCRIPTION
EXHIBIT B	-	OPERATING LEASE RENT AND PERCENTAGE RENT AMOUNTS
[OPTIONAL] ADDENDUM TO LEASE AGREEMENT

(ii)

INDEX


		Page(s)
Accrued Rent		3
Additional Charges		17
Affiliate		3
allowances		8
Alterations		29
Annual Budget		3
Annual Revenues Computation		1
Annual Threshold		1
Award		35
Base Rate		3
Base Rent		14
Business Day		4
Cash Management Agreement		4
Cash Management System		4
CERCLA		4
Claims		31
Code		4
Commencement Date		2
Condemnation		35
Condemnor		35
Consolidated Financials		4
Consumer Price Index		4
control		3
controlled by		3
Date of Taking		35
EBITDA		54
Eligible Independent Contractor		4
Encumbrance		49
Environmental Authority		5
Environmental Authorization		5
Environmental Laws		5
Environmental Liabilities		6
Event of Default		36
Excess Monthly Deposit Credit		23
Excess Personal Property		40
Facility		6
Fair Market Rental		6
Fair Market Value		6
FIFRA		7
Fiscal Year		7
Fixtures		2
Food and Beverages Revenues		7
Franchise Agreement		7
Full Replacement Cost		32

(iii)


		Page(s)
Furniture and Equipment		2
Government		7
Gross Operating Expenses		7
Gross Operating Profit		8
Gross Revenues		8, 22
Hazardous Materials		8
Impositions		9
Indemnified Party		9
Indemnifying Party		9
Independent Director		9
Insurance Requirements		10
Inventory		10
Land		1
Lease		1
Leased Improvements		2
Leased Property		1
Legal Requirements		10
Lender		11
Lessee		1
Lessee Indemnified Party		11
Lessee’s Personal Property		22
Lessor		1
Lessor Indemnified Party		11
Licenses		51
Loan		11
Loan Agreement		11
Loan Documents		11
Management Agreement		11
Manager		11
Monthly Deposit Credit		23
Monthly Revenues Computation		1
Monthly Threshold		1
Mortgage		11
Net Present Value		54
Note		11
Notice		49
Notices		49
Other Revenues		11
Overdue Rate		12
Parking Revenues		12
Payment Date		12
Percentage Rent		14
Person		12
Personal Property Limitation		40
Personal Property Taxes		12

(iv)


		Page(s)
Predecessor		12
Primary Intended Use		23
Proceeding		12
Qualified Manager		12
RCRA		12
Real Estate Taxes		12
REIT		54
REIT Requirements		39
Release		12
Rent		13
Room Revenues		13
SARA		13
State		13
Subsidiaries		13
Taking		13
Tax, Insurance and Reserve Amount		15
Term		2
TSCA		13
Unavoidable Delays		13
under common control with		3
Uneconomic for its Primary Intended Use		13
Uniform System		14
Unrelated Person		5
Unsuitable for its Primary Intended Use		14

(v)

LEASE AGREEMENT

THIS LEASE AGREEMENT (this “ Lease ”), dated as of , 20 , entered into by and between , a (“ Lessor ”) and , a (“ Lessee ”), provides as follows.

R E C I T A L S ::

A. Lessor has acquired that certain real property constituting various hotel properties more specifically described on Exhibit “A” attached hereto and incorporated herein by reference (collectively, the “ Leased Property ”).

B. Lessee has applied for and been granted various licenses to operate each of the Facilities on the Leased Property (as defined in Section 1.1 below).

C. Lessor desires to lease the Leased Property to Lessee and Lessee has agreed to lease the Leased Property from Lessor in accordance with the terms of this Lease.

D. In furtherance of the consummation of such series of transactions, Lessor and Lessee wish to enter into this Lease.

A G R E E M E N T :

NOW, THEREFORE, Lessor, in consideration of the payment of rent by Lessee to Lessor, the covenants and agreements to be performed by Lessee, and upon the terms and conditions hereinafter stated, does hereby rent and lease unto Lessee, and Lessee does hereby rent and lease from Lessor, the Leased Property.

ARTICLE 1

LEASED PROPERTY; TERM

1.1 Leased Property . The leased property (the “ Leased Property ”) is comprised of Lessor’s interest in the following:

(a) the land described in Exhibit “A” attached hereto and by reference incorporated herein (the “ Land ”);

(b) all buildings, structures and other improvements of every kind including, but not limited to, each Facility, alleyways and connecting tunnels, sidewalks, utility pipes, conduits and lines (on-site and off-site), parking areas [OPTIONAL: , including, without limitation that certain parking garage constructed on a portion of the Land and on a portion of the land adjacent to the Land and used by both the Facility and the owner of office building situated

on such adjacent land (collectively referred to herein as the “ Parking Facilities ”), ] and roadways appurtenant to [OPTIONAL: the Parking Facilities and ] such buildings and structures presently situated upon the Land (collectively, the “ Leased Improvements ”);

(d) all fixtures and equipment, machinery, and all other items of property, including all components thereof, now and hereafter permanently affixed to or incorporated into the Leased Improvements, including, without limitation, all furnaces, boilers, heaters, electrical equipment, heating, plumbing, lighting, ventilating, refrigerating, incineration, air and water pollution control, waste disposal, air-cooling and air-conditioning systems and apparatus, sprinkler systems and fire and theft protection equipment, all of which to the greatest extent permitted by law are hereby deemed by the parties hereto to constitute real estate, together with all replacements, modifications, alterations and additions thereto (but only to the extent such items constitute “real property” as such term is used in Section 512(b)(3)(A)(i) of the Code) (collectively, the “ Fixtures ”);

(e) all furniture, furnishings, wall coverings, fixtures and hotel equipment and systems located at, or used in connection with, any Facility, together with all replacements therefor and additions thereto, including, without limitation, (i) all equipment and systems required for the operation of kitchens, bars, if any, and laundry and dry cleaning facilities, (ii) dining room wagons, materials handling equipment, cleaning and engineering equipment, all items of bedding (iii) telephone and computerized accounting systems, and (iv) vehicles (collectively, “ Furniture and Equipment ”); provided , however , that to the extent any item of property that could reasonably be deemed to constitute both a Fixture and Furniture and Equipment, such item of property shall be deemed to be included in the definition of Fixture and not in this definition of Furniture and Equipment; and

(f) all existing leases of space within the Leased Property (including any security deposits or collateral held by Lessor pursuant thereto).

THE LEASED PROPERTY IS DEMISED IN ITS PRESENT, “AS-IS” CONDITION, WITHOUT REPRESENTATION OR WARRANTY (EXPRESSED OR IMPLIED) BY LESSOR AS MORE SPECIFICALLY SET FORTH IN SECTION 7.1 HEREOF AND SUBJECT TO THE EXISTING STATE OF TITLE INCLUDING ALL COVENANTS, CONDITIONS, RESTRICTIONS, EASEMENTS AND OTHER MATTERS OF RECORD INCLUDING ALL APPLICABLE LEGAL REQUIREMENTS, THE LIEN OF FINANCING INSTRUMENTS, MORTGAGES, DEEDS OF TRUST AND SECURITY DEEDS, AND INCLUDING OTHER MATTERS WHICH WOULD BE DISCLOSED BY AN INSPECTION OF THE LEASED PROPERTY OR BY AN ACCURATE SURVEY THEREOF.

1.2 Term . The term of this Lease (the “ Term ”) shall commence on the date hereof (the “ Commencement Date ”) and shall end on the fifth (5 ^th ) anniversary of the last day of the month in which the Commencement Date occurs, unless sooner terminated in accordance with the provisions hereof.

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ARTICLE 2

DEFINITIONS

2.1 Definitions . For all purposes of this Lease, except as otherwise expressly provided or unless the context otherwise requires, (a) the terms defined in this Article 2 have the meanings assigned to them in this Article and include the plural as well as the singular, (b) all accounting terms not otherwise defined herein have the meanings assigned to them in accordance with generally accepted accounting principles as are at the time applicable, (c) all references in this Lease to designated “ Articles ,” “ Sections ” and other subdivisions are to the designated Articles, Sections and other subdivisions of this Lease, and (d) the words “ herein ,” “ hereof ” and “ hereunder ” and other words of similar import refer to this Lease as a whole and not to any particular Article, Section or other subdivision:

Accrued Rent : Any amount of Base Rent or Percentage Rent that is not paid by Lessee as and when the same becomes due and payable under the terms of this Lease, which Accrued Rent shall bear interest at the Base Rate until paid or otherwise discharged in accordance with this Lease.

Additional Charges : As defined in Section 3.3 .

Affiliate : Any (a) Person that, directly or indirectly, controls or is controlled by or is under common control with such Person, (b) other Person that owns, beneficially, directly or indirectly, fifty (50%) percent or more of the outstanding capital stock, shares or equity interests of such Person, or (c) officer, director, employee, partner or trustee of such Person or any Person controlling, controlled by or under common control with such Person (excluding trustees and persons serving in similar capacities who are not otherwise an Affiliate of such Person). For the purposes of this definition, “ control ” (including the correlative meanings of the terms “ controlled by ” and “ under common control with ”), as used with respect to any Person, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, through the ownership of voting securities, partnership interests or other equity interests.

Alterations : As defined in Section 10.1 .

Annual Budget : The operating and capital budget prepared by Lessee and delivered to Lessor in accordance with Section 3.8 .

Annual Revenues Computation : As defined in Section 3.1(b) .

Award : As defined in Section 15.1(c) .

Base Rate : The rate of interest announced publicly by JPMorgan Chase Bank, New York, New York from time to time, as such bank’s base rate. If no such rate is announced or becomes discontinued, then such other rate as Lessor may reasonably designate.

Base Rent : As defined in Section 3.1(a) .

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Business Day : Each Monday, Tuesday, Wednesday, Thursday and Friday that is not a day on which national banks in the City of New York, New York, or in the municipality wherein the Leased Property is located, are closed.

Cash Management Agreement : That certain Cash Management Agreement dated as of the date hereof by and among Lessor, Lessee, the other Borrowers listed therein, the other Lessees listed therein and Lender.

Cash Management System : The cash management system established pursuant to the Cash Management Agreement and the other cash management agreements relating to or contemplated by the Loan Documents.

CERCLA : The Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended.

Claims : As defined in Article 12 .

Code : The Internal Revenue Code of 1986, as amended.

Commencement Date : As defined in Section 1.2 .

Condemnation, Condemnor : As defined in Section 15.1 .

Consolidated Financials : For any fiscal year or other accounting period for Lessee and Lessee’s consolidated subsidiaries, statements of earnings and retained earnings and of changes in financial position for such period and for the period from the beginning of the respective fiscal year to the end of such period and the related balance sheet as at the end of such period, together with the notes thereto, all in reasonable detail and setting forth in comparative form the corresponding figures for the corresponding period in the preceding fiscal year, and prepared in accordance with generally accepted accounting principles and audited by independent certified public accountants reasonably selected by Lessor.

Consumer Price Index : The “Consumer Price Index” published by the Bureau of Labor Statistics of the United States Department of Labor, U.S. City Average, All Items for Urban Wage Earners and Clerical Workers (1982-1984=100). If the Consumer Price Index is hereafter converted to a different standard reference base or otherwise revised, any determination hereunder that uses the Consumer Price Index shall be made with the use of such conversion factor, formula or table for converting the Consumer Price Index as may be published by the Bureau of Labor Statistics, or, if the bureau shall no longer publish the same, then with the use of such conversion factor, formula or table as may be published by Prentice Hall, Inc., or failing such publication, by any other nationally recognized publisher of similar statistical information.

Date of Taking : As defined in Section 15.1(b) .

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Eligible Independent Contractor : A management company that meets all of the following requirements:

(a) The management company does not own, directly or indirectly, more than thirty-five percent (35%) of the outstanding stock of Sunstone Hotel Investors, Inc..

(b) If the management company is a corporation (within the meaning of the Code), no more than thirty-five percent (35%) of the total combined voting power of such management company’s outstanding stock (or thirty-five (35%) of the total shares of all classes of the outstanding stock) or, if it is not a corporation, no more than thirty-five percent (35%) of the ownership interest in its assets or profits is owned directly or indirectly, by one or more Persons owning thirty-five percent (35%) or more of the outstanding stock of Sunstone Hotel Investors, Inc..

(c) Neither Sunstone Hotel Investors, Inc., the Lessor, the Lessee, nor any Affiliate thereof derives any income from the management company.

(d) At the time that the management company enters into a management agreement with the Lessee to operate the Leased Property, the management company (or any “ related persons ” within the meaning of Section 856(d)(9)(F) of the Code) is actively engaged in the trade or business of operating “ qualified lodging facilities ” within the meaning of Section 856(d)(9)(D) of the Code for any Person who is not a “related persons” within the meaning of Section 856(d)(9)(F) of the Code with respect to Sunstone Hotel Investors, Inc. or the Lessee (an “ Unrelated Person ”). For purposes of determining whether the requirement of this paragraph (d) has been met, a management company shall be treated as being actively engaged in such a trade or business if the management company (i) derives at least ten percent (10%) of both its profits and revenue from operating “qualified lodging facilities” within the meaning of Section 856(d)(9)(D) of the Code for Unrelated Persons or (ii) complies with any regulations or other administrative guidance under Section 856(d)(9) of the Code that provides a “safe harbor” rule with respect to the amount of hotel management business with Unrelated Persons that is necessary to qualify as an “eligible independent contractor” within the meaning of such Code section.

Encumbrance : As defined in Section 34.1 .

Environmental Authority : Any department, agency or other body or component of any Government that exercises any form of jurisdiction or authority under any Environmental Law.

Environmental Authorization : Any license, permit, order, approval, consent, notice, registration, filing or other form of permission or authorization required under any Environmental Law.

Environmental Laws : All applicable federal, state and local laws and regulations relating to pollution of the environment (including without limitation, ambient air, surface water, ground water, land surface or subsurface strata), including without limitation laws and regulations relating to emissions, discharges, Releases or threatened Releases of Hazardous Materials or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of Hazardous Materials. Environmental Laws include

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but are not limited to CERCLA, FIFRA, RCRA, SARA, TSCA, and all state and local counterparts.

Environmental Liabilities : Any and all obligations to pay the amount of any judgment or settlement, the cost of complying with any settlement, judgment or order for injunctive or other equitable relief, the cost of compliance or corrective action in response to any notice, demand or request from an Environmental Authority, the amount of any civil penalty or criminal fine, and any court costs and reasonable amounts for attorney’s fees, fees for witnesses and experts, and costs of investigation and preparation for defense of any claim or any Proceeding, regardless of whether such Proceeding is threatened, pending or completed, that may be or have been asserted against or imposed upon Lessor, Lessee, any predecessor, the Leased Property or any property used therein and arising out of:

(a) Failure of Lessee, Lessor, any predecessor or the Leased Property to comply at any time with all Environmental Laws;

(b) Presence of any Hazardous Materials on, in, under, at the Leased Property;

(d) Identification of Lessee, Lessor or any predecessor as a potentially responsible party under CERCLA, or under any Environmental Law similar to CERCLA;

(e) Presence at any time of any above-ground and/or underground storage tanks, as defined in RCRA or in any applicable Environmental Law on, in, at or under the Leased Property or any adjacent site or facility; or

(f) Any and all claims for injury or damage to persons or property arising out of exposure to Hazardous Materials originating or located at the Leased Property, or resulting from operation thereof or any adjoining property.

Event of Default : As defined in Section 16.1

Facility : Each hotel and/or other facility offering lodging and other services or amenities being operated or proposed to be operated on the Leased Property.

Fair Market Rental : The fair market rental of the Leased Property means the rental which a willing tenant not compelled to rent would pay a willing landlord not compelled to lease for the use and occupancy of such Leased Property, assuming that Lessee is not in default hereunder.

Fair Market Value : The fair market value of the Leased Property means an amount equal to the price that a willing buyer not compelled to buy would pay a willing seller not compelled to sell for such Leased Property, (a) assuming the same is unencumbered by this Lease, (b) assuming that such seller must pay customary closing costs and title premiums, and (c) taking into account the positive or negative effect on the value of the Leased Property

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attributable to the interest rate, amortization schedule, maturity date, prepayment penalty and other terms and conditions of any encumbrance that is assumed by the transferee. In addition, in determining the Fair Market Value with respect to damaged or destroyed Leased Property such value shall be determined as if such Leased Property has not been so damaged or destroyed.

FIFRA : The Federal Insecticide, Fungicide, and Rodenticide Act, as amended.

Fiscal Year : The 12-month period from January 1 to December 31.

Fixtures : As defined in Section 1.1 .

Food and Beverage Revenues : All revenues, receipts and income of every kind from the sale of food and beverages at, on or from the Leased Property, whether from restaurants, room service or otherwise but excluding (a) federal, state and municipal excise, sales, and use taxes collected directly as a part of the sales price of any such food or beverages (including alcohol), such as gross receipts or similar or equivalent taxes and paid over to federal, state or municipal governments, (b) gratuities, (c) proceeds from sales other than sales in the ordinary course of business, and (d) items constituting “allowances” under the Uniform System.

Franchise Agreement : Any franchise agreement or license agreement with a franchisor under which any Facility is operated.

Furniture and Equipment : As defined in Section 1.1 .

Government : The United States of America, any state, district or territory thereof, any foreign nation, any state, district, department, territory or other political division thereof, or any political subdivision of any of the foregoing.

Gross Operating Expenses : All salaries and employee expense and payroll taxes (including salaries, wages, bonuses and other compensation of all employees at the Facility, and benefits including life, medical and disability insurance and retirement benefits), payments made to any Manager under a Management Agreement, expenditures described in Section 9.1 , operational supplies, utilities, cost of insurance to be provided by Lessee, or otherwise reimbursed to Lessor, under the terms of this Lease, management fees and expenses paid to any management company engaged by Lessee for the operation of any Facility, governmental fees and assessments, food, beverages, laundry service expense, the cost of Inventories and fixed asset supplies, license fees, advertising, marketing, reservation systems and any and all other operating expenses as are reasonably necessary for the proper and efficient operation of each Facility incurred by Lessee in accordance with the provisions hereof (excluding, however, (a) federal, state and municipal excise, sales and use taxes collected directly from patrons and guests or as a part of the sales price of any goods, services or displays, such as gross receipts, admissions, cabaret or similar or equivalent taxes paid over to federal, state or municipal governments, (b) the cost of insurance to be carried by Lessor without reimbursement from Lessee, (c) expenditures by Lessor pursuant to Article 13 and (d) payments on any Mortgage or other mortgage or security instrument on any Facility); all determined in accordance with generally accepted accounting principles and the Uniform System. No part of Lessee’s central office overhead or general or administrative expense (as opposed to that of any Facility) shall be deemed to be a part of Gross Operating Expenses, as herein provided. Reasonable out-of-pocket

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expenses of Lessee or of any Manager under a Management Agreement incurred for the account of or in connection with the Facility operations, including but not limited to, postage, telephone charges and reasonable travel expenses of employees, officers and other representatives and consultants of Lessee or any Manager under a Management Agreement and their Affiliates, shall be deemed to be a part of Gross Operating Expenses and such persons shall be afforded reasonable accommodations, food, beverages, laundry, valet and other such services by and at the Facility without charge to such persons or Lessee.

Gross Operating Profit : For any Fiscal Year, the excess of Gross Revenues for such Fiscal Year over Gross Operating Expenses for such Fiscal Year.

Gross Revenues : All revenues, receipts, and income of any kind derived directly or indirectly by Lessee from or in connection with any Facility (including rentals or other payments from tenants, lessees, licensees or concessionaires but not including their gross receipts) whether on a cash basis or credit, paid or collected, determined in accordance with generally accepted accounting principles and the Uniform System, including without limitation Food and Beverage Revenues, Room Revenues and Other Revenues, but excluding, however: (a) funds furnished by Lessor, (b) federal, state and municipal excise, sales, and use taxes collected directly from patrons and guests or as a part of the sales price of any goods, services or displays, such as gross receipts, admissions, cabaret or similar or equivalent taxes and paid over to federal, state or municipal governments, (c) gratuities, (d) proceeds of insurance and condemnation, (e) proceeds from sales other than sales in the ordinary course of business, (f) all loan proceeds from financing or refinancings of the Facility or interests therein or components thereof, (g) judgments and awards, except any portion thereof arising from normal business operations of the hotel, and (h) items constituting “ allowances ” under the Uniform System.

Hazardous Materials : Any and all substances, materials, chemicals, wastes, pollutants, oils, or governmental regulated substances or contaminants as defined or designated as hazardous, toxic, radioactive, dangerous, or any other similar term in or under any of the statutes, laws, case law, regulations, and rules of the United States or the state of Minnesota, including without limitation:

(a) Solid or hazardous waste, as defined in RCRA or in any Environmental Law;

(b) Hazardous substances, as defined in CERCLA, or in any Environmental Law;

(d) Insecticides, fungicides, or rodenticides, as defined in FIFRA or in any Environmental Law; and

(e) Gasoline or any other petroleum product or byproduct, polychlorinated biphenols, asbestos and urea formaldehyde.

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Impositions : Collectively, all taxes (including, without limitation, all ad valorem, sales and use, single business, gross receipts, transaction privilege, rent or similar taxes as the same relate to or are imposed upon Lessee or Lessee’s business conducted upon the Leased Property, including all personal property taxes on Lessee’s Personal Property and Inventory, together with all replacement, modifications, alterations and additions thereto), assessments (including, without limitation, all assessments for public improvements or benefit, whether or not commenced or completed prior to the date hereof and whether or not to be completed within the Term), ground rents, water, sewer or other rents and charges, excises, tax inspection, authorization and similar fees and all other governmental charges, in each case whether general or special, ordinary or extraordinary, or foreseen or unforeseen, of every character in respect of the Leased Property or the business conducted thereon by Lessee (including all interest and penalties thereon caused by any failure in payment by Lessee), which at any time prior to, during or with respect to the Term hereof may be assessed or imposed on or with respect to or be a lien upon (a) Lessor’s interest in the Leased Property, (b) the Leased Property, or any part thereof or any rent therefrom or any estate, right, title or interest therein, or (c) any occupancy, operation, use or possession of, or sales from, or activity conducted on or in connection with the Leased Property, or the leasing or use of the Leased Property or any part thereof by Lessee. Nothing contained in this definition of Impositions shall be construed to require Lessee to pay (1) any tax based on net income (whether denominated as a franchise or capital stock or other tax) imposed on Lessor or any other Person, or (2) any net revenue tax of Lessor or any other Person, or (3) any tax imposed with respect to the sale, exchange or other disposition by Lessor of any Leased Property or the proceeds thereof, or (4) any single business, gross receipts (other than a tax on any rent received by Lessor from Lessee), transaction, privilege or similar taxes as the same relate to or are imposed upon Lessor, except to the extent that any tax, assessment, tax levy or charge that Lessee is obligated to pay pursuant to the first sentence of this definition and that is in effect at any time during the Term hereof is totally or partially repealed, and a tax, assessment, tax levy or charge set forth in clause (1) or (2) is levied, assessed or imposed expressly in lieu thereof.

Indemnified Party : Either of a Lessee Indemnified Party or a Lessor Indemnified Party.

Indemnifying Party : Any party obligated to indemnify an Indemnified Party pursuant to Section 8.3 or Article 22 .

Independent Director : A director of Lessee who is not at the time of initial appointment, or at any time while serving as a director of Lessee, and has not been at any time during the preceding five years:

(a) a stockholder, officer, director (other than as the Independent Director of Lessee), employee, member, partner, attorney or counsel of Lessee, Lessor or any affiliate of Lessee or Lessor (unless such natural person is a director provided by a nationally recognized company that provides professional independent managers and which also provides other corporate services in the ordinary course of business, in which case such natural person may receive reasonable fees for serving as a director of Lessee or an Affiliate);

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(b) a creditor, customer, supplier or other Person who derives any of its purchases or revenues from its activities (other than in payment for its role as Independent Director or costs related thereto) with Lessee, Lessor or any affiliate of either of them;

(c) a Person controlling or under common control with any such stockholder, partner, member, creditor, customer, supplier or other Person (as used herein, the term “ control ” means the possession, directly or indirectly, of the power to direct or cause the direction of management, policies or activities of a Person, whether through ownership of voting securities, by contract or otherwise); or

(d) a member of the immediate family of any such stockholder, director, officer, employee, partner, member, creditor, customer, supplier or other Person.

A natural person who satisfies the foregoing definition other than subsection (b) shall still be considered an Independent Director of Lessee if such individual is an independent director provided by a nationally recognized company that provides professional independent directors and that also provides other corporate services in the ordinary course of business. A natural person who otherwise satisfies the foregoing definition except for being the independent director of a “special purpose entity” affiliated with Lessee that does not own a direct or indirect equity interest in Lessee shall still be considered an Independent Director of Lessee if such individual is at the time of initial appointment an independent director provided by a nationally recognized company that provides professional independent directors. For purposes of this paragraph, a “special purpose entity” is an entity whose organizational documents contain restrictions on its activities substantially similar to those set forth in Article 19 .

Insurance Requirements : All terms of any insurance policy required by this Lease and all requirements of the issuer of any such policy.

Inventory : Collectively, all “Inventories of Merchandise” and “Inventories of Supplies” as defined in the Uniform System, including, but not limited to, linens and other non-depreciable personal property.

Land : As defined in Article 1 .

Leased Improvements; Leased Property : Each as defined in Article 1 .

Legal Requirements : All federal, state, county, municipal and other governmental statutes, laws, rules, orders, regulations, ordinances, judgments, decrees and injunctions affecting either the Leased Property or the maintenance, construction, use or alteration thereof (whether by Lessee or otherwise), whether or not hereafter enacted and in force, including (a) all laws, rules or regulations pertaining to the environment, occupational health and safety and public health, safety or welfare, and (b) any laws, rules or regulations that may (1) require repairs, modifications or alterations in or to the Leased Property, or (2) in any way adversely affect the use and enjoyment thereof; and all permits, licenses and authorizations and regulations relating thereto and all covenants, agreements, restrictions and encumbrances contained in any instruments, either of record or known to Lessee (other than encumbrances created by Lessor without the consent of Lessee), at any time in force affecting the Leased Property.

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Lender : Such lender as may be designated by Lessor to Lessee from time to time, and such lender’s successors and assigns.

Lessee Indemnified Party : Lessee, any Affiliate of Lessee, any other Person against whom any claim for indemnification may be asserted hereunder as a result of a direct or indirect ownership interest (including a stockholder’s interest) in Lessee, the officers, directors, stockholders, employees, agents and representatives of Lessee and any corporate stockholder, agent, or representative of Lessee, and the respective heirs, personal representatives, successors and assigns of any such officer, director, stockholder, employee, agent or representative.

Lessee’s Personal Property : As defined in Section 6.2 .

Lessor Indemnified Party : Lessor, any Affiliate of Lessor, any other Person against whom any claim for indemnification may be asserted hereunder as a result of a direct or indirect ownership interest (including a stockholder’s or partnership interest) in Lessor, the officers, directors, stockholders, employees, agents and representatives of the general partner of Lessor and any partner, agent or representative of Lessor, and the respective heirs, successors and assigns of any such officer, director, partner, stockholder, employee, agent or representative.

Loan : The loan, if any, made by Lender pursuant to the Loan Documents.

Loan Agreement : If any Loan is then in place, the Loan Agreement by and among Lessor, the other Borrowers listed therein and Lender.

Loan Documents : Collectively, the Loan Agreement and all other documentation related thereto (including, but not limited to, all mortgages, security agreements, promissory notes and other collateral documents).

Management Agreement : Any agreement entered into by Lessee with any Eligible Independent Contractor for the management of any Facility.

Manager : Any Eligible Independent Contractor retained to manage a Facility under a Management Agreement.

Monthly Revenues Computation : As defined in Section 3.1(b) .

Mortgage : As defined in the Loan Documents.

Note : Those certain Promissory Notes dated as of the date hereof by and among Owner, the other Borrowers listed therein and Lender.

Notice : A notice given pursuant to Article 32 .

Other Revenues : Any and all revenues generated by or at the Leased Property (other than Room Revenues, Food and Beverage Revenues, and Sublease and Concession Revenues [OPTIONAL: and Parking Revenues ] ), including without limitation, gross revenues attributable to vending machines, honor bars, movie rentals, telephone, concessions and similar services.

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Overdue Rate : On any date, a rate equal to the Base Rate plus 1.0% per annum, but in no event greater than the maximum rate then permitted under applicable law.

[OPTIONAL Parking Facilities : As defined in Section 1.1(f) . ]

[OPTIONAL Parking Revenues : Gross revenues derived from the operation of the Parking Facilities. For the sake of clarity, Parking Revenues shall not be reduced by expenses deducted by the manager of the Parking Facilities in arriving at the amounts to be distributed to Lessee. ]

Payment Date : Any due date for the payment of any installment of Base Rent.

Percentage Rent : As defined in Section 3.1(b) .

Person : Any Government, natural person, corporation, partnership or other legal entity.

Personal Property Taxes : All personal property taxes imposed on the furnishings or other items of personal property located on, and used in connection with, the operation of the Leased Improvements as a hotel (other than such items that compose Lessee’s Personal Property and Inventory), together with all replacement, modifications, alterations and additions thereto.

Predecessor : Any Person whose liabilities arising under any Environmental Law have or may have been retained or assumed by Lessee, either contractually or by operation of law, relating to the Leased Property.

Primary Intended Use : As defined in Section 7.2(b) .

Proceeding : Any judicial action, suit or proceeding (whether civil or criminal), any administrative proceeding (whether formal or informal), any investigation by a governmental authority or entity (including a grand jury), and any arbitration, mediation or other non-judicial process for dispute resolution.

Qualified Manager : A Manager that is (or is controlled by, controlling or under common control with) a professional management company which at the time of the Manager’s engagement as Manager shall be the property manager for at least ten (10) hotel properties containing at least one thousand three hundred (1,300) rooms exclusive of the Leased Properties.

RCRA : The Resource Conservation and Recovery Act, as amended.

Real Estate Taxes : All real estate taxes, including general and special assessments, if any, which are imposed upon the Land, and any improvements thereon.

Release : A “Release” as defined in CERCLA, or in any Environmental Law, unless such Release has been properly authorized and permitted in writing by all applicable Environmental Authorities or is allowed by such Environmental Law without authorizations or permits.

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Rent : Collectively, the Base Rent, Percentage Rent and Additional Charges.

Room Revenues : Gross revenue from the rental of guest rooms, whether to individuals, groups or transients, at any Facility, excluding the following:

(a) the amount of all credits, rebates or refunds to customers, guests or patrons; and

(b) all sales taxes or any other taxes imposed on the rental of such guest rooms.

SARA : The Superfund Amendments and Reauthorization Act of 1986, as amended.

State : The State or Commonwealth of the United States in which the Leased Property is located.

Sublease and Concession Revenues : Gross revenue derived from tenants of the Facility from subleases or concessions, including without limitation, gross revenues attributable to vending machines and roof-top antennae licenses.

Subsidiaries : Corporations in which Lessee owns, directly or indirectly, more than fifty percent (50%) of the voting stock or control, as applicable.

Taking : A taking or voluntary conveyance during the Term hereof of all or part of the Leased Property, or any interest therein or right accruing thereto or use thereof, as the result of, or in settlement of, any Condemnation or other eminent domain proceeding affecting the Leased Property whether or not the same shall have actually been commenced.

Term : As defined in Section 1.2 .

TSCA : The Toxic Substances Control Act, as amended.

Unavoidable Delays : Delays due to strikes, lock-outs, labor unrest, inability to procure materials, power failure, acts of God, governmental restrictions, enemy action, civil commotion, fire, unavoidable casualty or other causes beyond the control of the party responsible for performing an obligation hereunder, provided that lack of funds shall not be deemed a cause beyond the control of either party hereto unless such lack of funds is caused by the failure of the other party hereto to perform any obligations of such party under this Lease or any guaranty of this Lease.

Uneconomic for its Primary Intended Use : A state or condition of any Facility such that, in the good faith judgment of Lessee, reasonably exercised and evidenced by the resolution of the board of directors or other governing body of Lessee, such Facility cannot be operated on a commercially practicable basis for its Primary Intended Use, taking into account, among other relevant factors, the number of usable rooms and projected revenues, such that Lessee intends to, and shall, complete the cessation of operations from the Facility.

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Uniform System : The Uniform System of Accounts for Hotels (9th Revised Edition, 1996) as published by the Hotel Association of New York City, Inc., as same may hereafter be revised.

Unsuitable for its Primary Intended Use : A state or condition of any Facility such that, in the good faith judgment of Lessee, reasonably exercised and evidenced by the resolution of the board of directors or other governing body of Lessee, due to casualty damage or loss through Condemnation, the Facility cannot function as an integrated hotel facility consistent with standards applicable to a well maintained and operated hotel.

ARTICLE 3

RENT

3.1 Rent . Lessee will pay to Lessor in lawful money of the United States of America which shall be legal tender for the payment of public and private debts, in immediately available funds without reduction or offset, at Lessor’s address set forth in Article 32 hereof or at such other place or to such other Person, as Lessor from time to time may designate in a Notice, all Base Rent, Percentage Rent and Additional Charges, during the Term, as follows:

(a) Base Rent : The annual Base Rent payable for the Leased Property shall be equal to the amount described on Exhibit “B” attached hereto as “ Base Rent ” payable in arrears in equal, consecutive monthly installments, on or before the first day of each calendar month of the Term (“ Base Rent ”); provided , however , that the first and last monthly payments of Base Rent shall be pro rated as to any partial month, and

(b) Percentage Rent :

(i) For each month during the Term, Lessee shall pay percentage rent (“ Percentage Rent ”) in an amount calculated by the following formula:

The amount equal to the Monthly Revenues Computation (as defined on Exhibit “B” attached hereto)

less

an amount equal to the Base Rent paid for the applicable month

equals

Percentage Rent for the applicable month.

(ii) The Percentage Rent payable for the last month in any calendar quarter shall be adjusted to reflect the Percentage Rent that would be payable on a year-to-date cumulative basis based on the percentage of the Fiscal Year elapsed to the same percentage of the Annual Revenues Computation ( i.e . twenty-five percent (25%) for the first quarter, fifty percent (50%) for the second quarter and so forth). The amount equal to the Annual Revenues Computation is defined on Exhibit “B” attached hereto. Revenues for any quarter other than the last quarter of the Fiscal Year shall be annualized (e.g., revenues for the first, second and third

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quarters of the Fiscal Year shall be multiplied by four, two, and 1-1/3, respectively) for the Fiscal Year for purposes of this computation, and amounts for the first and last year of the Term shall be appropriately prorated.

Notwithstanding anything to the contrary contained herein, if the amount of Percentage Rent determined by way of the above formula with respect to a particular month during the Term shall be less than the sum of (x) all real estate taxes that accrue during such period with respect to the Leased Property and Lessee’s Personal Property, (y) the insurance premiums that become due during such period with respect to the insurance maintained with respect to the Leased Property or otherwise required to be maintained under the terms of this Lease and (z) the replacement reserve funds described in Section 40.1 below (such sum, the “ Tax, Insurance and Reserve Amount ”), then the Percentage Rent for such month shall be the applicable Tax, Insurance and Reserve Amount. If any Base Rent or Percentage Rent is not paid by Lessee when required pursuant to this Section 3.1 , such Base Rent or Percentage Rent shall automatically become Accrued Rent and shall not cause an Event of Default under this Lease except as expressly set forth in Section 16.1(a) and (b) hereof.

(c) Officer’s Certificates . An Officer’s Certificate shall be delivered to Lessor monthly setting forth the calculation of the Percentage Rent payment for the most recently completed month within thirty (30) days after the end of each month in the Term. The Percentage Rent payments for the months to which the Officer’s Certificates relate shall accompany such Officer’s Certificate. Such monthly payments shall be based on the formula set forth in Section 3.1(b)(i) , as the same may be adjusted pursuant to Section 3.1(b)(ii) . There shall be no reduction in the Base Rent regardless of the result of the Revenues Computation.

The obligation to pay Percentage Rent shall survive the expiration or earlier termination of the Term, and a final reconciliation, taking into account, among other relevant adjustments, any adjustments which are accrued after such expiration or termination date but which related to Percentage Rent accrued prior to such termination date, and Lessee’s good faith best estimate of the amount of any unresolved contractual allowances shall be made not later than two years after such expiration or termination date, but Lessee shall advise Lessor within sixty (60) days after such expiration or termination date of Lessee’s best estimate at that time of the approximate amount of such adjustments, which estimate shall not be binding on Lessee or have any legal effect whatsoever.

(d) CPI Adjustments to Base Rent and Room Revenue Thresholds . For each Fiscal Year of the Term beginning on or after January 1st of the first (1 ^st ) calendar year after the Commencement Date (but not earlier than January 1, 2006), the Base Rent then in effect, and the threshold Room Revenues then included in the Monthly and Annual Revenues Computations set forth in Section 3.1 shall be increased (but never decreased) as follows:

(1) Annual Adjustment Procedure . The year-end Consumer Price Index for the most recently ended Fiscal Year shall be divided by the year-end Consumer Price Index for the immediately preceding Fiscal Year.

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(A) The new Base Rent for the then current Fiscal Year shall be the adjusted amount obtained by multiplying the Base Rent for the immediately preceding Fiscal Year by the quotient obtained in subparagraph (1) above.

(B) The new threshold dollar amount in the Monthly and Annual Revenues Computations described in Section 3.1(b) above for the then current Fiscal Year shall be the product of the threshold dollar amount of Room Revenues in effect in the most recently ended Fiscal Year and the quotient obtained in subparagraph (d)(1) above.

By way of example, the amount of Base Rent and the threshold Room Revenues amounts in the Monthly and Annual Revenues Computations for the Fiscal Year commencing January 1, 2004 shall be increased (but never decreased) to reflect any change in the Consumer Price Index from the Fiscal Year ended December 31, 2003 as compared to the Fiscal Year ended December 31, 2002.

Adjustments calculated as set forth above in the Base Rent and threshold Room Revenues amounts shall be effective on January 1 of the Fiscal Year to which such adjusted amounts apply. If rent is paid in any Fiscal Year prior to the determination of the amount of any adjustment to Base Rent or the threshold Room Revenues applicable for such Fiscal Year, payment adjustments for any shortfall in or overpayment of rent paid shall be made with the first Base Rent Payment due after the amount of the adjustments are determined.

Notwithstanding anything to the contrary contained herein, adjustments to Base Rent and threshold Room Revenues shall in no event result in any decrease to Base Rent or threshold Room Revenues. Therefore, if any adjustment required under subparagraph 3(d)(1) above would result in a decrease in Base Rent and threshold Room Revenues, then Base Rent and threshold Room Revenues shall not be adjusted.

3.2 Confirmation of Percentage Rent . Lessee shall utilize, or cause to be utilized, an accounting system for the Leased Property in accordance with Lessee’s usual and customary practices, and in accordance with generally accepted accounting principles consistently applied and the Uniform System, that will accurately record all data necessary to compute Percentage Rent, and Lessee shall retain, for at least four years after the expiration of each Fiscal Year, reasonably adequate records conforming to such accounting system showing all data necessary to compute Percentage Rent for the applicable Fiscal Years. Lessor, at Lessor’s expense (except as provided hereinbelow), shall have the right from time to time by Lessor’s accountants or representatives to audit and examine all Lessee’s records (including supporting data and sales and excise tax returns) reasonably required to verify Percentage Rent, subject to any prohibitions or limitations on disclosure of any such data under Legal Requirements. If any such audit discloses a deficiency in the payment of Percentage Rent, and either Lessee agrees with the result of such audit or the matter is otherwise determined or compromised, Lessee shall forthwith pay to Lessor the amount of the deficiency, as finally agreed or determined, together with interest at the Overdue Rate from the date when said payment should have been made to the date of payment thereof; provided , however , that as to any audit that is commenced more than two years after the date Percentage Rent for any Fiscal Year is reported by Lessee to Lessor, the deficiency, if any, with respect to such Percentage Rent shall bear interest at the Overdue Rate only from the date such determination of deficiency is made unless such deficiency is the result of gross negligence

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or willful misconduct on the part of Lessee, in which case interest at the Overdue Rate will accrue from the date such payment should have been made to the date of payment thereof. If any such audit discloses that the actual Annual Revenues Computations for any Fiscal Year exceeds that reported by Lessee by more than three percent 3%, Lessee shall pay the cost of such audit and examination. Any proprietary information obtained by Lessor pursuant to the provisions of this Section shall be treated as confidential, except that such information may be used, subject to appropriate confidentiality safeguards, in any litigation between the parties and except further that Lessor may disclose such information to prospective lenders or as required to comply with applicable Legal Requirements, including without limitation, reporting requirements under state and federal securities laws. The obligations of Lessee contained in this Section shall survive the expiration or earlier termination of this Lease.

3.3 Additional Charges . In addition to the Base Rent and Percentage Rent, (a) Lessee also shall pay and discharge as and when due and payable all other amounts, liabilities, obligations and impositions that Lessee assumes or agrees to pay under this Lease, (b) in the event of any failure on the part of Lessee to pay any of those items referred to in clause (a) of this Section 3.3 , Lessee also shall promptly pay and discharge every fine, penalty, interest and cost that may be added for non-payment or late payment of such items, and (c) if any installment of Base Rent, Percentage Rent or Additional Charges (but only as to those Additional Charges that are payable directly to Lessor) shall not be paid on its due date, Lessee will pay Lessor on demand a late charge (to the maximum extent permitted by law) computed at the Overdue Rate on the amount of such installment, from the due date of such installment to the date of payment thereof (the items referred to in clauses (a), (b) and (c)) of this Section 3.3 are additional rent hereunder and are referred to herein collectively as the “ Additional Charges ”). Lessor shall have all legal, equitable and contractual rights, powers and remedies provided either in this Lease or by statute or otherwise in the case of non-payment of the Additional Charges as in the case of non-payment of the Base Rent. To the extent that Lessee pays any Additional Charges to Lessor pursuant to any requirement of this Lease, Lessee shall be relieved of Lessee’s obligation to pay such Additional Charges to the entity to which they would otherwise be due and Lessor shall pay same from monies received from Lessee.

3.4 Lease Provision . The Rent shall be paid so that this Lease shall yield to Lessor the full amount of the installments of Base Rent, Percentage Rent and Additional Charges throughout the Term, all as more fully set forth in Article 5 , but subject to any other provisions of this Lease that expressly provide for adjustment or abatement of Rent.

3.5 Addition or Deletion of Food or Beverage Services . If, during the Term, Lessee desires to provide additional food and beverage operations at any Facility (other than complimentary continental breakfast), or terminate any existing food and beverage operations, Lessee shall give notice of such desire to Lessor. Lessor shall have the right to approve or disapprove of any such addition or deletion of food and beverage operations. If Lessor shall approve such addition or deletion, Lessor and Lessee shall then commence negotiations to adjust Rent to reflect the proposed change to the operation of such Facility, each acting reasonably and in good faith. All other terms of this Lease will remain substantially the same. During negotiations, which shall not extend beyond sixty (60) days, Lessee shall not “convert” such Facility and shall continue fulfilling Lessee’s obligations under the existing terms of this Lease. If no agreement is reached after such 60-day period, such dispute shall be determined by

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arbitration in accordance with the International Arbitration Rules of the American Arbitration Association or any successor organization thereof and Title 9 of the U.S. Arbitration Act in New York, New York.

3.6 Change in Franchise Affiliation . Lessee shall not, without the prior written consent of Lessor, which consent may be granted or withheld in Lessor’s sole discretion, replace the existing franchise affiliation for any Facility or select a franchise affiliation for an unaffiliated facility.

3.7 Change in Scope of Work . If, during the renovation of any Facility, the Lessee and Lessor shall mutually determine to change the scope of the work that was originally agreed upon between the Lessor and the Lessee when the Rent was determined, then the following provisions shall apply:

(a) Lessee shall provide written notice to Lessor of the requested change in scope of the project including, if applicable, a requested change order in the form required for the construction contract applicable to the renovation if such Facility;

(b) Lessor shall determine the increased costs for the requested change order through consultation with the general contractor on the job or otherwise;

(c) Upon completion of the project at the Facility, the Lessor and Lessee shall then commence negotiations to adjust the Rent to reflect the additional expenditure by the Lessor to complete the changed work, each acting reasonably and in good faith; and

(d) All other terms of this Lease will remain substantially the same. During negotiations, which shall not extend beyond sixty (60) days, Lessee shall continue fulfilling Lessee’s obligations under the existing terms of this Lease. If no agreement is reached after the 60-day period, then the Lessee shall reimburse the Lessor for the actual costs of the change in work and this Lease shall otherwise continue in full force.

3.8 Annual Budget . Within ninety (90) days after the date of this Lease, and not later than fifteen (15) days prior to the commencement of each Fiscal Year beginning with the Fiscal Year commencing January 1st of the first (1 ^st ) calendar year after the Commencement Date, Lessee shall submit the Annual Budget to Lessor. The Annual Budget shall be subject to the approval of Lessor in Lessor’s sole discretion and shall contain the following:

(a) Lessee’s reasonable estimate of Gross Revenues (including room rates and Room Revenues), Gross Operating Expenses, and Gross Operating Profits for the forthcoming Fiscal Year for each Facility itemized on schedules on a quarterly basis as approved by Lessor and Lessee, as same may be revised or replaced from time to time by Lessee and approved by Lessor, together with the assumptions, in narrative form, forming the basis of such schedules.

(b) An estimate of the amounts to be spent for the repair, replacement, or refurbishment of Furniture and Equipment and/or Fixtures from Replacement Reserve Funds (as such term is defined in Section 40.1 below) or otherwise. In addition, to the extent required under any Loan Document, Lessee will furnish to Lessor, or Lender, on a monthly basis the monthly amount withheld from Gross Revenues for previous calendar month for Replacement

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Reserve Funds (together with the delivery of such amount to Lender, if required by Lender) and such other information required by Lender pertaining to Replacement Reserve Funds withheld and expenditures for the repair, replacement, or refurbishment of Furniture and Equipment and/or Fixtures.

(c) An estimate of any amounts Lessor will be required to provide (pursuant to franchise agreements, management agreements or otherwise) in the forthcoming Fiscal Year for required or desirable items which would be classified as capital items by generally accepted accounting principles, and projections of the amounts that may be required in the two succeeding Fiscal Years for such items.

(d) A cash flow projection.

(e) A narrative description of the program for advertising and marketing each Facility for the forthcoming Fiscal Year containing a detailed budget itemization of the proposed advertising expenditures by category and the assumptions, in narrative form, forming the basis of such budget itemization.

3.9 Books and Records . Lessee shall keep full and adequate books of account and other records reflecting the results of operation of each Facility on an accrual basis, all in accordance with the Uniform System and generally accepted accounting principles and the obligations of Lessee under this Lease. The books of account and all other records relating to or reflecting the operation of each Facility shall be kept either at such Facility or at Lessee’s offices, and shall be available to Lessor and Lessor’s representatives, auditors, accountants or lenders at all reasonable times for examination, audit, inspection and transcription. All of such books and records pertaining to each Facility including, without limitation, books of account, guest records and front office records, shall not be removed from such Facility or Lessee’s offices without the approval of Lessor.

3.10 Lessee Cure Right . Notwithstanding anything contained herein to the contrary, Lessor authorizes Lessee to take any and all action on Lessor’s behalf to cure or prevent any Default or Event of Default under the Loan Documents if Lessee reasonably determines that taking such action would be required to protect Lessee’s rights under this Lease or in Lessee’s Personal Property.

ARTICLE 4

IMPOSITIONS

4.1 Payment of Impositions . Subject to Article 12 relating to permitted contests, Lessee will pay, or cause to be paid, all Impositions (other than Real Estate Taxes which shall be paid by Lessor) before any fine, penalty, interest or cost may be added for non-payment, such payments to be made directly to the taxing or other authorities where feasible, and will promptly furnish to Lessor copies of official receipts or other satisfactory proof evidencing such payments. Lessee’s obligation to pay such Impositions shall be deemed absolutely fixed upon the date such Impositions become a lien upon the Leased Property or any part thereof. If any such Imposition may, at the option of the taxpayer, lawfully be paid in installments (whether or not interest shall accrue on the unpaid balance of such Imposition), Lessee may exercise the option to pay the

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same (and any accrued interest on the unpaid balance of such Imposition) in installments and in such event, shall pay such installments during the Term thereof (subject to Lessee’s right of contest pursuant to the provisions of Article 12 ) as the same respectively become due and before any fine, penalty, premium, further interest or cost may be added thereto. Lessor, at Lessor’s expense, shall, to the extent required or permitted by applicable law, prepare and file all tax returns and/or reports in respect of Lessor’s net income, gross receipts, sales and use, single business, transaction privilege, rent, ad valorem, franchise taxes, Real Estate Taxes and taxes on Lessor’s capital stock, and Lessee, at Lessee’s expense, shall, to the extent required or permitted by applicable laws and regulations, prepare and file all other tax returns and reports in respect to any Imposition as may be required by governmental authorities. If any refund shall be due from any taxing authority in respect of any Imposition paid by Lessee, the same shall be paid over to or retained by Lessee if no Event of Default shall have occurred hereunder and be continuing. If an Event of Default shall have occurred and be continuing, any such refund shall be paid over to or retained by Lessor. Any such funds paid over or retained by Lessor due to an Event of Default shall be applied as provided in Article 16 . Lessor and Lessee shall, upon request of the other, provide such data as is maintained by the party to whom the request is made with respect to the Leased Property as may be necessary to prepare any required returns and/or reports. Lessee shall file all returns and/or reports on Personal Property Taxes in such jurisdictions where it is legally required to so file. Lessor, to the extent it possesses the same, and Lessee, to the extent it possesses the same, will provide the other party, upon request, with cost and depreciation records necessary for filing returns for any property classified as personal property. Where Lessor is legally required to file Personal Property Tax returns, Lessee shall provide Lessor with copies of assessment notices in sufficient time for Lessor to file a protest. Lessor may, upon notice to Lessee, at Lessor’s option and at Lessor’s sole expense, protest, appeal, or institute such other proceedings (in Lessor’s or Lessee’s name) as Lessor may deem appropriate to effect a reduction of real estate or personal property assessments for those Impositions to be paid by Lessor, and Lessee, at Lessor’s expense as aforesaid, shall fully cooperate with Lessor in such protest, appeal, or other action. Lessor hereby agrees to indemnify, defend and hold harmless Lessee from and against any claims, obligations and liabilities against or incurred by Lessee in connection with such cooperation. Billings by Lessor to Lessee for reimbursement of any Personal Property Taxes paid by Lessor shall be accompanied by copies of a bill therefor and payments thereof which identify the personal property with respect to which such payments are made. Lessor, however, reserves the right to effect any such protest, appeal or other action and, upon notice to Lessee, shall control any such activity, which shall then go forward at Lessor’s sole expense. Upon such notice, Lessee, at Lessors expense, shall cooperate fully with such activities.

4.2 Notice of Impositions . Lessor shall give prompt Notice of all Impositions payable by Lessee hereunder of which Lessor at any time has knowledge provided that Lessor’s failure to give any such Notice shall in no way diminish Lessee’s obligations hereunder to pay such Impositions, but such failure shall obviate any default hereunder for a reasonable time after Lessee receives Notice of any Imposition which it is obligated to pay during the first taxing period applicable thereto.

4.3 Adjustment of Impositions . Impositions imposed in respect of the tax-fiscal period during which the Term terminates shall be adjusted and prorated between Lessor and

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Lessee, whether or not such Imposition is imposed before or after such termination, and Lessee’s obligation to pay Lessee’s prorated share thereof after termination shall survive such termination.

ARTICLE 5

ABATEMENT

5.1 No Termination, Abatement, Etc . Except as otherwise specifically provided in this Lease, and except for loss of any Franchise Agreement solely by reason of any action or inaction by Lessor, Lessee, to the fullest extent permitted by law, shall remain bound by this Lease in accordance with its terms and shall neither take any action without the written consent of Lessor to modify, surrender or terminate the same, nor seek nor be entitled to any abatement, deduction, deferment or reduction of the Rent, or setoff against the Rent, nor shall the obligations of Lessee be otherwise affected by reason of (a) any damage to, or destruction of, any Leased Property or any portion thereof from whatever cause or any Taking of the Leased Property or any portion thereof, (b) the lawful or unlawful prohibition of, or restriction upon, Lessee’s use of the Leased Property, or any portion thereof, or the interference with such use by any Person, or by reason of eviction by paramount title, (c) any claim which Lessee has or might have against Lessor by reason of any default or breach of any warranty by Lessor under this Lease or any other agreement between Lessor and Lessee, or to which Lessor and Lessee are parties, (d) any bankruptcy, insolvency, reorganization, composition, readjustment, liquidation, dissolution, winding up or other proceedings affecting Lessor or any assignee or transferee of Lessor, or (e) for any other cause whether similar or dissimilar to any of the foregoing other than a discharge of Lessee from any such obligations as a matter of law. Lessee hereby specifically waives all rights, arising from any occurrence whatsoever, which may now or hereafter be conferred upon it by law to (1) modify, surrender or terminate this Lease or quit or surrender the Leased Property or any portion thereof, or (2) entitle Lessee to any abatement, reduction, suspension or deferment of the Rent or other sums payable by Lessee hereunder, except as otherwise specifically provided in this Lease. The obligations of Lessee hereunder shall be separate and independent covenants and agreements and the Rent and all other sums payable by Lessee hereunder shall continue to be payable in all events unless the obligations to pay the same shall be terminated or abated pursuant to the express provisions of this Lease or by termination of this Lease other than by reason of an Event of Default.

5.2 Abatement Procedures . In the event of a partial Taking as described in Section 15.5 , this Lease shall not terminate for Taking, but the Base Rent shall be abated in the manner and to the extent that is fair, just and equitable to both Lessee and Lessor, taking into consideration, among other relevant factors, the number of usable rooms, the amount of square footage, or the revenues affected by such partial Taking. If Lessor and Lessee are unable to agree upon the amount of such abatement within thirty (30) days after such partial Taking, the matter may be submitted by either party to a court of competent jurisdiction for resolution.

5.3 Abatement During Renovation . Notwithstanding any other provision herein to the contrary, Base Rent shall be abated during any period in which the Lessor is renovating any Facility in an amount equal to the fraction, the numerator of which is the number of guest rooms out of service because of such renovations, and the denominator of which is the total number of guest rooms at all of the Facilities. Such abatement shall be calculated and applied monthly during the renovations.

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ARTICLE 6

PERSONAL PROPERTY; LESSOR’S LIEN

6.1 Ownership of the Leased Property . Lessee acknowledges that the Leased Property is the property of Lessor and that Lessee has only the right to the possession and use of the Leased Property upon the terms and conditions of this Lease.

6.2 Lessee’s Personal Property . Lessee will acquire and maintain throughout the Term such Inventory as is required to operate the Leased Property in the manner contemplated by this Lease. Lessee may (and shall as provided hereinbelow), at Lessee’s expense, install, affix or assemble or place on any parcels of the Land or in any of the Leased Improvements, any items of tangible personal property (including Inventory) owned by Lessee (collectively, the “ Lessee’s Personal Property ”), it being understood that all items of tangible personal property other than Furniture and Equipment and Fixtures located on, and used in connection with, the operation of the Leased Improvements as a hotel, together with all replacements, modifications, alterations and additions thereto, shall be deemed to be the Lessee’s Personal Property. All of Lessee’s Personal Property, other than Inventory (which shall remain with the Leased Premises and be conveyed to Lessor at the expiration of the term at no cost to Lessor), not removed by Lessee within ten (10) days following the expiration or earlier termination of the Term shall be appropriated, sold, destroyed or otherwise disposed of by Lessor without first giving Notice thereof to Lessee, provided that Lessor must compensate Lessee for any of such Lessee’s Personal Property that it appropriates, sells, destroys or otherwise disposes of in an amount equal to the fair market value thereof as appraised in conformity with market appraisal standards then in use for the locality in which the property is located, except that the appraisers need not be members of the American Institute of Real Estate Appraisers, but rather shall be appraisers having at least 10 years experience in valuing hotel tangible personal property. Lessee will, at Lessee’s expense, restore the Leased Property to its original condition (ordinary wear and tear excepted), including repair of all damage to the Leased Property caused by the removal of Lessee’s Personal Property, whether effected by Lessee or Lessor. Lessee may make such financing arrangements, title retention agreements, leases or other agreements with respect to the Lessee’s Personal Property as it sees fit; provided , that Lessee first advises Lessor of any such arrangement and such arrangement expressly provides that in the event of Lessee’s default thereunder, Lessor (or Lessor’s designee) may cure such default and assume Lessee’s obligations and rights under such arrangement.

6.3 Cash Management System . Lessor directs Lessee and Lessee acknowledges and agrees, pursuant to the terms of the Cash Management Agreement, to deposit or cause to be deposited all Gross Revenue (less any amounts any Manager is entitled to withhold pursuant to the terms of the Management Agreement relating to any Facility) from the operation of the Leased Property and the Facilities into the Cash Management System so long as any amounts under the Loan are outstanding. For purposes of this Section 6.3 only, the term “ Gross Revenues ” shall be deemed to include (a) proceeds of insurance and condemnation, (b) judgments and awards and (c) items constituting “allowances” under the Uniform System. Lessor hereby expressly authorizes Lessee to receive any and all amounts released by Lender from the Cash Management System, including amounts deposited by Lender into any remainder account or subaccount or released by Lender from any reserve or escrow account or subaccount. For each month during the Term, all funds deposited by Lessee into the Cash Management

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System less (i) any such funds deposited into the replacement reserve account, the operating expense subaccount or the extraordinary expense subaccount thereunder and (ii) any other such funds deposited into the remainder subaccount thereunder (the “ Monthly Deposit Credit ”), shall be deemed to offset and be applied to the payment of Rent owed by Lessee for such month. If the Monthly Deposit Credit exceeds the amount of Rent owed by Lessee for any given month (the “ Excess Monthly Deposit Credit ”), then the Excess Monthly Deposit Credit shall accrue interest at the Base Rate until paid or otherwise satisfied by Lessor or applied as payment of rent in future periods; provided , however , that Lessee hereby waives Lessee’s right to enforce or collect Excess Monthly Deposit Credits in cash against Lessor until the date which is 12 months after the Loan has been indefeasibly paid in full and any such Excess Monthly Deposit Credits shall be subject to and subordinate in all respects to the Loan and the Loan Documents. Notwithstanding anything contained herein to the contrary, Excess Monthly Deposit Credits shall, upon their creation, be applied first, to reduce and satisfy any Accrued Rent and all accrued and unpaid interest thereon, until all Accrued Rent has been satisfied in full.

ARTICLE 7

CONDITION OF LEASED PROPERTY; USE

7.1 Condition of the Leased Property . Lessee acknowledges receipt and delivery of possession of the Leased Property. Lessee has examined and otherwise has knowledge of the condition of the Leased Property and has found the same to be satisfactory for its purposes hereunder. Lessee is leasing the Leased Property “as is” in its present condition. Lessee waives any claim or action against Lessor in respect of the condition of the Leased Property. LESSOR MAKES NO WARRANTY OR REPRESENTATION, EXPRESS OR IMPLIED, IN RESPECT OF THE LEASED PROPERTY, OR ANY PART THEREOF, EITHER AS TO ITS FITNESS FOR USE, DESIGN OR CONDITION FOR ANY PARTICULAR USE OF PURPOSE OR OTHERWISE, AS TO THE QUALITY OF THE MATERIAL OR WORKMANSHIP THEREIN, LATENT OR PATENT, IT BEING AGREED THAT ALL SUCH RISKS ARE TO BE BORNE BY LESSEE. LESSEE ACKNOWLEDGES THAT THE LEASED PROPERTY HAS BEEN INSPECTED BY LESSEE AND IS SATISFACTORY TO LESSEE. Provided , however , to the extent permitted by law, Lessor hereby assigns to Lessee all of Lessor’s rights to proceed against any predecessor in title other than Lessee (or an Affiliate of Lessee which conveyed the Property to Lessor) or any contractor, materialmen or other similar Persons for breaches of warranties or representations or for latent defects in the Leased Property. Lessor shall fully cooperate with Lessee in the prosecution of any such claim, in Lessor’s or Lessee’s name, all at Lessee’s sole cost and expense. Lessee hereby agrees to indemnify, defend and hold harmless Lessor from and against any claims, obligations and liabilities against or incurred by Lessor in connection with such cooperation.

7.2 Use of the Leased Property .

(a) Lessee covenants that it will obtain and maintain all approvals needed to use and operate the Leased Property and the Facilities under applicable Legal Requirements.

(b) Lessee shall use or cause to be used the Leased Property only as a hotel facility, and for such other uses as may be necessary or incidental to such use (the “ Primary Intended Use ”). Lessee shall not use the Leased Property or any portion thereof for any other

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use without the prior written consent of Lessor, which consent may be granted, denied or conditioned in Lessor’s reasonable discretion. No use shall be made or permitted to be made of the Leased Property, and no acts shall be done, which will cause the cancellation or increase the premium of any insurance policy covering the Leased Property or any part thereof (unless another adequate policy satisfactory to Lessor is available and Lessee pays any premium increase), nor shall Lessee sell or permit to be kept, used or sold in or about the Leased Property any article which may be prohibited by law or fire underwriter’s regulations. Lessee shall, at Lessee’s sole cost, comply with all of the requirements pertaining to the Leased Property of any insurance board, association, organization or company necessary for the maintenance of insurance, as herein provided, covering the Leased Property and Lessee’s Personal Property.

(c) Subject to the provisions of Articles 14, 15, 21 and 22 , Lessee covenants and agrees that during the Term it will (1) operate continuously the Leased Property for the Primary Intended Use, (2) keep in full force and effect and comply with all the provisions of any Franchise Agreement (except that Lessee shall have no obligation to complete any capital improvements to the Leased Property required by the franchisor unless the Lessor funds the cost thereof), (3) not terminate or amend any Franchise Agreement without the consent of Lessor, (4) maintain appropriate certifications and licenses for such use, and (5) seek to maximize the Gross Revenues generated therefrom consistent with sound business practices, and (6) seek to keep the costs and expenses of the Leased Property payable by Lessor at reasonable levels.

(d) Lessee shall not commit or suffer to be committed any waste on the Leased Property, or in the Facility, nor shall Lessee cause or permit any nuisance thereon.

(e) Lessee shall neither suffer nor permit the Leased Property or any portion thereof, or Lessee’s Personal Property, to be used in such a manner as (1) might reasonably tend to impair Lessor’s (or Lessee’s, as the case may be) title thereto or to any portion thereof, or (2) may reasonably make possible a claim or claims of adverse usage or adverse possession by the public, as such, or of implied dedication of the Leased Property or any portion thereof, except as necessary in the ordinary and prudent operation of the Facility on the Leased Property.

7.3 Lessor to Grant Easements, Etc . Lessor will, from time to time, so long as no Event of Default has occurred and is continuing, at the request of Lessee and at Lessee’s cost and expense (but subject to the approval of Lessor, which approval shall not be unreasonably withheld or delayed), (a) grant easements and other rights in the nature of easements with respect to the Leased Property to third parties, (b) release existing easements or other rights in the nature of easements which are for the benefit of the Leased Property, (c) dedicate or transfer unimproved portions of the Leased Property for road, highway or other public purposes, (d) execute petitions to have the Leased Property annexed to any municipal corporation or utility district, (e) execute any covenants and restrictions affecting the Leased Property and (f) execute and deliver to any Person any instrument appropriate to confirm or effect such grants, releases, dedications, transfers, petitions and amendments (to the extent of Lessor’s interests in the Leased Property), but only upon delivery to Lessor of an officer’s certificate stating that such grant, release, dedication, transfer, petition or amendment does not interfere with the proper conduct of the business of Lessee on the Leased Property and does not materially reduce the value of the Leased Property.

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7.4 Engagement of a Manager : Lessee shall not engage a manager for the Leased Property other than a Qualified Manager without the written consent of the Lessor, which may be given or withheld in Lessor’s reasonable discretion. Any management contract, agreement or other arrangement entered into by Lessee shall not relieve Lessee of any of Lessee’s obligations hereunder and any such agreement shall be expressly subordinate to the terms and conditions of this Lease.

ARTICLE 8

COMPLIANCE WITH LAWS

8.1 Compliance with Legal and Insurance Requirements, Etc . Subject to Section 8.3 below and Article 12 relating to permitted contests, Lessee, at Lessee’s expense, will promptly (a) comply with all applicable Legal Requirements and Insurance Requirements in respect of the use, operation, maintenance, repair and restoration of the Leased Property, and (b) procure, maintain and comply with all appropriate licenses and other authorizations required for any use of the Leased Property and Lessee’s Personal Property then being made, and for the proper erection, installation, operation and maintenance of the Leased Property or any part thereof.

8.2 Legal Requirement Covenants . Subject to Section 8.3 below, Lessee covenants and agrees that the Leased Property and Lessee’s Personal Property shall not be used for any unlawful purpose and that Lessee shall not permit or suffer to exist any unlawful use of the Leased Property by others. Lessee shall acquire and maintain all appropriate licenses, certifications, permits and other authorizations and approvals needed to operate the Leased Property in its customary manner for the Primary Intended Use, and any other lawful use conducted on the Leased Property as may be permitted from time to time hereunder. Lessee further covenants and agrees that Lessee’s use of the Leased Property and maintenance, alteration, and operation of the same, and all parts thereof, shall at all times conform to all Legal Requirements, unless the same are finally determined by a court of competent jurisdiction to be unlawful (and Lessee shall cause all tenants, invitee or others to so comply with all Legal Requirements). Lessee may, however, upon prior Notice to Lessor, contest the legality or applicability of any such Legal Requirement or any licensure or certification decision if Lessee maintains such action in good faith, with due diligence, without prejudice to Lessor’s rights hereunder, and at Lessee’s sole expense. Lessee may delay compliance with any such Legal Requirement pending the outcome of any such contest provided no lien, charge or civil or criminal liability would be incurred and imposed upon Lessee, Lessor or the Leased Property by reason of any such delay and provided Lessee both (a) furnishes to Lessor security reasonably satisfactory to Lessor against any loss or injury by reason of such contest or delay and (b) prosecutes the contest with due diligence and in good faith.

8.3 Environmental Covenants . Lessor and Lessee (in addition to, and not in diminution of, Lessee’s covenants and undertakings in Sections 8.1 and 8.2 hereof) covenant and agree as follows:

(a) At all times hereafter until the later of (i) such time as all liabilities, duties or obligations of Lessee to the Lessor under this Lease have been satisfied in full and (ii) such time as Lessee completely vacates the Leased Property and surrenders possession of the same to Lessor, Lessee shall fully comply with all Environmental Laws applicable to the Leased Property

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and the operations thereon. Lessee agrees to give Lessor prompt written notice of (1) all Environmental Liabilities; (2) all pending, threatened or anticipated Proceedings, and all notices, demands, requests or investigations, relating to any Environmental Liability or relating to the issuance, revocation or change in any Environmental Authorization required for operation of the Leased Property; (3) all Releases at, on, in, under or in any way affecting the Leased Property, or any Release known by Lessee at, on, in or under any property adjacent to the Leased Property; and (4) all facts, events or conditions that could reasonably lead to the occurrence of any of the above-referenced matters.

(b) Lessor hereby agrees to defend, indemnify and save harmless any and all Lessee Indemnified Parties from and against any and all Environmental Liabilities other than Environmental Liabilities which were caused by the acts or grossly negligent failures to act of Lessee, Lessee’s agents, employees, contractors, invitees or licensees.

(c) Lessee hereby agrees to defend, indemnify and save harmless any and all Lessor Indemnified Parties from and against any and all Environmental Liabilities which were caused by the acts or grossly negligent failures to act of Lessee, Lessee’s agents, employees, contractors, invitees or licensees.

(d) If any Proceeding is brought against any Indemnified Party in respect of an Environmental Liability with respect to which such Indemnified Party may claim indemnification under either Section 8.3(b) or (c) , the Indemnifying Party, upon request, shall at such Indemnifying Party’s sole expense resist and defend such Proceeding, or cause the same to be resisted and defended by counsel designated by the Indemnified Party and approved by the Indemnifying Party, which approval shall not be unreasonably withheld; provided , however , that such approval shall not be required in the case of defense by counsel designated by any insurance company undertaking such defense pursuant to any applicable policy of insurance. Each Indemnified Party shall have the right to employ separate counsel in any such proceeding and to participate in the defense thereof, but the fees and expenses of such counsel will be at the sole expense of such Indemnified Party unless such counsel has been approved by the Indemnifying Party, which approval shall not be unreasonably withheld. The Indemnifying Party shall not be liable for any settlement of any such Proceeding made without its consent, which shall not be unreasonably withheld, but if settled with the consent of the Indemnifying Party, or if settled without such Indemnifying Party’s consent (if its consent shall be unreasonably withheld), or if there be a final, nonappealable judgment for an adversary party in any such Proceeding, the Indemnifying Party shall indemnify and hold harmless the Indemnified Parties from and against any liabilities incurred by such Indemnified Parties by reason of such settlement or judgment.

(e) At any time any Indemnified Party has reason to believe circumstances exist which could reasonably result in an Environmental Liability, upon reasonable prior written notice to Lessee stating such Indemnified Party’s basis for such belief, an Indemnified Party shall be given immediate access to the Leased Property (including, but not limited to, the right to enter upon, investigate, drill wells, take soil borings, excavate, monitor, cap and use available land for the testing of remedial technologies), Lessee’s employees, and to all relevant documents and records regarding the matter as to which a responsibility, liability or obligation is asserted or which is the subject of any Proceeding, provided that such access may be conditioned or restricted as may be reasonably necessary to ensure compliance with law and the safety of

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personnel and facilities or to protect confidential or privileged information. All Indemnified Parties requesting such immediate access and cooperation shall endeavor to coordinate such efforts to result in as minimal interruption of the operation of the Leased Property as practicable.

(f) The indemnification rights and obligations provided for in this Article 8 shall be in addition to any indemnification rights and obligations provided for elsewhere in this Lease.

(g) The indemnification rights and obligations provided for in this Article 8 shall survive the termination of this Lease.

(h) For purposes of this Section 8.3 , all amounts for which any Indemnified Party seeks indemnification shall be computed net of (a) any actual income tax benefit resulting therefrom to such Indemnified Party, (b) any insurance proceeds received (net of tax effects) with respect thereto, and (c) any amounts recovered (net of tax effects) from any third parties based on claims the Indemnified Party has against such third parties which reduce the damages that would otherwise be sustained, provided that in all cases, the timing of the receipt or realization of insurance proceeds or income tax benefits or recoveries from third parties shall be taken into account in determining the amount of reduction of damages. Each Indemnified Party agrees to use its reasonable efforts to pursue, or assign to Lessee or Lessor, as the case may be, any Claims or rights it may have against any third party which would materially reduce the amount of damages otherwise incurred by such Indemnified Party.

(i) Notwithstanding anything to the contrary contained in this Lease, if Lessor shall become entitled to the possession of this Leased Property by virtue of the termination of this Lease or repossession of the Leased Property, then Lessor may assign Lessor’s indemnification rights under Section 8.3 of this Lease (but not any other rights hereunder) to any Person to whom the Lessor subsequently transfers the Leased Property, subject to the following conditions and limitations, each of which shall be deemed to be incorporated into the terms of such assignment, whether or not specifically referred to therein:

(1) The indemnification rights referred to in this section may be assigned only if a known Environmental Liability then exists or if a proceeding is then pending or, to the knowledge of Lessee or Lessor, then threatened with respect to the Leased Property;

(2) Such indemnification rights shall be limited to Environmental Liabilities relating to or specifically affecting the Leased Property; and

(3) Any assignment of such indemnification rights shall be limited to the immediate transferee of Lessor, and shall not extend to any such transferee’s successors or assigns.

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ARTICLE 9

IMPROVEMENTS; MAINTENANCE

9.1 Capital Improvements, Maintenance and Repair .

(a) Subject to Section 9.1(b) , Lessee shall (i) keep the Leased Property and all private roadways, sidewalks and curbs appurtenant thereto that are under Lessee’s control, including windows and plate glass, parking lots, mechanical, electrical and plumbing systems and equipment (including conduit and ductware), and non-load bearing interior walls, in good order and repair, except for ordinary wear and tear (whether or not the need for such repairs occurred as a result of Lessee’s use, any prior use, the elements or the age of the Leased Property, or any portion thereof), and, (ii) except as otherwise provided in Articles 14 or 15 , with reasonable promptness, make all necessary and appropriate repairs thereto of every kind and nature, whether interior or exterior, ordinary or extraordinary, foreseen or unforeseen or arising by reason of a condition existing prior to the commencement of the Term of this Lease (concealed or otherwise), or required by any governmental agency having jurisdiction over the Leased property, except as to the structural elements of the Leased Improvements and underground utilities.

(b) Notwithstanding any other provision of this Lease, unless the need for compliance with Section 9.1(a) is caused by Lessee’s negligence or willful misconduct or that of Lessee’s employees or agents, Lessee shall not be required to bear the costs of complying with Section 9.1(a) with respect to items classified as either (i) capital items under generally accepted accounting principles, or (ii) Fixtures in, on, or under any Facility or its components, except to the extent (X) that amounts are available therefor from Lessor under Article 40 or otherwise, or (Y) required under Articles 14 and 15 on the conditions set forth therein.

(c) Article 40 sets forth the only obligations of Lessor to fund the cost of any repairs, replacements, alterations, restorations or renewals of any nature or description to the Leased Property, whether ordinary or extraordinary, foreseen or unforeseen, or to make any expenditure whatsoever with respect thereto, in connection with this Lease, or to maintain the Leased Property in any way. Lessee hereby waives, to the extent permitted by law, the right to make repairs at the expense of Lessor pursuant to any law in effect at the time of the execution of this Lease or hereafter enacted. Lessor shall have the right to give, record and post, as appropriate, notices of nonresponsibility under any mechanic’s lien laws now or hereafter existing.

(d) Nothing contained in this Lease and no action or inaction by Lessor shall be construed as (i) constituting the request of Lessor, expressed or implied, to any contractor, subcontractor, laborer, materialman or vendor to or for the performance of any labor or services or the furnishing of any materials or other property for the construction, alteration, additional repair or demolition of or to the Leased Property or any part thereof, or (ii) giving Lessee any right, power or permission to contract for or permit the performance of any labor or services or the furnishing of any materials or other property in such fashion as would permit the making of any claim against Lessor in respect thereof or to make any agreement that may create, or in any way be the basis for any right, title, interest, lien, claim or other encumbrance upon the estate of Lessor in the Leased Property, or any portion thereof.

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(e) Lessee will, upon the expiration or prior termination of the Term, vacate and surrender the Leased Property to Lessor in the condition in which the Leased Property was originally received from Lessor, except as repaired, rebuilt, restored, altered or added to as permitted or required by the provisions of this Lease and except for ordinary wear and tear (subject to the obligation of Lessee to maintain the Leased Property in accordance with Section 9.1(a) above during the entire Term of this Lease), or damage by casualty or Condemnation (subject to the obligations of Lessee to restore or repair as set forth in this Lease).

9.2 Encroachments, Restrictions, Etc . If any of the Leased Improvements, at any time, materially encroach upon any property, street or right-of-way adjacent to the Leased Property, or violate the agreements or conditions contained in any lawful restrictive covenant or other agreement affecting the Leased Property, or any part thereof, or impair the rights of others under any easement or right-of-way to which the Leased Property is subject, then promptly upon the request of Lessor or at the behest of any Person affected by any such encroachment, violation or impairment, Lessee shall cooperate with Lessor, at Lessor’s expense, subject to any title insurance insuring against such matter and any right to contest the existence of any encroachment, violation or impairment and, in such case, in the event of an adverse final determination, either (a) obtain valid and effective waivers or settlements of all claims, liabilities and damages resulting from each such encroachment, violation or impairment, whether the same shall affect Lessor or Lessee, or (b) make such changes in the Leased Improvements, and take such other actions, as are reasonably practicable to remove such encroachment, and to end such violation or impairment, including, if necessary, the alteration of any of the Leased Improvements, and in any event take all such actions as may be necessary in order to be able to continue the operation of the Leased Improvements for the Primary Intended Use substantially in the manner and to the extent the Leased Improvements were operated prior to the assertion of such violation, impairment or encroachment. Any such alterations shall be made by Lessee in conformity with the applicable requirements of Article 10 .

ARTICLE 10

ALTERATIONS

10.1 Alterations . Lessee shall obtain Lessor’s prior written consent to any additions, modifications or improvements to any part of the Leased Property (indiv i dually and collectively, “ Alterations ”) provided that Lessor’s consent shall not be required in connection with any Alterations that (together with the related cost of such alterations) have been provided for in the Annual Budget, provided that such Alterations (a) do not adversely affect any structural component of any Facility, any utility or HVAC system contained in any Facility or the exterior of any building constituting a part of any Facility and the aggregate cost thereof does not exceed the lesser of (x) One Million Dollars ($1,000,000) and (y) an amount equal to three percent (3%) of the amount listed in column F for the applicable Facility, or (b) are Alterations performed in connection with the restoration of the Leased Property after the occurrence of a casualty or condemnation in accordance with the terms and provisions of this Lease and the Loan Documents. If Lessee desires to make any Alterations, Lessee shall provide a written request to Lessor, along with any additional materials, plans, budgets and other items requested by Lessor. The cost of such additions, modifications or improvements to the Leased Property shall be paid by Lessee, and all such additions, modifications and improvements shall, without payment by Lessor at any time, be included under the terms of this Lease and upon expiration or earlier

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termination of this Lease shall pass to and become the property of Lessor. Notwithstanding anything to the contrary contained herein, if Lessor approves of any Alterations, Lessor shall have the right (but not the obligation) to require Lessee to deliver to Lessor funds for such Alterations in an amount deemed by Lessor, in Lessor’s reasonable discretion, to be adequate of such Alterations, which funds shall be disbursed by Lessor in accordance with the practices of commercially reasonable construction lenders in the jurisdiction in which the Leased Property is located.

10.2 Salvage . All materials which are scrapped or removed in connection with the making of repairs required by Articles 9 or 10 shall be or become the property of Lessor or Lessee depending on which party is paying for or providing the financing for such work.

10.3 Repairs and Improvements by Lessor . Lessor shall at all times have the right to make structural and non-structural repairs, additions and improvements to the Leased Improvements, including, without limitation, the addition of hotel rooms, the alteration of the facade of the Leased Property and the renovation of guest rooms. Lessee shall cooperate in Lessor’s undertaking such work, provided Lessee shall have no obligation to pay any third party costs in connection therewith, and further provided Lessee acknowledges that, except as provided in Section 5.3 of Article 10 , it shall not be entitled to any abatement of rent, offset or deduction as a result of such work, regardless of whether the work involves the temporary closure of the hotel or portions thereof.

ARTICLE 11

LIENS

Subject to the provision of Article 12 relating to permitted contests, Lessee will not directly or indirectly create or allow to remain and will promptly discharge at Lessee’s expense any lien, encumbrance, attachment, title retention agreement or claim upon the Leased Property or any attachment, levy, claim or encumbrance in respect of the Rent, not including, however, (a) this Lease, (b) the matters, if any, included as exceptions in the title policy insuring Lessor’s interest in the Leased Property, (c) restrictions, liens and other encumbrances which are consented to in writing by Lessor or any easements granted pursuant to the provisions of Section 7.3 of this Lease, (d) liens for those taxes upon Lessor which Lessee is not required to pay hereunder, (e) subleases permitted by Article 23 hereof, (f) liens for Impositions or for sums resulting from noncompliance with Legal Requirements so long as (i) the same are not yet payable or are payable without the addition of any fine or penalty, or (ii) such liens are in the process of being contested as permitted by Article 12 , (g) liens of mechanics, laborers, materialmen, suppliers or vendors for sums either disputed or not yet due, provided that (1) the payment of such sums shall not be postponed under any related contract for more than sixty (60) days after the completion of the action giving rise to such lien and such reserve or other appropriate provisions as shall be required by law or generally accepted accounting principles shall have been made therefor, or (2) any such liens are in the process of being contested as permitted by Article 12 hereof, (h) any liens created pursuant to the Loan Documents and (i) any liens which are the responsibility of Lessor pursuant to the provisions of Article 34 of this Lease. Notwithstanding anything to contrary contained herein, Lessee will not directly or indirectly create or allow to remain and will promptly discharge at Lessee’s expense any mortgage, deed of

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trust, lien, pledge, hypothecation, assignment, security interest, or any other encumbrance or charge on the Leased Property that is not permitted under the Loan Documents.

ARTICLE 12

PERMITTED CONTESTS

After receiving the prior written approval of Lessor, Lessee, at Lessee’s own expense, may contest the amount or validity of any Imposition to be paid by Lessee or any Legal Requirement or Insurance Requirement or any lien, attachment, levy, encumbrance, charge or claim (“ Claims ”) not otherwise permitted by Article 11 by appropriate legal proceeding, promptly initiated and conducted in good faith and with due diligence, provided that (a) Lessor would be permitted to do so under the provisions of any mortgage or deed of trust superior in lien to the this Lease; (b) such proceeding shall be permitted under and be conducted in accordance with the provisions of any other instrument to which Lessor is subject and shall not constitute a default thereunder and such proceeding shall be conducted in accordance with all applicable statutes, laws and ordinances; (c) the Leased Property nor any part thereof or interest therein will be in imminent danger of being sold, forfeited, terminated, canceled or lost; (d) Lessee shall promptly upon final determination thereof pay the amount of any such Claim, together with all costs, interest and penalties which may be payable in connection therewith; (e) such proceeding shall suspend the collection of such contested Claim from the Leased Property; and (f) Lessee shall furnish such security as may be required in the proceeding, or as may be reasonably requested by Lessor, to insure the payment of any such Claim, together with all interest and penalties thereon. Lessee shall be entitled to any refund of any Claims and such charges and penalties or interest thereon which have been paid by Lessee or paid by Lessor and for which Lessor has been fully reimbursed.

ARTICLE 13

INSURANCE

13.1 General Insurance Requirements .

(a) Coverages by Lessor . During the Term of this Lease, Lessor shall at Lessor’s expense, without reimbursement from Lessee, at all times keep the Leased Property insured with the kinds and amounts of insurance described in Section 6.1 of the Loan Agreement (except to the extent such insurance is required to be kept by the Lessee pursuant to Section 13.1(b) below). This insurance shall be written by companies authorized to issue insurance in the State. The policies must name Lessor or Lender, if applicable, as the insured or as an additional named insured, as the case may be

(b) Coverages by Lessee . During the term of this Lease, Lessee shall at Lessee’s expense keep the insurance described below. This insurance shall be written by companies authorized to issue insurance in the State and otherwise acceptable to Lessor. If required by Lessor, the policies must name Lessor or Lender as additional insureds, as applicable.

(i) Fidelity bonds with limits and deductibles as may be reasonably requested by Lessor, covering Lessee’s employees in job classifications normally bonded under prudent hotel management practices in the United States or otherwise required by law;

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(ii) Workers’ compensation insurance in accordance with all Legal Requirements for all persons employed by Lessee on the Leased Property to the extent necessary to protect Lessor and the Leased Property against Lessee’s worker’s compensation claims;

(iii) Vehicle liability insurance for owned, nonowned, and hired vehicles, including rented and leased vehicles containing minimum limits per occurrence of $1,000,000;

(iv) Comprehensive casualty insurance providing protection against any peril included within the classification “all risks” insurance coverage, together with insurance against flood, sewage backup, sprinkler damage, vandalism, and malicious mischief, to the extent of the Full Replacement Cost of Lessee’s Personal Property and Inventory, the proceeds of which will be distributed in accordance with Section 14.1 below; and

(v) Such other insurance as Lessor may reasonably request, provided , that such other insurance is customary for facilities such as the Leased Property and the operation thereof.

13.2 Replacement Cost . The term “ Full Replacement Cost ” as used herein shall mean the actual replacement cost of the Leased Property requiring replacement from time to time including an increased cost of construction endorsement, if available, and the cost of debris removal. In the event either party believes that full replacement cost (the then-replacement cost less such exclusions) has increased or decreased at any time during the Lease Term, it shall have the right to have such full replacement cost re-determined.

13.3 Waiver of Subrogation . All insurance policies carried by Lessor or Lessee covering the Leased Property, the Fixtures, any Facility or Lessee’s Personal Property, including, without limitation, contents, fire and casualty insurance, shall expressly waive any right of subrogation on the part of the insurer against the other party. The parties hereto agree that their policies will include such waiver clause or endorsement so long as the same are obtainable without extra cost, and in the event of such an extra charge the other party, at its election, may pay the same, but shall not be obligated to do so. Each party agrees to seek recovery from any applicable insurance coverage prior to seeking recovery against the other.

13.4 Form Satisfactory, Etc . All of the policies of insurance referred to in this Article 13 shall be written in a form, with deductibles and by insurance companies reasonably satisfactory to Lessor and also shall meet and satisfy the requirements of any ground lessor, lender or franchisor having any interest in the Leased Premises. Lessee shall deliver to Lessor policies or certificates of the insurance required under 13.1 above as of their effective date (and, with respect to any renewal policy, thirty (30) days prior to the expiration of the existing policy), and in the event of the failure of Lessee either to obtain such insurance as herein called for or to pay the premiums therefor, or to deliver such policies or certificates thereof to Lessor at the times required, Lessor shall be entitled, but shall have no obligation, to obtain such insurance and

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pay the premiums therefor, and Lessee shall reimburse Lessor for any premium or premiums paid by Lessor for the coverages required under this Section upon written demand therefor, and repay the same within thirty (30) days after Notice of such failure from Lessor shall constitute an Event of Default within the meaning of Section 16.1(d) . Each insurer mentioned in this Article 13 shall agree, by endorsement to the policy or policies issued by it, or by independent instrument furnished to Lessor thirty (30) days’ written notice before Lessor, the policy or policies in question shall be materially altered, allowed to expire or canceled.

13.5 Blanket Policy . Notwithstanding anything to the contrary contained in this Article 13 , Lessee or Lessor may bring the insurance provided for herein within the coverage of a so-called blanket policy or policies of insurance carried and maintained by Lessee or Lessor, provided , however , that the coverage afforded to Lessor and Lessee will not be reduced or diminished or otherwise be different from that which would exist under a separate policy meeting all other requirements of this Lease by reason of the use of such blanket policy of insurance, and provided further that the requirements of this Article 13 are otherwise satisfied.

13.6 Separate Insurance . Lessee shall not on Lessee’s own or pursuant to the request or requirement of any third party, take out separate insurance concurrent in form or contributing in the event of loss with that required in this Article 13 to be furnished, or increase the amount of any then existing insurance by securing an additional policy or additional policies, unless all parties having an insurable interest in the subject matter of the insurance, including in all cases Lessor, are included therein as additional insureds, and the loss is payable under such additional separate insurance in the same manner as losses are payable under this Lease. Lessee shall immediately provide Notice to Lessor that Lessee has obtained any such separate insurance or of the increasing of any of the amounts of the then existing insurance.

13.7 Reports on Insurance Claims . Lessee shall promptly investigate and make a complete and timely written report to the appropriate insurance company as to all accidents, claims for damage relating to the ownership, operation, and maintenance of any Facility, any damage or destruction to any Facility and the estimated cost of repair thereof and shall prepare any and all reports required by any insurance company in connection therewith. All such reports shall be timely filed with the insurance company as required under the terms of the insurance policy involved, and a final copy of such report shall be furnished to Lessor.

ARTICLE 14

DAMAGE AND DESTRUCTION

14.1 Insurance Proceeds . Subject to the rights of Lender under the Loan Documents, all proceeds payable by reason of any loss or damage to the Leased Property, or any portion thereof, and insured under any policy of insurance required by Article 13 of this Lease shall be paid to Lender and held in trust by Lender in an interest-bearing account for reconstruction or repair, as the case may be, of any damage to or destruction of the Leased Property, or any portion thereof, and, if applicable, shall be paid out by Lender from time to time for the reasonable costs of such reconstruction or repair in accordance with the terms of the Loan Documents; provided, however, in the event that the Leased Property is not covered by a Loan the foregoing provisions applicable to Lender shall apply to Lessor and such proceeds shall be paid out by Lessor from time to time for the reasonable costs of such reconstruction or repair upon satisfaction of

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reasonable terms and conditions specified by Lessor. To the extent any such proceeds under such insurance policies are released or otherwise paid by Lender to Lessor (or, if no Lender, received directly by Lessor) and are not required to be applied in any manner under the terms and provisions of the Loan Documents, or this Lease, then such funds shall be immediately paid over by Lessor to Lessee as is required to fairly compensate Lessee for any loss it suffers as a result of such loss or damage. All salvage resulting from any risk covered by insurance shall belong to Lessor.

14.2 Reconstruction in the Event of Damage or Destruction .

(a) Total Destruction . If during the Term the Leased Property is totally destroyed and the Facility thereby is rendered Unsuitable for its Primary Intended Use, Lessee shall restore the Facility to substantially the same condition as existed immediately before the damage or destruction and otherwise in accordance with the terms of this Lease. Such damage or destruction shall not terminate this Lease, and the insurance proceeds shall be paid out by Lessor from time to time for the reasonable costs of such restoration upon satisfaction of reasonable terms and conditions specified by Lessor, and any excess proceeds remaining after such restoration shall be retained by Lessor.

(b) Partial Damage . Except as otherwise provided in this Lease, if during the Term the Leased Property is partially destroyed, but the Facility is not thereby rendered Unsuitable for its Primary Intended Use, Lessee shall restore the Facility to substantially the same condition as existed immediately before the damage or destruction and otherwise in accordance with the terms of this Lease. Such damage or destruction shall not terminate this Lease, and the insurance proceeds shall be paid out by Lessor from time to time for the reasonable costs of such restoration upon satisfaction of reasonable terms and conditions specified by Lessor, and any excess proceeds remaining after such restoration shall be retained by Lessor.

14.3 Lessee’s Property . Lessor shall have no obligation to insure Lessee’s Personal Property against any loss of or damage to any of Lessee’s Personal Property. Lessee may separately insure its personal property, provided, however, no such payments under such insurance shall diminish or reduce the insurance payments otherwise payable to or for the benefit of Lessor hereunder.

14.4 Abatement of Rent . Unless this Lease is terminated in accordance herewith, any damage or destruction due to casualty notwithstanding, this Lease shall remain in full force and effect and Lessee’s obligation to make rental payments and to pay all other charges required by this Lease shall be equitably abated during any period required for the applicable repair and restoration.

14.5 Damage Near End of Term . Notwithstanding any provisions of this Article 14 appearing to the contrary, if damage to or destruction of any Facility renders it unsuitable for its Primary Intended Use occurs during the last 24 months of the Term, then either party shall have the right to terminate this Lease with respect to such Facility by giving Notice to the other within thirty (30) days after the date of damage or destruction, whereupon all Accrued Rent with respect

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to such Facility shall be paid immediately, and this Lease shall automatically terminate with respect to such Facility five (5) days after the date of such Notice.

14.6 Waiver . Lessee hereby waives any statutory or judicially created rights of termination that may arise by reason of any damage or destruction of any Facility that Lessor is obligated to restore or may restore under any of the provisions of this Lease.

ARTICLE 15

EMINENT DOMAIN

15.1 Definitions . (a) “ Condemnation ” means a Taking resulting from (1) the exercise of any governmental power, whether by legal proceedings or otherwise, by a Condemnor, and (2) a voluntary sale or transfer by Lessor to any Condemnor, either under threat of condemnation or while legal proceedings for condemnation are pending.

(b) “ Date of Taking ” means the date the Condemnor has the right to possession of the property being condemned.

(c) “ Award ” means all compensation, sums or anything of value awards, paid or received on a total or partial Condemnation.

(d) “ Condemnor ” means any public or quasi-public authority, or private corporation or individual, having the power of Condemnation.

15.2 Parties’ Rights and Obligations . If during the Term there is a Condemnation of all or any part of the Leased Property at a particular Facility or any interest in this Lease, the rights and obligations of Lessor and Lessees shall be determined by this Article 15 , subject in all respects to any and all rights of Lender under the Loan Documents. If Lender releases to Lessor any Award in connection with a Condemnation or Taking of all or any part of the Leased Property at a Facility that is not required to be applied in any manner by the terms and provisions of the Loan Documents, then such funds shall be immediately paid over by Lessor to Lessee in such amounts as is required to fairly compensate Lessee for any loss it suffers as a result of such Condemnation or Taking.

15.3 Total Taking . If title to the fee of the whole of the Leased Property at a particular Facility is condemned by any Condemnor, this Lease shall cease and terminate as of the Date of Taking by the Condemnor. If title to the fee of less than the whole of the Leased Property is so taken or condemned, which nevertheless renders the Leased Property Unsuitable or Uneconomic for its Primary Intended Use, Lessee and Lessor shall each have the option, by notice to the other, at any time prior to the Date of Taking, to terminate this Lease as of the Date of Taking. Upon such date, if such Notice has been given, this Lease shall thereupon cease and terminate. All Base Rent, Percentage Rent and Additional Charges paid or payable by Lessee hereunder shall be apportioned as of the Date of Taking, and Lessee shall promptly pay Lessor such amounts.

15.4 Partial Taking . If title to less than the whole of the Leased Property at a particular Facility is condemned, and such Leased Property is still suitable for its Primary Intended Use, and not Uneconomic for its Primary Intended Use, or if Lessee or Lessor is entitled but neither

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elects to terminate this Lease as provided in Section 15.3 , (a) Lessee, at Lessee’s sole cost and expense (subject to Lessor’s contribution as set forth below) shall with all reasonable dispatch restore the untaken portion of any Leased Improvements so that such Leased Improvements constitute a complete architectural unit of the same general character and condition (as nearly as may be possible under the circumstances) as the Leased Improvements existing immediately prior to the Condemnation, unless such restoration extends beyond the expiration of the Term, in which case Lessee shall not be required to make such restoration, and (b) Lessee shall continue to pay, in the manner and at the terms herein specified, full amounts of Base Rent and Additional Charges with an equitable reduction for the portion of the Leased Property so condemned.

15.5 Temporary Taking . If the whole or any part of the Leased Property at a particular Facility or of Lessee’s interest under this Lease is condemned by any Condemnor for its temporary use or occupancy, this Lease shall not terminate by reason thereof, but Lessee shall continue to pay, in the manner and at the terms herein specified, full amounts of Base Rent and Additional Charges with an equitable reduction for the portion of the Leased Property so condemned. Except only to the extent that Lessee may be prevented from so doing pursuant to the terms of the order of the Condemnor, Lessee shall continue to perform and observe all of the other terms, covenants, conditions and obligations hereof on the part of the Lessee to be performed and observed, as though such Condemnation had not occurred. In the event of any Condemnation described in this Section 15.6 the entire amount of any Award made for such Condemnation allocable to the Term of this Lease, whether paid by way of damages, rent or otherwise, shall be paid to Lessor. Lessee covenants that upon the termination of any such period of temporary use or occupancy Lessee’s will, at Lessee’s sole cost and expense, promptly commence and diligently prosecute the completion of the restoration of the Leased Property as nearly as possible to the condition the Leased Property was in immediately prior to such Condemnation, with such alterations as may be approved by Lessor and otherwise in accordance with the terms of this Lease and Lessor’s obligations under the Loan Documents, unless such period of temporary use or occupancy extends beyond the expiration of the Term, in which case Lessee shall not be required to make such restoration.

15.6 Allocation of Award . The total Award made with respect to the Leased Property or for loss of rent, or for Lessor’s loss of business beyond the Term, shall be solely the property of and payable to Lessor. Any Award made for loss of Lessee’s business during the remaining Term, if any, for the taking of Lessee’s Personal Property, or for removal and relocation expenses of Lessee in any such proceedings shall be the sole property of and payable to Lessee. In any Condemnation proceedings Lessor and Lessee shall each seek its Award in conformity herewith, at its respective expense; provided, however, Lessee shall not initiate, prosecute acquiesce in any proceedings that may result in a diminution of any Award payable to Lessor.

ARTICLE 16

DEFAULT; REMEDIES

16.1 Events of Default . If any one or more of the following events (individually, an “ Event of Default ”) occurs:

(a) if Lessee fails to make payment of the Base Rent within thirty (30) days after the same becomes due and payable ;

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(b) if Lessee fails to make payment of Percentage Rent within thirty (30) days after the same becomes due and payable;

(c) if Lessee fails to observe or perform any other term, covenant or condition of this Lease and such failure is not cured by Lessee within a period of thirty (30) days after receipt by the Lessee of Notice thereof from Lessor, unless such failure cannot with due diligence be cured within a period of thirty (30) days, in which case it shall not be deemed an Event of Default if Lessee proceeds promptly and with due diligence to cure the failure and diligently completes the curing thereof provided , however , in no event shall such cure period extend beyond ninety (90) days after such Notice; or

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

(e) if Lessee is liquidated or dissolved, or begins proceedings toward such liquidation or dissolution, or, in any manner, permits the sale or divestiture of substantially all of Lessee’s assets; or

(f) if the estate or interest of Lessee in the Leased Property or any part thereof is voluntarily or involuntarily transferred, assigned, conveyed, levied upon or attached in any proceeding (unless Lessee is contesting such lien or attachment in good faith in accordance with Article 12 hereof); or

(g) if, except as a result of damage, destruction or a partial or complete Condemnation, Lessee voluntarily ceases operations on the Leased Property; or

(h) if the Franchise Agreement with respect to any Facility has been terminated by the franchisor as a result of any action or failure to act by the Lessee, other than a failure to complete improvements required by the franchisor because the Lessor has not provided funds for such improvements;

then, and in any such event, Lessor may exercise one or more remedies available to it herein or at law or in equity, including but not limited to Lessor’s right to terminate this Lease by giving Lessee not less than ten (10) days Notice of such termination except in the case of a default under Sections 16.1(d) or (e) in which case no Notice shall be required.

No Event of Default (other than a failure to make a payment of money) shall be deemed to exist under clause (c) during any time the curing thereof is prevented by an

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Unavoidable Delay, provided that upon the cessation of such Unavoidable Delay, Lessee remedies such default or Event of Default without further delay.

16.2 Surrender . If an Event of Default occurs (and the event giving rise to such Event of Default has not been cured within the curative period relating thereto as set forth in Section 16.1) and is continuing, whether or not this Lease has been terminated pursuant to Section 16.1 , Lessee shall, if requested by Lessor so to do, immediately surrender and assign to Lessor or Lessor’s designee the Leased Property including, without limitation, any and all books, records, files, licenses, permits and keys relating thereto, and quit the same and Lessor may enter upon and repossess the Leased Property by reasonable force, summary proceedings, ejectment or otherwise, and may remove Lessee and all other persons and any and all personal property from the Leased Property, subject to rights of any hotel guests and to any requirement of law. Lessee hereby waives any and all requirements of applicable laws for service of notice to re-enter the Leased Property. Except as required by law, Lessor shall be under no obligation to, but may if it so chooses, relet the Leased Property or otherwise mitigate Lessor’s damages.

16.3 Damages . Neither (a) the termination of this Lease, (b) the repossession of the Leased Property, (c) the failure of Lessor to relet the Leased Property, nor (d) the reletting of all or any portion thereof, shall relieve Lessee of Lessee’s liability and obligations hereunder, all of which shall survive any such termination, repossession or reletting to the maximum extent permitted by law. In the event of any such termination, Lessee shall forthwith pay to Lessor all Rent due and payable with respect to the Leased Property to and including the date of such termination.

In addition, Lessee shall forthwith pay to Lessor, at Lessor’s option, as and for liquidated and agreed current damages for Lessee’s default, either:

(1) Without termination of Lessee’s right to possession of the Leased Property, each installment of Rent (including Percentage Rent as determined below) and other sums payable by Lessee to Lessor under this Lease as the same becomes due and payable, which Rent and other sums shall bear interest at the Overdue Rate from the date due until paid or otherwise discharged, and Lessor may enforce, by action or otherwise, any other term or covenant of this Lease; or

(2) the sum of:

(A) the unpaid Rent which had been earned at the time of termination, repossession or reletting, and

(B) the worth at the time of termination, repossession or reletting of the amount by which the unpaid Rent for the balance of the Term after the time of termination, repossession or reletting, exceeds the amount of such rental loss that Lessee proves could be reasonably avoided and as reduced for rentals received after the time of termination, repossession or reletting, if and to the extent required by applicable law, and

(C) any other amount necessary to compensate Lessor for all the detriment proximately caused by Lessee’s failure to perform Lessee’s obligations under this Lease or which in the ordinary course of things, would be likely to result therefrom. The worth

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at the time of termination, repossession or reletting of the amount referred to in subparagraph (B) is computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%).

Percentage Rent for the purposes of this Section 16.3 shall be a sum equal to (i) the average of the annual amounts of the Percentage Rent for the three Fiscal Years immediately preceding the Fiscal Year in which the termination, re-entry or repossession takes place, or (ii) if three Fiscal Years shall not have elapsed, the average of the Percentage Rent during the preceding Fiscal Years during which this Lease was in effect, or (iii) if one Fiscal Year has not elapsed, the amount derived by annualizing the Percentage Rent from the effective date of this Lease.

16.4 Waiver . If this Lease is terminated pursuant to Section 16.1 , Lessee waives, to the extent permitted by applicable law, (a) any right to a trial by jury in the event of summary proceedings to enforce the remedies set forth in this Article 16 , and (b) the benefit of any laws now or hereafter in force exempting property from liability for rent or for debt.

16.5 Application of Funds . Any payments received by Lessor under any of the provisions of this Lease during the existence or continuance of any Event of Default shall be applied to Lessee’s obligations in the order that Lessor may determine or as may be prescribed by the laws of the State.

ARTICLE 17

LESSOR’S RIGHT TO CURE

If Lessee fails to make any payment or to perform any act required to be made or performed under this Lease including, without limitation, Lessee’s failure to comply with the terms of any Franchise Agreement other than a failure to complete improvements required by the franchisor because the Lessor has not provided Lessee with the funds therefor, and fails to cure the same within the relevant time periods provided in Section 16.1 , Lessor, without waiving or releasing any obligation of Lessee, and without waiving or releasing any obligation or default, may (but shall be under no obligation to) at any time thereafter make such payment or perform such act for the account and at the expense of Lessee, and may, to the extent permitted by law, enter upon the Leased Property for such purpose and, subject to Section 16.4 , take all such action thereon as, in Lessor’s opinion, may be necessary or appropriate therefor. No such entry shall be deemed an eviction of Lessee. All sums so paid by Lessor and all costs and expenses (including, without limitation, reasonable attorneys’ fees and expenses, in each case to the extent permitted by law) so incurred, together with a late charge thereon (to the extent permitted by law) at the Overdue Rate from the date on which such sums or expenses are paid or incurred by Lessor, shall be paid by Lessee to Lessor on demand. The obligations of Lessee and rights of Lessor contained in this Article 17 shall survive the expiration or earlier termination of this Lease.

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ARTICLE 18

REIT REQUIREMENTS.

Lessee understands that in order for Sunstone Hotel Investors, Inc. to qualify as a REIT, the following requirements (the “ REIT Requirements ”) must be satisfied:

(a) Anything contained in this Lease to the contrary notwithstanding, the average of the Fair Market Value at the beginning and end of a Fiscal Year of Lessor’s personal Property that is leased to the Lessee under this Lease shall not exceed fifteen percent 15% of the average of the aggregate fair market values of all of the Leased Property at the beginning and at the end of such Fiscal Year (the “ Personal Property Limitation ”). If Lessor reasonably anticipates that the Personal Property Limitation will be exceeded with respect to the Leased Property for any Fiscal Year, Lessor shall notify Lessee, and Lessee either (i) shall purchase at fair market value any personal property anticipated to be in excess of the Personal Property Limitation (“ Excess Personal Property ”) either from the Lessor or a third party or (ii) shall lease the Excess Personal Property from a third party. In either case, Lessee’s Rent obligation shall be equitably adjusted. In addition, in the case of the purchase or lease of Excess Personal Property by the Lessee from a third party, the Lessor’s capital expenditure reserve obligation pursuant to Article 34 shall be appropriately decreased to reflect the reduced need for Lessor-owned personal property. Notwithstanding anything to the contrary set forth above, Lessee shall not be responsible in any way for determining whether or not Lessee has exceeded or will exceed the Personal Property Limitation, and shall not be liable to Lessor or any of Lessor’s shareholders in the event that the Personal Property Limitation is exceeded, as long as Lessee meets Lessee’s obligation to acquire or lease any Excess Personal Property as provided above. This Section 18 is intended to ensure that the Rent qualifies as “rents from real property,” within the meaning of Section 856(d) of the Code, or any similar or successor provisions thereto, and shall be interpreted in a manner consistent with such intent.

(b) Anything contained in this Lease to the contrary notwithstanding, Lessee shall not sublet the Leased Property on any basis such that the rental to be paid by the sublessee thereunder would be based, in whole or in part, on either (i) the net income or net profits derived by the business activities of the sublessee, or (ii) any other formula such that any portion of the Rent would fail to qualify as “rents from real property” within the meaning of Section 856(d) of the Code, or any similar or successor provision thereto.

(c) Lessee cannot sublet the Leased Property to any Person in which Sunstone Hotel Investors, Inc., owns, directly or indirectly, a ten percent (10%) or more interest, within the meaning of Section 856(d)(2)(B) of the Code, or any similar or successor provisions thereto.

(d) Lessee agrees to make an election to be, and to operate as a “taxable REIT subsidiary” of Sunstone Hotel Investors, Inc. within the meaning of Section 856(e) of the Code, or any similar or successor provision thereto.

(e) Lessee shall not (i) directly or indirectly operate or manage a “lodging facility” within the meaning of Section 856(d)(9)(D)(ii) of the Code or a “health care facility” within the meaning of Section 856(e)(6)(D)(ii) or (ii) directly or indirectly provide to any other Person (under a franchise, license, or otherwise) rights to any brand name under which any lodging facility or health care facility is operated; provided, however, that Lessee may provide such rights to Manager to operate or manage a lodging facility as long as such rights are held by Lessee as a franchisee, licensee, or in a similar capacity and such lodging facility is either owned by Lessee or is leased to Lessee by Lessor or one of Lessor’s Affiliates.

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(f) Lessee agrees, and agrees to use reasonable efforts to cause Lessee’s Affiliates, to use their best efforts to permit the REIT Requirements to be satisfied. Lessee agrees and agrees to use reasonable efforts to cause Lessee’s Affiliates, to cooperate in good faith with Sunstone Hotel Investors, Inc. and Lessor to ensure that the REIT Requirements are satisfied, including but not limited to, providing Sunstone Hotel Investors, Inc. with information about the ownership of Lessee, and Lessee’s Affiliates to the extent that such information is reasonably available. Lessee agrees, and agrees to use reasonable efforts to cause Lessee’s Affiliates, upon request by Sunstone Hotel Investors, Inc., and, where appropriate, at Sunstone Hotel Investors, Inc.’s expense, to take reasonable action necessary to ensure compliance with the REIT Requirements. Immediately after becoming aware that the REIT Requirements are not, or will not be, satisfied, Lessee shall notify, or use reasonable efforts to cause Lessee’s Affiliates to notify, Sunstone Hotel Investors, Inc. of such noncompliance.

(g) Both Lessee and Lessor agree that no provision of this lease shall be construed so as to cause Sunstone Hotel Investors, Inc. to fail to qualify as a REIT.

(h) Lessee shall not permit any wagering activities to be conducted at or in connection with the Leased Property 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 the Leased Property.

ARTICLE 19

COMPLIANCE WITH SPECIAL PURPOSE PROVISIONS

19.1 Special Purpose Requirements . (a) Lessee shall not do any of the following, without the unanimous approval of Lessee’s two (2) Independent Directors and all other directors of Lessee:

(i) file or consent to the filing of any bankruptcy, insolvency or reorganization petition, case or proceeding, or institute any proceedings under any applicable insolvency law or otherwise seek relief under any laws relating to the relief from debts or the protection of debtors generally;

(ii) seek or consent to the appointment of a receiver, liquidator, assignee, trustee, sequestrator, custodian or any similar official for Lessee or Lessor or a substantial portion of any Facility;

(iii) make any assignment for the benefit of the creditors of Lessee or Lessor; or

(iv) take any action in furtherance of the foregoing subparagraphs (i) through (iii).

(b) Special Purpose Covenants . Notwithstanding any other provision of this Lease and any provision of law that otherwise so empowers the Corporation, Lessee shall at all times, on Lessee’s own behalf and acting as the lessee of the Leased Property:

(i) remain solvent and pay Lessee’s debts and liabilities (including, as applicable, shared personnel and overhead expenses) from its assets as the same shall become due, and maintain adequate capital for the normal obligations reasonably foreseeable in a business of its size and character and in light of its contemplated business operations;

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(ii) correct any known misunderstanding regarding Lessee’s separate identity and not identify itself as a division of any other Person;

(iii) maintain Lessee’s bank accounts, books of account, books and records separate from those of any other Person, file its own tax returns except to the extent that it is required by law to file consolidated tax returns;

(iv) maintain Lessee’s own records, books, resolutions and By-laws;

(v) not commingle Lessee’s funds or assets with those of any other Person nor participate in any cash management system with any other Person, except as contemplated by the Loan Documents;

(vi) hold Lessee’s assets in its own name;

(vii) conduct Lessee’s business in its own name or in a name franchised or licensed to it by an entity other than an Affiliate of itself or of Lessor, except for services rendered under a business management services agreement with an Affiliate that complies with the terms contained in subparagraph (xxi) below, so long as the manager, or equivalent thereof, under such business management services agreement holds itself out as an agent of Lessee;

(viii) (A) maintain Lessee’s financial statements, accounting records and other entity documents separate from those of any other Person; (B) in its financial statements, show its assets and liabilities separate and apart from those of any other Person except as required by GAAP in connection with the preparation of consolidated financial statements; and (C) not permit its assets to be listed as assets on the financial statement of any other Person except as required by GAAP in connection with the preparation of consolidated financial statements; provided , however , that any such consolidated financial statements referenced in clause (B) or (C) above shall contain a note indicating that it is a separate entity and that its separate assets and liabilities are neither available to pay the debts of the consolidated entity nor constitute obligations of the consolidated entity;

(ix) pay Lessee’s own liabilities and expenses, including the salaries of its own employees, out of its own funds and assets, and maintain a sufficient number of employees in light of its contemplated business operations;

(x) observe all corporate formalities;

(xi) have no indebtedness except as expressly permitted by Lessee’s certificate of incorporation or other organizational documents as in effect on the date hereof;

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(xii) not assume or guarantee or become obligated for the debts of any other Person, hold out Lessee’s credit as being available to satisfy the obligations of any other Person;

(xiii) not acquire obligations or securities of Lessee’s shareholders or any other Affiliate;

(xiv) allocate fairly and reasonably any overhead expenses that are shared with any Affiliate, including, but not limited to, paying for shared office space and services performed by any employee of an Affiliate;

(xv) maintain and use separate stationery, invoices and checks bearing Lessee’s name. The stationery, invoices, and checks utilized to collect its funds or pay its expenses shall bear its own name and shall not bear the name of any other entity unless such entity is clearly designated as being the other entity agent;

(xvi) not pledge Lessee’s assets for the benefit of any other Person (other than Lender);

(xvii) hold itself out and identify itself as a separate and distinct entity under Lessee’s own name or in a name franchised or licensed to it by an entity other than an Affiliate of itself or of Lessor and not as a division or part of any other Person, except for services rendered under a business management services agreement with an Affiliate that complies with the terms contained in subparagraph (xxi) below, so long as the manager, or equivalent thereof, under such business management services agreement holds itself out as an agent of Lessor;

(xviii) maintain Lessee’s assets in such a manner that it will not be costly or difficult to segregate, ascertain or identify its individual assets from those of any other Person;

(xix) not make loans to any Person or hold evidence of indebtedness issued by any other Person or entity (other than cash and investment-grade securities issued by an entity that is not an Affiliate of or subject to common ownership with such entity)

(xx) not identify Lessee’s shareholders or any Affiliate of any of them, as a division or part of it, and not identify itself as a division of any other Person;

(xxi) not enter into or be a party to, any transaction with Lessee’s shareholders, or Affiliates except in the ordinary course of its business and on terms which are intrinsically fair, commercially reasonable and are no less favorable to it than would be obtained in a comparable arm’s-length transaction with an unrelated third party;

(xxii) not have any of Lessee’s obligations guaranteed by any Affiliate, except (x) that Lessor may guarantee obligations relating to any franchise or management arrangements for the Leased Properties or (y) as contemplated by the Loan Documents;

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(xxiii) not form, acquire or hold any subsidiary, except that Lessee may hold (x) subsidiaries solely for the purpose of holding liquor licenses and (y) a subsidiary solely for the purpose of holding title to the personal property at any Facility;

(xxiv) comply with all of the terms and provisions contained in Lessee’s organizational documents; and

(xxv) not engage in or seek to consent to any dissolution, winding up, liquidation, consolidation, merger, sale of all or substantially all of it assets, and have a Board of Directors separate from that of any other Person.

ARTICLE 20

HOLDING OVER

If Lessee for any reason remains in possession of the Leased Property after the expiration or earlier termination of the Term, such possession shall be as a tenant at sufferance during which time Lessee shall pay as rental each month two times the aggregate of (a) one-twelfth of the aggregate Base Rent and Percentage Rent payable with respect to the last Fiscal Year of the Term, (b) all Additional Charges accruing during the applicable month and (c) all other sums, if any, payable by Lessee under this Lease with respect to the Leased Property. During such period, Lessee shall be obligated to perform and observe all of the terms, covenants and conditions of this Lease, but shall have no rights hereunder other than the right, to the extent given by law to tenancies at sufferance, to continue Lessee’s occupancy and use of the Leased Property. Nothing contained herein shall constitute the consent, express or implied, of Lessor to the holding over of Lessee after the expiration or earlier termination of this Lease.

ARTICLE 21

RISK OF LOSS

During the Term, the risk of loss or of the decrease in the enjoyment and beneficial use of the Leased Property in consequence of the damage or destruction thereof by fire, the elements, casualties, thefts, riots, wars or otherwise, or in consequence of foreclosures, attachments, levies or executions (other than those caused by Lessor and those claiming from, through or under Lessor) is assumed by Lessee, and, in the absence of gross negligence, willful misconduct or breach of this Lease by Lessor pursuant to Section 34.3 , Lessor shall in no event be answerable or accountable therefor, nor shall any of the events mentioned in this Section entitle Lessee to any abatement of Rent except as specifically provided in this Lease.

ARTICLE 22

INDEMNIFICATION

22.1 Lessee Indemnification . Notwithstanding the existence of any insurance, and without regard to the policy limits of any such insurance or self-insurance, but subject to the last sentence of Section 13.4 if any insurance coverage is applicable, Section 16.4 and Article 8 , Lessee will protect, indemnify, hold harmless and defend Lessor from and against all liabilities, obligations, claims, damages, penalties, causes of action, costs and expenses (including, without limitation, reasonable attorneys’ fees and expenses), to the extent permitted by law, imposed upon or incurred by or asserted against Lessor Indemnified Parties by reason of: (a) any

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accident, injury to or death of persons or loss of or damage to property occurring on or about the Leased Property or adjoining sidewalks, including without limitation any claims under liquor liability, “dram shop” or similar laws, (b) any past, present or future use, misuse, non-use, condition, management, maintenance or repair by Lessee or any of Lessee’s agents, employees or invitee of the Leased Property or Lessee’s Personal Property or any litigation, proceeding or claim by governmental entitles or other third parties to which a Lessor Indemnified Party is made a party or participant related to such use, misuse, non-use, condition, management, maintenance, or repair thereof by Lessee or any of Lessee’s agents, employees or invitee, including any failure of Lessee or any of Lessee’s agents, employees or invitee to perform any obligations under this Lease or imposed by applicable law (other than arising out of Condemnation proceedings), (c) any Impositions that are the obligations of Lessee pursuant to the applicable provisions of this Lease, (d) any failure on the part of Lessee to perform or comply with any of the terms of this Lease, and (e) the non-performance of any of the terms and provisions of any and all existing and future subleases of the Leased Property to be performed by the landlord thereunder.

22.2 Lessor Indemnification . Lessor shall indemnify, save harmless and defend Lessee Indemnified Parties from and against all liabilities, obligations, claims, damages, penalties, causes of action, costs and expenses imposed upon or incurred by or asserted against Lessee Indemnified Parties as a result of the gross negligence or willful misconduct of Lessor arising in connection with this Lease.

22.3 Payments by Indemnifying Party . Any amounts that become payable by an Indemnifying Party under this Article 22 shall be paid within ten (10) days after liability therefor on the part of the Indemnifying Party is determined by litigation or otherwise, and if not timely paid, shall bear a late charge (to the extent permitted by law) at the Overdue Rate from the date of such determination to the date of payment. An Indemnifying Party, at such Indemnifying Party’s expense, shall contest, resist and defend any such claim, action or proceeding asserted or instituted against the Indemnified party. The Indemnified Party, at such Indemnifying Party’s expense, shall be entitled to participate in any such claim, action or proceeding, and the Indemnifying Party may not compromise or otherwise dispose of the same without the consent of the Indemnified Party, which may not be unreasonably withheld. Nothing herein shall be construed as indemnifying a Lessor Indemnified Party or a Lessee Indemnified Party against its own grossly negligent acts or omissions or willful misconduct.

22.4 Survival . Lessee’s or Lessor’s liability for a breach of the provisions of this Article 22 shall survive any termination of this Lease.

ARTICLE 23

SUBLETTING AND ASSIGNMENT

23.1 Subletting and Assignment . Subject to the provisions of Article 19 and Section 23.2 and any other express conditions or limitations set forth herein or in the Loan Documents, Lessee may, but only with the prior written consent of Lessor to be granted or withheld in Lessor’s sole discretion, (a) assign this Lease or sublet all or any part of the Leased Property or (b) sublet any retail or restaurant portion of the Leased Improvements in the normal course of the Primary Intended Use . In the case of a subletting, the sublessee shall comply with the provisions of Section 23.2 , and in the case of an assignment, the assignee shall assume in writing

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and agree to keep and perform all of the terms of this Lease on the part of Lessee to be kept and performed and shall be, and become, jointly and severally liable with Lessee for the performance thereof. Notwithstanding the above, Lessee may assign this Lease to an Affiliate without the consent of Lessor; provided that any such assignee assumes in writing and agrees to keep and perform all of the terms of this Lease on the part of the Lessee to be kept and preformed and shall be and become jointly and severally liable with Lessee for the performance thereof. In case of either an assignment or subletting made during the Term, Lessee shall remain primarily liable, as principal rather than as surety, for the prompt payment of the Rent and for the performance and observance of all of the covenants and conditions to be performed by Lessee hereunder. An original counterpart of each such sublease and assignment and assumption, duly executed by Lessee and such sublessee or assignee, as the case may be, in form and substance satisfactory to Lessor, shall be delivered promptly to Lessor.

23.2 Attornment . Lessee shall insert in each sublease permitted under Section 23.1 provisions to the effect that (a) such sublease is subject and subordinate to all of the terms and provisions of this Lease and to the rights of Lessor hereunder, (b) if this Lease terminates before the expiration of such sublease, the sublessee thereunder will, at Lessor’s option, attorn to Lessor and waive any right the sublessee may have to terminate the sublease or to surrender possession thereunder as a result of the termination of this Lease, and (c) if the sublessee receives a written Notice from Lessor or Lessor’s assignees, if any, stating that an uncured Event of Default exists under this Lease, the sublessee shall thereafter be obligated to pay all rentals accruing under said sublease directly to the party giving such Notice, or as such party may direct. All rentals received from the sublessee by Lessor or Lessor’s assignees, if any, as the case may be, shall be credited against the amounts owing by Lessee under this Lease.

ARTICLE 24

ESTOPPEL CERTIFICATES; FINANCIAL REPORTS

24.1 Lessee Estoppel Certificates . At any time and from time to time upon not less than ten (10) days Notice by Lessor, Lessee will furnish to Lessor or any Person designated by Lessor, an officer’s certificate certifying that this Lease is unmodified and in full force and effect (or that this Lease is in full force and effect as modified and setting forth the modifications), the date to which the Rent has been paid, whether there is any existing default or Event of Default hereunder by Lessee or, to the knowledge of Lessee, Lessor, and such other information as may be reasonably requested by Lessor. Any such certificate furnished pursuant to this Section may be relied upon by Lessor, Lender and any prospective purchaser of the Leased Property.

24.2 Financial Statements . Lessee will furnish the following statements to Lessor:

(a) with reasonable promptness, such information respecting the financial condition and affairs of Lessee, and any other information material to the Lessee’s continuing ability to perform Lessee’s obligations under the Lease; and

(b) annual audited financial statements within ninety (90) days of the end of each Fiscal Year prepared by the same certified independent accounting firm that prepares the returns for Lessor or such other accounting firm as may be approved by Lessor, as Lessor may request from time to time; and

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(c) the most recent Consolidated Financials of Lessee within forty-five (45) days after each quarter of any Fiscal Year (or, in the case of the final quarter in any Fiscal Year, the most recent audited Consolidated Financials of Lessee within ninety (90) days); and

(d) on or about the 15th day of each month, a detailed profit and loss statement for the Leased Property for the preceding month, a balance sheet for the Leased Property as of the end of the preceding month, and a detailed accounting of revenues for the Leased Property for the preceding month, each in form acceptable to Lessor.

24.3 Lessor Estoppel Certificate . At any time and from time to time upon not less than ten (10) days Notice by Lessee, Lessor will furnish to Lessee or any Person designated by Lessee an estoppel certificate certifying that this Lease is unmodified and in full force and effect (or that this Lease is in full force and effect as modified and setting forth the modifications), the date to which Rent has been paid, whether there is any existing default or Event of Default hereunder by Lessor or, to the knowledge of Lessor, Lessee, and such other information as may be reasonably requested by Lessee. Any such certificate furnished pursuant to this Section may be relied upon by Lessee, Lender and any prospective purchaser of the Leased Property.

ARTICLE 25

LESSOR’S RIGHT TO INSPECT

Lessee shall permit Lessor and Lessor’s authorized representatives as frequently as reasonably requested by Lessor to inspect the Leased Property and Lessee’s accounts and records pertaining thereto, and all records maintained by any franchisor under a Franchise Agreement and make copies thereof, during usual business hours upon reasonable advance Notice, subject only to any business confidentiality requirements reasonably requested by Lessee.

ARTICLE 26

NO WAIVER

No failure by Lessor or Lessee to insist upon the strict performance of any term hereof or to exercise any right, power or remedy consequent upon a breach thereof, and no acceptance of full or partial payment of Rent during the continuance of any such breach, shall constitute a waiver of any such breach or of any such term. To the extent permitted by law, no waiver of any breach shall affect or alter this Lease, which shall continue in full force and effect with respect to any other than existing or subsequent breach.

ARTICLE 27

REMEDIES CUMULATIVE

To the extent permitted by law, each legal, equitable or contractual right, power and remedy of Lessor or Lessee now or hereafter provided either in this Lease or by statute or otherwise shall be cumulative and concurrent and shall be in addition to every other right, power and remedy and the exercise or beginning of the exercise by Lessor or Lessee of any one or more of such rights, powers and remedies shall not preclude the simultaneous or subsequent exercise by Lessor or Lessee of any or all of such other rights, powers and remedies.

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ARTICLE 28

ACCEPTANCE OF SURRENDER

No surrender to Lessor of this Lease or of the Leased Property or any part thereof, or of any interest therein, shall be valid or effective unless agreed to and accepted in writing by Lessor and no act by Lessor or any representative or agent of Lessor, other than such a written acceptance by Lessor, shall constitute an acceptance of any such surrender.

ARTICLE 29

NO MERGER OF TITLE

There shall be no merger of this Lease or of the leasehold estate created hereby by reason of the fact that the same Person or entity may acquire, own or hold, directly or indirectly: (a) this Lease or the leasehold estate created hereby or any interest in this Lease or such leasehold estate and (b) the fee estate in the Leased Property.

ARTICLE 30

TRANSFER OF LEASED PROPERTY; SUBORDINATION

30.1 Conveyance by Lessor . If Lessor or any successor owner of the Leased Property conveys the Leased Property other than as security for a debt, and the grantee or transferee of the Leased Property expressly assumes all obligations of Lessor hereunder arising or accruing from and after the date of such conveyance or transfer, Lessor or such successor owner, as the case may be, shall thereupon be released from all future liabilities and obligations of Lessor under this Lease arising or accruing from and after the date of such conveyance or other transfer as to the Leased Property and all such future liabilities and obligations shall thereupon be binding upon the new owner.

30.2 Subordination to Mortgage . The rights and interest of Lessee under this Lease and any and all liens, rights and interests (whether choate or inchoate and including, without limitation, all mechanic’s and materialmen’s liens under applicable law) owed, claimed or held, by Lessee in and to the Leased Property, are and shall be in all respects subject, subordinate and inferior to the Loan and the Loan Documents and to the liens, security interests and all other rights and interests created or to be created therein or thereby for the benefit of Lender, and securing the repayment of the Loan including, without limitation, those created under the Mortgage covering, amount other things, the Leased Property, and filed or to be filed of record in the public records maintained for the recording of mortgages in the jurisdiction where the Leased Property is located, and all renewals, extensions, increases, supplements, spreaders, consolidations, amendments, modifications and replacements thereof and to all sums secured thereby and advances made thereunder with the same force and effect as if the Loan had been executed and delivered and the Mortgage recorded prior to the execution and delivery of this Lease. Lender, at Lender’s option and in its sole discretion, may elect to give the rights and interest of Lessee under this Lease priority over the lien of the Mortgage. In the event of such election, the rights and interest of Lessee under this Lease automatically shall have priority over the lien of the Mortgage and no additional consent or instrument shall be necessary or required. However, Lessee agrees to execute and deliver whatever instruments may be reasonably requested by Lender for such purposes, and in the event Lessee fails so to do after demand in

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writing, Lessee does hereby make, constitute and irrevocably appoint Lessor as Lessee’s attorney-in-fact and in its name, place and stead so to do.

ARTICLE 31

QUIET ENJOYMENT

So long a Lessee pays all Rent as the same becomes due and complies with all of the terms of this Lease and performs Lessee’s obligations hereunder, in each case within the applicable grace periods, if any, Lessee shall peaceably and quietly have, hold and enjoy the Leased Property for the Term hereof, free of any claim or other action by Lessor or anyone claiming by, through or under Lessor, but subject to all liens and encumbrances subject to which the Leased Property was conveyed to Lessor or hereafter consented to by Lessee or provided for herein. Notwithstanding the foregoing, Lessee shall have the right by separate and independent action to pursue any claim it may have against Lessor as a result of a breach by Lessor of the covenant of quiet enjoyment contained in this Section.

ARTICLE 32

NOTICES

All notices, demands, requests, consents, approvals and other communications (“ Notice ” or “ Notices ”) hereunder shall be in writing and personally served or mailed (by registered or certified mail, return receipt requested and postage prepaid), if to Lessor at 903 Calle Amanecer, San Clemente, California 92673, and if to Lessee at 903 Calle Amanecer, San Clemente, California 92673, or to such other address or addresses as either party may hereafter designate in accordance herewith. Personally delivered Notice shall be effective upon receipt, and Notice given by mail shall be complete at the time of deposit in the U.S. Mail system, but any prescribed period of Notice and any right or duty to do any act or make any response within any prescribed period or on a date certain after the service of such Notice given by mail shall be extended five (5) days.

ARTICLE 33

[RESERVED]

ARTICLE 34

LESSOR LIENS; LESSEE RIGHTS TO CURE

34.1 Lessor May Grant Liens . (a) Without the consent of Lessee, Lessor may, subject to the terms and conditions set forth below in this Article 34 , from time to time, directly or indirectly, create or otherwise cause to exist any lien, encumbrance or title retention agreement (“ Encumbrance ”) upon the Leased Property, or any portion thereof or interest therein, whether to secure any borrowing or other means of financing or refinancing. Pursuant to Section 30.2 hereof, this Lease shall automatically be subordinated to the lien of any such new mortgage on the Leased Property.

(b) Upon Lessor’s request, Lessee shall execute and deliver to Lessor financing statements in form sufficient to perfect the security interest granted to Lender pursuant

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to the Mortgage in (i) Lessee’s Personal Property and the proceeds thereof and (ii) all leases, contracts, concession agreements and other agreements with respect to the Leased Property.

34.2 Lessee’s Right to Cure . Subject to the provisions of Section 34.3 , if Lessor breaches any covenant to be performed by it under this Lease, Lessee, after Notice to and demand upon Lessor, without waiving or releasing any obligation hereunder, and in addition to all other remedies available to Lessee, may (but shall be under no obligation at any time thereafter to) make such payment or perform such act for the account and at the expense of Lessor. All sums so paid by Lessee and all costs and expenses (including, without limitation, reasonable attorneys’ fees) so incurred, together with interest thereon at the Overdue Rate from the date on which such sums or expenses are paid or incurred by Lessee, shall be paid by Lessor to Lessee on demand or, following entry of a final, nonappealable judgment against Lessor for such sums, may be offset by Lessee against the Base Rent payments next accruing or coming due. The rights of Lessee hereunder to cure and to secure payment from Lessor in accordance with this Section 34.2 shall survive the termination of this Lease with respect to the Leased Property.

34.3 Breach by Lessor . It shall be a breach of this Lease if Lessor fails to observe or perform any term, covenant or condition of this Lease on Lessor’s part to be performed and such failure continues for a period of thirty (30) days after Notice thereof from Lessee, unless such failure cannot with due diligence be cured within a period of thirty (30) days, in which case such failure shall not be deemed to continue if Lessor, within such thirty (30)-day period, proceeds promptly and with due diligence to cure the failure and diligently completes the curing thereof for a period not to exceed ninety (90) days. The time within which Lessor shall be obligated to cure any such failure also shall be subject to extension of time due to the occurrence of any Unavoidable Delay. Upon a breach by Lessor, Lessee shall be entitled to all available remedies at law and in equity.

ARTICLE 35

MISCELLANEOUS

35.1 Miscellaneous .

(a) Survival of Claims . Anything contained in this Lease to the contrary notwithstanding, all claims against, and liabilities of, Lessee or Lessor arising prior to any date of termination of this Lease shall survive such termination.

(b) Severability . If any term or provision of this Lease or any application thereof is invalid or unenforceable, the remainder of this Lease and any other application of such term or provisions shall not be affected thereby.

(c) Maximum Interest Rate . If any late charges or any interest rate provided for in any provision of this Lease are based upon a rate in excess of the maximum rate permitted by applicable law, the parties agree that such charges shall be fixed at the maximum permissible rate.

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(d) Amendment . Neither this Lease nor any provision hereof may be changed, waived, discharged or terminated except by a written instrument signed by Lessor and Lessee.

(e) Attorneys’ Fees . If litigation is commenced with respect to any alleged default under this Lease, the prevailing party in such litigation shall receive, in addition to such prevailing party’s damages incurred, such sum as the court shall determine as its reasonable attorneys’ fees, and all costs and expenses incurred in connection therewith.

(f) Successors and Assigns . All the terms and provisions of this Lease shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns.

(g) Headings . The headings in this Lease are for convenience of reference only and shall not limit or otherwise affect the meaning hereof.

(h) Governing Law . This Lease shall be governed by and construed in accordance with the laws of the State, but not including its conflicts of laws rules.

35.2 Transition Procedures . Upon the expiration or termination of the Term of this Lease, for whatever reason, Lessor and Lessee shall do the following (and the provisions of this Section 35.2 shall survive the expiration or termination of this Lease until they have been fully performed) and, in general, shall cooperate in good faith to effect an orderly transition of the management or lease of any Facility.

(a) Transfer of Licenses . Upon the expiration or earlier termination of the Term, Lessee shall use Lessee’s best efforts (i) to the full extent possible to transfer to Lessor or Lessor’s nominee all licenses, operating permits and other governmental authorizations and all contracts, including contracts with governmental or quasi-governmental entities, that may be necessary for the operation of any Facility, including any Franchise Agreement (collectively, “ Licenses ”), or (ii) if such transfer is prohibited by law or Lessor otherwise elects, to cooperate with Lessor or Lessor’s nominee in connection with the processing by Lessor or Lessor’s nominee of any applications for, any such Licenses; provided , in either case, that the costs and expenses of any such transfer or the processing of any such application shall be paid by Lessor or Lessor’s nominee.

(b) Subleases and Concessions . Lessee shall assign to Lessor or Lessor’s nominee simultaneously with the termination of this Lease, and the assignee shall assume all subleases and concession agreements in effect with respect to each Facility then in Lessee’s name.

(c) Books and Records . All books and records for each Facility kept by Lessee (or the franchisor under any Franchise Agreement) shall be delivered promptly to Lessor or Lessor’s nominee, simultaneously with the termination of this Lease, but such books and records shall thereafter be available to Lessee at all reasonable times for inspection, audit, examination and transcription for a period of one (1) year and Lessee may retain (on a confidential basis) copies or computer records thereof.

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(d) Remittance . Lessee shall remit to Lessor or Lessor’s nominee, simultaneously with the termination of this Lease, all funds remaining, if any, after payment of all accrued Gross Operating Expenses, and other amounts due Lessee and after deducting the costs of any scheduled repair, replacement or refurbishment of Furniture and Equipment with respect to which deposits have been made.

35.3 Waiver of Presentment, Etc. Lessee waives all presentments, demands for payment and for performance, notices of nonperformance, protests, notices of protest, notices of dishonor, and notices of acceptance and waives all notices of the existence, creation, or incurring of new or additional obligations, except as expressly granted herein.

ARTICLE 36

MEMORANDUM OF LEASE

Lessor and Lessee shall promptly upon the request of either enter into a short form memorandum of this Lease, in form suitable for recording under the laws of the State in which reference to this Lease, and all options contained herein, shall be made. Lessee shall pay all costs and expenses of recording such memorandum of this Lease.

ARTICLE 37

[RESERVED]

ARTICLE 38

LESSOR’S OPTION TO TERMINATE UPON SALE

In the event Lessor enters into a bona fide contract to sell the Leased Property to a non-Affiliate, Lessor may terminate this Lease by giving not less than thirty (30) days prior Notice to Lessee of Lessor’s election to terminate this Lease effective upon the closing under such contract. Effective upon such closing, this Lease shall terminate and be of no further force and effect except as to any obligations of the parties existing as of such date that survive termination of this Lease. As compensation for an early termination, Lessor must within one hundred and eighty (180) days after the closing either (a) pay to the Lessee as a termination fee an amount equal to thirty-five percent (35%) of the net income (as calculated in accordance with GAAP) earned by Lessee with respect to the Leased Property (but excluding any proceeds or other consideration attributable to the sale of the Leased Property) for the 12-month period ended as of the last day of the calendar month immediately preceding such termination; or (b) offer to lease to Lessee one or more comparable substitute hotel facilities (which facilities must be satisfactory to Lessee in Lessee’s reasonable discretion) pursuant to one or more leases that would create for Lessee leasehold estates that have an aggregate fair market value equal to Lessee’s leasehold estate under the Lease determined as of the closing of the sale of the Leased Property. A termination payment is due to Lessee only if Lessee is not then in default in the payment of Base Rent for more than thirty (30) days.

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ARTICLE 39

FRANCHISE AGREEMENT

To the extent any of the provisions of any Franchise Agreement impose a greater obligation on Lessee than the corresponding provisions of this Lease, then Lessee shall be obligated to comply with, and to take all reasonable actions necessary to prevent breaches or defaults under, the provisions of such Franchise Agreement. It is the intent of the parties hereto that, except as otherwise specifically provided by this Lease, Lessee shall comply in every respect with the provisions of any Franchise Agreement so as to avoid any default thereunder during the term of this Lease. Lessor and Lessee agree to cooperate fully with each other in the event it becomes necessary to obtain a franchise extension or modification or a new franchise for the Leased Property, provided , however , that Lessor shall pay the entire cost of any upgrades required by any franchisor.

ARTICLE 40

ROOM SET-ASIDE; CAPITAL EXPENDITURES

40.1 Room Set-Aside . Lessee shall repair or replace, or cause the Manager to repair or replace, in each Fiscal Year, Fixtures and Furniture and Equipment (a) as required by the terms of any Franchise Agreement, Management Agreement and/or the Loan Documents, (b) as required by Article 9 and Article 39 and (c) otherwise when and in a manner it deems fit, to the extent funds are available therefor from amounts the Lessor is obligated to make available to Lessee under this Section 40.1 or otherwise makes available to Lessee. During the Term, Lessee shall be entitled to receive an amount (herein referred to as the “ Replacement Reserve Funds ”) equal to the greater of (x) four percent (4%) of Gross Revenues from the Facility and (y) the percentage of Gross Revenues from the Facility as set forth in the Management Agreement, or Franchise Agreement or Loan Agreement, whichever agreement is most restrictive, for repairing or replacing Fixtures, Furniture and Equipment. The Replacement Reserve Funds shall be deposited into an account (the “ Replacement Reserve Account ”) in accordance with the provisions of the Loan Documents. Subject to the provisions of the Loan Documents, the Replacement Reserve Funds shall be retained by Lessee from Gross Revenues, and to the extent Lender requires the Replacement Reserve Funds to be held by Lender, Lessee shall deposit the Replacement Reserve Funds with Lender and request distributions from Lender for the repairing or replacing Fixtures, Furniture and Equipment in accordance with the provisions of the Loan Documents. The Replacement Reserve Funds shall be used by Lessee for periodic repairing or replacement of Fixtures, Furniture and Equipment at the Leased Property in connection with the Primary Intended Use. To the extent any Furniture and Equipment and/or Fixtures is so purchased with the Replacement Reserve Funds such Furniture and Equipment and/or Fixtures shall become and at all times remain the sole property of Lessor and Lessee shall, upon Lessee’s request, execute any documents reasonably necessary to confirm such title in Lessor, it being understood that any such newly purchased Furniture and Equipment and/or Fixtures will automatically become subject to the security interest discussed in Section 34.1 above.

40.2 Capital Expenditures . Subject to Section 9.1 , Lessor shall be obligated to pay the actual costs of any items that are classified as capital items under generally accepted accounting principles which are necessary in the reasonable judgment of Lessor for the continued operation

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of any Facility in accordance with the operating standards of any Franchise Agreement, if applicable, and otherwise approved by Lessor.

40.3 Subordination of Management Fee . Lessee agrees that following receipt of written notice that an Event of Default hereunder has occurred, and prior to any cure thereof, Lessee shall not pay Manager any fees or reimburse Manager for any expenses pursuant to the Management Agreement, regardless of whether accrued or not. Any payments made by Lessee under the Management Agreement in violation of this Section 40.4 shall be returned by the Manager to the Lessee upon written notice by the Lessor to the Manager.

ARTICLE 41

CHANGE IN REIT STATUS OR REIT REGULATIONS

In the event that Sunstone Hotel Investors, Inc. terminates its status as a real estate investment trust (“ REIT ”) for tax purposes, or in the event that the Internal Revenue Code provisions are amended so that REITs are permitted to operate hotels, Lessor may elect to terminate this Lease. In the event that this Lease is so terminated, Lessor shall be obligated to pay to Lessee a termination payment equal to the Net Present Value (as hereinafter defined), as of the termination date of this Lease, of the cash flow to Lessee from the operations of the Leased Property (after payment of all Rent hereunder). The “ Net Present Value ” of the cash flow to Lessee from the operations of the Leased Property shall be calculated by multiplying (a) the average annual EBITDA (as hereinafter defined) to Lessee net of all Rent for the three (3) Fiscal Years ended immediately prior to the termination date, times (b) the number of Fiscal Years (or portions thereof) remaining in the Lease Term, times (c) one hundred percent (100%) plus the average annual percentage increase in the Consumer Price Index during the three (3) Fiscal Years ended immediately prior to the date of sale, and (d) discounting the product of (a) times (b) times (c) above by the Base Rate plus one percent. “ EBITDA ” means net earnings before interest, taxes, depreciation and amortization.

ARTICLE 42

ADDITIONAL COVENANTS

42.1 Indemnification Regarding Defaults Under Franchise Agreements .

(a) By Lessee .

The Lessee hereby agrees, during the term of this Lease, to defend, indemnify and hold harmless the Lessor for any unpaid franchise fees and termination fees under any Franchise Agreement, except for defaults resulting from the Lessor’s failure to pay for capital expenditures required under such Franchise Agreements, as provided in Section 40.2 hereof.

(b) By Lessor .

The Lessor hereby agrees to defend, indemnify and hold harmless the Lessee for any defaults under the Franchise Agreements resulting from the Lessor’s failure to pay for capital expenditures required under any Franchise Agreements.

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IN WITNESS WHEREOF, the parties have executed this Lease by their duly authorized officers as of the date first above written.


“LESSOR”
		,
a

By:
	Printed Name:
	Title:

“LESSEE”
		,
a

By:
	Printed Name:
	Title:

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EXHIBIT “A”

PROPERTY DESCRIPTION

[Attached as the immediately following page]

EXHIBIT “A”

-1-

EXHIBIT “B”

OPERATING LEASE RENT AND PERCENTAGE RENT AMOUNTS

The “ Base Rent ” shall equal Dollars ($ ) per month.

The “ Monthly Revenues Computation ” shall mean the amount obtained by adding, for the applicable month, an amount equal to (A) the product of (i) percent ( %) and (ii) $ (i.e., total Room Revenues for such month) (herein the “ Monthly Threshold ”), plus the product of (x) the percent ( %) and (y) the amount of all Room Revenues for such month in excess of the Monthly Threshold, plus (B) percent ( %) of Food and Beverage Revenue, if any, plus (C) percent ( %) of any Sublease and Concession Revenues at the Facility, plus (D) [OPTIONAL: percent ( %) of Parking Revenues, plus ] (E) percent ( %) of Other Revenues.

The “ Annual Revenues Computation ” shall mean the amount obtained by adding, for the applicable Fiscal Year, an amount equal to (A) the product of (i) percent ( %) and (ii) $ (i.e., total Room Revenues for such Fiscal Year) (herein the “ Annual Threshold ”, plus the product of (x) percent ( %) and (y) the amount of all Room Revenues for such Fiscal Year in excess of the Annual Threshold, plus (B) percent ( %) of food and beverage Revenue, plus (C) percent ( %) of any Sublease and Concession Revenues, plus (D) [OPTIONAL: percent ( %) of Parking Revenues, plus (F) ] percent ( %) of Other Revenues.

EXHIBIT “B”

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[ OPTIONAL ] ADDENDUM TO LEASE AGREEMENT

This ADDENDUM TO LEASE AGREEMENT (this “ Addendum ”) is made and entered into by and between , a (“ Lessor ”) and , a (“ Lessee ”), as of the date set forth on the first page of that certain Lease Agreement (the “ Lease ”) between Lessor and Lessee to which this Addendum is attached and incorporated. The terms, covenants and conditions set forth herein are intended to and shall have the same force and effect as if set forth at length in the body of the Lease. To the extent that the provisions of this Addendum are inconsistent with any provisions of the Lease, the provisions of this Addendum shall supersede and control.

[INSERT ANY LENDER SPECIFIC PROVISIONS]

IN WITNESS WHEREOF, Lessor and Lessee have executed this Addendum concurrently with the Lease of even date herewith.


“LESSOR”

		,
a

By:
	Printed Name:
	Title:

“LESSEE”

		,
a

By:
	Printed Name:
	Title:

[OPTIONAL]

ADDENDUM TO

LEASE

AGREEMENT

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Exhibit 10.11

LIMITED LIABILITY COMPANY AGREEMENT

SUNSTONE HOTEL PARTNERSHIP, LLC

THIS LIMITED LIABILITY COMPANY AGREEMENT, dated as of , 2004 of Sunstone Hotel Partnership, LLC (the “ Company ”) is entered into by and among Sunstone Hotel Investors, Inc., as Managing Member (the “ Managing Member ”), and the Persons identified on the signature pages hereto (the “ Non-Managing Members ”), together with any other Persons who become Members (as defined herein) in the Company as provided herein;

WHEREAS, the Company was formed by the filing of a certificate of formation with the Secretary of State of the State of Delaware on June 29, 2004 by an authorized person of the Company;

WHEREAS, immediately prior to the execution hereof, the Managing Member was the sole member of the Company;

WHEREAS, as part of the Formation and Structuring Transactions (as defined below), the Company will issue Non-Managing Membership Interests to each of Sunstone Hotel Investors, L.L.C. (“ SHI ”), Sunstone/WB Hotel Investors, IV, LLC (“ Sunstone/WB IV ”), Sunstone/WB Manhattan Beach, LLC (“ Sunstone/WB MB ”) and WB Hotel Investors, LLC (“ WB Hotel ”) as set forth on Exhibit A hereto;

WHEREAS, the Members desire that the Managing Member be the sole Managing Member of the Company upon the completion of the Managing Member’s initial public offering of its common stock and the contribution by the Managing Member of the net proceeds from its initial public offering as set forth on Exhibit A hereto; and

WHEREAS, the Members desire to continue the Company under the Act (as defined below) and to set forth their respective rights and duties relating to the Company on the terms as provided herein;

NOW, THEREFORE, in consideration of the mutual promises and agreements herein made, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the Members hereby agree as follows:

ARTICLE I

DEFINED TERMS

The following definitions shall be for all purposes, unless otherwise clearly indicated to the contrary, applied to the terms used in this Agreement.

“ Act ” means the Delaware Limited Liability Company Act, as it may be amended from time to time, and any successor to such statute.

“ Additional Non-Managing Member ” means a Person admitted to the Company as a Non-Managing Member pursuant to Section 4.2 and who is shown as such on the books and records of the Company.

“ Adjusted Capital Account ” means the Capital Account maintained for each Member as of the end of each Membership Year (a) increased by any amounts which such Member is obligated to restore pursuant to any provision of this Agreement or is deemed to be obligated to restore pursuant to the penultimate sentences of Regulations Sections 1.704-2(g)(1) and 1.704-2(i)(5) and (b) decreased by the items described in Regulations Sections 1.704-1(b)(2)(ii)(d)(4), 1.704-1(b)(2)(ii)(d)(5), and 1.704-1(b)(2)(ii)(d)(6). The foregoing definition of Adjusted Capital Account is intended to comply with the provisions of Regulations Section 1.704-1(b)(2)(ii)(d) and shall be interpreted consistently therewith.

“ Adjusted Capital Account Deficit ” means, with respect to any Member, the deficit balance, if any, in such Member’s Adjusted Capital Account as of the end of the relevant Membership Year.

“ Adjusted Property ” means any property the Carrying Value of which has been adjusted pursuant to Section 4.4 .

“ Affiliate ” means, with respect to any Person, any Person directly or indirectly controlling, controlled by or under common control with such 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.

“ Agreed Value ” means (a) in the case of any Contributed Property set forth on Exhibit B and as of the time of its contribution to the Company, the Agreed Value of such property as set forth on Exhibit B ; (b) in the case of any Contributed Property not set forth on Exhibit B and as of the time of its contribution to the Company, the 704(c) Value of such property or other consideration, reduced by any liabilities either assumed by the Company upon such contribution or to which such property is subject when contributed, and (c) in the case of any property distributed to a Member by the Company, the Company’s Carrying Value of such property at the time such property is distributed, reduced by any indebtedness either assumed by such Member upon such distribution or to which such property is subject at the time of distribution as determined under Section 752 of the Code and the Regulations thereunder.

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“ Agreement ” means this Limited Liability Company Agreement and all Exhibits attached hereto, as the same may be amended, supplemented or restated from time to time.

“ Assignee ” means a Person to whom one or more Membership Units have been transferred but who has not been admitted as a Substituted Non-Managing Member, and who has the rights set forth in Section 11.5 .

“ Available Cash ” means, with respect to any period for which such calculation is being made, (a) all cash revenues and funds received by the Company from whatever source (excluding the proceeds of any Capital Contribution to the Company pursuant to Section 4.1 ) plus the amount of any reduction (including, without limitation, a reduction resulting because the Managing Member determines such amounts are no longer necessary) in reserves of the Company, which reserves are referred to in clause (b)(iv) below;

(b) less the sum of the following (except to the extent made with the proceeds of any Capital Contribution):

(i) all interest, principal and other debt payments made during such period by the Company,

(ii) all cash expenditures (including capital expenditures) made by the Company during such period,

(iii) investments in any entity (including loans made thereto) to the extent that such investments are not otherwise described in clauses (b)(i) or (ii), and

(iv) the amount of any reserve created or increase in reserves established during such period which the Managing Member determines are necessary or appropriate in its sole and absolute discretion.

Notwithstanding the foregoing, Available Cash shall not include any cash received or reductions in reserves, or take into account any disbursements made or reserves established, after commencement of the dissolution and liquidation of the Company.

“ Bankruptcy ” as to any Person, shall be deemed to have occurred when (i) such Person commences a voluntary proceeding seeking liquidation, reorganization or other relief under any bankruptcy, insolvency or other similar law now or hereafter in effect, (ii) such Person is adjudged as bankrupt or insolvent, or a final and nonappealable order for relief under any bankruptcy, insolvency or similar law now or hereafter in effect has been entered against such Person, (iii) such Person executes and delivers a general assignment for the benefit of such Person’s creditors, (iv) such Person files an answer or other pleading admitting or failing to contest the material allegations of a petition filed against such Person in any proceeding of the nature described in clause (ii) above, (v) such Person seeks, consents to or acquiesces in the appointment of a trustee, receiver or liquidator for such Person or for all or any substantial part of such Person’s properties, (vi) any proceeding seeking liquidation, reorganization or other relief under any bankruptcy, insolvency or other similar law now or hereafter in effect has not been dismissed within 120 days after the commencement thereof, (vii) the appointment without such Person’s consent or acquiescence of a trustee, receiver or liquidator has not been vacated or

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stayed within 90 days of such appointment, or (viii) an appointment referred to in clause (vii) is not vacated within 90 days after the expiration of any such stay.

“ Book-Tax Disparities ” means, with respect to any item of Contributed Property or Adjusted Property, as of the date of any determination, the difference between the Carrying Value of such Contributed Property or Adjusted Property and the adjusted basis thereof for Federal income tax purposes as of such date. A Member’s share of the Company’s Book-Tax Disparities in all of its Contributed Property and Adjusted Property will be reflected by the difference between such Member’s Capital Account balance as maintained pursuant to Section 4.4 and the hypothetical balance of such Member’s Capital Account computed as if it had been maintained strictly in accordance with Federal income tax accounting principles.

“ Business Day ” means any day except a Saturday, Sunday or other day on which commercial banks in New York City are authorized or required by law to close.

“ Capital Account ” means the capital account maintained by the Company for each Member pursuant to Section 4.4 .

“ Capital Contribution ” means, with respect to each Member, the total amount of cash, cash equivalents and the Agreed Value of Contributed Property which such Member contributes or is deemed to contribute to the Company pursuant to Section 4.1 or 4.2 and which are intended to be treated as a contribution to the Company pursuant to Section 721(a) of the Code.

“ Carrying Value ” means (a) with respect to a Contributed Property or Adjusted Property, the 704(c) Value of such property (or in the case of an Adjusted Property, the fair market value of such property at the time of its latest adjustment under Section 4.4(d) ) reduced (but not below zero) by all Depreciation with respect to such Contributed Property or Adjusted Property charged to the Members’ Capital Accounts and (b) with respect to any other Company property, the adjusted basis of such property for Federal income tax purposes, all as of the time of determination. The Carrying Value of any property shall be adjusted from time to time in accordance with Section 4.4(d) , and to reflect changes, additions or other adjustments to the Carrying Value for dispositions and acquisitions of Company Properties, as deemed appropriate by the Managing Member.

“ Cash Amount ” means an amount of cash per Unit equal to the number of Units offered for redemption by the Redeeming Member (multiplied by the Unit Adjustment Factor) multiplied by the Value of a Common Share on the Valuation Date.

“ Certificate ” means the Certificate of Formation relating to the Company filed in the office of the Secretary of State of the State of Delaware, as amended from time to time in accordance with the terms hereof and the Act.

“ Charter ” means the Articles of Incorporation of the Managing Member filed in the office of the Maryland State Department of Assessments and Taxation on June 28, 2004, as amended from time to time in accordance with the terms thereof and the Maryland General Corporation Law, and any successor to such statute.

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“ Code ” means the Internal Revenue Code of 1986, as amended. Any reference herein to a specific section or sections of the Code shall be deemed to include a reference to any corresponding provision of future law.

“ Common Share Rights ” has the meaning set forth in Section 4.2(e) .

“ Common Shares ” means the shares of common stock, $0.01 par value per share, of the Managing Member.

“ Company ” means Sunstone Hotel Partnership, LLC, the limited liability company formed under the Act and any successor thereto.

“ Company Property ” means such interests in real property and personal property including without limitation, fee interests, interests in ground leases, interests in joint ventures, interests in mortgages, and Debt instruments as the Company may hold from time to time.

“ Consent ” means the consent or approval of a proposed action by a Member given in accordance with Section 14.1 .

“ Contributed Property ” means each property or other asset (but excluding cash and cash equivalents), in such form as may be permitted by the Act contributed or deemed contributed to the Company. Once the Carrying Value of a Contributed Property is adjusted pursuant to Section 4.4 , such property shall no longer constitute a Contributed Property, but shall be deemed an Adjusted Property for purposes of Section 4.4 .

“ Debt ” means, as to any Person, as of any date of determination, (a) all indebtedness of such Person for borrowed money or for the deferred purchase price of property or services, which purchase price is due more than six months after the date of placing such property in service or taking delivery and title thereto or the completion of such services, (b) all amounts owed by such Person to banks or other Persons in respect of reimbursement obligations under letters of credit, surety bonds and other similar instruments guaranteeing payment or other performance of obligations by such Person, (c) all indebtedness for borrowed money or for the deferred purchase price of property or services secured by any lien on any property owned by such Person, to the extent attributable to such Person’s interest in such property, even though such Person has not assumed or become liable for the payment thereof, (d) lease obligations of such Person which, in accordance with generally accepted accounting principles, should be capitalized and (e) all guarantees and other contingent obligations of such Person with respect to Debt of others.

“ Depreciation ” means for each fiscal year or other period, an amount equal to the Federal income tax depreciation, amortization, or other cost recovery deduction allowable with respect to an asset for such year or other period, except that if the Carrying Value of an asset differs from its adjusted basis for Federal income tax purposes at the beginning of such year or other period, Depreciation shall be an amount which bears the same ratio to such beginning Carrying Value as the Federal income tax depreciation, amortization, or other cost recovery deduction for such year or other period bears to such beginning adjusted tax basis; provided , however , that if the Federal income tax depreciation, amortization, or other cost recovery deduction for such year is zero,

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Depreciation shall be determined with reference to such beginning Carrying Value using any reasonable method selected by the Managing Member.

“ Effective Date ” means the date of closing of the initial public offering of the Common Shares upon which date the contributions set forth on Exhibit A shall become effective.

“ Events of Dissolution ” has the meaning set forth in Section 13.1 .

“ Exchange Act ” has the meaning set forth in Section 7.1(a)(2) .

“ ERISA ” means the Employee Retirement Income Security Act of 1974, as amended.

“ Formation and Structuring Transactions ” means the transactions outlined in Exhibit A to the Structuring and Contribution Agreement.

“ Guaranty ” has the meaning set forth in Section 11.2(e) .

“ IRS ” means the Internal Revenue Service, which is charged with administering the internal revenue laws of the United States.

“ Immediate Family ” means, with respect to any natural Person, such natural Person’s spouse, parents, grandparents, descendants (including adopted children and step-children), nephews, nieces, brothers, and sisters.

“ Incapacity ” or “ Incapacitated ” means (a) as to any individual Member, death, total physical disability or entry by a court of competent jurisdiction adjudicating him incompetent to manage his Person or his estate, (b) as to any corporation that is a Member, the filing of a certificate of dissolution, or its equivalent, for the corporation or the revocation of its charter, (c) as to any partnership that is a Member, the dissolution and commencement of winding up of the partnership, (d) as to any estate that is a Member, the distribution by the fiduciary of the estate’s entire interest in the Company, (e) as to any trust that is a Member, the termination of the trust (but not the substitution of a new trustee), or (f) as to any Member, the Bankruptcy of such Member.

“ Incentive Plans ” means Common Share or Unit incentive plans or other employee benefit plans established by, or for the benefit of the employees of, the Managing Member, the Company or any Subsidiary, including the Sunstone Hotel Investors, Inc. 2004 Long-Term Incentive Plan and the Sunstone Hotel Investors, Inc. Senior Management Incentive Plan.

“ Indemnitee ” means (a) any Person made a party to a proceeding by reason of his status as (i) the Managing Member (including as a guarantor of any Membership Debt) or (ii) an officer of the Company or a director or officer of the Managing Member, and (b) such other Persons (including Affiliates of the Managing Member or the Company) as the Managing Member may designate from time to time, in its sole and absolute discretion.

“ Investors Agreement ” means the Investors Agreement dated as of , 2004 by and among the Managing Member, SHI, Sunstone/WB IV, Sunstone/WB MB and WB Hotel.

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“ Liquidating Transaction ” means any sale or other disposition of all or substantially all of the assets of the Company or a related series of transactions that, taken together, results in the sale or other disposition of all or substantially all of the assets of the Company.

“ Liquidator ” has the meaning set forth in Section 13.2 .

“ Managing Member ” means Sunstone Hotel Investors, Inc., a Maryland corporation, and its successors as a Managing Member of the Company in accordance with the terms of this Agreement.

“ Managing Membership Interest ” means a Membership Interest held by the Managing Member (including any Membership Interest acquired by the Managing Member pursuant to Section 4.2 hereof) that is a Managing Membership interest and includes any and all benefits to which the Managing Member may be entitled and all obligations of the Managing Member hereunder. A Managing Membership Interest may be expressed as a number of Membership Units. All Membership Units held by the Managing Member shall be deemed to be the Managing Member Interest.

“ Member ” means individually, the Managing Member or a Non-Managing Member, and “ Members ” means collectively, the Managing Member and the Non-Managing Members.

“ Member Minimum Gain ” means an amount, with respect to each Member Nonrecourse Debt, equal to the Company Minimum Gain that would result if such Member Nonrecourse Debt were treated as a Nonrecourse Liability, determined in accordance with Regulations Section 1.704-2(i)(3).

“ Member Nonrecourse Debt ” has the meaning set forth in Regulations Section 1.704-2(b)(4).

“ Member Nonrecourse Deductions ” has the meaning set forth in Regulations Section 1.704-2(i)(2), and the amount of Member Nonrecourse Deductions with respect to a Member Nonrecourse Debt for a Membership Year shall be determined in accordance with the rules of Regulations Section 1.704-2(i)(2).

“ Membership Interest ” means an ownership interest in the Company representing a Capital Contribution by either a Non-Managing Member or the Managing Member and includes any and all benefits to which the holder of such a Membership Interest may be entitled as provided in this Agreement, together with all obligations of such Person to comply with the terms and provisions of this Agreement. A Membership Interest may be expressed as a number of Membership Units.

“ Membership Minimum Gain ” has the meaning set forth in Regulations Section 1.704-2(b)(2), and the amount of Membership Minimum Gain, as well as any net increase or decrease in Membership Minimum Gain, for a Membership Year shall be determined in accordance with the rules of Regulations Section 1.704-2(d).

“ Membership Record Date ” means the record date established by the Managing Member for the distribution of Available Cash pursuant to Section 5.1 hereof, which record date shall be

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the same as the record date established by the Managing Member for a distribution to its shareholders of some or all of its portion of such distribution, and also means any record date established by the Managing Member in connection with any vote or consent of the Non-Managing Members pursuant to this Agreement.

“ Membership Unit ” or “ Unit ” means a fractional, undivided share of the Membership Interests of all Members issued pursuant to Sections 4.1 and 4.2 , in such number as set forth on Exhibit A , as such Exhibit may be amended from time to time. Any rights and preferences or other obligations with respect to Units as may be authorized hereunder shall be set forth in an exhibit hereto.

“ Membership Year ” means the fiscal year of the Company, which shall be the calendar year.

“ Minimum Tax Distribution ” means an amount per Membership Unit (other than Preferred Units) for each calendar quarter for each taxable year of the Company equal to the product of (i) the sum of (a) the greater of the highest marginal Federal income tax rate for such taxable year applicable to (x) individuals or (y) large, widely-held corporations and (b) the highest combined marginal state and local income tax rates for such taxable year for the state and city with the highest marginal income tax rates and (ii) the taxable income allocable to each Membership Unit for such calendar quarter as reasonably estimated by the Company.

“ Net Income ” means for any taxable period, the excess, if any, of the Company’s items of income and gain for such taxable period over the Company’s items of loss and deduction for such taxable period. The items included in the calculation of Net Income shall be determined in accordance with Section 4.4 . Once an item of income, gain, loss or deduction that has been included in the initial computation of Net Income is subjected to the special allocation rules in Sections 6.3 and 6.4 , Net Income or the resulting Net Loss, whichever the case may be, shall be recomputed without regard to such item.

“ Net Loss ” means for any taxable period, the excess, if any, of the Company’s items of loss and deduction for such taxable period over the Company’s items of income and gain for such taxable period. The items included in the calculation of Net Loss shall be determined in accordance with Section 4.4 . Once an item of income, gain, loss or deduction that has been included in the initial computation of Net Loss is subjected to the special allocation rules in Sections 6.3 and 6.4 , Net Loss or the resulting Net Income, whichever the case may be, shall be recomputed without regard to such item.

“ New Securities ” has the meaning set forth in Section 4.2(c) .

“ Non-Managing Member ” means any Person named as a Non-Managing Member on Exhibit A , as such Exhibit may be amended from time to time, including any Substituted Non-Managing Member or Additional Non-Managing Member, in such Person’s capacity as a Non-Managing Member in the Company.

“ Non-Managing Membership Interest ” means a Membership Interest held by a Non-Managing Member representing a fractional part of the Membership Interests of all Non-Managing Members and includes any and all benefits to which such Non-Managing Member

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may be entitled and all obligations of such Non-Managing Member hereunder. A Non-Managing Membership Interest may be expressed as a number of Membership Units.

“ Nonrecourse Built-in Gain ” means, with respect to any Contributed Properties or Adjusted Properties that are subject to a mortgage or negative pledge securing a Nonrecourse Liability, the amount of any taxable gain that would be allocated to the Members pursuant to Section 6.4(b) if such properties were disposed of in a taxable transaction in full satisfaction of such liabilities and for no other consideration.

“ Nonrecourse Deductions ” has the meaning set forth in Regulations Section 1.704-2(b)(1), and the amount of Nonrecourse Deductions for a Membership Year shall be determined in accordance with the rules of Regulations Section 1.704-2(c).

“ Nonrecourse Liability ” has the meaning set forth in Regulations Section 1.752-1(a)(2).

“ Non-Restricted Transfer Date ” means the first Business Day following the completion of the initial public offering of the Managing Member and each anniversary of such date (or the next succeeding Business Day if the anniversary falls on a non-Business Day).

“ Notice of Redemption ” means a Notice of Redemption substantially in the form of Exhibit C .

“ Percentage Interest ” means, as to any Member, its interest in the Company as determined by dividing the Membership Units owned by such Member by the total number of Membership Units then outstanding and as specified on Exhibit A , as such Exhibit may be amended from time to time.

“ Person ” means an individual or a corporation, partnership, trust, unincorporated organization, association, limited liability company, estate or other entity.

“ Plan Asset Regulation ” means the regulations promulgated by the United States Department of Labor in Title 29, Code of Federal Regulations, Part 2510, Section 101.3, and any successor regulations thereto.

“ Preferred Shares ” has the meaning set forth in Section 4.2(c) .

“ Qualified REIT Subsidiary ” means any Subsidiary of the Managing Member that is a “qualified REIT subsidiary” within the meaning of Section 856(i) of the Code. Immediately following the Formation and Structuring Transactions and the Effective Date, there will be no Qualified REIT Subsidiaries.

“ Recapture Income ” means any gain recognized by the Company (computed without regard to any adjustment required by Section 734 or Section 743 of the Code) upon the disposition of any property or asset of the Company, which gain is characterized as ordinary income because it represents the recapture of deductions previously taken with respect to such property or asset.

“ Recourse Liabilities ” has the meaning set forth in Regulations Section 1.752-1(a)(1).

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“ Redeeming Member ” shall have the meaning as set forth in Section 4.2(e)(1) .

“ Redemption Right ” shall have the meaning as set forth in Section 4.2(e)(1) .

“ REIT ” means a real estate investment trust under Section 856 of the Code.

“ REIT Requirements ” shall have the meaning set forth in Section 5.1 .

“ Regulations ” means the Income Tax Regulations promulgated under the Code, as such regulations may be amended from time to time (including corresponding provisions of succeeding regulations).

“ Residual Gain ” or “ Residual Loss ” means any item of gain or loss, as the case may be, of the Company recognized for Federal income tax purposes resulting from a sale, exchange or other disposition of Contributed Property or Adjusted Property, to the extent such item of gain or loss is not allocated pursuant to Section 6.4(b)(1)(i) or 6.4(b)(2)(i) to eliminate Book-Tax Disparities.

“ Securities Act ” shall have the meaning set forth in Section 4.2(e)(4).

“ 704(c) Value ” of any Contributed Property means the value of such property as set forth on Exhibit B , or if no value is set forth on Exhibit B , the fair market value of such property or other consideration at the time of contribution as determined by the Managing Member using such reasonable method of valuation as it may adopt. Subject to Section 4.4 , the Managing Member shall use such method as it deems reasonable and appropriate to allocate the aggregate of the 704(c) Value of Contributed Properties among each separate property on a basis proportional to its fair market value.

“ Shares ” means any Common Shares, of any class, and Preferred Shares issued to a Non-Managing Member pursuant to Section 4.2(e) .

“ Shares Amount ” shall mean a number of Common Shares equal to the number of Units offered for redemption by a Redeeming Member, multiplied by the Unit Adjustment Factor.

“ Specified Redemption Date ” means the tenth Business Day after receipt by the Managing Member of a Notice of Redemption.

“ Structuring and Contribution Agreement ” means the Structuring and Contribution Agreement, dated as of July 2, 2004, by and among the Company, the Managing Member and the other parties thereto.

“ Subsidiary ” means, with respect to any Person, any corporation or other entity of which a majority of (a) the voting power of the voting equity securities or (b) the outstanding equity interests is owned, directly or indirectly, by such Person.

“ Substituted Non-Managing Member ” means a Person who is admitted as a Non-Managing Member to the Company pursuant to Section 11.4 .

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“ Tendered Units ” shall have the meaning set forth in Section 4.2(e)(1) .

“ Transaction ” has the meaning set forth in Section 11.2(c) .

“ Unit Adjustment Factor ” means initially 1.0, unless provided otherwise in an exhibit hereto setting forth rights, preferences and obligations with respect to any specific class or series of Membership Units issued after the date hereof; provided , however , that in the event that the Managing Member (a) declares or pays a dividend on its outstanding Common Shares in Common Shares or makes a distribution to all holders of its outstanding Common Shares in Common Shares, (b) subdivides its outstanding Common Shares, or (c) combines its outstanding Common Shares into a smaller number of Common Shares, the Unit Adjustment Factor, as applicable, shall be adjusted by multiplying the Unit Adjustment Factor by a fraction, the numerator of which shall be the number of Common Shares issued and outstanding on the record date (assuming for such purposes that such dividend, distribution, subdivision or combination has occurred as of such time), and the denominator of which shall be the actual number of Common Shares (determined without the above assumption) issued and outstanding on the record date for such dividend, distribution, subdivision or combination. Any adjustment to the Unit Adjustment Factor shall become effective immediately after the effective date of such event retroactive to the record date, if any, for such event. Any adjustment to the Unit Adjustment Factor shall be carried forward to successive adjustments.

“ Unrealized Gain ” attributable to any item of Company Property means, as of any date of determination, the excess, if any, of (a) the fair market value of such property (as determined under Section 4.4 ) as of such date, over (b) the Carrying Value of such property (prior to any adjustment to be made pursuant to Section 4.4 ) as of such date.

“ Unrealized Loss ” attributable to any item of Company Property means, as of any date of determination, the excess, if any, of (a) the Carrying Value of such property (prior to any adjustment to be made pursuant to Section 4.4 ) as of such date, over (b) the fair market value of such property (as determined under Section 4.4 ) as of such date.

“ Valuation Date ” means the date of receipt by the Managing Member of a Notice of Redemption or, if such date is not a Business Day, the first Business Day thereafter.

“ Value ” means, with respect to a Common Share, of any class, the average of the daily market price for the twenty (20) consecutive trading days immediately preceding the Valuation Date. The market price for each such trading day shall be: (a) if the Common Shares are listed or admitted to trading on any securities exchange or the NASDAQ-National Market System, the closing price, regular way, on such day, or if no such sale takes place on such day, the average of the closing bid and asked prices on such day; (b) if the Common Shares are not listed or admitted to trading on any securities exchange or the NASDAQ-National Market System, the last reported sale price on such day or, if no sale takes place on such day, the average of the closing bid and asked prices on such day, as reported by a reliable quotation source designated by the Managing Member; or (c) if the Common Shares are not listed or admitted to trading on any securities exchange or the NASDAQ-National Market System and no such last reported sale price or closing bid and asked prices are available, the average of the reported high bid and low asked prices on such day, as reported by a reliable quotation source designated by the Managing

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Member, or if there shall be no bid and asked prices on such day, the average of the high bid and low asked prices, as so reported, on the most recent day (not more than 20 days prior to the date in question) for which prices have been so reported; provided , however , that if there are no bid and asked prices reported during the 20 days prior to the date in question, the Value of the Common Shares shall be determined by the Managing Member acting in good faith on the basis of such quotations and other information as it considers, in its judgment, appropriate. In the event a holder of Common Shares, of any class, would be entitled to receive Common Share Rights, then the Value of such Common Share Rights shall be determined by the Managing Member acting in good faith on the basis of such quotations and other information as it considers, in its reasonable judgment, appropriate.

ARTICLE II

ORGANIZATIONAL MATTERS

Section 2.1 Organization and Continuation; Application of Act .

(a) Organization and Continuation of Company . The Managing Member and the Non-Managing Members do hereby continue the Company as a limited liability company according to all of the terms and provisions of this Agreement and otherwise in accordance with the Act. The Managing Member is the sole Managing Member and the Non-Managing Members are the sole Non-Managing Members of the Company.

(b) Application of Act . The Company is a limited liability company subject to the provisions of the Act and the terms and conditions set forth in this Agreement. Except as expressly provided herein to the contrary, the rights and obligations of the Members and the administration and termination of the Company shall be governed by the Act. No Member has any interest in any Company Property and the Membership Interests of each Member shall be personal property for all purposes.

Section 2.2 Name . The name of the Company is Sunstone Hotel Partnership, LLC. The Company’s business may be conducted under any other name or names deemed advisable by the Managing Member, including the name of the Managing Member or any Affiliate thereof. The words “limited liability company,” or “LLC” or similar words or letters shall be included in the Company’s name where necessary for the purposes of complying with the laws of any jurisdiction that so requires. The Managing Member in its sole and absolute discretion may change the name of the Company at any time and from time to time and shall notify the Non-Managing Members of such change in the next regular communication to the Non-Managing Members.

Section 2.3 Registered Office and Agent; Principal Office . The address of the registered office of the Company in the State of Delaware is located c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, Delaware 19808, County of New Castle and the registered agent for service of process on the Company in the State of Delaware at such registered office is the Corporation Service Company. The principal office of the Company is located at 903 Calle Amanecer, Suite 100, San Clemente, California 92673, or such other place as the Managing Member may from time to time designate by notice to the Non-Managing

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Members. The Company may maintain offices at such other place or places within or outside the State of Delaware as the Managing Member deems advisable.

Section 2.4 Term . The term of the Company shall continue until dissolved pursuant to the provisions of Article XIII or as otherwise provided by law.

ARTICLE III

PURPOSE

Section 3.1 Purpose and Business . The purpose and nature of the business to be conducted by the Company is (a) to conduct any business that may be lawfully conducted by a limited liability company organized pursuant to the Act, provided, however, that as long as the Managing Member has determined to continue to qualify as a REIT, such business shall be limited to and conducted in such a manner as to permit the Managing Member at all times to be classified as a REIT for federal income tax purposes, unless the Managing Member ceases to qualify as a REIT for reasons other than the conduct of the business of the Company, (b) to enter into any partnership, joint venture or other similar arrangement to engage in any of the foregoing or the ownership of interests in any entity engaged in any of the foregoing and (c) to do anything necessary or incidental to the foregoing which, in each case, is not in breach of this Agreement.

Section 3.2 Powers . The Company is empowered to do any and all acts and things necessary, appropriate, proper, advisable, incidental to or convenient for the furtherance and accomplishment of the purposes and business described herein and for the protection and benefit of the Company including, without limitation, full power and authority, directly or through its ownership interest in other entities, to enter into, perform and carry out contracts of any kind, borrow money and issue evidences of indebtedness, whether or not secured by mortgage, deed of trust, pledge or other lien, acquire, own, manage, improve and develop real property, and lease, sell, transfer and dispose of real property; provided , however , that as long as the Managing Member has determined to continue to qualify as a REIT, the Company shall not take, or refrain from taking, any action which, in the judgment of the Managing Member, in its sole and absolute discretion, (i) could adversely affect the ability of the Managing Member to continue to qualify as a REIT, (ii) could subject Managing Member to any taxes under Section 857 or Section 4981 of the Code, or (iii) could violate any law or regulation of any governmental body or agency having jurisdiction over the Managing Member or its securities, unless any such action (or inaction) under (i), (ii) or (iii) shall have been specifically consented to by the Managing Member in writing.

Section 3.3 Certain ERISA Matters . Each Member acknowledges that the Company is intended to qualify as a “real estate operating company” (as such term is defined in the Plan Asset Regulation). The Managing Member may structure the investments in, relationships with and conduct with respect to Company Properties and any other assets of the Company so that the Company will be a “real estate operating company” (as such term is defined in the Plan Asset Regulation).

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ARTICLE IV

CAPITAL CONTRIBUTIONS;

ISSUANCE OF UNITS; CAPITAL ACCOUNTS

Section 4.1 Capital Contributions of the Members .

(a) Initial Capital Contributions . At the time of the execution of this Agreement, the Members shall make or shall have made the Capital Contributions set forth in Exhibit A to this Agreement. The Members shall own Membership Units in the amounts set forth on Exhibit A and shall have a Percentage Interest in the Company as set forth on Exhibit A , which Percentage Interest shall be adjusted on Exhibit A from time to time by the Managing Member to the extent necessary to reflect accurately redemptions, conversions, Capital Contributions, the issuance of additional Membership Units, or similar events having an effect on a Member’s Percentage Interest. The ownership of Membership Units may be evidenced by a form of certificate for units designated by the Managing Member; provided , however , that the Managing Member may provide that some or all of any or all classes or series of the Membership Units shall be uncertificated. Each certificate for Membership Units shall be consecutively numbered or otherwise identified. Certificates of Membership Units shall be signed by or in the name of the Company by the Chief Executive Officer, the President or a Vice President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary of the Company. Where a certificate is countersigned by a transfer agent, other than the Company or an employee of the Company, or by a registrar, the signatures of one or more officers of the Company may be facsimiles. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, the certificate may be issued by the Company with the same effect as if such officer, transfer agent or registrar were such officer, transfer agent or registrar at the date of its issue.

(b) Additional Capital Contributions .

(1) No Member shall be assessed or, except as provided for in Section 4.1(b)(2) and except for any such amounts which a Non-Managing Member may be obligated to repay under Section 10.5 , be required to contribute additional funds or other property to the Company. Any additional funds or other property required by the Company, as determined by the Managing Member in its sole discretion, may, at the option of the Managing Member and without an obligation to do so (except as provided for in Section 4.1(b)(2) ), be contributed by the Managing Member as additional Capital Contributions. If and as the Managing Member or any other Member makes additional Capital Contributions to the Company, each such Member shall receive additional Membership Units as provided for in Section 4.2 .

(2) Except to the extent provided in Section 7.5 below relating to interests in Company Properties held directly by the Company or through Subsidiaries, the net proceeds of any and all funds raised by or through the

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Managing Member through the issuance of additional Shares of the Managing Member shall be contributed to the Company as additional Capital Contributions, and in such event the Managing Member shall be issued additional Membership Units pursuant to Section 4.2 below.

(c) Return of Capital Contributions . Except as otherwise expressly provided herein, the Capital Contribution of each Member will be returned to that Member only in the manner and to the extent provided in Article V and Article XIII hereof, and no Member may withdraw from the Company or otherwise have any right to demand or receive the return of its Capital Contribution to the Company (as such), except as specifically provided herein. Under circumstances requiring a return of any Capital Contribution, no Member shall have the right to receive property other than cash, except as specifically provided herein. No Member shall be entitled to interest on any Capital Contribution or Capital Account notwithstanding any disproportion therein as between the Members. Except as specifically provided herein, the Managing Member shall not be liable for the return of any portion of the Capital Contribution of any Non-Managing Member, and the return of such Capital Contributions shall be made solely from Company assets.

(d) Liability of Members . No Member shall have any further personal liability to contribute money to, or in respect of, the liabilities or the obligations of the Company, nor shall any Member be personally liable for any obligations of the Company, except as otherwise provided in this Article IV or in the Act.

Section 4.2 Issuances of Additional Membership Interests .

(a) Issuance to Other Than the Managing Member . The Managing Member is hereby authorized to cause the Company to issue such additional Membership Interests in the form of Membership Units for any Company purpose at any time or from time to time, to the Members (other than issuances to the Managing Member, which issuances are governed by Section 4.2(b) and Section 4.2(c) ) or to other Persons for such consideration and on such terms and conditions as shall be established by the Managing Member in its sole and absolute discretion, all without the approval of any Non-Managing Members except to the extent provided herein; provided , however , that the Company also may from time to time issue to third parties additional Membership Interests (other than any such issuance to the Managing Member which is governed by Sections 4.2(b) and 4.2(c) ) in one or more classes, or one or more series of any of such classes, with such voting powers, full or limited, or no voting powers, and such designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions thereof, including voting powers, designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions senior to Non-Managing Membership Interests, as may be set forth an exhibit hereto from time to time, subject to Delaware law, including, without limitation, with respect to (i) the allocations of items of income, gain, loss, deduction and credit to each such class or series of Membership Interests, (ii) the right of each such class or series of Membership Interests to share in distributions, and (iii) the rights of each such class or series of Membership Interests upon dissolution and liquidation of the

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Company. To the extent more than one class of Membership Units is outstanding, the Membership Units in this Agreement shall be referred to as Class A Units. To the extent more than one class of Common Shares is outstanding, the Common Shares in this Agreement shall be referred to as Class A Common Shares.

(b) Issuance to the Managing Member . The Company also may from time to time issue to the Managing Member additional Membership Units or other Membership Interests in one or more classes, or one or more series of any of such classes, with such voting powers, full or limited, or no voting powers, and such designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions thereof, including voting powers, designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions senior to Non-Managing Membership Interests, as may be set forth in an exhibit hereto from time to time, all as shall be determined by the Managing Member, subject to Delaware law, including, without limitation, with respect to (i) the allocations of items of income, gain, loss, deduction and credit to each such class or series of Membership Interests, (ii) the right of each such class or series of Interests to share in distributions, and (iii) the rights of each such class or series of Membership Interests upon dissolution and liquidation of the Company; provided , however , that (x) the additional Membership Interests are issued in connection with an issuance of shares of the Managing Member, which shares have designations, preferences and other rights, all such that the economic interests are substantially similar to the designations, preferences and other rights of the additional Membership Interests issued to the Managing Member in accordance with this Section 4.2(b) , and (y) the Managing Member shall make a Capital Contribution to the Company (1) in an amount equal to the net proceeds raised in connection with the issuance of such shares of the Managing Member in the event such shares are sold for cash or cash equivalents or (2) in the form of the property received in consideration for such shares, in the event such shares are issued in consideration for other property.

(c) Issuance of Additional Common Shares or Preferred Shares . The Managing Member is explicitly authorized to issue additional Common Shares, of any class, or preferred shares of beneficial interest of the Managing Member (“ Preferred Shares ”), or rights, options, warrants or convertible or exchangeable securities containing the right to subscribe for or purchase Common Shares, of any class, or Preferred Shares (“ New Securities ”) and in connection therewith, as further provided in Section 4.2(b) , (i) the Managing Member shall cause the Company to issue to the Managing Member Membership Interests or rights, options, warrants or convertible or exchangeable securities of the Company having designations, preferences and other rights, as may be set forth on an exhibit hereto from time to time, all such that the economic interests are substantially similar to those of the New Securities, and (ii) the Managing Member shall contribute the net proceeds from, or the property received in consideration for, the issuance of such New Securities and from the exercise of rights contained in such New Securities to the Company. In connection with the issuance of Membership Interests which are substantially similar to New Securities, the Managing Member is authorized to modify or amend the distributions or allocations hereunder solely to the extent necessary to give effect to the designations, preferences and other rights pertaining to such Membership Interests.

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(d) Issuance Pursuant to Option Plans .

(1) Upon the exercise of an option granted by the Managing Member for Common Shares, of any class, the Managing Member shall cause the Company to issue to the Managing Member one Membership Unit for each such Common Share acquired upon such exercise pursuant to the Option Plans (or such other number of Membership Units based on the relationship a different class of Common Shares bears to Common Shares), and the Managing Member shall contribute to the Company the net proceeds received upon such exercise (it being understood that the Managing Member may issue Common Shares in connection with the Option Plans without receiving a specified amount of proceeds and that the issuance of such Common Shares shall nonetheless entitle the Managing Member to additional Membership Units).

(2) The Managing Member shall cause the Company to issue Membership Units to employees of the Company upon the exercise by any such employees of an option to acquire Membership Units granted by the Company pursuant to the Option Plans in accordance with the terms of the Option Plans. Membership Units so issued shall represent Non-Managing Membership Interests.

(3) The Managing Member shall cause the Company to issue Membership Units to any Subsidiary upon the exercise by an employee of such Subsidiary of an option to acquire Membership Units granted by such Subsidiary pursuant to the Option Plans, and such Subsidiary shall transfer to the Company the price per Membership Unit required by the Option Plans to be paid by Subsidiaries. Membership Units issued to any such Subsidiary shall represent Non-Managing Membership Interests.

(e) Redemption of Units .

(1) Subject to Section 11.3(d) and the further provisions of this Section 4.2(e) , and except as otherwise set forth in an exhibit hereto setting forth rights, preferences and obligations with respect to any particular class or series of Membership Units issued after the date hereof, each Non-Managing Member shall have the right (i) on or after the date twelve (12) months after the Effective Date, with respect to the Membership Units acquired on or contemporaneously with the Effective Date, or (ii) on or after such other date as expressly provided in any agreement entered into between the Company and any Non-Managing Member, including the Structuring and Contribution Agreement, to require the Company to redeem (the “ Redemption Right ”) on a Specified Redemption Date all or a portion of the Membership Units held by such Non-Managing Member at a redemption price equal to and in the form of the Cash Amount to be paid by the Company. The Redemption Right shall be exercised pursuant to a Notice of Redemption delivered to the Company (with a copy to the Managing Member) by the Non-Managing Member who is exercising the Redemption Right (the “ Redeeming Member ”); provided , however , that the Company shall not be obligated to satisfy such Redemption Right if the Managing Member elects to purchase the

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Membership Units subject to the Notice of Redemption (the “ Tendered Units ”); provided , further , that in the event the Managing Member issues to all holders of Common Shares rights, options, warrants or convertible or exchangeable securities entitling the shareholders to subscribe for or purchase Common Shares, or any other securities or property (collectively, the “ Common Share Rights ”) then (except to the extent such rights have already been reflected in an adjustment to the Unit Adjustment Factor as provided in Section 4.2(e)(2) below) the Redeeming Member shall also be entitled to receive such Common Share Rights that a holder of that number of Common Shares would be entitled to receive. A Non-Managing Member may not exercise the Redemption Right for less than ten thousand (10,000) Membership Units or, if such Non-Managing Member holds less than ten thousand (10,000) Membership Units, all of the Membership Units held by such Non-Managing Member.

(2) Notwithstanding the provisions of Section 4.2(e)(1) , a Non-Managing Member that exercises the Redemption Right shall be deemed to have offered to sell the Membership Units described in the Notice of Redemption to the Managing Member, and the Managing Member may, in its sole and absolute discretion, elect to assume directly and satisfy a Redemption Right, and acquire some or all of such Membership Units by paying to the Redeeming Member either the Cash Amount, or the Shares Amount, as elected by the Managing Member (in its sole and absolute discretion), on the Specified Redemption Date, whereupon the Managing Member shall acquire the Membership Units offered for redemption by the Redeeming Member. If the Managing Member shall elect to exercise its right to purchase Membership Units under this Section 4.2(e)(2) with respect to a Notice of Redemption, it shall so notify the Redeeming Member promptly after the receipt by the Company of such Notice of Redemption. In the event the Managing Member shall exercise its right to purchase Membership Units with respect to the exercise of a Redemption Right in the manner described in the first sentence of this Section 4.2(e)(2) , the Company shall have no obligation to pay any amount to the Redeeming Member with respect to Redeeming Member’s exercise of the Redemption Right, and each of the Redeeming Member, the Company and the Managing Member shall treat the transaction between the Managing Member and the Redeeming Member for federal income tax purposes as a sale of the Redeeming Member’s Membership Units to the Managing Member.

(3) In the event of any change in the Unit Adjustment Factor, the number of Membership Units held by each Member shall be proportionately adjusted by multiplying the number of Membership Units held by such Member immediately prior to the change in the Unit Adjustment Factor by the new Unit Adjustment Factor; the intent of this provision is that one Membership Unit remains equivalent in value to one Common Share without dilution (including any securities for which Shares are exchanged in a transaction contemplated by Section 11.2(c) ). In the event the Managing Member issues any Common Shares in exchange for Membership Units pursuant to this Section 4.2(e) , any such Membership Units so acquired by the Managing Member shall immediately

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thereafter be canceled by the Company and the Company shall issue to the Managing Member new Membership Units pursuant to Section 4.2(c) hereof. Each Redeeming Member agrees to execute such documents as the Managing Member may reasonably require in connection with the issuance of Common Shares upon exercise of the Redemption Right.

(4) The Shares Amount, if applicable, shall be delivered as duly authorized, validly issued, fully paid and nonassessable Common Shares and, if applicable, free of any pledge, lien, encumbrance or restriction, other than those provided in the Charter, the Bylaws of the Managing Member, the Securities Act of 1933, as amended (the “ Securities Act ”), relevant state securities or blue sky laws and any applicable registration rights agreement with respect to such Common Shares entered into by the Redeeming Member. Notwithstanding any delay in such delivery (but subject to Section 4.2(e)(6) ), the Redeeming Member shall be deemed the owner of such Common Shares for all purposes, including without limitation, rights to vote or consent, and receive dividends, as of the Specified Redemption Date. In addition, the Common Shares for which the Membership Units might be exchanged shall also bear a legend which generally provides the following:

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 (THE “CODE”). SUBJECT TO CERTAIN FURTHER RESTRICTIONS AND EXCEPT AS EXPRESSLY PROVIDED IN THE CORPORATION’S CHARTER, (I) NO INDIVIDUAL 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 INDIVIDUAL IS AN EXCEPTED HOLDER (IN WHICH CASE THE EXCEPTED HOLDER LIMIT SHALL BE APPLICABLE); (II) NO INDIVIDUAL 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 INDIVIDUAL 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

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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.

(5) Each Non-Managing Member covenants and agrees with the Managing Member that all Tendered Units shall be delivered to the Managing Member free and clear of all liens, claims and encumbrances whatsoever and should any such liens, claims and/or encumbrances exist or arise with respect to such Tendered Units, the Managing Member shall be under no obligation to acquire the same. Each Non-Managing Member further agrees that, in the event any state or local property transfer tax is payable solely with respect to its Tendered Units transferred to the Managing Member (or its designee), such Non-Managing Member shall assume and pay such transfer tax.

(6) Notwithstanding the provisions of Section 4.2(e) or any other provision of this Agreement, a Member (i) shall not be entitled to effect a Redemption for cash or an exchange for Common Shares to the extent the ownership or right to acquire Common Shares pursuant to such exchange by such Member on the Specified Redemption Date could cause such Member or any other Person to violate the restrictions on ownership and transfer of Common Shares set forth in the Charter and (ii) shall have no rights under this Agreement to acquire Common Shares which would otherwise be prohibited under the Charter. To the extent any attempted redemption or exchange for Common Shares would be in violation of this Section 4.2(e)(6) , it shall be null and void ab initio and such

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Member shall not acquire any rights or economic interest in the cash otherwise payable upon such redemption or the Common Shares otherwise issuable upon such exchange.

(7) Notwithstanding anything herein to the contrary (but subject to Section 4.2(e)(6) ), with respect to any redemption or exchange for Common Shares pursuant to this Section 4.2(e) :

(i) All Membership Units acquired by the Managing Member pursuant thereto shall automatically, and without further action required, be converted into and deemed to be Managing Member Interests comprised of the same number and class of Membership Units.

(ii) The consummation of any redemption or exchange for Common Shares shall be subject to the expiration or termination of the applicable waiting period, if any, under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.

(iii) Each Redeeming Member shall continue to own all Membership Units subject to any redemption or exchange for Common Shares, and be treated as a Non-Managing Member with respect to such Membership Units for all purposes of this Agreement, until the Specified Redemption Date. Until a Specified Redemption Date, the Redeeming Member shall have no rights as a stockholder of the Managing Member with respect to such Redeeming Member’s Membership Units, except as may be provided in the Investors Agreement.

Section 4.3 No Preemptive Rights . Except as specifically provided in this Agreement, no Person shall have any preemptive, preferential or other similar right with respect to (a) additional Capital Contributions or loans to the Company, or (b) issuance or sale of any Membership Units.

Section 4.4 Capital Accounts of the Members .

(a) General . The Company shall maintain for each Member a separate Capital Account in accordance with the rules of Regulations Section 1.704-1(b)(2)(iv). Such Capital Account shall be increased by (a) the amount of all Capital Contributions made by such Member to the Company pursuant to this Agreement and (b) all items of income and gain (including income and gain exempt from tax) computed in accordance with Section 4.4(b) hereof and allocated to such Member pursuant to Sections 6.1 through Section 6.3 of the Agreement, and decreased by (i) the amount of cash or Agreed Value of all actual and deemed distributions of cash or property made to such Member pursuant to this Agreement and (ii) all items of deduction and loss computed in accordance with Section 4.4(b) hereof and allocated to such Member pursuant to Sections 6.1 through Section 6.3 of the Agreement.

(b) Income, Gains, Deductions and Losses . For purposes of computing the amount of any item of income, gain, loss or deduction to be reflected in the Members’ Capital Accounts, unless otherwise specified in this Agreement, the determination,

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recognition and classification of any such item shall be the same as its determination, recognition and classification for Federal income tax purposes determined in accordance with Section 703(a) of the Code (for this purpose all items of income, gain, loss or deduction required to be stated separately pursuant to Section 703(a)(1) of the Code shall be included in taxable income or loss), with the following adjustments:

(1) Except as otherwise provided in Regulations Section 1.704-1(b)(2)(iv)(m), the computation of all items of income, gain, loss and deduction shall be made without regard to any election under Section 754 of the Code which may be made by the Company.

(2) The computation of all items of income, gain, loss and deduction shall be made without regard to the fact that items described in Sections 705(a)(1)(B) or 705(a)(2)(B) of the Code are not includable in gross income or are neither currently deductible nor capitalized for Federal income tax purposes.

(3) Any income, gain or loss attributable to the taxable disposition of any Company Property shall be determined as if the adjusted basis of such property as of such date of disposition were equal in amount to the Company’s Carrying Value with respect to such property as of such date.

(4) In lieu of the depreciation, amortization, and other cost recovery deductions taken into account in computing such taxable income or loss, there shall be taken into account Depreciation for such fiscal year.

(5) In the event the Carrying Value of any Company asset is adjusted pursuant to Section 4.4(d) hereof, the amount of any such adjustment shall be taken into account as gain or loss from the disposition of such asset.

(6) Any items specially allocated under Section 6.4 hereof shall not be taken into account.

(c) Transfers of Membership Units . A transferee of a Membership Unit shall succeed to a pro rata portion of the Capital Account of the transferor.

(d) Unrealized Gains and Losses .

(1) Consistent with the provisions of Regulations Section 1.704-1(b)(2)(iv)(f), and as provided in Section 4.4(d)(2) , the Carrying Values of all Company assets shall be adjusted upward or downward to reflect any Unrealized Gain or Unrealized Loss attributable to such Company Property, as of the times of the adjustments provided in Section 4.4(d)(2) hereof, as if such Unrealized Gain or Unrealized Loss had been recognized on an actual sale of each such property and allocated pursuant to Section 6.1 of the Agreement.

(2) Such adjustments shall be made as of the following times: (i) immediately prior to the acquisition of an additional interest in the Company by any new or existing Member in exchange for more than a de minimis Capital

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Contribution; (ii) immediately prior to the distribution by the Company to a Member of more than a de minimis amount of Property as consideration for an interest in the Company; and (iii) immediately prior to the liquidation of the Company or the Managing Member’s interest in the Company within the meaning of Regulations Section 1.704-l(b)(2)(ii)(g); provided , however , that adjustments pursuant to clauses (i) and (ii) above shall be made only if the Managing Member reasonably determines that such adjustments are necessary or appropriate to reflect the relative economic interests of the Members in the Company.

(3) In accordance with Regulations Section 1.704-1(b)(2)(iv)(e), the Carrying Values of Company assets distributed in kind shall be adjusted upward or downward to reflect any Unrealized Gain or Unrealized Loss attributable to such Company Property, as of the time any such asset is distributed.

(4) In determining such Unrealized Gain or Unrealized Loss, the aggregate cash amount and fair market value of all Company assets (including cash or cash equivalents) shall be determined by the Managing Member using such reasonable method of valuation as it may adopt, or in the case of a liquidating distribution pursuant to Article XIII of this Agreement, be determined and allocated by the Liquidator using such reasonable methods of valuation as it may adopt. The Managing Member, or the Liquidator, as the case may be, shall allocate such aggregate value among the assets of the Company (in such manner as it determines in its sole and absolute discretion to arrive at a fair market value for individual properties).

(e) Modification by Managing Member . The provisions of this Agreement relating to the maintenance of Capital Accounts are intended to comply with Regulations issued under Sections 704(b) and 514(c)(9) of the Code, and shall be interpreted and applied in a manner consistent with such Regulations. In the event the Managing Member shall determine that it is prudent to modify the manner in which the Capital Accounts, or any debits or credits thereto (including, without limitation, debits or credits relating to liabilities which are secured by contributed or distributed property or which are assumed by the Company, the Managing Member, or any Non-Managing Members) are computed in order to comply with such Regulations, the Managing Member may make such modification; provided , however , that it will not have a material effect on the amounts distributable to any Person pursuant to Article XIII of this Agreement upon the liquidation of the Company. The Managing Member also shall (a) make any adjustments that are necessary or appropriate to maintain equality between the Capital Accounts of the Members and the amount of Company capital reflected on the Company’s balance sheet, as computed for book purposes, in accordance with Regulations Section 1.704-1(b)(2)(iv)(q), and (b) make any appropriate modifications in the event unanticipated events might otherwise cause this Agreement not to comply with Regulations Section 1.704-1(b).

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ARTICLE V

DISTRIBUTIONS

Section 5.1 Requirement and Characterization of Distributions . The Managing Member shall cause the Company to distribute quarterly all, or such portion as the Managing Member may in its discretion determine, of Available Cash among the Members (i) first, with respect to any class of Membership Interests issued pursuant to Section 4.2(a) or 4.2(b) which are entitled to a preference over Membership Units on the distribution of Available Cash and are specially allocated items under Section 6.1 prior to allocated items with respect to amounts distributed pursuant to clause (ii) below (and within and among such classes, in order of the preferences designated therein and pro rata among any such classes), and (ii) thereafter, pro rata in accordance with their respective Percentage Interests from time to time as determined by the Managing Member; provided that Available Cash for each calendar quarter shall be distributed on or about the 15 ^th day of January, April, July and October of each year in an amount with respect to each Membership Unit at least equal to the Minimum Tax Distribution; provided , however , that in no event may a Member receive a distribution of Available Cash with respect to a Unit if such Member is entitled to receive a dividend from the Managing Member which is derived from a distribution of Available Cash to the Managing Member with respect to a Common Share for which such Unit has been redeemed or exchanged. In the event the Company is subject to any tax or other obligation that is attributable to the interest of one or more Members in the Company, but fewer than all the Members, such tax or other obligation shall be specially allocated to, and charged against the Capital Account of, such Member or Members, and the amounts otherwise distributable to such Member or Members pursuant to this Agreement shall be reduced by such amount. The Managing Member shall take such reasonable efforts, as determined by it in its sole and absolute discretion and consistent with its qualification as a REIT, to cause the Company to distribute sufficient amounts to enable the Managing Member, for so long as the Managing Member has determined to qualify as a REIT, to pay stockholder dividends that will (a) satisfy the requirements for qualifying as a REIT under the Code and Regulations (“ REIT Requirements ”), and (b) except to the extent otherwise determined by the Managing Member, avoid any federal income or excise tax liability of the Managing Member.

Section 5.2 Amounts Withheld . All amounts withheld pursuant to the Code or any provisions of any state or local tax law and Section 10.5 hereof with respect to any allocation, payment or distribution to the Managing Member, or any Non-Managing Members or Assignees shall be treated as amounts distributed to the Managing Member or such Non-Managing Members, or Assignees pursuant to Section 5.1 for all purposes under this Agreement.

Section 5.3 Distributions Upon Liquidation . Proceeds from a Liquidating Transaction shall be distributed to the Members in accordance with Section 13.2 .

ARTICLE VI

ALLOCATIONS

Section 6.1 Allocations For Capital Account Purposes Other than the Taxable Year of Liquidation . Subject to a preferential allocation of gain or net income to any class of Membership Interests issued pursuant to Section 4.2(a) or 4.2(b) which is entitled to a preference

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over Membership Units on the distribution of Available Cash, for purposes of maintaining the Capital Accounts and in determining the rights of the Members among themselves, the Company’s items of income, gain, loss and deduction (computed in accordance with Section 4.4 hereof) shall be allocated among the Members for each taxable year (or portion thereof) as provided herein below:

(a) Net Income . After giving effect to the special allocations set forth in Sections 6.2 and 6.3 below, Net Income shall be allocated to the Members in accordance with their respective Percentage Interests.

(b) Net Losses . After giving effect to the special allocations set forth in Sections 6.2 and 6.3 below, Net Losses shall be allocated to the Members in accordance with their respective Percentage Interests.

(c) Nonrecourse Liabilities . For purposes of Regulations Section 1.752-3(a), the Members agree that Nonrecourse Liabilities of the Company in excess of the sum of (i) the amount of Membership Minimum Gain and (ii) the total amount of Nonrecourse Built-in Gain shall be allocated among the Members in the manner determined by the Managing Member, provided that such allocation shall be permissible under Regulations Section 1.752-3.

(d) Gains . Any gain allocated to the Members upon the sale or other taxable disposition of any Company asset shall to the extent possible, after taking into account other required allocations of gain pursuant to Section 6.3 below, be characterized as Recapture Income in the same proportions and to the same extent as such Members have been allocated any deductions directly or indirectly giving rise to the treatment of such gains as Recapture Income, all in such a manner consistent with Regulations Section 1.1245-1.

Section 6.2 Allocations for Capital Account Purposes in the Taxable Year of Liquidation . Subject to Section 6.3 , the Net Income and Net Loss of the Company for the taxable year of liquidation of the Company shall be allocated prior to the final liquidating distributions of the Company and shall be allocated first to eliminate any Member’s Adjusted Capital Account Deficit and then, to the extent permissible under Sections 704(b) and 514(c)(9) of the Code, in a manner such that the Capital Accounts of the Members immediately prior to such final liquidating distributions are equal to the amount which would have been distributable to the Members under Section 5.1 if such distributions were to be governed by Section 5.1 . Notwithstanding the preceding sentence, actual distributions made subsequent to the allocations under this Section 6.2 shall be made pursuant to Section 5.3 .

Section 6.3 Special Allocation Rules . Notwithstanding any other provision of this Agreement, the following special allocations shall be made in the following order:

(a) Minimum Gain Chargeback . Notwithstanding any other provisions of Article VI, if there is a net decrease in Membership Minimum Gain during any Membership Year, each Member shall be specially allocated items of Company income and gain for such year (and, if necessary, subsequent years) in an amount equal to such

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Member’s share of the net decrease in Membership Minimum Gain, as determined under Regulations Section 1.704-2(g). Allocations pursuant to the previous sentence shall be made in proportion to the respective amounts required to be allocated to each Member pursuant thereto. The items to be so allocated shall be determined in accordance with Regulations Section 1.704-2(f)(6). This Section 6.3(a) is intended to comply with the minimum gain chargeback requirements in Regulations Section 1.704-2(f) and for purposes of this Section 6.3(a) only, each Member’s Adjusted Capital Account Deficit shall be determined prior to any other allocations pursuant to Section 6.1 of the Agreement with respect to such fiscal year and without regard to any decrease in Member Minimum Gain during such fiscal year.

(b) Member Minimum Gain Chargeback . Notwithstanding any other provision of Article VI (except Section 6.3(a) hereof), if there is a net decrease in Member Minimum Gain attributable to a Member Nonrecourse Debt during any Membership Year, each Member who has a share of the Member Minimum Gain attributable to such Member Nonrecourse Debt, determined in accordance with Regulations Section 1.704-2(i)(5), shall be specially allocated items of Company income and gain for such year (and, if necessary, subsequent years) in an amount equal to such Member’s share of the net decrease in Member Minimum Gain attributable to such Member Nonrecourse Debt, determined in accordance with Regulations Section 1.704-2(i)(5). Allocations pursuant to the previous sentence shall be made in proportion to the respective amounts required to be allocated to each Member pursuant thereto. The items to be so allocated shall be determined in accordance with Regulations Section 1.704-2(i)(4). This Section 6.3(b) is intended to comply with the minimum gain chargeback requirement in such Section of the Regulations and shall be interpreted consistently therewith. Solely for purposes of this Section 6.3(b) , each Member’s Adjusted Capital Account Deficit shall be determined prior to any other allocations pursuant to Article VI of this Agreement with respect to such fiscal year, other than allocations pursuant to Section 6.3(a) hereof.

(c) Qualified Income Offset . In the event any Member unexpectedly receives any adjustments, allocations or distributions described in Regulations Sections 1.704-1(b)(2)(ii)(d)(4), 1.704-1(b)(2)(ii)(d)(5), or 1.704-1(b)(2)(ii)(d)(6), and after giving effect to the allocations required under Sections 6.3(a) and 6.3(b) hereof, such Member has an Adjusted Capital Account Deficit, items of Company income and gain shall be specially allocated to such Member in an amount and manner sufficient to eliminate, to the extent required by the Regulations, its Adjusted Capital Account Deficit created by such adjustments, allocations or distributions as quickly as possible. It is intended that this Section 6.3(c) qualify and be construed as a “qualified income offset” within the meaning of Regulations 1.704-1(b)(2)(ii)(d), which shall be controlling in the event of a conflict between such Regulations and this Section 6.3(c) .

(d) Nonrecourse Deductions . Nonrecourse Deductions for any taxable period shall be allocated to the Members in the manner determined by the Managing Member, provided that such allocation shall be permissible under Section 704(b) of the Code.

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(e) Member Nonrecourse Deductions . Any Member Nonrecourse Deductions for any fiscal year shall be specially allocated to the Member who bears the economic risk of loss with respect to the Member Nonrecourse Debt to which such Member Nonrecourse Deductions are attributable in accordance with Regulations Sections 1.704-2(b)(4) and 1.704-2(i)(2).

(f) Code Section 754 Adjustments . To the extent an adjustment to the adjusted tax basis of any Company asset pursuant to Section 734(b) or 743(b) of the Code is required, pursuant to Regulations Section 1.704-1(b)(2)(iv)(m), to be taken into account in determining Capital Accounts, the amount of such adjustment to the Capital Accounts shall be specially allocated to the Members in a manner consistent with the manner in which their Capital Accounts are required to be adjusted pursuant to such Section of the Regulations.

Section 6.4 Allocations for Tax Purposes.

(a) General . Except as otherwise provided in this Section 6.4 , for Federal income tax purposes, each item of income, gain, loss and deduction shall be allocated among the Members in the same manner as its correlative item of “book” income, gain, loss or deduction is allocated pursuant to Sections 6.1 and 6.3 of this Agreement.

(b) To Eliminate Book-Tax Disparities . In an attempt to eliminate Book-Tax Disparities attributable to a Contributed Property or Adjusted Property, items of income, gain, loss, and deduction shall be allocated for Federal income tax purposes among the Members as follows:

(1) (i) In the case of a Contributed Property, such items attributable thereto shall be allocated among the Members consistent with the principles of Section 704(c) of the Code in a manner that takes into account the variation between the 704(c) Value of such property and its adjusted basis at the time of contribution, and (ii) any item of Residual Gain or Residual Loss attributable to a Contributed Property shall be allocated among the Members in the same manner as its correlative item of “book” gain or loss is allocated pursuant to Sections 6.1 and 6.3 of this Agreement.

(2) (i) In the case of an Adjusted Property, such items shall (A) first, be allocated among the Members in a manner consistent with the principles of Section 704(c) of the Code in a manner to take into account the Unrealized Gain or Unrealized Loss attributable to such property and the allocations thereof pursuant to Section 4.4 and (B) second, in the event such property was originally a Contributed Property, be allocated among the Members in a manner consistent with Section 6.4(b)(1)(i) , and (ii) any item of Residual Gain or Residual Loss attributable to an Adjusted Property shall be allocated among the Members in the same manner as its correlative item of “book” gain or loss is allocated pursuant to Sections 6.1 and 6.4 of this Agreement.

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(3) All other items of income, gain, loss and deduction shall be allocated among the Members in the same manner as their correlative item of “book” gain or loss is allocated pursuant to Sections 6.1 and 6.3 of this Agreement.

(c) Power of Managing Member to Elect Method . To the extent Treasury Regulations promulgated pursuant to Section 704(c) of the Code permit a partnership to utilize alternative methods to eliminate the disparities between the agreed value of property and its adjusted basis, and subject to any agreements existing between the Company and any Member or Members prior to the date hereof, the Managing Member shall have the authority to elect the method to be used by the Company and such election shall be binding on all Members.

ARTICLE VII

MANAGEMENT AND OPERATION OF BUSINESS

Section 7.1 Management .

(a) Powers of Managing Member . Except as otherwise expressly provided in this Agreement, all management powers over the business and affairs of the Company are exclusively vested in the Managing Member, and no Non-Managing Member shall have any right to participate in or exercise control or management power over the business and affairs of the Company. Notwithstanding anything to the contrary in this Agreement, the Managing Member may not be removed by the Non-Managing Members with or without cause. In addition to the powers now or hereafter granted a Managing Member of a limited liability company under applicable law or which are granted to the Managing Member under any other provision of this Agreement, the Managing Member, subject to Section 7.3 hereof, shall have full power and authority to do all things deemed necessary or desirable by it to conduct the business of the Company, to exercise all powers set forth in Section 3.2 hereof and to effectuate the purposes set forth in Section 3.1 hereof including, without limitation:

(1) the making of any expenditures (including, without limitation, making prepayments on loans and borrowing money to permit the Company to make distributions to its Members in such amounts as will permit the Managing Member (so long as the Managing Member has determined to qualify as a REIT) to avoid the payment of any federal income tax (including, for this purpose, any excise tax pursuant to Section 4981 of the Code) and to make distributions to its stockholders sufficient to permit the Managing Member to maintain REIT status), the lending or borrowing of money, the assumption or guarantee of, or other contracting for, indebtedness and other liabilities, the issuance of evidences of indebtedness (including the securing of same by mortgage, deed of trust or other lien or encumbrance on the Company’s assets) and the incurring of any obligations it deems necessary for the conduct of the activities of the Company;

(2) the making of tax, regulatory and other filings, or rendering of periodic or other reports to the New York Stock Exchange, governmental or other

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agencies having jurisdiction over the business or assets of the Company, the registration of any class of securities of the Company under the Securities Exchange Act of 1934, as amended (the “ Exchange Act ”), and the listing of any debt securities of the Company on any exchange;

(3) the acquisition, disposition, sale, conveyance, financing, refinancing, mortgage, pledge, encumbrance, hypothecation, contribution or exchange of any assets of the Company or the merger or other combination of the Company with or into another entity on such terms as the Managing Member deems proper;

(4) the use of the assets of the Company (including, without limitation, cash on hand) for any purpose consistent with the terms of this Agreement and on any terms it sees fit including, without limitation, the financing of the assets and the operations of the Managing Member, the Company or any of the Company’s Subsidiaries, the lending of funds to other Persons (including the Managing Member or any of the Company’s Subsidiaries) and the repayment of obligations of the Company and its Subsidiaries and any other Person in which it has an equity investment and the making of capital contributions to its Subsidiaries, the holding of any real, personal and mixed property of the Company in the name of the Company or in the name of a nominee or trustee (subject to Section 7.10 ), the creation, by grant or otherwise, of easements or servitudes, and the performance of any and all acts necessary or appropriate to the operation of the Company assets including, but not limited to, applications for rezoning, objections to rezoning, constructing, altering, improving, repairing, renovating, rehabilitating, razing, demolishing or condemning any improvements or property of the Company or any Subsidiary of the Company;

(5) the negotiation, execution, and performance of any contracts, conveyances or other instruments (including with Affiliates of the Company to the extent provided in Section 7.6 ) that the Managing Member considers useful or necessary to the conduct of the Company’s operations or the implementation of the Managing Member’s powers under this Agreement including, without limitation, the execution and delivery of leases on behalf of or in the name of the Company (including the lease of Company Property for any purpose and without limit as to the term thereof, whether or not such term (including renewal terms) shall extend beyond the date of termination of the Company and whether or not the portion so leased is to be occupied by the lessee or, in turn, subleased in whole or in part to others);

(6) the opening and closing of bank accounts, the investment of Company funds in securities, certificates of deposit and other instruments, and the distribution of Company cash or other Company assets in accordance with this Agreement;

(7) the selection and dismissal of employees of the Company or the Managing Member (including, without limitation, employees having titles such as

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“president”, “vice president”, “secretary” and “treasurer”), and the engagement and dismissal of agents, outside attorneys, accountants, engineers, appraisers, consultants, contractors and other professionals on behalf of the Managing Member or the Company and the determination of their compensation and other terms of employment or hiring;

(8) the maintenance of such insurance for the benefit of the Company and the Members and the directors and officers of the Company as it deems necessary or appropriate;

(9) the formation of, or acquisition of an interest in, and the contribution of property to, any further limited or general partnerships, joint ventures or other relationships that it deems desirable (including, without limitation, the acquisition of interests in, and the contribution of property to, its Subsidiaries and any other Person in which it has an equity investment from time to time); provided , that, as long as the Managing Member has determined to continue to qualify as a REIT, the Company may not engage in any such formation, acquisition or contribution that could cause the Managing Member to fail to qualify as a REIT;

(10) the control of any matters affecting the rights and obligations of the Company, including the conduct of litigation and the incurring of legal expense and the settlement of claims and litigation, and the indemnification of any Person against liabilities and contingencies to the extent permitted by law;

(11) the undertaking of any action in connection with the Company’s direct or indirect investment in its Subsidiaries or any other Person (including, without limitation, the contribution or loan of funds to, incurring indebtedness on behalf of, or guaranteeing the obligations of any such Persons);

(12) the determination of the fair market value of any Company property distributed in kind using such reasonable method of valuation as it may adopt;

(13) the management, operation, leasing, landscaping, repair, alteration, demolition or improvement of any real property or improvements owned by the Company or any Subsidiary of the Company or any Person in which the Company has made a direct or indirect equity investment;

(14) holding, managing, investing and reinvesting cash and other assets of the Company;

(15) the collection and receipt of revenues and income of the Company;

(16) the exercise, directly or indirectly through any attorney-in-fact acting under a general or limited power of attorney, of any right, including the right to vote, appurtenant to any asset or investment held by the Company;

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(17) the exercise of any of the powers of the Managing Member enumerated in this Agreement on behalf of or in connection with any Subsidiary of the Company or any other Person in which the Company has a direct or indirect interest, or jointly with any such Subsidiary or other Person;

(18) the exercise of any of the powers of the Managing Member enumerated in this Agreement on behalf of any Person in which the Company does not have an interest pursuant to contractual or other arrangements with such Person;

(19) the making, execution and delivery of any and all deeds, leases, notes, deeds to secure debt, mortgages, deeds of trust, security agreements, conveyances, contracts, guarantees, warranties, indemnities, waivers, releases or legal instruments or agreements in writing necessary or appropriate in the judgment of the Managing Member for the accomplishment of any of the powers of the Managing Member enumerated in this Agreement;

(20) the issuance of Membership Interests, as appropriate, pursuant to Section 4.2 of this Agreement; and

(21) the consummation of the Formation and Structuring Transactions.

(b) No Approval Required for Above Powers . Except as expressly provided in this Agreement (including, without limitation, the last sentence of this Section 7.1(b)) , each of the Members agrees that the Managing Member is authorized to execute, deliver and perform the above-mentioned agreements and transactions on behalf of the Company without any further act, approval or vote of the Members, notwithstanding any other provision of this Agreement, the Act or any applicable law, rule or regulation to the fullest extent permitted under the Act or other applicable law, rule or regulation. The execution, delivery or performance by the Managing Member or the Company of any agreement authorized or permitted under this Agreement shall not constitute a breach by the Managing Member of any duty that the Managing Member may owe the Company or the Non-Managing Members or any other Persons under this Agreement or of any duty stated or implied by law or equity.

(c) Insurance . At all times from and after the date hereof, the Managing Member may cause the Company to obtain and maintain casualty, liability and other insurance on Company Properties and liability insurance for the Indemnitees hereunder. The right to procure such insurance on behalf of the Indemnitees shall in no way mitigate or otherwise affect the right of any such Indemnitee to indemnification under Section 7.7 .

(d) Working Capital Reserves . At all times from and after the date hereof, the Managing Member may cause the Company to establish and maintain working capital reserves in such amounts as the Managing Member, in its sole and absolute discretion, deems appropriate and reasonable from time to time.

(e) No Obligation to Consider Tax Consequences to Non-Managing Members . In exercising its authority under this Agreement, the Managing Member may,

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but shall be under no obligation to, take into account the tax consequences to any Member of any action taken by it. The Managing Member and the Company shall not have liability to a Non-Managing Member under any circumstances as a result of an income tax liability incurred by such Non-Managing Member as a result of an action (or inaction) by the Managing Member pursuant to its authority under this Agreement.

(f) No Obligation To Expend Individual Funds, etc . Except as otherwise provided herein, to the extent the duties of the Managing Member require expenditures of funds to be paid to third parties, the Managing Member shall not have any obligations hereunder except to the extent that Company funds are reasonably available to it for the performance of such duties, and nothing herein contained shall be deemed to authorize or require the Managing Member, in its capacity as such, to expend its individual funds for payment to third parties or to undertake any individual liability or obligation on behalf of the Company.

Section 7.2 Certificate of Formation . To the extent that such action is determined by the Managing Member to be reasonable and necessary or appropriate, the Managing Member shall file amendments to and restatements of the Certificate and do all the things to maintain the Company as a limited liability company (or an entity in which the Non-Managing Members have limited liability) under the laws of the State of Delaware and each other jurisdiction in which the Company may elect to do business or own property. Subject to the terms of Section 8.5(a)(4) hereof, the Managing Member shall not be required, before or after filing, to deliver or mail a copy of the Certificate, as it may be amended or restated from time to time, to any Non-Managing Member. The Managing Member shall use all reasonable efforts to cause to be filed such other certificates or documents as may be reasonable and necessary or appropriate for the formation, continuation, qualification and operation of a limited liability company (or an entity in which the Non-Managing Members have limited liability) in the State of Delaware and any other jurisdiction in which the Company may elect to do business or own property.

Section 7.3 Restrictions on Managing Member’s Authority . The Managing Member may not, without the written Consent of all of the Non-Managing Members, take any action in contravention of this Agreement including, without limitation:

(a) take any action that would make it impossible to carry on the ordinary business of the Company, except as otherwise provided in this Agreement (provided that this restriction shall not be deemed to restrict the sale, lease, transfer or disposition of all or substantially all of the Company’s assets as may otherwise be provided herein);

(b) possess Company property, or assign any rights in specific Company property, for other than a Company purpose except as otherwise provided in this Agreement (other than this Section 7.3 );

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(d) perform any act that would subject a Member to personal liability for the debts, obligations and liabilities of the Company except as provided herein or under the Act.

Section 7.4 Responsibility for Expenses .

(a) No Compensation . Except as provided in this Section 7.4 and elsewhere in this Agreement (including the provisions of Articles V and VI regarding distributions, payments and allocations to which it may be entitled), the Managing Member shall not be compensated for its services as Managing Member of the Company.

(b) Responsibility for Ownership and Operation Expenses . The Company shall be responsible for and shall pay all expenses relating to the Company’s ownership of its assets, and the operation of, or for the benefit of, the Company. The Managing Member is hereby authorized to pay compensation for accounting, administrative, legal, technical, management and other services rendered to the Company. The Managing Member shall be reimbursed on a monthly basis, or such other basis as the Managing Member may determine in its sole and absolute discretion, for all expenses it incurs relating to the Company’s ownership of its assets and the operation of, or for the benefit of, the Company; provided , however , that the amount of any such reimbursement shall be reduced by any interest or other amounts earned by the Managing Member with respect to bank accounts or other instruments held by it as permitted in Section 7.5(a) . The Non-Managing Members acknowledge that all such expenses of the Managing Member are deemed to be for the benefit of the Company. Such reimbursements shall be in addition to any reimbursement to the Managing Member as a result of indemnification pursuant to Section 7.7 hereof. In the event that certain expenses are incurred for the benefit of the Company and other entities (including the Managing Member), such expenses shall be allocated to the Company and such other entities in such a manner as the Managing Member in its sole and absolute discretion deems fair and reasonable. All payments and reimbursements hereunder shall be characterized for federal income tax purposes as expenses of the Company incurred on its behalf, and not as expenses of the Managing Member.

(c) Responsibility for Organization Expenses . The Company shall be responsible for and shall pay all expenses incurred relating to the admission of the Managing Member to the Company.

(d) Common Share Repurchases . If the Managing Member shall elect to purchase from its stockholders Common Shares for the purpose of delivering such Common Shares to satisfy an obligation under any dividend reinvestment program adopted by the Managing Member, any employee stock purchase plan adopted by the Managing Member, or any similar obligation or arrangement undertaken by the Managing Member in the future or for the purpose of retiring such Common Shares, the purchase price paid by the Managing Member for such Common Shares and any other expenses incurred by the Managing Member in connection with such purchase shall be considered expenses of the Company and shall be advanced to the Managing Member or reimbursed to the Managing Member, subject to the condition that: (i) if such Common

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Shares subsequently are sold by the Managing Member, the Managing Member shall pay to the Company any proceeds received by the Managing Member for such Common Shares (which sales proceeds shall include the amount of dividends reinvested under any dividend reinvestment or similar program; provided, that a transfer of Common Shares for Membership Units pursuant to Section 4.2(e) would not be considered a sale for such purposes); and (ii) if such Common Shares are not retransferred by the Managing Member within thirty (30) days after the purchase thereof, or the Managing Member otherwise determines not to retransfer such Common Shares, the Managing Member shall cause the Company to redeem a number of Membership Units held by the Managing Member equal to the number of such Common Shares, as adjusted (x) pursuant to Section 7.5 (in the event the Managing Member acquires material assets, other than on behalf of the Company) and (y) for stock dividends and distributions, stock splits and subdivisions, reverse stock splits and combinations, distributions of rights, warrants or options, and distributions of evidences of indebtedness or assets relating to assets not received by the Managing Member pursuant to a pro rata distribution by the Company (in which case such advancement or reimbursement of expenses shall be treated as having been made as a distribution in redemption of such number of Membership Units held by the Managing Member).

(e) If and to the extent any reimbursements to the Managing Member pursuant to this Section 7.4 constitute gross income of the Managing Member (as opposed to the repayment of advances made by the Managing Member on behalf of the Company), such amounts shall constitute guaranteed payments within the meaning of Section 707(c) of the Code, shall be treated consistently therewith by the Company and all Members, and shall not be treated as distributions for purposes of computing the Members’ Capital Accounts.

Section 7.5 Outside Activities of the Managing Member .

(a) The Managing Member shall not directly or indirectly enter into or conduct any business, other than in connection with the ownership, acquisition and disposition of Membership Interests as a Managing Member or Non-Managing Member and the management of the business of the Company, its operation as a public reporting company with a class (or classes) of securities registered under the Exchange Act and listed on the New York Stock Exchange, its operation as a REIT and such activities as are incidental thereto. The Managing Member shall not own any assets other than Membership Interests (except for certain interests in Company Properties held directly by the Managing Member or which have been caused by the Managing Member to be contributed to or purchased by Subsidiaries, which interests shall not exceed 1% of the aggregate economic interests of any property) and other than such bank accounts or similar instruments as it deems necessary to carry out its responsibilities contemplated under this Agreement and the Charter. The Managing Member and Affiliates of the Managing Member may acquire Non-Managing Membership Interests and shall be entitled to exercise all rights of a Non-Managing Member relating to such Non-Managing Membership Interests.

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(b) Purchases of Shares . In the event the Managing Member purchases Shares, then the Managing Member shall cause the Company to purchase from it an equal number of Membership Units (after application of the Unit Adjustment Factor) on the same terms that the Managing Member purchased such Shares.

Section 7.6 Contracts with Affiliates .

(a) Loans . The Managing Member may cause the Company to lend or contribute to its Subsidiaries or other Persons in which the Company has an equity investment, and such Persons may borrow funds from the Company, on terms and conditions established in the sole and absolute discretion of the Managing Member. The foregoing authority shall not create any right or benefit in favor of any Subsidiary or any other Person.

(b) Transfers of Assets . Except as provided in Section 7.5(a) , the Managing Member may cause the Company to transfer assets to joint ventures, other partnerships, corporations or other business entities in which the Company is or thereby becomes a participant upon such terms and subject to such conditions consistent with this Agreement and applicable law as the Managing Member in its sole discretion deems advisable.

(c) Employee Benefit Plans . The Managing Member, in its sole and absolute discretion and without the approval of the Non-Managing Members, may propose and adopt on behalf of the Managing Member and the Company employee benefit plans funded by the Company for the benefit of employees of the Managing Member, the Company, Subsidiaries of the Company or any Affiliate of any of them in respect of services performed, directly or indirectly, for the benefit of the Company, the Managing Member, or any of the Company’s Subsidiaries, including any such plan which requires the Company, the Managing Member or any of the Company’s Subsidiaries to issue or transfer Membership Units to employees. The Managing Member also is expressly authorized to cause the Company to issue to it Membership Units corresponding to Common Shares issued by the Managing Member pursuant to any such plan or any similar or successor plan and to repurchase such Membership Units to the extent necessary to permit the Managing Member to repurchase such Common Shares in accordance with such plan.

(d) Other Agreements . The Managing Member is expressly authorized to enter into, on its own behalf or in the name and on behalf of the Company, asset management agreements, cross-indemnity agreements, registration rights agreements with respect to the Common Shares, right of first opportunity arrangements or other conflict avoidance agreements with various Affiliates of the Company and the Managing Member on such terms as the Managing Member, in its sole and absolute discretion, believes are advisable. Any indemnification pursuant to this Section 7.7 shall be made only out of the assets of the Company, and any insurance proceeds from any liability policy covering the Managing Member and any Indemnitee, and neither the Managing Member nor any Non-Managing Member shall have any obligation to contribute to the capital of the Company or otherwise provide funds to enable the Company to fund its

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obligations under this Section 7.7 , except to the extent otherwise expressly agreed to by such Member and the Company.

Section 7.7 Indemnification .

(a) General . The Company shall indemnify, in accordance with and to the fullest extent now or hereafter permitted by law, any Person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that the Person is or was a Member, director, officer, employee or agent of the Company or the Managing Member, or is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the Person in connection with such action, suit or proceeding if the Person acted in good faith and in a manner the Person reasonably believed to be in or not opposed to the best interests of the Company, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the Person’s conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the Person did not act in good faith and in a manner which the Person reasonably believed to be in or not opposed to the best interests of the Company, and, with respect to any criminal action or proceeding, had reasonable cause to believe that the Person’s conduct was unlawful.

(b) Actions in the Right of the Company . The Company shall indemnify any Person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Company to procure a judgment in its favor by reason of the fact that the Person is or was a Member, director, officer, employee or agent of the Company or the Managing Member, or is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys’ fees) actually and reasonably incurred by the Person in connection with the defense or settlement of such action or suit if the Person acted in good faith and in a manner the Person reasonably believed to be in or not opposed to the best interests of the Company and except that no indemnification shall be made in respect of any claim, issue or matter as to which such Person shall have been adjudged to be liable to the Company unless and only to the extent that the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such Person is fairly and reasonably entitled to indemnity or such expenses which such court shall deem proper.

(c) Authorization . Any indemnification under subsections (a) and (b) of this section (unless ordered by a court) shall be made by the Company only as authorized in the specific case upon a determination that indemnification of the present or former Member, director, officer, employee or agent is proper in the circumstances because the Person has met the applicable standard of conduct set forth in subsections (a) and (b) of

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this section. Such determination shall be made in the sole and absolute discretion of the Managing Member.

(d) In Advance of Final Disposition . Expenses (including attorneys’ fees) incurred by a Person entitled to indemnification hereunder in defending any civil, criminal, administrative or investigative action, suit or proceeding may be paid by the Company in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such Person to repay such amount if it shall ultimately be determined that such Person is not entitled to be indemnified by the Company as authorized in this section. Such expenses (including attorneys’ fees) incurred by such Persons may be so paid upon such terms and conditions, if any, as the Managing Member deems appropriate.

(e) Non-Exclusive Section . The indemnification and advancement of expenses provided by, or granted pursuant to, this Agreement shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any agreement, or otherwise, both as to action in such Person’s official capacity and as to action in another capacity while holding such office.

(f) Insurance . The Company shall have power to purchase and maintain insurance on behalf of any Person who is or was a Member, director, officer, employee or agent of the Company, or is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against such Person and incurred by such Person in any such capacity, or arising out of such Person’s status as such, whether or not the Company would have the power to indemnify such Person against such liability under this section.

(g) Merger and Consolidation; Other Enterprises . For purposes of this section, references to “the Company” shall include, in addition to the resulting entity, any constituent entity (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its members, directors, officers, and employees or agents, so that any person who is or was a Member, director, officer, employee, or agent of such constituent entity, or is or was serving at the request of such constituent entity as a director, officer, employee or agent of another corporation, partnership, joint venture trust or other enterprise, shall stand in the same position under this section with respect to the resulting or surviving corporation as such Person would have with respect to such constituent entity if its separate existence had continued. For purposes of this section, references to “other enterprises” shall include employee benefit plans; references to “fines” shall include any excise taxes assessed on a Person with respect to any employee benefit plan; and references to “serving at the request of the Company” shall include any service as a Member, director, officer, employee or agent of the Company which imposes duties on, or involves services by, such Member, director, officer, employee, or agent with respect to an employee benefit plan, its participants or beneficiaries; and a Person who acted in good faith and in a manner such Person reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed

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to have acted in a manner “not opposed to the best interests of the Company” as referred to in this section.

(h) Continuation . The indemnification and advancement of expenses provided by, or granted pursuant to, this section shall, unless otherwise provided when authorized or ratified, continue as to a Person who has ceased to be a Member, director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a Person.

(i) Interested Transactions . A Person entitled to indemnification hereunder shall not be denied indemnification in whole or in part under this Section 7.7 because the Indemnitee had an interest in the transaction with respect to which the indemnification applies if the transaction was otherwise permitted by the terms of this Agreement.

(j) Binding Effect . The provisions of this Section 7.7 are for the benefit of the Indemnitees, their heirs, successors, assigns and administrators and shall not be deemed to create any rights for the benefit of any other Persons. Any amendment, modification or repeal of this Section 7.7 or any provision hereof shall be prospective only and shall not in any way affect the limitations on the Company’s liability to any Indemnitee under this Section 7.7 as in effect immediately prior to such amendment, modification or repeal with respect to claims arising from or relating to matters occurring, in whole or in part, prior to such amendment, modification or repeal, regardless of when such claims may arise or be asserted.

(k) Reimbursements to Managing Member Shall Not Be Treated As Distributions . If and to the extent any reimbursements to the Managing Member pursuant to this Section 7.7 constitute gross income of the Managing Member (as opposed to the repayment of advances made by the Managing Member on behalf of the Company) such amounts shall constitute guaranteed payments within the meaning of Section 707(c) of the Code, shall be treated consistently therewith by the Company and all Members, and shall not be treated as distributions for purposes of computing the Members’ Capital Accounts.

Section 7.8 Liability of the Managing Member .

(a) General . Notwithstanding anything to the contrary set forth in this Agreement, the Managing Member shall not be liable for monetary damages to the Company, any Members or any Assignees for losses sustained or liabilities incurred as a result of errors in judgment or of any act or omission, unless (i) the Managing Member actually received an improper benefit in money, property or services (in which case, such liability shall be for the amount of the benefit in money, property or services actually received), or (ii) the Managing Member’s action or failure to act was the result of active and deliberate dishonesty, gross negligence or bad faith and was material to the cause of action being adjudicated; provided , however , that the Managing Member shall owe the same duty of care to the Non-Managing Members as its directors owe to the Shareholders of the Managing Member.

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(b) No Obligation to Consider Interests of Non-Managing Members . The Non-Managing Members expressly acknowledge that the Managing Member is acting on behalf of the Company, the Non-Managing Members and the Managing Member’s shareholders collectively, that, except as otherwise provided in Section 7.8(a) , the Managing Member is under no obligation to give priority to the separate interests of the Managing Member’s shareholders or the Non-Managing Members (including, without limitation, the tax consequences to Non-Managing Members or Assignees) in deciding whether to cause the Company to take (or decline to take) any actions which the Managing Member has undertaken in good faith on behalf of the Company. If there is a conflict between the interests of the Managing Member’s shareholders on the one hand and the interests of the Non-Managing Members on the other, the Managing Member will endeavor in good faith to resolve the conflict in a manner not adverse to either the Managing Member’s shareholders or the Non-Managing Members; provided, however, that for so long as the Managing Member owns a controlling interest in the Company, any conflict that cannot be resolved in a manner not adverse to either the Managing Member’s shareholders or the Non-Managing Members will be resolved in favor of the Managing Member’s shareholders. The Managing Member shall not be liable for monetary damages for losses sustained, liabilities incurred, or benefits not derived by Non-Managing Members in connection with such decisions with respect to causing the Company to take (or decline to take) any actions which the Managing Member has undertaken in good faith on behalf of the Company, unless (i) the Managing Member actually received an improper benefit in money, property or services (in which case, such liability shall be for the amount of the benefit in money, property or services actually received), or (ii) the Managing Member’s action or failure to act was the result of active and deliberate dishonesty, gross negligence or bad faith and was material to the cause of action being adjudicated.

(c) Acts of Agents . Subject to its obligations and duties as Managing Member set forth in Section 7.1(a) hereof, the Managing Member may exercise any of the powers granted to it by this Agreement and perform any of the duties imposed upon it hereunder either directly or by or through its agents. The Managing Member shall not be responsible for any misconduct or negligence on the part of any such agent appointed by it in good faith.

(d) Effect of Amendment . Any amendment, modification or repeal of this Section 7.8 or any provision hereof shall be prospective only and shall not in any way affect the limitations on the Managing Member’s liability to the Company and the Non-Managing Members under this Section 7.8 as in effect immediately prior to such amendment, modification or repeal with respect to claims arising from or relating to matters occurring, in whole or in part, prior to such amendment, modification or repeal, regardless of when such claims may arise or be asserted.

Section 7.9 Other Matters Concerning the Managing Member .

(a) Reliance on Documents . The Managing Member may rely and shall be protected in acting or refraining from acting upon any resolution, certificate, statement, instrument, opinion, report, notice, request, consent, order, bond, debenture, or other

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paper or document believed by it to be genuine and to have been signed or presented by the proper party or parties.

(b) Reliance on Consultants and Advisers . The Managing Member may consult with legal counsel, accountants, appraisers, management consultants, investment bankers and other consultants and advisers selected by it, and any act taken or omitted to be taken in reliance upon the opinion of such Persons as to matters which such Managing Member reasonably believes to be within such Person’s professional or expert competence shall be conclusively presumed to have been done or omitted in good faith and in accordance with such opinion.

(c) Action Through Officers and Attorneys . The Managing Member shall have the right, in respect of any of its powers or obligations hereunder, to act through any of its duly authorized officers and a duly appointed attorney or attorneys-in-fact. Each such attorney shall, to the extent provided by the Managing Member in the power of attorney, have full power and authority to do and perform all and every act and duty which is permitted or required to be done by the Managing Member hereunder.

(d) Action Related to Maintaining REIT Status . Notwithstanding any other provisions of this Agreement or any non-mandatory provision of the Act, any action of the Managing Member on behalf of the Company or any decision of the Managing Member to refrain from acting on behalf of the Company, undertaken in the good faith belief that such action or omission is necessary or advisable in order (i) to protect the ability of the Managing Member, for so long as the Managing Member has determined to qualify as a REIT, to continue to qualify as a REIT or (ii) to avoid the Managing Member incurring any taxes under Section 857 or Section 4981 of the Code, is expressly authorized under this Agreement and is deemed approved by all of the Members.

Section 7.10 Title to Company Assets . Company assets, whether real, personal or mixed and whether tangible or intangible, shall be deemed to be owned by the Company as an entity, and no Member, individually or collectively, shall have any ownership interest in such Company assets or any portion thereof. Title to any or all of the Company assets may be held in the name of the Company, the Managing Member or one or more nominees, as the Managing Member may determine, including Affiliates of the Managing Member. The Managing Member hereby covenants, declares and warrants that any Company assets as to which legal title is held in the name of the Managing Member or any nominee or Affiliate of the Managing Member shall be held by the Managing Member or such nominee or Affiliate for the exclusive use and benefit of the Company in accordance with the provisions of this Agreement; provided , however , that the Managing Member shall use its best efforts to cause beneficial and record title to such assets to be vested in the Company as soon as reasonably practicable. All Company assets shall be recorded as the property of the Company in its books and records, irrespective of the name in which legal title to such Company assets is held.

Section 7.11 Reliance by Third Parties . Notwithstanding anything to the contrary in this Agreement, any Person dealing with the Company shall be entitled to assume that the Managing Member has full power and authority to encumber, sell or otherwise use in any manner any and all assets of the Company and to enter into any contracts on behalf of the

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Company, and such Person shall be entitled to deal with the Managing Member as if it were the Company’s sole party in interest, both legally and beneficially. Each Non-Managing Member hereby waives any and all defenses or other remedies which may be available against such Person to contest, negate or disaffirm any action of the Managing Member in connection with any such dealing. In no event shall any Person dealing with the Managing Member or its representatives be obligated to ascertain that the terms of this Agreement have been complied with or to inquire into the necessity or expedience of any act or action of the Managing Member or its representatives. Each and every certificate, document or other instrument executed on behalf of the Company by the Managing Member or its representatives shall be conclusive evidence in favor of any and every Person relying thereon or claiming thereunder that (a) at the time of the execution and delivery of such certificate, document or instrument, this Agreement was in full force and effect, (b) the Person executing and delivering such certificate, document or instrument was duly authorized and empowered to do so for and on behalf of the Company and (c) such certificate, document or instrument was duly executed and delivered in accordance with the terms and provisions of this Agreement and is binding upon the Company.

ARTICLE VIII

RIGHTS AND OBLIGATIONS OF NON-MANAGING MEMBERS

Section 8.1 Limitation of Liability . The Non-Managing Members shall have no liability under this Agreement except as expressly provided in this Agreement, including Section 10.5 hereof, or under the Act.

Section 8.2 Management of Business . No Non-Managing Member or Assignee (other than the Managing Member, any of its Affiliates or any officer, director, employee, member or agent of the Managing Member, the Company or any of their Affiliates, in their capacity as such) shall take part in the operation, management or control (within the meaning of the Act) of the Company’s business, transact any business in the Company’s name or have the power to sign documents for or otherwise bind the Company. The transaction of any such business by the Managing Member, any of its Affiliates or any officer, director, employee, member or agent or trustee of the Managing Member, the Company or any of their Affiliates, in their capacity as such, shall not affect, impair or eliminate the limitations on the liability of the Non-Managing Members or Assignees under this Agreement.

Section 8.3 Outside Activities of Non-Managing Members . Subject to any agreements entered into pursuant to Section 7.6 hereof and subject to any other agreements entered into by a Non-Managing Member or its Affiliates with the Managing Member, the Company or a Subsidiary, the following rights shall govern outside activities of Non-Managing Members: (a) any Non-Managing Member (other than the Managing Member) and any officer, director, employee, agent, trustee, Affiliate or shareholder of any Non-Managing Member shall be entitled to and may have business interests and engage in business activities in addition to those relating to the Company, including business interests and activities in direct competition with the Company; (b) neither the Company nor any Members shall have any rights by virtue of this Agreement in any business ventures of any Non-Managing Member or Assignee; (c) none of the Non-Managing Members (in their capacities as Non-Managing Members) nor any other Person shall have any rights by virtue of this Agreement or the Company relationship established hereby in any business ventures of any other Person, other than the Managing Member, and such Person

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shall have no obligation pursuant to this Agreement to offer any interest in any such business ventures to the Company, any Non-Managing Member or any such other Person, even if such opportunity is of a character which, if presented to the Company, any Non-Managing Member or such other Person, could be taken by such Person; (d) the fact that a Non-Managing Member may encounter opportunities to purchase, otherwise acquire, lease, sell or otherwise dispose of real or personal property and may take advantage of such opportunities himself or introduce such opportunities to entities in which it has or has not any interest, shall not subject such Member to liability to the Company or any of the other Members on account of the lost opportunity; and (e) except as otherwise specifically provided herein, nothing contained in this Agreement shall be deemed to prohibit a Non-Managing Member or any Affiliate of a Non-Managing Member from dealing, or otherwise engaging in business, with Persons transacting business with the Company or from providing services relating to the purchase, sale, rental, management or operation of real or personal property (including real estate brokerage services) and receiving compensation therefor, from any Persons who have transacted business with the Company or other third parties. Nothing in this Section 8.3 is intended to alter any fiduciary obligations of any Person under applicable Delaware law.

Section 8.4 Return of Capital and Priority Among Members . Except pursuant to the Redemption Rights set forth in Section 4.2(e) hereof, no Member shall be entitled to the withdrawal or return of his or her Capital Contribution, except to the extent of distributions made pursuant to this Agreement or upon termination of the Company as provided herein. No Member or Assignee shall have priority over any other Member or Assignee either as to the return of Capital Contributions or otherwise unless expressly provided in this Agreement, as to profits, losses, distributions or credits.

Section 8.5 Rights of Non-Managing Members Relating to the Company .

(a) Copies of Business Records . In addition to other rights provided by this Agreement or by the Act, and except as limited by Section 8.5(c) hereof, each Non-Managing Member shall have the right, for a purpose reasonably related to such Non-Managing Member’s interest as a Non-Managing Member in the Company, upon written demand with a statement of the purpose of such demand and at such Non-Managing Member’s own expense:

(1) to obtain a copy of the most recent annual and quarterly reports filed with the Securities and Exchange Commission by the Managing Member pursuant to the Exchange Act, and each communication sent to all of the stockholders of the Managing Member;

(2) to obtain a copy of the Company’s Federal, state and local income tax returns for each Membership Year;

(3) to obtain a current list of the name and last known business, residence or mailing address of each Member;

(4) to obtain a copy of this Agreement and the Certificate and all amendments thereto, together with executed copies of all powers of attorney

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pursuant to which this Agreement, the Certificate and all amendments thereto have been executed; and

(5) to obtain true and full information regarding the amount of cash and a description and statement of any other property or services contributed by each Member and which each Member has agreed to contribute in the future, and the date on which each became a Member.

(b) Notification of Changes in Unit Adjustment Factor . The Company shall notify each Non-Managing Member in writing of any change made to the Unit Adjustment Factor within 10 Business Days of the date such change becomes effective.

(c) Confidential Information . Notwithstanding any other provision of this Section 8.5 , the Managing Member may keep confidential from the Non-Managing Members, for such period of time as the Managing Member determines in its sole and absolute discretion to be reasonable, any Company information that (i) the Managing Member believes to be in the nature of trade secrets or other information the disclosure of which the Managing Member in good faith believes is not in the best interests of the Company or (ii) the Company is required by law or by agreements with unaffiliated third parties to keep confidential.

(d) Debt Allocation . The Managing Member may allow (but shall not be required to allow) any Non-Managing Member to guarantee on a “bottom dollar basis,” an amount of indebtedness of the Company or any successor thereto, as is necessary from time to time to provide an allocation of debt to such Non-Managing Member equal to the amount of debt then required to be allocated to such Non-Managing Member to enable such Non-Managing Member to avoid recognizing gain pursuant to Section 731(a)(1) of the Code as a result of a deemed distribution of money to such Non-Managing Member pursuant to Section 752(b) of the Code. The Managing Member may, in its discretion, permit other Non-Managing Members to provide similar guarantees from time to time or as a result of minimum gain chargebacks.

(e) Notice for Certain Transactions . In the event of (a) a dissolution or liquidation of the Company or the Managing Member, (b) a merger, consolidation or combination of the Company or the Managing Member with or into another Person (including the events set forth in Sections 11.2(c) and 11.2(d) ), (c) the sale of all or substantially all of the assets of the Company or the Managing Member, or (d) the transfer by the Managing Member of all or any part of its interest in the Company, the Managing Member shall give written notice thereof to each Non-Managing Member at least twenty (20) Business Days prior to the effective date or, to the extent applicable, record date of such transaction, whichever comes first.

ARTICLE IX

BOOKS, RECORDS, ACCOUNTING AND REPORTS

Section 9.1 Records and Accounting . The Managing Member shall keep or cause to be kept at the principal office of the Company appropriate books and records with respect to the

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Company’s business, including, without limitation, all books and records necessary to provide to the Non-Managing Members any information, lists and copies of documents required to be provided pursuant to Section 9.3 hereof or required by the Act. Any records maintained by or on behalf of the Company in the regular course of its business may be kept on, or be in the form of, punch cards, magnetic tape, photographs, micrographics or any other information storage device; provided , however , that the records so maintained are convertible into clearly legible written form within a reasonable period of time. The books of the Company shall be maintained for financial purposes on an accrual basis in accordance with generally accepted accounting principles and for tax reporting purposes on the accrual basis.

Section 9.2 Fiscal Year . The fiscal year of the Company shall be the calendar year.

Section 9.3 Reports .

(a) Annual Reports . As soon as practicable, but in no event later than 120 days after the close of each Membership Year, or such earlier date that they are filed with the Securities and Exchange Commission, the Managing Member shall cause to be mailed to each Non-Managing Member as of the close of the Company Year, an annual report containing financial statements of the Company, or of the Managing Member if such statements are prepared solely on a consolidated basis with the Managing Member, for such Membership Year, presented in accordance with generally accepted accounting principles, such statements to be audited by a nationally recognized firm of independent public accountants selected by the Managing Member.

(b) Quarterly Reports . As soon as practicable, but in no event later than 60 days after the close of each calendar quarter (except the last calendar quarter of each year), or such earlier date that they are filed with the Securities and Exchange Commission, the Managing Member shall cause to be mailed to each Non-Managing Member as of the last day of the calendar quarter, a report containing unaudited financial statements of the Company, or of the Managing Member, if such statements are prepared solely on a consolidated basis with the Managing Member, and such other information as may be required by applicable law or regulation, or as the Managing Member determines to be appropriate.

ARTICLE X

TAX MATTERS

Section 10.1 Preparation of Tax Returns . The Managing Member shall arrange for the preparation and timely filing of all returns of Company income, gains, deductions, losses and other items required of the Company for Federal and state income tax purposes and shall use all reasonable efforts to furnish the tax information reasonably required by the Managing Member and the Non-Managing Members for Federal and state income tax reporting purposes within 60 days after the close of such taxable year. Each Non-Managing Member shall promptly provide the Managing Member with any information reasonably requested by the Managing Member relating to any Contributed Property contributed (directly or indirectly) by such Non-Managing Member to the Company.

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Section 10.2 Tax Elections . Except as otherwise provided herein, the Managing Member shall, in its sole and absolute discretion, determine whether to make any available election pursuant to the Code, except that the election under Section 754 of the Code in accordance with applicable regulations thereunder shall be made at the request of any Member. The Managing Member shall have the right to seek to revoke any such election (including without limitation, any election under Section 754 of the Code) upon the Managing Member’s determination in its sole and absolute discretion that such revocation is the best interests of the Members.

Section 10.3 Tax Matters Member .

(a) General . The Managing Member shall be the “tax matters Member” of the Company for Federal income tax purposes. Pursuant to Section 6223(c) of the Code, upon receipt of notice from the IRS of the beginning of an administrative proceeding with respect to the Company, the tax matters Member shall provide the Members notice of such receipt and shall furnish the IRS with the name, address and profit interest of each of the Non-Managing Members; provided , however , that such information is provided to the Company by the Non-Managing Members. The Non-Managing Members shall provide such information to the Company as the Managing Member shall reasonably request.

(b) Powers . The tax matters Member is authorized, but not required:

(1) to enter into any settlement with the IRS with respect to any administrative or judicial proceedings for the adjustment of Company items required to be taken into account by a Member for income tax purposes (such administrative proceedings being referred to as a “tax audit” and such judicial proceedings being referred to as “judicial review”), and in the settlement agreement the tax matters Member may expressly state that such agreement shall bind all Members, except that such settlement agreement shall not bind any Member (a) who (within the time prescribed pursuant to the Code and Regulations) files a statement with the IRS providing that the tax matters Member shall not have the authority to enter into a settlement agreement on behalf of such Member or (b) who is a “notice Member” (as defined in Section 6231 of the Code) or a member of a “notice group” (as defined in Section 6223(b)(2) of the Code);

(2) in the event that a notice of a final administrative adjustment at the Company level of any item required to be taken into account by a Member for tax purposes (a “final adjustment”) is mailed or otherwise given to the tax matters Member, to seek judicial review of such final adjustment, including the filing of a petition for readjustment with the Tax Court or the United States Claims Court, or the filing of a complaint for refund with the District Court of the United States for the district in which the Company’s principal place of business is located;

(3) to intervene in any action brought by any other Member for judicial review of a final adjustment;

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(4) to file a request for an administrative adjustment with the IRS at any time and, if any part of such request is not allowed by the IRS, to file an appropriate pleading (petition, complaint or other document) for judicial review with respect to such request;

(5) to enter into an agreement with the IRS to extend the period for assessing any tax which is attributable to any item required to be taken into account by a Member for tax purposes, or an item affected by such item; and

(6) to take any other action on behalf of the Members of the Company in connection with any tax audit or judicial review proceeding to the extent permitted by applicable law or regulations.

The taking of any action and the incurring of any expense by the tax matters Member in connection with any such proceeding, except to the extent required by law, is a matter in the sole and absolute discretion of the tax matters Member, and the provisions relating to indemnification of the Managing Member set forth in Section 7.7 of this Agreement shall be fully applicable to the tax matters Member in its capacity as such.

(c) The tax matters Member shall, upon the request of any Member, provide such Member with copies of any tax returns, elections or any returns or documents to be filed with the IRS at least ten Business Days prior to the date such filing is required.

(d) Reimbursement . The tax matters Member shall receive no compensation for its services. All third-party costs and expenses incurred by the tax matters Member in performing its duties as such (including legal and accounting fees) shall be borne by the Company. Nothing herein shall be construed to restrict the Company from engaging an accounting firm and a law firm to assist the tax matters Member in discharging its duties hereunder, so long as the compensation paid by the Company for such services is reasonable.

Section 10.4 Organizational Expenses . The Company shall elect to deduct expenses, if any, incurred by it in organizing the Company ratably over a 60-month period as provided in Section 709 of the Code.

Section 10.5 Withholding . Each Non-Managing Member hereby authorizes the Company to withhold from or pay on behalf of or with respect to such Non-Managing Member any amount of Federal, state, local, or foreign taxes that the Managing Member determines that the Company is required to withhold or pay with respect to any amount distributable or allocable to such Non-Managing Member pursuant to this Agreement, including, without limitation, any taxes required to be withheld or paid by the Company pursuant to Section 1441, 1442, 1445 or 1446 of the Code. Any amount paid on behalf of or with respect to a Non-Managing Member shall constitute a loan by the Company to such Non-Managing Member, which loan shall be repaid by such Non-Managing Member within 15 days after notice from the Managing Member that such payment must be made unless (a) the Company withholds such payment from a distribution which would otherwise be made to the Non-Managing Member or (b) the Managing Member determines, in its sole and absolute discretion, that such payment may be satisfied out of

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the available funds of the Company which would, but for such payment, be distributed to the Non-Managing Member. Any amounts withheld pursuant to the foregoing clauses (a) or (b) shall be treated as having been distributed to such Non-Managing Member. Each Non-Managing Member hereby unconditionally and irrevocably grants to the Company a security interest in such Non-Managing Member’s Membership Interest to secure such Non-Managing Member’s obligation to pay to the Company any amounts required to be paid pursuant to this Section 10.5 . In the event that a Non-Managing Member fails to pay any amounts owed to the Company pursuant to this Section 10.5 when due, the Managing Member may, in its sole and absolute discretion, elect to make the payment to the Company on behalf of such defaulting Non-Managing Member, and in such event shall be deemed to have loaned such amount to such defaulting Non-Managing Member and shall succeed to all rights and remedies of the Company as against such defaulting Non-Managing Member (including, without limitation, the right to receive distributions). Any amounts payable by a Non-Managing Member hereunder shall bear interest at the base rate on corporate loans at large United States money center commercial banks, as published from time to time in the Wall Street Journal , plus four percentage points (but not higher than the maximum lawful rate) from the date such amount is due ( i.e. , 15 days after demand) until such amount is paid in full. Each Non-Managing Member shall take such actions as the Company or the Managing Member shall request in order to perfect or enforce the security interest created hereunder.

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ARTICLE XI

TRANSFERS AND WITHDRAWALS

Section 11.1 Transfer .

(a) Definition . The term “transfer,” when used in this Article XI with respect to a Membership Unit, shall be deemed to refer to a transaction by which the Managing Member purports to assign its Managing Membership Interest to another Person or by which a Non-Managing Member purports to assign its Non-Managing Membership Interest to another Person, and includes a sale, assignment, gift, pledge, encumbrance, hypothecation, mortgage, exchange or any other disposition by law or otherwise.

(b) Requirements . No Membership Interest shall be transferred, in whole or in part, except in accordance with the terms and conditions set forth in this Article XI. Any transfer or purported transfer of a Membership Interest not made in accordance with this Article XI shall be null and void.

Section 11.2 Transfer of Managing Member’s Membership Interest .

(a) General . The Managing Member may not transfer any of its Managing Membership Interest or withdraw as Managing Member except as provided in Section 11.2(b) or in connection with a transaction described in either Section 11.2(c) or Section 11.2(e) .

(b) Transfer to Company . The Managing Member may transfer Membership Interests held by it to the Company in accordance with Section 7.5(b) hereof.

(c) Transfer in Connection With Reclassification, Recapitalization, or Business Combination Involving Managing Member . Except as otherwise provided in Section 11.2(d), the Managing Member shall not engage in any merger, consolidation or other business combination with or into another Person or sale of all or substantially all of its assets, or any reclassification, or recapitalization or change of outstanding Common Shares (other than a change in par value, or from par value to no par value, or as a result of a subdivision or combination as described in the definition of “Unit Adjustment Factor”) (“Transaction”), unless as a result of the Transaction each Non-Managing Member thereafter remains entitled to redeem each Membership Unit owned by such Non-Managing Member (after application of the Unit Adjustment Factor) 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 Transaction, if such Non-Managing Member had exercised its Redemption Right immediately prior to the Transaction, provided that if, in connection with the Transaction, a purchase, tender or exchange offer shall have been made to and accepted by the holders of more than 50 percent of the outstanding Common Shares, the holders of Membership Units shall receive the greatest amount of cash, securities, or other property which a Non-Managing Member would have received had it exercised the Redemption Right and received Common Shares in exchange for its Membership Units immediately prior to the expiration of such purchase, tender or exchange offer. In connection with any merger,

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consolidation or business combination described in this Section 11.2(c) in which Common Shares were exchanged for securities of the acquiring Person, the Non-Managing Members shall (unless Non-Managing Members Consent is obtained) remain entitled to exercise their Redemption Right with respect to such Person and the Unit Adjustment Factor shall continue to apply.

(d) Merger Involving Managing Member Where Surviving Entity’s Assets Contributed to Company . Notwithstanding Section 11.2(c) , the Managing Member may merge with another entity if, under the terms of the transaction, Non-Managing Members will not engage in a sale or exchange for Federal income tax purposes and immediately after such merger substantially all of the assets of the surviving entity, other than Membership Units held by the Managing Member, are contributed to the Company as a Capital Contribution in exchange for Membership Units with a fair market value equal to the 704(c) Value of the assets so contributed.

(e) Pledge of Membership Units by Managing Member . The Managing Member may (i) pledge its Managing Membership Interest as security for any obligations of the Company or the Managing Member under any credit facility that the Company may enter into from time to time, and (ii) transfer such Managing Membership Interest in the event of any foreclosure (or in lieu of any foreclosure) on such pledge.

Section 11.3 Non-Managing Members’ Rights to Transfer .

(a) General . Prior to twelve (12) months after the closing of the initial public offering of Common Shares, no Non-Managing Member shall transfer all or any portion of its Membership Interests to any transferee without the consent of the Managing Member, which consent may be withheld in its sole and absolute discretion. After such twelve (12) month anniversary and subject to the remaining provisions of this Section 11.3 as well as Section 11.4 , a Non-Managing Member may transfer all or any portion of his Membership Interest, or any of such Non-Managing Member’s rights as a Non-Managing Member, without the prior written consent of the Managing Member. In order to effect such transfer, the Non-Managing Member must deliver to the Managing Member a duly executed copy of the instrument making such transfer and such instrument must evidence the written acceptance by the assignee of all of the terms and conditions of this Agreement and represent that such assignment was made in accordance with all applicable laws and regulations. Notwithstanding the foregoing, any transferee of any transferred Membership Interest shall be subject to any and all ownership limitations contained in the Charter. Unless admitted as a Non-Managing Member, no transferee, whether by a voluntary transfer, by operation of law or otherwise, shall have any rights hereunder, other than the rights of an Assignee as provided in Section 11.5 .

(b) Incapacitated Non-Managing Members . If a Non-Managing Member is subject to Incapacity, the executor, administrator, trustee, committee, guardian, conservator or receiver of such Non-Managing Member’s estate shall have all the rights of a Non-Managing Member, but not more rights than those enjoyed by other Non-Managing Members for the purpose of settling or managing the estate and such power as the Incapacitated Non-Managing Member possessed to transfer all or any part of his or its

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interest in the Company. The Incapacity of a Non-Managing Member, in and of itself, shall not dissolve or terminate the Company.

(c) Transfers Contrary to Securities Laws . The Managing Member may prohibit any transfer otherwise permitted under this Section 11.3 by a Non-Managing Member of its Membership Units if, in the opinion of legal counsel to the Company, such transfer would require filing of a registration statement under the Securities Act or would otherwise violate any Federal or state securities laws or regulations applicable to the Company or the Company Units.

(d) Publicly Traded Partnership Restrictions . No Member may assign or transfer any Membership Unit (or any portion thereof or interest therein) if such assignment or transfer would result in the sum of the percentage interests in Membership Units transferred during the Company’s taxable year exceeding two percent (2%) of the total Membership Units of the Company. Notwithstanding the foregoing, the following transfers shall be disregarded in determining whether Membership Units in excess of two percent (2%) of the Membership Units have been transferred during the Company’s taxable year:

(1) transfers in which the tax basis of the Membership Unit in the hands of the transferee is determined, in whole or in part, by reference to the basis of the Membership Unit in the hands of the transferor or is determined under Section 732 of the Code;

(2) transfers at death, including transfers from an estate or testamentary trust;

(3) transfers between members of a family (for this purpose, including only brothers and sisters (whether by the whole or half blood), spouses, ancestors and lineal descendants);

(4) transfers involving the issuance of interests by (or on behalf of) the Company in exchange for cash, property or services;

(5) transfers involving distributions from a retirement plan qualified under Section 401(a) of the Code or an individual retirement account;

(6) transfers by a Member and any related persons (within the meaning of Section 267(b) or 707(b)(1) of the Code) in one or more transactions during any 30 calendar day period of Membership Units representing in the aggregate more than two percent (2%) of the total Membership Units;

(7) transfers by one or more Members of Membership Units representing in the aggregate 50 percent or more of the total Membership Units in one transaction or a series of related transactions; and

(8) transfers made pursuant to Section 4.2(e) that are made on a Non-Restricted Transfer Date.

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Any Member seeking to transfer or assign Membership Units pursuant to any of the foregoing disregarded transfers shall, prior to such transfer or assignment, deliver to the Company a certificate of a duly authorized officer of such Member setting forth the facts relating to such transfer or assignment and the basis for disregarding such transfer for these purposes. The Company shall, in the sole and absolute discretion of the Managing Member, determine whether to permit such transfer or assignment; provided , that any transfer that complies with any exception in Section 11.3(d)(1) through (d)(8) shall be permitted. Any attempted transfer or assignment in contravention of the provisions of this Section 11.3(d) or that is not permitted by the Managing Member pursuant to the preceding sentence shall be null and void ab initio, the purported transferor shall continue to be the Member for all purposes and the purported transferee shall not become a Member as a result of such purported transfer, and the Company shall in no event admit such purported transferee as a Member or otherwise recognize any rights of such purported transferee (including, without limitation, any right to receive distributions (directly or indirectly) or to acquire any interest in the capital or profits of the Company). Any Member seeking to transfer or assign Membership Units may request confirmation from the Company that such transfer or assignment is permissible under Section 11.3(a) or the first sentence of this Section 11.3(d) .

Section 11.4 Substituted Non-Managing Members .

(a) Consent of Managing Member Required . A Non-Managing Member shall have the right in its discretion to substitute a transferee as a Non-Managing Member in his place, in which event such substitution shall occur if the Non-Managing Member so provides; provided, however, that any transferee desiring to become a Substituted Non-Managing Member must furnish to the Managing Member (i) evidence of acceptance in form satisfactory to the Managing Member of all of the terms and conditions of this Agreement, including, without limitation, the power of attorney granted in Article XVI and (ii) such other documents or instruments as may be required in the reasonable discretion of the Managing Member in order to effect such Person’s admission as a Substituted Non-Managing Member.

(b) Rights and Duties of Substituted Non-Managing Members . A transferee who has been admitted as a Substituted Non-Managing Member in accordance with this Article XI shall have all the rights and powers and be subject to all the restrictions and liabilities of a Non-Managing Member under this Agreement.

(c) Amendment of Exhibit A . Upon the admission of a Substituted Non-Managing Member, the Managing Member shall amend Exhibit A to reflect the name, address, number of Membership Units, and Percentage Interest of such Substituted Non-Managing Member and to eliminate or adjust, if necessary, the name, address and interest of the predecessor of such Substituted Non-Managing Member.

Section 11.5 Assignees . If a Non-Managing Member, in its sole and absolute discretion, does not provide for the admission of any permitted transferee under Section 11.4(a) as a Substituted Non-Managing Member, as described in Section 11.4 , such transferee shall be considered an Assignee for purposes of this Agreement. An Assignee shall be entitled to all the rights of an assignee of a Non-Managing Membership Interest under the Act, including the right

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to receive distributions from the Company and the share of Net Income, Net Losses, gain, loss and Recapture Income attributable to the Company Units assigned to such transferee, but shall not be deemed to be a holder of Membership Units for any other purpose under this Agreement, and shall not be entitled to vote such Membership Units in any matter presented to the Non-Managing Members for a vote (such Membership Units being deemed to have been voted on such matter in the same proportion as all Membership Units held by Non-Managing Members are voted). In the event any such transferee desires to make a further assignment of any such Membership Units, such transferee shall be subject to all the provisions of this Article XI to the same extent and in the same manner as any Non-Managing Member desiring to make an assignment of Membership Units.

Section 11.6 General Provisions .

(a) Withdrawal of Non-Managing Member . No Non-Managing Member may withdraw from the Company other than as a result of (i) a permitted transfer of all of such Non-Managing Member’s Membership Units in accordance with this Article XI and the transferee of such Membership Units being admitted to the Company as a Substituted Non-Managing Member or (ii) pursuant to redemption or exchange of all of its Membership Units under Section 4.2(e) .

(b) Transfer of All Membership Units by Non-Managing Member . Any Non-Managing Member who shall transfer all of his Membership Units in a transfer permitted pursuant to this Article XI where the transferee was admitted as a Substituted Non-Managing Member or pursuant to the redemption or exchange of all of its Membership Units under Section 4.2(e) shall cease to be a Non-Managing Member.

(c) Timing of Transfers . Transfers pursuant to this Article XI may only be made on the first day of a calendar month of the Company or on a Non-Restricted Transfer Date, unless the Managing Member otherwise agrees.

(d) Allocation When Transfer Occurs . If any Membership Interest is transferred during any quarterly segment of the Company’s fiscal year in compliance with the provisions of this Article XI or redeemed or converted pursuant to Section 4.2(e) , Net Income, Net Losses, each item thereof and all other items attributable to such interest for such fiscal year shall be divided and allocated between the transferor Member and the transferee Member in accordance with the method determined by the Managing Member, provided that such method shall be permissible under Section 706(d) of the Code and the regulations issued thereunder. Solely for purposes of making such allocations, each of such items for the calendar month in which the transfer or redemption occurs shall be allocated to the Person who is a Member as of midnight on the last day of said month. All distributions of Available Cash with respect to which the Membership Record Date is before the date of such transfer or redemption shall be made to the transferor Member, and all distributions of Available Cash with Membership Record Dates thereafter shall be made to the transferee Member.

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ARTICLE XII

ADMISSION OF MEMBERS

Section 12.1 Admission of Successor Managing Member . A successor to all of the Managing Member’s Managing Membership Interest pursuant to Section 11.2 hereof who is proposed to be admitted as a successor Managing Member shall be admitted to the Company as the Managing Member, effective upon such transfer. Any such transferee shall carry on the business of the Company without dissolution. In each case, the admission shall be subject to the successor Managing Member executing and delivering to the Company an acceptance of all of the terms and conditions of this Agreement and such other documents or instruments as may be required to effect the admission.

Section 12.2 Admission of Additional Non-Managing Members .

(a) General . A Person who makes a Capital Contribution to the Company in accordance with this Agreement or who exercises an option to receive Membership Units shall be admitted to the Company as an Additional Non-Managing Member only upon furnishing to the Managing Member (i) evidence of acceptance in form reasonably satisfactory to the Managing Member of all of the terms and conditions of this Agreement, including, without limitation, the power of attorney granted in Article XVI hereof and (ii) such other documents or instruments as may be required in the reasonable discretion of the Managing Member in order to effect such Person’s admission as an Additional Non-Managing Member.

(b) Consent of Managing Member Required . Notwithstanding anything to the contrary in this Section 12.2 , no Person shall be admitted as an Additional Non-Managing Member without the consent of the Managing Member, which consent may be given or withheld in the Managing Member’s sole and absolute discretion. The admission of any Person as an Additional Non-Managing Member shall become effective on the date upon which the name of such Person is recorded on the books and records of the Company, following the consent of the Managing Member to such admission.

Section 12.3 Amendment of Agreement and Certificate . For the admission to the Company of any Member, the Managing Member shall take all steps necessary and appropriate under the Act to amend the records of the Company and, if necessary, to prepare as soon as practical an amendment of this Agreement (including an amendment of Exhibit A ) and, if required by law, shall prepare and file an amendment to the Certificate and may for this purpose exercise the power of attorney granted pursuant to Article XVI hereof.

ARTICLE XIII

DISSOLUTION AND LIQUIDATION

Section 13.1 Dissolution . The Company shall not be dissolved by the admission of Substituted Non-Managing Members or Additional Non-Managing Members or by the admission of a successor Managing Member in accordance with the terms of this Agreement. The Company shall dissolve, and its affairs shall be wound up, upon the first to occur of any of the following (“ Events of Dissolution ”):

(a) Withdrawal of Managing Member —an event of withdrawal of the Managing Member, as defined in the Act, unless, within 90 days after the withdrawal all the remaining Members agree in writing to continue the business of the Company and to the appointment, effective as of the date of withdrawal, of a substitute Managing Member;

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(b) Voluntary Dissolution —from and after the date of this Agreement, with the Consent of a majority of the Percentage Interests of the Non-Managing Members, an election to dissolve the Company made by the Managing Member, in its sole and absolute discretion;

(c) Judicial Dissolution Decree —entry of a decree of judicial dissolution of the Company pursuant to the provisions of the Act;

(d) Sale of Company’s Assets —the sale or disposition of all or substantially all of the assets and properties of the Company or a related series of transactions that, taken together, result in the sale or other disposition of all or substantially all of the assets of the Company;

(e) Bankruptcy or Insolvency of Managing Member—the Managing Member

(1) makes an assignment for the benefit of creditors;

(2) files a voluntary petition in bankruptcy;

(3) is adjudged a bankrupt or insolvent, or has entered against it an order for relief in any bankruptcy or insolvency proceeding;

(4) files a petition or answer seeking for itself any reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief under any statute, law or regulation;

(5) files an answer or other pleading admitting or failing to contest the material allegations of a petition filed against it in any proceeding of this nature; or

(6) seeks, consents to or acquiesces in the appointment of a trustee, receiver or liquidator of the Managing Member or of all or any substantial part of its properties; or

(f) Readjustment, etc . One hundred and twenty (120) days after the commencement of any proceeding against the Managing Member seeking reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief under any statute, law or regulation, the proceeding has not been dismissed, or if within 90 days after the appointment without the Managing Member’s consent or acquiescence of a trustee, receiver or liquidator of the Managing Member or of all or any substantial part of its properties, the appointment is not vacated or stayed, or within 90 days after the expiration of any such stay, the appointment is not vacated.

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Section 13.2 Winding Up .

(a) General . Upon the occurrence of an Event of Dissolution, the Company shall continue solely for the purposes of winding up its affairs in an orderly manner, liquidating its assets, and satisfying the claims of its creditors and Members. No Member shall take any action that is inconsistent with, or not necessary to or appropriate for, the winding up of the Company’s business and affairs. The Managing Member (or, in the event there is no remaining Managing Member, any Person elected by a majority in interest of the Non-Managing Members (the “ Liquidator ”)) shall be responsible for overseeing the winding up and dissolution of the Company and shall take full account of the Company’s liabilities and property and the Company property shall be liquidated as promptly as is consistent with obtaining the fair value thereof, and the proceeds therefrom (which may, to the extent determined by the Managing Member, include shares of stock in the Managing Member) shall be applied and distributed in the following order:

(1) First, to the payment and discharge of all of the Company’s debts and liabilities to creditors other than the Members;

(2) Second, to the payment and discharge of all of the Company’s debts and liabilities to the Members, pro rata in accordance with amounts owed to each such Member; and

(3) The balance, if any, to the Managing Member and Non-Managing Members in accordance with their Capital Accounts, after giving effect to all contributions, distributions, and allocations for all periods.

The Managing Member shall not receive any additional compensation for any services performed pursuant to this Article XIII other than reimbursement of its expenses as provided for in Section 7.4 .

(b) Where Immediate Sale of Company’s Assets Impractical . Notwithstanding the provisions of Section 13.2(a) hereof which require liquidation of the assets of the Company, but subject to the order of priorities set forth therein, if prior to or upon dissolution of the Company the Liquidator determines that an immediate sale of part or all of the Company’s assets would be impractical or would cause undue loss to the Members, the Liquidator may, in its sole and absolute discretion, defer for a reasonable time the liquidation of any assets except those necessary to satisfy liabilities of the Company (including to those Members as creditors) or, with the Consent of the Non-Managing Members holding a majority of the Non-Managing Membership Units, distribute to the Members, in lieu of cash, as tenants in common and in accordance with the provisions of Section 13.2(a) hereof, undivided interests in such Company assets as the Liquidator deems not suitable for liquidation. Any such distributions in kind shall be made only if, in the good faith judgment of the Liquidator, such distributions in kind are in the best interest of the Members, and shall be subject to such conditions relating to the disposition and management of such properties as the Liquidator deems reasonable and equitable and to any agreements governing the operation of such properties at such time.

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The Liquidator shall determine the fair market value of any property distributed in kind using such reasonable method of valuation as it may adopt.

Section 13.3 Capital Contribution Obligation . If any Member has a deficit balance in his or her Capital Account (after giving effect to all contributions, distributions and allocations for the taxable years, including the year during which such liquidation occurs), such Member shall have no obligation to make any contribution to the capital of the Company with respect to such deficit, and such deficit at any time shall not be considered a debt owed to the Company or to any other Person for any purpose whatsoever, except to the extent otherwise expressly agreed to by such Member and the Company.

Section 13.4 Compliance with Timing Requirements of Regulations; Allowance for Contingent or Unforeseen Liabilities or Obligations . Notwithstanding anything to the contrary in this Agreement, in the event the Company is “liquidated” within the meaning of Regulations Section 1.704-1(b)(2)(ii)(g), distributions shall be made pursuant to this Article XIII to the Managing Member and Non-Managing Members who have positive Capital Accounts in compliance with Regulations Section 1.704-1(b)(2)(ii)(b)(2) (including any timing requirements therein). In the discretion of the Managing Member, a pro rata portion of the distributions that would otherwise be made to the Managing Member and Non-Managing Members pursuant to this Article XIII may be: (i) distributed to a liquidating trust established for the benefit of the Managing Member and Non-Managing Members for the purposes of liquidating Company assets, collecting amounts owed to the Company, and paying any contingent or unforeseen liabilities or obligations of the Company or of the Managing Member arising out of or in connection with the Company (the assets of any such trust shall be distributed to the Managing Member and Non-Managing Members from time to time, in the reasonable discretion of the Managing Member, in the same proportions as the amount distributed to such trust by the Company would otherwise have been distributed to the Managing Member and Non-Managing Members pursuant to this Agreement); or (ii) withheld or escrowed to provide a reasonable reserve for Company liabilities (contingent or otherwise) and to reflect the unrealized portion of any installment obligations owed to the Company, provided that such withheld or escrowed amounts shall be distributed to the Managing Member and Non-Managing Members in the manner and priority set forth in Section 13.2(a) as soon as practicable.

Section 13.5 Other Events . Notwithstanding any other provision of this Article XIII, in the event the Company is liquidated within the meaning of Regulations Section 1.704-1(b)(2)(ii)(g) but no Event of Dissolution has occurred, the Company’s property shall not be liquidated, the Company’s liabilities shall not be paid or discharged, and the Company’s affairs shall not be wound up. Instead, for federal income tax purposes the Company shall be deemed to have contributed all of its assets and liabilities to a new limited liability company in exchange for an interest in the new limited liability company and, immediately thereafter, the terminated Company shall be deemed to distribute interests in the new Company to the Managing Member and Non-Managing Members in proportion to their respective Membership Interests in liquidation of the terminated Company.

Section 13.6 Rights of Non-Managing Members . Except as specifically provided in this Agreement, each Non-Managing Member shall look solely to the assets of the Company for the return of his Capital Contribution and shall have no right or power to demand or receive

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property other than cash from the Company. Except as specifically provided in this Agreement, no Non-Managing Member shall have priority over any other Non-Managing Member as to the return of his Capital Contributions, distributions, or allocations.

Section 13.7 Notice of Dissolution . In the event an Event of Dissolution or an event occurs that would, but for provisions of Section 13.1 , result in a dissolution of the Company, the Managing Member shall, within 30 days thereafter, provide written notice thereof to each of the Members and to all other parties with whom the Company regularly conducts business (as determined in the discretion of the Managing Member) and shall publish notice thereof in a newspaper of general circulation in each place in which the Company regularly conducts business (as determined in the discretion of the Managing Member).

Section 13.8 Cancellation of Certificate . Upon the completion of the liquidation of the Company as provided in Section 13.2 hereof, the Company shall be terminated and the Certificate and all qualifications of the Company as a foreign limited liability company in jurisdictions other than the State of Delaware shall be canceled and such other actions as may be necessary to terminate the Company shall be taken.

Section 13.9 Reasonable Time for Winding-Up . A reasonable time shall be allowed for the orderly winding-up of the business and affairs of the Company and the liquidation of its assets pursuant to Section 13.2 hereof, in order to minimize any losses otherwise attendant upon such winding-up, and the provisions of this Agreement shall remain in effect between the Members during the period of liquidation.

ARTICLE XIV

AMENDMENT OF AGREEMENT; MEETINGS

Section 14.1 Amendments .

(a) General . Amendments to this Agreement may be proposed by the Managing Member or by any Non-Managing Members holding 25 percent or more in the aggregate of the Membership Interests held by all Non-Managing Members. Following such proposal, the Managing Member shall submit any proposed amendment to the Non-Managing Members. The Managing Member shall seek the written vote of the Members on the proposed amendment or shall call a meeting to vote thereon and to transact any other business that it may deem appropriate. For purposes of obtaining a written consent, the Managing Member may require a response within a reasonable specified time, but not less than 15 days, and failure to respond in such time period shall constitute a consent which is consistent with the Managing Member’s recommendation (if so recommended) with respect to the proposal; provided, that, an action shall become effective at such time as requisite consents are received even if prior to such specified time. Except as provided in Section 14.1(b) , 14.1(c) or 14.1(d) , a proposed amendment shall be adopted and be effective as an amendment hereto if it is approved by the Managing Member and it receives the Consent of Non-Managing Members holding a majority of the Percentage Interests of the Non-Managing Members.

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(b) Managing Member’s Power to Amend . Notwithstanding Section 14.1(a) , the Managing Member shall have the power, without the consent of the Non-Managing Members, to amend this Agreement as may be required to facilitate or implement any of the following purposes:

(1) to add to the obligations of the Managing Member or surrender for the benefit of the Non-Managing Members any right or power granted to the Managing Member or any Affiliate of the Managing Member;

(2) to reflect the issuance of additional Membership Interests or the admission, substitution, termination, or withdrawal of Members in accordance with this Agreement;

(3) to set forth the rights, powers, duties, and preferences of the holders of any additional Membership Interests issued pursuant to Section 4.2(b) hereof;

(4) to reflect a change that is of an inconsequential nature and does not adversely affect the Non-Managing Members in any material respect, or to cure any ambiguity, correct or supplement any provision in this Agreement not inconsistent with law or with other provisions;

(5) to 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;

(6) to reflect such changes as are reasonably necessary for the Managing Member to maintain its status as a REIT, including changes which may be necessitated due to a change in applicable law (or an authoritative interpretation thereof) or a ruling of the IRS; and

(7) to modify the manner in which Capital Accounts are computed as set forth in Section 4.4(e) .

The Managing Member will provide notice to the Non-Managing Members when any action under this Section 14.1(b) is taken.

(c) Consent of Adversely Affected Member Required . Notwithstanding Section 14.1(a) and Section 14.1(b) hereof, this Agreement shall not be amended without the Consent of each Member adversely affected if such amendment would (i) convert a Non-Managing Member’s interest in the Company into a Managing Member’s interest (except as a result of the Managing Member acquiring such interest), (ii) modify the limited liability of a Non-Managing Member, (iii) alter rights of the Member to receive distributions pursuant to Article V, or the allocations specified in Article VI (except as permitted pursuant to Section 4.2 and Section 14.1(b)(3) hereof), (iv) alter or modify the Redemption Right as set forth in Sections 4.2(e) and 11.2(b) , and related definitions hereof, (v) cause the termination of the Company prior to the time set forth in Sections 2.5 or 13.1 or (vi) amend this Section 14.1(c) . Further, no amendment may alter the

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restrictions on the Managing Member’s authority set forth in Section 7.3 without the Consent specified in that section. This Section 14.1(c) does not require unanimous consent of all Members adversely affected unless the amendment is to be effective against all Members adversely affected.

(d) When Consent of Majority of Non-Managing Membership Interests Required. Notwithstanding Section 14.1(a) hereof, the Managing Member shall not amend Section 4.2(b), the second sentence of Section 7.1(a), Sections 7.5, 7.6, 7.8, 11.2, and 14.1(c), this Section 14.1(d) or Section 14.2 without the Consent of two-thirds of the Percentage Interests of the Non-Managing Members.

Meetings of the Members.

(a) General . Meetings of the Members may be called by the Managing Member and shall be called upon the receipt by the Managing Member of a written request by Non-Managing Members holding 25 percent or more of the Membership Interests. The call shall state the nature of the business to be transacted. Notice of any such meeting shall be given to all Members not less than seven days nor more than 30 days prior to the date of such meeting. Members may vote in person or by proxy at such meeting. Whenever the vote or Consent of Members is permitted or required under this Agreement, such vote or Consent may be given at a meeting of Members or may be given in accordance with the procedure prescribed in Section 14.1 hereof. Except as otherwise expressly provided in this Agreement, the Consent of holders of a majority of the Percentage Interests shall control.

(b) Informal Action . Any action required or permitted to be taken at a meeting of the Members may be taken without a meeting if a written Consent setting forth the action so taken is signed by a majority of the Percentage Interests of the Members (or such other percentage as is expressly required by this Agreement). Such Consent may be in one instrument or in several instruments, and shall have the same force and effect as a vote of a majority of the Percentage Interests of the Members (or such other percentage as is expressly required by this Agreement). Such Consent shall be filed with the Managing Member. An action so taken shall be deemed to have been taken at a meeting held on the effective date so certified.

(c) Proxies . Each Non-Managing Member may authorize any Person or Persons to act for him by proxy on all matters in which a Non-Managing Member is entitled to participate, including waiving notice of any meeting, or voting or participating at a meeting. Every proxy must be signed by the Non-Managing Member or his attorney-in-fact. No proxy shall be valid after the expiration of 11 months from the date thereof unless otherwise provided in the proxy. Every proxy shall be revocable at the pleasure of the Non-Managing Member executing it.

(d) Conduct of Meeting . Each meeting of Members shall be conducted by the Managing Member or such other Person as the Managing Member may appoint pursuant to such rules for the conduct of the meeting as the Managing Member or such other Person deems appropriate.

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ARTICLE XV

GENERAL PROVISIONS

Section 15.1 Addresses and Notice . All notices and demands under this Agreement shall be in writing, and may be either delivered personally (which shall include deliveries by courier), by telefax, telex or other wire transmission (with request for assurance of receipt in a manner appropriate with respect to communications of that type, provided that a confirmation copy is concurrently sent by a nationally recognized express courier for overnight delivery) or mailed, postage prepaid, by certified or registered mail, return receipt requested, directed to the parties at their respective addresses set forth on Exhibit A , as it may be amended from time to time, and, if to the Company, such notices and demands sent in the aforesaid manner must be delivered at its principal place of business set forth above. Unless delivered personally or by telefax, telex or other wire transmission as above (which shall be effective on the date of such delivery or transmission), any notice shall be deemed to have been made three (3) days following the date so mailed. Any party hereto may designate a different address to which notices and demands shall thereafter be directed by written notice given in the same manner and directed to the Company at its office hereinabove set forth.

Section 15.2 Titles and Captions . All article or section titles or captions in this Agreement are for convenience only. They shall not be deemed part of this Agreement and in no way define, limit, extend or describe the scope or intent of any provisions hereof. Except as specifically provided otherwise, references to “Articles” and “Sections” are to Articles and Sections of this Agreement.

Section 15.3 Pronouns and Plurals . Whenever the context may require, any pronoun used in this Agreement shall include the corresponding masculine, feminine or neuter forms, and the singular form of nouns, pronouns and verbs shall include the plural and vice versa.

Section 15.4 Further Action . The parties shall execute and deliver all documents, provide all information and take or refrain from taking action as may be necessary or appropriate to achieve the purposes of this Agreement.

Section 15.5 Binding Effect . This Agreement shall be binding upon and inure to the benefit of the parties hereto and their heirs, executors, administrators, successors, legal representatives and permitted assigns.

Section 15.6 Waiver of Partition . The Members hereby agree that the Company Properties are not and will not be suitable for partition. Accordingly, each of the Members hereby irrevocably waives any and all rights (if any) that it may have to maintain any action for partition of any of the Company Properties.

Section 15.7 Entire Agreement . This Agreement constitutes the entire agreement among the parties with respect to the matters contained herein; it supersedes any prior agreements or understandings among them and it may not be modified or amended in any manner other than pursuant to Article XIV.

Section 15.8 Securities Law Provisions . The Membership Units have not been registered under the Federal or state securities laws of any state and, therefore, may not be resold

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unless appropriate Federal and state securities laws, as well as the provisions of Article XI hereof, have been complied with.

Section 15.9 Remedies Not Exclusive . Any remedies herein contained for breaches of obligations hereunder shall not be deemed to be exclusive and shall not impair the right of any party to exercise any other right or remedy, whether for damages, injunction or otherwise.

Section 15.10 Time . Time is of the essence of this Agreement.

Section 15.11 Creditors . None of the provisions of this Agreement shall be for the benefit of, or shall be enforceable by, any creditor of the Company.

Section 15.12 Waiver . No failure by any party to insist upon the strict performance of any covenant, duty, agreement or condition of this Agreement or to exercise any right or remedy consequent upon a breach thereof shall constitute waiver of any such breach or any other covenant, duty, agreement or condition.

Section 15.13 Execution Counterparts . This Agreement may be executed in counterparts, all of which together shall constitute one agreement binding on all the parties hereto, notwithstanding that all such parties are not signatories to the original or the same counterpart. Each party shall become bound by this Agreement immediately upon affixing its signature hereto.

Section 15.14 Applicable Law . This Agreement shall be construed in accordance with and governed by the laws of the State of Delaware, without regard to the principles of conflicts of law.

Section 15.15 Invalidity of Provisions . If any provision of this Agreement is or becomes invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein shall not be affected thereby.

Section 15.16 No Rights as Stockholders . Nothing contained in this Agreement shall be construed as conferring upon the holders of Membership Units any rights whatsoever as stockholders of the Managing Member, including without limitation any right to receive dividends or other distributions made to stockholders of the Managing Member or to vote or to consent or to receive notice as stockholders in respect of any meeting of stockholders for the election of directors of the Managing Member or any other matter, except as may be provided in the Investors Agreement.

ARTICLE XVI

POWER OF ATTORNEY

Section 16.1 Power of Attorney .

(a) Scope . Each Non-Managing Member and each Assignee constitutes and appoints the Managing Member, any Liquidator, and authorized officers and attorneys-in-fact of each, and each of those acting singly, in each case with full power of

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substitution, as its true and lawful agent and attorney-in-fact, with full power and authority in its name, place and stead to:

(1) execute, swear to, acknowledge, deliver, publish, file and record in the appropriate public offices (a) all certificates, documents and other instruments (including, without limitation, this Agreement and the Certificate and all amendments or restatements thereof) that the Managing Member or the Liquidator deems appropriate or necessary to form, qualify or continue the existence or qualification of the Company as a limited liability company (or an entity in which the Non-Managing Members have limited liability) in the State of Delaware and in all other jurisdictions in which the Company may conduct business or own property; (b) all instruments that the Managing Member or any Liquidator deems appropriate or necessary to reflect any amendment, change, modification or restatement of this Agreement in accordance with its terms; (c) all conveyances and other instruments or documents that the Managing Member or any Liquidator deems appropriate or necessary to reflect the dissolution and liquidation of the Company pursuant to the terms of this Agreement, including, without limitation, a certificate of cancellation; (d) all instruments relating to the admission, withdrawal, removal or substitution of any Member pursuant to, or other events described in, Article XI, XII or XIII hereof or the Capital Contribution of any Member; and (e) all certificates, documents and other instruments relating to the determination of the rights, preferences and privileges of Membership Interests; and

(2) execute, swear to, acknowledge and file all ballots, consents, approvals, waivers, certificates and other instruments appropriate or necessary, in the sole and absolute discretion of the Managing Member, to make, evidence, give, confirm or ratify any vote, consent, approval, agreement or other action which is made or given by the Members hereunder or is consistent with the terms of this Agreement or appropriate or necessary, in the sole discretion of the Managing Member, to effectuate the terms or intent of this Agreement.

Nothing contained herein shall be construed as authorizing the Managing Member to amend this Agreement except in accordance with Article XIV hereof or as may be otherwise expressly provided for in this Agreement.

(b) Irrevocability . The foregoing power of attorney is hereby declared to be irrevocable and a power coupled with an interest, in recognition of the fact that each of the Members will be relying upon the power of the Managing Member to act as contemplated by this Agreement in any filing or other action by it on behalf of the Company, and it shall survive and not be affected by the subsequent Incapacity of any Non-Managing Member or Assignee and the transfer of all or any portion of such Non-Managing Member’s or Assignee’s Membership Units and shall extend to such Non-Managing Member’s or Assignee’s heirs, successors, assigns and personal representatives. Each such Non-Managing Member or Assignee hereby agrees to be bound by any representation made by the Managing Member, acting in good faith pursuant to such power of attorney; and each such Non-Managing Member or Assignee hereby waives any and all defenses which may be available to contest, negate or disaffirm the action of the Managing Member, taken in good faith under such power of attorney. Each Non-Managing Member or Assignee shall execute and deliver to the Managing Member or the Liquidator, within 15 days after receipt of the Managing Member’s request therefor, such further designation, powers of attorney and other instruments as the Managing Member or the Liquidator, as the case may be, deems necessary to effectuate this Agreement and the purposes of the Company.

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IN WITNESS WHEREOF, the parties hereto have executed this Limited Liability Company Agreement of Sunstone Hotel Partnership, LLC as of the date first written above.


Managing Member:

Sunstone Hotel Investors, Inc.

By:
		Name:
		Title:

Non-Managing Members:

Sunstone Hotel Investors, L.L.C.

By:
		Name:
		Title:

Sunstone/WB Hotel Investors, IV, LLC

By:
		Name:
		Title:

Sunstone/WB Manhattan Beach, LLC

By:
		Name:
		Title:

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WB Hotel Investors, LLC

By:
		Name:
		Title:

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EXHIBIT A

MEMBERS, CONTRIBUTIONS AND

MEMBERSHIP INTERESTS


Name and Address of Member	Cash Contribution		Agreed Value of Contributed Property		Membership Units	Percentage Interest
Managing Member:
Sunstone Hotel Investors, Inc. 903 Calle Amanecer, Suite 100, San Clemente, California 92673	$		$	0		%
Non-Managing Members:
Sunstone Hotel Investors, L.L.C. 903 Calle Amanecer, Suite 100, San Clemente, California 92673		0
Sunstone/WB Hotel Investors, IV, LLC 903 Calle Amanecer, Suite 100, San Clemente, California 92673		0
Sunstone/WB Manhattan Beach, LLC 903 Calle Amanecer, Suite 100, San Clemente, California 92673		0
WB Hotel Investors, LLC 903 Calle Amanecer, Suite 100, San Clemente, California 92673		0

Total	$		$			100	%

EXHIBIT B

VALUE OF CONTRIBUTED PROPERTY


Contributed Property		Basis		704(c) Value

EXHIBIT C

NOTICE OF REDEMPTION

The undersigned hereby irrevocably (a) elects to exercise its Redemption Right set forth in the Limited Liability Company Agreement of Sunstone Hotel Partnership, LLC (the “Agreement”; capitalized terms used and not otherwise defined herein shall have the meanings assigned to such terms in the Agreement), with respect to an aggregate of Membership Units, (b) surrenders such Membership Units and all right, title and interest therein, and (c) directs that the Cash Amount or Shares Amount (as determined by the Managing Member) deliverable upon exercise of the Redemption Right be delivered to the address specified below, and if Common Shares are to be delivered, such Common Shares be registered or placed in the name(s) and at the address(es) specified below.

Dated:

Name of Non-Managing Member:

(Signature of Non-Managing Member)

(Street Address)

(City) (State) (Zip Code)

Signature Guaranteed by:

If Common Shares are to be issued, issue to:

Please insert social security or identifying number:

Name:

Exhibit 10.12

CITIGROUP GLOBAL MARKETS INC.

CITICORP NORTH AMERICA, INC.

390 Greenwich Street

New York, New York 10013

MERRILL LYNCH, PIERCE,

FENNER & SMITH

INCORPORATED

4 World Financial Center North Tower New York, New York 10080

MORGAN STANLEY SENIOR

FUNDING, INC.

1585 Broadway

New York, New York 10036

September 14, 2004

S UNSTONE H OTEL I NVESTORS , L.L.C.

903 Calle Amanecer, Suite 100

San Clemente, California 92673

Attention: Jon D. Kline

Executive Vice President

and Chief Financial Officer

$150,000,000 Senior Secured Revolving Credit Facility

and $75,000,000 Subordinate Term Loan Facility

COMMITMENT LETTER

Ladies and Gentlemen:

Citicorp North America, Inc. (“ CNAI ”), Merrill Lynch Capital Corporation (“ MLCC ”) and Morgan Stanley Senior Funding, Inc. (“ Morgan Stanley ”; collectively with CNAI and MLCC, the “ Initial Lenders ”) are each pleased to inform Sunstone Hotel Investors, L.L.C. (“ Sunstone ”) of its several commitment to provide Sunstone Hotel Partnership, LLC (the “ Borrower ”) with 33 ² / 3 % of the full principal amount of (i) a $150,000,000 senior secured revolving credit facility (the “ Revolving Credit Facility ”) and (ii) a $75,000,000 subordinate term loan facility (the “ Term Loan Facility ”; collectively with the Revolving Credit Facility, the “ Facilities ”), subject to the terms and conditions of this letter and the attached Annexes I and II (collectively, and together with the Fee Letter referred to below, this “ Commitment Letter ”). Further, Citigroup Global Markets Inc. (“ CGMI ”), Merrill Lynch, Pierce, Fenner & Smith Incorporated (“ Merrill Lynch ”; collectively with CGMI and Morgan Stanley, the “ Co-Lead Arrangers ”) and Morgan Stanley are each pleased to inform Sunstone of its several commitment to act as joint lead arrangers and joint book running managers for the Facilities, subject to the terms and conditions of this Commitment Letter. Furthermore, CNAI is pleased to inform Sunstone of its commitment to act as administrative agent and collateral agent for the Facilities, subject to the terms and conditions of this Commitment Letter. The proceeds of the Facilities will be used for general corporate purposes of the Borrower, acquisitions, refinancing of certain existing mortgage indebtedness and payment of fees and expenses related to the Facility and the other transactions contemplated by the loan documents.

Section 1. Conditions Precedent . The commitments of the Initial Lenders and Co-Lead Arrangers (collectively, the “ Lender Parties ”) hereunder are subject to: (i) the preparation, execution and delivery of mutually acceptable loan documentation incorporating substantially the terms and conditions outlined in this Commitment Letter (the “ Operative Documents ”); (ii) the absence of (A) any material adverse change in the business, condition (financial or otherwise), operations or prospects, of the Borrower or the Borrower and its subsidiaries, taken as a whole since December 31, 2003, and (B) any circumstance, change or condition in the loan syndication, financial or capital markets generally that, in the judgment of the Co-Lead Arrangers, could reasonably be expected to materially impair syndication of the Facility; (iii) the accuracy and completeness of all representations that the Borrower makes to the Lender Parties and all information

that the Borrower or any of its affiliates furnishes to the Lender Parties; and (iv) compliance by Sunstone and the Borrower with the terms of this Commitment Letter, including, without limitation, the payment in full of all fees, expenses and other amounts payable under this Commitment Letter.

Section 2. Commitment Termination . The commitments of the Lender Parties hereunder will terminate on the earlier of (a) the date the Operative Documents become effective, and (b) December 31, 2004. Before such date, any Lender Party may terminate its commitment hereunder if any event occurs or information becomes available that, in the judgment of such Lender Party, results or is likely to result in the failure to satisfy any condition set forth in Section 1.

Section 3. Syndication . The Initial Lenders reserve the right, before or after the execution of the Operative Documents and any Advances thereunder, to syndicate all or a portion of their commitments to one or more other financial institutions, reasonably acceptable to the Borrower, that will become parties to the Operative Documents pursuant to a syndication to be managed by the Co-Lead Arrangers (the financial institutions becoming parties to the Operative Documents being collectively referred to herein as the “ Lenders” ), and the commitments of the Initial Lenders hereunder shall be reduced in a manner agreed to by the Co-Lead Arrangers as and when commitments are received from the Lenders. The Co-Lead Arrangers will manage all aspects of the syndication in consultation with Sunstone (or, if after the Closing, the Borrower), including the timing of all offers to potential Lenders, the determination of the amounts offered to potential Lenders, the acceptance of commitments of the Lenders and the compensation to be provided to the Lenders. Notwithstanding anything to the contrary, the Lender Parties will not launch a formal syndication of the Facilities prior to completion of an initial public offering of Sunstone Hotel Investors, Inc.

Sunstone shall take, and shall cause the Borrower to take, all action as the Co-Lead Arrangers may reasonably request to assist the Co-Lead Arrangers in forming a syndicate acceptable to the Co-Lead Arrangers. The assistance of Sunstone and the Borrower in forming such a syndicate shall include but not be limited to (i) making senior management and representatives of Sunstone and the Borrower available to participate in information meetings with potential Lenders at such times and places as the Co-Lead Arrangers may reasonably request; (ii) using the reasonable efforts of Sunstone and the Borrower to ensure that the syndication efforts benefit from the lending relationships of Sunstone and the Borrower; and (iii) providing the Co-Lead Arrangers with all information reasonably deemed necessary by it to successfully complete the syndication.

To ensure an effective syndication of the Facility, Sunstone agrees that until the earlier of (i) termination of the syndication (as determined by the Co-Lead Arrangers in consultation with Sunstone), and (ii) the 120 ^th day after the Closing, Sunstone will not, and will not permit the Borrower or any of its affiliates to, syndicate or issue, attempt to syndicate or issue, announce or authorize the announcement of the syndication or issuance of, or engage in discussions concerning the syndication or issuance of, any debt facility or debt security (including any renewals thereof), without the prior written consent of the Co-Lead Arrangers; provided, however , that the foregoing shall not limit the ability of Sunstone Hotel Investors, Inc. or the Borrower to issue commercial paper, equity or public debt securities or incur mortgage debt on properties other than the seven properties comprising collateral for the Revolving Credit Facility.

CNAI will act as the sole administrative agent and sole collateral agent for the Facilities and the Co-Lead Arrangers will act as the sole co-lead arrangers. No additional agents, co-agents or arrangers will be appointed, or other titles conferred, without the consent of the Lender Parties.

Section 4. Fees . In addition to the fees described in Annexes I and II, Sunstone shall pay, or cause the Borrower to pay, the non-refundable fees set forth in the letter agreement dated the date hereof (the “ Fee Letter ”) between Sunstone and the Lender Parties. The terms of the Fee Letter are an integral part of each Lender Party’s commitment hereunder and constitute part of this Commitment Letter for all purposes hereof.

Section 5. Indemnification . Sunstone shall indemnify and hold harmless, and shall cause the Borrower to indemnify and hold harmless, the Lender Parties, each Lender and each of their respective affiliates and each of their respective officers, directors, employees, agents, advisors and representatives (each, an “ Indemnified Party ”) from and against any and all claims, damages, losses, liabilities and expenses (including, without limitation, fees and disbursements of counsel), joint or several, that may be incurred by or asserted or awarded against any Indemnified Party (including, without limitation, in connection with any investigation, litigation or proceeding or the preparation of a defense in connection therewith), in each case arising out of or in connection with or by reason of this Commitment Letter or the Operative Documents or the transactions contemplated hereby or thereby or any actual or proposed use of the proceeds of the Facilities, except to the extent such claim, damage, loss, liability or expense is found in a final, non-appealable judgment by a court of competent jurisdiction to have resulted from such Indemnified Party’s gross negligence or willful misconduct. In the case of an investigation, litigation or other proceeding to which the indemnity in this paragraph applies, such indemnity shall be effective whether or not such investigation, litigation or proceeding is brought by Sunstone, the Borrower, any of their respective directors, security holders or creditors, an Indemnified Party or any other person or an Indemnified Party is otherwise a party thereto and whether or not the transactions contemplated hereby are consummated.

No Indemnified Party shall have any liability (whether in contract, tort or otherwise) to Sunstone or the Borrower or any of their respective security holders or creditors for or in connection with the transactions contemplated hereby, except to the extent such liability is determined in a final non-appealable judgment by a court of competent jurisdiction to have resulted from such Indemnified Party’s gross negligence or willful misconduct. In no event, however, shall any Indemnified Party be liable on any theory of liability for any special, indirect, consequential or punitive damages (including, without limitation, any loss of profits, business or anticipated savings).

Section 6. Costs and Expenses . Sunstone shall pay, or cause the Borrower to pay, or reimburse the Lender Parties on demand for, all out-of-pocket costs and expenses incurred by the Lender Parties (whether incurred before or after the date hereof) in connection with the Facility and the preparation, negotiation, execution and delivery of this Commitment Letter, including, without limitation, the reasonable fees and expenses of counsel (subject to the terms of the Fee Letter), regardless of whether any of the transactions contemplated hereby are consummated. Sunstone shall also pay, or shall cause the Borrower to pay, all costs and expenses of the Lender Parties (including, without limitation, the reasonable fees and disbursements of counsel) incurred in connection with the enforcement of any of its rights and remedies hereunder.

Section 7. Confidentiality . By accepting delivery of this Commitment Letter, Sunstone agrees that this Commitment Letter is for the confidential use of Sunstone and the Borrower only and that neither its existence nor the terms hereof will be disclosed by Sunstone, or permitted by Sunstone to be disclosed by the Borrower, to any person other than their respective officers, directors, employees, accountants, attorneys and other advisors, agents and representatives and then only on a confidential and “need to know” basis in connection with the transactions contemplated hereby; provided, however, that Sunstone may make, and may permit the Borrower to make, (i) such other public disclosures of the terms and conditions hereof as

Sunstone or the Borrower is required by law, in the opinion of its counsel, to make, (ii) such disclosure of the terms and conditions set forth in Annexes I and II to potential lenders that may participate in either one or both of the Facilities (which disclosure shall, as and to the extent requested by the Co-Lead Arrangers, be made in writing pursuant to summaries of terms approved for such purpose by the Co-Lead Arrangers), and (iii) such disclosure of the terms and conditions hereof (exclusive of the Fee Letter) as may be required by applicable rules or regulations of the Securities Exchange Commission (“ SEC ”) or as may otherwise be reasonably necessary or desirable and consistent with customary market practice in the Form S-11 filed by Sunstone Hotel Investors, Inc. with the SEC.

Section 8. Representations and Warranties of Sunstone . Sunstone represents and warrants that (i) all information (other than financial projections) that has been or will hereafter be made available to the Lender Parties, any Lender or any potential Lender by Sunstone or the Borrower or any of their respective representatives in connection with the transactions contemplated hereby is and will be complete and correct in all material respects and does not and will not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein not misleading in light of the circumstances under which such statements were or are made and (ii) all financial projections that have been or will be prepared by Sunstone or the Borrower and made available to the Lender Parties, any Lender or any potential Lender have been or will be prepared in good faith based upon reasonable assumptions (it being understood that such projections are subject to significant uncertainties and contingencies, many of which are beyond the control of Sunstone or the Borrower, and that no assurance can be given that the projections will be realized). Sunstone agrees to supplement, or cause the Borrower to supplement, the information and projections from time to time until the Operative Documents become effective so that the representations and warranties contained in this paragraph remain correct.

In providing this Commitment Letter, the Lender Parties are relying on the accuracy of the information furnished to them by or on behalf of Sunstone and its affiliates without independent verification thereof.

Section 9. No Third Party Reliance, Etc. The agreements of the Lender Parties hereunder and of any Lender that issues a commitment to provide financing under either of the Facilities are made solely for the benefit of Sunstone and the Borrower and may not be relied upon or enforced by any other person. Please note that those matters that are not covered or made clear herein are subject to mutual agreement of the parties. Sunstone may not, and may not permit the Borrower to, assign or delegate any of its rights or obligations hereunder without the Initial Lender Parties’ prior written consent. This Commitment Letter may not be amended or modified, or any provision hereof waived, except by a written agreement signed by all parties hereto. This Commitment Letter is not intended to create a fiduciary relationship among the parties hereto.

Sunstone acknowledges, for itself and on behalf of the Borrower, that the Lender Parties and/or one or more of their affiliates may provide financing, equity capital, financial advisory and/or other services to parties whose interests may conflict with the interests of Sunstone or the Borrower. Consistent with the Lenders Parties’ policies to hold in confidence the affairs of its customers, neither any Lender Party nor its respective affiliates will furnish confidential information obtained from Sunstone or the Borrower to any of such Lender Party’s other customers. Furthermore, neither any Lender Party nor any of its respective affiliates will make available to Sunstone or the Borrower confidential information that such Lender Party obtained or may obtain from any other person.

Section 10. Governing Law, Etc. This Commitment Letter shall be governed by, and construed in accordance with, the law of the State of New York. This Commitment Letter sets forth the entire agreement

among the parties with respect to the matters addressed herein and supersedes all prior communications, written or oral, with respect hereto. This Commitment Letter may be executed in any number of counterparts, each of which, when so executed, shall be deemed to be an original and all of which, taken together, shall constitute one and the same Commitment Letter. Delivery of an executed counterpart of a signature page to this Commitment Letter by telecopier shall be as effective as delivery of an original executed counterpart of this Commitment Letter. Sections 3 through 8, 10 and 11 hereof shall survive the termination of the Lender Parties’ commitments hereunder. Sunstone acknowledges, for itself and the Borrower, that information and documents relating to the Facility may be transmitted through Intralinks, the internet or similar electronic transmission systems.

Section 11. Waiver of Jury Trial . Each party hereto irrevocably waives all right to trial by jury in any action, proceeding or counterclaim (whether based on contract, tort or otherwise) arising out of or relating to this Commitment Letter or the transactions contemplated hereby or the actions of the parties hereto in the negotiation, performance or enforcement hereof.

[Balance of Page Intentionally Left Blank.]

Please indicate Sunstone’s acceptance of the provisions hereof by signing the enclosed copy of this Commitment Letter and the Fee Letter and returning them to David Bouton, Director, Citigroup Global Markets Inc., 390 Greenwich Street, New York, New York 10013 (fax: 212-723-8540) at or before 5:00 p.m. (New York City time) on September 21, 2004 the time at which the commitments of the Lender Parties hereunder (if not so accepted prior thereto) will terminate. If Sunstone elects to deliver this Commitment Letter by telecopier, please arrange for the executed original to follow by next-day courier.


Very truly yours,

CITIGROUP GLOBAL MARKETS INC.

By		/ S / D AVID B OUTON
Name:		David Bouton
Title:		Director

CITICORP NORTH AMERICA, INC.

By		/ S / D AVID B OUTON
Name:		David Bouton
Title:		Vice President

MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED

By		/ S / S TEPHEN B. P ARAS
Name:		Stephen B. Paras
Title:		Managing Director

MERRILL LYNCH CAPITAL CORPORATION

By		/ S / S TEPHEN B. P ARAS
Name:		Stephen B. Paras
Title:		Vice President

MORGAN STANLEY SENIOR FUNDING, INC.

By		/ S / T ODD V ANNUCCI
Name:		Todd Vannucci
Title:		Executive Director

[Signatures continued on next page]


ACCEPTED AND AGREED on September 15, 2004:

SUNSTONE HOTEL INVESTORS, L.L.C.

By		/ S / J ON D. K LINE
Name:		Jon D. Kline
Title:		Executive Vice President and Chief Financial Officer

Annex I

SUNSTONE HOTEL PARTNERSHIP, LLC

Summary of Terms and Conditions

$150 Million Senior Secured Credit Facility



*Borrower:*		Sunstone Hotel Partnership, LLC (the “Borrower”).

*Guarantors:*		All obligations of the Borrower under the Facility and under any interest protection or other hedging arrangements entered into with a Lender (or any affiliate thereof) will be unconditionally guaranteed by each existing and subsequently acquired subsidiary of the Borrower (subject to certain exceptions to be agreed, including an exception for any entity contractually prevented from providing such a guaranty), including those holding Borrowing Base Assets.

*Senior Facility Amount:*		$150,000,000 or such other amount as provide for under the Commitment Increase and Commitment Reduction sections of this Indicative Summary of Terms and Conditions, but in any event not more than $225,000,000.

*Type of Facility:*		Senior Secured Revolving Credit Facility (the “Facility”). The Facility will include a Letter of Credit subfacility (subject to a $75,000,000 sublimit) and a Swingline subfacility (subject to a sublimit to be agreed).

*Purpose:*		General corporate purposes, acquisitions, refinancing of certain existing mortgage indebtedness and payment of fees and expenses related to the Facility and the other transactions contemplated by the loan documents.

*Availability:*		The Borrower may borrow, repay and reborrow.

*Collateral:*		First priority perfected mortgage liens on all Borrowing Base Assets, and a first priority perfected assignment of and security interest in all related (i) equipment, fixtures and personal property, (ii) leases and rents, management agreements, licenses and other significant agreements and (iii) permits (to the extent permitted by law), approvals, contracts and other agreements applicable to construction, use or operation of the property. The Borrower will obtain title insurance insuring the mortgages in amounts acceptable to the Agent, ALTA land surveys certified to the Agent and opinions of local counsel with respect to the enforceability and perfection of the mortgages.

*Administrative Agent and Senior Collateral Agent:*		Citicorp North America, Inc. (the “Agent”).

*Co-Lead Arrangers:*		Citigroup Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley Senior Funding, Inc.

*Lenders:*		Citicorp North America, Inc. (“CNAI”), Merrill Lynch Capital Corporation (“Merrill Lynch”), Morgan Stanley Senior Funding, Inc. (“Morgan Stanley”) and other financial institutions acceptable to the Borrower and the Agent.



*Closing Date:*		[ ], 2004, or such other date as may be agreed upon by the Borrower and the Agent.

*Commitment Termination Date:*		Three years from the Closing Date, subject to the Facility Extension section.

*Extension of Commitments:*		The Borrower will have the right to extend the Lenders’ commitments for an additional one-year period, provided that on the extension date, the Agent shall have received a certificate signed by a duly authorized officer of the Borrower stating that: (i) the representations and warranties contained in the loan documents are true and correct on and as of the extension date, and (ii) no default has occurred and is continuing or would result from such extension. The Borrower will pay the extending Lenders a Facility Extension Fee as set forth in Exhibit 1 hereto.

*Commitment Increase:*		The Borrower will have the right, no more than once a year, to increase the Facility Amount, in minimum increments of $5,000,000, up to a maximum Facility Amount of $225,000,000, provided that no Default (as defined in the Conditions Precedent to Closing) or Event of Default has occurred and is continuing. The Borrower may offer the increase to (x) its existing Lenders, and each existing Lender will have the right, but no obligation, to commit to all or a portion of the proposed increase (the “Proposed Increased Commitment”) (allocations will be based on the ratio of each existing Lender’s Proposed Increased Commitment, if any, to the aggregate of all Proposed Increased Commitments) and, if the aggregate of all Proposed Increased Commitments of the existing Lenders is less than the requested increase, (y) third party financial institutions acceptable to the Agent, provided that the minimum commitment of each such institution equals or exceeds $5,000,000.

*Commitment Reduction:*		The Borrower will have the right, upon at least 3 business days’ notice, to terminate or cancel, in whole or in part, the unused portion of the Facility Amount in excess of the aggregate outstanding Advances, provided that each partial reduction shall be in a minimum amount of $1,000,000 or any whole multiple of $250,000 in excess thereof. Once terminated, a commitment may not be reinstated.

*Unused Fee:*		As set forth in Exhibit 1 hereto.

*Upfront Fee:*		As set forth in a separate Fee Letter.

*Letter of Credit Fee:*		As set forth in Exhibit 1 hereto.

*Annual Agency Fee:*		As set forth in a separate Fee Letter.

*Interest Rates and Interest Periods:*		At the Borrower’s option, any Advance that is made to it will be available at the rates and for the Interest Periods stated below:

		1) Base Rate : a fluctuating rate equal to Citibank, N.A.’s Base Rate plus the Applicable Margin.

		2) Eurodollar Rate : a periodic fixed rate equal to LIBOR plus the Applicable Margin.



		The Eurodollar Rate will be fixed for Interest Periods of 1, 2, 3 or 6 months.

		Upon the occurrence and during the continuance of any Event of Default, each Eurodollar Rate Advance will convert to a Base Rate Advance at the end of the Interest Period then in effect for such Eurodollar Rate Advance.

*Applicable Margin:*		As set forth in Exhibit 1 hereto.

*Reference Banks:*		Citibank, N.A. and certain other banks to be determined.

*Interest Payments:*		At the end of each Interest Period for each Advance, but no less frequently than quarterly. Interest will be computed on a 365/366-day basis for Base Rate Advances and a 360-day basis for Eurodollar Rate Advances.

*Advances:*		Advances will be in minimum principal amounts of $1,000,000 and integral multiples of $250,000 in excess thereof. All Advances will be made by the Lenders ratably in proportion to their respective commitments. Advances will be available on same day notice for Base Rate Advances and 3 business days’ notice for Eurodollar Rate Advances. Advances and Letters of Credit issuances will be subject to the Borrowing Base.

*Repayment:*		The Borrower will repay each Advance no later than on the Commitment Termination Date.

*Amortization:*		None.

*Optional Prepayment:*		Advances may be prepaid without penalty, on same day notice for Base Rate Advances and 2 business days’ notice for Eurodollar Rate Advances, in minimum amounts of $1,000,000 and increments of $250,000 in excess thereof. The Borrower will bear all breakage costs related to the prepayment of a Eurodollar Rate Advance prior to the last day of the Interest Period thereof.

*Loan Documentation:*		The commitments will be subject to the preparation, execution and delivery of mutually acceptable loan documentation, which will contain conditions precedent, representations and warranties, covenants, events of default and other provisions customary for facilities of this nature, including, but not limited to, those noted below.

*Conditions Precedent to Closing:*		Customary for facilities of this nature, including, but not limited to:

		1) Completion of the Formation and Structuring Transactions described in the Form S-11 (the “Registration Statement”) filed by Sunstone Hotel Investors, Inc. (the “REIT”) with the Securities and Exchange Commission (the “SEC”), and closing of the initial public offering of the REIT contemplated therein generating primary equity issuance gross proceeds of at least $250,000,000.

		2) Board resolutions.

		3) Incumbency/specimen signature certificate.


		4) Accuracy of representations and warranties.

		5) No Event of Default, or event which with the giving of notice or lapse of time or both would be an Event of Default (a “Default”), has occurred and is continuing.

		6) Favorable legal opinion from counsel for the Borrower.

		7) Favorable legal opinion from counsel for the Agent.

		8) The Borrower shall enter into interest rate protection agreements, pursuant to documentation reasonably satisfactory to the Agent, such that not less than 66 ² / 3 % of consolidated debt for borrowed money is hedged or bears interest at a fixed rate.

		9) Receipt of appraisals, engineering and environmental reports satisfactory to the Agent.

		10) The repayment of certain existing mortgage indebtedness in the amounts and to the lenders described in the “Use of Proceeds” Section of the Registration Statement.

*Conditions Precedent to all Advances and Issuance/Extensions of Letters of Credit:*		Customary for facilities of this nature, including, but not limited to:

		1) All representations and warranties are true and correct on and as of the date of the Advance or issuance/extension of a Letter of Credit, before and after giving effect to such Advance or issuance/extension of a Letter of Credit, as the case may be, and to the application of the proceeds therefrom, as though made on and as of such date.

		2) No Default or Event of Default has occurred and is continuing, or would result from such Advance or issuance/extension of a Letter of Credit, as the case may be.

		3) Advances and Letters of Credit not to exceed the Borrowing Base Availability.

*Representations and Warranties:*		Customary for facilities of this nature, including, but not limited to:

		1) Confirmation of corporate status and authority.

		2) Due authorization of the loan documents.

		3) Execution, delivery, and performance of loan documents do not violate law or existing agreements.

		4) No governmental or regulatory approvals required.


		5) No litigation, proceeding or investigation which could reasonably be expected to have a material adverse effect on the business, condition (financial or otherwise), operations or prospects, or which could reasonably be expected to affect the legality, validity and enforceability of the loan documents.

		6) No material adverse change in the business, condition (financial or otherwise), operations or prospects of the Borrower and its subsidiaries, taken as a whole, since December 31, 2003.

		7) Accuracy of information, financial statements.

		8) Legality, validity, binding effect and enforceability of the loan documents.

		9) Material compliance with all laws and regulations, including ERISA and all applicable environmental laws and regulations.

		10) Margin regulations.

		11) Not an investment company.

		12) Solvency.

		13) The REIT qualifies as a real estate investment trust under the Internal Revenue Code.

*Corporate Financial Covenants:*		Customary for facilities of this nature, applicable to the Borrower and the Guarantors, including but not limited to:

		1) Minimum Tangible Net Worth: 85% of Tangible Net Worth per GAAP as of the end of the fiscal quarter most recently ended prior to the Closing Date plus 75% of the net proceeds of primary equity issuances.

		2) Minimum Adjusted EBITDA to Fixed Charges: 1.5:1.0

		3) Maximum REIT Dividend Payout Ratio: 95% of FFO or an amount necessary to maintain REIT status.

		4) Maximum Total Debt to EBITDA: 7.0:1.0 through 12/30/06 and 6.5:1.0 thereafter.

		5) Maximum Senior Debt to EBITDA: 6.5:1.0 through 12/30/06 and 6.0:1.0 thereafter.

*Notes Regarding Corporate Financial Covenants:*		1) Adjusted EBITDA will equal EBITDA less the FF&E Reserve.

		2) FF&E Reserve will equal 4% of revenues.

		3) Fixed Charges will equal the sum of interest expense on Total Debt plus scheduled amortization (not including final maturities) plus preferred dividends.


*Covenants:*		Customary for facilities of this nature, including, but not limited to:

		1) Preservation and maintenance of corporate existence.

		2) Material compliance with laws and regulations (including ERISA and applicable environmental laws and regulations).

		3) Payment of taxes.

		4) Payment of material obligations.

		5) Visitation and inspection rights.

		6) Maintenance of books and records.

		7) Maintenance of properties.

		8) Maintenance of insurance.

		9) Maintenance of first priority perfected liens on the Collateral.

		10) Certain restrictions to be agreed on change of business, transactions with affiliates, acquisitions, permitted investments, asset dispositions, consolidations, mergers, sales of assets and sale/leaseback transactions.

		11) Delivery of audited annual consolidated financial statements and unaudited quarterly consolidated financial statements (it being acknowledged that the annual and quarterly public reporting filed by the REIT with the SEC will satisfy the foregoing requirements), together with other financial information as the Agent may request.

		12) Other reporting requirements and notices of default, material litigation, material claims affecting Borrowing Base Assets and material environmental events.

		13) Use of proceeds.

		14) The REIT shall at all times (i) remain a publicly traded company listed on the NYSE or other national stock exchange and (ii) maintain its status as a real estate investment trust under IRS rules and regulations.

		15) Appraisals of the Borrowing Base Assets to be performed at the request of the Agent, but not more frequently than annually.


*Borrowing Base Assets:*		The initial Borrowing Base Assets will consist of: 1. Holiday Inn - Boise, ID 2. Holiday Inn - Hollywood, CA 3. Hilton Garden Inn - Lake Oswego, OR 4. Marriott - Portland, OR 5. Marriott - Riverside, CA 6. Hyatt Regency - Atlanta, GA 7. Marriott - Napa, CA

*Borrowing Base Covenants:*		1) Maximum Revolver Outstanding to Borrowing Base Value: 65%.

		2) Minimum Borrowing Base Debt Service Coverage Ratio: 2.0:1.0, calculated with reference to (i) Adjusted NOI of the Borrowing Base Assets and (i) annual interest payments under the Facility applying an interest rate equal to the Applicable Margin for Eurodollar Rate Advances under the Facility plus the greater of 3.0% and the 3-year swap rate.

		3) The Borrowing Base shall at all times have a minimum of six Borrowing Base Assets and no single Borrowing Base Asset (other than the Marriott – Napa, CA asset) may account for more than 25% of the pool on an Adjusted NOI basis unless approved by the Required Lenders (defined below).

		4) Additions to the Borrowing Base limited to hotels with at least one year of operating history that are rated “upscale”, upper upscale” or better by Smith Travel Research. On the date of any acquisition, the Adjusted NOI of the Borrowing Base Assets (adjusted on a pro forma basis to account for the acquisition) must produce an Implied Debt Service Coverage Ratio of not less than 1.4:1.0. 5) Proposed additions to the Borrowing Base that fail to meet the criteria described above will become Borrowing Base Assets only with the approval of the Required Lenders. 6) Removal of Borrowing Base Assets will be permitted, subject to the aforementioned criteria plus an average RevPAR for all Borrowing Base Assets (measured on a proforma basis as of the date immediately following the removal) of not less than 95% of the RevPAR that existed as of the date immediately preceding such removal.

*Notes Regarding Borrowing Base Covenants:*		1) An appraisal will be required for each Borrowing Base Asset and all subsequent additions to the Borrowing Base. The Borrowing Base Value will be the appraised value.

		2) Adjusted NOI will equal net operating income, less a management fee (equal to the greater of 3.5% of revenues or actual), less an FF&E reserve (equal to 4% of revenues).


		3) Implied Debt Service will equal annual interest payments on the outstanding Senior Facility Amount (adjusted on a pro forma basis to include any Advances made in connection with the acquisition) based on a debt constant of 8.5%.

*Events of Default:*		Customary for facilities of this nature, including, but not limited to:

		1) Failure to pay principal when due and failure to pay interest, fees and other amounts within 3 business days of when due.

		2) Representations or warranties materially incorrect.

		3) Failure to comply with covenants (with notice and cure periods as applicable).

		4) Cross-default to (i) payment defaults on principal aggregating (a) $10,000,000 or more for indebtedness that is recourse to the Borrower or (b) $100,000,000 or more for any other indebtedness of the Borrower or any of its subsidiaries, or (ii) other events if the effect is to accelerate or permit acceleration of such debt (subject to certain cure rights to be agreed).

		5) Failure to pay a judgment or court order if not stayed within an appropriate period in excess of $10,000,000 individually or in the aggregate.

		6) Bankruptcy, liquidation, or the appointment of a receiver or similar official or institution of any such proceeding against the Borrower or a Guarantor if not dismissed within an appropriate period.

		7) ERISA.

		8) Change of control or ownership.

		9) Failure to maintain first priority perfected liens on the Collateral.

*Other:*		Loan documentation will include:

		1) Indemnification of the Agent and Lenders and their respective affiliates, officers, directors, employees, agents and advisors for any liabilities and expenses arising out of the Facility or the use or proposed use of proceeds including environmental liabilities.

		2) Waiver of consequential damages.

		3) Normal agency, set-off and sharing language.


		4) “Required Lenders” defined as those holding greater than 50% of the sum of all outstanding Advances plus all unused commitments. The consent of all or affected Lenders will be required to increase the size of the Facility (other than as provided for in the Commitment Increase section), extend the Commitment Termination Date (other than as provided in the Extension of Commitments section), decrease interest rates, principal or fees, postpone scheduled payment dates or for those provisions requiring 100% Lender approval, reduce the percentage of Lenders required to take action or release any Guarantor or Collateral.

*Assignments and Participations:*		Each Lender will have the right to assign to one or more eligible assignees all or a portion of its rights and obligations under the loan documents, with the consent, not to be unreasonably withheld, of the Agent and, so long as no default has occurred, the Borrower. Minimum aggregate assignment levels will be $5,000,000 and increments of $1,000,000 in excess thereof. The parties to the assignment (other than the Borrower) will pay to the Agent an administrative fee of $3,500.

		Each Lender will also have the right, without the consent of the Borrower or the Agent, to assign (i) as security, all or part of its rights under the loan documents to any Federal Reserve Bank and (ii) with notice to the Borrower and the Agent, all or part of its rights and obligations under the loan documents to any of its affiliates.

		Each Lender will have the right to sell participations in its rights and obligations under the loan documents, subject to customary restrictions on the participants’ voting rights.

*Yield Protection, Taxes, and Other Deductions:*		1) The loan documents will contain yield protection provisions, customary for facilities of this nature, protecting the Lenders in the event of unavailability of funding, funding losses, and reserve and capital adequacy requirements.

		2) All payments to be free and clear of any present or future U.S. taxes, withholdings or other deductions whatsoever (other than franchise and income taxes in the jurisdiction of the Lender’s applicable lending office). The Lenders will use reasonable efforts to minimize to the extent possible any applicable taxes and the Borrower will indemnify the Lenders and the Agent for such taxes paid by the Lenders or the Agent. Foreign lenders will furnish appropriate evidence of exemption from U.S. withholding taxes.

*Governing Law:*		State of New York.

*Counsel to the Agent:*		Shearman & Sterling LLP.

*Expenses:*		The Borrower will reimburse the Arranger and the Agent for all out-of-pocket expenses (including fees and expenses of counsel to the Agent) incurred by them in the negotiation, syndication and execution of the Facility. Such expenses will be reimbursed by the Borrower upon presentation of a statement of account, regardless of whether the transaction contemplated is actually completed or the loan documents are signed.

*Submission to Jurisdiction:*		The Borrower will agree to submit to the non-exclusive jurisdiction of the courts of the State of New York in connection with disputes that may arise in connection with the Facility.

Exhibit 1


*Applicable Margin:*		The Applicable Margin for Eurodollar Rate Advances and Base Rate Advances means an amount which will vary, as per the Pricing Grid below, based on the Total Debt to Adjusted EBITDA, provided that (i) the Applicable Margin will initially be 200 bps for Eurodollar Rate Advances and 100 bps for Base Rate Advances, and (ii) upon the occurrence and during the continuance of any Event of Default, the Applicable Margin will increase by 200 basis points per annum.


*Unused Fee:*		50 bps, payable on the average unused commitment. The Unused Fee will be payable on each Lender’s commitment, quarterly in arrears on the last day of each March, June, September and December, and on the Commitment Termination Date. The Unused Fee will be calculated on a 360-day basis.

*Facility Extension Fee:*		The Borrower will pay the extending Lenders a Facility Extension Fee of 25 bps based on their respective commitments.

*Letter of Credit Fee:*		12.5 bps fronting fee payable to the Issuing Bank upon the issuance of each Letter of Credit. Usage fees on the average aggregate available amount of all Letters of Credit will be payable to all Lenders in an amount equal to the Applicable Margin for Eurodollar Rate Advances.

Annex II

SUNSTONE HOTEL PARTNERSHIP, LLC

Summary of Terms and Conditions

$75 Million Subordinate Term Loan Facility


*Borrower:*		Sunstone Hotel Partnership, LLC (the “Borrower”).

*Guarantors:*		All obligations of the Borrower under the Facility and under any interest protection or other hedging arrangements entered into with a Lender (or any affiliate thereof) will be unconditionally guaranteed by Sunstone Hotel Investors, Inc. (the “REIT”) and each existing and subsequently acquired subsidiary of the Borrower (subject to certain exceptions to be agreed, including an exception for any entity contractually prevented from providing such a guaranty).

*Subordinate Term Facility Amount:*		$75,000,000.

*Type of Facility:*		Subordinate Lien Term Loan Facility (the “Facility”).

*Purpose:*		General corporate purposes, acquisitions, refinancing of certain existing mortgage indebtedness and payment of fees and expenses related to the Facility and the other transactions contemplated by the loan documents.

*Availability:*		Single advance at Closing (the “Term Advance”).

*Collateral:*		First priority pledge of 100% of the ownership interests in all of the Borrower’s subsidiaries (subject to certain exceptions to be agreed, including an exception for any entity contractually prevented from doing so), but including either (i) 100% of the membership interests in the Borrower, or (ii) 100% of the ownership interests in a holding company subsidiary through which the Borrower owns its other subsidiaries.

*Administrative Agent and Junior Collateral Agent:*		Citicorp North America, Inc. (the “Agent”).

*Co-Lead Arrangers:*		Citigroup Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley Senior Funding, Inc.

*Lenders:*		Citicorp North America, Inc. (“CNAI”), Merrill Lynch Capital Corporation (“Merrill Lynch”), Morgan Stanley Senior Funding, Inc. (“Morgan Stanley”) and other financial institutions acceptable to the Borrower and the Agent.

*Closing Date:*		[ ], 2004, or such other date as may be agreed upon by the Borrower and the Agent.

*Commitment Termination Date:*		Four years from the Closing Date.

*Commitment Reduction:*		Any prepayment will automatically reduce the Commitments of the Lenders in a like amount. Amounts prepaid may not be reborrowed.


*Upfront Fee:*		As set forth in a separate Fee Letter.

*Annual Agency Fee:*		As set forth in a separate Fee Letter.

*Interest Rates and Interest Periods:*		At the Borrower’s option, any Advance that is made to it will be available at the rates and for the Interest Periods stated below:

		1) Base Rate : a fluctuating rate equal to Citibank, N.A.’s Base Rate plus the Applicable Margin.

		2) Eurodollar Rate : a periodic fixed rate equal to LIBOR plus the Applicable Margin.

		The Eurodollar Rate will be fixed for Interest Periods of 1, 2, 3 or 6 months.

		Upon the occurrence and during the continuance of any Event of Default, each Eurodollar Rate Advance will convert to a Base Rate Advance at the end of the Interest Period then in effect for such Eurodollar Rate Advance.

*Applicable Margin:*		The Applicable Margin will be 400 bps for Eurodollar Rate Advances and 300 bps for Base Rate Advances. Upon the occurrence and during the continuance of any Event of Default, the Applicable Margin will increase by 200 bps per annum.

*Reference Banks:*		Citibank, N.A. and certain other banks to be determined.

*Interest Payments:*		At the end of each Interest Period for each Advance, but no less frequently than quarterly. Interest will be computed on a 365/366-day basis for Base Rate Advances and a 360-day basis for Eurodollar Rate Advances.

*Advances:*		Single Term Advance by each Lender at Closing aggregating the full Facility Amount. All Advances will be made by the Lenders ratably in proportion to their respective commitments.

*Repayment:*		The Borrower will repay each Advance no later than on the Commitment Termination Date.

*Amortization:*		None.

*Optional Prepayment:*		Advances may prepaid, in whole or in part (i) during the first 6 months after the Closing Date only upon payment of yield maintenance in an amount equal to 150 bps of the principal amount of the Advances being prepaid, (ii) during months 7 through 12 after the Closing Date only upon payment of yield maintenance in an amount equal to 100 bps of the principal amount of the Advances being prepaid, (iii) during months 13 through 18 after the Closing Date only upon payment of yield maintenance in an amount equal to 50 bps of the principal amount of the Advances being prepaid, and (iv) thereafter without penalty. Prepayments may be made on same day notice for Base Rate Advances and require 2 business days’ notice for Eurodollar Rate Advances. All prepayments must be in minimum amounts of $1,000,000 and increments of $250,000 in excess thereof. The Borrower will bear all breakage costs


		related to the prepayment of a Eurodollar Rate Advance prior to the last day of the Interest Period thereof.

*Mandatory Prepayment:*		The Borrower shall offer to the Agent (who shall respond on behalf of the Lenders within ten business days) to prepay Advances in an aggregate amount equal to the net proceeds of any issuance of debt for borrowed money by the Borrower or its subsidiaries (exclusive of (i) revolving credit borrowings under the Borrower’s Senior Secured Credit Facility, and (ii) asset level or mezzanine secured indebtedness that is not recourse to the Borrower other than to the extent of customary non-recourse carve-outs).

*Loan Documentation:*		The commitments will be subject to the preparation, execution and delivery of mutually acceptable loan documentation which will contain conditions precedent, representations and warranties, covenants, events of default and other provisions customary for facilities of this nature, including, but not limited to, those noted below.

*Intercreditor Agreement:*		The Lenders and the Junior Collateral Agent will enter into an Intercreditor Agreement with the Senior Lenders and the Senior Collateral Agent under the Borrower’s Senior Secured Credit Facility (the “Senior Lenders”) on customary terms and conditions.

*Conditions Precedent to Closing:*		Customary for facilities of this nature, including, but not limited to:

		1) Completion of the Formation and Structuring Transactions described in the Form S-11 (the “Registration Statement”) filed by the REIT with the Securities and Exchange Commission (the “SEC”), and closing of the initial public offering of the REIT contemplated therein generating primary equity issuance gross proceeds of at least $250,000,000.

		2) Board resolutions.

		3) Incumbency/specimen signature certificate.

		4) Accuracy of representations and warranties.

		5) No Event of Default, or event which with the giving of notice or lapse of time or both would be an Event of Default (a “Default”), has occurred and is continuing.

		6) Favorable legal opinion from counsel for the Borrower.

		7) Favorable legal opinion from counsel for the Agent.

		8) The Borrower shall enter into interest rate protection agreements, pursuant to documentation reasonably satisfactory to the Agent, such that not less than 66 ² / 3 % of consolidated debt for borrowed money is hedged or bears interest at a fixed rate.

		9) Receipt of appraisals, engineering and environmental reports satisfactory to the Agent.


		10) The repayment of certain existing mortgage indebtedness in the amounts and to the lenders described in the “Use of Proceeds” Section of the Registration Statement.

*Conditions Precedent to the Term Advance:*		Customary for facilities of this nature, including, but not limited to:

		1) All representations and warranties are true and correct on and as of the date of the Advance, before and after giving effect to such Advance, and to the application of the proceeds therefrom, as though made on and as of such date.

		2) No Default or Event of Default has occurred and is continuing, or would result from such Advance.

*Representations and Warranties:*		Customary for facilities of this nature, including, but not limited to:

		1) Confirmation of corporate status and authority.

		2) Due authorization of the loan documents.

		3) Execution, delivery, and performance of loan documents do not violate law or existing agreements.

		4) No governmental or regulatory approvals required.

		5) No litigation, proceeding or investigation which could reasonably be expected to have a material adverse effect on the business, condition (financial or otherwise), operations or prospects, or which could reasonably be expected to affect the legality, validity and enforceability of the loan documents.

		6) No material adverse change in the business, condition (financial or otherwise), operations or prospects of the Borrower and its subsidiaries, taken as a whole, since December 31, 2003.

		7) Accuracy of information, financial statements.

		8) Legality, validity, binding effect and enforceability of the loan documents.

		9) Material compliance with all laws and regulations, including ERISA and all applicable environmental laws and regulations.

		10) Margin regulations.

		11) Not an investment company.

		12) Solvency.


		13) The REIT qualifies as a real estate investment trust under the Internal Revenue Code.

*Corporate Financial Covenants:*		Customary for facilities of this nature, applicable to the Borrower and the Guarantors, including but not limited to:

		1) Minimum Tangible Net Worth: 85% of Tangible Net Worth per GAAP as of the end of the fiscal quarter most recently ended prior to the Closing Date plus 75% of the net proceeds of primary equity issuances.

		2) Minimum Adjusted EBITDA to Fixed Charges: 1.5:1.0

		3) Maximum REIT Dividend Payout Ratio: 95% of FFO or an amount necessary to maintain REIT status.

		4) Maximum Total Debt to EBITDA: 7.0:1.0 through 12/30/06 and 6.5:1.0 thereafter.

		5) Maximum Senior Debt to EBITDA: 6.5:1.0 through 12/30/06 and 6.0:1.0 thereafter.

*Notes Regarding Corporate Financial Covenants:*		1) Adjusted EBITDA will equal EBITDA less the FF&E Reserve.

		2) FF&E Reserve will equal 4% of revenues.

		3) Fixed Charges will equal the sum of interest expense on Total Debt plus scheduled amortization (not including final maturities) plus preferred dividends.

*Covenants:*		Customary for facilities of this nature, including, but not limited to:

		1) Preservation and maintenance of corporate existence.

		2) Material compliance with laws and regulations (including ERISA and applicable environmental laws and regulations).

		3) Payment of taxes.

		4) Payment of material obligations.

		5) Visitation and inspection rights.

		6) Maintenance of books and records.

		7) Maintenance of properties.

		8) Maintenance of insurance.

		9) Maintenance of first priority perfected liens on the Collateral.

		10) Prohibition on (i) Recourse Debt that is senior to the Facility, other than revolving credit borrowings under the Borrower’s Senior


		Secured Credit Facility, and (ii) Recourse Debt that is pari passu to the Facility, unless and to the extent that the Borrower complies with the Mandatory Prepayment section above (subject to certain customary exceptions to be agreed). “Recourse Debt” defined as indebtedness that is recourse to the Borrower, except to the extent of liabilities in respect of non-recourse carve-out guarantees issued in connection with asset level or mezzanine secured financings that are not otherwise recourse to the Borrower.

		11) Certain restrictions to be agreed on change of business, transactions with affiliates, acquisitions, permitted investments, asset dispositions, consolidations, mergers, sales of assets and sale/leaseback transactions.

		12) Delivery of audited annual consolidated financial statements and unaudited quarterly consolidated financial statements (it being acknowledged that the annual and quarterly public reporting filed by the REIT with the SEC will satisfy the foregoing requirements), together with other financial information as the Agent may request.

		13) Other reporting requirements and notices of default, material litigation and material environmental events.

		14) Use of proceeds.

		15) The REIT shall at all times (i) remain a publicly traded company listed on the NYSE or other national stock exchange and (ii) maintain its status as a real estate investment trust under IRS rules and regulations.

*Events of Default:*		Customary for facilities of this nature, including, but not limited to:

		1) Failure to pay principal when due and failure to pay interest, fees and other amounts within 3 business days of when due.

		2) Representations or warranties materially incorrect.

		3) Failure to comply with covenants (with notice and cure periods as applicable).

		4) Cross-default to (i) payment defaults on principal aggregating (a) $10,000,000 or more for indebtedness that is recourse to the Borrower or (b) $50,000,000 or more for any other indebtedness of the Borrower or any of its subsidiaries, or (ii) other events if the effect is to accelerate or permit acceleration of such debt (subject to certain cure rights to be agreed).

		5) Failure to pay a judgment or court order if not stayed within an appropriate period in excess of $10,000,000 individually or in the aggregate.

		6) Bankruptcy, liquidation, or the appointment of a receiver or similar official or institution of any such proceeding against the Borrower or a Guarantor if not dismissed within an appropriate period.


		7) ERISA.

		8) Change of control or ownership.

		9) Failure to maintain first priority perfected liens on the Collateral.

*Other:*		Loan documentation will include:

		1) Indemnification of the Agent and Lenders and their respective affiliates, officers, directors, employees, agents and advisors for any liabilities and expenses arising out of the Facility or the use or proposed use of proceeds including environmental liabilities.

		2) Waiver of consequential damages.

		3) Normal agency, set-off and sharing language.

		4) “Required Lenders” defined as those holding greater than 50% of outstanding Advances. The consent of all or affected Lenders will be required to increase the size of the Facility, extend the Commitment Termination Date (other than as provided in the Extension of Commitments section), decrease interest rates, principal or fees, postpone scheduled payment dates or for those provisions requiring 100% Lender approval, reduce the percentage of Lenders required to take action or release any Guarantor or Collateral.

*Assignments and Participations:*		Each Lender will have the right to assign to one or more eligible assignees all or a portion of its rights and obligations under the loan documents, with the consent, not to be unreasonably withheld, of the Agent and, so long as no default has occurred, the Borrower. Minimum aggregate assignment levels will be $1,000,000 and increments of $500,000 in excess thereof. The parties to the assignment (other than the Borrower) will pay to the Agent an administrative fee of $3,500 on secondary assignments and participations.

		Each Lender will also have the right, without the consent of the Borrower or the Agent, to assign (i) as security, all or part of its rights under the loan documents to any Federal Reserve Bank and (ii) with notice to the Borrower and the Agent, all or part of its rights and obligations under the loan documents to any of its affiliates.

		Each Lender will have the right to sell participations in its rights and obligations under the loan documents, subject to customary restrictions on the participants’ voting rights.

*Yield Protection, Taxes, and Other Deductions:*		1) The loan documents will contain yield protection provisions, customary for facilities of this nature, protecting the Lenders in the event of unavailability of funding, funding losses, and reserve and capital adequacy requirements. 2) All payments to be free and clear of any present or future U.S. taxes, withholdings or other deductions whatsoever (other than franchise and income taxes in the jurisdiction of the Lender’s applicable


		lending office). The Lenders will use reasonable efforts to minimize to the extent possible any applicable taxes and the Borrower will indemnify the Lenders and the Agent for such taxes paid by the Lenders or the Agent. Foreign lenders will furnish appropriate evidence of exemption from U.S. withholding tax.

*Governing Law:*		State of New York.

*Counsel to the Agent:*		Shearman & Sterling LLP.

*Expenses:*		The Borrower will reimburse the Arranger and the Agent for all out-of-pocket expenses (including fees and expenses of counsel to the Agent) incurred by them in the negotiation, syndication and execution of the Facility. Such expenses will be reimbursed by the Borrower upon presentation of a statement of account, regardless of whether the transaction contemplated is actually completed or the loan documents are signed.

*Submission to Jurisdiction:*		The Borrower will agree to submit to the non-exclusive jurisdiction of the courts of the State of New York in connection with disputes that may arise in connection with the Facility.

EXHIBIT 10.14

SUNSTONE HOTEL INVESTORS, INC.

SENIOR MANAGEMENT INCENTIVE PLAN

Section 1. Purposes . The purpose of the Sunstone Hotel Investors, Inc. Senior Management Incentive Plan (the “ Plan ”) is to attract, retain and motivate selected employees of Sunstone Hotel Investors, Inc. (the “ Company ”) and its subsidiaries and affiliates who are officers of the Company, its subsidiaries or affiliates in order to promote the Company’s long-term growth and profitability.

Section 2. Administration .

(a) Subject to Section 2(d), the Plan shall be administered by a committee (the “ Committee ”) appointed by the Board of Directors of the Company (the “ Board ”), whose members shall serve at the pleasure of the Board. The Committee at all times shall be composed of at least two directors of the Company, each of whom is a “non-employee director” within the meaning of Rule 16b-3 promulgated under the Securities Exchange Act of 1934, as amended. Unless otherwise determined by the Board, the Committee shall be the Compensation Committee of the Board.

(b) The Committee shall have complete control over the administration of the Plan, and shall have the authority in its sole and absolute discretion to: (i) exercise all of the powers granted to it under the Plan; (ii) construe, interpret and implement the Plan; (iii) prescribe, amend and rescind rules and regulations relating to the Plan, including rules and regulations governing its own operations; (iv) make all determinations necessary or advisable in administering the Plan (including, without limitation, calculating the size of the Bonus payable to each Participant (as defined in Section 4(a)); (v) correct any defect, supply any omission and reconcile any inconsistency in the Plan; and (vi) amend the Plan to reflect changes in or interpretations of applicable law, rules or regulations.

(c) The determination of the Committee on all matters relating to the Plan and any amounts payable thereunder shall be final, binding and conclusive on all parties.

(d) Notwithstanding anything to the contrary contained herein, the Committee may allocate among its members and may delegate some or all of its authority or administrative responsibility to such individual or individuals who are not members of the Committee as it shall deem necessary or appropriate.

(e) No member of the Board or the Committee or any employee of the Company or any of its subsidiaries or affiliates (each such person a “ Covered Person ”) shall have any liability to any person (including, without limitation, any Participant) for any action taken or omitted to be taken or any determination made in good faith with respect to the Plan or any Bonus. Each Covered Person shall be indemnified and held harmless by the Company against and from any loss, cost, liability or expense (including attorneys’ fees) that may be imposed upon or incurred by such Covered Person in connection with or resulting from any action, suit or proceeding to which such Covered Person may be a party or in which such Covered Person may be involved by reason of any action taken or omitted to be taken under the Plan and against and from any and all amounts paid by such Covered Person, with the Company’s approval, in settlement thereof, or paid by such Covered Person in satisfaction of any judgment in any such action, suit or

proceeding against such Covered Person, provided that the Company shall have the right, at its own expense, to assume and defend any such action, suit or proceeding and, once the Company gives notice of its intent to assume the defense, the Company shall have sole control over such defense with counsel of the Company’s choice. The foregoing right of indemnification shall not be available to a Covered Person to the extent that a court of competent jurisdiction in a final judgment or other final adjudication, in either case, not subject to further appeal, determines that the acts or omissions of such Covered Person giving rise to the indemnification claim resulted from such Covered Person’s bad faith, fraud or willful criminal act or omission. The foregoing right of indemnification shall not be exclusive of any other rights of indemnification to which Covered Persons may be entitled under the Company’s Certificate of Incorporation or Bylaws, as a matter of law, or otherwise, or any other power that the Company may have to indemnify such persons or hold them harmless.

Section 3. Performance Period . The Plan shall operate for successive calendar years or portions of a fiscal year periods as determined by the Committee (each a “ Performance Period ”). Thereafter, each Performance Period shall be one full fiscal year and/or portions of fiscal years of the Company, as determined by the Committee.

Section 4. Participation.

(a) Prior to the 90th day after the beginning of a Performance Period, or as otherwise determined by the Committee (the “ Participation Date ”), the Committee shall designate those individuals who shall participate in the Plan for the Performance Period (the “ Participants ”).

(b) Except as provided below, the Committee shall have the authority at any time (i) during the Performance Period to remove Participants from the Plan for that Performance Period and (ii) prior to the Participation Date (or later in a manner determined by the Committee) to add Participants to the Plan for a particular Performance Period.

Section 5. Bonus Amounts.

(a) The Committee shall determine in its sole discretion the amount of a Bonus to be granted to each Participant. The amount of any Bonus may, but need not, be based on objective performance goals and a targeted level or levels of performance with respect to each goal as specified by the Committee.

(b) If a Participant’s employment with the Company terminates for any reason before the end of a Performance Period, the Committee shall have the discretion to determine whether (i) such Participant shall be entitled to any Bonus at all, (ii) such Participant’s Bonus shall be reduced on a pro-rata basis to reflect the portion of such Performance Period the Participant was employed by the Company or (iii) to make such other arrangements as the Committee deems appropriate in connection with the termination of such Participant’s employment.

Section 6. Payment of Bonus Amount; Voluntary Deferral . Each Participant’s Bonus shall be payable by such Participant’s Participating Employer (as defined in Section 7(j)), or in the case of a Participant employed by more than one Participating Employer, by each such employer as determined by the Committee. The Bonuses shall be payable in the discretion of the Committee in cash and/or an equity award of equivalent value (provided that in determining the

number of Company restricted or deferred stock units payable in cash or shares of the Company’s common stock, restricted shares of the Company’s common stock or unrestricted shares of the Company’s common stock that is equivalent to a dollar amount, that dollar amount shall be divided by the average closing price of the Company’s common stock during the 30 consecutive trading days immediately prior to the date of grant by the Committee (with fractional shares rounded to the nearest whole share). Any equity-based award shall be subject to such terms and conditions (including vesting requirements) as the Committee administering the plan under which such equity award is granted may determine. The Bonuses shall be paid at such time as bonuses are generally paid by the Participating Employer(s) for the relevant fiscal year. Subject to approval by the Committee and to any requirements imposed by the Committee in connection with such approval, each Participant may be entitled to defer receipt, under the terms and conditions of any applicable deferred compensation plan of the Company, of part or all of any payments otherwise due under this Plan.

Section 7. General Provisions.

(a) Amendment, Termination, etc. The Board reserves the right at any time and from time to time to modify, alter, amend, suspend, discontinue or terminate the Plan, including in any manner that adversely affects the rights of Participants. No Participant shall have any rights to payment of any amounts under this Plan unless and until the Committee determines the amount of such Participant’s Bonus, that such Bonus shall be paid and the method and timing of its payment.

(b) Nonassignability . No rights of any Participant (or of any beneficiary pursuant to this Section 7(b)) under the Plan may be sold, exchanged, transferred, assigned, pledged, hypothecated or otherwise disposed of (including through the use of any cash-settled instrument), either voluntarily or involuntarily by operation of law, other than by will or by the laws of descent and distribution. Any sale, exchange, transfer, assignment, pledge, hypothecation or other disposition in violation of the provisions of this Section 7(b) shall be void. In the event of a Participant’s death, any amounts payable under the Plan shall be paid in accordance with the Plan to a Participant’s estate. A Participant’s estate shall have no rights under the Plan to receive such amounts, if any, as may be payable under this Section 7(b), and all of the terms of this Plan shall be binding upon any such Participant’s estate.

(c) Plan Creates No Employment Rights . Nothing in the Plan shall confer upon any Participant the right to continue in the employ of the Company for the Performance Period or thereafter or affect any right which the Company may have to terminate such employment.

(d) Arbitration . Any dispute, controversy or claim between the Company and any Participant arising out of or relating to or concerning the provisions of the Plan shall be finally settled by arbitration in Orange County, California before, and in accordance with, the rules then obtaining of the American Arbitration Association (the “ AAA ”) in accordance with the commercial arbitration rules of the AAA. Prior to arbitration, all disputes, controversies or claims maintained by any Participant must first be submitted to the Committee in accordance with claim procedures determined by the Committee in its sole discretion.

(e) Governing Law. ALL RIGHTS AND OBLIGATIONS UNDER THE PLAN SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF CALIFORNIA, WITHOUT REGARD TO PRINCIPLES OF CONFLICT OF LAWS.

(f) Tax Withholding . In connection with any payments to a Participant or other event under the Plan that gives rise to a federal, state, local or other tax withholding obligation relating to the Plan (including, without limitation, FICA tax), (i) the Company and any Participating Employer may deduct or withhold (or cause to be deducted or withheld) from any payment or distribution to such Participant whether or not pursuant to the Plan or (ii) the Committee shall be entitled to require that such Participant remit cash (through payroll deduction or otherwise), in each case in an amount sufficient in the opinion of the Company to satisfy such withholding obligation.

(g) Right of Offset . The Company and any Participating Employer shall have the right to offset against the obligation to pay a Bonus to any Participant, any outstanding amounts (including, without limitation, travel and entertainment or advance account balances, loans or amounts repayable to it pursuant to tax equalization, housing, automobile or other employee programs) such Participant then owes to it.

(h) Severability; Entire Agreement . If any of the provisions of this Plan is finally held to be invalid, illegal or unenforceable (whether in whole or in part), such provision shall be deemed modified to the extent, but only to the extent, of such invalidity, illegality or unenforceability and the remaining provisions shall not be affected thereby. This Plan shall not supersede any other agreement, written or oral, pertaining to the matters covered herein, except to the extent of any inconsistency between this Plan and any prior agreement, in which case this Plan shall prevail.

(i) No Third Party Beneficiaries . The Plan shall not confer on any person other than the Company and any Participant any rights or remedies hereunder.

(j) Participating Employers . Each subsidiary or affiliate of the Company that employs a Participant (a “ Participating Employer ”) shall adopt this Plan by executing Schedule A . Except for purposes of determining the amount of each Participant’s Bonus, this Plan shall be treated as a separate plan maintained by each Participating Employer and the obligation to pay the Bonus to each Participant shall be the sole liability of the Participating Employer(s) by which the Participant is employed, and neither the Company nor any other Participating Employer shall have any liability with respect to such amounts.

(k) Successors and Assigns . The terms of this Plan shall be binding upon and inure to the benefit of the Company, each Participating Employer and their successors and assigns and each permitted successor or assign of each Participant as provided in Section 7(b).

(l) Plan Headings . The headings in this Plan are for the purpose of convenience only and are not intended to define or limit the construction of the provisions hereof.

(m) Construction . In the construction of this Plan, the singular shall include the plural, and vice versa, in all cases where such meanings would be appropriate. Nothing in this Plan shall preclude or limit the ability of the Company, its subsidiaries and affiliates to pay any compensation to a Participant under any other plan or compensatory arrangement whether or not in effect on the date this Plan was adopted.

IN WITNESS WHEREOF, and as evidence of the adoption of this Plan effective as of , 2004, by the Company, it has caused the same to be signed by its duly authorized officer this day of , 2004.


SUNSTONE HOTEL INVESTORS, INC.

By:
Name:
Title:

Schedule A

As evidenced by the duly authorized signature below, the undersigned entity hereby adopts and elects to participate in the Sunstone Hotel Investors, Inc. Senior Management Incentive Plan, as such Plan may be amended from time to time, and appoints Sunstone Hotel Investors, Inc. as its agent to do all things necessary to effect such participation.

[ Name of Entity ]



By:
Name:
Title		Authorized Person

Exhibit 10.15

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT (this “ Agreement ”), effective as of the Effective Date (as defined below), is entered into by and among Sunstone Hotel Investors, Inc., a Maryland corporation (“ Sunstone ”), Sunstone Hotel Partnership, LLC, a Delaware limited liability company (the “ Operating Partnership ”), and Robert A. Alter (the “ Executive ”).

WHEREAS, Sunstone and the Operating Partnership (collectively, the “ Company ”) desire to employ the Executive and to enter into an agreement embodying the terms of such employment; and

WHEREAS, the Executive desires to accept employment with the Company, subject to the terms and conditions of this Agreement.

NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:

1. Employment Period . Subject to the provisions for earlier termination hereinafter provided, the Executive’s employment hereunder shall be for a term (the “ Employment Period ”) commencing on the Effective Date and ending on the third anniversary of the Effective Date (the “ Initial Termination Date ”); provided, however , that this Agreement shall be automatically extended for one additional year on the Initial Termination Date and on each subsequent anniversary of the Initial Termination Date, unless either the Executive or the Company elects not to so extend the term of the Agreement by notifying the other party, in writing, of such election not less than ninety (90) days prior to the last day of the term as then in effect. For the avoidance of doubt, non-renewal of the Agreement pursuant to the proviso contained in the preceding sentence shall not be deemed to give rise to any payment to the Executive as might be the case in connection with a termination of this Agreement. For purposes of this Agreement, “ Effective Date ” shall mean the date of the closing of the initial public offering of shares of Sunstone’s common stock.

2. Terms of Employment .

(a) Position and Duties .

(i) During the Employment Period, subject to the last sentence of this subsection (i), the Executive shall serve as President and Chief Executive Officer of Sunstone and the Operating Partnership and shall perform such employment duties as are usual and customary for such positions and such other duties as the Board of Directors of Sunstone (the “ Board ”) shall from time to time reasonably assign to the Executive. The Executive shall report directly to the Board. At the Board’s request, the Executive shall serve the Company and/or its subsidiaries and affiliates in other offices and capacities in addition to the foregoing, provided that his duties and responsibilities shall be commensurate with his position. In the event that the Executive, during the Employment Period, serves in any one or more of such additional capacities, the Executive’s compensation shall not be increased beyond that specified in Section 2(b) of this Agreement. In addition, in the event the Executive’s service in one or more of such additional capacities is subsequently terminated, the Executive’s compensation, as specified in Section 2(b) of this Agreement, shall not be diminished or reduced in any manner as

a result of such termination for so long as the Executive otherwise remains employed under the terms of this Agreement. Notwithstanding the foregoing, the Executive acknowledges that during the Term the Company may seek to and may retain another individual to serve as the President and Chief Executive Officer of the Company (a “ Change in Circumstances ”). If during the Term there occurs a Change in Circumstances for any reason other than the termination of the Executive’s employment with the Company by the Company or the Executive pursuant to the terms hereof, then, for purposes hereof, this Agreement shall be deemed modified so that the Executive shall serve solely as the Chairman of the Company and shall perform such duties as are usual and customary for such position. The Executive may not terminate this Agreement for Good Reason (defined below) as a result of a Change in Circumstances.

(ii) During the Employment Period, and excluding any periods of vacation and sick leave to which the Executive is entitled, the Executive agrees to devote substantially all of his business time, energy, skill and best efforts to the performance of his duties hereunder in a manner that will faithfully and diligently further the business and interests of the Company. Notwithstanding the foregoing, during the Employment Period it shall not be a violation of this Agreement for the Executive to (A) serve on corporate, civic or charitable boards or committees consistent with the Company’s conflicts of interests policies and corporate governance guidelines in effect from time to time, (B) deliver lectures or fulfill speaking engagements or (C) manage his personal investments, so long as such activities do not interfere with the performance of the Executive’s responsibilities as an executive officer of the Company. It is expressly understood and agreed that to the extent that any such activities have been conducted by the Executive prior to the Effective Date and fully disclosed in writing and agreed to by the Company in writing, the continued conduct of such activities subsequent to the Effective Date shall not thereafter be deemed to interfere with the performance of the Executive’s responsibilities to the Company; provided, however, that no such activity shall be permitted that violates any written non-competition agreement between the parties or prevents the Executive from devoting substantially all of his business time to the fulfillment of his duties hereunder.

(iii) The Executive agrees that he will not take personal advantage of any business opportunity that arises during his employment by the Company and which may be of benefit to the Company unless all material facts regarding such opportunity are promptly reported by the Executive to the Board for consideration by the Company and the disinterested members of the Board determine to reject the opportunity and to authorize the Executive’s participation therein.

(b) Compensation .

(i) Base Salary . During the Employment Period, the Executive shall receive a base salary (the “ Base Salary ”) of $550,000 per annum, as the same may be increased thereafter. Notwithstanding the foregoing, if there should occur a Change in Circumstances, then for all purposes under this Agreement, the Base Salary shall equal $275,000 per annum. The Base Salary shall be paid at such intervals as the Company pays executive salaries generally. During the Employment Period, the Base Salary shall be reviewed at least annually for possible increase (but not decrease) in the Company’s sole discretion, as determined by the Company’s compensation committee; provided, however, that the Executive shall be entitled to any annual cost-of-living increases in Base Salary that are granted to senior executives of the Company

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generally. Any increase in Base Salary shall not serve to limit or reduce any other obligation to the Executive under this Agreement. The term “Base Salary” as utilized in this Agreement shall refer to Base Salary as so adjusted.

(ii) Annual Bonus . In addition to the Base Salary, the Executive shall be eligible to earn, for each fiscal year of the Company ending during the Employment Period, an annual cash performance bonus (an “ Annual Bonus ”) under the Company’s bonus plan or plans applicable to senior executives. The amount of the Annual Bonus and the performance goals applicable to the Annual Bonus for any applicable Employment Period shall be determined in accordance with the terms and conditions of said bonus plan as in effect from time to time with the following targets: (1) minimum target equal to 40% of Base Salary ; (2) mid-point target equal to 100% of Base Salary (“ Target Annual Bonus ”), however, in the first year after the Effective Date, the Target Annual Bonus shall equal 75% of Base Salary; and (3) maximum target equal to 125% of Base Salary ; provided, however, that no minimum bonus is guaranteed. Notwithstanding the foregoing, for the period beginning on the Effective Date and ending on December 31, 2004, the Executive will receive a bonus of $365,000 (“ 2004 Bonus ”), which 2004 Bonus shall be paid no later than March 15, 2005. The terms and conditions of any such bonus plan shall be determined by Sunstone’s compensation committee in its sole discretion.

(iii) Restricted Stock Units Award . Subject to adoption by the Board and approval by Sunstone’s stockholders of Sunstone’s 2004 Stock Option And Incentive Plan (the “Incentive Plan”), Sunstone shall, as of the Effective Date, grant the Executive two hundred ten thousand five hundred twenty-six ( 210,526 ) restricted stock units (the “ Restricted Stock Units ”) Said number of Restricted Stock Units shall not change notwithstanding that the actual initial public offering price of a share of Sunstone’s common stock may be higher or lower than $19.00 per share. Subject to the Executive’s continued employment with the Company, (i) 25.0% of the number of shares of Restricted Stock Units granted to the Executive shall vest on the Effective Date, (ii) 15.0% of the number of Restricted Stock Units granted to the Executive shall vest on the second anniversary of the Effective Date, (iii) 20.0% of the number of Restricted Stock Units granted to the Executive shall vest on the third anniversary of the Effective Date, and (vi) 40% of the number of Restricted Stock Units shall vest in increments equal to 1/24 ^th of the number of such Restricted Stock Units at the end of each successive calendar month following the third anniversary of the Effective Date that the Executive remains employed by the Company pursuant hereto. Notwithstanding the foregoing, if a Change in Circumstances should occur during the Term, one-half of any then unvested Restricted Stock Units shall be canceled without any further action on behalf of the Company, and the remaining unvested Restricted Stock Units shall vest proportionately in accordance with the foregoing vesting schedule. Consistent with the foregoing, the terms and conditions of the Restricted Stock Units shall be set forth in a restricted stock unit agreement (the “ Restricted Stock Unit Agreement ”) to be entered into by Sunstone and the Executive in the form adopted by the Board or the compensation committee of the Company, as applicable, in conjunction with the adoption of the Incentive Plan.

(iv) Incentive, Savings and Retirement Plans . During the Employment Period, the Executive shall be eligible to participate in all other incentive plans, practices, policies and programs, and all savings and retirement plans, policies and programs, in each case that are applicable generally to senior executives of the Company.

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(v) Welfare Benefit Plans . During the Employment Period, the Executive and the Executive’s eligible family members shall be eligible for participation in the welfare benefit plans, practices, policies and programs (including, if applicable, medical, dental, vision, disability, employee life, group life and accidental death insurance plans and programs) maintained by the Company for its senior executives.

(vi) Business Expenses . During the Employment Period, the Executive shall be entitled to receive prompt reimbursement for all reasonable business expenses incurred by the Executive in accordance with the policies, practices and procedures of the Company provided to senior executives of the Company.

(vii) Fringe Benefits . During the Employment Period, the Executive shall be entitled to such fringe benefits and perquisites as are provided by the Company to its senior executives from time to time, in accordance with the policies, practices and procedures of the Company. At a minimum, Executive shall continue to receive all benefits presently provided by the Predecessor Company, including, but not limited to, the split-dollar life insurance policy matching deferred compensation program carried over from the prior Sunstone Hotel Investors, Inc.

(viii) Vacation . During the Employment Period, the Executive shall be entitled to paid vacation of four weeks in each calendar year in accordance with the plans, policies, programs and practices of the Company applicable to its senior executives.

(ix) Indemnification Agreement . On the Effective Date, Sunstone and the Executive shall enter into an indemnification agreement in the form adopted by the Board for the officers of Sunstone and which contains customary terms and conditions for a public company.

(c) Additional Agreements . As a condition to the Company entering into this Agreement, the Executive shall concurrently herewith enter into a (i) Non-Disclosure Agreement with the Company (the “ Non-Disclosure Agreement ”), a form of which is set forth as Exhibit B hereto, and (ii) a Noncompetition Agreement with the Company (the “ Noncompetition Agreement ”), a form of which is set forth as Exhibit C hereto.

3. Termination of Employment:

(a) Death or Disability . The Executive’s employment shall terminate automatically upon the Executive’s death or Disability during the Employment Period. For purposes of this Agreement, “ Disability ” means Executive’s inability by reason of physical or mental illness to fulfill his obligations hereunder for 90 consecutive days or on a total of 150 days in any 12-month period which, in the reasonable opinion of an independent physician selected by the Company or its insurers and reasonably acceptable to the Executive or the Executive’s legal representative, renders Executive unable to perform the essential functions of his job, even after reasonable accommodations are made by the Company. The Company is not, however, required to make unreasonable accommodations for Executive or accommodations that would create an undue hardship on the Company.

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(b) Cause . The Company may terminate the Executive’s employment during the Employment Period for Cause or without Cause. For purposes of this Agreement, “ Cause ” shall mean the occurrence of any one or more of the following events:

(i) The Executive’s willful failure to perform or gross negligence in performing his duties owed to the Company, after ten (10) days following a written notice being delivered to the Executive by the Board, which notice specifies such failure or negligence;

(ii) The Executive’s commission of an act of fraud or dishonesty in the performance of his duties;

(iii) The Executive’s conviction of, or entry by the Executive of a guilty or no contest plea to, any felony or any felony or misdemeanor involving moral turpitude;

(iv) Any breach by the Executive of his fiduciary duty or duty of loyalty to the Company; or

(v) The Executive’s material breach of any of the provisions of this Agreement, which is not cured within ten (10) days following written notice thereof from the Company, or any breach of the Non-Competition Agreement or the Non-Disclosure Agreement.

The termination of employment of the Executive shall not be deemed to be for Cause unless and until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of a majority the Board at a meeting of the Board called and held for such purpose (after reasonable notice is provided to the Executive and the Executive is given an opportunity to be heard before the Board), finding that, in the good faith opinion of the Board, sufficient Cause exists to terminate the Executive pursuant to this Section 3(b) ; provided , that if the Executive is a member of the Board, the Executive shall not participate in the deliberations regarding such resolution, vote on such resolution, nor shall the Executive be counted in determining a majority of the Board.

(c) Good Reason . The Executive’s employment may be terminated by the Executive for Good Reason or by the Executive without Good Reason. For purposes of this Agreement, “ Good Reason ” shall mean the occurrence of any one or more of the following events without the Executive’s prior written consent, unless the Company cures the circumstances constituting Good Reason (provided such circumstances are capable of cure) prior to the Date of Termination (as defined below):

(i) Other than in connection with a Change in Circumstances, a material reduction in the Executive’s titles, duties, authority and responsibilities, or the assignment to the Executive of any duties materially inconsistent with the Executive’s position, authority, duties or responsibilities without the written consent of the Executive;

(ii) Other than in connection with a Change in Circumstances, the Company’s reduction of the Executive’s annual Base Salary or bonus opportunity as in effect or as may be increased from time to time;

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(iii) The relocation of the Company’s headquarters to a location more than thirty five (35) miles from the Company’s current headquarters in San Clemente, California; or

(iv) the Company’s failure to cure a material breach of its obligations under this Agreement within fifteen (15) days after written notice is delivered to the Board by the Executive which specifically identifies the manner in which the Executive believes that the Company has breached its obligations under this Agreement.

(d) Notice of Termination . Any termination by the Company for Cause, or by the Executive for Good Reason, shall be communicated by Notice of Termination to the other parties hereto given in accordance with Section 12(c) of this Agreement. For purposes of this Agreement, a “ Notice of Termination ” means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive’s employment under the provision so indicated and (iii) if the Date of Termination (as defined below) is other than the date of receipt of such notice, specifies the termination date (which date shall be not more than thirty (30) days after the giving of such notice). The failure by the Executive or the Company to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or Cause shall not waive any right of the Executive or the Company, respectively, hereunder or preclude the Executive or the Company, respectively, from asserting such fact or circumstance in enforcing the Executive’s or the Company’s rights hereunder.

(e) Date of Termination . “ Date of Termination ” means (i) if the Executive’s employment is terminated by the Company for Cause, the date of receipt of the Notice of Termination or any later date specified therein (which date shall not be more than thirty (30) days after the giving of such notice), as the case may be, (ii) if the Executive’s employment is terminated by the Company other than for Cause or Disability, the Date of Termination shall be the date on which the Company notifies the Executive of such termination, (iii) if the Executive’s employment is terminated by the Executive with or without Good Reason, the Date of Termination shall be the thirtieth day after the date on which the Executive notifies the Company of such termination, unless otherwise agreed by the Company and the Executive, and (iv) if the Executive’s employment is terminated by reason of death or Disability, the Date of Termination shall be the date of death or Disability of the Executive, as the case may be.

4. Obligation of the Company Upon Termination .

(a) Without Cause or For Good Reason . If, during the Employment Period, the Company shall terminate the Executive’s employment without Cause or the Executive shall terminate his employment for Good Reason:

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Termination to the extent not previously paid (the “ Accrued Obligations ”), and (B) an amount (the “ Severance Amount ”) equal to one (1) times the sum of (x) the Base Salary in effect on the Date of Termination plus (y) the Bonus Severance Amount (as defined below) in effect on the Date of Termination. For purposes hereof, the Bonus Severance Amount shall equal: (A) if the Date of Termination is on or prior to December 31, 2004, the 2004 Bonus, (B) if the Date of Termination is during the calendar year 2005, the Target Annual Bonus for such year and (C) if the Date of Termination is during the remainder of the Employment Period, the lesser of the Target Annual Bonus for the year in which the Date of Termination takes place or the actual Annual Bonus that the Executive earned in the prior calendar year. The Accrued Obligations shall be paid when due under California law and the Severance Amount shall be paid no later than 60 days after the Date of Termination.

(ii) For a period of eighteen (18) months following the Termination Date, the Company shall, at the Company’s sole expense, continue to provide the Executive and the Executive’s eligible family members with group health insurance coverage at least equal to that which would have been provided to them if the Executive’s employment had not been terminated (or at the Company’s election, pay the applicable COBRA premium for such coverage); provided, however , that if the Executive becomes re-employed with another employer and is eligible to receive group health insurance coverage under another employer’s plans, the Company’s obligations under this Section 4(a)(iii) shall be reduced to the extent comparable coverage is actually available to the Executive and the Executive’s eligible family members, and any such coverage shall be reported by the Executive to the Company.

(iii) All outstanding stock options, restricted stock units and other equity awards granted to the Executive under any of the Company’s equity incentive plans (or awards substituted therefore covering the securities of a successor company) shall be modified to reflect an additional twelve (12) months of vesting.

(iv) To the extent not theretofore paid or provided, the Company shall timely pay or provide to the Executive any vested benefits and other amounts or benefits required to be paid or provided or which the Executive is eligible to receive as of the Termination Date under any plan, program, policy or practice or contract or agreement of the Company and its affiliates (such other amounts and benefits shall be hereinafter referred to as the “ Other Benefits ”). Notwithstanding the foregoing, it shall be a condition to the Executive’s right to receive the amounts and benefits provided for in Sections 4(a)(i)(B), 4(a)(ii) and 4(a)(iii) above that the Executive execute, deliver to the Company and not revoke a release of claims in substantially the form attached hereto as Exhibit A .

(b) For Cause or Without Good Reason . If the Executive’s employment shall be terminated by the Company for Cause or by the Executive without Good Reason during the Employment Period, the Company shall have no further obligations to the Executive under this Agreement other than pursuant to Sections 7 and 8 hereof, and the obligation to pay to the Executive the Accrued Obligations, and to provide the Other Benefits. If the Executive’s employment shall be terminated by the Company for Cause any Restricted Stock Units or other equity awards granted to the Executive shall immediately cease vesting and shall terminate and be of no further force or effect.

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(c) Death or Disability . If the Executive’s employment is terminated by reason of the Executive’s death or Disability during the Employment Period:

(i) The Accrued Obligations shall be paid to the Executive’s estate or beneficiaries or to the Executive, as applicable, in cash within 30 days of the Date of Termination;

(ii) 100% of the Executive’s annual Base Salary, as in effect on the Date of Termination, shall be paid to the Executive’s estate or beneficiaries or to the Executive, as applicable, in cash within 30 days of the Date of Termination;

(iv) For a period of eighteen (18) months following the Date of Termination, the Executive and the Executive’s eligible family members shall continue to be provided, at the Company’s sole expense, with group health insurance coverage at least equal to that which would have been provided to them if the Executive’s employment had not been terminated (or at the Company’s election, pay the applicable COBRA premium for such coverage); provided, however , that if the Executive becomes re-employed with another employer and is eligible to receive group health insurance coverage under another employer’s plans, the Company’s obligations under this Section 4(d)(iv) shall be reduced to the extent comparable coverage is actually available to the Executive and the Executive’s eligible family members, and any such coverage shall be reported by the Executive to the Company; and

(v) The Other Benefits shall be paid or provided to the Executive on a timely basis.

(i) Any transaction or event resulting in the beneficial ownership of voting securities, directly or indirectly, by any “person” or “group” (as those terms are defined in Sections 3(a)(9), 13(d), and 14(d) of the Exchange Act and the rules thereunder) having “beneficial ownership” (as determined pursuant to Rule 13d-3 under the Exchange Act) of securities entitled to vote generally in the election of directors (“voting securities”) of Sunstone that represent greater than 50% of the combined voting power of Sunstone’s then outstanding voting securities (unless Executive has beneficial ownership of at least 50% of such voting securities), other than any transaction or event resulting in the beneficial ownership of securities:

(A) By a trustee or other fiduciary holding securities under any employee benefit plan (or related trust) sponsored or maintained by Sunstone or any person controlled by Sunstone or by any employee benefit plan (or related trust) sponsored or maintained by Sunstone or any person controlled by Sunstone, or

(B) By Sunstone or a corporation owned, directly or indirectly, by the stockholders of Sunstone in substantially the same proportions as their ownership of the stock of Sunstone, or

(ii) Individuals who, as of the Effective Date, constitute the Board (the “ Incumbent Board ”) cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election by Sunstone’s stockholders, or nomination for election by the Board, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an election contest with respect to the election or removal of directors or other solicitation of proxies or consents by or on behalf of a person other than the Board;

(iii) The consummation by Sunstone (whether directly involving Sunstone or indirectly involving Sunstone through one or more intermediaries) of (x) a merger, consolidation, reorganization, or business combination or (y) a sale or other disposition of all or substantially all of Sunstone’s assets or (z) the acquisition of assets or stock of another entity, in each case, other than a transaction

(A) which results in Sunstone’s voting securities outstanding immediately before the transaction continuing to represent (either by remaining outstanding or by being converted into voting securities of Sunstone or the person that, as a result of the transaction, controls, directly or indirectly, Sunstone or owns, directly or indirectly, all or substantially all of Sunstone’s assets or otherwise succeeds to the business of Sunstone (Sunstone or such person, the “Successor Entity”)) directly or indirectly, greater than 50% of the combined voting power of the Successor Entity’s outstanding voting securities immediately after the transaction, and

(B) after which no person or group beneficially owns voting securities representing greater than 50% of the combined voting power of the Successor Entity; provided, however, that no person or group shall be treated for purposes of this clause (B) as beneficially owning greater than 50% of the combined voting power of the Successor Entity solely as a result of the voting power held in Sunstone prior to the consummation of the transaction; or

(iv) The approval by Sunstone’s stockholders of a liquidation or dissolution of Sunstone.

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For purposes of clause (i) above, the calculation of voting power shall be made as if the date of the acquisition were a record date for a vote of Sunstone’s stockholders, and for purposes of clause (iii) above, the calculation of voting power shall be made as if the date of the consummation of the transaction were a record date for a vote of Sunstone’s stockholders.

6. [ Intentionally omitted .]

7. Full Settlement . The Company’s obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company may have against the Executive or others. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under any of the provisions of this Agreement and except as expressly provided, such amounts shall not be reduced whether or not the Executive obtains other employment. If any party to this Agreement institutes any action, suit, counterclaim, appeal, arbitration or mediation for any relief against another party, declaratory or otherwise (collectively an “ Action ”), to enforce the terms hereof or to declare rights hereunder, then the Prevailing Party in such Action shall be entitled to recover from the other party all costs and expenses of the Action, including reasonable attorneys’ fees and costs (at the Prevailing Party’s attorneys’ then-prevailing rates) incurred in bringing and prosecuting or defending such Action and/or enforcing any judgment, order, ruling or award (collectively, a “ Decision ”) granted therein, all of which shall be deemed to have accrued on the commencement of such Action and shall be paid whether or not such Action is prosecuted to a Decision. Any Decision entered in such Action shall contain a specific provision providing for the recovery of attorneys’ fees and costs incurred in enforcing such Decision. A court or arbitrator shall fix the amount of reasonable attorneys’ fees and costs upon the request of either party. Any judgment or order entered in any final judgment shall contain a specific provision providing for the recovery of all costs and expenses of suit, including reasonable attorneys’ fees and expert fees and costs incurred in enforcing, perfecting and executing such judgment. For the purposes of this paragraph, costs shall include, without limitation, in addition to costs incurred in prosecution or defense of the underlying action, reasonable attorneys’ fees, costs, expenses and expert fees and costs incurred in the following: (a) postjudgment motions and collection actions; (b) contempt proceedings; (c) garnishment, levy, debtor and third party examinations; (d) discovery; (e) bankruptcy litigation; and (f) appeals of any order or judgment. “ Prevailing Party ” within the meaning of this Section includes, without limitation, a party who agrees to dismiss an Action (excluding an Action instituted in contravention of the requirements of Paragraph 12(b) below) in consideration for the other party’s payment of the amounts allegedly due or performance of the covenants allegedly breached, or obtains substantially the relief sought by such party.

8. Certain Additional Payments by the Company .

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imposed upon the Excise Tax Gross-Up Payment, the Executive retains an amount of the Excise Tax Gross-Up Payment equal to the Excise Tax imposed upon the Payments. Notwithstanding the foregoing provisions of this Section 8(a) , if it shall be determined that the Executive is entitled to the Excise Tax Gross-Up Payment, but that the Parachute Value of all Payments does not exceed 110% of the Safe Harbor Amount, then no Excise Tax Gross-Up Payment shall be made to the Executive and the amounts payable under this Agreement shall be reduced so that the Parachute Value of all Payments, in the aggregate, equals the Safe Harbor Amount. The reduction of the amounts payable hereunder, if applicable, shall be made by first reducing the payments under Section 4(a)(i) , unless an alternative method of reduction is elected by the Executive, and in any event shall be made in such a manner as to maximize the Value of all Payments actually made to the Executive. For purposes of reducing the Payments to the Safe Harbor Amount, only amounts payable under this Agreement (and no other Payments) shall be reduced. If the reduction of the amount payable under this Agreement would not result in a reduction of the Parachute Value of all Payments to the Safe Harbor Amount, no amounts payable under the Agreement shall be reduced pursuant to this Section 8(a ). The Company’s obligation to make Excise Tax Gross-Up Payments under this Section 8 shall not be conditioned upon the Executive’s termination of employment.

(b) Subject to the provisions of Section 8(c) , all determinations required to be made under this Section 8 , including whether and when an Excise Tax Gross-Up Payment is required, the amount of such Excise Tax Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by such nationally recognized accounting firm as may be selected by the Company and reasonably acceptable to the Executive (the “ Accounting Firm ”); provided , that the Accounting Firm’s determination shall be made based upon “substantial authority” within the meaning of Section 6662 of the Code. The Accounting Firm shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the receipt of notice from the Executive that there has been a Payment or such earlier time as is requested by the Company. All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Excise Tax Gross-Up Payment, as determined pursuant to this Section 8 , shall be paid by the Company to the Executive within five days of the receipt of the Accounting Firm’s determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive, unless the Company obtains an opinion of outside legal counsel, based upon at least “substantial authority” within the meaning of Section 6662 of the Code, reaching a different determination, in which event such legal opinion shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Excise Tax Gross-Up Payments that will not have been made by the Company should have been made (the “ Underpayment ”), consistent with the calculations required to be made hereunder. In the event the Company exhausts its remedies pursuant to Section 8(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive.

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later than 10 business days after the Executive is informed in writing of such claim. The Executive shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which the Executive gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that the Company desires to contest such claim, the Executive shall:

(i) give the Company any information reasonably requested by the Company relating to such claim,

(ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to-time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company,

(iii) cooperate with the Company in good faith in order effectively to contest such claim, and

(iv) permit the Company to participate in any proceedings relating to such claim;

provided, however , that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such-contest, and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 8(c) , the Company shall control all proceedings taken in connection with such contest, and, at its sole discretion, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the applicable taxing authority in respect of such claim and may, at its sole discretion, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however , that, if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis, and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties) imposed with respect to such advance or with respect to any imputed income in connection with such advance; and provided, further , that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company’s control of the contest shall be limited to issues with respect to which the Excise Tax Gross-Up Payment would be payable hereunder, and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority.

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(d) If, after the receipt by the Executive of an Excise Tax Gross-Up Payment or an amount advanced by the Company pursuant to Section 8(c) , the Executive becomes entitled to receive any refund with respect to the Excise Tax to which such Excise Tax Gross-Up Payment relates or with respect to such claim, the Executive shall (subject to the Company’s complying with the requirements of Section 8(c) , if applicable) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 8(c) , a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial of refund prior to the expiration of 30 days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Excise Tax Gross-Up Payment required to be paid.

(e) Notwithstanding any other provision of this Section 8 , the Company may, in its sole discretion, withhold and pay over to the Internal Revenue Service or any other applicable taxing authority, for the benefit of the Executive, all or any portion of any Excise Tax Gross-Up Payment, and the Executive hereby consents to such withholding.

(f) Any other liability for unpaid or unwithheld Excise Taxes shall be borne exclusively by the Company, in accordance with Section 3403 of the Code. The foregoing sentence shall not in any manner relieve the Company of any of its obligations under this Employment Agreement.

(g) Definitions . The following terms shall have the following meanings for purposes of this Section 8 :

(i) “ Excise Tax ” shall mean the excise tax imposed by Section 4999 of the Code, together with any interest or penalties imposed with respect to such excise tax.

(ii) “ Parachute Value ” of a Payment shall mean the present value as of the date of the change of control for purposes of Section 280G of the Code of the portion of such Payment that constitutes a “parachute payment” under Section 280G(b)(2), as determined by the Accounting Firm for purposes of determining whether and to what extent the Excise Tax will apply to such Payment.

(iii) A “ Payment ” shall mean any payment or distribution in the nature of compensation (within the meaning of Section 280G(b)(2) of the Code) to or for the benefit of the Executive, which is paid or payable pursuant to this Agreement or any other plan or agreement of the Company.

(iv) The “ Safe Harbor Amount ” shall mean 2.99 times the Executive’s “base amount,” within the meaning of Section 280G(b)(3) of the Code.

(v) “ Value ” of a Payment shall mean the economic present value of a Payment as of the date of the change of control for purposes of Section 280G of the Code, as determined by the Accounting Firm using the discount rate required by Section 280G(d)(4) of the Code.

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9. [Intentionally omitted]

10. Successors .

(a) This Agreement is personal to the Executive and without the prior written consent of the Company shall not be assignable by the Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by the Executive’s legal representatives.

(b) This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns.

(c) The Company will require any successor (whether direct or indirect, by purchase merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. As used in this Agreement, “Company” shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise.

11. Payment of Financial Obligations . The payment or provision to the Executive by the Company of any remuneration, benefits or other financial obligations pursuant to this Agreement shall be allocated to the Operating Partnership, Sunstone, Sunstone Hotel TRS Lessee, Inc. and, if applicable, any of their respective subsidiaries and/or affiliates in accordance with any employee sharing and expense allocation agreement, by and between Sunstone and the Operating Partnership, as in effect from time to time.

12. Miscellaneous .

(a) Governing Law . This Agreement shall be governed by and construed in accordance with the laws of the State of California, without reference to principles of conflict of laws. The captions of this Agreement are not part of the provisions hereof and shall have no force or effect. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives.

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excess of the filing fees required by a federal or state court with jurisdiction. The Company shall pay the arbitrator’s fees and any AAA administrative expenses. Any judgment upon the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. Possible disputes covered by the above include (but are not limited to) unpaid wages, breach of contract, torts, violation of public policy, discrimination, harassment, or any other employment-related claims under laws including but not limited to, Title VII of the Civil Rights Act of 1964, the Americans With Disabilities Act, the Age Discrimination in Employment Act, the California Fair Employment and Housing Act, the California Labor Code, and any other statutes or laws relating to an employee’s relationship with his/her employer, regardless of whether such dispute is initiated by the Executive or the Company. Thus, this bilateral arbitration agreement applies to any and all claims that the Company may have against the Executive, including but not limited to, claims for misappropriation of Company property, disclosure of proprietary information or trade secrets, interference with contract, trade libel, gross negligence, or any other claim for alleged wrongful conduct or breach of the duty of loyalty by the Executive. However, notwithstanding anything to the contrary contained herein, Company and Executive shall have their respective rights to seek and obtain injunctive relief with respect to any controversy, claim or dispute to the extent permitted by law. Claims for workers’ compensation benefits and unemployment insurance (or any other claims where mandatory arbitration is prohibited by law) are not covered by this arbitration agreement, and such claims may be presented by either Executive or the Company to the appropriate court or government agency. BY AGREEING TO THIS BINDING ARBITRATION PROVISION, BOTH EXECUTIVE AND THE COMPANY GIVE UP ALL RIGHTS TO TRIAL BY JURY. This arbitration agreement is to be construed as broadly as is permissible under applicable law.

(c) Notices . All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows:

If to the Executive : at the Executive’s most recent address on the records of the Company,

If to Sunstone or the Operating Partnership :

Sunstone Hotel Investors, Inc.

903 Calle America, Suite 100

San Clemente, CA 92673

Attn: Corporate Secretary

with a copy to:

Allen Matkins Leck Gamble & Mallory LLP

515 South Figueroa Street

Seventh Floor

Los Angeles, CA 90071-3398

Attn: Michael F. Sfregola

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or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.

(d) Sarbanes-Oxley Act of 2002 . Notwithstanding anything herein to the contrary, if the Company determines, in its good faith judgment, that any transfer or deemed transfer of funds hereunder is likely to be construed as a personal loan prohibited by Section 13(k) of the Exchange Act and the rules and regulations promulgated thereunder, then such transfer or deemed transfer shall not be made to the extent necessary or appropriate so as not to violate the Exchange Act and the rules and regulations promulgated thereunder.

(e) Severability . The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement. If any provision or term hereof is deemed to have exceeded applicable legal authority or shall be in conflict with applicable legal limitations, such provision shall be reformed and rewritten as necessary to achieve consistency with such applicable law.

(f) Withholding . The Company may withhold from any amounts payable under this Agreement such Federal, state, local or foreign taxes as shall be required to be withheld pursuant to any applicable law or regulation. In addition, notwithstanding any other provision of this Agreement, the Company may, in its sole discretion, withhold and pay over to the Internal Revenue Service or any other applicable taxing authority, for the benefit of the Executive, all or any portion of any Excise Tax Gross-Up Payment and the Executive hereby consents to such withholding.

(g) No Waiver . The Executive’s or the Company’s failure to insist upon strict compliance with any provision of this Agreement or the failure to assert any right the Executive or the Company may have hereunder, including, without limitation, the right of the Executive to terminate employment for Good Reason pursuant to Section 3(c) of this Agreement, shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement.

(h) Entire Agreement . As of the Effective Date, this Agreement, the Noncompetition Agreement and the Non-Disclosure Agreement, each of which is being entered into between the parties concurrently herewith, constitute the final, complete and exclusive agreement between the Executive and the Company with respect to the subject matter hereof and replaces and supersedes any and all other agreements, offers or promises, whether oral or written, made to Executive by any entity (a “ Predecessor Employer ”), or representative thereof, whose business or assets the Company succeeded to in connection with the initial public offering of the common stock of Sunstone or the transactions related thereto. The Executive agrees that any such agreement, offer or promise between the Executive and a Predecessor Employer (or any representative thereof) is hereby terminated and will be of no further force or effect, and the Executive acknowledges and agrees that upon his execution of this Agreement, he will have no right or interest in or with respect to any such agreement, offer or promise. In the event that the Effective Date does not occur, this Agreement (including, without limitation, the immediately preceding sentence) shall have no force or effect.

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(i) Representations and Warranties . The Executive represents and warrants to the Company that (i) this Agreement is valid and binding upon and enforceable against him in accordance with its terms, (ii) the Executive is not bound by or subject to any contractual or other obligation that would be violated by his execution or performance of this Agreement, including, but not limited to, any non-competition agreement presently in effect, and (iii) the Executive is not subject to any pending or, to the Executive’s knowledge, threatened claim, action, judgment, order, or investigation that could adversely affect his ability to perform his obligations under this Agreement or the business reputation of the Company. The Executive has not entered into, and agrees that he will not enter into, any agreement either written or oral in conflict herewith.

(j) Consultation with Counsel . The Executive acknowledges that he has had a full and complete opportunity to consult with counsel and other advisors of his own choosing concerning the terms, enforceability and implications of this Agreement, and that the Company has not made any representations or warranties to the Executive concerning the terms, enforceability or implications of this Agreement other than as reflected in this Agreement.

(k) Counterparts . This Agreement may be executed simultaneously in two counterparts, each of which shall be deemed an original but which together shall constitute one and the same instrument.

[signatures follow next page]

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IN WITNESS WHEREOF, the Executive has hereunto set the Executive’s hand and, pursuant to the authorization from the Board, the Company has caused these presents to be executed in its name on its behalf, all as of the day and year first above written.


SUNSTONE HOTEL INVESTORS, INC., a Maryland corporation

By:
		Name:
		Its:

SUNSTONE HOTEL PARTNERSHIP, LLC, a Delaware limited liability company

By:		Sunstone Hotel Investors, Inc.
		Its: Managing Member

By:
		Name:
		Its:

“EXECUTIVE”


Name:		Robert A. Alter

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EXHIBIT A

TO EMPLOYMENT AGREEMENT

GENERAL RELEASE

For a valuable consideration, the receipt and adequacy of which are hereby acknowledged, the undersigned does hereby release and forever discharge the “Releasees” hereunder, consisting of Sunstone Hotel Investors, Inc., a Maryland corporation, Sunstone Operating Partnership, LLC, a Delaware limited liability company and each of their partners, subsidiaries, associates, affiliates, successors, heirs, assigns, agents, directors, officers, employees, representatives, lawyers, insurers, and all persons acting by, through, under or in concert with them, or any of them, of and from any and all manner of action or actions, cause or causes of action, in law or in equity, suits, debts, liens, contracts, agreements, promises, liability, claims, demands, damages, losses, costs, attorneys’ fees or expenses, of any nature whatsoever, known or unknown, fixed or contingent (hereinafter called “ Claims ”), which the undersigned now has or may hereafter have against the Releasees, or any of them, by reason of any matter, cause, or thing whatsoever from the beginning of time to the date hereof. The Claims released herein include, without limiting the generality of the foregoing, any Claims in any way arising out of, based upon, or related to the employment or termination of employment of the undersigned by the Releasees, or any of them; any alleged breach of any express or implied contract of employment; any alleged torts or other alleged legal restrictions on Releasee’s right to terminate the employment of the undersigned; and any alleged violation of any federal, state or local statute or ordinance including, without limitation, Title VII of the Civil Rights Act of 1964, the Age Discrimination In Employment Act, the Americans With Disabilities Act, and the California Fair Employment and Housing Act.

THE UNDERSIGNED ACKNOWLEDGES THAT HE HAS BEEN ADVISED BY LEGAL COUNSEL AND IS FAMILIAR WITH THE PROVISIONS OF CALIFORNIA CIVIL CODE SECTION 1542, WHICH PROVIDES AS FOLLOWS:

“A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR.”

THE UNDERSIGNED, BEING AWARE OF SAID CODE SECTION, HEREBY EXPRESSLY WAIVES ANY RIGHTS HE MAY HAVE THEREUNDER, AS WELL AS UNDER ANY OTHER STATUTES OR COMMON LAW PRINCIPLES OF SIMILAR EFFECT.

IN ACCORDANCE WITH THE OLDER WORKERS BENEFIT PROTECTION ACT OF 1990, THE UNDERSIGNED IS HEREBY ADVISED AS FOLLOWS:

(A) HE HAS THE RIGHT TO CONSULT WITH AN ATTORNEY BEFORE SIGNING THIS RELEASE;

EXHIBIT A

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(B) HE HAS TWENTY-ONE (21) days TO CONSIDER THIS RELEASE BEFORE SIGNING IT; AND

(C) HE HAS SEVEN (7) days AFTER SIGNING THIS RELEASE TO REVOKE THIS RELEASE, AND THIS RELEASE WILL BECOME EFFECTIVE UPON THE EXPIRATION OF THAT REVOCATION PERIOD.

The undersigned represents and warrants that there has been no assignment or other transfer of any interest in any Claim which he may have against Releasees, or any of them, and the undersigned agrees to indemnify and hold Releasees, and each of them, harmless from any liability, Claims, demands, damages, costs, expenses and attorneys’ fees incurred by Releasees, or any of them, as the result of any such assignment or transfer or any rights or Claims under any such assignment or transfer. It is the intention of the parties that this indemnity does not require payment as a condition precedent to recovery by the Releasees against the undersigned under this indemnity.

The undersigned agrees that if he hereafter commences any suit arising out of, based upon, or relating to any of the Claims released hereunder or in any manner asserts against Releasees, or any of them, any of the Claims released hereunder, then the undersigned agrees to pay to Releasees, and each of them, in addition to any other damages caused to Releasees thereby, all attorneys’ fees incurred by Releasees in defending or otherwise responding to said suit or Claim.

The undersigned further understands and agrees that neither the payment of any sum of money nor the execution of this Release shall constitute or be construed as an admission of any liability whatsoever by the Releasees, or any of them, who have consistently taken the position that they have no liability whatsoever to the undersigned.

IN WITNESS WHEREOF, the undersigned has executed this Release this day of , 20 .

EXHIBIT A

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EXHIBIT B

TO EMPLOYMENT AGREEMENT

NON-DISCLOSURE AGREEMENT

This Non-Disclosure Agreement (“ Agreement ”) is made as of this day of , 2004 by and among Sunstone Hotel Investors, Inc., a Maryland corporation (“ Sunstone ”), and Sunstone Hotel Partnership, LLC, a Delaware limited liability company (“ Operating Partnership ”) (Sunstone and the Operating Partnership collectively, the “ Company ”), and Robert A. Alter (“ Executive ”).

For good and valuable consideration, Executive and Company hereby agree as follows:

1. This Agreement will be effective on , 2004.

2. Executive hereby assigns to Company all rights or interests that Executive may presently have or which may be acquired during the term of Executive’s employment with the Company, in Company “Proprietary Information” as defined below in Section 5, and acknowledges that all such Proprietary Information is the sole property of Company and its assigns.

3. Subject to the provisions of Section 7 hereof, in the event that, during the term of Executive’s employment with the Company, Executive creates or assists in the creation of any Company “Proprietary Information,” or any other Company intellectual property, and/or Executive prepares, accumulates or otherwise comes into possession of any materials or information during the course of performance of Executive’s duties which relate in any manner to Company’s business or development of services, Executive agrees that all such “Proprietary Information” and intellectual property shall be and remain the property of Company. In the event Executive’s employment with Company is terminated, for any reason, Executive shall promptly deliver to Company all such “Proprietary Information” and intellectual property (and any copies thereof), as well as any materials related to Company’s trade secrets or confidential information (and any copies thereof), which are within Executive’s custody or control.

4. Executive agrees to disclose to Company all “Proprietary Information” and intellectual property developed during the term of his employment, whether made solely or jointly with others, which relate to Company’s business, research, or development of products and services.

5. During the term of Executive’s employment with Company and thereafter, Executive will not offer or disclose by any means, or use in any manner, for Executive’s own benefit or the benefit of any other person or entity (other than Company or its affiliates), any Company “Proprietary Information” or Company intellectual property. As used herein, the terms “Proprietary Information,” “intellectual property” and “trade secrets,” shall include, but not be limited to: (a) all information of any kind regarding Company’s business, research, marketing, sales, operations and products and plans for development of new business products and services; (b) all operational designs and techniques related to business, marketing and financial information or data of any kind related to Company’s business and business opportunities; (c) all

EXHIBIT B

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information of any kind regarding Company’s suppliers, vendors, consultants, agents and customers, including lists or compilations of any such persons or entities; (d) all information of any kind regarding Company’s officers, directors and shareholders (other than Executive), including their respective abilities, functions, conduct or pay; (e) all proprietary information of any kind received or developed under agreement or other arrangement by Company with any third party; and (f) all unpublished materials received or developed, including all works of authorship, which relate to the business of Company, including but not limited to those concerning proprietary, trade secret or Company-private information, investment strategies, development plans, research and development data, and any other technical reports relating to Company’s business operations now existing or which may be developed during the term of Executive’s employment with Company.

6. Executive understands and agrees that a breach of the provisions contained herein could cause significant and irreparable harm to Company that could not be satisfactorily compensated in monetary terms. Accordingly, and without in any way limiting Company from taking any other legal action to which it may be entitled to under law or in equity, in the event of any such breach or threatened breach, Company will be entitled to injunctive relief including the immediate ex parte issuance, without bond, of a temporary restraining order against any such breach of threatened breach.

7. This Agreement shall not apply to: (a) any invention developed by Executive which qualifies under the provisions of California Labor Code, Section 2870; (b) any information which is or becomes publicly available, unless it becomes such as a result of a breach of this Agreement; (c) any information which Company subsequently discloses to any other person or entity without restriction; or (d) disclosure required by law or legal process; provided , that if Executive receives actual notice that the Executive is or may be required by law or legal process to disclose any such information, Executive shall promptly so notify Company, but in any event no more than five (5) days after the receipt of such notice.

8. No amendment or modification to this Agreement shall be valid unless in writing signed by Executive and an authorized officer of Company.

9. The execution of this Agreement shall not be construed in any manner to alter Executive’s employment with Company as provided in his Employment Agreement.

10. The waiver by any party of a breach of any provision of this Agreement will not operate or be construed as a waiver of any subsequent breach thereof or as a waiver of any other provisions of this Agreement. The remedies set forth herein are nonexclusive and are in addition to any other remedies that any party may have at law or in equity.

11. If any legal action, arbitration or other proceeding is brought for the enforcement of this Agreement, or because of an alleged dispute, breach or default in connection with any of the provisions of this Agreement, the prevailing party shall be entitled to recover attorneys’ fees and costs as set forth in the Employment Agreement.

EXHIBIT B

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12. All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows:

If to the Executive : at the Executive’s most recent address on the records of the Company,

If to the Company :

c/o Sunstone Hotel Investors, Inc.

903 Calle America, Suite 100

San Clemente, CA 92673

Attn: Corporate Secretary

with a copy to:

Allen Matkins Leck Gamble & Mallory LLP

515 South Figueroa Street

Seventh Floor

Los Angeles, CA 90071-3398

Attn: Michael F. Sfregola

or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.

13. This Agreement is entered into and shall be governed and interpreted in accordance with the laws of the State of California, without regard to or application of choice of law rules or principles. It shall be binding upon and inure to the benefit of the parties, and to their respective heirs, personal representatives, successors and assigns. In the event that any provision of this Agreement is found by a court, arbitrator or other tribunal to illegal, invalid or unenforceable, then the remaining provisions of this Agreement shall not be voided, but shall be enforced to the maximum extent permissible by law.

IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first set forth above.


“EXECUTIVE”	SUNSTONE HOTEL INVESTORS, INC., a Maryland corporation

	By:
Robert A. Alter		Name:
		Its:

EXHIBIT B

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SUNSTONE HOTEL PARTNERSHIP, LLC, a Delaware limited liability company

By:		Sunstone Hotel Investors, Inc. Its: Managing Member

By:
		Name:
		Its:

EXHIBIT B

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EXHIBIT C

TO EMPLOYMENT AGREEMENT

NONCOMPETITION AGREEMENT

THIS NONCOMPETITION AND NONSOLICITATION AGREEMENT (this “ Agreement ”) is dated as of , 2004, by and among Sunstone Hotel Investors, Inc., a Maryland corporation (“ Sunstone ”), Sunstone Hotel Partnership, LLC, a Delaware limited liability company (the “ Operating Partnership ”), and Robert A. Alter (the “ Executive ”). Sunstone and the Operating Partnership are collectively referred to herein as the “ Company .”

WHEREAS, certain entities in which the Executive directly or indirectly owns an interest have entered into a Structuring and Contribution Agreement, dated as of July 2, 2004, pursuant to which such entities agreed to contribute, or cause others to contribute, to the Operating Partnership, certain interests, as a partner or member, in certain partnerships and limited liability companies which hold interests in certain hotel properties, in exchange for units in the Operating Partnership;

WHEREAS, concurrently with the execution of this Agreement, the Company and the Executive have entered into (i) an employment agreement, pursuant to which the Company has agreed to employ the Executive, and the Executive has agreed to be employed by the Company (the “ Employment Agreement ”), and (ii) a non-disclosure agreement (the “ Non-Disclosure Agreement ”);

WHEREAS, subject to adoption by Sunstone’s Board of Directors and approval by Sunstone’s stockholders of the Company’s incentive award plan (the “ Incentive Plan ”), Sunstone shall, as of the effective date of the Employment Agreement, grant the Executive [ ( )] restricted stock units (the “ Restricted Stock Units ”), the terms and conditions of which shall be set forth in a restricted stock agreement (the “ Restricted Stock Unit Agreement ”) to be entered into by the Company and the Executive in the form adopted by Sunstone’s Board of Directors, or the compensation committee of the Company, as applicable, in conjunction with the adoption of the Incentive Plan;

WHEREAS, the Company and the Executive agree that, in connection with the execution of the Employment Agreement and the Executive’s employment and stock ownership in Sunstone pursuant to the Incentive Plan, the Executive will not engage in competition with the Company pursuant to the terms and conditions hereof;

WHEREAS , capitalized terms used herein without definition shall have the meanings ascribed thereto in the Employment Agreement.

NOW, THEREFORE, in furtherance of the foregoing and in exchange for good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, the parties hereto hereby agree as follows:

1. Noncompetition; Nonsolicitation.

(a) During the Employment Period and, if the Executive’s employment is terminated by the Company or the Executive terminates his employment for any reason, for one (1) year thereafter, the Executive shall not engage in Competition (as defined below) with the Company or any of its subsidiaries or affiliates.

(b) The term “ Competition ” for purposes of this Agreement shall mean the taking of any of the following actions by the Executive: (i) the conduct of, directly or indirectly

EXHIBIT C

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(including, without limitation, engaging in, assisting or performing services for), any business that engages in any activity which is directly competitive with the business of the Company, whether such business is conducted by the Executive individually or as principal, partner, officer, director, consultant, security holder, creditor, employee, stockholder, member or manager of any person, partnership, corporation, limited liability company or any other entity; and/or (ii) ownership of interests in any business which is competitive, directly or indirectly, with any business carried on by the Company (or any successor thereto) or its subsidiaries or affiliates; provided, however, that the term “ Competition ” shall be deemed to exclude (i) the direct or indirect ownership by the Executive of up to three percent of the outstanding equity interests of any public company, and (ii) the Executive’s existing ownership interests in hotel properties as such interests are disclosed in the Company’s Registration Statement on Form S-11 (No. 333 - 117141) filed with the Securities and Exchange Commission, as amended from time to time.

(c) During the Employment Period, and for one (1) year thereafter, the Executive shall not, directly or indirectly, solicit the employment of or employ any person who is then or has been within three (3) months prior to the time of such action, an employee of the Company, or any affiliate of either Sunstone or the Operating Partnership.

2. Specific Performance . The Executive acknowledges that in the event of breach or threatened breach by the Executive of the terms of Section 1 hereof, the Company could suffer significant and irreparable harm that could not be satisfactorily compensated in monetary terms, and that the remedies at law available to the Company may otherwise be inadequate and the Company shall be entitled, in addition to any other remedies to which it may be entitled to under law or in equity, to specific performance of this Agreement by the Executive including the immediate ex parte issuance, without bond, of a temporary restraining order enjoining the Executive from any such violation or threatened violation of Section 1 hereof and to exercise such remedies cumulatively or in conjunction with all other rights and remedies provided by law and not otherwise limited by this Agreement. The Executive hereby acknowledges and agrees that the Company shall not be required to post bond as a condition to obtaining or exercising any such remedies, and the Executive hereby waives any such requirement or condition.

3. Adequacy of Consideration . The Executive acknowledges that his receipt of the Restricted Stock Units pursuant to the Employment Agreement and the Restricted Stock Unit Agreement and the Executive’s indirect interests in units of the Operating Partnership will be full, fair and adequate to support his obligations hereunder.

4. Confidential Information; Intangible Assets and Goodwill . The Executive acknowledges and agrees that he has been and will be exposed to proprietary information, intellectual property and trade secrets concerning Sunstone’s business, as more fully described in the Non-Disclosure Agreement. The Executive expressly acknowledges and understands that Company and its affiliates would not have entered into the Restricted Stock Unit Agreement, or any other agreements with the Executive, but for the fact that the Executive is concurrently entering into the Employment Agreement.

5. Reasonableness of Covenants . The Executive agrees that all of the covenants contained in this Agreement are reasonably necessary to protect the legitimate interests of the Company and its affiliates, are reasonable with respect to time and territory and that he has read

EXHIBIT C

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and understands the descriptions of the covenants so as to be informed as to their meaning and scope.

6. Attorneys’ Fees . If any legal action, arbitration or other proceeding is brought for the enforcement of this Agreement, or because of an alleged dispute, breach or default in connection with any of the provisions of this Agreement, the prevailing party shall be entitled to recover attorneys’ fees and costs as set forth in the Employment Agreement.

7. No Alteration of Employment Status . The execution of this Agreement shall not be construed in any manner to alter the Executive’s employment with the Company as provided in the Employment Agreement.

8. Effect of Waiver . The waiver by either party of a breach of any provision of this Agreement will not operate or be construed as a waiver of any subsequent breach thereof or as a waiver of any other provision of this Agreement. The remedies set forth herein are nonexclusive and are in addition to any other remedies that the Company may have at law or in equity.

9. Severability . Any provision of this Agreement which is deemed invalid, illegal or unenforceable in any jurisdiction shall, as to that jurisdiction and subject to this paragraph, be ineffective to the extent of such invalidity, illegality or unenforceability, without affecting in any way the remaining provisions hereof in such jurisdiction or rendering that any other provisions of this Agreement invalid, illegal or unenforceable in any other jurisdiction. Notwithstanding the foregoing, if any provision of this Agreement should be deemed invalid, illegal or unenforceable because its scope or duration is considered excessive, such provision shall be modified so that the scope of the provision is reduced only to the minimum extent necessary to render the modified provision valid, legal and enforceable.

10. Governing Law . This Agreement shall be governed, construed, interpreted and enforced in accordance with the laws of the State of Delaware, without regard to the conflict of laws principles thereof. The parties irrevocably elect as the sole judicial forum for the adjudication of any matters arising under or in connection with this Agreement, and consent to the exclusive jurisdiction of, the federal and state courts of the State of Delaware.

11. Entire Agreement . This Agreement, together with the Employment Agreement, the Non-Disclosure Agreement and the Restricted Stock Unit Agreement, contains the entire agreement and understanding between the Company and the Executive with respect to the subject matter hereof, and no representations, promises, agreements or understandings, written or oral, not herein contained shall be of any force or effect. This Agreement shall not be changed unless in writing and signed by both the Executive and the Board of Directors of Sunstone.

12. Assignment . This Agreement may not be assigned by the Executive, but may be assigned by the Company to any successor to its business and will inure to the benefit of and be binding upon any such successor.

EXHIBIT C

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13. Notice . All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows:

If to the Executive : at the Executive’s most recent address on the records of the Company,


If to the Company :		c/o Sunstone Hotel Investors, Inc.
		903 Calle America, Suite 100
		San Clemente, CA 92673
		Attn: Corporate Secretary

with a copy to:		Allen Matkins Leck Gamble & Mallory LLP
		515 South Figueroa Street
		Seventh Floor
		Los Angeles, CA 90071-3398
		Attn: Michael F. Sfregola

or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.

14. Counterparts . This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument.

15. Executive’s Acknowledgment . The Executive acknowledges (a) that he has had the opportunity to consult with independent counsel of his own choice concerning this Agreement, and (b) that he has read and understands this Agreement, is fully aware of its legal effect, and has entered into it freely based on his own judgment.

IN WITNESS WHEREOF, the parties have executed this Agreement as of the date and year first above written.


“EXECUTIVE”	SUNSTONE HOTEL INVESTORS, INC., a Maryland corporation

	By:
Robert A. Alter		Name:
		Its:

	SUNSTONE HOTEL PARTNERSHIP, LLC, a Delaware limited liability company

	By:	Sunstone Hotel Investors, Inc.
		Its: Managing Member

	By:
		Name:
		Its:

EXHIBIT C

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Exhibit 10.16

EMPLOYMENT AGREEMENT

WHEREAS, Sunstone and the Operating Partnership (collectively, the “ Company ”) desire to employ the Executive and to enter into an agreement embodying the terms of such employment; and

WHEREAS, the Executive desires to accept employment with the Company, subject to the terms and conditions of this Agreement.

NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:

1. Employment Period . Subject to the provisions for earlier termination hereinafter provided, the Executive’s employment hereunder shall be for a term (the “ Employment Period ”) commencing on the Effective Date and ending on the fifth anniversary of the Effective Date (the “ Initial Termination Date ”); provided , however , that this Agreement shall be automatically extended for one additional year on the Initial Termination Date and on each subsequent anniversary of the Initial Termination Date, unless either the Executive or the Company elects not to so extend the term of the Agreement by notifying the other party, in writing, of such election not less than ninety (90) days prior to the last day of the term as then in effect. For the avoidance of doubt, non-renewal of the Agreement pursuant to the proviso contained in the preceding sentence shall not be deemed to give rise to any payment to the Executive as might be the case in connection with a termination of this Agreement. For purposes of this Agreement, “ Effective Date ” shall mean the date of the closing of the initial public offering of shares of Sunstone’s common stock.

2. Terms of Employment .

(a) Position and Duties .

(i) During the Employment Period, the Executive shall serve as Executive Vice President and Chief Financial Officer of Sunstone and the Operating Partnership and shall perform such employment duties as are usual and customary for such positions and such other duties as the Board of Directors of Sunstone (the “ Board ”) shall from time to time reasonably assign to the Executive. The Executive shall report to the Chief Executive Officer of the Company. At the Board’s request, the Executive shall serve the Company and/or its subsidiaries and affiliates in other offices and capacities in addition to the foregoing, provided that his duties and responsibilities shall be commensurate with his position. In the event that the Executive, during the Employment Period, serves in any one or more of such additional capacities, the Executive’s compensation shall not be increased beyond that specified in Section 2(b) of this Agreement. In addition, in the event the Executive’s service in one or more of such additional capacities is subsequently terminated, the Executive’s compensation, as

specified in Section 2(b) of this Agreement, shall not be diminished or reduced in any manner as a result of such termination for so long as the Executive otherwise remains employed under the terms of this Agreement.

(b) Compensation .

(i) Base Salary . During the Employment Period, the Executive shall receive a base salary (the “ Base Salary ”) of $375,000 per annum, as the same may be increased thereafter. The Base Salary shall be paid at such intervals as the Company pays executive salaries generally. During the Employment Period, the Base Salary shall be reviewed at least annually for possible increase (but not decrease) in the Company’s sole discretion, as determined by the Company’s compensation committee; provided, however, that the Executive shall be entitled to any annual cost-of-living increases in Base Salary that are granted to senior executives of the Company generally. Any increase in Base Salary shall not serve to limit or reduce any other obligation to the Executive under this Agreement. The term “Base Salary” as utilized in this Agreement shall refer to Base Salary as so adjusted.

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in accordance with the terms and conditions of said bonus plan as in effect from time to time with the following targets: (1) minimum target equal to 40% of Base Salary ; (2) mid-point target equal to 75% of Base Salary (“ Target Annual Bonus ”); and (3) maximum target equal to 125% of Base Salary ; provided, however, that no minimum bonus is guaranteed. Notwithstanding the foregoing, for the period beginning on the Effective Date and ending on December 31, 2004, the Executive will receive a bonus of $294,000 (“ 2004 Bonus ”), which 2004 Bonus shall be paid no later than March 15, 2005. The terms and conditions of any such bonus plan shall be determined by Sunstone’s compensation committee in its sole discretion. Any Annual Bonus earned in the first year of the Employment Period shall be pro-rated for the number of days of the year that the Executive is employed by the Company. Executive shall also receive a bonus of $100,000 within thirty (30) days after the closing Effective Date.

(vii) Fringe Benefits . During the Employment Period, the Executive shall be entitled to such fringe benefits and perquisites as are provided by the Company to its

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senior executives from time to time, in accordance with the policies, practices and procedures of the Company.

3. Termination of Employment :

(ii) The Executive’s commission of an act of fraud or dishonesty in the performance of his duties;

(iii) The Executive’s conviction of, or entry by the Executive of a guilty or no contest plea to, any felony or any felony or misdemeanor involving moral turpitude;

(iv) Any breach by the Executive of his fiduciary duty or duty of loyalty to the Company; or

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(i) A material reduction in the Executive’s titles, duties, authority and responsibilities, or the assignment to the Executive of any duties materially inconsistent with the Executive’s position, authority, duties or responsibilities without the written consent of the Executive;

(ii) The Company’s reduction of the Executive’s annual Base Salary or bonus opportunity as in effect or as may be increased from time to time;

(iii) The relocation of the Company’s headquarters to a location more than thirty five (35) miles from the Company’s current headquarters in San Clemente, California; or

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by the Executive or the Company to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or Cause shall not waive any right of the Executive or the Company, respectively, hereunder or preclude the Executive or the Company, respectively, from asserting such fact or circumstance in enforcing the Executive’s or the Company’s rights hereunder.

4. Obligation of the Company Upon Termination .

(i) The Executive shall be paid, in two lump sum payments (A) the Executive’s earned but unpaid Base Salary and accrued but unpaid vacation pay through the Date of Termination, and any Annual Bonus required to be paid to the Executive pursuant to Section 2(b)(ii) above for any fiscal year of the Company that ends on or before the Date of Termination to the extent not previously paid (the “ Accrued Obligations ”), and (B) an amount (the “ Severance Amount ”) equal to one (1) times (the “ Severance Multiple ”) the sum of (x) the Base Salary in effect on the Date of Termination plus (y) the Bonus Severance Amount (as defined below) in effect on the Date of Termination. For purposes hereof, the Bonus Severance Amount shall equal: (A) if the Date of Termination is on or prior to December 31, 2004, the 2004 Bonus, (B) if the Date of Termination is during the calendar year 2005, the Target Annual Bonus for such year and (C) if the Date of Termination is during the remainder of the Employment Period, the lesser of the Target Annual Bonus for the year in which the Date of Termination takes place or the actual Annual Bonus that the Executive earned in the prior calendar year. The Accrued Obligations shall be paid when due under California law and the Severance Amount shall be paid no later than 60 days after the Date of Termination.

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and is eligible to receive group health insurance coverage under another employer’s plans, the Company’s obligations under this Section 4(a)(iii) shall be reduced to the extent comparable coverage is actually available to the Executive and the Executive’s eligible family members, and any such coverage shall be reported by the Executive to the Company.

(c) Death or Disability . If the Executive’s employment is terminated by reason of the Executive’s death or Disability during the Employment Period:

(i) The Accrued Obligations shall be paid to the Executive’s estate or beneficiaries or to the Executive, as applicable, in cash within 30 days of the Date of Termination;

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that which would have been provided to them if the Executive’s employment had not been terminated (or at the Company’s election, pay the applicable COBRA premium for such coverage); provided, however , that if the Executive becomes re-employed with another employer and is eligible to receive group health insurance coverage under another employer’s plans, the Company’s obligations under this Section 4(d)(iv) shall be reduced to the extent comparable coverage is actually available to the Executive and the Executive’s eligible family members, and any such coverage shall be reported by the Executive to the Company; and

(v) The Other Benefits shall be paid or provided to the Executive on a timely basis.

5. Termination Upon a Change in Control . If a Change in Control (as defined herein) occurs during the Employment Period, and the Executive’s employment is terminated by the Company without Cause or by the Executive for Good Reason, in each case within twelve (12) months after the effective date of the Change in Control, then the Executive shall be entitled to the payments and benefits provided in Section 4(a) , subject to the terms and conditions thereof, provided, however, that in calculating the Severance Amount the Severance Multiple shall equal two (2). In addition, in the event of such a termination of the Executive’s employment, all outstanding stock options, restricted stock units and other Equity Awards granted to the Executive under any of the Company’s equity incentive plans (or awards substituted therefore covering the securities of a successor company) shall become immediately vested and exercisable in full. For purposes of this Agreement, “ Change in Contro l” shall mean the occurrence of any of the following events:

(B) By Sunstone or a corporation owned, directly or indirectly, by the stockholders of Sunstone in substantially the same proportions as their ownership of the stock of Sunstone, or

(ii) Individuals who, as of the Effective Date, constitute the Board (the “ Incumbent Board ”) cease for any reason to constitute at least a majority of the Board;

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provided, however, that any individual becoming a director subsequent to the date hereof whose election by Sunstone’s stockholders, or nomination for election by the Board, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an election contest with respect to the election or removal of directors or other solicitation of proxies or consents by or on behalf of a person other than the Board;

(A) which results in Sunstone’s voting securities outstanding immediately before the transaction continuing to represent (either by remaining outstanding or by being converted into voting securities of Sunstone or the person that, as a result of the transaction, controls, directly or indirectly, Sunstone or owns, directly or indirectly, all or substantially all of Sunstone’s assets or otherwise succeeds to the business of Sunstone (Sunstone or such person, the “ Successor Entity ”)) directly or indirectly, greater than 50% of the combined voting power of the Successor Entity’s outstanding voting securities immediately after the transaction, and

(B) after which no person or group beneficially owns voting securities representing greater than 50% of the combined voting power of the Successor Entity; provided, however, that no person or group shall be treated for purposes of this clause (B) as beneficially owning greater than 50% of the combined voting power of the Successor Entity solely as a result of the voting power held in Sunstone prior to the consummation of the transaction; or

(iv) The approval by Sunstone’s stockholders of a liquidation or dissolution of Sunstone.

6. [ Intentionally omitted .]

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party to this Agreement institutes any action, suit, counterclaim, appeal, arbitration or mediation for any relief against another party, declaratory or otherwise (collectively an “ Action ”), to enforce the terms hereof or to declare rights hereunder, then the Prevailing Party in such Action shall be entitled to recover from the other party all costs and expenses of the Action, including reasonable attorneys’ fees and costs (at the Prevailing Party’s attorneys’ then-prevailing rates) incurred in bringing and prosecuting or defending such Action and/or enforcing any judgment, order, ruling or award (collectively, a “ Decision ”) granted therein, all of which shall be deemed to have accrued on the commencement of such Action and shall be paid whether or not such Action is prosecuted to a Decision. Any Decision entered in such Action shall contain a specific provision providing for the recovery of attorneys’ fees and costs incurred in enforcing such Decision. A court or arbitrator shall fix the amount of reasonable attorneys’ fees and costs upon the request of either party. Any judgment or order entered in any final judgment shall contain a specific provision providing for the recovery of all costs and expenses of suit, including reasonable attorneys’ fees and expert fees and costs incurred in enforcing, perfecting and executing such judgment. For the purposes of this paragraph, costs shall include, without limitation, in addition to costs incurred in prosecution or defense of the underlying action, reasonable attorneys’ fees, costs, expenses and expert fees and costs incurred in the following: (a) postjudgement motions and collection actions; (b) contempt proceedings; (c) garnishment, levy, debtor and third party examinations; (d) discovery; (e) bankruptcy litigation; and (f) appeals of any order or judgment. “ Prevailing Party ” within the meaning of this Section includes, without limitation, a party who agrees to dismiss an Action (excluding an Action instituted in contravention of the requirements of Paragraph 12(b) below) in consideration for the other party’s payment of the amounts allegedly due or performance of the covenants allegedly breached, or obtains substantially the relief sought by such party.

8. Certain Additional Payments by the Company .

(a) Anything in this Agreement to the contrary notwithstanding and except as set forth below, in the event it shall be determined that any Payment would be subject to the Excise Tax, then the Executive shall be entitled to receive an additional payment (the “ Excise Tax Gross-Up Payment ”) in an amount such that, after payment by the Executive of all taxes (and any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Excise Tax Gross-Up Payment, the Executive retains an amount of the Excise Tax Gross-Up Payment equal to the Excise Tax imposed upon the Payments. Notwithstanding the foregoing provisions of this Section 8(a) , if it shall be determined that the Executive is entitled to the Excise Tax Gross-Up Payment, but that the Parachute Value of all Payments does not exceed 110% of the Safe Harbor Amount, then no Excise Tax Gross-Up Payment shall be made to the Executive and the amounts payable under this Agreement shall be reduced so that the Parachute Value of all Payments, in the aggregate, equals the Safe Harbor Amount. The reduction of the amounts payable hereunder, if applicable, shall be made by first reducing the payments under Section 4(a)(i) , unless an alternative method of reduction is elected by the Executive, and in any event shall be made in such a manner as to maximize the Value of all Payments actually made to the Executive. For purposes of reducing the Payments to the Safe Harbor Amount, only amounts payable under this Agreement (and no other Payments) shall be reduced. If the reduction of the amount payable under this Agreement would not result in a reduction of the Parachute Value of all Payments to the Safe Harbor Amount, no amounts

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payable under the Agreement shall be reduced pursuant to this Section 8(a ). The Company’s obligation to make Excise Tax Gross-Up Payments under this Section 8 shall not be conditioned upon the Executive’s termination of employment.

(c) The Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Excise Tax Gross-Up Payment. Such notification shall be given as soon as practicable, but no later than 10 business days after the Executive is informed in writing of such claim. The Executive shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which the Executive gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that the Company desires to contest such claim, the Executive shall:

(i) give the Company any information reasonably requested by the Company relating to such claim,

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(iii) cooperate with the Company in good faith in order effectively to contest such claim, and

(iv) permit the Company to participate in any proceedings relating to such claim;

provided , however , that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such-contest, and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 8(c) , the Company shall control all proceedings taken in connection with such contest, and, at its sole discretion, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the applicable taxing authority in respect of such claim and may, at its sole discretion, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided , however , that, if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis, and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties) imposed with respect to such advance or with respect to any imputed income in connection with such advance; and provided , further , that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company’s control of the contest shall be limited to issues with respect to which the Excise Tax Gross-Up Payment would be payable hereunder, and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority.

(e) Notwithstanding any other provision of this Section 8 , the Company may, in its sole discretion, withhold and pay over to the Internal Revenue Service or any other

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applicable taxing authority, for the benefit of the Executive, all or any portion of any Excise Tax Gross-Up Payment, and the Executive hereby consents to such withholding.

(g) Definitions . The following terms shall have the following meanings for purposes of this Section 8 :

(i) “ Excise Tax ” shall mean the excise tax imposed by Section 4999 of the Code, together with any interest or penalties imposed with respect to such excise tax.

(iv) The “ Safe Harbor Amount ” shall mean 2.99 times the Executive’s “base amount,” within the meaning of Section 280G(b)(3) of the Code.

9. [ Intentionally omitted ]

10. Successors .

(b) This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns.

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to the same extent that the Company would be required to perform it if no such succession had taken place. As used in this Agreement, “Company” shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise.

12. Miscellaneous .

(b) Arbitration . To the fullest extent allowed by law, any controversy, claim or dispute between Executive and the Company (and/or any of its owners, directors, officers, employees, affiliates, or agents) relating to or arising out of Executive’s employment or the cessation of that employment will be submitted to final and binding arbitration in the county in which Executive work(ed) for determination by one arbitrator in accordance with the American Arbitration Association’s (“AAA”) National Rules for the Resolution of Employment Disputes, as the exclusive remedy for such controversy, claim or dispute. In any such arbitration, the parties may conduct discovery in accordance with the applicable rules of the arbitration forum, except that the arbitrator shall have the authority to order and permit discovery as the arbitrator may deem necessary and appropriate in accordance with applicable state or federal discovery statutes. The arbitrator shall issue a reasoned, written decision, and shall have full authority to award all remedies which would be available in court. The parties shall share the filing fees required for the arbitration, provided that Executive shall not be required to pay an amount in excess of the filing fees required by a federal or state court with jurisdiction. The Company shall pay the arbitrator’s fees and any AAA administrative expenses. Any judgment upon the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. Possible disputes covered by the above include (but are not limited to) unpaid wages, breach of contract, torts, violation of public policy, discrimination, harassment, or any other employment-related claims under laws including but not limited to, Title VII of the Civil Rights Act of 1964, the Americans With Disabilities Act, the Age Discrimination in Employment Act, the California Fair Employment and Housing Act, the California Labor Code, and any other statutes or laws relating to an employee’s relationship with his/her employer, regardless of whether such dispute is initiated by the Executive or the Company. Thus, this bilateral arbitration agreement applies to any and all claims that the Company may have against the Executive, including but not limited to, claims for misappropriation of Company property, disclosure of proprietary information or trade secrets, interference with contract, trade libel, gross negligence, or any other claim for alleged wrongful conduct or breach of the duty of loyalty by the Executive. However,

-14-

notwithstanding anything to the contrary contained herein, Company and Executive shall have their respective rights to seek and obtain injunctive relief with respect to any controversy, claim or dispute to the extent permitted by law. Claims for workers’ compensation benefits and unemployment insurance (or any other claims where mandatory arbitration is prohibited by law) are not covered by this arbitration agreement, and such claims may be presented by either Executive or the Company to the appropriate court or government agency. BY AGREEING TO THIS BINDING ARBITRATION PROVISION, BOTH EXECUTIVE AND THE COMPANY GIVE UP ALL RIGHTS TO TRIAL BY JURY. This arbitration agreement is to be construed as broadly as is permissible under applicable law.

If to the Executive : at the Executive’s most recent address on the records of the Company,

If to Sunstone or the Operating Partnership :

Sunstone Hotel Investors, Inc.

903 Calle America, Suite 100

San Clemente, CA 92673

Attn: Corporate Secretary

with a copy to:

Allen Matkins Leck Gamble & Mallory LLP

515 South Figueroa Street

Seventh Floor

Los Angeles, CA 90071-3398

Attn: Michael F. Sfregola

or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.

-15-

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(k) Counterparts . This Agreement may be executed simultaneously in two counterparts, each of which shall be deemed an original but which together shall constitute one and the same instrument.

[signatures follow next page]

-17-


SUNSTONE HOTEL INVESTORS, INC., a Maryland corporation

By:
		Name:
		Its:



SUNSTONE HOTEL PARTNERSHIP, LLC, a Delaware limited liability company

By:	Sunstone Hotel Investors, Inc. Its: Managing Member

	By:
		Name:
		Its:

“EXECUTIVE”


Name:	Jon D. Kline

-18-

EXHIBIT A

TO EMPLOYMENT AGREEMENT

GENERAL RELEASE

THE UNDERSIGNED ACKNOWLEDGES THAT HE HAS BEEN ADVISED BY LEGAL COUNSEL AND IS FAMILIAR WITH THE PROVISIONS OF CALIFORNIA CIVIL CODE SECTION 1542, WHICH PROVIDES AS FOLLOWS:

THE UNDERSIGNED, BEING AWARE OF SAID CODE SECTION, HEREBY EXPRESSLY WAIVES ANY RIGHTS HE MAY HAVE THEREUNDER, AS WELL AS UNDER ANY OTHER STATUTES OR COMMON LAW PRINCIPLES OF SIMILAR EFFECT.

IN ACCORDANCE WITH THE OLDER WORKERS BENEFIT PROTECTION ACT OF 1990, THE UNDERSIGNED IS HEREBY ADVISED AS FOLLOWS:

(A) HE HAS THE RIGHT TO CONSULT WITH AN ATTORNEY BEFORE SIGNING THIS RELEASE;

EXHIBIT A

-1-

(B) HE HAS TWENTY-ONE (21) DAYS TO CONSIDER THIS RELEASE BEFORE SIGNING IT; AND

(C) HE HAS SEVEN (7) DAYS AFTER SIGNING THIS RELEASE TO REVOKE THIS RELEASE, AND THIS RELEASE WILL BECOME EFFECTIVE UPON THE EXPIRATION OF THAT REVOCATION PERIOD.

IN WITNESS WHEREOF, the undersigned has executed this Release this day of , 20 .

EXHIBIT A

-2-

EXHIBIT B

TO EMPLOYMENT AGREEMENT

NON-DISCLOSURE AGREEMENT

For good and valuable consideration, Executive and Company hereby agree as follows:

1. This Agreement will be effective on , 2004.

EXHIBIT B

-1-

information or data of any kind related to Company’s business and business opportunities; (c) all information of any kind regarding Company’s suppliers, vendors, consultants, agents and customers, including lists or compilations of any such persons or entities; (d) all information of any kind regarding Company’s officers, directors and shareholders (other than Executive), including their respective abilities, functions, conduct or pay; (e) all proprietary information of any kind received or developed under agreement or other arrangement by Company with any third party; and (f) all unpublished materials received or developed, including all works of authorship, which relate to the business of Company, including but not limited to those concerning proprietary, trade secret or Company-private information, investment strategies, development plans, research and development data, and any other technical reports relating to Company’s business operations now existing or which may be developed during the term of Executive’s employment with Company.

8. No amendment or modification to this Agreement shall be valid unless in writing signed by Executive and an authorized officer of Company.

9. The execution of this Agreement shall not be construed in any manner to alter Executive’s employment with Company as provided in his Employment Agreement.

EXHIBIT B

-2-

If to the Executive : at the Executive’s most recent address on the records of the Company,

If to the Company :

c/o Sunstone Hotel Investors, Inc.

903 Calle America, Suite 100

San Clemente, CA 92673

Attn: Corporate Secretary

with a copy to:

Allen Matkins Leck Gamble & Mallory LLP

515 South Figueroa Street

Seventh Floor

Los Angeles, CA 90071-3398

Attn: Michael F. Sfregola

or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.

IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first set forth above.

“EXECUTIVE”

SUNSTONE HOTEL INVESTORS, INC.,

a Maryland corporation

By:

Jon D. Kline

Name:

Its:

EXHIBIT B

-3-

SUNSTONE HOTEL PARTNERSHIP, LLC,

a Delaware limited liability company

By:

Sunstone Hotel Investors, Inc.

Its: Managing Member

By:

Name:

Its:

EXHIBIT B

-4-

EXHIBIT C

TO EMPLOYMENT AGREEMENT

NONCOMPETITION AGREEMENT

THIS NONCOMPETITION AND NONSOLICITATION AGREEMENT (this “ Agreement ”) is dated as of , 2004, by and among Sunstone Hotel Investors, Inc., a Maryland corporation (“ Sunstone ”), Sunstone Hotel Partnership, LLC, a Delaware limited liability company (the “ Operating Partnership ”), and Jon D. Kline (the “ Executive ”). Sunstone and the Operating Partnership are collectively referred to herein as the “ Company .”

WHEREAS, concurrently with the execution of this Agreement, the Company and the Executive have entered into (i) an employment agreement, pursuant to which the Company has agreed to employ the Executive, and the Executive has agreed to be employed by the Company, as its Executive Vice President and Chief Financial Officer (“ CFO ”) (the “ Employment Agreement ”), and (ii) a non-disclosure agreement (the “ Non-Disclosure Agreement ”);

WHEREAS , capitalized terms used herein without definition shall have the meanings ascribed thereto in the Employment Agreement.

1. Noncompetition; Nonsolicitation .

EXHIBIT C

-1-

(b) The term “ Competition ” for purposes of this Agreement shall mean the taking of any of the following actions by the Executive: (i) the conduct of, directly or indirectly (including, without limitation, engaging in, assisting or performing services for), any business that engages in any activity which is directly competitive with the business of the Company, whether such business is conducted by the Executive individually or as principal, partner, officer, director, consultant, security holder, creditor, employee, stockholder, member or manager of any person, partnership, corporation, limited liability company or any other entity; and/or (ii) ownership of interests in any business which is competitive, directly or indirectly, with any business carried on by the Company (or any successor thereto) or its subsidiaries or affiliates; provided, however, that the term “ Competition ” shall be deemed to exclude (i) the direct or indirect ownership by the Executive of up to three percent of the outstanding equity interests of any public company, and (ii) the Executive’s existing ownership interests in hotel properties as such interests are disclosed in the Company’s Registration Statement on Form S-11 (No. 333- 117141) filed with the Securities and Exchange Commission, as amended from time to time.

5. Reasonableness of Covenants . The Executive agrees that all of the covenants contained in this Agreement are reasonably necessary to protect the legitimate interests of the

EXHIBIT C

-2-

Company and its affiliates, are reasonable with respect to time and territory and that he has read and understands the descriptions of the covenants so as to be informed as to their meaning and scope.

EXHIBIT C

-3-

If to the Executive : at the Executive’s most recent address on the records of the Company,


If to the Company :		c/o Sunstone Hotel Investors, Inc.
		903 Calle America, Suite 100
		San Clemente, CA 92673
		Attn: Corporate Secretary

with a copy to:		Allen Matkins Leck Gamble & Mallory LLP
		515 South Figueroa Street
		Seventh Floor
		Los Angeles, CA 90071-3398
		Attn: Michael F. Sfregola

or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.

14. Counterparts . This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument.

IN WITNESS WHEREOF, the parties have executed this Agreement as of the date and year first above written.

“EXECUTIVE”

SUNSTONE HOTEL INVESTORS, INC.,

a Maryland corporation

By:

Jon D. Kline

Name:

Its:

SUNSTONE HOTEL PARTNERSHIP, LLC,

a Delaware limited liability company

By:

Sunstone Hotel Investors, Inc.

Its: Managing Member

By:

Name:

Its:

EXHIBIT C

-4-

Exhibit 10.17

EMPLOYMENT AGREEMENT

WHEREAS, Sunstone and the Operating Partnership (collectively, the “ Company ”) desire to employ the Executive and to enter into an agreement embodying the terms of such employment; and

WHEREAS, the Executive desires to accept employment with the Company, subject to the terms and conditions of this Agreement.

NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:

1. Employment Period . Subject to the provisions for earlier termination hereinafter provided, the Executive’s employment hereunder shall be for a term (the “ Employment Period ”) commencing on the Effective Date and ending on the fifth anniversary of the Effective Date (the “ Initial Termination Date ”); provided , however , that this Agreement shall be automatically extended for one additional year on the Initial Termination Date and on each subsequent anniversary of the Initial Termination Date, unless either the Executive or the Company elects not to so extend the term of the Agreement by notifying the other party, in writing, of such election not less than ninety (90) days prior to the last day of the term as then in effect. For the avoidance of doubt, non-renewal of the Agreement pursuant to the proviso contained in the preceding sentence shall not be deemed to give rise to any payment to the Executive as might be the case in connection with a termination of this Agreement. For purposes of this Agreement, “ Effective Date ” shall mean the date of the closing of the initial public offering of shares of Sunstone’s common stock.

2. Terms of Employment .

(a) Position and Duties .

(i) During the Employment Period, the Executive shall serve as Executive Vice President and Chief Investment Officer of Sunstone and the Operating Partnership and shall perform such employment duties as are usual and customary for such positions and such other duties as the Board of Directors of Sunstone (the “ Board ”) shall from time to time reasonably assign to the Executive. The Executive shall report to the Chief Executive Officer of the Company. At the Board’s request, the Executive shall serve the Company and/or its subsidiaries and affiliates in other offices and capacities in addition to the foregoing, provided that his duties and responsibilities shall be commensurate with his position. In the event that the Executive, during the Employment Period, serves in any one or more of such additional capacities, the Executive’s compensation shall not be increased beyond that specified in Section 2(b) of this Agreement. In addition, in the event the Executive’s service in one or more of such additional capacities is subsequently terminated, the Executive’s compensation, as specified in Section 2(b) of this Agreement, shall not be diminished or reduced

in any manner as a result of such termination for so long as the Executive otherwise remains employed under the terms of this Agreement.

(b) Compensation .

(i) Base Salary . During the Employment Period, the Executive shall receive a base salary (the “ Base Salary ”) of $350,000 per annum, as the same may be increased thereafter. The Base Salary shall be paid at such intervals as the Company pays executive salaries generally. During the Employment Period, the Base Salary shall be reviewed at least annually for possible increase (but not decrease) in the Company’s sole discretion, as determined by the Company’s compensation committee; provided, however, that the Executive shall be entitled to any annual cost-of-living increases in Base Salary that are granted to senior executives of the Company generally. Any increase in Base Salary shall not serve to limit or reduce any other obligation to the Executive under this Agreement. The term “Base Salary” as utilized in this Agreement shall refer to Base Salary as so adjusted.

-2-

with the following targets: (1) minimum target equal to 40% of Base Salary ; (2) mid-point target equal to 75% of Base Salary (“ Target Annual Bonus ”); and (3) maximum target equal to 125% of Base Salary ; provided, however, that no minimum bonus is guaranteed. Notwithstanding the foregoing, for the period beginning on the Effective Date and ending on December 31, 2004, the Executive will receive a bonus of $263,500 (“ 2004 Bonus ”), which 2004 Bonus shall be paid no later than March 15, 2005. The terms and conditions of any such bonus plan shall be determined by Sunstone’s compensation committee in its sole discretion. Any Annual Bonus earned in the first year of the Employment Period shall be pro-rated for the number of days of the year that the Executive is employed by the Company. Executive shall also receive a bonus of $100,000 within thirty (30) days after the closing Effective Date.

(vii) Fringe Benefits . During the Employment Period, the Executive shall be entitled to such fringe benefits and perquisites as are provided by the Company to its

-3-

senior executives from time to time, in accordance with the policies, practices and procedures of the Company.

3. Termination of Employment :

(ii) The Executive’s commission of an act of fraud or dishonesty in the performance of his duties;

(iii) The Executive’s conviction of, or entry by the Executive of a guilty or no contest plea to, any felony or any felony or misdemeanor involving moral turpitude;

(iv) Any breach by the Executive of his fiduciary duty or duty of loyalty to the Company; or

-4-

(ii) The Company’s reduction of the Executive’s annual Base Salary or bonus opportunity as in effect or as may be increased from time to time;

(iii) The relocation of the Company’s headquarters to a location more than thirty five (35) miles from the Company’s current headquarters in San Clemente, California; or

-5-

4. Obligation of the Company Upon Termination .

-6-

(c) Death or Disability . If the Executive’s employment is terminated by reason of the Executive’s death or Disability during the Employment Period:

(i) The Accrued Obligations shall be paid to the Executive’s estate or beneficiaries or to the Executive, as applicable, in cash within 30 days of the Date of Termination;

-7-

(v) The Other Benefits shall be paid or provided to the Executive on a timely basis.

(B) By Sunstone or a corporation owned, directly or indirectly, by the stockholders of Sunstone in substantially the same proportions as their ownership of the stock of Sunstone, or

(ii) Individuals who, as of the Effective Date, constitute the Board (the “ Incumbent Board ”) cease for any reason to constitute at least a majority of the Board;

-8-

(A) which results in Sunstone’s voting securities outstanding immediately before the transaction continuing to represent (either by remaining outstanding or by being converted into voting securities of Sunstone or the person that, as a result of the transaction, controls, directly or indirectly, Sunstone or owns, directly or indirectly, all or substantially all of Sunstone’s assets or otherwise succeeds to the business of Sunstone (Sunstone or such person, the “ Successor Entity ”)) directly or indirectly, greater than 50% of the combined voting power of the Successor Entity’s outstanding voting securities immediately after the transaction, and

(iv) The approval by Sunstone’s stockholders of a liquidation or dissolution of Sunstone.

For purposes of clause (i) above, the calculation of voting power shall be made as if the date of the acquisition were a record date for a vote of Sunstone’s stockholders, and for purposes of clause (iii)above, the calculation of voting power shall be made as if the date of the consummation of the transaction were a record date for a vote of Sunstone’s stockholders.

6. [ Intentionally omitted .]

-9-

8. Certain Additional Payments by the Company .

-10-

(i) give the Company any information reasonably requested by the Company relating to such claim,

(ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to-time, including, without limitation,

-11-

accepting legal representation with respect to such claim by an attorney reasonably selected by the Company,

(iii) cooperate with the Company in good faith in order effectively to contest such claim, and

(iv) permit the Company to participate in any proceedings relating to such claim;

-12-

(g) Definitions . The following terms shall have the following meanings for purposes of this Section 8 :

(i) “ Excise Tax ” shall mean the excise tax imposed by Section 4999 of the Code, together with any interest or penalties imposed with respect to such excise tax.

(iv) The “ Safe Harbor Amount ” shall mean 2.99 times the Executive’s “base amount,” within the meaning of Section 280G(b)(3) of the Code.

9. [Intentionally omitted]

10. Successors .

(b) This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns.

-13-

12. Miscellaneous .

-14-

to, claims for misappropriation of Company property, disclosure of proprietary information or trade secrets, interference with contract, trade libel, gross negligence, or any other claim for alleged wrongful conduct or breach of the duty of loyalty by the Executive. However, notwithstanding anything to the contrary contained herein, Company and Executive shall have their respective rights to seek and obtain injunctive relief with respect to any controversy, claim or dispute to the extent permitted by law. Claims for workers’ compensation benefits and unemployment insurance (or any other claims where mandatory arbitration is prohibited by law) are not covered by this arbitration agreement, and such claims may be presented by either Executive or the Company to the appropriate court or government agency. BY AGREEING TO THIS BINDING ARBITRATION PROVISION, BOTH EXECUTIVE AND THE COMPANY GIVE UP ALL RIGHTS TO TRIAL BY JURY. This arbitration agreement is to be construed as broadly as is permissible under applicable law.

If to the Executive : at the Executive’s most recent address on the records of the Company,

If to Sunstone or the Operating Partnership :

Sunstone Hotel Investors, Inc.

903 Calle America, Suite 100

San Clemente, CA 92673

Attn: Corporate Secretary

with a copy to:

Allen Matkins Leck Gamble & Mallory LLP

515 South Figueroa Street

Seventh Floor

Los Angeles, CA 90071-3398

Attn: Michael F. Sfregola

or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.

(e) Severability . The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this

-15-

Agreement. If any provision or term hereof is deemed to have exceeded applicable legal authority or shall be in conflict with applicable legal limitations, such provision shall be reformed and rewritten as necessary to achieve consistency with such applicable law.

(j) Consultation with Counsel . The Executive acknowledges that he has had a full and complete opportunity to consult with counsel and other advisors of his own choosing

-16-

concerning the terms, enforceability and implications of this Agreement, and that the Company has not made any representations or warranties to the Executive concerning the terms, enforceability or implications of this Agreement other than as reflected in this Agreement.

(k) Counterparts . This Agreement may be executed simultaneously in two counterparts, each of which shall be deemed an original but which together shall constitute one and the same instrument.

[signatures follow next page]

-17-


SUNSTONE HOTEL INVESTORS, INC.,
a Maryland corporation

By:
		Name:
		Its:

SUNSTONE HOTEL PARTNERSHIP, LLC,
a Delaware limited liability company

By:		Sunstone Hotel Investors, Inc.
		Its: Managing Member

By:
		Name:
		Its:

“EXECUTIVE”


Name:		Gary A. Stougaard

-18-

EXHIBIT A

TO EMPLOYMENT AGREEMENT

GENERAL RELEASE

THE UNDERSIGNED ACKNOWLEDGES THAT HE HAS BEEN ADVISED BY LEGAL COUNSEL AND IS FAMILIAR WITH THE PROVISIONS OF CALIFORNIA CIVIL CODE SECTION 1542, WHICH PROVIDES AS FOLLOWS:

THE UNDERSIGNED, BEING AWARE OF SAID CODE SECTION, HEREBY EXPRESSLY WAIVES ANY RIGHTS HE MAY HAVE THEREUNDER, AS WELL AS UNDER ANY OTHER STATUTES OR COMMON LAW PRINCIPLES OF SIMILAR EFFECT.

IN ACCORDANCE WITH THE OLDER WORKERS BENEFIT PROTECTION ACT OF 1990, THE UNDERSIGNED IS HEREBY ADVISED AS FOLLOWS:

(A) HE HAS THE RIGHT TO CONSULT WITH AN ATTORNEY BEFORE SIGNING THIS RELEASE;

EXHIBIT A

-1-

(B) HE HAS TWENTY-ONE (21) days TO CONSIDER THIS RELEASE BEFORE SIGNING IT; AND

(C) HE HAS SEVEN (7) days AFTER SIGNING THIS RELEASE TO REVOKE THIS RELEASE, AND THIS RELEASE WILL BECOME EFFECTIVE UPON THE EXPIRATION OF THAT REVOCATION PERIOD.

IN WITNESS WHEREOF, the undersigned has executed this Release this day of , 20 .

EXHIBIT A

-2-

EXHIBIT B

TO EMPLOYMENT AGREEMENT

NON-DISCLOSURE AGREEMENT

For good and valuable consideration, Executive and Company hereby agree as follows:

1. This Agreement will be effective on , 2004.

EXHIBIT B

-1-

8. No amendment or modification to this Agreement shall be valid unless in writing signed by Executive and an authorized officer of Company.

9. The execution of this Agreement shall not be construed in any manner to alter Executive’s employment with Company as provided in his Employment Agreement.

EXHIBIT B

-2-

If to the Executive : at the Executive’s most recent address on the records of the Company,

If to the Company :

c/o Sunstone Hotel Investors, Inc.

903 Calle America, Suite 100

San Clemente, CA 92673

Attn: Corporate Secretary

with a copy to:

Allen Matkins Leck Gamble & Mallory LLP

515 South Figueroa Street

Seventh Floor

Los Angeles, CA 90071-3398

Attn: Michael F. Sfregola

or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.

EXHIBIT B

-3-

IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first set forth above.


“EXECUTIVE”	SUNSTONE HOTEL INVESTORS, INC., a Maryland corporation

	By:
Gary A. Stougaard		Name:
		Its:

	SUNSTONE HOTEL PARTNERSHIP, LLC, a Delaware limited liability company

	By:	Sunstone Hotel Investors, Inc.
		Its: Managing Member

	By:
		Name:
		Its:

EXHIBIT B

-4-

EXHIBIT C

TO EMPLOYMENT AGREEMENT

NONCOMPETITION AGREEMENT

THIS NONCOMPETITION AND NONSOLICITATION AGREEMENT (this “ Agreement ”) is dated as of , 2004, by and among Sunstone Hotel Investors, Inc., a Maryland corporation (“ Sunstone ”), Sunstone Hotel Partnership, LLC, a Delaware limited liability company (the “ Operating Partnership ”), and Gary A. Stougaard (the “ Executive ”). Sunstone and the Operating Partnership are collectively referred to herein as the “ Company .”

WHEREAS, concurrently with the execution of this Agreement, the Company and the Executive have entered into (i) an employment agreement, pursuant to which the Company has agreed to employ the Executive, and the Executive has agreed to be employed by the Company, as its Executive Vice President and Chief Investment Officer (“ CIO ”) (the “ Employment Agreement ”), and (ii) a non-disclosure agreement (the “ Non-Disclosure Agreement ”);

WHEREAS , capitalized terms used herein without definition shall have the meanings ascribed thereto in the Employment Agreement.

1. Noncompetition; Nonsolicitation .

(b) The term “ Competition ” for purposes of this Agreement shall mean the taking of any of the following actions by the Executive: (i) the conduct of, directly or indirectly

EXHIBIT C

-1-

EXHIBIT C

-2-

and understands the descriptions of the covenants so as to be informed as to their meaning and scope.

EXHIBIT C

-3-

If to the Executive : at the Executive’s most recent address on the records of the Company,


If to the Company :		c/o Sunstone Hotel Investors, Inc. 903 Calle America, Suite 100 San Clemente, CA 92673 Attn: Corporate Secretary

with a copy to:		Allen Matkins Leck Gamble & Mallory LLP 515 South Figueroa Street Seventh Floor Los Angeles, CA 90071-3398 Attn: Michael F. Sfregola

or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.

14. Counterparts . This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument.

IN WITNESS WHEREOF, the parties have executed this Agreement as of the date and year first above written.


“EXECUTIVE”	SUNSTONE HOTEL INVESTORS, INC., a Maryland corporation

	By:
Gary A. Stougaard		Name:
		Its:

	SUNSTONE HOTEL PARTNERSHIP, LLC, a Delaware limited liability company

	By:	Sunstone Hotel Investors, Inc.
		Its: Managing Member

	By:
		Name:
		Its:

EXHIBIT C

-4-

EXHIBIT 21.1

SUBSIDIARIES OF

SUNSTONE HOTEL INVESTORS, INC.


Entity Name		Jurisdiction Organized
Buy Efficient, L.L.C.		Delaware
IHC GP, L.L.C.		Delaware
Kahler E&P Partners Lessee Inc.		Delaware
Kahler E&P Partners L.P. I		Delaware
Kahler SPM, Inc.		Delaware
Rochester BevFlow, Inc.		Delaware
Rochester Res Lessee, Inc.		Delaware
Rochester RIBM Lessee, Inc.		Delaware
RTS Lessee, Inc.		Delaware
SHP DT Bevflow, Inc.		Delaware
SHP Lessee Corp.		Delaware
SHP Lessee II Corp.		Delaware
SHP Lessee III Corp.		Delaware
SHP Ogden LLC		Delaware
Sun Houston, Inc.		Delaware
Sun Houston, LLC		Delaware
Sun Manhattan, LLC		Delaware
Sunstone Chandler, LLC		Delaware
Sunstone Holdco 1, LLC		Delaware
Sunstone Hotel Management, L.L.C.		Delaware
Sunstone Hotel Partnership, LLC		Delaware
Sunstone Hotel TRS Lessee, Inc.		Delaware
Sunstone Hotels, LLC		Delaware
Sunstone Napa Lessee Corp.		Delaware
Sunstone Napa, L.L.C.		Delaware
Sunstone OP Properties L.L.C.		Delaware
Sunstone Hotels Rochester, L.L.C.		Delaware
Sunstone Outparcel, L.L.C.		Delaware
Sunstone SH Hotels L.L.C.		Delaware
Sunstone Windy Hill, L.L.C.		Delaware
Sunstone Windy Hills Lessee, Inc.		Delaware
Sunstone/WB Manhattan Beach Lessee, Inc.		Delaware
TTS Facilities, LLC		Delaware
WB Grand Rapids Hotels, Inc.		Delaware
WB Grand Rapids SPM, Inc.		Delaware
WB Grand Rapids, Inc.		Delaware
WB Grand Rapids, LLC		Delaware
WB Ontario, Inc.		Delaware
WB Ontario, LLC		Delaware
WB Sunstone-Boise, Inc.		Delaware
WB Sunstone-Boise, LLC		Delaware
WB Sunstone-Hollywood, Inc.		Delaware


Entity Name		Jurisdiction Organized
WB Sunstone-Hollywood, LLC		Delaware
WB Sunstone-Lake Oswego, Inc.		Delaware
WB Sunstone-Lake Oswego, LLC		Delaware
WB Sunstone-Portland, Inc.		Delaware
WB Sunstone-Portland, LLC		Delaware
WB Sunstone-Riverside, Inc.		Delaware
WB Sunstone-Riverside, LLC		Delaware
WB Sunstone-Windy Hills LLC		Delaware
Westbrook Hotel Co-Investment Partners IV, L.L.C.		Delaware
Westbrook Hotel Partners IV, L.L.C.		Delaware
WHP BevFlow, LLC		Texas
WHP Ground Lessor, L.P.		Delaware
WHP Hotel Lessee-1, Inc.		Delaware
WHP Hotel Lessee-2, Inc.		Delaware
WHP Hotel Lessee-2A, Inc.		Delaware
WHP Hotel Lessee-3, Inc.		Delaware
WHP Hotel Owner-1, L.P.		Delaware
WHP Hotel Owner-2A, L.L.C.		Delaware
WHP Hotel Owner-2B, L.L.C.		Delaware
WHP Hotel Owner-3, L.P.		Delaware
WHP Hotel Owner-3A, L.L.C.		Delaware
WHP Junior Mezz Borrower-1, L.L.C.		Delaware
WHP Junior Mezz Borrower-2, L.L.C.		Delaware
WHP Junior Springing Member-1, Inc.		Delaware
WHP Junior Springing Member-2, Inc.		Delaware
WHP Manager-1, L.L.C.		Delaware
WHP Manager-3, L.L.C.		Delaware
WHP Mezz Borrower-1, L.L.C.		Delaware
WHP Mezz Borrower-2, L.L.C.		Delaware
WHP Springing Member-1, Inc.		Delaware
WHP Springing Member-2 Inc.		Delaware
WHP Springing Member-3, Inc.		Delaware
WHP Texas Beverage-1, Inc.		Texas
WHP Texas Beverage-2, Inc.		Texas

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

October 7, 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

October 7, 2004

Exhibit 99.3

I consent to the use of my name as a proposed Director in the “Management” section of Amendment No. 3 of the Registration Statement filed by Sunstone Hotel Investors, Inc. on Form S-11 and the related Prospectus and any amendments thereto.

Dated: September 23, 2004

/ S / L EW W OLFF

Lew Wolff

EXHIBIT 99.4

I consent to the use of my name as a proposed Director in the “Management Section” of the Registration Statement to be filed by Sunstone Hotel Investors, Inc. on Form S-11 and the related Prospectus and any amendments thereto.

Dated: October 5, 2004




		/s/ Z. J AMIE B EHAR
		Z. Jamie Behar

EXHIBIT 99.5

Dated: September 28, 2004

/s/ B ARBARA S. B ROWN

Barbara S. Brown

Exhibit 99.6

Dated: September 23, 2004

/s/ A NTHONY W. D ONA

Anthony W. Dona

Exhibit 99.7

Dated: September 23, 2004

/ S / D AVID M. S IEGEL

David M. Siegel

EXHIBIT 99.8

Dated: October 1, 2004

/s/ Keith Russell

Keith Russell